Not every business suffers during a disaster or economic upheaval. In general, however, small businesses overwhelmingly face the most risk and bear the brunt of negative impacts. The reason can be boiled down to one critical factor: access to capital.
While public companies have multiple mechanisms to raise capital when revenues are down, small, privately held businesses facing the same scenario have only one choice – borrow more money. To stay solvent during difficult times, small business owners often must obtain additional loans. If that isn’t an option, they may borrow against their home, borrow from friends, or use credit cards to manage the gap. The increased debt places a strain on the business that can be difficult to overcome.
The COVID-19 pandemic and its ongoing impacts have provided our most recent example of the strain lost revenue places on small businesses during economic downturns, but it is not the first. The pandemic has rightly been compared to major events such as the Great Recession and the Great Depression for many reasons, including its economic impacts.
Fortunately, there are a few key differences between the pandemic and those historical events which could lessen the impact to small businesses.
Financial assistance. During the Great Depression, the federal government famously refused to provide financial relief to businesses, resulting in massive closures and crippling unemployment numbers. Seeking to avoid a similar disastrous outcome, the government and Federal Reserve stepped in during the early months of the pandemic to provide assistance through lowered interest rates and the Paycheck Protection Program.
Both tools worked, providing temporary relief to thousands of companies and supporting the employment of 51 million workers. The process wasn’t perfect, of course. The same relief was available to companies whether they were faring well or suffering badly, for example. Regulators also recognized flaws and have attempted to address them. Qualifications for the second round of PPP funding have been tweaked to better identify and target businesses that are truly in need, with the goal of keeping them viable until the pandemic pressures subside.
Lender strength. The banking industry’s performance during past economic downturns has not been stellar. Rampant bank failures during the Great Depression spurred regulatory changes that transformed the industry. In the Great Recession, as it became clear big banks had been a cause of the catastrophe, the word “bank” became a four-letter word and major reform ensued.
Banks are a reflection of their local economies, so small business success or failure during the pandemic will certainly impact lenders, but the industry entered into our current situation much healthier than in past economic downturns, for several reasons.
First, lenders are required to monitor and prepare for anticipated credit losses. As unemployment projections soared in early 2020 and small businesses were forced to shut down, banks built up their reserves to protect against anticipated losses. Second, government-backed financial assistance for businesses and a quick economic recovery in the summer helped banks maintain a position of strength, allowing them to provide ongoing client support.
Lenders were also able to play a key role by providing federal assistance which enabled small businesses to keep workers employed. The U.S. Small Business Administration utilized lenders as a vehicle to distribute PPP loans — a massive undertaking which simply would not have been possible without bankers working around the clock to help clients apply for and receive support.
To put it in context, throughout 2019 the SBA approved about 42,000 disaster loans for $2.2 billion. Over just a few months in 2020, the PPP program resulted in 4.4 million loans for $510.2 billion. Alerus alone distributed 1,580 loans during that time, obtaining $363 million in funding relief for clients.
The health of small businesses, and those that serve them, will continue to be a major concern throughout 2021. Nearly 99% of North Dakota’s businesses (73,142 businesses) are small businesses, employing more than half of North Dakota’s workers. Small businesses are the lifeblood of communities, and widespread small business failure can create a devastating economic domino effect.
Additional federal relief will provide much-needed support. But until the pandemic subsides, hard-hit sectors such as hospitality and commercial real estate will continue to suffer and the negative implications will spread to lenders that are over-leveraged in those sectors, making it difficult for them to support clients. While the consequences may not be as widespread as in the past, it will be important for businesses to seek out financial partners with capacity to service their needs and the ability to provide helpful guidance.
Randy Newman is president and CEO of Alerus, a diversified financial services company headquartered in Grand Forks, N.D., with additional offices in Fargo, N.D., the Minneapolis-St. Paul metro area, Arizona, Michigan, and New Hampshire.