Small Businesses

The Engine of Growth

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June 11-12, 2012Sofia, Bulgaria

Giuseppe GramignaChief Economist

U.S. Small Business Administrationgiuseppe.gramigna@sba.gov

The statements, findings, conclusions, and recommendations found in this study are those of the author and do not necessarily reflect the views of the United States Small Business Administration, or the United States government

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Summary

1. The recent recovery has been slow. Current growth rates are below historical averages, resulting in levels far below “full capacity”. Does this mean that there is a new economic reality, i.e. a new level for the economy?

2. Two contradictory pictures of the Corporate Sector. Large Firms’ profits are at historical highs, but at mid cycle for Small Firms.

3. Small firms’ access to capital may be improving slightly, but lack of data makes it difficult to confirm.

4. The big SME policy issues.

5. The federal government support for small firms.

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Small Businesses in the U.S. Economy

1. Broadly classified as firms with 500 or less employees.

2. Represent 99.7% of all employer firms;

3. Employ just over half of all private sector employees;

4. Have generated 64% of net new jobs over the past 15 years;

5. Create more than half of the nonfarm private GDP;

6. Produce 13 times more patents per employee than large patenting firms.

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The economy: Actual vs. Potential Real GDP.(a)growth rates: below “normal”: Current 1.9% vs. Historical 3.4(b)Level: room for growth; Actual 95% vs. historical average 100%.

a

b

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•During the Great Recession (2008Q1 to 2009Q2) the contraction was centered around the private sector while the Government Sector expanded.

•During the recent recovery, the Private Sector expanded and the Government Sector contracted.

Government contractions are a big deal, and are associated with major structural changes in the economy.

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NFIB small firms’ Sales and Earnings are rebounding strongly, especially during 2012.

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Source: Bureau of Economic Analysis, National Income and Product Account , Federal Reserve Bank of St. Louis

Peak After Tax Corporate Profits as a percentage of GDP.Large firms’ exposure to foreign and commodity markets.

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Employment by firm size: Small firms got hit hard during this recession. Recovery is slow.

2008-09 Recession

2001Recession

Recovery

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Small Firms’ Capital Expenditure Plans have rebounded, but not as much as Sales and Earnings.

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Capital goods orders for the nation, have returned to pre-crisis levels.

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Credit Demand at small and large firms (a) FED: Rebounding from a typical cyclical decline. (b) NFIB: Still near the lowest levels in 25 years.

a

b

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Credit Supply: Small Loan Balances (and possibly originations) at Commercial Banks are still declining.

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SBA loan guarantees:(a)Dollar Value guarantees have returned to pre-recession levels;(b)Number of guarantees are still lagging.

a

b

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The big issues in SME: Job creationSmall firms vs. young firms

Assertions:1. “Small firms create 64% of net new jobs”;2. “Young firms create all the new jobs”;3. “High growth high impact firms create most new jobs”;4. “A small number (less than 1%) of big firms create 60% of net new

jobs and pay higher wages and benefits”

Policy implications: Target government assistance to1. All small firms who provide not only job creation, but income

distributions and foster greater competition;2. young, innovative firms that provide the greatest impact on future

job creation, and economic growth;3. to proven (incumbent) fast growing firms, but early in their growth

stage;4. Ibid.

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The big issues in SME: InnovationThe technological lifecycle vs. the firm lifecycle

Debate:1.1980’s: “The rate of technological change impacts economic growth.”2.1990s – 2000s: “Small, young firms, are the economic agents with the greatest propensity to introduce new technologies”

Policy Implications: Government can foster:1.Promising new technologies (basic R&D, financial, technical, tax)2.Entrepreneurship (training, social networks, legal, educational infrastructures

Hot topics:1.Young, innovative firms who are ideas rich, but collateral poor could benefit from their intangible assets (patents, Trade Marks, etc.) as the basis for intangible-based collateral.2.Social and technological networks foster informal knowledge “spill-over” as innovation rarely occurs in isolation, but is a highly interactive process, which increasingly involves collaboration by a diverse network of stakeholders, institutions and users.3.Faster technological innovation is often accompanied with a rising need for higher skilled labor force. SMEs are at a disadvantage at training their workforce.

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The big issues in SME: Access to financeBig vs. small; Credit Scores vs. Relationship Banking

Long-standing debate- The problem the Asymmetry of SME information.

1.“Larger financial institutions, through their Credit Scores, can better serve the financial needs of SMEs at a lower cost”2.“Smaller, financial institutions, with their better SMEs banking relationships are better suited to understand and provide for the financial needs of SMEs”

Policy Implications - Regulations should foster banking:1.Consolidation.2.Decentralization.

The 2008-2009 financial crisis:Disproportional impact on SME financing.Lack of data; question if it was due to a supply or demand issue.

Basel III: greater differentiation of financial assets and capital reserves.•SME loans 100% risk weight;•Loans to larger firms 20% risk weight;•SME loans with an 80% guarantees from AAA rated entity will l reduce the capital requirement form 100% to 20%;•Participation of SME in the credit decision making process: mutual guarantee and credit mediation schemes.

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The big issues in SME: Globalization and Demand PoliciesReducing barriers, rationalizing procurement, and collaborating with the private sector.

Globalization issues: 1.High entry barriers (mostly informational) create a comparative disadvantage for SMEs in accessing foreign markets;2.SME are rarely represented at international trade negotiations.

Policy implications: Governments can:1.Provide informational services and training for SMEs;2.Include SME issues in trade negotiations;3.Act as a catalyst in assisting SMEs in entering the Global Supply Chain.

Demand-side policies - Public procurement:The use of public procurement can stimulate entrepreneurship and innovation, create or enlarge markets, and thus influence production and consumption trends, all the while maintaining efficiency and competition objectives.

Policy implications: Governments can:1.Rationalize procurement practices to foster specific objectives;2.Collaborate with private sector to leverage assets, infrastructures, common commercial objectives.

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U.S. government actions: The Federal ReserveMonetary Policy: Conventional and non-conventional.

The Federal Reserve: Monetary Policy1.Drastically reduced short-term interest rates (traditional);2.Intervenes outside its traditional sphere of influence to ensure liquidity and price stability in the financial markets (non-traditional):

a) Extends direct-lending to Primary Dealers in Equity Markets;b) Directly purchases equities of trouble financial institutions;c) Guarantees assets of large financial institutions;d) Provides funding for the guarantees of large financial institutions (BofA and

Citi);e) Enhances liquidity in Asset Baked Markets;f) Swaps (sells) "safe" treasuries for less liquid assets;g) Purchases ABS of recent vintage;h) Enhances liquidity in the currency markets;i) Swaps U.S. dollars for other currencies with other central banks;j) Purchases long-term U.S. treasuries (AKA “Quantitative Easing”).

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1. Economic Stimulus Act of 2008: $152 billion to extend tax rebates to low and middle-income individuals, and for accelerated capital depreciation for small businesses.

2. Emergency Economic Stabilization Act of 2008: $700 billion to establish the Troubled Asset Relief Program (TARP) to assist financial institutions.

3. American Recovery and Reinvestment Act of 2009: $787 billion for tax cuts, social programs, infrastructure Investment, energy efficiencies and renewable energy investment, and small business related programs.

4. Small Business Jobs and Credit Act of 2010 creates a $30 billion small business lending fund, provides $12 billion in tax cuts to help small businesses, and provides $504 millions to SBA.

5. America Invest Act of 2011 revises patent laws from “first to invent” to “first to file”. The act simplifies and reduces the cost of patenting, provides for accelerated patent process.

6. Jumpstart Our Business Startup Act of 2012 (JOBS Act). Liberalizes small equity issuance by allowing SMEs to raise capital via the internet with minimal regulation (Crowdfunding). Increases the minimum issuance that requires SEC oversight form $5.0 Million/500 investors to $50.0 Million/2000 investors . Introduces Emerging Growth Companies.

U.S. government actions: Congress and the AdministrationFiscal Policy: Tax cuts, loan guarantees, transfers to persons.

Overview of SBA Programs

7(a) Loans

504 Loans

Microloans

SBICs (Investment Program)

The three Cs of SBA:

SBA supports small businesses through three major functions:

•Capital Access: credit & investment programs

•Contracting: increase access to federal procurement for small business

•Counseling: technical support through Small Business Development Centers, Women’s Business Centers, and SCORE chapters.)

Within Capital Access, SBA provides several core financing programs for small business

Product Type: Delivered through:

•Loan guarantees for new & existing businesses•Used for general business expenses•Up to $5 Million

•Nearly 5,000 banks and credit unions all across the country

•Long-term, fixed-rate financing (e.g. land, buildings, equipment)•Up to $5 or 5.5 Million

•+ 250 Community Development Corporations (CDCs)

•Smaller loans up to $50,000

•Over 170 non-profit intermediaries and CDFIs

•Debentures to support private equity capital, long-term, and debt-security investments

•300 Small Business Investment Co.’s•Privately owned and managed venture funds

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Increased fundingARRA of 2009: increased SBA funding by $680 million, which led to $30 billion in additional loan support.

Small Business Act of 2010: increased SBA funding by $505 million, which is led to $15 billion in additional loan support.

Program changes Increased guarantees from 75% to 90% [temporary];Reduced or eliminated fees [temporary] ;Increased loan limits [permanent]:

•7(a), and 504 Programs from $ 2 million to $5 or to $5.5 million; •Express Loans from $ 350,000 to $ 1 million;•Microloans from $35,000 to $50,000;Increased pricing flexibility : formerly only Prime +, now also Libor +.

Federal Stimulus: The SBA Component. Capital Access

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New Programs at SBA: Capital Access

New Programs Motor vehicle dealer floor provides financing for auto dealers’ inventories.

Export Assistance to increase small business exports.• Export Express is now permanent with a 90% guarantee for loans up to $350,000

and 75% for loans between $350,000 and $500,000;• A new $90 million program for export related grants to states over three years ;

504 Program changes:• Secondary market: Larger loan size requires distribution of risk;

• Refinancing: It is now possible to obtain a 504 guarantee for refinancing real estate and fixed asset loans. Strict eligibility requirements. Temporary, and with zero taxpayers subsidy.

Community Advantage Program: 75-85% loan guarantees available to “mission focused” financial institutions such as Certified Development Financial Institutions, Certified Development Companies, and Non-profit SBA Microlending Intermediaries.

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Tax benefits to increase investment and employment:Accelerated first year depreciation to 50% for 2008-20010 capital purchases.

Increased expensing limit from $133,000 to $250,000 (2008-2009) to $500,000 for 2010-2011.

100% exclusion on capital gains taxes for purchases of small businesses during 2009-2011.

$1,000 new employee tax credit.

Up to 35% tax credits toward employee healthcare premiums.

Up to $10,000 start-up costs deductibility

We have seen a noticeable rise in our equipment related loan guarantees from around 4% to 6.5% of our 7(a) program.

Government Intervention and The Small Business Component. Tax Benefits

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U.S. government actions: Innovation Linking and leveraging government and private assets.

1. National Innovation Marketplace. A web-based portal to connect technology requestors and potential suppliers.

2. National Network for Manufacturing Innovation creates a network industry, academic institutions, federal agencies, and states to provide shared assets to access cutting-edge capabilities to educate students and train workers in advanced manufacturing skills.

3. National Design Engineering and Manufacturing Consortium enables small and medium-sized manufacturers to develop and test their products using advanced modeling and simulation tools that have historically only been available to large companies.

4. Advanced Manufacturing Jobs and Innovation Accelerator Challenge, a cluster-based investments, bring together educational, research organizations, state and regional economic development authorities, and the private sector to conduct proof-of-concept and commercialization activities

5. ExporTech™ Program assists manufacturers in developing an international growth plan, by providing expert advisors and connects manufacturers with federal, state and local organizations to quicken export sales.

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U.S. government actions: Government Procurement Increased contracts to SMEs and reduced payment time

1. SBA is responsible for ensuring that 23% of all federal prime government contracts go to small businesses.

2. Since 2009, nearly $300 billions of federal prime contracts and $200 billions of subcontracts have gone to small businesses.

3. Reduced the payment time from 30 days to 15 days.

4. Established the Interagency Taskforce on Federal Contracting Opportunities for SME’s and minorities.