Despite headwinds, the outlook for small businesses is bright


Originally published in American City Business Journals

By Mark Abell

As the Trump administration focuses on promoting small businesses and reducing small business effective tax rates, 2018 looks set to be another great year for this vital part of the American economy.

However, while economic and credit conditions favor strong business growth, there are some headwinds that could make expansion difficult for some businesses.

Small business optimism has spiked since the election of Donald Trump and has risen steadily since, according to the NFIB Index of Small Business Optimism, driven by expectations of a strong economy and rising incomes, lower taxes, strong consumer sentiment, and rising home prices as well as a surge in construction activity after a tough hurricane season.

At the same time, credit should remain readily accessible to businesses as banks continue to lend amid growing profits. Fiscal 2017, which ended in September, was a record year for small business lending. The U.S. Small Business Administration backed $25.44 billion of its 7(a) loans, its main lending program for starting or expanding a business. It funded another $5 billion of its 504 loans, typically used to finance owner-occupied real estate projects.

There is every reason to expect that lending could be even more robust in 2018: The SBA currently has a $27 billion cap for 7(a) loans under a congressional continuing resolution for 2018 and is seeking to increase this to $29.5 billion through legislation — a clear indication that SBA expects to guarantee even more credit in the coming year.

Signs of economic stress

The new year won’t all be smooth sailing, however. With the economic expansion set to notch its ninth birthday in June, signs of economic stress are starting to appear.

After a busy hurricane season, raw material prices are rising, particularly for construction materials and wages. Labor shortages could be a particular headache for the year ahead as the unemployment rate hovers at about 4 percent — a level that equates to full employment.

Nowhere is that more evident than in the construction sector, where labor is now stretched to the limit. Many subcontractors are simply unable to find suitable workers to add to payrolls. The end result is a stretching of the time needed to complete construction projects, dampening prospects for those firms seeking to expand into new or additional locations.

As the shortage of labor persists, the overall costs of construction projects are rising, too, crimping profits. The general pool of labor needed in low-wage roles, everything from restaurants and retail stores, is also tapped out, making it hard to expand through growth without offering higher wages.

Companies that require specialized staff to expand (for example, manufacturing companies seeking engineers and technicians to program and operate robotic machinery) are finding it harder to source experienced staff. In the year ahead, such firms may have to offer higher compensation to fill critical roles that demand experienced staff while filling out their payroll with a greater number of younger staff with fewer years of on-the-job experience.

A seller’s market

For business owners interested in selling their businesses, the coming year could be a great time to sell, doing so before the economic expansion finally runs its course. Most businesses have several years of strong profits and cash flow, which should allow businesses to command strong sales prices.

Although the Federal Reserve raised its benchmark interest rate by 25 basis points in December and is expected to increase rates another three times in 2018, overall interest rates remain comparatively low, making now a good time for buyers to finance acquisitions.

While most experts expect merger and acquisition activity to remain strong in the coming year as a result of the above factors, there are early signs the business acquisition market may be at a plateau. The 2017 Buyer-Seller Confidence Index, conducted by BizBuySell, reveals that with the stock market buoyant and the economy strong, buyers believe that small business owners are setting their asking prices too high when selling up: More than 55 percent of buyers believe currently for-sale businesses are overvalued, while only 4 percent see them as undervalued.

Financing challenges

Meanwhile, some of the rules of small business lending changed on January 1, when the SBA tightened some underwriting practices to ensure that SBA-backed loans have sufficient equity. Today, people seeking SBA financing to purchase or start a business will need a minimum of 10 percent of the total project costs in equity to meet the new rules.

For business acquisitions, SBA rules that allowed certain types of seller financing to count as part of the buyer’s equity have been further tightened, and only seller notes that have no payments for the term of the SBA loan will meet the new requirements. Also, the buyer will need to contribute at least half of the required equity.

Historically, underwriters found creative ways of working around the minimum equity rules (especially for professional practices like dentists and doctors or companies that sold to their employees), but this will be harder to accomplish in 2018.

Still, for high-value firms and select franchises, it will be a little easier to get a loan in 2018. A company selling at a price point that exceeds the value of its assets by $500,000 or more (i.e. having an intangible value of $500,000 or greater) previously required a total of 25 percent or more in equity in order to qualify for streamlined delegated underwriting and approval.

Under the new rules, a company will only need 10 percent equity to meet the minimum equity requirements. For those seeking to purchase or start a franchise, the SBA has dramatically simplified its process for approving these loans, as it will maintain a directory of approved franchises that meet their requirements, eliminating much of the work previously required to qualify.

While small businesses do face headwinds, absent an unforeseen catastrophe, the current expansion should continue unabated in the coming year. On balance, 2018 looks like an extremely positive year for small businesses.

Mark Abell is senior vice president and SBA division director at NBH Bank, Member FDIC, Equal Housing Lender.