Inflation is worrying chief executives globally, according to a surveyreleased Thursday by the Conference Board, a business research group, and data shared by the U.S. Bureau of Labor Statistics on Thursday backs their concerns.
Some 55% of CEOs expect higher prices to last until mid-2023 or beyond next year, according to the survey.
Rising inflation is the second-most common external business worry for CEOs, trailing only disruptions caused by Covid-19, after being just the 22nd most cited concern in Conference Board’s 2021 poll.
Supply chain bottlenecks were the most common explanation for the rising prices among CEOs, and 82% of respondents said their businesses were impacted by rising input costs, such as raw materials or wages.
The poll was conducted between October and November of last year among 917 CEOs in the U.S., Asia, Europe and South America.
Big Number9.7%. That’s how much the Producer Price Index, a measure tracking the prices manufacturers pay for goods, rose in 2021, the highest year-over-year increase since the Bureau of Labor Statistics began calculating the statistic in 2010. The PPI is considered a forward-looking indicator for consumer prices, meaning that the highest inflation U.S. consumers have faced in four decades could climb even further.
The Conference Board survey found that the U.S. has faced unique labor issues during the pandemic. Labor shortages were considered the top external threat to business by U.S. respondents as a record number of Americans quit their jobs, but were not higher than third on the list of CEOs from other countries.
A primarily remote workforce is also a mostly American phenomenon: More than half of American CEOs said that they expect 40% or more of their workforce to work remotely after the pandemic, compared with just 31% of CEOs from Europe and 17% of CEOs from Japan.
I’m a New Jersey-based news desk reporter covering sports, business and more. I graduated this spring from Duke University, where I majored in Economics and served as sports editor for The Chronicle, Duke’s student newspaper.
The 48 professional forecasters surveyed by the National Association for Business Economics were asked when the so-called core inflation rate (which leaves out food and energy prices) might return to the 2% range that the Federal Reserve targets (and that was commonplace before the pandemic).1 Right now the rate—as measured by the year-over-year change in the Bureau of Labor Statistics’ Personal Consumption Expenditures price index—is 4.1%, the highest since 1991.23
Most respondents said it would take at least until the second half of 2023, including more than a third who forecast 2024 or later. Since the survey was conducted in mid-November—before the omicron variant of COVID-19 was identified—it doesn’t account for how that news might impact their outlook.
The Federal Reserve has determined that roughly 2% is a healthy middle ground for inflation, one that enables a strong economy without hurting people’s buying power too much. The longer inflation stays hotter than that, the more likely the Fed is to do things to put a lid on it,4 like raise the benchmark federal funds rate. That rate influences all kinds of other interest rates, impacting the cost of borrowing on credit cards, mortgages, and other loans.5
Personal income grew 0.5% in October compared with the month before, as wage increases more than made up for declines in unemployment benefits from the government following the expiration of pandemic-era relief programs, the Bureau of Economic Analysis said Wednesday in its monthly report on income and spending.1
People were inclined to spend the extra pocket money, as inflation-adjusted spending accelerated for a third month, rising 0.7%. They also saved less of their disposable income—7.3%, compared with 8.2% in September—staying within pre-pandemic norms and a far cry from April 2020, when the saving rate hit 33.8%.23
All that extra money didn’t go as far as it might have, though. The report also showed core inflation (not including food and energy) rising to 4.1% from a year ago, compared with 3.7% in September, hitting its highest level since 1991. That was in line with what forecasters at Moody’s Analytics had expected, possibly signaling that elevated inflation isn’t going away anytime soon.
“Inflation is no doubt a headwind, but in October at least, it was not enough to stop consumers from spending,” economists at Wells Fargo Securities said in a commentary.
If you have some money invested in mutual funds, using them to pay off debt may seem like an attractive option. You may assume that you’ll get more benefit from using the money that you’ve invested to eliminate debt (and the associated high interest rates). But cashing in your mutual funds may not be the best way to become debt-free if there are other options available. And depending on where you hold your mutual funds, you could end up receiving a steep tax bill.
Cashing out mutual funds may not be the best option for repaying debt.
You may owe capital gains tax on mutual funds that you cash out from a taxable brokerage account.
Cashing out mutual funds from an IRA or other qualified retirement account could trigger income tax on earnings, as well as an early withdrawal tax penalty.
Withdrawing money from your investments to pay debt means missing out on future growth from compounding interest.
Pros and Cons of Cashing Out Mutual Funds to Pay Off Debt
Using mutual funds to pay off debt may seem appealing at first glance. If you aren’t using the money that you’ve invested for any particular financial goal, then why not use it to pay off credit cards, student loans, or other debts? After all, eliminating debt can free up more money in your budget that you can then reinvest in mutual funds, stocks, or other securities.However, there are some problems with that logic.
Specifically, there are two major drawbacks associated with cashing out mutual funds to pay down debt. The first is taxes; the second is how it may negatively impact your long-term financial goals.In terms of tax implications, there are two ways that cashing out mutual funds to pay debt can backfire, depending on where you hold them. If you have mutual funds in a taxable brokerage account, then cashing them out may trigger capital gains tax if you’re selling them above what you initially paid for them.
Short-term capital gains on securities owned for less than one year are subject to ordinary income tax rates.1 The long-term capital gains tax rate is 0%, 15%, or 20%, depending on your income.
If you hold mutual funds inside an individual retirement account (IRA), then you can avoid capital gains tax. But you may pay ordinary income tax on earnings, as well as a 10% early withdrawal penalty, depending on the type of IRA, how long you’ve had the account, and your age at the time of withdrawal.
If the mutual funds are in an IRA, you may pay ordinary income tax on the entire withdrawal, the exception would be if you had any basis in your IRA. Then a 10% penalty may apply. The rules are slightly different for Roth IRAs, especially when it comes to taxes.
Aside from the tax consequences of using mutual funds to pay down debt, it’s also important to consider how it may impact your ability to grow wealth. By selling off mutual funds and not replacing them with other investments, you miss out on the power of compounding interest. Depending on how much of your mutual fund holdings you choose to sell, that could mean losing thousands of dollars in growth over time.
If you’re considering cashing out mutual funds in a brokerage account, use an online capital gains tax calculator to estimate how much you may owe on the sale.
Other Options for Paying Off Debt
Cashing out mutual funds isn’t the only way to manage debt. There are other possibilities for eliminating debt faster while also saving money on interest, including:
Refinancing student loans, personal loans, or other loans at a lower interest rate
Consolidating credit card debts into a single personal loan
Taking advantage of 0% credit card balance transfer offers
Selling vehicles or other non-investment assets that you own and applying the proceeds to your debt balances
If you’re struggling with debt repayment, then you may consider other options, such as a debt management plan or debt settlement. With a debt management plan, you work with a certified credit counselor to create a plan for paying off what’s owed. This may include reducing interest rates or fees. You make a single payment to the credit counselor, who then distributes the funds among your creditors.
Debt settlement is something that you may consider for past-due debts. This involves working with a consumer debt specialist to negotiate debts with creditors. The goal is to pay off debts for less than what’s owed to avoid filing for bankruptcy as a last resort.
Debt management and debt settlement may have potentially negative impacts to your credit score, so it’s important to weigh these options carefully.
Making an Informed Decision
If you’re considering selling mutual funds to pay off debt, it’s important to do your research beforehand. Your broker or financial advisor can provide you with the expected rate of return for a mutual fund going forward. Compare this rate to the fund’s historical performance to ensure its accuracy. If the mutual funds pay dividends, then this amount should be included in the assessment. If funds are held within a retirement account, find out the fees and penalties for cashing out.
Again, cashing out of a traditional IRA before age 59½ results in a 10%, or 25% if you have a SIMPLE IRA, tax penalty. There are exceptions for withdrawals, such as disability, medical debt, certain educational expenses, and buying a home. Mutual funds held within regular brokerage accounts have the standard commission charges, but the fund itself still may charge a fee for redeeming your shares. Brokers and financial advisors are great resources for this information.
The interest rate on your debt and the length of the loan should provide the last pieces of evidence to make an informed decision. Debts such as credit cards and short-term loans typically have higher interest rates than longer-term debts such as vehicle loans or mortgages. For mortgages, check to make sure that you have a fixed interest rate. Adjustable-rate mortgages (ARMs) can keep increasing over time and lead to payments that might balloon above your ability to repay them.
A 401(k) loan also is an option for repaying debt, but if you separate from your job before the loan is repaid, then the entire amount could be treated as a taxable distribution.
The Bottom Line
While becoming debt-free may be relief, there are some downsides to consider if you’re using mutual funds to achieve that goal. Fees and penalties are red flags when thinking about cashing in your mutual funds. Loss of future investment income and the lack of a retirement account can put you in a worse situation later in life.
You can make additional debt payments using current income to shorten the length of the loan and reduce the total amount of interest that you have to pay, assuming your budget allows it. If you’re truly struggling with how to repay debt, then consider reaching out to debt relief companies to see how they may be able to help.
When researching debt relief companies, be sure to get a clear explanation of the services that they offer and the fees that you might have to pay before signing a contract for services.
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Nathan Buehler is a well-established writer on the VIX and its related exchange traded products. Nathan also provides coverage on publicly traded companies, commodities, and personal finance/budgeting. Not only is Nathan a writer, but he is also a teacher. His drive to help others doesn’t end in the classroom. This is evident by the time and commitment he gives to his readers through personal feedback and open discussion of topics. He has written articles on topics such as economics, investing, and finance.
One way to achieve this is by taking all the information they have about their customers and turning it into services that enhance customers’ financial wellness. Doing so would be especially welcome in the post-pandemic landscape and the financial uncertainty it has spurred.
While almost every bank now offers financial wellness tools of some sort, whether a budgeting app, a financial literacy course or education on financial planning, these services are generalized to all customers rather than addressing individuals’ personal financial wellness needs. Because financial situations vary greatly across individuals, the truly personalized element is vital.
For example, to help individuals build their savings, banks can use predictive AI technologies to understand customer transactions and cash flow patterns and automatically divert the right amount of extra funds to savings or investments. Royal Bank of Canada says it has helped clients save an average of $358 per month with this type of tool.
Further, by mining debit card data, banks can gain insights into spending habits that they can share with customers or incorporate into personalized offerings. Through AI-driven interventions, personalized “nudges” and micro-level targeting, banks can ensure customers take the steps needed to embrace their financial destiny.
Data and AI underpinnings
Achieving a new hyper-personalized banking future requires the right customer data and digitizing front-to-back-office operations. The financial services industry is arguably the most data-intensive sector in the global economy. Banks, in particular, have enormous amounts of customer data (e.g., deposits/withdrawals, POS purchases, online payments, KYC profiles). Historically, however, they haven’t been very good at utilizing these rich datasets.
By harnessing data responsibly — taking into consideration ethical and regulatory aspects, and striking the right balance between machine-driven and human-centric work — FIs can identify and serve new customer segments of one.
At HSBC, for example, customers can begin a conversation in the bank’s mobile app with an AI chatbot, answering simple questions immediately. Complex inquiries get passed to front-line colleagues. The AI system provides agents with details on the issue and guidance on how to resolve it.
We’ve been working with FIs to pull history and experience via AI into the conversation. We use emotion recognition tools (e.g., intelligent real-time language processing and sentiment analysis) to better understand the context of a customer’s inquiry and when a customer might be vulnerable, even if they’re not aware of it themselves.
This type of information can be harnessed to create personalized engagement plans that customize interactions. These tools can also enable banks to match agents’ personality and strengths with customers to help build deeper, more trusted customer relationships.
Time for a new approach
In addition to the customer benefits of personalization, banks can also realize cost savings and performance gains. According to Boston Consulting Group, hyper-personalization can lower rates of customer churn and boost sales, leading to annual revenue uplifts of 10%.
However, there’s plenty of work to do. Right now, only 45% of consumers are satisfied with the quality of personalized services they receive from their banks. Here are three key ingredients for progressing toward personalized banking capabilities:
Banks need a mashup of data analytics, AI and automation to deliver personalization, intelligence and predictions at speed. This requires harnessing high-quality data to feed AI/ML algorithms so they can deliver experiences and services that anticipate customers’ needs, wants and desires, as well as combining automation with human supervision to build trust and empathy.
For example, we are working with FIs to link up data sources and introduce AI-powered algorithms that provide a dynamic view of a customer’s financial profile. This helps customers with their financial wellness plans and enables FIs to suggest products that enhance customers’ financial wellness.
Along with adroit technologists, banks need designers, anthropologists, ethnographers and others with social science pedigrees to apply human-centric design thinking to product and service development.
Social scientists are equipped to understand and apply the complexities of human behavior to help FIs predefine user personas and scenarios and use these to shape and personalize the experiences they provide.
In this spirit, we are helping a European state-owned organization to implement a user-centered digital product and service offering, including completely reengineering its mobile banking app. The existing app was plagued by a number of challenges, including a dated technology platform, poor user experience, low adoption and high cost-to-serve across non-digital channels.
We helped the organization define its go-to-market, mobile-first digital strategy, identifying key market-facing propositions based on user research as well as delivering these propositions at scale. Multiple subject matter experts were involved in the project from the outset to ensure a holistic approach, including program/project managers, scrum masters, data architects, human-centric design leads, UX and UI designers, researchers, developers, business analysts and process improvement specialists.
With this project, the bank aims to significantly increase its customer base over the next five years, by combining customer trust with a best-in-class user experience on its re-engineered mobile app, which puts it on par with challenger banks.
To drive change, customer well-being and digitization need to become part of the FI’s culture. This is more than merely embracing Lean methodologies and/or more flexible ways of working. Helping customers achieve financial wellness demands a fresh outlook that maximizes new, agile ways of working and data-driven approaches embedded enterprise-wide — from leadership down to every employee.
Turning the tables
For banks whose business models are based on profiting from customers’ lack of financial wellness (overdrafts, fees, charges, etc.), it can be challenging to adopt this approach. The majority of banks have a high cost-to-serve, with legacy infrastructures and high overhead.
In the face of tough competition from savvy fintechs and non-bank disruptors, however, it’s clear that incumbents urgently need to pivot their approach. FIs that incorporate personalized financial wellness into their business strategy have an outstanding opportunity to support their customers while also reinvigorating their brands — and realize growth and cost savings at the same time.
Amazon has always presented its Marketplace, where outside businesses sell products through Amazon’s platform, as one of its biggest success stories: mutually beneficial to Amazon, sellers, and customers alike. But a new report says those benefits are increasingly lopsided — in Amazon’s favor.
The report, which comes from the nonprofit Institute for Local Self-Reliance (ILSR), asserts that Amazon takes a larger and larger cut of sellers’ earnings through the various fees it levies on them. These fees have become so lucrative for Amazon that they now represent the company’s most profitable segment as well as its fastest-growing revenue stream, according to ILSR. And because sellers are paying Amazon high fees, customers may face inflated prices, even when they shop beyond Amazon’s borders.
“Amazon is the only winner here,” Stacy Mitchell, ILSR co-director and author of the report, told Recode. “It’s exploiting its monopoly power over these small businesses to pocket a huge and growing cut of their revenue.”
You might consider this to be a good business strategy on Amazon’s part, as it’s certainly paid off for the company. And some sellers on Amazon’s platform say they’re happy with the arrangement — at least, for now. But a growing number of others argue that Amazon’s dominance over the e-commerce market and its power over its sellers has given rise to anti-competitive practices that hurt Amazon’s competitors, competition in general, and consumers.
“Amazon’s dominance is bad for businesses, jobs, and America’s competitiveness,” Rep. David Cicilline, chair of the House Judiciary Antitrust Subcommittee, told Recode. “This important study makes clear that Amazon is crushing sellers through abusive policies that make it nearly impossible for everyday businesses to get ahead.”
These are some of the same issues identified by regulators and lawmakers who have accused Amazon of abusing its market dominance. They say it’s further evidence that action must be taken to curb Amazon’s power — and some of them are already working on legislation.
“It is important to understand how tech platforms can exploit their power to hurt small businesses and raise prices for consumers,” Sen. Amy Klobuchar, chair of the Senate Judiciary Antitrust Subcommittee, told Recode. “This report highlights how Amazon’s tactics can lead to that result and why Congress must act to set clear rules of the road for the digital giants that dominate our online economy.”
Amazon disputes the report’s findings, calling it “intentionally misleading” for lumping its mandatory fees and optional services together as “seller fees.” Amazon maintains that all of its fees — mandatory and optional — are competitive with what similar services charge, and that many sellers are successful without taking advantage of those optional services. But Mitchell says many sellers feel compelled to pay those ostensibly optional fees if they want their businesses to stay afloat.
Marketplace: The gift that keeps on giving (to Amazon)
Marketplace is a huge part of Amazon’s business. In his 2020 letter to shareholders, Jeff Bezos said it accounted for nearly 60 percent of Amazon’s retail sales, which come from nearly 2 million sellers. So when you buy a product on Amazon, chances are it was sold by an independent business using Amazon’s platform. Amazon isn’t providing that platform for free.
“The trade-off that any seller is dealing with is you get access to a huge audience, you get access to scale, the ability to scale your sales, but it comes at a cost to margin,” Andrew Lipsman, principal analyst at eMarketer, told Recode.
The cost to sellers is increasing every year, according to ILSR’s analysis, making business unsustainable for some sellers while Amazon’s profits grow.
The new ILSR report found that Amazon’s seller fees accounted for an average of 19 percent of sellers’ earnings in 2014. That’s almost doubled to 34 percent in 2021. And while seller fees accounted for 14 percent of Amazon’s entire revenue in 2014, that figure is up to 25 percent in 2021. Amazon will pull in $121 billion from seller fees alone, ILSR estimates.
That revenue translates to a lot of profit — more than even Amazon Web Services (AWS), Amazon’s cloud computing platform typically believed to be the company’s most profitable arm. AWS netted $13.5 billion in 2020, according to Amazon’s financial data. ILSR estimates seller fees netted $24 billion. (Amazon says these figures are inaccurate but did not provide its own; the company’s public earnings statements also don’t combine seller fees in this way.)
“Everyone thinks AWS generates all of Amazon’s profits,” Mitchell said. “But in fact, Marketplace is this massive tollbooth that gushes profits.”
Seller fees primarily come from three things: sales, fulfillment, and ads. Every item sold is subject to a referral fee, which is Amazon’s commission. Over the years, that’s stayed pretty consistent at 15 percent (it may be lower or higher, depending on the product category). According to ILSR, those referral fees made up the majority of seller fees as recently as 2017.
Since then, however, the majority of fees come from Fulfillment by Amazon (FBA), Amazon’s service that stores, packs, and ships sellers’ items to customers. Ad revenue is steadily gaining ground as more sellers pay for more ads to get prominent placement on Amazon’s site, including on product pages and search results.
Sellers who use FBA pay Amazon a fee based on the size and type of item they sell. Sellers also have to pay to ship items to and from Amazon’s fulfillment centers and to store them there. For some sellers, this might be a cheaper or easier option than doing it all themselves. Amazon says FBA’s pricing is competitive with similar fulfillment services if not cheaper, and sellers aren’t required to use it.
But help with logistics isn’t the only appeal of FBA for many sellers. Enrolling in the FBA program is the only way that most sellers can qualify for Prime. (Some sellers may qualify for Seller Fulfilled Prime, but it’s not accepting new enrollees at this time.) Getting that Prime badge is huge for a seller. Amazon shoppers — especially those 200 million Prime members — are far more likely to buy products that qualify for Amazon Prime. But that’s not only because they want to take advantage of the free shipping. It’s also because customers may not even see non-Prime offerings in the first place, thanks to the mechanics of the so-called Buy Box.
When multiple sellers offer the same item, Amazon’s algorithm picks one of them to be the default purchase on the product’s page. This is called “winning the Buy Box,” and when the customer clicks to add an item to their cart or to buy now, the seller who won the Buy Box is the one who gets the sale.
Prime items are far more likely to win the Buy Box than non-Prime items, and customers rarely click on that small “other sellers” link or the small “new and used” box where all the other listings are housed. This gives sellers a major incentive to pay for FBA, even if it costs more than taking care of the shipping themselves.
These FBA fees have been great for Amazon, which has dramatically expanded the logistics network that powers FBA as well as the number of sellers participating in the program. Five years ago, about half of Amazon’s top 10,000 sellers worldwide used FBA. By 2019, it was 85 percent. Amazon even offers a version of FBA for products ordered from other e-commerce services, including Shopify. Dave Clark, the CEO of Amazon’s consumer business, believes his company will be the largest delivery service in the United States by early 2022.
FBA aside, there are other ways sellers are paying Amazon more and more in the hope of generating sales. Amazon has been making a big push into digital advertising recently, and seller ads are part of its strategy. Critics have accused Amazon of increasing the number of sponsored slots in search results to increase ad inventory, and of charging more for the ads in them. (Amazon says the number of ads varies, and pricing is determined by an auction.)
Because of this, some sellers feel like they’re paying more and getting less. Amazon itself says these ads increase product visibility, which can translate into more sales. But that also means less visibility for the products in organic search results that earned their placement through strong sales and positive reviews. Sellers are already competing for this space with Amazon’s own products, and that competition might not be fair, as Amazon reportedly ranks its own products above others that had higher ratings. (Amazon has disputed these reports and says its ranking models don’t take into account whether the product is made by Amazon or offered by a third-party seller.)
Either way, many sellers increasingly feel pressure to buy ads just to get the same search placement (and sales) they once got for free. In a statement to Recode, Amazon maintained that FBA and ads are not mandatory and that sellers may find them beneficial.
“Sellers are not required to use our logistics or advertising services, and only use them if they provide incremental value to their businesses,” an Amazon spokesperson said.
How sellers’ problems affect your wallet
If you’re not a seller that relies on Amazon to survive, you might not see how any of this affects you. If you’re an Amazon customer, you might even think that this system is ensuring that you can buy products at the best price. But you might be wrong.
“Whether you shop on Amazon or not, you are paying higher prices because of its monopoly power,” Mitchell said.
When sellers have to raise their prices to account for Amazon’s increased fees, they often pass those costs along to the customer. And, thanks to Amazon’s fair pricing policy, sellers have to offer the same price on other platforms that they do on Amazon — even if their costs to sell on those platforms are less. If they don’t, Amazon may suspend or demote their listings. Sellers don’t want to take that risk, which could be potentially devastating to their business.
This policy could mean that, as sellers adjust their prices to account for Amazon’s fees, prices end up being higher elsewhere, too. It also makes it harder for other e-commerce platforms to compete with Amazon and challenge its market dominance, since they aren’t able to offer lower prices that would attract more customers. The lack of options means sellers are basically stuck with Amazon if they want to reach its exponentially larger and loyal consumer base.
Sellers have helped Amazon grow to own 40 percent and 50 percent (depending which report you cite) of the e-commerce market in the United States, and in some product categories, its share is far higher. Its closest platform competitor, Walmart, has just 7 percent. Amazon is often the first place online shoppers look for products — even before search engines — especially if those shoppers are Prime members. A large, established company can pull itself out of Amazon, as Nike did in 2019, and still do fine. Most businesses don’t have that luxury.
“Small businesses don’t have other options when it comes to the digital economy,” Rep. Ken Buck, the ranking member of the House Judiciary Antitrust Subcommittee, told Recode. “Amazon continues to use their monopoly power to crush competition.”
One solution is for lawmakers and regulators to step in. Some are trying: The European Commission announced last year that it is investigating whether Amazon gave preferential treatment to itself and sellers that used FBA when determining who gets the Buy Box. The fair pricing policy and its potential to inflate prices across the internet is the basis of the District of Columbia’s lawsuit against Amazon, as well as a class action lawsuit filed by Amazon customers last year.
Several members of Congress — Buck, Cicilline, and Klobuchar among them — have introduced bills that would forbid some of Amazon’s practices they believe to be anti-competitive. These bills came out of a 16-month-long House antitrust subcommittee investigation into Big Tech companies, including Amazon. The committee accused Amazon of luring in customers and sellers with artificially low prices and Prime memberships that the company loses money on, only to raise rates as soon as Amazon’s market dominance was assured.
The proposed legislation would forbid Amazon from giving its own products prominent placement, unless it earned that place organically, and from requiring sellers to pay for ads or services like FBA in order to get preferred placement. One bill would forbid Amazon from competing in a marketplace it also owns, and could force Amazon to split off into a first-party sales company and a company that operates a platform for third-party sellers.
Amazon has responded to all of this by denying that such measures are necessary or that it’s doing anything wrong. The company has become one of the biggest lobbying spenders in the country, and it’s been emailing select sellers to warn them that pending antitrust legislation could make it difficult or impossible for them to sell their products on Amazon.
After years of studying Amazon’s business practices, Mitchell, of ILSR, thinks the best solution is arguably the most drastic.
“Policymakers could regulate Amazon’s fees — basically accept it as a regulated shopping monopoly, like a utility,” she said. “But I think a much better, more market-oriented approach is to break it up by splitting Amazon’s major divisions into stand-alone companies.”
The old business adage that the time to fix the roof is when the sun is shining has never been more relevant than right now. Many businesses have seen a boost in activity over the last few months, but with the Delta variant still a threat and flu season officially underway, there may be yet another spike in Covid cases on the horizon. As this may result in new government restrictions, now is the time to access business capital that you may need later on, including considering debt financing options for your business.
During the pandemic, you likely found a way to keep your business afloat through pivoting, innovating, or accessing government relief funds like the Paycheck Protection Program (PPP), the Economic Injury Disaster Loan (EIDL), the Restaurant Revitalization Fund (RRF), or the Shuttered Venue Operators Grant (SVOG). But, those funds are likely dwindling if not completely, and you may be wondering, “What’s next?”While you might not want to acquire more debt, that is likely the best bet for your business. There are no more federal grant programs on the horizon, and it is difficult to attract equity investors unless your business can scale quickly.
And, even if you could attract equity investors, you would have to dilute your ownership in the business you built. While, of course, you have to repay debt, the advantage is you retain control of your business and typically can have a long time horizon to repay it.The first step in applying for loans is to prepare your business finances. That means getting your books up to date so you can generate profit-and-loss statements and balance sheets, making sure your tax returns are as current as possible, and ensuring you have a future-looking business plan so you can explain how you plan to use funds. Many small businesses and independent contractors who were not prepared accordingly missed out on opportunities in the past.
Here are three debt financing options for your business that you can try to access:
1. Bank loans
Working with a full-service bank is still almost required to run a business and source debt capital. Again, a lesson learned from PPP was that those businesses with strong banking relationships—not just an account but a personal relationship with an account manager—were able to apply and secure PPP loans at a much easier and faster pace. In addition, those businesses with accounts at local banks, rather than national chains, also fared much better.
Banks will take a hard look at your credit score, business cash flow, last two years of tax returns, and planned use of funds before deciding on the size of a loan or line or credit, length of term, and interest rates. In many cases they will also want to collateralize your loan with either your businesses assets or, in some cases, your home. This means if you default on your loan, you’ll need to sell those assets or your home to repay the loan. It is a good idea to shop around for the right bank that can offer the best terms.
Community development financial institutions (CDFIs) are also a good option if you live in an economically disadvantaged or underserved community. CDFIs are banks or credit unions, loan funds, and venture capital funds, whose goal is to broaden economic opportunity for low income and minority communities. These loans are more easily attainable, have lower interest rates, and come with business development help. The downside is the application times and receipt of funds can take much longer than banks or other funding sources.
2. Small Business Administration loans
There are several types of SBA loans:
Economic Injury Disaster Loans (EIDL)
The EIDL program is a traditional SBA program for areas of the country hit by natural disasters like hurricanes, fires, or other unforeseen events that devastate communities. In the case of Covid, the SBA determined the entire country was a disaster area, allowing every business to apply for these loans.
Applying for an EIDL loan is fairly easy and is done directly through the SBA website at www.sba.gov/eidl. The cap on EIDL loans is $500,000, with the typical loan around $150,000 with a 30-year repayment term. The money is meant for working capital to meet normal and customary expenses. Due to Covid, the SBA also instituted a two-year moratorium on the first payment, although interest does accrue. The interest rate on an EIDL loan is 3.5%, which is one of the lowest rates you will find. Non-profits may also qualify for an EIDL loan at a 2.5% interest rate. The Covid EIDL loans came with a grant portion as well that was $1,000 per employee up to 10 employees, or $10,000, although high demand reduced this amount to $1,000 regardless of your employee head count.
Due to the ongoing effects of Covid, EIDL loans are still available through December 31, 2021, and if you already received one, you may be eligible for an increased loan amount. If you are eligible for an increase to your existing EIDL loan, the SBA will contact you directly with more information and instructions, so be on the lookout for that email.
SBA 7(a) loans
The most common SBA loan is the 7(a) program, which can be used for short- and long-term working capital, refinancing of existing debt, and the purchase of furniture, fixtures, and supplies. These loans are most useful if real estate is part of the equation, such as for the purchase or construction of a new building or the renovation of an existing building. It is not required, however.
In order to apply, you’ll need the same paperwork basically required for a bank loan. This includes personal and business financial statements, such as balance sheets and profit-and-loss statements, tax returns, business licenses, and business plans, among other items. You apply for 7(a) loans through your bank and they are 85% guaranteed on loans up to $150,000 and 75% on loans greater than $150,000.
SBA 504 loans
SBA 504 loans provide long-term, fixed-rate financing of up to $5 million for major fixed assets that “promote business growth and job creation.” To be eligible for a 504 loan you must be doing business within the United States, have a net worth of less than $15 million, and have annual revenue after taxes of less than $5 million for the preceding two years. You apply for the loan through Certified Development Centers (CDCs), which are community partners of the SBA that promote economic development in their communities. The CDCs will also evaluate your business plan, management experience, and ability to repay the loan, among other factors.
The 504 loans can be used for the purchase or renovation of existing buildings or land, new facilities, or long-term machinery and equipment. They cannot be used for working capital or inventory, consolidating, repaying or refinancing debt, or speculation or investing in rental real estate. The loans can be repaid over a 10-, 20-, or 25-year term, and interest rates are automatically tied to a percentage above the current market interest rates for 5- and 10-year U.S. Treasury bonds.
3. Small business bonds
The SMBX, a new San Francisco-based fintech financing marketplace, has developed a platform for small and medium-sized businesses to issue bonds to their customers, community, and institutional investors. The company performs an underwriting service at no cost to determine how much credit the small business can qualify for, at what interest rate, and over how long a time horizon.
The capital raised ranges from $25,000 to as much as $5 million. Interest rates typically range between 4% and 10% and the time horizon is 1-10 years. The SMBX platform offers a couple of features that other lending programs do not.
First, if you borrow money from the SBA or a bank, you pay the principal and interest back to those entities. There is likely no other benefit to your business other than the loan. With SMBX your investors are your customers, and so every month they receive a reminder about your business when their principal and interest payment hits their account. Likewise, that capital stays within your community. Plus, even though your customers and community are not equity owners in your business as bonds are debt, they still feel the pride of ownership that can generate more sales and increased check sizes.
Second, the SMBX also provides free marketing around your bond offering. So once your business is listed on the exchange, the SMBX marketing team will provide email and social media marketing to your online followers. They provide messaging and creative development and can also provide flyers, mailers, or advertising copy. In many cases, businesses are seeing the marketing services they receive are of greater value than the cost of the capital borrowed.
Get capital for your business before you need it
It is highly unlikely that there will be a full shutdown of the economy again, or at least not in the majority of the country. That being said, many restrictions are already coming back and many businesses are still recovering from last year. It is critical to avoid being undercapitalized in this business environment. While the thought of taking on debt (or taking on more debt) may not sound appealing, it is still the best bet for small businesses to obtain the capital they need to maintain, grow, and thrive.
About the Author
Neil Hare is an attorney and President of GVC Strategies, where he specializes in small business policy, advocacy, and communications campaigns; follow him on Twitter @nehare and on LinkedIn. See more of Neil’s articles and full bio on AllBusiness.com.