December 2010

Moderator: Welcome to the Federal Reserve Bank of Atlanta's Small Business podcast series. I'm Alfreda Norman, assistant vice president and community affairs officer with the Federal Reserve Bank of Dallas. Today we're talking with Dr. Lisa Servon, professor with Milano the New School for Management and Urban Policy.

Creating effective policy responses to the sweeping foreclosure crisis and economic recession of the past two years has been complicated by both the diversity of the affected communities and the wide range of issues demanding attention. One point of consensus appears to be that the growth and retention of small and young businesses represents a vital component of local economic development and recovery. In this podcast, we will discuss the effect of the economic crisis and small business challenges on local communities, as well as what local agencies are doing to promote economic development in their communities in a time of financial constraint.

Dr. Lisa Servon served for two years as the dean of Milano the New School for Management and Urban Policy, where she has been a professor since 2001. Dr. Servon teaches and conducts research in the areas of urban poverty, community development, economic development, and issues of gender and race. Milano the New School for Management and Urban Policy is a graduate school dedicated to encouraging creative thinking and research in the public, private, and nonprofit areas.

Dr. Servon, thank you for joining me today.

Lisa Servon: It's really great to be here. Thanks for having me.

Moderator: Promoting entrepreneurship and small business development is being hailed at the federal and state level as one way out of the country's recent economic recession. What role do small businesses play at the local level in growing and sustaining a community's economic development, especially jobs?

Servon: That's a really good question, and I think when we look at what's happened in previous recessions, we often see that small businesses are one of the kind of engines that help get us out of the recession. They create a lot of jobs, they employ a lot of people, and for that reason, it's really important to think about how we can support them at this moment. Now, a lot of people are saying that this recession is different from previous ones in many ways, but I think that, regardless, small businesses have always been an engine of creative ideas and innovation, and many of those small businesses—while people often think about the failure rate of small businesses—many of those small businesses also grow up to be big businesses. And so, it is very important to think about what we need to do now to make sure that that sector is healthy and strong.

Moderator: There has been considerable discussion in financial circles around small business access to credit, without which many small companies cannot purchase inventory or hire and expand operations. What are some of the challenges small businesses have faced in the past couple of years in accessing credit, and how is this environment different from five years ago?

Servon: I think the first thing to think about is what do we mean when we talk about small business? And people tend to define that quite differently. Just to put a little bit of a frame on that for our conversation, my research has focused mostly on businesses with 20 or fewer employees, but some people go as high as saying 200 or fewer employees.

Some of the problems are the same, but some are different. Small businesses, which have always had some trouble—especially if they are new, they can't demonstrate performance and past success—they've had a harder time accessing credit. That's gotten tighter in the last couple of years in a couple of ways. One is that, whereas in the past, small business lending was often based on relationships as well as things like small business credit scoring, the relationship aspect of it has contracted. So, those who are lending to small businesses are using stricter criteria, which makes it harder for the small businesses to get credit. And at the same time, what we are seeing is that even the businesses that have had successful loans in the past are having a hard time reborrowing. Many of those businesses have had declining sales or revenues over the past two years, so of course that's a red flag for lenders.

Another challenge that they faced is that, whereas in the past it was kind of common practice for a business that used suppliers to get 30, 60, 90 days to pay their suppliers, everybody is more nervous in this market and in this economy, and so suppliers are now asking businesses to pay up front for their supplies. So, in some ways, that was a kind of informal credit, that they were getting a loan in a sense; they could use those supplies, sell the product. And so, it's kind of creating this downward spiral, this domino effect.

I would say the third piece that's hard is that people have often used the equity in their homes to finance their businesses. Equity in homes and also loans from friends and family have been two of the primary sources of capital for small businesses. So, now you have a lot of people who don't have the same kind of equity because of the collapse of the housing market, and people just having their network be a lot less reliable than it used to be. And so even going to friends and family for loans is not as stable a source of finance as it used to be.

Moderator: We often hear about the impact of current economic conditions on individual small businesses, but there's been relatively little discussion about the aggregate impacts on communities. What have been the effects of small business challenges and other challenges created by the economic crisis on local communities?

Servon: That's a good question, and I think a complex one. I mean, I think, almost anybody that's listening to this, certainly myself in the neighborhood that I live in in Brooklyn, you walk down the street and a lot of the mom-and-pop shops have closed. So, there's kind of a depressing effect on communities, where people can't get the, they don't have access to the goods and services that they use to get. Certainly the local jobs are drying up. And there's just kind of a challenge in the community being able to support those businesses.

Moderator: There are a variety of entities that support small business sustainability and growth, such as small business development centers, local and state economic development departments, community developing financial institutions, and Small Business Administration loans. What are examples of the most innovative or effective programs focused on small or young businesses being implemented to promote economic development in local communities?

Servon: Great question. I think that one of the most interesting components of this field are the CDFIs, you mentioned the community development financial institutions, and, in particular, microenterprise development organizations. We do have kind of a small and fragmented, but quite strong at the same time, sector of microenterprise programs here in the U.S. They provide loans often, and sometimes training to small businesses to help them get going and get started. Now, one of the issues that has been identified in the last few years is that, first of all, that set of institutions doesn't cover geographically everybody who needs to be covered. And then the other issue, though, is that, once you graduate from a microenterprise program, you might be able to take out as much as say $25,000—there's a gap between the highest loan that that organization will give and the smallest loan that a bank will give. So, between $25,000 or $50,000 and $100,000 is a gap, and it's often hard for the business to make the transition to a traditional financial institution like a bank.

So, going back to the notion of best practices or innovative ideas, there are several banks that are partnering with microenterprise programs to create what have been called "second look programs." So, let's say that you are an entrepreneur and you go into a bank, you want a loan for your business, you don't fit the criteria—rather than the bank simply saying, "I'm really sorry, it's not going to work. Come back when you have two years of growing sales receipts that you can show me," that bank might be partnering with a microenterprise organization. And, the loan officer will then call that organization, make the link, see if that organization would make the loan, and actually maybe even bring that customer through the bank to process the loan. So, the banker will end up getting some CRE credit, and that entrepreneur, if they are successful, may go to that bank and be a customer for the next loan.

Moderator: How can policymakers at the local and federal levels better support small businesses throughout the business life cycle, from start-up to development and growth?

Servon: Well, I think one of the ways is one that I just mentioned, which is thinking about how they can partner with the non-profit sector and maybe with banks. I think the public sector can really play a role in making those partnerships work. So, you know, I just mentioned second look programs, and in New York City, AXIO New York, which is a microenterprise development organization, and Chase Bank are partnering with the Department of Small Business Services, which is a New York City agency. And so, sometimes then there might not be as strong an incentive for that nonprofit and the bank to get together, they might not recognize what their mutual interests are, and then the public sector can really be the glue for putting those things together. I think they can also create some incentives for people to work together—for there to be, maybe, local clearinghouses of information. One of the things that I've noted in my own work with small entrepreneurs is that they often don't even know what the resources are that are available to them, either on the nonprofit side or the city side and certainly on the private sector side as well.

And then, finally, I would say that there are other kinds of loan products, tax credits, and things like that as well that the public sector can really try out at the local level, at the state level, and champion.

Moderator: Dr. Servon, thank you so much for joining us today.

Servon: Thank you. It's been a pleasure.

Moderator: This concludes our podcast. We've been speaking with Dr. Lisa Servon, professor at The New School of Management and Urban Policy.
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