LOS ANGELES -- Bank of America Corp., under pressure to raise capital and cut risks, is severing lines of credit to some small-business owners who have used them to stay afloat.
The Charlotte, N.C., bank is demanding that these customers pay off their credit line balances all at once instead of making monthly payments. If they can't pay in full, they are being offered new repayment plans for as long as five years, but with far higher interest rates than their original credit lines had.
I have repeatedly warned small businesses of this risk and am almost-universally laughed off.
Folks, this is personal experience speaking here. In the early 1990s I had a very good friend who ran a small manufacturing outfit for highly-proprietary, very expensive devices. Nice stuff, good quality, good guy. Straight-up no-BS dude. He had an operating line from the bank where he had done business for 20 years.
One day he got a phone call: His credit line was being pulled.
He had never been late, business was fine, his financials were ok, he had no problems with trades, making payments on time, taxes or anything else. The bank simply needed to reduce its portfolio and he was "it."
He was done overnight. Literally.
When I ran MCSNet I had our bankers literally pawing me every time I went in the place or talked to them about anything. They were constantly trying to get me to take an operating line of credit along with whatever other facility they were pushing this day or that. They knew damn well that we had a hell of money in their bank and what our gross receipts were like, since they literally saw them on a daily basis. They knew what our payroll was too since they cashed the checks and took the tax deposits (this was before EFPTS online; tax deposits were made with coupons at the bank.)
Several times over the years I looked at their loan commitment paperwork. In every single case I found some term or combination of terms that would allow them to yank that credit line any time they wanted.
I was always assured that "they'd never do that" but in the end that's crap -- they both could under the contract and I assumed they would if for any reason they felt it was to their advantage to do so.
I never borrowed a nickel.
One such customer, Babak Zahabizadeh, was told in a letter that the $96,000 debt carried by his Burbank messenger service must be repaid Jan. 25. A loan officer offered multiple alternatives over the phone that Zahabizadeh called unaffordable, including paying off the debt at 12 percent interest over two years. That's about $4,500 a month, nearly 10 times his current interest-only payment.
Bluntly: Babak is a fool. He got in debt far enough that he couldn't pay it off immediately. And if he could pay it off immediately why take the loan in the first place? There's no reason to -- the interest, even if low, is an operating cost you don't need to pay!
"If small businesses are going to lead the way out of the economic doldrums we now face in this country, they must have access to capital, not only to hire more people but to protect the jobs they are currently providing," Hauge said.
Small business can only lead the way out and is only viable if it can generate enough cash flow and operating profit to expand on the merits.
Doing so on credit is a gamble and you're gambling with other people's money.
MCSNet, as an Internet company, was in the unenviable position of having to roll over our technology about every 18 months. This was insanely capital-intensive and what's worse is that IRS depreciation rules meant we had hardware on the books long after it had any economic value at all. As a consequence any material error in vendor or product selection during one of those replacement cycles and we were done.
That risk belonged properly to the shareholders and, as the majority shareholder, that meant the risk was in large part mine. I took that execution risk with the operating capital of the firm and did so in a form and fashion that allowed us to rebuild that capital and have the ability to make those investments as required to grow the business. A proper business plan, which you damn well ought to have drawn before you open the doors and which you should keep updated, will show you whether what you intend to do at the outset has a decent probability of actually working without using this sort of leverage and taking the risk of having the rug pulled out from under you.
Most small businesses do not write such plans and do not keep them updated. This is a critical error and when you compound it by taking on leverage that you cannot get rid of on short (or no!) notice when your line gets yanked you find yourself utterly and completely screwed.
Let me reiterate: The reliance on "credit" as opposed to capital is a critical error in small business planning, and indeed in business planning of all sorts.
This is an inherently-unstable paradigm and we must abandon it!
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