Economy Matters

Many small businesses are struggling to cope with the economic shock created by the COVID-19 pandemic shutdown, Federal Reserve research shows.

The most recent Small Business Credit Survey, an annual report of business conditions and expectations compiled by the 12 banks in the Federal Reserve System, shows that many U.S. firms with fewer than 500 employees were under pressure even before COVID-19 prompted shelter-in-place orders and travel bans. For example, 66 percent of the roughly 5,500 small businesses that participated in the survey said they faced financial difficulties that included paying their operating expenses.

Across the Atlanta Fed’s coverage area—which includes Georgia, Florida, and Alabama as well as parts of Louisiana, Mississippi, and Tennessee—small businesses face an urgent need for capital to meet their payrolls and have problems retaining customers, according to interviews with lenders, nonprofits, and other stakeholders contacted by the Atlanta Fed’s community and economic development (CED) group in recent weeks. In the Southeast, businesses in the leisure and hospitality sector have been particularly hard hit by the coronavirus.

“The longer the crisis lingers, the longer the recovery will take for small businesses and the communities they depend on to thrive,” said Atlanta Fed staffers Janelle Williams, a senior CED adviser, and Mary Hirt, CED research analyst.

Using data from the latest small business survey, which was fielded before the COVID-19 crisis, researchers at the Federal Reserve Bank of New York took a closer look at funding levels, profitability, and credit risk to determine whether companies were healthy, stable, at risk, or distressed. Of more than 3,200 small companies examined, 35 percent were judged to be healthy since they rated favorably on all three measures. An additional 35 percent of those firms were characterized as stable, meeting two criteria. Another 23 percent meet just one of the three conditions so were deemed at risk, and 6 percent were found to be distressed, meeting none of the criteria.

New survey question on unexpected revenue loss

The 2020 credit survey, which was conducted in the third and fourth quarters of 2019, included a new question asking small companies how they would respond to a potential financial loss equal to two months of revenue. Coping strategies differed according to the businesses’ financial health. Firms considered at risk and distressed indicated they were more likely to use the owner’s personal funds in the event of such a revenue loss, while those deemed healthy and stable responded they were more likely to initially cut salaries or lay off employees if faced with such an income drain. Other actions firms indicated they would take in response to a two-month revenue loss included downsizing operations, taking out debt, and closing or selling the business (see the table).

How Small Businesses Would Respond to a Two-Month Revenue Loss

Companies that participated in the Small Business Credit Survey fielded in the second half of 2019 said they would take a number of actions to cope with a two-month revenue loss. These results are based on responses from 5,139 firms with less than 500 workers.

With U.S. unemployment now topping more than 30 million people, it’s clear that many small companies have cut staff. “What we’re hearing anecdotally from a lot of small businesses is that they have encouraged their employees to file for unemployment insurance with the hope that they will eventually come back,” said Claire Kramer Mills, assistant vice president at the Federal Reserve Bank of New York. She cowrote an article that accompanies this year’s credit survey on the ability of small businesses to weather the pandemic.

Jessica Battisto, a senior analyst at the New York Fed, said small businesses are likely turning to a number of coping strategies, including using owner’s personal funds. Some firms have also been changing their business models—for example, increasing their use of online tools. She said these moves will likely continue as businesses look to improve their resiliency.

“Using different technologies for payroll or to connect their employees are things that small businesses can build in now,” Battisto said.

Concerns about nonemployer, minority firms

The U.S. government has allocated more than $600 billion through the Paycheck Protection Program (PPP) to help small businesses through the coronavirus slowdown, but there are questions as to whether those funds are reaching many smaller enterprises that need them. Mills pointed out that 80 percent of the tiniest small businesses are nonemployer firms, which have no workers other than the firms’ owners. A 2019 report from the Federal Reserve showed that these small companies—many of which have been opened in recent years by African-American women—had significant financial problems, with a majority of them either unprofitable or just breaking even.

Just as data indicate that the COVID-19 disease is disproportionately affecting African Americans and Hispanic people, minority-owned small businesses also face various hurdles and are likely under pressure during the current economic downturn.

Mills said banks, especially community banks, have been a significant means through which the federal funds earmarked for small businesses have been distributed. Since minority-owned small firms are less likely than their White-owned counterparts to have an existing banking relationship, obtaining financial relief could be complicated. “We see in our survey that minority borrowers are more likely to be served through credit unions or community development financial institutions and fintech providers,” Mills said. There are data that indicate financial technology firms have dispersed smaller sums under the PPP, she added.

Karen Jacobs

Staff writer for Economy Matters