The Impact of Politics on Small and Mid-Sized Business

 

Changes in tax and business regulations that occur due to the political climate at any given time can have a huge impact on businesses and can even be the difference between their success or failure.

Because small and mid-sized business are in the front lines of commerce, they’re also among the first in the economy to feel the effects of delayed growth or public policy that’s unfavorable to business owners.

This requires business owners to be keenly aware of how the laws legislators pass will affect them, and it’s also why it’s important for them to be politically active for candidates who are aware of and prioritize the needs of small businesses.

 

SHARING POLITICAL ASSOCIATIONS …

However, it’s often best for business owners to keep their political associations private rather than share them on behalf of the business – especially if those political views are particularly alienating to customers.

It’s not uncommon for consumers to take issue with businesses who are openly supportive of political candidates or stances they disagree with, which could cause some customers to become biased against your company and even leave you bad reviews online.

This could negatively impact a business as 88 percent of consumers are influenced by online reviews.  Instead of openly criticizing political decisions that are affecting a business, try to be diplomatic about current events if speaking as the business owner.

 

 

A SHARP DRAWBACK …

Due to political prospective in financial institutions, smaller businesses reported that major sources of credit including credit cards and bank loans drew back sharply last quarter, according to results from the Q3 Private Capital Access Index (PCA Index) from Dun & Bradstreet and Pepperdine Graziadio Business School.

More businesses reported they were unable to secure credit from 14 of 17 lending categories measured including bank loans, credit cards (personal and business), and credit unions.

The number of businesses that were able to secure a loan from a traditional bank declined 41.5% quarter over quarter, with 31% of businesses reporting that they were successful securing a bank loan as a source of funding compared to 53% the previous quarter.

Trade credit – a common lending practice in which businesses agree to exchange goods without paying cash up front and the supplier is paid at a later scheduled date – also dropped significantly from 65% of business reporting success in Q2 to 43% reporting success in Q3.

Successful loans from credit unions also dropped 39.2% from 51% of businesses reporting financing success in Q2 to 31% reporting success in Q3 2019.

 

DECREASES WITH FIRM SIZE …

The variance of both profitability and growth decreases with firm size.

The second key source of divergence is that smaller enterprises have a lower probability of survival than larger enterprises. 

In a normally functioning financial market, some of these differences should be reflected in higher interest rates or less favorable terms of debt financing.

This general observation, as well as the following points, should be considered in the design of policy responses to the needs of Small and Medium Sized Enterprises (SMEs).

> Financial institutions assess smaller and medium enterprises as being inherently riskier.

> Larger firms usually comply with higher disclosure requirements to a greater extent than SMEs because of their access to a broad range of external funds (including bonds, equity and loans). Financial institutions charge higher interest rates to SMEs than to bigger companies in order to compensate for the higher costs of information collection, the smaller volume of external financing and the greater risk of failure.

> For many existing SMEs “insiders” (the entrepreneur, management) have better information about the expected profits of activities than external financial institutions. This lack of information leads to higher market rates to compensate for risk which may crowd out low risk, low-return borrowers, leaving a relatively higher number of high risk/return borrowers in the market. Charging higher interest rates may therefore not be in the interest of banks as low-risk borrowers — those most likely to repay loans — are driven from the market.

>  In the case of new enterprises or activities, outsiders (experienced bankers or other specialized financial intermediaries) can, in many cases, better assess the risks involved than relatively inexperienced “insiders”.  A specific disadvantage of young firms is that they cannot point to credit histories which provide important signals and help facilitate access to debt financing.

> Lending to SMEs is more likely to be based on collateral than is the case for loans to larger firms. This may lead to situations in which lending is not based on expected return but rather upon access to collateral. On the other hand, collateral reduces or eliminates contract problems such as “moral hazard” and “adverse selection”. Many SMEs lacking access to “good collateral” suffer from credit rationing.

 

WHEN YOU NEED FINANCING …

Uncertain regulations, changing tariffs, shifting environmental regulations and employment rules and new tax laws, all combine to have impact on small and mid-sized businesses.

And, as demonstrated above, where all of these uncertainties come together is when businesses need to obtain financing.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Bankruptcy Help May Be On The Way

 

In a recent blog, we wrote about the high cost of Chapter 11 bankruptcy for small and mid-sized companies (SME).

As we talk with owners and managers of troubled companies, we often hear: “If I can’t work things out, I’ll just declare bankruptcy.”

By bankruptcy, they mean Chapter 11, which allows the debtor to reorganize the company by submitting a plan of reorganization that is acceptable to the creditors and approved by the bankruptcy court.

While Chapter 11 reorganization for a smaller or mid-sized company won’t approach the staggering number of a large company, it is still extremely expensive relative to the size of the business.

 

 

It’s Very Expensive …

The reason a Chapter 11 bankruptcy is so expensive is because it involves two separate elements:
1. a reorganization plan and
2. a debt repayment plan.

The reorganization plan has to convince the court and your creditors that the business can make a profit in the near future. This plan must be supported by reliable data.

Then you have to show a budget where you outline how you can repay your creditors over the next several years.  And then you will have to negotiate the terms of the plan with the court and your creditors. 

While that is going on, your budget has to allow for the payment of your attorney’s fees, your creditors attorney’s fees and for financial advisors on both sides.

 

Success Rates Are Very Low …

The success rate in Chapter 11 bankruptcies is extremely low, meaning that a very low percentage of reorganization plans actually obtain court approval.  Depending on size and financial capability, experts put the number between 20 and 30 percent.  Thus there is a high chance that the company will spend a lot of money putting together the plan and attempting to persuade the court, but fail to do so and end up in Chapter 7 liquidation.

But it appears that help may be on the way. Proposed changes to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) offer significant help for Small and Mid-Sized Enterprises (SME) seeking protection in Bankruptcy.

In the proposed changes, a company is considered an SME if:

1. No publicly traded securities were included in its capital structure or in the capital structure of any affiliated debtor whose cases are being jointly administered with the debtors case.

2. It had less than $10 million in assets or liabilities on a consolidated basis with any debtor or non-debtor affiliate as of the petition date.

3. If a debtor met the above requirements, but had between $10 and $50 million in assets, the company could request that the SME rules apply.

 

What’s The Advantage?

So, what is the advantage to the proposed SME rules?  An SME would have the opportunity to avoid one of the largest costs of a Chapter 11, namely a committee of creditors along with all of the legal and advisory costs that go along with that.

Specifically, unless the court, after a motion from an unsecured creditor that a creditors committee was necessary to protect the interests of unsecured creditors, the default rule for SME’s would be that no creditors committee would be appointed.

A debtor or party in interest could still request the appointment of an estate neutral individual to advise the debtor in possession (DIP) on operation and financial matters and in the negotiation of a plan of reorganization. This individual would be paid by the estate and represent the estate’s interest. This would provide for a much lower cost than the adversarial relationship that exists in the Bankruptcy Code today.

 

One Of The Most Interesting Aspects … 

One of the most interesting aspects of the proposed changes is the ability for SME equity to retain a substantial stake in the debtor under a plan. The proposal envisions an amendment to the Absolute Priority rule in Section 1129 of the Bankruptcy Code to allow existing equity to maintain 100% voting control of the debtor when it emerges from bankruptcy subject to 85% of the rights to receive economic distributions being vested in creditors.

While it is unclear if these proposals will become law in their present form, the intent is to make Chapter 11 less costly and more effective for small to mid-sized companies. 

 

Important To Note That …

It is important to note that even if these changes are accepted, they do not affect secured debt and unsecured creditors can and may object to a plan individually.  With enough objections, a plan may not be approved by the court.

Even with reduced costs, bankruptcy remains expensive and it is always beneficial for companies to deal with problems proactively to avoid the expense and risk of the proceedings.

As this is our last blog of 2015, we thank all of you who read and comment on our writing and want to wish you, family and friends the very best of the Holiday Season.

We look forward to having more to say in the coming year.