How to buy insurance for a business so financial disaster doesn’t strike

Many Main Street businesses could be playing with fire — literally — by not maintaining appropriate levels of business insurance coverage, especially given the spate of natural disasters affecting multiple areas of the U.S.

Skimping on property damage and business interruption coverage is understandable to some extent, given the cost. While the price of a business owner’s policy — designed for small businesses in low-risk industries — varies based on a variety of underwriting factors and optional coverages selected, generally speaking, a small business owner might pay somewhere between $500 and $3,500 per year for this type of policy, according to Pogo, which helps owners find insurance.

But pinching pennies can be foolhardy as climate change continues to impact the severity of weather-related events. As of Sept. 11, there had been 23 confirmed weather/climate disaster events this year with losses exceeding $1 billion each in the U.S., according to The National Centers for Environmental Information, which was above both the long-term and five-year annual averages. These events included two flooding events, 18 severe storm events, one tropical cyclone event, one wildfire event, and one winter storm event. 

Hurricanes don’t just happen in Florida and tornadoes don’t just touch down in Kansas, said John Hyland, who leads the Sentry Insurance unit that providers business insurance solutions. Especially with weather patterns changing, a natural disaster is “coming to your neighborhood more and more often,” he said. 

Consider Friday’s flash floods in New York as an example of this new reality.

Here’s what small businesses need to know about business insurance amid climate change:

Understand property damage exclusions and deductibles — the fine print matters more than ever.

There’s often a big disconnect between coverage business owners think they are getting and what they actually are getting, said Hubert Klein, partner and practice leader for the Financial Advisory Services Group at EisnerAmper. They should press for greater detail with insurance agents and know, for instance, what property damage is covered and what exclusions may apply. They should also know what their deductible is and when coverage kicks in. It’s also important to understand whether the policy covers the full cost of replacement cost and what limitations apply.

Owners also have to understand the nuances of business interruption coverage, which can include waiting periods, co-insurance requirements and provisions for civil authority bans, when certain areas are declared inaccessible after a disaster. 

The fine print matters, Klein said. He offers the example of a business with multiple locations and roughly $20 million of coverage. If there’s a $1.5 million per-location limit and the business suffers extensive damage to multiple facilities, the business may not be adequately covered. By contrast, a policy that has a blanket limit might be more favorable, even with a slightly lower limit overall, Klein said.

Don’t rely on a policy’s ‘summary’ info or opt for lower cost without a thorough understanding of coverages.

Many small businesses chase prices without understanding what they are giving up, Klein said. At renewal time, they may get sticker shock and ask for a premium reduction, but they don’t always understand there are trade-offs for a $300 or $3,000 policy reduction, he said. He recommends owners read their policy carefully, not relying solely on the summary of costs or summary of coverages. 

Run through likely weather scenarios and don’t expect to ‘beat the storm.’

To ensure they are appropriately covered, owners should perform a thorough evaluation of what could go wrong with respect to their business property, whether that’s fire, flood, hurricane or something else. This analysis should take into account how much cash the business owner has on hand in the event of a disaster.

Owners “tend to think they can outsmart the weatherman or beat the storm,” Klein said. 

Even businesses that aren’t directly affected by disasters can face unexpected issues. In the aftermath of Superstorm Sandy, for example, some businesses didn’t have direct damage to their facilities, but utility company issues left them without power for weeks, Hyland said. Businesses that were properly covered for this type of occurrence had a source of revenue to continue paying their employees and the other expenses, he said.

Decisions related to specific coverage, endorsements and deductibles will vary based on a particular business’s needs, but it’s important to understand the various exposures, Hyland said. Even if businesses decide not to purchase particular coverages, they shouldn’t be oblivious to the potential exposure, he said.

Conduct an annual review and include inflation in business valuation and property replacement cost estimates.

Inflation makes the cost of replacing property more expensive, and the coverage you planned for three years ago may no longer be appropriate given a changed price environment. Yet many businesses don’t re-evaluate their insurance needs and coverage yearly, Klein said. 

Most business policies build in inflation-adjustments, but they often aren’t enough to keep up with real-world scenarios such as supply issues, significantly higher labor costs and longer completion times, said Nancy Germond, executive director of risk management and education at The Independent Insurance Agents & Brokers of America.

Check if more emergency cash might be required in your geographic market.

In certain areas of the country, the deductible for perils related to fire, wind and hail are higher than deductibles for other covered events, said Jen Tadin, managing director of the global small business practice at Gallagher, an insurance brokerage and risk management consultant. Especially in riskier markets, business owners may have to keep more cash on hand than say 30 or even 45 days, especially when there are higher deductibles to consider. “We can’t change the fact that in Florida, you’ll have a higher deductible. But you have to plan for it,” Tadin said.

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Small business confidence is tanking again, especially when it comes to banks and Biden

As President Biden begins to more forcefully build a reelection case citing Bidenomics, Wall Street forecasts and actual GDP data are supportive, as are recent improving sentiment scores from consumers and CEOs. But on Main Street, small business owners remain a difficult group for Biden to win over.

Small business confidence is back at an all-time low, according to the just-released CNBC|SurveyMonkey Small Business Survey for the third quarter. That’s nothing new for Biden, as small business confidence has hung around a low throughout his presidency. In fact, the latest decline in the confidence index to a score of 42 out of 100 matches the all-time low from exactly one year ago.

With a business owner demographic that skews conservative, the twin economic issues of inflation and rising interest rates have compounded the general concerns about a Democratic administration. But at a time when signs are pointing to progress in the fight against inflation and a potential though by no means certain end to Federal Reserve interest rate hikes, the Q3 data presents more specific — and potentially more troubling — concerns for the president.

Even with a resilient economy, with interest rates at a multi-decade high, the number of small business owners who say they can easily access the capital needed to operate their firms continues to decline, now at under half (48%) versus 53% last quarter. This should not come as a surprise, as higher interest rates make banks stricter when it comes to lending requirements, a dynamic that tends to disproportionately punish small businesses, and linger or even intensify the longer a higher rate environment persists. Even for businesses that can secure loans, double-digit percentage rates are a cash flow challenge.

Data released on Monday from small business trade group NFIB reported similar difficulty among business owners attempting to access capital, with over half (58%) who borrowed or tried to borrow reporting high interest rates as their biggest complaint, and 40% of owners saying interest rates were a significant issue in the ability to access capital.

Wall Street banks and Main Street lending

The latest monthly report from alternative lending firm Biz2Credit from earlier this month shows small business loan approval percentages at banks with over $10 billion in assets at 13.3% in July, an approval rate that has been falling steadily and, pre-pandemic, had been as high as 28.3% in February 2020.

Rohit Arora, CEO of Biz2Credit, noted in a release on his firm’s data that as regulators raise capital requirements at some large banks in the years ahead, steps being taken today to prepare include more hesitancy to lend to smaller companies, since these loans can often range from five to seven years in term length.

Beyond recent concerns about the stability of regional banks, rating agencies say that even the largest Wall Street banks are on downgrade watch, not a situation in which banks are likely to be more accommodating to the capital needs of small firms, and in fact, the CNBC|SurveyMonkey data recorded a sharp drop in financial system confidence among business owners who work with large banks.

When it comes to accessing capital, small firms that hold accounts with large banks recorded the largest drop quarter-over-quarter, a 10% decline, from 59% saying it was easy for them to access business capital down to just 49% now. That was a much larger decline than among business owners who bank with a regional bank (down 2% quarter over quarter) and those who work with a community bank (down 4%). The largest group of small businesses (41%) conduct their business with large banks.

SurveyMonkey’s analysis of the data pointed to a gap between business owners who express confidence and a lack of confidence in banks that has widened from just 1 percentage point in Q2 (49% confident, 50% not confident) to 9 points now (45% confident, 54% not confident) this quarter.

“These data are a good reminder that the general economy for small business owners can often be very different from the economy that consumers on one side or large corporations on the other are experiencing,” said Laura Wronski, research science manager at SurveyMonkey.

The CNBC|SurveyMonkey Small Business Survey was conducted among over 2,000 small business owners across the U.S. between August 7-August 14.

While concerns across the economy about the banking crisis have lessened since the last quarter, that is not reflected in the conditions that small businesses are facing.

“Banking concerns have become even more top-of-mind for small business owners now, with their confidence in the U.S. banking system weakening and their ability to access needed capital hampered,” Wronski said.

Biden’s business supporters are increasingly negative

The CNBC|SurveyMonkey quarterly confidence index includes a series of core sentiment indicators related to policy that contributed to the decline back to the all-time low, with more small business owners saying they expect immigration policy and tax policy to be a negative. 

That’s notable, according to SurveyMonkey analysis of the results, with these index components that had the largest drag on the overall scores not those tied to hiring or economic conditions, but “two factors that fall squarely within the remit of the president and Congress.”

Business owner expectations for revenue and hiring were largely unchanged, and the percentage that describe economic conditions as “good” changed only slightly, from 40% to 38%. More describe conditions as “middling,” up from 43% to 46% this quarter. But only 15% describe business conditions as “bad.”

“Small business owners seem to be more heavily factoring the political environment into their confidence estimations than the economic environment. The economy has shown promising growth over the last quarter, with fewer concerns about a recession economy-wide now and less immediate threat from a banking crisis,” Wronski said.

In the confidence index scoring, rather than broader survey questions, there was a notable drop for Biden. According to SurveyMonkey, overall approval of the president now matches the same level as Q3 2022 survey, with 31% saying they approve and 68% saying they disapprove of the way Joe Biden is handling his job as president. The small business survey data matches the overall trend in the recent FiveThirtyEight polling average.

But Wronski said, “What’s really surprising is that general confidence among small business owners is falling now for the first time among Biden’s supporters.”

With the overall confidence index back at the all-time low of 42, the gap in confidence index scoring specifically between Biden’s supporters and his detractors is now a record-low 18 points, according to SurveyMonkey (55 versus 37). Among survey respondents who identify as Democrats, the quarterly confidence score declined from 58 to 52, the lowest it has been since Biden became president. Among independents, the decline was from 49 to 42, the lowest it has been among these respondents since the first quarter of 2021. Republican confidence moved the least, declining from a score of 39 to 37.

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The IRS is cracking down on a popular small business tax break that could lead to a costly audit

A cottage industry of specialist firms has sprung up to help business owners claim the Employee Retention Credit (ERC), a governmental tax incentive intended for companies stressed by the pandemic. But businesses need to be careful not to get hoodwinked. 

There are strict eligibility requirements for the ERC — one way it can be claimed is for wages paid during pandemic periods when gross receipts declined — and many owners may not really understand the criteria. This means they could inadvertently gloss over the opportunity and lose out on credit of up to $26,000 per employee. Or, they could easily be duped by dodgy providers into improperly seeking money they aren’t entitled to — with a hefty fee attached, of course — and likely ramifications down the road.

The problem is particularly pervasive given how easy it is to file for the credit and dupe small businesses in the process, said Donald N. Hoffman, a partner with Eisner Advisory Group. “Every business owner is getting dozens of emails and mail and being bombarded by television ads,” he said.

To be sure, the IRS warned business owners last October to be on the lookout for third parties promoting improper ERC claims. It renewed that warning in March of this year given what it said in a release “continue to be promoters who aggressively mislead people and businesses into thinking they can claim these credits.”

The IRS went so far as to add fraudulent claims involving the ERC to its annual “Dirty Dozen” list of tax scams. 

“The aggressive marketing of these credits is deeply troubling and a major concern,” said IRS Commissioner Danny Werfel in a release. “There are very specific guidelines around these pandemic-era credits; they are not available to just anyone.” 

These promotions may rely on inaccurate information about eligibility or how the credit is calculated, the IRS said. What’s more, some of these advertisements are designed to collect a taxpayer’s sensitive information, which is then used for identity theft purposes, the IRS said.

Here are important things owners need to know about the ERC to avoid issues, including in the worst-case scenario, an audit.

Start by understanding the basic ERC claim requirements

Start by knowing the basics so you can understand whether your business may qualify for a credit.

Eligible taxpayers can claim the ERC on an original or amended employment tax return for qualified wages paid between March 13, 2020, and Dec. 31, 2021, according to the IRS. Businesses can be eligible if they sustained a full or partial suspension of operations due to a pandemic-related government-ordered shutdown during applicable time periods. A business can also be eligible if it experienced a decline in gross receipts during the first three quarters of 2021, or a significant decline in gross receipts during 2020. Another way to be eligible is if the company qualified as a “recovery startup business” — a business started during the pandemic — for the third or fourth quarters of 2021.

Businesses can still be eligible for the credit if they received PPP loan forgiveness, which some owners may not realize, said Gina Perrone, a senior tax manager at accounting, tax and advisory firm Sax LLP. When the ERC was first created this was not allowed, but it was later revised. There are however, restrictions on double-dipping, which a tax professional can help ensure doesn’t happen.

Consult a CPA before signing with an ERC specialist

It’s very confusing for small businesses because of the various requirements, so it is advisable to consult with a CPA firm that is familiar with the ERC rules — even if a third party suggests the business automatically qualifies. There are many definitions and particulars that need to be sorted out to ensure that a business is, in fact, eligible. 

For instance, the definition of gross receipts for credit purposes is the one used by the Small Business Administration, and it refers to the figure reported on your tax return, Hoffman said.

Certainly, don’t sign an agreement with a third party before consulting with a trusted and reputable financial professional.

Learn to spot the ERC red flags to avoid an audit

Even though a provider may make it sound “super simple,” there are many complicated factors in determining eligibility, said Jenn McCabe, partner at accounting and consulting firm Armanino. Be wary of any firm that uses pressure tactics to encourage businesses to act quickly, she said. These firms sometimes charge hefty upfront fees or a fee that is contingent on the refund amount.

Another red flag is when a third party doesn’t ask for documentation to ensure a business owner qualifies, Perrone said. Businesses don’t have to provide that documentation to the IRS, but they should nonetheless ensure they are entitled to the credit to avoid costly headaches later on. If the business wasn’t really eligible, but received the credit and is later audited, it will owe the money back with penalties and interest, Perrone said. This can occur several years later, and meanwhile, the business has already paid the third party and is unlikely to recover those funds, Perrone said. 

To help avoid an audit, “make sure you can substantiate your claim and your eligibility requirements,” Perrone said.

If your business does qualify, next steps with tax return

Once the business ascertains it qualifies, the next step is to file Form 941-X, an amended quarterly payroll tax return, for each quarter for which the business seeks credit. For 2020, businesses have until April 15, 2024 to file; for 2021, they have until April 15, 2025, Perrone said. 

Businesses that file for the credit also need to amend their applicable tax returns to account for the additional income based on the year they qualified for the credit. “They cannot just report the income in the year they received the cash,” Hoffman said.

Also know that professional standards prohibit CPAs from charging contingency fees for preparing original or amended returns — a necessary step in receiving the credit. 

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The risky options for Main Street cash, credit, when banks say no to lending

Under current banking and credit conditions, many small businesses are likely being bombarded with pitches for online loans and cash advances. Some of these offers, however, could lead the business down — or further down — the rabbit hole of debt.

Certainly, online lending platforms can make it easier for small businesses to obtain financing, and they serve a key need in a market that has long struggled to get the attention of traditional banks. The recent CNBC|Momentive Small Business Survey found owners saying they had lost confidence in banks as a result of the regional banking crisis, and even more to the point, almost half said it isn’t easy for them to access capital to operate. The debt ceiling fight has introduced another element of economic uncertainty that has small business owners on edge.

Compared with a bank loan, online loan providers typically require fewer hoops for borrowers to go through, more relaxed underwriting standards and a quicker turnaround. The challenge is finding a reputable provider, at a reasonable cost, and with terms that won’t undermine the business’s long-term prospects.

“Some people say you shouldn’t have a credit card, but it’s not the credit card. It’s how you use the credit card. The same is true with online financing,” said Nicole Davis, founder and principal of Butler-Davis Tax & Accounting LLC. 

Here are five things small businesses need to know when considering an online financing offer:

Online loans 

An online loan can be used to fund various business expenses. It’s generally easier to apply and qualify for than a traditional bank loan, and options may exist even if you have less-than-stellar credit. The loan amount can vary, with many ranging between $100,000 and $500,000. Some online loans are 12 months or less, but longer-term options may also be available. These loans generally carry higher interest rates than might be available from a traditional bank or the U.S. Small Business Administration, with annual percentage rates often in the range of 6% to 99%, according to a NerdWallet analysis. Terms are based on the owner’s credit profile, how long the business has been operating, its financials and the amount borrowed, said Travis Miskowitz, a partner in the CFO advisory services group at the accounting and advisory firm Wiss. 

Pay attention to fees that could make the loan more costly, Miskowitz said. These could include an application fee, a good-standing fee to see whether the business is in compliance with local laws, and a credit check fee.

Many lenders may also require a personal guarantee, which can be debilitating in a default and can also impact the owner’s ability to qualify for a personal loan, such as a mortgage. A secured loan could be more advantageous because the rate will likely be lower and the lender might not require a personal guarantee, Miskowitz said.

Merchant cash advance

With a merchant cash advance, companies borrow money against their future sales and pay it back as these sales are generated, often over three to 18 months. A merchant cash advance can be particularly attractive when a small business needs cash fast, generally within a few days, said Alan Wink, managing director of Eisner Advisory Group. This type of funding can also be more accessible to owners with bad credit.

But there are caveats. Terms vary widely by provider and the cost of capital typically isn’t expressed as an APR, making it harder for businesses to understand. Funders charge their fees as a factor rate, generally 1.1 to 1.5, according to NerdWallet.

The advance amount multiplied by the factor rate is what needs to be paid back. But knowing that total doesn’t necessarily help the owner understand how expensive the cash advance is since owners are generally more familiar with APR. Doing a conversion can be useful for comparison purposes. 

A cash advance can be quite costly — in the triple digits when expressed as an APR, according to NerdWallet. 

Fixed vs. variable rate debt

Beyond the type of financing, businesses need to consider whether the rate is fixed or variable, the duration, the business’s ability to pay it back on time, costs, including underwriting and late fees, if any, whether personal or business guarantees are required, and what happens if a payment is missed.

“This is not a scroll-down-and-accept-the-terms-situation,” said Will Luckert, president of small business solutions at Corpay, a corporate payments company. “There can be a number of tricky things buried in the terms and conditions,” Luckert said.

Especially with merchant cash advance, owners get into trouble because they don’t understand what they are signing up for. Start by crunching the numbers on your own. To illustrate, Luckert offers the example of a $10,000 advance where $12,000 needs to be repaid in 30 days. To determine the APR, take $12,000 and divide by $10,000. Then subtract one and multiply by 100. Take that answer, 20 percent, and multiple by 12 to get an APR of 240%. Owners can also use this NerdWallet calculator to help determine what their effective APR would be.

Also consider the repayment frequency — daily, weekly or monthly — especially if you are already in a cash crunch, Davis said. She doesn’t recommend daily repayments, for example, saying, “It’s a quick fix to a problem that can become a ruinous cycle.”

In an attempt to protect small businesses, California now requires certain cost disclosures to merchants. New York is also implementing disclosure rules, even as the California regulations are being challenged in court. In the meantime, it’s still a buyer-beware market. “People need to do the math themselves, especially on a cash advance, and see if there’s anything you can do that would be less expensive,” said Paul A. Rianda, an attorney in Irvine, Calif., who specializes in serving the bankcard industry.

How to find a reputable business loan provider 

To help avoid a bad actor, it’s a good idea to vet potential providers through your CPA or attorney since they likely deal with online providers frequently, Wink said. 

Also look at online customer reviews and browse for regulatory actions against the funding company, said Waseem Daher, chief executive and cofounder of Pilot, which specializes in bookkeeping, tax, and CFO services for high-growth technology startups.

Owners can also check in with the Small Business Finance Association, an industry organization whose 25 members are mostly online lenders and funders. Members of the SBFA have to agree to follow certain best practices related to pricing and term transparency, access to customer service and fair collection, among other things. A small business can contact the SBFA to see if a particular financing company is a member or to ask specific questions about the industry, said Steve Denis, the organization’s executive director.

Additionally, the SBFA has a relatively new certification for industry professionals to help ensure they are properly trained. A database of certified professionals is planned for the future, but in the meantime, owners can contact the SBFA for this information, Denis said. 

Other alternative lending options

Depending on the circumstances, another form of funding might be a better option. This could include family and friends, investor equity or credit cards. Businesses should also think about what can potentially be done to prop up the business without relying on third-parties, Daher said.

Can you get your customers to prepay in exchange for a discount, for example? Can you get longer payment terms from your vendors? Can you do anything else to reduce your costs?

These efforts won’t cost you anything and can help avoid the need to rely on a third-party for funding, Daher said.

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With debt ceiling, default threat, these are banking moves every small business should be making

U.S. President Joe Biden hosts debt limit talks with House Speaker Kevin McCarthy (R-CA) in the Oval Office at the White House in Washington, May 22, 2023.

Leah Millis | Reuters

Politicians often like to say that small businesses are the engine of the economy, but if that’s the case, the high-stakes poker game over the debt ceiling that is being played by the Republican-led House and Biden administration is risking a major stall out.

And the uncertainty about what is supposed to be most certain of all — the U.S. government paying its debt — comes on top of what already is a fraught economic environment for Main Street entrepreneurs.

“Small business owners right now are nervous,” said Asahi Pompey, Goldman Sachs Foundation global head of corporate engagement and president, at the recent CNBC Small Business Playbook virtual event. “They’re hearing a credit crunch, rising inflation. They’re hearing debt ceiling default. This is a scary time, and it is somewhat bewildering and challenging for small business owners.”

A warning from the Fitch credit rating agency about U.S. debt added fresh urgency on Thursday to the ongoing debt ceiling negotiations between the White House and congressional Republicans, with only seven days to go before the United States faced the threat of debt default, but a deal was reportedly close on Friday and the market rallied as investors bet the threat was receding.

Models suggest a default would do serious damage to the markets and economy, and the vast majority of small business owners (90%) want the government to avoid a debt default, according to a recent Goldman Sachs 10,000 Small Business Voices survey. With the battle in Washington, D.C. highly political, the survey results from small business owners are notable given that it’s a community that consistently skews conservative in demographic composition and political views.

How bad could it get? A 2013 estimate from Fed economists undertaken given a prior debt ceiling showdown projected a 30% decline in the stock market, a 10% drop in the value of the dollar, and a “mild” two-quarter recession. But mild still likely means millions of jobs would be lost and real GDP would take a big hit, according to the Brookings Institution.

The first to face the blows of this potential financial crisis will likely be small businesses that are paid directly by the federal government through contract work, which has happened in government shutdowns in recent history. But for all small businesses, already under the strain of a credit crunch that began with the biggest Fed rate increases in decades and a regional banking crisis that has made lenders much more conservative with new loans, a debt default would worsen an already deteriorating environment for growth.

Main Street already struggling to access credit

Almost half (44%) of small business owners already are experiencing “negative effects” in their ability to access credit, according to the Small Business & Entrepreneurship Council. And that matches the data from the recent CNBC|Momentive Small Business Survey which found owners saying they had lost confidence in banks as a result of the banking crisis, and even more to the point, almost half said it isn’t easy for them to access capital to operate.

Sixty-five percent of small businesses believe they will be negatively impacted if the debt ceiling is not raised, according to Goldman’s surveying, and most prominently through reduce access to capital.

In April of 2022, Goldman Sachs found that 77% of small business owners were confident in their ability to access capital. However, this past April, it found a full reversal, with the same percentage now worried about access to capital.

“Small businesses rely on small banks. And so we can’t overlook the fact that the banking crisis and concern over the last several months is driving some of that concern by small businesses about whether they’ll be able to really access capital,” Pompey said.

Along with the limited opportunities to obtain funding, small business owners would also face higher interest rates — even higher than rates that have already hit double-digit percentages for many business loans due to the Fed’s aggressive monetary policy that took rates from zero to 5% in a year.

“It’s a bit of a tightrope really that small business owners are trying to navigate. They want inflation to go down, but obviously they don’t want to have to pay more to access capital,” Pompey said.

Small business moves for an uncertain economy

All small businesses can do is prepare for the economic uncertainty that lies ahead. Control what they can control — i.e. not the debt ceiling talks — and Pompey says that means shoring up financial relationships and financial knowledge. In fact, even if a deal is reached, it is expected to only cover two years, and unless the political parties agree on a fix to make this issue go away for good, another debt ceiling crisis could be back before long. The moves small business owners should make now are ones that should be built into a regular, permanent business practice in advance of what are sure to be future economic uncertainties.

Pompey provided four key steps that small business owners should be taking in the current economic environment at the recent CNBC small business event.

1. Bank before you need it

When it comes time to access funding, bankers want to be able to know who their small business customers are and how to best understand the business and the impact they are making in their local communities. But that can’t happen if small business owners aren’t proactively managing that relationship before they actually need money.

Pompey recalled a small business owner advising her that “the worst time to meet a banker is when you need capital.”

It’s critical to know your banker and have an established connection with them in case there comes a time where you need to access funding, Pompey said. Calling your banker and updating them on what’s going on with your business are small efforts that can go a long way if the economy takes a turn for the worse.

That relationships needs to be re-established if its not been maintained, and then it is important to get in the habit of communicating on a regular basis with a bank, which also allows owners to share timely updates on business milestones.

2. Go deep into your numbers

Pompey said that time and time again she hears that small business owners feel a degree of discomfort when going into their financials. She suggested for owners to take a few days to really review their numbers, which will make them feel more empowered in this time of uncertainty even if it’s uncomfortable.

“The No. 1 thing that comes back to bite business owners later on tends to be something hiding in their numbers that they didn’t take the time to look at,” she said.

“Taking that time, which can be uncomfortable, to really go through your numbers is the first step to working on your business instead of in your business,” she added.

3. Know your customer

While coming face-to-face with financials in a slowing economy may be stressful, this is the fun part of the business, Pompey said. When small business owners understand their customer profiles and put themselves in the customers’ shoes, they can lean in on how to best adjust and pivot their businesses to meet the needs of customers.

4. Build a small business network

Pompey said that she hears over and over again from small business owners one thing: it’s lonely. As a result, having the proper support as well as opportunities to collaborate and share strategies or business programs are critical to success.

“Tap into your small business besties,” she said.

The Current State of Main Street in America

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There may never be a better time to create a retirement plan

Small businesses have new incentives to help their employees plan for retirement, thanks to Secure 2.0, a sweeping retirement reform bill signed into law late last year.

The incentives, which include tax credits that are especially attractive to businesses with 50 or fewer employees, are designed in part to encourage small companies to create retirement plans for their employees — especially the smallest firms, among whom less than half (48%) offer a retirement plan, according to research by Anqi Chen and Alicia Munnell of the Center for Retirement Research at Boston College, which uses 2019 U.S. Bureau of Labor Statistics data. 

But that’s changing, in part inspired by more attractive tax breaks and a highly competitive labor market in which every benefit matters more in the war for talent. Among companies not offering a 401(k) or similar plan, 42% say they are likely to begin sponsoring a plan in the next two years, according to a new survey report published May 2 by nonprofit Transamerica Institute and its Transamerica Center for Retirement Studies. Among those that are not likely to sponsor a plan in this time frame, 31% cited cost concerns. 

Before discounting plan sponsorship — especially for cost reasons — small businesses should consider the potential financial benefits Secure 2.0 has to offer. There are eligibility requirements and specific variables that can affect these benefits, so it makes sense to consult a tax advisor to help weigh the various options.

But as a general rule, these credits “add up to sizable benefits for employers looking to start plans,” said Amy Vaillancourt, senior vice president of workplace product, strategy and architecture at Voya Financial.

Here are some basic features of the legislation and points to consider in balancing costs and benefits — to both employer and employee.

A big tax credit can cut down on plan setup costs

Secure 2.0 created a souped-up credit to offset administrative costs associated with starting a qualified retirement plan. For businesses with between one and 50 employees, the legislation increased the percentage of coverage up to 100% of qualified start-up costs, up from 50%. There’s a $5,000 per year cap that’s available for three years. Larger businesses — those with 51 to 100 employees — are still eligible to receive up to 50% of plan start-up costs.

Employer contributions also generate tax advantages

Additionally, Secure 2.0 offers a new tax credit for five years to businesses with up to 100 employees who make employer contributions to a new defined contribution plan. This credit is designed to encourage small businesses to contribute to their employees’ retirement savings. The exact amount of the credit depends on factors such as the number of eligible employees and the number of years since the plan began.

The credit is especially beneficial to employers with 50 or fewer employees. For these businesses, the credit is up to $1,000 per year for each employee earning less than $100,000, and the amount of the credit reduces 25% each year starting in the third year, said Marc Scudillo, managing officer of EisnerAmper wealth management and corporate benefits. 

For larger businesses — those with 51 to 100 employees — the tax credit is based on a sliding scale.

Small businesses using the credit should talk to their tax preparer to understand how deductions for employer contributions will be reduced, said Kelly Gillette, a partner with accounting firm Armanino.

A smaller auto-enrollment credit can offset some costs

A $500 tax credit is available to small companies that add an automatic enrollment feature, available for the first three years, to a new or existing 401(k) plan. While this feature isn’t required until 2025, small businesses could choose to do it now and get the credit earlier, Gillette said. While auto-enrollment tends to increase participation, and thus add costs for a small business, the credit could help offset these added costs.

Starter 401(k) plan doesn’t require an employer match

Employers can now offer a starter 401(k) plan that allows them to take advantage of the applicable administrative tax credits even though they aren’t making contributions on their employees’ behalf, Scudillo said. Many small businesses don’t want or can’t afford to offer an employer match, but having this option can be a significant boon for employees. 

Seventy-one percent of respondents said they expect their primary source of income in retirement to come from what they save on their own in an employer-sponsored defined contribution plan, according to a recent survey from Natixis Investment Managers.

This new type of plan can be useful for recruiting purposes and for helping employees prepare for retirement, Scudillo said. The option is available to small businesses that do not have a plan in place.

Military families receive extra attention in legislation

Military spouses often lose out on the ability to save for retirement because they may not stay at a job long enough to qualify for retirement benefits or become vested. Secure 2.0 offers eligible employers a credit of up to $500 credit per military spouse that participates in the company’s defined contribution plan, provided certain conditions are met.

For instance,  military spouses must be immediately eligible to participate in the plan within two months of hire. Also, upon plan eligibility, the military spouse must be eligible for any matching or nonelective contribution that he or she would have been eligible for otherwise at two years of service.

The credit applies for three years and does not apply to highly compensated employees.

New Roth IRA options for small businesses

Secure 2.0 allows business owners to offer a Roth version within SEP IRAs and SIMPLE IRAs. These are often used by small businesses because they tend to have less administrative responsibilities than a 401(k),” said Eric Bronnenkant, head of tax at Betterment. The ability to offer a Roth option in these plans could benefit the owner directly, but it is also helpful for recruiting and retention purposes, Bronnenkant said. 

The self-employed are not left out of legislation

The retirement legislation also has multiple benefits available for all individuals, including the self-employed. One of these benefits is the increased ability to contribute more money to retirement after age 50. For 2023, the catch-up contribution limit is $7,500, compared with $6,500 in 2022 for people ages 50 and above. Under Secure 2.0, the catch-up contribution limit will increase even more for participants between the ages of 60 and 63 starting in 2025, Gillette said.

Additionally, the age at which people must take required minimum distributions from their traditional 401(k) or traditional IRA has increased. Beginning in 2023, Secure 2.0 raised the age that a person must start taking RMDs to age 73. What’s more, starting in 2024, there is no RMD requirement for Roth 401(k) and Roth 403(b) plans, so it puts them on par with a Roth IRA, which can also be a significant benefit, Gillette said.

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The Biden tax proposals that could hit baby boomer, family businesses

U.S. President Joe Biden delivers remarks about his budget for fiscal year 2024 at the Finishing Trades Institute in Philadelphia, Pennsylvania, March 9, 2023.

Evelyn Hockstein | Reuters

President Joe Biden’s 2024 budget proposals contain several proposals that could hit small businesses right where it hurts — their wallets.

Proposals in the budget include boosting the top capital gains rate for income over $1 million, eliminating the so-called “step-up in basis” loophole, expanding who has to pay investment income tax and at what rate, and bumping up the corporate tax rate.

“The White House’s 2024 budget proposal contains $2.5 trillion in harmful tax hikes that would crush Main Street’s ability to grow and create jobs,” said Brad Close, NFIB president, in a statement detailing its campaign to prevent the measures from becoming law. “Some of these tax increases are again being wrongly characterized as the closing of a ‘tax loophole’ and would directly hit small businesses and compound with other rate hikes,” Close said.

Although the budget comes at a time when many small businesses are feeling thrown under the bus by the effects of inflation, hiring pressures and other adverse business conditions, the good news is that tax experts are circumspect about the chances of Biden’s wish list passing as proposed. 

For one, many of the provisions within the budget have been floated before, and a divided Congress lessens the likelihood they’ll be adopted without revision. Even so, the budget represents efforts to rebalance some of the cuts enacted by The Tax Cuts and Jobs Act of 2017, especially for higher income individuals, said Eric Hylton, national director of compliance at alliantgroup, a Houston-based consultancy.

Currently, the top individual rate is 37% for income over $578,125 for a single taxpayer, or $693,750 for married couples filing jointly. Biden’s proposal would boost the top individual rate to 39.6% and change the threshold to $400,000 for a single taxpayer and $450,000 for a married couple filing jointly. The rate is already set to increase at the end of 2025, when certain provisions of The Tax Cuts and Jobs Act sunset, but this proposal would make it effective for taxable years beginning after December 31, 2022, and it could ensnare more businesses.

While Congress may be more inclined to move ahead with measures that apply more broadly to wealthy individuals, “there’s going to be a lot of debate as to what should go forward,” said Hylton, a former IRS Commissioner of the Small Business/Self Employed Division.

it’s important for small business owners to be aware of what’s being floated, especially since certain provisions that apply more directly to business operations are likely to rear their head at a later time and the recent tax season included some ugly surprises for small businesses related to recent changes in tax law. “These ideas don’t truly go away; they just go into hibernation until somebody else comes along,” said Ray Beeman, leader of Ernst & Young’s Washington Council.

Here are five provisions business owners should be aware of in President Biden’s budget:

A higher capital gains tax rate would be bad for business sellers.

Biden’s proposal would raise the top marginal rate on long-term capital gains and qualified dividends to 44.6% for income over $1 million, up from 23.8%, including the net investment income tax. The impact would be significant for many small business owners who want to sell businesses, especially the scores of Baby Boomers who are aging out, said Brad Sprong, national industry tax leader for KPMG Private Enterprise. “They don’t have big 401(k) accounts; they have equity in the business, so selling the business could mean an even bigger hit. I think that would be tough for people and it will impact their retirement.”

Eliminating the “step-up in basis” would hit family businesses.

Biden is once again floating the idea of ending the “stepped-up basis” rule that allows preferential tax treatment for assets held until death.

Current rules exempt capital gains on assets that a taxpayer does not sell before the end of his or her life, according to the Institute on Taxation and Economic Policy, a non-profit, non-partisan tax policy group.

The proposed change would be especially impactful when family-business assets are passed to the next generation, since there are few exceptions to the capital gains tax consequences, according to the NFIB, which opposes the change.

“That’s a factor in families transferring businesses from one generation to the other right now,” said Mark Prater, managing director with PwC’s Tax Policy Services team. It would be a double-whammy for small businesses, he said, if the other proposal to increase the capital gains rate moves forward.

Still, Biden’s budget partially mitigates these concerns by exempting $5 million of unrealized gains per individual and effectively $10 million per married couple, according to an analysis from the Institute on Taxation and Economic Policy. “The President also proposes allowing any family business (including farms) to delay the tax if the business continues to be family-owned and operated,” the blog said.

Property owners could lose leverage in real estate transactions.

The budget once again seeks to eliminate so-called 1031 like-kind exchanges of more than $500,000 for each taxpayer, or $1 million for married individuals filing a joint return. Under current law, if certain conditions are met, a property owner can sell and buy another piece of real estate for business or investment purchase and defer paying taxes on the initial gain, Sprong said. If that benefit is eliminated, certain small businesses would lose the ability to leverage their capital in this way.

A higher corporate tax rate would hurt businesses that don’t use a pass-through structure.

Biden is proposing that the corporate tax rate be increased to 28% from 21%. The majority of small businesses are pass-through businesses that are not subject to the corporate income tax, but for companies that are, the increase would be meaningful, tax experts said. Before moving ahead, Congress would need to consider how this pits the U.S. against other developed nations, Sprong said. “You wouldn’t want to be an outlier.”

Potentially higher net investment income tax.

Biden’s proposal would increase the 3.8% net investment income tax rate on small business income over $400,000 to 5%. Many small businesses today don’t pay this tax, but if the plan passes, they would not only pay, but at a higher rate than what’s currently in place, Beeman said.

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Owe the IRS more in tax than expected? These are the next steps for business owners

Some small businesses may have received an unwelcome surprise at tax time.

As the U.S. continues to emerge from the pandemic, certain businesses might be seeing improved revenue and owe more taxes than they have in the past few years. Tax law changes in 2022 are also causing some shocking tax bills in the small business world. Meanwhile, newly self-employed often mistakenly equate gross pay and net pay, without taking taxes into account. “If you’ve been living as if the money that’s in your bank account is your net pay, that can be a rude awakening,” said Andy Phillips, director at The Tax Institute at H&R Block.

If owners haven’t estimated appropriately, or have spent the cash elsewhere, it can create large problems. It can be especially vexing since the first estimate for the current tax year is generally due at the same time as last year’s tax bill, a double-whammy.

But a larger-than-expected income tax bill doesn’t have to sink the ship. Here are ways small businesses can handle unexpectedly high tax bills.

File even if you can’t pay the whole IRS bill.

Some small businesses may not have filed their taxes by April 18 this year because they don’t have the money to pay their bill. They should still file as soon as possible, however, to mitigate the IRS’s “Failure to File” penalty, which applies to taxpayers who have a tax liability and don’t file by the due date. The penalty is a percentage of the taxes you didn’t pay on time.

If seeking an extension, you still have to pay.

Some business owners likely have sought an extension, thinking this will allow them to push off their payments without financial repercussions. “It’s an extension to file, not an extension to pay,” said Kimberly Wilkinson, senior tax manager at Wiss & Company.

Check for local disaster exceptions to filing.

Certain taxpayers may be able to benefit from IRS extensions for filing last year’s taxes and 2023 estimated taxes due to disaster situations in their local area. To learn more, they can visit the section of the IRS’s website specifically dedicated to this topic. “It’s a tremendous relief for those that are impacted,” said Michael Prinzo, managing principal of tax with CliftonLarsonAllen in Greenwood Village, Colorado.

Review payment plan options.

Owners who need more time to pay may qualify for a short-term or long-term payment plan. They can visit the relevant section of the IRS’s website to see what’s available, as well as potential costs and filing options.

Owners should keep in mind the IRS’s “Failure to Pay” penalty based on how long their overdue taxes remain unpaid. Though future penalties may be reduced by setting up a payment plan, it’s advisable to pay off the tax liability as soon as possible to limit the adverse effects of accruing interest. 

Don’t dip into payroll tax money.

Sometimes small business owners with employees try to tap money earmarked for payroll taxes to pay their personal taxes. That’s not allowed and could result in a stiff penalty. “It’s incredibly important that small business owners never borrow from their payroll withholdings to pay anything else,” Phillips said.

Consider personal loans, credit even at higher interest rates.

A small business owner who needs cash to pay his or her taxes might consider a bank or credit card loan or some other type of short-term financing, such as tapping an existing line of credit if available. Interest rates may be high for some of these options — in many cases reaching into double-digits on a percentage basis after a year of Federal Reserve rate hikes. But owners have to weigh credit costs against the penalties and interest they’ll accrue from the IRS, according to Anne Zimmerman, president and founder of Zimmerman & Co CPAs and co-chair of Small Business for America’s Future, a national coalition of small business owners and leaders. “Don’t use the IRS as your banker,” Zimmerman said.

Consider filing an amended return.

It behooves small businesses to take a second look at their tax return and consider filing an amended return if they are able to eke out additional deductions.

“Often business owners aren’t taking advantage of all the things they’re entitled to,” Prinzo said. “Make sure there haven’t been any missed planning opportunities.”

For example, there are favorable rules associated with taking accelerated depreciation, often referred to as bonus depreciation, which can help lower the tax burden.

In addition, there may be additional opportunities to deduct expenses, such as software, advertising or certain professional service fees, Phillips said. Small business owners may also be able to deduct home office expenses, if applicable. 

For many small business owners, personal tax benefits can also reduce the taxes due. Owners may not have taken into account new life circumstances that could qualify them for a tax benefit or benefits, such as marriage, having children, caregiving for certain individuals or education expenses. “Life changes generally mean tax changes,” Phillips said.

Work with a CPA to plan ahead, and potentially defer taxes.

Planning ahead with a CPA can help ensure owners aren’t blind-sided in the future.

For instance, if an owner sees in the middle of the year he or she is making more money, estimates can be tweaked to minimize some of the impact at income tax time. “The goal is to have your tax paid by the end of the year,” Wilkinson said.

Small businesses could also consider setting up a tax-deferred retirement plan for 2023, which can help with tax savings, said Cary Carbonaro, a certified financial planner with Advisors Capital Management in Winter Garden, Fla. A client recently did this mid-year and eliminated the need for a $300,000 estimated tax payment, Carbonaro said.

Thanks to recent passage of the SECURE 2.0 retirement savings legislation, there could be additional tax benefits for certain business owners who start tax-deferred retirement plans, so that’s also worth investigating, Prinzo said. Secure 2.0 encourages small business owners to create retirement savings plans through starter plan options and tax credits for both administrative costs in setting up a plan and making employee match contributions.

Nevertheless, even if you take all these steps, it’s still important to keep enough cash on hand for the next tax cycle, just in case there’s another surprise.

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How to manage cash and stay out of debt running a business in a recession

Melissa Bradley has helped guide thousands of business founders through challenges.

The founder of 1863 Ventures, and a serial entrepreneur and investor, says if a recession becomes economic reality and customers cut back more due to inflation, it won’t be anything new for minority entrepreneurs.

“They are concerned because of the impact it will have on customers,” Bradley told CNBC Senior Personal Finance Correspondent Sharon Epperson at the virtual Small Business Playbook event on Dec.14. “The reality is Black and brown businesses are used to being locked out of access to capital, and used to having to spend more for things, so they plan.”

With a 98% success rate during Covid among over 3,000 Black and brown entrepreneurs with whom her organization has partnered, Bradley says consistent planning and “always expecting the worst” is in a minority business owner’s DNA. “Nothing is a guarantee,” she said.

The difference now for all business owners is the need to be mindful of what customers can afford going forward. The latest retail sales report showed a much bigger drop than expected, adding to fears that the economy and consumer are rapidly slowing.

“The first thing is plan. Your financial statements tell you a lot,” Bradley said, adding that they tell you about a lot more than just the assets and liabilities. “Be laser-focused on what financials are telling you about customers,” she said.

It’s more important than ever, she says, to understand drivers of growth, and dig into the details from all the business data at your disposal, showing what customers like and don’t like, where they search and shop, and when and how often they come back.

“Keeping customers engaged and happy is the greatest gift you can give yourself this holiday season to make sure revenue keeps coming in,” Bradley said.

She has some advice for business owners on how to stay out of bad debt, make the right investments, and keep sales flowing even through a recession.

Get a handle on costs and prices

Cash is king, “or queen,” Bradley said, depending on the entrepreneur, and it’s the first thing to get a handle on in a tough economy — specifically by looking at costs and prices.

She provided the example of a spirits business that experienced a big increase in the cost of glass that resulted in the need to reevaluate pricing. All businesses need to be able to at least cover costs without dipping into the owner’s pocket to pay, and that’s become more challenging amid inflation.

Don’t dip into personal savings

Bradley stressed that a business owner should not dip into your person savings, or “borrow against your house,” to keep a business going.

“You need to make sure your business can stand on its own,” she said.

Entrepreneurs are sold on a bootstrapping mentality, “a fake it until you make it” mantra, but the reality is it’s a big mistake to bring your personal life down as your business life goes on a rollercoaster.

“Stay really focused on the numbers and know some months are going to be high and some low,” she said.

Rethink contractors and extra cash

If business owners stay on top of their financials and avoid the bad debt decisions, they may be fortunate enough to end up with extra cash. Where that money is invested can make a big difference — either good or bad.

Bradley cautioned that the “world of contractors and 1099s” has been a great thing for the small business community, but during times of uncertainty there is greater risk associated with variable costs that many contractors operate under. Variable costs are harder to predict as part of ongoing cash flow.

She advises moving more costs to the fixed cost bucket, “so you can become laser focused on it, so you don’t have a deficit at the end,” she said.

Scrutinize the use of consultants

New business formation in recent years has been at record levels and when many businesses are first starting out they rely more heavily on consultants. Bradley says now is the time to reevaluate a reliance on multiple consultants. “Every quarter, think about what key operations and processes are needed to keep the business going and how many people are touching them,” she said.

If there are too many people involved, whether internal or external, that’s a risk in and of itself and it is not the sign of an efficient business. All tasks should be centralized and aggregated in the right way, and that might mean having one person on the job rather than three consultants.

Bradley provided marketing as one example, with the tasks of script writing, social media and photography all handled by different people. The smart money move may be to hire one person for all three tasks, but she said owners are often too busy running a company to pay attention to how their money is being invested down to that level.

But being busy is no excuse.

“You can’t make it if you are not paying attention to the steps along the way, how are you spending money so it has a positive ROI over the future,” she said.

Invest a little at a time in yourself

As an investor in many businesses, Bradley sets a cap on what she will put into any entity. “You can’t fund a business forever,” she said. Setting an amount of investment and a duration of investment is part of being disciplined about the funding process.

It is critical to keep personal and business accounts separate, but just as important to know you will at some point need more money for your business and you should be paying yourself as you go — not necessarily a lot, but with consistency.

“Really stay on top of being able to pay yourself a little, and pay off those expenses,” Bradley said.

She said one of the biggest challenges business owners face is waiting too long to pay themselves. “Even if you only have $100, pay yourself $50. This is about building the muscles to sustain and grow the business over time,” she said. “Take $50 and put $25 to a bill and $25 to yourself. It is not about waiting for the big jackpot at the end of the rainbow. … It’s about making steady progress in paying down any personal debt and continuing to invest in the business,” she said.

Make changes in smaller increments

Staying focused on the numbers is likely to result in the need to make changes based on greater understanding of what is and isn’t working. Plenty of businesses have been started during recessions, Bradley said, so change is not a reason to panic.

A business owner shouldn’t be making changes all the time — that is its own form of panic — but changes should be considered in small increments. Each month, each quarter, business owners should be considering changes. And they should not be planning in terms of “next year,” Bradley said.

“What do you want to accomplish between now and the end of the year? In January? … Making changes is not a sign of failure, it’s a sign of keeping pace with customers and what you’re learning from the market,” she said.

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Federal Reserve’s increasing interest rate hikes put Main Street economy ‘dangerously close’ to edge of lending cliff

Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, July 27, 2022.

Elizabeth Frantz | Reuters

The Federal Reserve’s decision to raise interest rates by three-quarters of a percentage point, or 75 basis points, for the third-consecutive time at the Federal Open Market Committee meeting, is a step being taken to cool the economy and bring down inflation, but it is also putting small business owners across the country in a lending fix they have not experienced since the 1990s.

If the Federal Reserve’s FOMC next moves match the market’s expectation for two more interest rate hikes by the end of the year, small business loans will reach at least 9%, maybe higher, and that will bring business owners to a difficult set of decisions. Businesses are healthy today, especially those in the rebounding services sector, and credit performance remains good throughout the small business community, according to lenders, but the Fed’s more aggressive turn against inflation will lead more business owners to think twice about taking out new debt for expansion.

Partly, it is psychological: with many business owners never having operated in anything but a low interest rate environment, the sticker shock on debt stands out more even if their business cash flow remains healthy enough to cover the monthly repayment. But there will also be more businesses finding it harder to make cash flow match monthly repayment at a time of high inflation across all of their other business costs, including goods, labor, and transportation.

“Demand for lending hasn’t changed yet, but we’re getting dangerously close to where people will start to second guess,” said Chris Hurn, the founder and CEO of Fountainhead, which specializes in small business lending.

“We’re not there yet,” he said. “But we’re closer.”

Increasing interest cost

Fed expected to keep rates higher for longer

The big change since the summer, reflected in the stock market as well, is the acknowledgment that the Fed is not likely to quickly reverse its interest rate hikes, as inflation proves stickier than previously forecast, and key areas of the economy, like the labor market, don’t cool fast enough. As recently as the last FOMC meeting in July, many economists, traders and business owners expected the Fed to be cutting rates as soon as early 2023.

Now, according to CNBC’s surveying of economists and investment managers, the Fed is likely to reach peak rates above 4% and hold rates there throughout 2023. This outlook implies at least two more rate hikes in November and December, for a total of at least 75 basis points more, and including Wednesday’s hike, 150 basis points in all from September through the end of the year. And that is a big change for business owners.

The FOMC meeting decision reinforced this expectation of a more hawkish Fed, with the two-year treasury bond yield hitting its highest rate since 2007 and the central bank’s expectations for when it starts cutting rates again pushed out even further in time. In 2025, the fed funds rate median target is 2.9%, implying restrictive Fed policy into 2025.

How SBA loans work and why rate hikes are a big issue

SBA loans are floating rate loans, meaning they re-adjust based on changes in the prime rate, and that has not been an issue for business owners during the low interest rate environment, but it is suddenly becoming a prominent concern. With SBA loans based on the prime rate, currently at 5.50%, the interest rates are already between 7%-8%. With the prime rate poised to reach 6.25% after the Fed’s latest 75 basis point hike, SBA loans are heading to as high as the 9%-9.5% range.

“Most of the business owners today, because they have lived in such a low rate environment, while they have floating interest rate loans they didn’t even realize that on existing loans it could go up,” Arora said. “Everyone expected with gas prices coming down to what I would call ‘pre-high inflation levels’ that things looked a lot better. Now people are realizing that oil prices don’t solve the problem and that’s new for lots of business owners who thought inflation would taper off and the Fed not be so hawkish.”

He stressed, like Hurn, that demand for business loans is still healthy, and unlike deteriorating consumer credit, small business credit performance is still strong because many firms were underleveraged pre-Covid and then supported by the multiple government programs during the pandemic, including the PPP and SBA EIDL loans. “They are well capitalized and are seeing strong growth because the economy is still doing pretty well,” Arora said, and he added that the majority of small businesses are in the service economy, which is the strongest part of the economy right now.

But many business owners were waiting for the Fed to cut in early 2023 before making new loan decisions. Now, they’ve been caught flatfooted by adjustable loan rates that went up, and an interest rate environment poised to go higher still.

“Lots of business owners look at gas prices first and that was true for most of the year, and now it’s broken down. Wage inflation and rent inflation are running amok, so we’re not seeing inflation coming down anytime soon,” Arora said.

That’s leading to more interest in fixed-rate products.

Fixed versus adjustable rate debt

Demand for fixed-rate loans is going up because businesses can lock in rates, from a year to three years. “Though it’s pretty late to the game, they feel like maybe the next 14 to 15 months, before rates start coming down, they can at least lock in a rate,” Arora said. “The expectation is, in the short term, SBA loans will adjust up and non-SBA loans are shorter tenure,” he said.

SBA loans range from three years to as long as 10 years.

A fixed rate loan, even if it is a little higher than an SBA loan today, may be the better option given the change in interest rate outlook. But there’s considerable potential downside. Trying to time the Fed’s policy has proven difficult. The change from the summer to now is proof of that. So if there is a significant recession and the Fed starts cutting rates earlier than the current expectation, then the fixed-rate loan becomes more expensive and getting out of it, though an option, would entail prepayment penalties.

“That’s the one big risk you run if taking a fixed-rate loan in this environment,” Arora said.

The other tradeoff in choosing a fixed-rate loan: the shorter duration means a higher monthly repayment amount. The amount a business can afford to pay back every month depends on the amount of income coming in, and a fixed rate loan with a higher monthly repayment amount requires a business to have more income to devote to servicing the loan.

“After 2008, business owners never experienced a jumped in SBA loans and now they see monthly interest payments increasing, and are feeling the pinch and starting to plan for it … get adjusted to the new reality,” Arora said. “Demand is still healthy but they are worried about the increased interest cost while they are still battling inflation, even as lower oil prices have helped them.”

SBA loan guaranty waiver ending

Another cost that is suddenly influencing the SBA loan decision is the end of a waiver this month on SBA loan guaranty fees that are traditionally charged to borrowers so that in the event of a default, the SBA pays the portion of the loan that was guaranteed.

With that waiver ending in September, the cost of guaranteeing a loan can be significant. For example, a 3% SBA guaranty fee on a $500,000 loan would cost the business borrowing the money $15,000.

“It’s adding to the costs,” Arora said.

It’s still a mistake to wait too long to access credit

While oil prices are coming down, food and other inventory costs remain high, as do rent and labor costs, and that means the need for working capital isn’t changing. And business owners who have been through downturns before know that the time to access credit is before the economy and cash flow start to deteriorate. At some point, in the most severe downturns, “you won’t get money at any cost,” Arora said.

“If you have a reasonably calculated growth plan, no one is going to say keep your head in the sand and wait until Q2 of next year and see where rates are,” Hurn said. “Banks don’t like to lend when the economy is slowing and there are higher rates, which translate to higher risk of defaults.”

Hurn said loan covenants are being “tripped” more frequently now in deteriorating sectors of the economy, though that by no means typifies the credit profile on Main Street.

“Once interest rates go up, and if inflation does not go down, we will see more debt service coverage ratios getting violated,” Arora said. This has to be taken into account because here is a lag between Fed policy decisions and economic impact, and this implies that sticker forms of inflation will last for longer even as sectors like housing and construction are deteriorating.

Much of the surplus liquidity businesses are sitting on due to government support is being eroded, even amid healthy customer demand, because of high inflation. And even if this economic downturn may not be anything like the severe liquidity crisis of 2008, business owners are in a better position when they have the access to credit before the economic situation spirals.

This is not 2008, or 1998

The systemic issues in the financial sector, and the liquidity crisis, were much bigger in 2008. Today, unemployment is much lower, lender balance sheets are much stronger, and corporate balance sheets are stronger too.

“We’re just running into a slowing economy,” Hurn said.

When he started in small business lending back in 1998, business loans reached as high as 12% to 12.5%. But telling a business owner that today, like telling a mortgage borrower that rates used to be much higher, doesn’t help after an artificially low interest rate era.

“Psychologically, people set their expectations for borrowing costs … ‘they will be this cheap forever,'” Hurn said. “It’s changing radically now.”

“If rates go close to 10%, psychologically, businesses will start hesitating to borrow,” Arora said.  

And with a peak Fed rate level of 4% or higher reached by late this year, that is where SBA loan rates are heading.

The problem of higher interest rates and recession

Another 150-175 basis points in total from the Fed, if it has its intended effect of bringing inflation down, would leave many businesses in a stable condition because all of the other costs they are facing outside of debt would be more manageable. But the key question is how quickly the interest rate actions bring down inflation, because the higher rates will impact the cash flow of businesses and their monthly loan payments.

Lower inflation in stickier parts of the economy, like labor, combined with energy costs remaining lower, would allow small businesses to effectively manage cash flow. But if those things don’t happen as quickly as people are expecting, “then there will be pain, and consumer spending will be down too, and that will have a bigger impact,” Arora said. “The challenge is recession and high interest rates together that they have to handle and haven’t seen in 40 years,” he said.

Rates are not ordinarily considered the determining factor in a business’s decision to take out a loan. It should be the business opportunity. But rates can become a determining factor based on the monthly repayment amount, and if a business is looking at cash flow against monthly costs like payroll being harder to make, expansion may have to wait. If rates go up enough, and inflation doesn’t fall off fast enough, all borrowing may need to be applied to working capital.

One thing that won’t change, though, is that the U.S. economy is based on credit. “People will continue to borrow, but whether they can borrow at inexpensive rates, or even get capital trying to borrow form traditional sources, remains to be seen,” Hurn said.

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