How Congress can flatten the curve for small business

We’ve all come to learn the imperative of “flattening the curve” in recent weeks — slowing the spread of the coronavirus to avoid overwhelming our healthcare system. While the concept derives from epidemiology, the present effort to rescue our nation’s small businesses can benefit from its insight.

Every empty sidewalk makes clear that the coronavirus has foisted a massive spike of losses onto small firms nationwide. Congress has recognized the scale of the challenge, authorizing a new $367 billion small business loan program. Yet, as structured, the businesses that most need help may be least able to participate.

The recently passed stimulus offers a heavily discounted loan to nearly every small business in the country. But there’s a catch: The business must first find a bank willing to lend it the money. For firms fortunate to remain steady through the crisis, this will be a welcome boost. For those businesses that have been forced to shutter, it’s an awfully tough assignment.

Flattening the curve would suggest we pursue an additional approach — providing rapid, intensive care to save companies on the precipice today, even as we extend broader stimulus to others. Of the nation’s 6 million small businesses, a sector analysis indicates that slightly less than half will need to curtail much or all of their operations in a shutdown. These include firms in the most visibly affected industries such as restaurants, retailing, and tourism, as well as related fields such as distribution and manufacturing if production is impeded. The aggregate effect is enormous — in 2017, small businesses in these sectors employed 30 million people with a payroll exceeding $1.2 trillion.

But not all small businesses will close their doors, and not all are on the brink. Lawyers, accountants, and most other professional firms continue to operate, albeit remotely. Demand for veterinary clinics and auto repair shops endures. And, while it would be no one’s wish, some firms focused on healthcare and basic goods may see growth. Firms like these comprise the other half of small businesses. They are no doubt pressured by this crisis, but they remain profitable and do not face the imminent peril of their peers.

Fortunately, there is a near-term, straightforward solution.

In addition to the stimulus bill, Congress should separately authorize a tax rebate for small businesses equal to the losses they incur this quarter, payable immediately and continuing in subsequent quarters as needed. For businesses that are closed and unable to generate revenues, this cash rebate will enable them to continue to pay their employees and expenses. For those businesses that have seen more modest impacts, the amount will be proportionately less. At the end of the year, if the business has returned to profitability, the government can recoup the difference.

To be effective, these payments must carry robust guardrails. The total rebate amount should be limited to the income taxes paid by a business (or for a passthrough or new entity, its owners) over a historical period, say 10 years. Those businesses that are structurally unprofitable or have avoided their prior tax obligations would need to find help elsewhere. Rebates covering the compensation of owners and other highly-paid employees should be capped at a reasonable amount, as should increases in a firm’s overall cost structure. And, consistent with the current plan, companies should be required to maintain their payrolls throughout.

Businesses that incur losses because they are shuttered generally need to replace those funds with equity, which a tax rebate provides. Based on industry-level data compiled by the Risk Management Association, companies in the most likely-affected sectors maintain profit margins averaging 8 percent of revenues. Put another way, a single month’s expenses are roughly equivalent to a full year of earnings for these firms. The current stimulus includes partial loan forgiveness for two months of payroll. A tax rebate would be complementary — firms also have overhead and existing loans to pay, and many will take more time to recover. As well, because the rebate would apply only to losses, the two programs could work in tandem. By contrast, adding more debt that amounts to years worth of earnings creates an unsustainable burden.

Many small businesses struggled to obtain bank financing before the current crisis. Even fewer will qualify now that their condition is more tenuous. While the government has said it will guarantee these new loans, lenders know that such guarantees are contingent and the government may later refuse to pay in full (an event euphemistically called “repairing” the guarantee). In addition, because the proposed loan forgiveness is both partial and conditional, banks cannot calculate upfront how much debt the business will ultimately carry. With these uncertainties, lenders may well focus their efforts on the safest bets, rather than those firms most in need of assistance.

Moreover, the loan program’s complex structure — with its mixture of guarantees, conditional forgiveness, and third-party origination — will take time to implement. The loan program’s infrastructure rests on an existing Small Business Administration program, known as “7(a)”, that is well-regarded, though operates at a fraction of the contemplated scale. In 2019, the 7(a) program processed an average of $2 billion in loans per month. Published 7(a) program data shows that 70 percent of banks in the country made no 7(a) loans at all last year; of the banks that did, half made less than five loans each. Most banks do not have systems in place to verify employer payrolls as the loan program requires, or to calculate loan forgiveness based on these amounts. Even with added capacity, borrowers with urgent cash needs may find themselves caught in lengthy queues — possibly for longer than they can afford to wait.

Flattening the curve isn’t about curing the disease, it’s about limiting the initial damage to improve overall survival. Government-backed loans are a critical component of a broader economic stimulus, and banks have an essential role to play. But loans, even if discounted, will not resuscitate many companies forced to close through no fault of their own. Offering small businesses direct relief through cash refunds provides them with what they need right now — a flattened financial curve that allows them to persevere today through to a brighter recovery tomorrow.

Jason Tepperman served as the Director of the U.S. Treasury’s Small Business Lending Fund from 2010 to 2014. He currently is Managing Director of PLC Fund Advisors, LLC, a specialized small business lender. He holds an MBA with Distinction from Harvard Business School and a bachelors with honors in computer science and ethics, politics, & economics from Yale University.