entrepreneur beware

An Analysis of The United States Small Business Administration

"War is Peace!"
(Wordcount: 2,041; Pages: 6) But my question was, "Exactly how much do you estimate I'd have to invest in certification before you recommend I even start marketing my company to the government? And while on the subject of certification, if I've got to invest the same amount of time and resources as an uncertified company to market my services to government spenders, then why are you standing there trying to convince me to waste my precious time and resources on getting certified?" The speaker, a "business opportunity specialist/contracting officer" presenting on behalf of the United States Small Business Administration 8(a) program for "disadvantaged businesses" at a recent seminar answered the first question, "I don't really know", and answered the second with a shrug of his shoulders and an, "Um, you can shut up now" look on his face. It was evident he fought mightily to not concur with my reasonable inquiry, like one of those "War is Peace" moments from Orwell's "1984".

The SBA sincerely believes that its mission is to help small business owners become big business owners. It does this by primarily facilitating lower interest, longer-term loans from a wider, more trusted pool of "respectable" lenders (access to capital). Secondarily, it introduces businesses to government spending and hopefully positions the small business owner (who also happens to be a tax payer) to supply their products or services to their country. And also important, they provide counseling and assistance through a variety of free services which include everything from certification processes to management know-how.

Aware that some business owners are a wee bit more savvy than others or perhaps have certain advantages that makes the playing field less equal when competing for the government's attention, the SBA has introduced special programs for "disadvantaged businesses" which they define as:

"persons who have been subjected to ethnic or racial prejudice or cultural bias because of their identities as members of groups or individual qualities. African Americans, Hispanic Americans, Asian Pacific Americans, Native Americans, and Subcontinent Asian Americans are [automatically] presumed to be disadvantaged." If you're not part of these groups, you're welcome to prove you're disadvantaged through a litany of tests. And the disadvantage has to be "chronic" (1).

Economically disadvantaged individuals basically have bad credit and are on the verge of robbing a bank. The same groups are presumed to be economically disadvantaged.

Access to Capital

The SBA "aids only 0.4% of the entrepreneurs in the United States" through "a portfolio of roughly 219,000 loans worth more than $45 billion" (2). The misconception is that these loans are much higher risk because banks and lenders wouldn't touch them with a 10-foot pole, or unless the SBA guarantees that they won't lose any money for granting loans, which is precisely how the SBA works.

The SBA doesn't underwrite loans, they merely promise lenders that they won't lose money on any loan they give a small business that applies using SBA criteria. Although lenders are thought of as banks, there are thousands of non-bank SBA-preferred lenders (a.k.a. commercial lenders) who will gladly give loans to even riskier prospects (at a higher rate, of course).

However, both banks and non-banks will not lend the full amount of the loan, instead preferring that the borrower put a little "skin in the game" in the form of collateral, be it car, home, or bank accounts, but preferably home. (The real mental leap here is why these lenders would even have such a requirement if their money is virtually risk-free thanks to the SBA's enormous generosity. Furthermore, like every senseless conundrum in capitalism, if a borrower had the money on hand, they wouldn't go to a lender in the first place.)

Why is collateral like a home preferred? Simple - it turns a regular, risk free loan for all into a highly risky, secured loan for the borrower (it remains risk-free to the lender). In other words, if the borrower couldn't pay back the loan, the borrower's assets would then be up for grabs by the lender. It's similar to a mortgage, except the money is used for a business purpose. It's worth noting here that through its various partner programs like the Small Business Development Center (http://www.sba.gov/sbdc/) and SCORE (http://www.score.org), the SBA is also screening prospective borrowers, so there is even less risk involved for the lender.

This arrangement doesn't just provide an exceptional and free lead-generation machine to lenders, it also virtually guarantees lenders will make money, particularly lenders to borrowers counseled on business, but not on borrowing. Is it any wonder then that with such easy money to be made, there's often little room for ethical conduct, even by the most preferred of lenders? Just recently, a prolific lender was caught in a $76 million "inside" fraud scheme (3). Had it been a merely a borrower, he would have been nabbed at $10,000.

Getting Certified and Winning Government Contracts

"Why is collateral like a home preferred? Simple - it turns a regular, risk free loan for all into a highly risky, secured loan for the borrower (it remains risk-free to the lender)."

The whole concept of an 8(a) program - named after the specific section of law where it comes from - is that certain types of government spending must be "set-aside" to offer them to these small businesses. Naturally, "set-asides" are promoted as a good thing, because if it weren't set-aside, small businesses may never have a crack at winning that spending. Set-asides put about $7 billion into the bank accounts of disadvantaged businesses.

But, upon closer inspection, a set-aside isn't all it's cracked out to be. The government spends almost $3 trillion every year on things like payrolls, equipment, and services (4). Thus, disadvantaged firms limit themselves to a paltry 0.23% of the pie, graciously set-aside for them, assuming of course, they meet the criteria (read: obstacles) set up to get their crumb. Since criteria aren't revealed, they can be changed at will and without notice, (i.e. from Top Secret classifications to too sensitive to allow some disadvantaged business owner with ties to illegals to do the project). Makes even the dullest curiosity wonder exactly what kind of criteria organizations like KBR and Bechtel meet that consistently wins them no-bid contracts in the hundreds of millions and billions (even after they admit to delays, failures and cost overruns.) And it would certainly bring a smile to your face to recall Darlene Druyun, formerly the most powerful female in the Air Force, who whimsically approved billion dollar contracts for Boeing in return for jobs for her daughter and herself (5). Of course, what's a few billion among friends when you have $30 billion to spend, unquestioned, of the Air Force's money? I wonder how many certifications Boeing had to go through to be eligible for those contracts?

Assuming you're OK with investing tons of your valuable resources competing for just 0.23% of government spending as a certified business, and assuming that you're OK with not really knowing if the spending set-aside for this 0.23% is actually serious work or stuff you'd give your kids to do, you then have to consider that the SBA has those pesky criteria you've got to meet in order to be classified "small", which either they can change at will and without notice or you can shift out of if you grow too much any given year. In other words, the SBA inadvertently encourages the small business owner to remain tiny, but not indefinitely, because after 9 years, the SBA is revoking all their certifications whether you've grown or not, (a plan clearly designed by bureaucrats with a laughable understanding of business management.

(Imagine spending 9 years at relatively the same size, to then grow exponentially from year 9 to year 10; it's like having sextuplets when you planned for just one child. To be sure, the SBA wants their business to be an ever decreasing part of their program participants total income every year, but it doesn't presume to instruct these small businesses on how they should go about doing that. In fact, it may come as no surprise that these "section 8a" participants spend more time trying to figure out how to stay in the system than growing their businesses, which many successfully do by simply reapplying every year under new corporate names and owners.

(Based on research conducted by this firm, the 80/20 rule can apply in this case, where just under 20% of the potential candidates for this program do the effort of applying over and over. The fact that they apply doesn't assure that they're applying with the intentions of remaining small business owners after they've squeezed every penny from the program they can. So, after 9, 18, or even 27 years, they close up shop. For the disadvantaged to take advantage of this program, they have to make exploiting the program their full-time job, an unfortunate side-effect of any welfare program.)

The fact of the matter is that firms who are interested in getting certified only want to apply for guaranteed contracts or at the very least, find contacts that can help them win guaranteed contracts (6). But rather than give small businesses what they want, the SBA certifiers merely emphasize that applicants should not expect any guarantees of contracts.

Free Counseling

The SBA delivers free counseling via SBA-partner programs such as SCORE and SBDC and here's the real scoop:

SBDC spends over $150 million recruiting professional business advisers (often with advanced degrees) to help small businesses. But what isn't explicit is that the organizations or individuals offering the advice often have long-term contracts, and like all long-term government deals, in danger of profiting the advisers enormously. Why is profiting a bad thing in this area? Because in order to make this profit, these contractors work on keeping their costs as low as possible. And the best way to keep costs low in a service business is to standardized processes and methods. So, in order to service the greatest number of entrepreneurs and make gobs of tax-payer money, the advice offered isn't always relevant to the entrepreneur. Moreover, the gobs of money is so addictive, the adviser isn't incentivized to branch out into new services for fear of increasing costs. This means that their only innovation is keeping these contracts well-past their shelf life, so that entire swaths of entrepreneurs potentially end up getting the short end of the counseling stick.

SCORE spends about $5 million on a volunteer network of very "senior" and unusually animated former professionals to advise small businesses. The draw for these volunteers is the on-going stimulation of the business world on an extremely flexible schedule. The drawback for entrepreneurs is that they may not always get the most relevant, up-to-date, or even most professional advice (7). Not surprisingly, there's constant politicking between SCORE and SBDC for attention from entrepreneurs and Congressional funding.

Other programs include support with getting certified, which is a program set up by the SBA where they mobilize hundreds of highly trained advisers to help businesses save tens of thousands on paying private "consultants" to guide them through the seemingly endless and bewildering mazes the SBA set up in order to become certified. This would sound like a wonderfully bureaucratic solution to bureaucracy, if it weren't for the fact many small businesses end up paying to get contracts, not merely to get certified.

Remembering that free advice is actually loan screening in disguise, all told, the SBA screens and eliminates almost all lending risk for just under 1 million entrepreneurs every year for nearly $2 billion in loans (8).

Considering Going To The SBA

The small business owner considering going to the SBA for assistance should not be dissuaded from considering it based on this analysis. In fact, being more informed on its operations and benefits, the small business owner may yet find the SBA useful as a recruitment ground for future executives to be tasked with the sole responsibility of helping their business win some tax-payer money or loans. The (non-tech, non-pharma) start-up may consider utilizing friends, family, and credit cards as start-up capital, which is typically enough to acquire the assets they'll eventually need to collateralize future loans that require collateral. Ultimately, it's the entrepreneur's responsibility to do all the legwork and analysis to understand what they're getting into rather than relying on outside, disinterested, inexperienced-at-starting-businesses, government-sponsored bureaucrats to guide them along the arduous journey of launching and growing a small business.


(1) Source: SBA Seminar, Oct 25 2006

(2) Wikipedia entry on the Small Business Administration: http://en.wikipedia.org/wiki/Small_Business_Administration

(3) Statement of SBA Administrator Steven Preston,
On Loan Fraud Arrests, http://www.sba.gov/idc/groups/public/documents/sba_homepage/010907_news.pdf

(4) U.S. Office of Management and Budget, http://www.whitehouse.gov/omb/budget/fy2007/tables.html

(5) Merle, Renae, "Business: Defense Contractors", Washington Post, Nov 16, 2004, http://www.washingtonpost.com/wp-dyn/articles/A52052-2004Nov15.html

(6) Testimony Before the Committee on Small Business, U.S. Senate on Expectations of Firms in SBA's 8(a) Program Are Not Being Met by the United States General Accounting Office, http://www.gao.gov/archive/2000/rc00261t.pdf, pages 7 & 9

(7) Berrios, Al, "Inside the World of "Free Consulting" and How Your Entrepreneurial Dream May Suffer: A Practical Framework to Advising Entrepreneurs", http://www.alberrios.com/c/0606entrepreneur.html

(8) Source: respective counseling organization websites; al berrios & co. analysis

Al Berrios is Managing Director of al berrios & co., a pure strategy consulting firm, specializing in advising organizations + entrepreneurs on managing their enterprises in a service economy. Write or Subscribe to Consumer Strategies Report.


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