Business applications still surging: What new owners should know

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Jun 20

A sustained high number of new business applications from mid-2020 to now indicates an optimism not necessarily shared across the economy. That ambition may be tested in the coming months.

From January to July 2020 — the six-month period with a very short and deep recession smack dab in its middle — the number of applications for employer identification numbers (EINs) from the IRS nearly doubled. That ambitious optimism amid great economic uncertainty persists: As of April 2023, filings of these new business applications were 55% higher than in that January three years earlier.

But banks are being more cautious about lending, and consumers may begin pulling back on spending after a long campaign by the Federal Reserve to cool the economy. New businesses, by their nature often on already-vulnerable financial footing, should prepare for rocky times with the knowledge that all healthy businesses, young or old, can benefit from contingency planning.

New businesses still elevated, three years after peak

COVID-19 lockdowns and layoffs encouraged people to get creative about how they spent their time and how they earned and spent their money. For many, that period was the proverbial kick in the butt needed to finally chase a dream of being self-employed. The number of new business applications peaked in July 2020 at about 552,000, up from 279,000 just six months earlier. And while the surge has subsided slightly, it remains higher than any pre-COVID period tracked.

Could this be evidence that the pandemic did have a long-term impact on how we think about work? Perhaps. It could also indicate more people are starting side businesses to help them cover the increased costs of living under high inflation, or they're eager to capture the increased demand for services that has ballooned as the pandemic has waned. Most likely, it's a combination of factors whose influence will become clearer as time goes on.

Even the businesses deemed most likely to succeed (called "high propensity" by the U.S. Census Bureau) remain elevated. What identifies these businesses as high propensity, according to the agency, can include planned wages and hiring, corporate backing, or being in certain industries such as food services and accommodations, construction and manufacturing, educational services, health care and others. These applications also peaked in July 2020, at about 175,000, 73% higher than six months before. In April of this year, there were still 44% more such applications than in January 2020.

All states have experienced similar growth, albeit to varying degrees. The states that saw the biggest increases from January 2020 to their peak were Illinois and Mississippi, growing 248% and 247% respectively to their July 2020 highs. In Wyoming, application rates peaked later, in April 2023, the most recent month for which data is available. And there, they remain the most elevated, 181% more than the January 2020 rate.

But lenders say they're pulling back

In the early stages of a new business, startup and expansion funding can be crucial. But for new businesses in 2023, access to these funds could prove increasingly difficult.

The share of domestic banks tightening lending standards for small businesses stood at 47% in the second quarter of this year, up from zero one year prior, according to the Senior Loan Officer Opinion Survey from the Fed. Loan officers report similar tightening for larger businesses, too. Lenders are most likely to cite economic uncertainty — not banking instability — for the tightening and anticipate the trend to continue.

What to expect (and how to prepare) for the rest of 2023

Throughout 2023, it will remain more difficult (and costly) for owners of all sizes of businesses to access funding. The economic uncertainty driving credit tightening is closely related to the lack of certainty around whether the Fed will continue to raise rates, pause or begin reducing them; whether the labor market will finally weaken; whether we'll enter a recession this year; and whether any additional unforeseen economic shocks — like war or a pandemic — head our way. So businesses old and new would be wise to hope for the best but plan for tough times.

Prepare for falling consumer demand. The Fed's battle against inflation is an effort to cool the economy and, in part, consumer demand. People will be spending less, whether or not we ultimately end up in recessionary territory. Businesses that make money from discretionary consumer spending could feel this the most.

Look for ways to reduce expenses. Think ahead — you may not need to change suppliers or reduce shipping frequency today, but where will you cut back if the need arises? Knowing where to cut when times get lean allows you to take quick action when those times occur.

Consider a line of credit. A business line of credit can act as an emergency relief valve — it's close at hand if you need it and generally comes with relatively minimal carrying costs if you don't end up using it. If your business has unpredictable or volatile cash flows, it can be an at-the-ready emergency fund.

If you have to borrow, consider a local bank or CDFI. Now is not a great time to need a loan: Rates are high, and lenders are watching their money carefully. But if you do need to borrow, consider a local bank, credit union or community development financial institution (CDFI). If you already have a relationship with one of these smaller institutions, you're one step ahead. Because they're in the relationship business, they may have competitive advantages over larger banks for smaller businesses.

Ask for help — before you need it. Having a plan in place just in case things get dicey can provide peace of mind even if they don't. As a new business owner, you may not know what you don't know, and it could pay to have someone with experience help inform your decisions. Small Business Development Centers offer free consulting and free or low-cost training to small-business owners. And SCORE, a nonprofit that partners with the Small Business Administration, provides mentors and resources to help small businesses succeed.

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