Locavesting
The Revolution in Local Investing and How to Profit From It
By Amy Cortese
John Wiley & Sons
Copyright © 2011
John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-91138-9
Chapter One
Motherhood, Apple
Pie, and Political
Theatre
How We Are Failing Our Small Businesses
If we've learned anything from our near economic collapse and
its aftermath, it's that small business is right up there with motherhood
and apple pie in the pantheon of American ideals. Just ask
any politician, from either side of the divide.
President Obama preached the gospel of small business as
he crisscrossed the country in 2010 pushing his $30 billion small
business stimulus package. A typical venue was the Tastee Sub
Shop in Edison, New Jersey—a town, the president noted, that was
"named after somebody who was not only one of history's greatest
inventors but also a pretty savvy small business owner." Addressing
a crowd that included local business owners, he intoned: "Helping
small businesses, cutting taxes, making credit available. This is as
American as apple pie. Small businesses are the backbone of our
economy. They are central to our identity as a nation. They are
going to lead this recovery."
Just two months later, ahead of the midterm elections, a dozen
House Republicans took to Tart Hardware ("Everything to Build
Anything") in a suburban Virginia industrial park to unveil their
"Pledge to America," a 45-page glossy pamphlet brimming with
lofty promises to cut taxes and regulation that read like a Big
Business wish list. "We are here to listen to the small-business people
who are facing the same kind of uncertainty that small-business
people all over the country are dealing with," declared then-minority
leader John Boehner, who likes to remind folks that he is
just a small business guy himself who "stumbled into politics."
The rush to the nearest mom-and-pop store, camera crews in
tow, in times of economic adversity is a political tradition. If we
had a dollar for every time a politician delivered small-business
bromides against the backdrop of a patriotic banner, we could
retire the national debt. No doubt some genuinely hold this
view, but politicians are nothing if not savvy. They are playing to
the deeply held belief in small business that is central to how we
view ourselves as a nation—less a melting pot than an audacious
mashup of immigrants, commerce, and ambition.
From its earliest days, the country relied on and admired its
independent business people—the merchants, farmers, and artisans
that plied their trades in the colonies. Benjamin Franklin,
the son of a soap maker turned eclectic entrepreneur and patriot,
so valued independence and self-reliance that he bequeathed
2,000 pounds sterling (a small fortune in those days) to the cities
of Boston and Philadelphia to establish loan funds that would
help young artisans and apprentices start their own businesses. He
specified a fixed interest rate of 5 percent to deter excessive profit
making from the loans. In his will, Franklin explained his motive,
noting that he had been trained as a printer in Philadelphia and
that "kind loans of money from two friends" served as "the foundation
of my fortune, and all the utility in life that may be ascribed
to me." (This generous act led one observer to dub Franklin "the
inventor of microfinance.")
Many of us are descended from self-made businesspeople and
entrepreneurs. My grandfather Ralph arrived at Ellis Island as
a young boy in 1906, just one family among a wave from southern
Italy looking for better economic opportunity. He never went to
college, but like many of his generation, he was a tinkerer, experimenting
with new electrode technology in his basement. After
working at Westinghouse, in 1930 he founded his own company,
Engineering Glass Laboratories. EGL built a thriving business
producing electrodes, tubing, and other components for neon
signs—a French innovation introduced to the United States in
1923. The company became the market leader, with a significant
export business, and continues today.
My maternal great-great-grandmother, Mary Moore, serves as
a reminder that American entrepreneurship is open to all. She ran
a boarding house in rough-and-tumble New York for the scores
of young men arriving from Ireland in the late 1800s through
the turn of the century, becoming something of a local powerhouse
with her ability to deliver the vote among that fast-growing
population.
We all have stories like this to tell. And many of us aspire to
someday, perhaps, unchain ourselves from our corporate overlords
and go into business for ourselves. That impulse is what
led Sagar Sheth and Kory Weiber, two young engineers with
promising careers at General Motors, to strike out on their own.
Their company, Moebius Technologies, manufactures high-tech
medical equipment in a plant in Lansing, Michigan. "It's one of
these things where you realize you have to try, or you'll always
wonder what could have been," Sheth, whose parents were born
in India, told me. "To a large extent the American Dream is about
entrepreneurs. What's beautiful about this country is that anyone
can be an entrepreneur—that's very different from most places
in the world." Indeed, business ownership has been the escalator
to the middle class for generations of ambitious immigrants.
If we've canonized small business entrepreneurs, it's for good
reason: They provide real economic benefits. What Franklin and
his Revolutionary peers no doubt understood, and what our contemporary
leaders intimate, is the value that local businesses bring
to a community. They are engaged in the community's civic life
and add to its diversity, identity, and independence. They contribute
to the community's prosperity by employing local workers and
spending profits locally, allowing that money to recirculate in the
community—what is known by economists as the multiplier effect.
Studies have shown that a dollar spent at a locally owned enterprise
generates three times more direct, local economic activity
than the same dollar spent at a corporate-owned peer. And their
tax contributions help pay for local services. (It's a pretty good
bet that the owner of your local hardware store isn't stashing his
profits in a tax shelter in the Cayman Islands.)
While Wall Street has increasingly chosen fast, speculative
profits over productive investment, small businesses are the engine
of the
real economy, the firmly on-the-ground Main Street. Broadly
defined by the Small Business Administration as firms with 500 or
fewer employees, small businesses make up 99 percent of all U.S.
companies. They range from sole proprietors and mom-and-pop
shops to established, locally owned companies that employ hundreds
of workers. Also among their ranks are high-growth startups
that have the potential to become corporate powerhouses themselves
someday. Collectively, these 27.5 million companies employ
half of all private sector employees and contribute half of private
GDP—about $5.5 trillion annually. That's more than the entire
economic output of Germany and the United Kingdom combined.
They're innovative, producing 16 times more patents than
their larger counterparts. And, most significantly in these days of
high unemployment, they are responsible for more than two out
of every three jobs created. From 1990 to 2003, small firms with
fewer than 20 employees generated 80 percent of net new jobs.
A study by Harvard professor Edward L. Glaeser highlights the
link between firm size and employment growth. Analyzing census
data from 1977 to 2007, Glaeser found that the U.S. counties with the
smallest firms experienced job growth of 150 percent. As average firm
size increased, job growth decreased almost in lockstep. Counties in
the middle quintile had 90 percent employment growth, while those
with the largest companies added just 50 percent more jobs.
Large corporations create a lot of jobs, to be sure, but they
eliminate more—at least domestically—making them net job
destroyers. Indeed, in their drive to cut costs and boost margins,
some of our biggest and most iconic corporations seem locked in
a cycle of job destruction. In June 2010, Hershey Foods shuttered
its historic chocolate plant in the Pennsylvania town that bears its
name and moved production to Mexico. IBM abandoned its birthplace
of Endicott, New York, earlier in the decade. And, like many
Silicon Valley firms, Apple employs 10 times more workers in China
than it employs at home. Big corporations moved quickly to cut
jobs during the recession. Citigroup shed nearly 60,000 workers. In
January 2009 alone, America's largest public companies, including
Caterpillar, Pfizer, Home Depot, and Sprint Nextel, sent pink slips
to more than 160,000 employees. Even before then, the trend was
clear. Collectively, U.S. multinational corporations shed 2 million
domestic jobs from 1999 to 2008, an 8 percent decrease. Over the
same period, their overseas hiring swelled by 30 percent, aided in
part by tax breaks that encourage them to keep profits and investment
overseas. The 1.4 million jobs that domestic corporations
added overseas in 2010 would have lowered the U.S. unemployment
rate to 8.9 percent, according to the Economic Policy Institute.
Benjamin Franklin, or my grandfather for that matter, could
hardly have imagined the vast scale of the multinationals that rule
global commerce today. But small enterprises are still the underpinning
of our towns, communities, and nation, enriching us culturally
and economically. So it's no wonder politicians and special-interest
peddlers want to wrap themselves in small business' warm glow.
Sticking Up for the Local Butcher
The problem is that for all of the flag-waving rhetoric, we have
treated our small businesses dismally. Everything from federal tax
policy to investment allocation to local development initiatives has
favored the largest, most powerful enterprises—at the expense of
the small entrepreneur. The photo op at the mom-and-pop has
become a hollow ritual.
For a vivid illustration of where our national priorities lie,
look no further than the bailout of Too Big to Fail financial institutions
engineered in late 2008 by then-Treasury secretary Henry
Paulson. As we know, hundreds of billions of taxpayer dollars
went to prop up megabanks and those that enabled them, such as
insurance giant AIG. All told, with federal lending programs, debt
purchases, and guarantees factored in, the total assistance reached
$3 trillion by July 2009, according to Neil Barofsky, inspector general
for the Troubled Asset Relief Program (TARP).
That bailout likely averted disaster. But rather than stimulate
lending and economic activity, as hoped, it seems to have served
mainly to fuel the record trading profits of its recipients and leave
them larger and more systemically important than ever. Prominent
critics, such as Nobel Prize–winning economist Joseph Stiglitz, have
argued that TARP money would have been better spent supporting
smaller financial institutions that did not engage in the reckless
behavior that precipitated the crisis and might have actually used
the money to make loans. It wasn't until September 2010—after
a protracted battle with some of Congress' self-professed champions
of small business—that President Obama signed the Small
Business Jobs Act, establishing a $30 billion fund to spur local bank
lending to small business as well as a smattering of tax breaks to aid
struggling entrepreneurs. It was a welcome boost. But that's tens of
billions for small business, trillions for Too Big to Fail business.
As outrageous as the bailout was for many Americans, it's just
the tip of the iceberg. Each year, a staggering amount of subsidies,
grants, and tax breaks go to our most profitable and politically
connected corporations—an estimated $125 billion—with
little economic or social payoff. There are farm subsidies to Big
Agriculture ($10 billion to $30 billion a year, paid mostly to industrial-scale
and absentee farmers); tax breaks for oil and gas companies
(more than $17 billion a year); and tens of billions more
proffered by state and local officials to woo large corporations to
set up plants, offices, and stores within their borders.
Policy debates (or what passes for them these days) concerning
everything from health care to financial reform to tax cuts,
have been framed in terms of what is good or bad for small business
owners. All too often, though, Joe the Small Business Owner
is simply a prop, providing cover for an entirely different agenda
driven by big business interests. The Chamber of Commerce, for
example, actually claimed in a $2 million ad campaign that the
creation of a Consumer Financial Protection Bureau intended
to protect the public from abusive credit card and loan products
would have a chilling effect on the local butcher. And the few
programs aimed at giving smaller firms a fair shake often end up
being perversely exploited by big corporations.
It hardly matches the rhetoric.
Sadly, this is not a new phenomenon. As a delegate to a 1980
White House Small Business summit told the
New York Times: "Our
problem is small business has always been a `motherhood' issue—everybody
is for it, but everybody ignores it." And Republicans
since Ronald Reagan have been trying to kill the Small Business
Administration, the one government agency dedicated to helping
the nation's entrepreneurs.
Indeed, the crisis has simply illuminated what has been going
on quietly for 30 years: federal economic, tax, and fiscal policy is
crafted by and for the largest corporations, which are increasingly
disconnected from any U.S. locale. This unholy alliance is bound
by campaign contributions, lobbying muscle, and a revolving door
among powerful corporations and the government agencies that
oversee them. (Consider that the cost of winning a House seat
has risen more than threefold since 1986, to $1.3 million in 2008,
while senators in 2008 spent an average of $7.5 million.) In this
cozy pay-for-play system, the little guy doesn't stand a chance.
A Growing Capital Gap
It's more than politics working against small business. As investors,
we have let them down as well. The link between investors and businesses
has largely been severed, with Wall Street acting as the intermediating
force, extracting fees—or rent, in economic jargon—every
step of the way. More and more small business owners are falling
through the widening cracks of our financial system. Without access
to capital, products go undeveloped, expansion is put on hold, hiring
is snuffed out, and innovation suffers. A lack of capital is a key reason
why half of new businesses don't last more than five years.
Entrepreneurs have always scrambled to raise funds, bootstrapping
their ventures by tapping credit cards, personal savings,
and home mortgages, hitting up rich relatives, and eventually
securing bank loans and lines of credit. High-growth ventures
batting for the fences have been able to seek equity infusions from
angel or venture capital investors. But those customary sources of
early funding, never ideal, have all but dried up since the financial
crisis. And the long-term trends are not promising.
Venture capital, for example, has always been reserved for
a rarified category of companies—tech-savvy startups with game-changing
potential. Think Google, Apple, and Facebook. Fewer
than 2 percent of all entrepreneurs seeking funding from VCs or
angel investors get it.
But even for high-growth startups, venture capital has become
scarce. VC firms from Silicon Valley to Boston retreated during
the recession. Venture investments plunged 37 percent in 2009, to
$17.7 billion, the lowest level in a dozen years. And despite a brief
spike, investment fell again in 2010. When they did invest, VCs
preferred less risky, later-stage companies with proven potential,
continuing a pattern started well before the crisis. The move upstream
is, in part, a reflection of the ballooning size of venture
funds. As $1 billion funds have become common, venture capitalists
need to do larger deals, often investing tens of millions of dollars
at a time. (In January 2011, the two-year-old online coupon
site Groupon raised $950 million from about 10 venture firms).
(Continues...)
Excerpted from Locavesting
by Amy Cortese
Copyright © 2011 by John Wiley & Sons, Ltd.
Excerpted by permission of John Wiley & Sons. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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