If anything, CIT Group’s close brush with bankruptcy last week revealed the precarious state of small business lending in the current recession and how vulnerable the franchise industry is to any further dislocations of credit.
More than a few Dunkin’ Donuts shops and Papa John’s pizza parlors are at stake. As the franchise industry goes, so goes the economy. The two are closely linked because franchised businesses tend to be recession resistant and traditionally have been huge generators of jobs, which is critical to the recovery.
That’s why the International Franchise Association (IFA) and other small business groups went into panic mode after the U.S. Treasury Department and the Federal Deposit Insurance Company (FDIC) refused to help CIT get through a liquidity crisis.
The lender finances about 1 million businesses, from Dunkin’ Brands to Eddie Bauer Holdings, according to Bloomberg. The lender also accounts for about 70 percent — or $40 billion annually — of all domestic short-term financing known as factoring. Had CIT failed it would have put 760 manufacturing clients at risk of failure and “precipitated a crisis” for as many as 300,000 retailers, according to a regulatory filing.
A study prepared by the IFA in May confirmed that the franchise industry’s ability to create jobs is already being hampered by the credit crunch. A CIT failure would have been an even more crippling blow, erasing thousands of potential jobs.
According to the study, franchising as a business model has been extremely resilient to economic slowdowns in the past. Between 1999 and 2006, the number of franchised units grew at an annual average rate of almost 6 percent. During the 1999-2002 collapse of the tech bubble, franchised businesses still continued to grow, at a 5 percent annual pace.
But this recession is different because it was precipitated by the near collapse of the financial system, which led to a severe shortage of capital and a sharp tightening of underwriting standards.
The study found that for every 1 million dollars of lending obtained by franchised small businesses, 34.1 jobs are created and $3.6 million in annual economic output is realized. But based on the current conditions, franchise lending could be curtailed by as much as 40 percent this year.
That’s only enough financing for 10,781 new units and 16,912 transfers of franchised businesses. “This amounts to 25,547 lost direct jobs and another 22,992 indirect jobs, or a total loss of 48,539 jobs,” the study states. The economy as a whole would lose $5.1 billion in economic output — $1.9 billion directly and another $3.2 billion indirectly, according to the IFA’s calculations.
In contrast, without the current capital constraints, the study projects the addition of 12,965 new franchised businesses and the sale or transfer of 20,338 units.
“This equates to 151,660 direct jobs and 126,566 indirect jobs either created or protected, for a total of 278,226 jobs,” it states. Total annual economic output would be $30.1 billion — $11.6 billion directly and $18.5 billion indirectly, the study concludes. To fund 100 percent of 2009 demand would require about $8.4 billion in financing.
In 2008, excluding lodging, 45,463 unit transactions were financed; 22,547 were new units and 22,916 were transfers. The study estimates that nearly $12 billion was loaned to franchisees last year.
The calculations are important because unemployment is expected to exceed 10 percent in the next few months and some economists predict it could go much higher. Many of those jobs are being lost in industries that are unlikely to hire back those who have been laid off.
In past recessions, franchises have not only helped spur the pace of economic recovery but have also provided alternatives for individuals who were down-sized or displaced by other businesses or economic sectors, according to the IFA. Without the ability to play that role, the recovery could be delayed, or worse.
For the past month or so, a growing number of economists have raised the prospect of a double-dip recession. A sharp rise in oil prices or a burst of inflation coupled with anemic job growth is all it would take to send the economy into another downturn, according to some scenarios.
Nouriel Roubini, who was one of the first prominent economists to predict the crash, said recently the recovery is likely to be “anemic and sub-par.” Oil prices are rising too fast, unemployment is still growing and the financial system is still shaky, all of which raise the odds of a double-dip recession, he noted.
The only real solution is to encourage vigorous job growth. Yet IFA President and Chief Executive Matthew Shay notes that out of $800 billion earmarked by the government for economic stimulus, less than one-tenth of 1 percent has been dedicated to assisting small businesses. “Congress and the administration must do more,” he asserts.
Shay recommends such steps as creating a federal program to facilitate the syndication of franchisee loans (perhaps using the TALF as a model), doubling to $4 million the maximum size of Small Business Administration flagship 7(a) loans and boosting the maximum guarantee amount to $3.6 million.
“We believe that one of the fastest ways to kick-start the American economy into a sustainable recovery is to target categories of businesses that can create and sustain the most jobs, such as franchising,” he says. “Franchising grew nearly four times faster than the overall economy in the four years following the last recession [from 2001 to 2005].”
A debate is already underway in Washington about a second round of stimulus financing. Any proposal should focus on the direct stimulation of jobs. A recovery without job growth won’t be a recovery at all, and will leave the nation too vulnerable to the next recession — possibly as soon as next year.