California's State of Uncertainty

As Governor Schwarzenegger attempts to lighten regulatory burdens on small businesses, some entrepreneurs aren't sticking around

In 1947, Hoyt Buck moved to California and started a business that turned worn-out metal files into first-class blades. Over the next half century, as Buck Knives was handed from father to son, and the workforce grew to 270 employees, the brand became a favorite with hunters the world over -- and, in its own small way, something of a symbol for the entrepreneurial spirit and ingenuity that has always inspired California's economy.

Now, with the San Diego outfit's recent announcement that it will be moving its factory and headquarters to Post Falls, Idaho, by 2005, it has become an emblem of another trend: businesses quitting the Golden State to escape what its current president, C.J. Buck, describes as unfair regulatory burdens on small businesses (for a Q&A with Buck, see "Idaho Beckons a Golden State Warrior").

"The first year in Idaho, we're going to save over $500,000 in workers' compensation -- kaboom! -- just for being someplace else," says Buck. "We can save over 60% on our utilities bill [which have run as high as $70,000 a month] by moving to Idaho. We are anticipating that it's going to take less than a year for our moving costs to be offset by [bottom line] improvements."


  To many of California's small-business owners, Buck's logic rings all too true. What's the point, they ask, in staying in a state where legislators and regulators have made it increasingly difficult to turn a profit? The nation's highest workers'-compensation costs top their list of complaints, and no wonder -- they have tripled over just the past three years.

After that, as BusinessWeek Online learned during an informal survey of California's would-be entrepreneurial refugees, it's the impact of unstable energy prices, which business owners claim make it next to impossible to plan for the future. Start with those headaches, add the impact of environmental regulations, antidiscrimination laws, and other measures, and you have what one California business owner termed "the death of a thousand cuts."

When Buck Knives packs up and heads for the state line, it won't be the first. Nor is it likely to be the last -- a major worry for new Governor Arnold Schwarzenegger, who was sworn in Nov. 17 and must now find a way to halt the exodus. Strongly supported by California's business community, Schwarzenegger has his work cut out, given that he will have to cope with a legislature dominated by Democrats still seething at what they see as the underhanded recall initiative that prompted the ouster of former Governor Gray Davis.


  In 2003, California ranked 46th on the Small Business Survival Committee's (SBSC) yearly Survival Index, a state-by-state comparison that charts the relative difficulties entrepreneurs face. While workers'-comp costs and energy uncertainties led entrepreneurs' gripes, the state did rate fairly well on health-care costs. Good news? Not for long. The ink on the SBSC's September report was hardly dry when Davis signed a health-care bill that will soon oblige small businesses to cover 80% of their employees' insurance premiums.

Though statistical confirmation of a mass exodus across state lines is hard to come by, a wealth of anecdotal evidence suggests just such a trend. Of the small-business advocates and experts who discussed California's business climate while this report was being prepared, every single one could name at least a few businesses preparing to strike out for greener, less regulated pastures.

One example: Jack Kyser, chief economist for the Los Angeles County Economic Development Corp., needed only a second's thought before rattling off the names of nine businesses that he said were either pulling up stakes or thinking seriously of doing so. As he noted, those names also represent roughly 1,100 employees -- people who will no longer be paying state taxes or supporting local economies with their paychecks.


  Existing businesses moving out of state may not be California's biggest problem, however. Business owners simply shutting down may prove to be an even bigger trend. As Bruce Phillips, a senior economist at the National Federation of Independent Business, explains it, many mom-and-pops have no choice. "These are local, community-based people," he notes. "They have kids in schools, and their clients and customers are local. They're not going to run to Idaho and Montana -- local retailers and service businesses can't move that easily."

While small manufacturers and service providers -- with, say, 100 employees -- might move operations out of the state, Phillips is far more concerned about potential entrepreneurs not opening businesses. He cites both census figures, which show that California's population shrank by over 100,000 in 2003, and a Small Business Administration report that shows a three-year decline in business creation in California. "That's clearly not a good harbinger for the state," says Phillips. "Basically, if the number of new firms coming online is not great enough to cover the ones that are shutting down, that means there's a net loss in the number of small businesses in California. Period."

Gus Annan, owner of five Hungry Howie's Pizza franchises in Clovis, near Fresno, emphatically agrees. His restaurants now employ between 60 and 70 people, and until recently, he had planned to open new stores at five fresh locations. That expansion would have doubled his workforce, but he says the recent increases in workers' comp made him scrap those plans. Says Annan: "We were doing good until our workers' comp quadrupled, and our energy costs tripled."


  Even though businesses with fewer than 100 employees won't be required to pay for employees' health-care coverage until 2005, Annan's back-of-the-envelope estimate is that costs from this initiative alone might easily have put him out of business, even if he had gone ahead with plans to open just two new outlets. "Let's say I have 60 employees," he begins. "That means I have to come up with $130,000 more per year. That means I have to sell $1.3 million to $1.4 million more food to get the $130,000 -- and that's impossible. I would love to talk to the politicians who made up these laws and have them explain to me how I'm supposed to come up with this sort of money."

Annan and others are encouraged by the initial days of the Schwarzenegger Administration -- actually, make that minutes, because that was how long it took the former Hollywood superstar to sign an executive order revoking the recently passed car tax, a law hated by businesses that rely on deliveries. His next move was to call for a special session of the legislature and demand that it drastically reform and reduce the newly introduced workers'-comp coverage.

The first obstacle Schwarzenegger faces is also the most obvious. He's a lone reformer, and the very same legislators to whom he's appealing are the same ones who supported the measures he's now calling on them to repudiate.


  Add to that the stiff opposition of the state's labor unions, some of California's most powerful and politically active special-interest groups, and the task becomes even more problematic. According to economist Kyser, one reason the unions supported the initiative to make employers pick up 80% of health-care premiums was a desire to make union employers, contractually obligated to provide health coverage, more competitive with nonunion shops. A union spokesman dismissed Kyser's observation, saying simply that all working people deserve health coverage.

Until now, while Schwarzenegger has yet to reveal his strategy for overcoming these political obstacles, it's clear from the governor's success on the stump that he can make effective use of the bully pulpit -- and some evidence also shows, too, that Californians favor of some changes Schwarzenegger is advocating. The California Chamber of Commerce, now trying to mount a referendum aimed at repealing the health-care initiative, conducted a survey that found a majority in favor of repealing that law. It also stands to reason that Californians wouldn't have voted to recall Davis if they weren't hungry for change.

On the other side is the question of the extent to which the state's residents feel reforms need to go. The fact of the matter is that all of California's recent economic troubles have taken place during a nationwide recession, which hit the state's bellwether industries especially hard. Schwarzenegger's opponents argue that the bursting of the dot-com bubble is the real reason for the slower business-formation rate, not those legislative initiatives that business leaders love to hate.


  Whatever the answer, as C.J. Buck sees it, Californians have some bitter pills to swallow if they're to retain businesses that, unlike his, have not yet made up their minds about leaving. "These antibusiness initiatives aren't [the work of] people trying to be unfriendly to business," he concedes, adding: "They're laws trying to make people's lives better, so there's a very positive intent. But the ugly reality is that everybody is in competition. California is in competition with other states and other countries. So you just can't be doing these nice things that push California over that competitive edge."

So, how close is California to the edge, and how far can it fall? Buck agrees that those questions invite speculation and debate but in the meantime he and his business aren't hanging around to wait for any answers.

By Edward Popper in New York

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