By Robert Fairlie
On Monday, President Obama announced a plan to unfreeze capital for small businesses (see here). With the potential of creating new jobs and helping the country move out of the recession, the White House offered several actions to help small businesses obtain the capital that they need. The financial crisis has taken a devastating toll on entrepreneurs as capital has become increasingly scarce. This year’s projections for loans guaranteed by the Small Business Administration are down to $10 billion, which is half the amount of loans guaranteed last year.
To get capital flowing again for small businesses, the President’s plan calls for purchasing securities backed by SBA loans, reducing lending fees, increasing loan guarantees, and easing the tax burden. To increase confidence among banks to lend to entrepreneurs in current economic conditions, the White House will temporarily raise guarantees on loans to 90 percent in SBA 7(a) Loan Program. Currently, the government guarantees on small business loans made by private lenders are either 85 percent for loans under $150,000 or 75 percent for larger loans. The temporary reduction will provide some needed confidence to a shaky banking sector. Although the findings from research on SBA’s loan programs are mixed, with critics noting that making credit too easily available sets up many small businesses for failure and wastes money, a temporary increase may be what we need right now to regain reasonable levels of access to credit. Many entrepreneurs who own otherwise successful and efficiently-run businesses may go under because they cannot pay the rent or meet payroll in this historically deep downturn. In an extensive research project of mine using confidential Census data, I find that access to capital is the most important factor predicting whether small businesses will survive or fail.
President Obama also plans to substantially reduce and ultimately eliminate capital gain taxes on investments made in small businesses. The current plan is to exclude 75 percent of capital gains for investors in small businesses who hold their investments for at least five years. The reduction or elimination of these taxes will increase the effective return from investing in small businesses. Although many investors, understandably, will continue to be wary of putting their money into small businesses in these economic conditions, reducing capital gains taxes could inject some much-needed capital into the small business sector because of the current lack of attractive alternatives.
In my research I have found that the most common source of capital among small business owners is their own or family savings. But, with incomes falling, the stock market down, and housing equity drying up, entrepreneurs will increasingly need to seek out alternative sources of capital, such as banks, credit unions and angel investors.
These are desperate times and they call for quick and bold actions by the federal government to help what many consider to be the life-blood of the U.S. economy — small businesses. Maintaining adequate access to financial capital for the nation’s nearly 13 million business owners should be viewed as one of the most important goals of the economic stimulus plan.
by Robert Fairlie