Every entrepreneur quickly learns that Time is the X (horizontal) axis of any business plan. The Statement of Cash Flow (cash inflows and outflows) is of equal importance with the Profit and Loss Statement and the Balance Sheet. Of course, cash is the bloodstream of any enterprise. Sadly, many prosperous growing companies have been plunged into bankruptcy because of cash starvation -- acute anemia. How can this happen?
Seed money is required to launch any venture. This upfront money can be drawn from a number of sources: the savings of the founders and their families and friends, borrowing funds secured by other assets of the founders (quite commonly, their homes), and even the shaky expedient of "maxing" credit cards. While much more difficult today, venture capital (VC) may be contributed by "angel" investors. Special situations sometimes find important vendors, suppliers and/or customers participating in the startup of a promising new venture.
But once the high hurdles of initial entry are cleared, the successful new venture rather quickly encounters a capital starvation zone that could be called "Capital No Man's Land." This is the zone where capital needs are too big for the founders but too small to attract loans or equity from institutions or venture capital firms. In this zone, revenues of the company are typically between $1 million and $10 million, and the capital needed is less than $1 million. This is the critical zone where many growing companies with high potential stagnate and die due to the lack of capital to sustain their growth.
This is the dilemma that the BRIDGE Act, a bill now pending in Congress, is designed to address.
Growing companies have two kinds of cash needs -- accountants will classify them as current expenses and capital expenditures. First, rapid growth inevitably sees current expenses (cash outflows) substantially preceding revenues (cash inflows). These are the expenses for hiring and training new personnel, advertising, and the like. And second, rapid growth almost always requires continuing expenditures for both working capital and fixed capital. Working capital is the buildup of inventories for production and shipping, and accounts receivable through the extension of credit to business customers. Fixed capital is the expenditures for plant and equipment, capitalized R&D, and/or development of intellectual property. While "expenses" are deducted currently from revenues to determine the profit of the business, "expenditures" for working and fixed capital are NOT totally deductible currently in the calculation of profit (i.e., must be "capitalized" and deducted over a period of time). As a result of this distinction between expenses and expenditures, a growing business can be profitable (i.e., revenues exceed "expenses," while, at the same time, it is starved for capital because it is "cash-flow negative." These two kinds of demands create voracious cash needs.
Some "cooler heads" often caution that aggressive growth may not be healthy. However, in today's highly competitive global economy, eschewing vigorous growth frequently spells calamity. Rapid growth is often unavoidable if one is to achieve market position, technological pre-eminence, and competitive advantage. A most dramatic example of this growth strategy has been the chronicle of Amazon.com, Inc. Naysayers shook their heads for years watching a company that failed to report a quarterly profit or even positive cash flow. It now appears that this aggressive strategy has achieved an unassailable market position and exceptional technology. But Amazon's continuing cash needs were ravenous.
Particularly troubling is the predicament of the growing business that does generate a profit -- i.e., taxable income -- and is hiring new personnel, but then sees a significant part of those earnings diverted to meeting its tax liabilities rather than being available for reinvestment to meet the capital needs of the business. The BRIDGE Act is an innovative solution to this problem. Conceptually, the BRIDGE (Business Retained Income During Growth and Expansion) Act is quite straightforward.
The creative proposal of Douglass Tatum, the CEO of Tatum Partners, a Washington "outsider," the BRIDGE Act would allow a business with annual gross receipts up to $10 million, which is also exhibiting at least 10 percent growth for the year over the average gross receipts for the past two years, to defer up to $250,000 in federal income taxes for two years, and then pay the taxes with accrued interest over the next four years. Essentially, this proposal enables the company to retain more cash in the business during this critical growth period, and allows it to pay its taxes when it is larger or when its growth rate slows down (but in any case over a specific time period). It is "revenue neutral" over the long run; the government loses no tax revenues. The BRIDGE Act simply defers the date of receipt with interest. Tatum has explained, "The BRIDGE Act would provide cash flow relief to a very specific and economically important taxpayer -- the emerging-growth company."
The BRIDGE Act appears to be a win-win idea. This legislation can be seen as a win for small business, as it would enable profitable small businesses to continue to grow. Equally importantly, the BRIDGE Act can be seen as a win for labor since it is the growth of small businesses that constitute the greatest opportunities for growth in employment. This broad support is reflected in its noteworthy bipartisan appeal, being initially sponsored in the last session of Congress by Jim DeMint (R-SC) and Brian Baird (D-WA) in the House, and by John Kerry (D-MA) and Olympia Snowe (R-ME) in the Senate. Senator Kerry explains, "With banks tightening their credit and a slumping economy taking its toll, emerging-growth companies have nowhere to turn. ... The BRIDGE Act ensures that rapidly growing small businesses have the resources for self-financing and the capital needed to continue producing new jobs and new opportunities."
Representative DeMint was formerly a consultant to smaller businesses and, therefore, "understood completely" when he first met with Doug Tatum. "While there are encouraging signs of positive economic recovery, high unemployment continues to be an area of concern," said DeMint, who believes that this initiative will accelerate "the growth engine of the economy." "The BRIDGE Act could create an estimated 600,000 new jobs in the next three years by offering vital relief to growing small businesses. The legislation would be an excellent complement to other stimulus measures being considered," he said. [View the BRIDGE Act legislation and obtain more information at Congressman DeMint: The Bridge Act]
"Even in this economic downturn, the American entrepreneurial spirit is strong," said Rep. Baird. "The BRIDGE Act helps our small business owners free up capital to ensure growth and expansion, rather than force them to exhaust revenue on taxes. We need to jumpstart our economy, starting with our small businesses. The tax-deferral measures in this bill are a crucial step toward job creation and continued prosperity for American businesses."
The bill garnered support from a number of prominent Republicans and Democrats on the small business and tax-writing committees in both chambers when originally introduced in the 107th Congress, and it is expected to continue to enjoy strong bipartisan support when re-introduced in the next few weeks.
Quite predictably, leaders of small, growing businesses have been proclaiming their vigorous support; e.g., see Ed Rankin and Harden Wiedemann, both of Dallas, and Les Walker of Irvine, California. An editorial in the December 2001 issue of Inc magazine (George Gendron, then Editor-in-Chief) hailed the BRIDGE Act as "an ingenious, fiscally sound mechanism for keeping billions in the hands of a group that makes the most efficient use of capital." Swiftly growing smaller businesses with fewer than 100 employees were the primary creator of new jobs during the last decade -- 85 percent between 1994 and 1998 -- according to research published by Arc Analytics, formerly Cognetics, Inc., (Waltham, Massachusetts) specializing in the job-growth economics of smaller businesses.
The bill's sponsors have estimated that the tax deferment offered through the BRIDGE Act could create over 640,000 jobs during its initial three years. Allowing growing businesses to reinvest their profits for the short term, thus "bridging" their funding gap, may "cost" the government several billion dollars in tax revenues during the early years, but is estimated to yield a $1.1 billion net revenue gain over a 10-year period, according to the Congressional Joint Tax Committee. The legislation is slated for sunset after four years.
A recent study by the National Commission on Entrepreneurship indicates that rapidly growing companies are located in all sates and regions of the country, including urban, surburban, and rural areas (see, High-Growth Companies: Mapping America's Entrepreneurial Landscape, July 2001). Thus, the BRIDGE Act tax deferral proposal would benefit all areas of the country, not just the high-tech corridors.
Great idea! No real opposition. But why isn't it happening? With the frenzy of other activity currently encumbering the Congress, neither the White House nor the GOP Congressional leadership is giving this proposal the support it deserves and needs. An additional impediment has been the counter-intuitive fact that profitable businesses that are growing could be starved for cash. Some legislators (the ones who have never run a growing business) have had some difficulty understanding the distinction between expenses and expenditures of capital.
If you feel this imaginative initiative should immediately become the "Law of the Land," you can share your views with Congress by clicking on the following link to identify the Members of the House and Senate who represent you, along with their contact information: The U.S. Government's Official Web Portal
It is difficult to believe that the BRIDGE Act, offering such important economic benefits with no foreseen downside, has not been rushed through enactment. We hope that Congress and the Administration will soon get to work on this important proposal, which would help stimulate capital investment and job growth in the current struggling economy.
© Copyright 2003 Thomas A. Faulhaber / The Business Forum Online®