Small Firms Are Cautious About Recession

While Fed rate cuts and high oil prices rattle businesses, smaller players have some advantages.

Businessman standing on wall with arms up

No one yet knows the real economic impact of the Fed's aggressive interest rate cuts in January, but one effect is apparent: Small-business owners are more worried about the future of the economy. The National Federation of Independent Business index that measures the overall optimism of small businesses was down after the month of January to a level that survey author William Dunkelberg said was akin to 1991, when the Fed also made big rate cuts in fear of a recession. In both cases, Dunkelberg says, "the optimism hit the skids after the Fed announcements."

Other surveys show similar pessimism: While it showed an uptick in February, the Discover Financial Small Business Watch survey's findings on the percentage of small-business owners feeling good about the economy is way down now compared with 2006 and 2007. Sastry Rachakonda, who led the survey's research, said "cautious is a good word" to describe the attitudes of small business about the prospect of a recession.

Are small businesses justified in being spooked by the Fed's alarm? What would a recession really mean for them?

A weaker economy is making things a little bit tighter. High gas prices act, in effect, as a major tax on small businesses. "To the extent that energy prices go up, they feel the pinch," says Steve Preston, head of the Small Business Administration. Their cash flow is in question, too: The Discover survey found that 43 percent of small businesses reported cash-flow issues in February, up from 32 percent last year.

There's also the fear that a weak economy means less consumer demand, drying up sales for small businesses. That would mean less risk-taking and less expansion.

So far this seems to be a problem specific to certain regions. Joel Libala is an Ohio-based consultant who helps small-business people interested in starting franchises. He says his phone lines are no longer ringing as they usually do with interested entrepreneurs: "In the last two weeks, the faucet has turned off." But in Sacramento, Calif., Karl Paluchuk, who also runs a small-business consulting company, says he hasn't seen any signs of recession. "We have clients in all sorts of business across Sacramento—lawyers, doctors, software manufacturers. We have a number of clients who are expanding," he says. "I don't know of any who are cutting down on the number of employees."

Overall, though, Paluchuk's situation seems to be closer to what most small businesses are experiencing. Small businesses can take comfort that although their optimism is down to 1991 levels, other variables are not. "What's held up are job openings, plans to hire and create new jobs, and plans for capital spending," Dunkelberg says. "As opposed to the decline in 1991—that was no capital spending and no hiring."

Another piece of good news is that if the economy really goes into the dumps, the smallest of businesses probably will suffer the least. Businesses with only a few employees and little overhead can be more nimble in a slow economy. Dawn Rivers Baker, who runs her own publishing company that reports on small businesses in the MicroEnterprise Journal, says, "Because they don't have mountains of hierarchy that has to be maintained whether the orders are coming or not, instead of doing damage control, [businesses with a few employees] can stay afloat and look for new opportunities."

Also, since many small businesses have a personal connection with their customers that big businesses do not, they have an advantage at keeping customers who might otherwise stop spending during hard times. Paluchuk advises small-business owners to "take care of their existing customers so they don't lose anything. If you've done that, you've avoided the recession."