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Entrepreneurs, Fasten Your Seat Belts

What's the outlook for small companies in the coming downturn? It's no idle question since they contribute about half of all U.S. business profits. The answer, in a word, is "awful." But if economic history is any guide, it may not be quite as awful as everyone expects.

Make no mistake, it's going to be rough: Entrepreneurs, even the ones nowhere near Ground Zero in New York, are telling BusinessWeek Online that orders began to dry up after September 11. Indeed, a survey by National Federation of Independent Business (NFIB) says confidence among its 600,000 members fell after the attack to its lowest level since 1993, with expectations for hiring, capital spending, business conditions, and sales all plunging after the attacks.

WAITING AND PRAYING. Among those affected: Mary Jo Blythe, president of MasterPlan Inc., a meeting planning company based outside Chicago. She was running an event in France when the attack hit. By the time Blythe made her way home on Sept. 18, nearly all her events for the coming weeks were canceled, slicing 10% off her annual revenue, and attendance at the remaining ones fell by half. Even more worrisome is that bookings for the first quarter of 2002 have been close to nil. She's wondering if she can avoid layoffs from her staff of 8 employees and 25 contractors. Says Blythe: "If there's another incident, that's really going to hurt us."

The gloom and doom is a sharp break from the unflagging optimism that usually prevails at small companies. Data from the Bureau of Economic Analysis shows that, from 1950 to 1998, annualized noncorporate nonfarm income -- which includes unincorporated firms, sole proprietors, partnerships, doctors, lawyers, and self-employed workers -- has fallen in only 8 quarters, vs. more than 50 quarters for corporate income. (see chart below)

What's more, the downturns in the noncorporate sector have been milder and shorter, acting as a shock absorber for the rest of the economy. For instance, Corporate America's annualized profits have posted double-digit declines in 17 quarters during the last 50 years. Non-corporate profits did that just once -- in the second quarter of 1982, when they declined 10.7%. (The sector doesn't include S corporations, but economists say the results with them would be similar.)

BIG VS. SMALL. Why the difference in performance? It's not necessarily because small companies are superior. Some of it is cyclical, say economists: When people lose their corporate jobs, they go out and start a business -- which boosts the non-corporate figure -- and then return to the work force when times get better.

Also, small companies tend to be in the service sector, which uses less capital and has less volatile earnings than manufacturers, says David Wyss, economist at Standard & Poor's Corp. (which, like BusinessWeek, is owned by The McGraw-Hill Companies.) Even in bad times, notes Bruce Phillips, former research director at the Small Business Administration and now an NFIB consultant, people still need a barber to get haircuts or an estate lawyer when someone dies.

But the key difference everyone agrees on is flexibility: Small businesses are closer to their customers. They learn about changing market conditions sooner, and because their organizations are smaller, they can react faster. Remember Blythe? She's looking at adding event-cancellation insurance. If customers are still too nervous, MasterPlan will offer its videoconferencing service. "It's kind of a sellout," Blythe says ruefully, noting that she's supposed to promote travel. "But we're ready with that product if they don't want to go."

MORE SUPPORT NEEDED. To be sure, this consistent track record can't prop up the economy all by itself. "Is this going to prevent a recession? No," says John Puchalla, an economist at Moody's Investor Service. But many entrepreneurs went into September in a strong position to ride it out: The Federal Reserve estimates that noncorporate profits were still rising more than 4% annually during the second quarter, even as corporate profits fell almost 15%, and cash continued to pile up at a healthy pace.

Meanwhile, the NFIB reports debt levels were relatively low in September and loan rates were plunging toward the 8% mark. Yes, entrepreneurs will have to struggle and thousands of individual companies will fail in the coming months. But if history repeats, the remaining 20 million small businesses in this sector may provide some stability for a shell-shocked economy.

By Rick Green in New York

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