Credit is the amount of capital you can access against future earnings or existing assets. For business, credit is like food for the corporate soul. Without credit, most corporations would cease to exist. A company needs credit to fund payroll, manage operating costs, maintain product and service lines, and bridge the gap between sales and receivables. If a company creates new products, it may need to raise capital for research and development and marketing the product to consumers. It may also need expansion capital to build new facilities and infrastructure and hire new employees.
In the corporate world, this is called corporate finance. A publicly traded company can raise capital by issuing stock and selling shares or by creating fixed income securities (aka bonds). Entire industries are built around securities. Investment banking raises capital for corporations by issuing bonds against future earnings and taking a fee for their services. Short-term financing can help cover working capital costs, while longer-term capital in the form of bonds can defer the costs of acquisitions and R&D. Essentially this means that corporations with bonds outstanding are commonly leveraged – aka “in debt” in order to stay afloat.
Large corporations can easily obscure their liabilities by moving debt “off the balance sheet” and into SPV’s (special purpose vehicles: i.e. Citigroup, Bank of America, Countrywide Financial, Washington Mutual), inflate profits and fake earnings (i.e. Enron), and hide leverage positions (i.e. Lehman Brothers, Bear Stearns). To determine real company value, an investment bank, ratings agency, and accounting firm with vested interest in fee-based valuation is only as good as its talent, reputation, and ethical standards (cite Arthur Anderson, Merrill Lynch, Goldman Sachs, Standard & Poor’s).
The old adage that “it takes money to make money” sums up the business of corporate credit. Credit is also necessary when earnings projections are poor. A distressed economy pushed corporate America to high levels of borrowing and bond issuance to weather the financial storm throughout 2009 and 2010. Investment banks and large financial institutions received vital credit lifelines to provide this financing from the Federal Reserve and US Treasury during the financial crisis. This arrangement continues today through the Fed Discount Window, Quantitative Easing, and other federal credit-based programs. The reason the Fed does this is simple: our economy is based on credit, therefore if credit dries up as it did in October 2008, our economy would cease to function.
Does Big B need credit more than Small B?
So why is access to credit good for the goose (Corporate America) and not for the gander (Small Business America) according to big business advocates like Forbes Magazine?
According to Forbes, unlike like large private and public companies, small businesses don’t need credit to operate. The Forbes claim is based on a “survey of small businesses” by the National Federation of Independent Businesses (NFIB).
Contrary to what we are told seemingly every day, the lack of growth in small businesses is not due to a lack of credit. The same NFIB survey showed that 22% of small businesses report their credit needs are fully met, and 52% report they don’t want or need any credit at all. Add to this the 12% that did not answer this set of questions, and a full 86% of small businesses are not expressing concerns over borrowing. Their main concern is much easier to identify, but much harder to fix – fewer clients.
(Note: no link or criteria for the survey can be found in the Forbes article or elsewhere.)
Growing Your Small Business
As small business veterans ourselves at Good-b, we understand that small-b’s need credit to survive just like their big brothers and sisters. We too, need cash to make payroll, manage operating costs, weather financial storms, and bring new products to market. If small business has few customers or clients, just like the big guys, it needs access to credit all the more. Credit allows a small business to innovate new products and services and promote them in the marketplace. If nobody knows about the product, how small-b’s reach new customers?
The truth is that every big-b was a small-b at one time. A good revenue model and product can catapult a small-b to become a global corporation. Yet credit, resourcefulness, and luck all contribute to corporate success. Where would Bank of America be without credit? Who would ever had heard of Hewlett Packard if its founders couldn’t get a loan to move out of the garage?
Three of the biggest businesses of our time: Twitter, Facebook, Google were launched and operated for a few years without a saleable product or revenue model. To remain operational, they received oodles of cash to promote their services and develop a loyal customer base. To this day, do you know what Twitter sells? How many of you have ever spent a dime on Facebook products? Google is a household word, but have you ever paid for a search?
Groupon is one of the most popular names in business today, yet despite being four years old and post-IPO, the billion-dollar company doesn’t have net revenues. In fact, according to most sources, Groupon, the Deal of the Day King, operates a few hundred million dollars in the red. So how do they keep going? Credit, stocks, bonds…i.e. other people’s money! The hope is that the company, like Google and Facebook will figure out a way to be profitable. In the meantime, they rely on credit to keep going. Without it, Groupon has little chance to survive.
So what does all this mean for small business? It means that contrary to the Forbes report, small business like its bigger counterparts needs access to credit to not only survive, but thrive.
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