Fun While It Lasted

Someday, the '90s may look like a fleeting golden age for small business

Small business is hot. But the very notion raises the question: Suppose, for a moment, that today's entrepreneurial bliss is really a just a fad--an aberration fueled by foolhardy youth and reckless investors? The results might read something like this frontier story from Mar. 29, 2003:

Moping through the empty halls of her defunct Salt Lake City environmental firm, Susan Smithson launches into a rant. "I never saw it coming," says the research chemist, who founded her once-$12 million company in early 1999 at the height of the entrepreneurial golden age.

For thousands of business owners like Smithson, the financial shock that began a year ago has triggered a brutal pileup. Hardest hit have been members of the so-called Gilded Generation. This flock of young business founders swaggered through the booming '90s, never learning to cope with hard times. "Our last recession? I didn't even have a driver's license yet," says Smithson, 29. Not so coincidentally, she has traded in her Range Rover for a Mitsubishi.

How did the economy's wheels fall off so suddenly? In reality, it was a gradual weakening. Four main causes have so far emerged: The effects of wage inflation picked up in late 2000, despite a series of rate hikes by the Federal Reserve. Overeager banks kept lending to consumers and businesses already buried in debt. The Internet bubble burst violently with Amazon's surprise decision last month to dismantle its online department store. And behind it all: three years of hypercompetition unleashed by the Web, in which big and small companies invaded one another's turf, zapping small businesses' profits.

It makes conditions at the turn of the century seem even more remarkable. Standard lending rates, on the rise since late 2000, have topped 11.5% after the Fed's fourth inflation-fighting rate hike in 12 months. Bankers, who pushed lower rates and relaxed standards during the 1990s, have now tightened their credit standards. The unspoken fear is an onslaught of defaults, especially by small companies that as early as 1998 were leveraging an astounding 75% of the value of their businesses.

Could a full-blown credit crunch be in the wings? If so, the dazed Smithson appears to be one of the earliest victims. Just six weeks into the downturn, Smithson's bank pulled the $2 million credit line she had used to fund payroll for 22 high-wage employees. The reason: As a service business typical of the New Economy's knowledge-based companies, her firm had no collateral to offer. "The big banks always squeeze out the small-business lending first," says Guy Kawasaki, the former online financial guru and now district vice-president for a California credit union. "Twenty years ago, you could buy more time, because you had assets. But what's 20 PCs and a couple of chairs going to get you?"

The bad vibes are even worse across the West in Silicon Valley, once the center of Internet speculation. Some 120 Net-based companies have closed shop since last month's so-called Game Over stock crash, when 85% of publicly traded Net stocks hit all-time lows. "We all knew there were huge bets on the table," says one Valley investor. "But we didn't expect to lose them all at once." Amazon's abrupt announcement is also forcing a sudden reshaping of the Valley's--and by extension, the country's--fearless entrepreneurialism. Already, six large companies control 79% of the Web's total commercial traffic, a number that has risen steadily ever since the America Online-CBS/Viacom merger in 2001. On Tuesday, Commerce Secretary Steven A. Ballmer riled an Austin entrepreneurs' group when he declared that the race to control the Internet is "over and done with. And the little guys have lost."

The Internet may not be the only place they'll lose. Venture capital in all sectors is running at just 30% of last year's levels. Citi-Merrill says it's seeing a surge of new resumes from former employees who left to bootstrap their own companies. Indeed, entrepreneurs' prospects seem less glamorous than they did in February, 1999. That's when Smithson opened her company with a sushi-and-champagne bash. "That night, I was living my generation's dream," she says. This latest shock will certainly not spell the end of America's entrepreneurs, but after a decade on the hero's pedestal, it plants their feet back on the earth.

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