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Small Businesses Face Big Odds in Fending Off Bankruptcy

Each year thousands of eager entrepreneurs set up fledgling companies and attempt to make a go of it. For the most part, we admire their ambition and perhaps wonder, “Why didn’t I think of that?” No matter how good the idea, though, small business owners face big challenges, and many end up in bankruptcy. 

Too many, say Richard Carter, professor of finance, and Howard Van Auken, professor of management. Hundreds businesses declare bankruptcy in Iowa each year.  “Iowa is a state of small companies,” Van Auken says. “We depend on them.”

Economics aside, these business failures could mean that a valuable service or innovative product won’t have the chance to succeed. “What if Microsoft had never made it out of the garage?” Carter asks. “By cutting a company off early, we might delay a medical breakthrough that could make a critical difference in people’s lives. If companies can’t get through that first stage, we all lose.”

To try to understand what small businesses need, Carter and Van Auken surveyed over 300 bankrupt and non-bankrupt firms and compared the results. The firms averaged five employees with less than $1 million in assets each. Compared to the solvent companies, the bankrupt firms were older (12 years on average), used the Internet less, and were more likely to be organized as sole proprietorships or partnerships.

The researchers found three factors that contributed to bankruptcy: lack of information, limited access to debt, and a poor economic climate. “We can help them with the information and debt factors,” Carter says. “And hopefully that will prepare them to handle stressful economic conditions.”

Getting information to firms so they can move forward is a major challenge, especially in a time of tight budgets and cuts to government resource programs for business. The bankrupt firms reported they felt left behind in using the Internet to conduct business and needed more knowledge, particularly in the areas of promotional strategy and pricing. “My personal experience is if you don’t dig out information, you’re not going to get it,” Carter says. “But we have to figure out a way to help business owners access information when they need it, so they can make good business decisions.”

Ken Craig (’78 Industrial Administration) is one business owner seeking help early on. Co-owner of Off-Campus Apparel and Novelties, with stores in Des Moines and Cedar Rapids, Craig called the College of Business after reading a Des Moines Register article about the bankruptcy study. Although not one of those surveyed, Craig recognized his firm’s need for assistance. “There’s help available for start-ups,” he says, “but once you get going and need help, information is hard to find.”

Craig and business partner Bob Sills (attended Iowa State‘72/’73) opened their store specializing in Iowa State and University of Iowa apparel in October 2001. “We had talked about it for years and made the decision while driving to the Insight.com bowl in Phoenix,” he recalls. So far, their business knowledge and backgrounds, combined with enthusiasm for their products, have made the business work. They added warehouse space in 2002, opened a store in Cedar Rapids in 2003, and this year opened a second store in the Des Moines area.

But the partners face pressing cash flow and inventory issues. “Most of our sales occur from August through December,” Craig explains. “We have enough income to offset expenses in the fall, but then we struggle from January to July, when we have to place our orders for the next season. It’s further complicated by state taxes and how they are assessed on businesses. I’ve been in the problem-solving business my entire professional life, helping other people fix problems, but now my business is at the stage where we need to evaluate our next steps.”

This fall, he’ll get some assistance from a class, Managing New Ventures (Mgmt 415), taught by Richard Smith, “The class will spend a semester doing business analysis,” Craig says. “It will give us a new perspective for looking at our situation in the marketplace.”

In their study, Carter and Van Auken found access to debt as another major concern for the bankrupt firms. This category includes problems with suppliers, availability of business loans, the high cost of borrowing, poor cash flow, and lack of capital to support business operations. “These business owners weren’t looking for handouts,” Carter stresses. “They wanted access to the normal sources of capital that financial markets provide, but creditors find them too high a risk.” One solution, he says, would be for the state to offer incentives to financial institutions. “Banks determine a cut-off point for the amount of risk they will accept. If that point could be adjusted to accept higher risk, more companies would be eligible for loans.”

For Carter, it comes back to the idea that small businesses deserve a chance to succeed. “I just think we should give all companies as much of an advantage to get off the ground as we can,” he says. “If they have poor management or a bad product, the market will eliminate them, but it’s a shame if they never get a chance to try.”