Small businesses have taken the brunt of the economic damage caused by lockdowns in March and April, and a huge force behind-the-scenes regarding overall employment in the country. The small business dynamic has shifted dramatically – PPP loans were aimed at these business, with 500 or less employees, but money ran dry quickly in April. A second stimulus program would not have as much available to loan through the PPP system. But small businesses are still shuttering doors, some might never reopen, and some might never reach old employment levels; the small business dynamic has changed substantially in a short period of time, but how it has done so is worrisome.
On a global scale, many small businesses have been concerned with four main things: having less revenues, attracting new customers, having to reduce salaries, and keeping employees safe and healthy. These insights come from Visa’s (V) recent ‘Back to Business’ study (to read my article about that study click here). Some stores are adopting new methods to operating – offering contactless payments and pickups, in response to higher customer preference of those options in stores.
A study of over 5,800 small businesses shows a similar picture domestically, although the data looks back to April, where the situation was just beginning. However, many of the same conclusions can be drawn between this data and more recent data, like the Back to Business study as well as data from Yelp.
As a whole, small businesses reflect the 75% optimism about the future that Visa outlined, with about that level expecting to remain open at the time of the survey. Yet the variability increases in the number of businesses expecting to remain open as the duration extends, trending lower on a larger confidence interval as the duration reaches the fall or next year.
Source: PNAS
The survey also found that for businesses “expect[ing] a 6-mo crisis, the average expectation of remaining open falls to 39%” – that puts the crisis end at October, as the survey counts April as month ‘0’. Expectations of remaining open were related to cash on hand as well as size. Companies with more cash on hand (50% of firms with more than the median cash on hand expecting to be open compared to 31% with less) and companies of larger sizes (20+ employees) were more optimistic about the future as well as remaining open by the end of 2020, possibly due to access to capital and other resources
Cash coverage of expenses also paint a bleak picture for the small business environment. Looking at monthly expenses, as those expenses rose past $10,000, the median company had less than one month’s cash on hand; in most cases, less than two weeks’ cash. However, note that the data is positively skewed – this is most likely due to companies on the larger scale (hundreds of employees, up to 500) having more cash on hand and therefore a longer duration of cash on hand, yet the majority are clustered at or below the median value.
Source: PNAS
With cash balances low going in to the pandemic, firms were already in a precarious position month to month. As the duration of the pandemic continues to lengthen as we hit the 4 month mark from the survey, the likelihood that firms “will either have to dramatically cut expenses, take on additional debt, or declare bankruptcy” is very high – these three points were concerns at the beginning of the pandemic.
This coincides domestically with data released by Yelp (YELP) – while a fraction of businesses do indeed declare bankruptcy, a far larger amount simply close doors and walk away. Yelp found that “more than 80,000 [small businesses] permanently shuttered from March 1 to July 25” with nearly 60,000 considered ‘local’ businesses, or those with five or fewer locations. Only about 800 firms filed for formal Chapter 11 bankruptcy.
Source: Bloomberg
Restaurants and retail accounted for about one-third of local business closures, in line with broader macro trends as the retail and restaurant industry suffered due to closures. Beauty stores fell to the same fate, with some salons and spas not able to keep doors open or not willing to. But these 60,000 firms closing doors permanently aren’t representing the full picture – many of these likely were facing a month or less of cash on hand, high expenses, and a lack of customers unable to offset losses, and many more than 60,000 are likely facing the same.
60,000 (or higher) is not too large of a number when keeping in mind the overall size of the small business environment – nearly a quarter of a million new firms started up and nearly the same exited the market just in Q4 2018. The small business environment is very fluid as firms take their chances, but just as many fail as those that enter.
But looking at the net new establishments (startups minus exits), the last recession saw more exits than startups. With over 80,000 closures based on Yelp’s data, concerns about less revenues and customer attraction from Visa, and the third study showing the relative lack of cash overall, the total net new establishments could plunge for much of the pandemic duration. As “38% of businesses viewed it as unlikely or only somewhat likely that they would be open as of the end of 2020,” that suggests that the exit side will be higher – but startups will probably fall as well, since starting a local, physical-store business right now is likely extremely difficult.
Source: SBA 2020 Small Business Profile
Yet small businesses are extremely important to the economy due to their proportion of the workforce. Small businesses account for 47.1% of private employment, with 60.6 million total employed. However, due to their relative financial fragility compared to firms with over 500 employees, small businesses found it hard to either remain open or remain as fully staffed as before, with many of the firms from the 5,800 study group “reduc[ing] their active employment by 39%”.
Source: SBA 2020 Small Business Profile
Taking a look at how employment is split among firms of different sizes, the 60.6 million employed by small firms are split quite evenly between the three sizes. But small business employment creates large job gains nonetheless, even as large business employment looks to be accelerating at a quicker rate. In 2019, firms with less than 20 employees “experienced the largest gains, adding 1.1 million net jobs.”
Yet these are the firms that have been the most likely to go under during the pandemic. As small firms are vanishing during the pandemic, with just a minute fraction actually filing for formal bankruptcy (many do not, as record of a bankruptcy makes it harder to get loans in the future and increases the difficulty of starting up another business), the share of job losses from small businesses might not recover as quickly in the long run.
Once closed, small businesses might not reopen until after the pandemic, or might never reopen. Business owners who have closed their small businesses still could be paying off loans, and that might ultimately drive them back into the market, while new startups could look to fill the void left by these closures. However, net new establishments for 2020 is likely to be as wide if not wider than the previous recession due to the substantial changes in conducting business with minimal or no contact. A majority of small firms did not have enough cash to cover expenses for two weeks or one month, and even with the PPP program supplying billions, money can’t solve everything. As the pandemic continues without a vaccine, the variability in small businesses expecting to remain open dramatically increases, at some points with just 20% at the low end of the confidence interval. Small businesses are historically very fluid, with hundreds of thousands entering and exiting the market each quarter, but the exits this year will be much higher than normal. Small businesses are vital to employment, accounting for 47.1% of total employment, and net new job creation, with firms less than 20 employees adding 1.1 million jobs last year. If small businesses are unable to reach old employment levels due to less revenues, inability to cover that level of expenses, or extended fear of potential closure later in the year, net new employment from small businesses won’t be there.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.