istory shows that small businesses are a key component of national recovery in economic downtimes. But in today’s sputtering job market, these traditional engines of growth and employment are limping along at best. Many small firms are handicapped by a new twist on an old parasitic business practice that large corporations are using in the wake of the 2008–09 financial crisis, one that has significantly reduced the cash available to small businesses to invest and hire new employees. By addressing this phenomenon in your State of the Union address, Mr. President, you could have a significant positive impact on America’s capacity to create new jobs, and show small business owners across America that you are on their side.
Let me explain. In previous recessions, small businesses across America came back to life first, leading the economy forward with new job creation. That has not been the case in 2010. Even as large corporations are starting to hire again, small firms are still shedding jobs. This is exceptionally bad news, since these businesses account for about half of all private-sector jobs in America, and more than 60 percent of the new jobs generated in the past decade. If small firms aren’t creating jobs, the nation’s unemployment rate will remain stubbornly high. Perhaps high enough to cost you reelection in 2012.
Recent surveys by the Small Business Administration and private entities have shown that even as big corporations have amassed huge profits and cash reserves, small businesses are having trouble paying bills on time, managing their cash flows, and maintaining sufficient financing to invest in themselves. A PNC Bank survey showed in late 2010 that even as small business owners nationwide are beginning to increase capital spending, 60 percent are still delaying hiring as their concerns linger about the economy and the burdens they face. In my own work as head of a small private-equity firm that invests in small businesses in all regions of the country, I see the reality of such statistics every day.
Why are big firms cash rich and thriving while small firms are cash poor and struggling even in a recovering economy? As is well understood, one major reason is that banks have scaled back small business lending. You’ve tried, Mr. President, to get credit flowing to entrepreneurs with the Small Business Jobs Act, which will offer billions of dollars in loan enhancements and other help. Unfortunately, such measures are likely to be undercut by a whole variety of barriers that confront small businesses in the new economy. For retail businesses, and those linked to real estate and construction, weak demand tied to unemployment and depressed housing prices will no doubt linger. But for millions of small businesses that supply billions of dollars of goods and services to America’s largest corporations—business-to-business or B2B sales, as they are known—another insidious trend over the past two years has cropped up that further undermines small business’s ability to invest in new job creation.
The trend has to do with cash flow. In bad times, all companies, big and small, seek to husband their cash by collecting their accounts receivable as fast as possible and honoring their accounts payable as slowly as possible. What is different in this downturn is that, thanks to structural changes in industry supply chains, large firms now have vastly more clout to engage in such behavior than small ones do. In fact, many large companies today have simply announced that as a matter of policy they will be paying their bills late—sometimes as much as four months late. This in effect forces small businesses, which really are hurting, to make free loans to big businesses instead of being able to use their working capital. As the CFO of one small business that we invested in says about his company’s subcontract work with big aerospace companies, “They basically have their whole supply chain of businesses like us helping to finance their business.” His company was told recently that for any new work from its largest customer, they will have to wait ninety days rather than the customary thirty days to be paid. What is interesting about this phenomenon is that America’s large corporations don’t generally need this money—statistics show that they are sitting on nearly $2 trillion of idle capital on their balance sheets.
This past November, the Washington Monthly spoke with more than a dozen Inc. 500 companies, and the majority reported experiencing extended payment terms. Indeed, as we dug into the matter, we found more and more evidence that the practice of unilaterally changing the terms of trade is widespread in corporate America.
Take Cisco Systems, Inc., one of the world’s largest technology companies. Cisco has seen its net earnings increase by 26.6 percent, from $6.1 to $7.8 billion in the last year. Yet effective March 31, 2010, Cisco announced to its small business suppliers that as a rule Cisco would wait sixty days after receipt of an invoice—or net 60, in business jargon—before cutting a check. The reason Cisco gave for this new policy was not that it was hard up: the company has nearly $39 billion of cash on its balance sheet, and in the third quarter of 2010 alone it spent $2.7 billion to repurchase its own shares. Rather, the corporation explained that it had been “benchmarking against our technology peers” and found a precedent for “new payment terms.” In other words: Everyone is doing it, so we are too.
It appears that large institutions in the nonprofit sector have also followed suit, taking advantage of their small suppliers. Boston University, for example, recently enacted a net 60 policy, giving the same justification as Cisco: It’s become an industry norm.
Another high-profile example in the corporate world is AB InBev, the Belgian-based conglomerate that bought out Anheuser-Busch in 2008, gaining control of nearly half the beer market in the United States. AB InBev has been forcing many of its suppliers, notably advertising agencies, to go as long as four months, or net 120, before getting compensated. As a column in the trade journal Advertising Age complained, “By forcing other companies to finance its operations, InBev is tying up capital that doesn’t belong to it. That hinders those companies’ ability to invest in innovation—not to mention meet their monthly payrolls. InBev is stealing their futures, plain and simple. And in plain sight.”
Just so. Mr. President, as far as I can tell, our government’s statistical agencies don’t have a handle on the extent of this problem, but if you spend some time with small business people you’ll realize it’s very big. And it damages the whole economy. While large companies sit on mountains of cash, small businesses struggle to maintain lines of working capital, to pay their creditors in thirty days, and to meet payroll every two weeks—all while waiting two months or more after sending out an invoice to get paid themselves. Multiply this by millions of small firms and you have another piece of the missing-jobs puzzle.
Of course, there are other reasons small businesses aren’t hiring. Demand is still weak, and an increase in federal regulations isn’t helping matters. But it’s important to recognize that government regulation is only one weight on the small business sector. Just as significant is the manner in which big business has systematically passed its pain down the chain to squeeze small business profits and cash flow—our day-to-day lifeblood. We in the small business sector need your help, Mr. President, to set rules of the game that are fair and reasonable.
What can you do? First, in your State of the Union address, you can call attention to this trend as an unfair business practice, and you could ask the Office of Advocacy in the Small Business Administration to research how widespread it has become. Second, you can take a simple but meaningful unilateral action: issue an executive order mandating that all companies with federal contracts pay their suppliers within thirty days of invoice. Net 30 has long been the policy of the federal government itself in paying contractors. Virtually all major corporations today are in some way federal contractors, and they should be held to the same terms that they enjoy in their dealings with the federal government. Such an order would cost the government no money. But it would make cash flow faster down the value chain to small business suppliers across the economy, and this could free up more capital for job creation. And the symbolism of a president willing to stand up for the little guy being squeezed by big corporate America would be worth its weight in political gold!
However we might try to stimulate the economy, it will do little good if so much of the money winds up financing de facto loans from struggling small businesses to powerful big ones. Address this problem and you’ll prove to every small business in America that you get it—and that you’re on our side.
Jeffrey Leonard is CEO of the Global Environment Fund, a growth-capital-oriented investment firm, and chairman of the Washington Monthly board of directors. He is the author of five books and numerous articles on issues relating to energy, the environment, and economics.