Coronavirus: Economic Impact for Small Business

According to the Centers for Disease Control, the U.S. has now passed the half-million mark for COVID-19 infections, and reached 21,942 related deaths. Public health experts have modeled daily infection rates, indicating what’s to be expected. The models vary, with those based on the experience of Wuhan, China indicating we are nearing a peak in the rate of new infections. Others point to the case of Italy, where 0.002% of the population has been infected. If this were to happen in the U.S., it would reach 745,000 Americans in the coming weeks.

As we covered in the previous article, the economic impact has been severe. To put the “COVID economy” in perspective:

• Morgan Stanley now predicts a 30% contraction in economic output for the second quarter, when we were experiencing 2 – 3% growth;
• Over the past three weeks more than 16 million people have filed for unemployment benefits, meaning we’ve lost 10% of the workforce;
• Unemployment could easily hit 17 – 20%, with the Federal Reserve Bank of St. Louis predicting it may reach 30% (it hit 24.9% during the Great Depression);
• Reuters is reporting we are already in a Global Recession; and
• Goldman Sachs and the World Economic Forum are predicting a deeper recession than that following the 2008 Financial Crisis.

It has been difficult to compare the economic shock from Coronavirus to other periods of economic contraction, because this is not simply a fall in consumer and business purchasing, nor has it been induced by businesses and financiers creating asset bubbles. This is an external shock from the contagion, and it has included shocks on the supply side. The closure of workplaces means that we’re unable to provide many goods and services, and in some cases we’re seeing the vulnerability of complex international supply chains. (Please see the Wall Street Journal, “After Face Masks, Should We Worry About Food?”

Market Effect

During the Great Depression, between 1929 and 1932 the market lost 90% of its value; and after the 2008 Financial Crisis the Dow fell from its October 2007 peak of 14,164 to 6,594 in March 2009. Through March 2020 the S&P (a measure of the stock performance of 500 large companies) had its worst quarter since 2008, with a decline of 20% and the Dow fell 23%.

The Shiller P/E Ratio (or CAPE) is used to gauge whether a stock is undervalued or overvalued by comparing its inflation adjusted historical earnings record. The historical average (since 1926) is 18.25, with a high of over 40 during the 1990s Dot Com bubble. Today we’re seeing 26, meaning that stocks are far from cheap, and to put that in context, in 2009 it bottomed at 13. It’s also fair to anticipate continued volatility, sharp declines in earnings in under-performing industries, and related falls in share prices.

Quarterly sales in many industries will be negatively impacted, with the Economist predicting, “In this downturn, 50% will be common, as high streets become ghost towns and factories are shut.”  The author also clarifies that global oil demand has dropped by a third, and automobiles and parts shipped on railroads has fallen 70%. Downward revisions to quarterly earnings feel inevitable.

On the fixed income side there has been an understandable “rush to cash”, as the treasury yield curve indicates that investors have sought short-term T-Bills. Similarly, in February and March investors sold off $80 billion in emerging market stocks and bonds, and “The sell-off in emerging market currencies over the past four weeks has been one of the sharpest on record, matching the pace of depreciation during the 2008 global financial crisis, according to JPMorgan”

Small Business

These market changes have been particularly challenging for small business owners. From complete shut-downs to lay-offs, from a drop in sales to the emergency loan programs – it’s been difficult. First, no one knows how long it will take to achieve a drop in U.S. Coronavirus cases, with estimates ranging from weeks to months. That difference will be significant for the economy. The longer the Stay Home orders continue, the more severe the impacts.

According to McKinsey, a consultancy, small and mid-sized businesses (SMBs) account for 44% of the U.S. economy and employ 59 million people; and 60% of recent SMB survey respondents indicated that their business has been affected by COVID-19. The U.S. Chamber of Commerce has found that 54% of SMBs, those which are not sole proprietors, are either closed or expected to close.

These impacts are in three areas. First, the effects that are already playing out. Those businesses which have been most impacted include retail trade, leisure and hospitality, non-essential health care, as well as arts, entertainment and recreation. The most impacted businesses have already furloughed employees, and reduced purchasing. As owners anticipate cash shortfalls, and apply for emergency financing (see below), they are rightly conserving as much cash as possible to avoid insolvency.

Second, as these restrictions take hold there are predictable implications. Suppliers of those shuttered will increasingly become affected. The unemployment figures provide a good gauge as to the sectors most impacted, and we can anticipate further B2B impacts for supply chain partners including wholesalers and distributors, importers and manufacturers. Shortages and border controls may exacerbate the issue and create new inefficiencies. Also, banks and commercial property firms leasing real estate will come under pressure. Those businesses that are reliant on project-based investment will be vulnerable to losses in new orders, effecting firms in construction as well as business and professional services. To some extent, this effect could be muted through government investment in infrastructure.

Third, the lifting of closures will take place in different states in different ways. We anticipate staged re-openings as people first return to workplaces, and later to public events and recreational activities. In the longer-term we anticipate a re-thinking of global supply chains, and government determinations of those industries considered strategic to the state. Firms seeking greater resiliency will start to accept inefficiencies through the diversification of suppliers. There could also easily be a consolidation in technology-based industries, particularly in those segments of the economy that have proved valuable in the pandemic. Connective technologies that have facilitated online shopping, distance working, and financial transactions will be most attractive. Smaller ventures in these spaces could seek mergers to defend against larger rivals, and cash rich Private Equity firms could easily go shopping for related post-pandemic, under-valued assets.

Emergency Finance

There has been a surge in applications for the loan programs offered through the Small Business Administration. In 2019 there were approximately 60,000 loan applications, and last week there were 500,000 or 8X as many. Naturally, the volume creates bottlenecks as officials and underwriters work to address demand. A recent CNCB piece also highlighted the need for banks to loosen credit requirements to close emergency loans, and reported that “there’s going to be a lot of issues and there’s going to be a lot of people laid off and a lot of companies that go out of business.”  

The re-opening of businesses, when it occurs, will feature some important dynamics. These are worth considering for new business opportunities:

• Essential industries will continue to be top priority – essential health care, food, housing;
• Increasing infrastructure spending will create opportunities for construction-based contractors;
• Less densely populated states will be first to lift restrictions, and people will slowly return to work, then to leisure activities (particularly those outdoors and deemed less risky); and
• Government contracts will continue, as federal agencies bolster defense, data security, energy and transportation.

For the small business owner, conserving cash is all about survival. Continue to cut costs, and manage the budget. There are a range of small business loan programs, including: the Economic Injury Disaster Loans (EIDL), Paycheck Protection Program (PPP), SBA Bridge Loans, and the Small Business Debt Relief program. These programs are a not a given, but they are worth exploring with your banker.

Other opportunities from crowd-funding sites include COVID-19 programs at Kiva, EnrichHER, WeFunder and Kickstarter.

Preparation for these programs and for their underwriters will include:

1. Construct the cash budget – reducing costs and making the cash last as long as possible.
2. Negotiate longer repayment terms on payables.
3. Research opportunities to defer tax payments.
4. Project sales in three scenarios – an optimistic one such as a May 15th re-opening with a full return to 2019 sales levels,  a base case which calculates a June 1st re-opening along with a  reduction in sales based on historic experience of a past recession, and a third pessimistic case with a later a re-opening as well as the sales reduction.
5. Approach receivables carefully, and consider requests for early payment from larger customers and consider factor financing.
6. Prepare a list of all assets and liabilities (Balance Sheet) for your business, and be prepared to discuss personal assets, non-business liabilities and additional sources of income.

Now What?

Join us on the next's Zoom Meeting when we’ll discuss preparing for a loan application, and how small business owners should conserve cash.

• Thursdays in April from 12pm – 1pm
• For more information, please visit: www.meetup.com/1MCRVA

If you have any specific questions, please feel free to email me: [email protected]