Undercapitalization is one of the primary drivers of the high failure rates for small businesses. Of all the impacts the recession has had on small business, the magnification of this particular issue is the greatest. Of course, sufficient capitalization by itself does not guarantee success nor does undercapitalization guarantee failure. However, what a business gets with sufficient capitalization is room…room to experiment, room for the economy to slow and, most importantly, room to make mistakes. No business executes flawlessly, and the amount of operating capital that a business has access to dictates how close to flawless they have to execute in order to ‘make it’. The more cash (or credit) a business has, the further from the path of perfection they can explore and still find success. This path to success has been further muddied for small business by two simultaneous and dramatic impacts on operating capital:
- Reduction in customer spending (less cash in the door)
- Reduction in lending (less access to cash through borrowing)
This means the small business segment, already undercapitalized in many instances, is seeing its position further weakened. The result? Increased bankruptcies and continued job cuts. In fact, businesses with less than 50 employees cut 68,000 jobs in November (according to ADP and CNN). This represents 40% of the 169,000 total private sector job cuts that ADP reported (PDF) for November. Looking for a bright spot? How about this: according to the same report small businesses with less than 50 employees account for 44% of total employment, so the 40% number represents a contraction rate slower than businesses with 50 or more employees. A stretch? Yeah, a bit…but still something to consider as I believe it will be the small and local businesses that lead out us of the recession.