Among Small Business Owners, Signs of Hope

Karen Barnett can feel the thaw. The president and CEO of decal maker Valley Screen Process in Mishawaka, Ind., says that July orders from RV customers jumped 50% from the month before, albeit from a low base. And Barnett's push into new businesses, including advertising decal wraps for cars, is boosting revenues. But that's only after sales at her RV, vehicle, and boat decal company slid 33%, to $5.4 million, last year, and she says sales this year could be down an additional 10%. Numbers like that have forced Barnett, who took over the family business from her father in 1998, to halve her workforce, to 35 employees. But although she recently had to cut a few more office staffers, she also brought a couple of employees back to work in her plant. And she's hoping to bring two more back in the next month. "For the first time in over a year, I feel hopeful," Barnett says.

That's an increasingly common sentiment among business owners. After a year and a half of being pummeled by a worsening economy, small business leaders are beginning to sense things may have bottomed out. Still, few entrepreneurs are banking on a robust recovery. That caution means many are holding off on new spending and investment. Even those ready to shift into expansion mode may find that tight credit markets make it impossible. "There is a controlled sense of optimism," says Ryan Scully, director of Discover Business Card, the small business credit card put out by Discover Financial Services (DFS). "But I think many feel like it will still be tough for a while."

The monthly optimism index put out by the National Federation of Independent Business, which factors in how business owners view the economy, as well as their plans for hiring and investment, slipped one point in June, to 87.9, but has gained 6.9 points since a dismal March reading. The Discover Small Business Watch, the card company's monthly survey, also signaled rising confidence. Its optimism index, which looks for shifts in business outlook on economic conditions and business growth and spending, rose to 82.1 in July, from 80.9 in June. While half those surveyed by Discover still sense the economy is sliding, 30% said it's getting better, up from 26% a month earlier.

Many business owners say there seems to have been a small but important change in their customers' psychology, too. Peter Marczyk, president of Marczyk Fine Foods, a 28-person upscale grocer in Denver with $5 million in sales, says foot traffic in his store is up over the past few months. That is starting to translate into higher sales, and Marczyk says shoppers seem less worried than they were earlier in the year. "I don't hear a lot of doom and gloom from our customers," he says.

But such glimmers of hope don't mean the economic pain is ending. Small companies continue to tighten their belts when it comes to things like inventory and head count. According to the NFIB's monthly index, small outfits planning to cut inventory over the next three to six months outnumber those planning increases. Inventory cutting has been a major drag on the broad economy. And job cuts by small companies are continuing at a blinding pace. According to the ADP National Employment Report, a study based on data from the giant payroll processor, firms with fewer than 50 employees cut 177,000 jobs in June. That's down from a peak of 288,000 job cuts in March, and part of a 17-month string of job cuts.

Joel Prakken, chairman of St. Louis-based Macroeconomic Advisors, which does the ADP report, says inventories have been cut so dramatically that, when demand picks up a bit, "The production boost could be quite large." And Prakken figures that while job cuts will continue for a few more months, he expects small businesses will begin hiring again by early next year. Joseph Brusuelas, director at Moody's (MCO), agrees. "We had a complete panic at the end of 2008," Brusuelas says. "Firms cutting labor weren't just cutting the fat—they were cutting to the bone."

Most small businesses aren't opening their wallets just yet. The Discover Small Business Watch found 49% of those surveyed planned to cut business development spending over the next six months. That may be because this recession has been so much deeper and longer than previous downturns. Many worry the recovery will be different, too. David Broehm, president of Mid-State Bolt & Nut, a 35-person, $13 million maker of fasteners used in cars, furniture, and other products, says he saw sales drop 23% between last fall and early 2009. Since then, revenue at the Columbus (Ohio) company has bounced back about 10%—but Broehm isn't celebrating just yet. "We never fell this far in previous downturns," Broehm says. "And I don't think the economy will recover as fast as it did in past recessions, either." So while Broehm is exploring opening new branches to be closer to big customers, he says he'll wait until a robust recovery is under way.

Sherrie Soria, president of Mesa (Ariz.)-based La Poblana Food Machines, a five-person, $150,000-in-sales purveyor of tortilla-making equipment, is also treading lightly. Soria plans to add a new product line within the next year. If she were more confident in a strong recovery, Soria says, she'd do it sooner: "I'm not going to do anything while there is economic softness out there. I don't want to overextend."

Such wariness won't be the only restraint on small business expansion. Greenwich Associates, a Stamford (Conn.) financial-services research and consulting firm, found in July that almost 70% of small outfits surveyed reported their access to credit is more limited than it was a year ago. Steven Busby, Greenwich's managing director, says tight credit could hamper a recovery. "The runway will be a lot shorter" for small companies trying to make it, Busby says. "Even those businesses that have strong growth potential are at a greater risk of not succeeding." It's no surprise, then, that the Small Business Administration estimates that 595,600 businesses with employees (most of them small companies) failed in 2008, up from 571,300 in 2007.

Even growth companies are feeling the squeeze. Michael Franco, CEO of MicroBlade, a Madison (Wis.) maker of compact, energy-efficient servers, says sales are on track to grow fourfold this year, from $560,000 in 2008. Franco says he could expand even faster if he could hire more sales staff and invest more in marketing. But he says venture capitalists aren't doing many new deals, and banks want hard assets as loan collateral—something MicroBlade lacks. "We just have to accept a slower growth rate," Franco says. If credit remains shut off to more businesses like his, the U.S. economy may have to settle for less growth as well.

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