Why it's too hard to start a new business - small business capital

Washington Monthly, March, 1994 by Jon Meacham

Liberals and conservatives alike must concede points that each hold dear to solve this. Liberals need to recognize that sometimes the best thing government can do is to get out of the way. Some regulations, no matter how noble-sounding, cost too much for small businesses to handle. Some taxes and paperwork are simply too burdensome.

But conservatives, too, need to give up their automatic assumption that the free market always works--that on a level playing field, people who are diligent enough and smart enough will win. The problem is that the playing field is not level right now; lots of good ideas never get a fair hearing (the agreed-on figure in venture capital circles is that one out of every 1 O0 plausible deals gets funded). And government, in many cases, can be the best means of removing the obstacles which keep entrepreneurs from credit and capital. In short, creating small businesses (a slippery term, but basically ranging from businesses straggling to open to firms with 100 employees) challenges the shibboleths of left and right and requires thinking about government and the market in ways that do not fit neatly into party platforms.

Capital Punishment

Historically, half of small business credit has come from banks. But banking regulations have been increasing since the late eighties, when the S&L industry collapsed and banks were failing at unprecedented rates. (From 1940 to 1980, an average of five banks a year closed; from 1985 to 1990, about 200 a year failed.) In 1993, Arthur Andersen and National Small Business United found that small businessmen reporting trouble with their banks were twice as likely to cite too many regulations as the problem than they were to say the bank wasn't interested in their idea.

Both the Federal Reserve and the private Center for Entrepreneurial Management estimate that the average small business loan is $25,000 to $50,000. Yet when the 1989 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) passed, regulators went overboard, requiting extensive paperwork on all loans, which makes it just as expensive to make a small loan as it is to process a multimillion-dollar one. Instead of concentrating their examinations on big dollar deals where losses could be greater and there might be banker-client corruption, regulators are wrongly spending a lot of time worrying over small loans where the chance of a bank's customers getting ripped off is minimal.

Before 1989, for example, to make small lending easier, bankers would simply take a "blanket lien" on a small borrower's assets and base the credit decision on cash flow and other business factors. Banks may already have been tight with loans, but the 1989 act turned conservatism into frigidity. The law required, for instance, a 14-point certified appraisal of all property proposed as collateral on loans over $100,000, at a cost of $2,500 to $10,000. That's enough to snuff an entire deal. One Pennsylvania entrepreneur needed $120,000 to build a pre-fabricated office building. The bank decided to make the loan, but FIRREA required a $3,500 appraisal. It was too much, and the customer walked.