Disaster loans: does preparedness matter?

Carton, Robert ; Lockwood, Frank ; Richmond, William 等

ABSTRACT

It is generally accepted that being prepared for a disaster is simply good business practice and essential for reestablishing the business after an interruption. This research addresses the question of whether being prepared with backup operating and financial records materially impacts the ability of small businesses to receive state or federally-backed disaster recovery loans to reopen their establishments. We conclude that obtaining disaster recovery loans and the time from application to funding was more a function of the policies and procedures of the state and federal governments, than the preparedness of the affected small businesses. The use of a consultative approach by the lending agency was much more effective than a traditional loan officer approach.

INTRODUCTION

All businesses are subject to business interruptions. They are caused by factors that affect as few as a single company, such as a fire, or factors that can affect an entire region, such as hurricanes. It is generally accepted that being prepared for a disaster is simply good business practice and essential for reestablishing the business after an interruption. This preparedness includes plans for restoring or replacing critical company resources and capabilities be they human, physical, or financial. Natural disasters create particularly challenging issues for small businesses and their disaster preparedness plans. Complicating recovery efforts after a natural disaster is the failure of small businesses to obtain adequate insurance to recover financially. Recognizing this circumstance, federal and state governments have created disaster recovery loan programs to provide capital for small businesses to reopen. This research examines a group of 88 small businesses located along the rivers in the area surrounding Asheville, North Carolina that received disaster recovery loans and considers whether having a disaster recovery plan and/or financial and operating records mattered in disaster loan approval and funding.

The issue of disaster preparedness has primarily been addressed in both scholarly literature and popular articles that describe the best practices for developing recovery programs at large companies and for information technology departments. Very little of that literature addresses the needs and issues of small businesses. The little that does exist focuses on the importance of planning (Bielski 2002, La Fazia, Ames & Koch 2004, Tiller 1994) and on what a disaster recovery plan should contain (Bielski 2002, Kinkade 2005, La Fazia, Ames & Koch 2004, Pofcher 2005, Scarinci 2002, Tiller 1994).

Prior literature on pre-planning for natural disasters primarily comes from the Information Technology (IT). Grant and Leibs (2006) surveyed 1,286 managers responsible for business contingency plans and found the vast majority of those responding were IT managers, technology staffers, or chief information officers. Their responses indicated that large companies focus was on establishing hot backup sites, located sufficiently far from the primary IT operations so that they would not be impacted by the same natural disaster. This study did not explicitly address the case of small businesses that do not have dedicated risk managers or IT staff.

The Florida Bureau of Recovery and Mitigation, part of the Florida Division of Emergency Management, conducted a survey of 230 small businesses in Duval County, Jacksonville, Florida that analyzed the steps taken to mitigate the affects of a natural disaster (Yoshida 2005). The survey focused on three mitigation factors: business continuity planning; structural hazard mitigation; and purchase of disaster insurance. The study found three primary reasons small businesses do not take steps to mitigate the effects of a natural disaster: (1) the type of business; (2) access to expert counseling; and (3) the perceived exposure on the part of the small business owner to the location of the business.

Runyan (2006) interviewed business owners in five Gulf Coast counties affected by Hurricane Katrina in 2005. The anecdotal information gathered from these interviews found small businesses: failed to have a recovery plan; were vulnerable to interruptions in cash flow; lacked necessary capital to recover from a disaster; were frustrated in reopening due to major disruptions to infrastructure (roads, electricity, etc.); and were unsuccessful in dealing with federal assistance programs offered by the U.S. Small Business Administration.

It is the general consensus from those articles that discussed small business and natural disasters that most small businesses were ill-prepared. However, nothing in the literature was found to address what a business should do when disaster strikes and the small business either did not have a disaster recovery plan or the disaster was so extensive that the disaster recovery plan failed.

Governmental Programs that Provide Business Capital after Natural Disasters

There is an underlying assumption that business interruptions are individualized to a company--the disaster happens solely to the company. Risk management focuses on insurance to replace property, plant, equipment, and inventory, while contingency plans focus on relocating facilities and operations including information technology and communication systems, recreating product and/or service delivery, reestablishing sales and marketing functions, and restoring financial and administrative functions. Commercial risk management products and services deal with these circumstances. However they do not deal with a general collapse of society, markets, and infrastructure. That is the responsibility of local, state, and federal governmental agencies.

Restoring business as usual is not possible when an entire region is affected by a natural disaster. The issues faced by businesses in this situation are more akin to starting a new venture than recovering from a single business interruption. All of the assets of the business may have been lost in the disaster including facilities, inventories, and most importantly, employees may have been displaced and lost temporarily or even permanently if they choose to relocate. Customers may be in the process of recovering, leaving no local demand. The ability to ship outside the immediate region may be disrupted due to a damaged infrastructure including impassable roads, inoperable marine terminals, damaged airfreight facilities, and shortages of essential commodities such as fuel and power. Suppliers may be out of business or have no readily available inventory to provide the critical inputs for the business. Employees may have evacuated and upon their return, they may be consumed with recovering their personal lives. In essence, the business involved in a regional disaster may have to develop an entirely new business plan including target markets, operating strategy, staffing plans, and attracting new financial resources.

Both Federal and State government programs exist to assist small businesses obtain capital after a widespread disaster. The Federal programs are administered by the SBA. State programs vary in format and function from state-to-state. The one common denominator is the programs are intended to get businesses functioning as quickly as possible to provide vitally need products and services as well as reestablishing the employment base by providing capital in the form of low interest loans with deferred repayment schedules. As with any lending program, the applicant for a loan must demonstrate a need for the funds and the ability to repay the loan. Logically, a business that has properly prepared for a disaster will have backups of historical financial records and a business plan for the business going forward. Practically, when a natural disaster completely destroys a business as well as the local accountants' and attorneys' offices, as well as the local banks and the surrounding residential communities, original and backup copies of financial records may simply not exist. Additionally, most insurance policies exclude natural disasters such as floods and earthquakes meaning that the losses sustained by the business will not be reimbursed, even if records did exist to substantiate what was lost. The net result is businesses that do not have historical records, collateral, or equity apply for disaster loans.

The SBA disaster loan programs have been soundly criticized both in Congress and in the popular press as ineffective (Seck, 2006). The main reasons cited were the overly bureaucratic approach regarding the loan application process and the inability of the SBA to handle the number of loan requests. Since SBA loans are based on the ability to repay, the application must include three years of tax returns and other documentation that demonstrate the business has the income potential to pay interest and repay principal. According to some reports, incomplete applications are stacked into piles awaiting completion putting potential borrowers in "SBA limbo." The SBA had received approximately 30,000 loan applications after Hurricanes Katrina (August 24, 2005) and Rita (September 24, 2005) left the Gulf Coast in shambles. According to a report in Business Week (Klein, 2005) the SBA had managed to process only 9% of the applications, approving 949 and declining 1,835. And, these results were after the SBA relaxed the requirement for applicants to provide their last three years' monthly sales analysis or a title or record search as well as waiving the need to include three years of business tax returns.

To more directly address the economic needs of the regions affected by a natural disaster, the State of North Carolina established the North Carolina Recovery and Development Fund (READE). READE is a program to not only make disaster loans to small business, but to also provide them with business counseling to help them be successful in reestablishing their businesses in a dynamic and challenging economic environment. The READE program approach is philosophically different than the SBA in that the SBA approach uses bank lending procedures while the READE uses a consultative approach. The State of North Carolina believes that the approach adopted by the READE program was more likely to result in timely disaster loan approvals and superior loan repayments than the loan officer approach.

The reports of unprocessed loans due to lack of financial information begs the question, does being prepared with backup operating and financial records materially impact the ability of small businesses to receive state or federally-backed disaster recovery loans to reopen their establishments? Further, do the loan processes and procedures impact the likelihood and timeliness of disaster loan approvals? This research examines 88 small businesses in Western North Carolina that applied for disaster recovery loans from the READE program, and in some cases from the SBA program as well, to investigate these questions.

METHODS

We examined the issues surrounding disaster recovery funding using a private data set provided by the North Carolina Small Business Development and Technology Center (SBTDC). The SBTDC administered the READE program in cooperation with the Department of Commerce that was initiated after Hurricane Floyd struck eastern North Carolina in 1999 (READE1). The READE2 program was offered to small businesses affected by the Hurricanes Frances and Ivan in the fall of 2004. Businesses affected by flooding from these hurricanes could apply for disaster relief loans to cover physical damage, economic damage and debt consolidation. The loan process included completing a loan application and meeting with a loan counselor from the SBTDC. It was the responsibility of the loan counselor to help the applicant complete the application, to advise them on the type and format of supporting data to provide, and to prescreen applicants for qualification for the program. In this capacity, the counselor was an advisor, an advocate, and a gatekeeper for the READE program.

Data was gathered from the loan applications for all of the firms that were approved for loans. Further, data was gathered and coded from reviews of the case notes for the firms that either did not complete the loan application or whose loan application was turned down. In most cases, the clients withdrew early in the process either because they were unwilling to provide the required documentation or were advised by the loan counselor that they would not be successful in obtaining a loan.

At the start of the initial consulting session, the client provided basic demographic information about the business, including: the business owner's race, gender, veteran status, and disability status, as well as the date the business was started, the type of business, and its organizational structure (e.g., sole proprietorship). They then completed the loan application. Frequently, this took multiple meetings, but the loan application package included both an application and supporting documentation. The application specifies such information as the amount of damage, other sources of funds, such as insurance, the amount of the loan being applied and how the funds will be used. The supporting documentation included verification of the existence of physical loss, verification of the value of physical loss, and verification of the value of economic loss. All applicants were required to provide copies of their federal income tax returns. These documents were used to verify business profitability, which was used both to verify economic loss and the client's ability to repay the loan.

Our specific concern was with how the client verified their loss claims. Based on the documentation in the application file, we coded 20 different variables: the documentation used to verify the existence of physical loss; the documentation used to verify the value of physical loss; the documentation used to verify the value of economic loss and the source of the client's federal tax returns.

To document the existence of physical loss, clients used four alternatives. In most cases (54 out of 80), clients took pictures of the damage. The pictures were taken after the floods and showed damage to the physical plant, such as washed away picnic areas or loss of inventory. In the case of the loss of inventory, the pictures showed that there was a loss, but did not show each and every item lost. In one case, the client was a nursery. The pictures showed the plants growing several miles from the nursery. Alternatives to pictures include physical inspection by someone other than the client, historical records of the assets or the client's memory. In the case of the client's memory, there was no outside verification that a loss occurred. In some cases, the clients used multiple approaches to document the existence of physical loss.

To document the value of the physical loss, the clients used six alternatives. The most common approach to document the loss was providing receipts for the replaced items (39 out of 80). These receipts were included as part of the file documentation. We did not verify that the value of the receipts equaled the value of the physical loss claimed, but that was a required procedure for the counselor. The use of receipts implies that they had already fixed the damage incurred. Since the hurricanes hit in September 2004 and the loan program did not occur until April 2005, it is not surprising that those businesses that could recover their physical losses did so. The other alternatives included historical records (typically inventory records from an accounting system), insurance claims (the documentation used to verify the loss to the insurance company was not documented), memory (typically a list of items lost with the client's estimate of the value of the loss), vendor estimate (usually of the cost to fix the physical plant, replace the machinery or replace the inventory), and tax appraisal (for loss of physical plant). In some cases, the clients used multiple approaches to document the value of physical loss.

To document the value of economic loss, the client had to show what their sales would have been without the hurricanes. The estimated cost of goods sold was then deducted to calculate the economic loss. The key factors here were documenting the monthly revenue and the cost of goods sold. In most cases (47 out of 65), to document the sales for the economic loss, the client provided records. For a few of these cases, the records were included in the file. Types of records included were sales records from an accounting system and/or copies of sales tax forms (from their own records, their accountant or from the state government). When the records were not included in the files, we assumed the client had detailed monthly sales records if the level of detail indicated this (e.g., differing monthly sales figures down to the penny). This classification was supported by interviews with the loan counselors. In other cases, the client relied on their memory, supplemented by their federal tax returns, which showed their annual sales. In these cases, the loan consultant assumed that the client's annual sales were evenly distributed across each month.

Finally, all loan applicants were required to provide copies of their federal tax returns for the preceding three years (2002, 2003, and 2004). The tax returns were classified as being their own copy, their accountant's copy or a copy requested from the IRS. In some cases, the different years' returns were from different sources. Table 1 provides descriptive statistics for the data.

DISCUSSION

The correlations among the variables are shown in Table 2. In general, the correlations among the variables were very low. In a few cases, correlations were high (in absolute value) because the variables are part of a set, such as the variables for business type and organizational structure (business types 81 and 44 have a correlation of -.65; organizational types 1 and 3 have a correlation of -.68). Other high correlations were expected, such as the correlations between the amount of the loan applied for, the amount of damage incurred, the amount of loan received and the amounts of other sources of disaster funds). The only correlations of interest are:

* The relationship between start year and amount of damage

* Other funding and historical records to document the existence of physical loss

* To document the existence of physical loss, pictures and inspections were typically used with another method, but not with each other.

* Replacement receipts were also usually associated with another method of showing the value of the loss

* The sources of tax returns are correlated.

Many of the companies in the study lost their homes along with their businesses. Consequently, backup documentation, such as tax returns or electronic backups of computer data, was lost to the same storm that destroyed the business and its records. Relying on local service providers such as accountants and bankers for maintaining backup information frequently proved to be ineffective because those offices were destroyed as well.

Having data or not having data did not affect getting a disaster recovery loan. The only reason we have been able to identify for not receiving a loan was the inability to pay. The state of North Carolina's definition or evaluation of a business's ability to repay the loan was much more lenient than the SBA. Of the 46 businesses that applied for an SBA loan, 20 were denied the loan, but the READE2 program approved a loan.

Almost one-third of the businesses with physical damage could not document the existence of the damage, except through their own statement of loss. This, however, did not prevent them from obtaining a recovery loan. Almost 40% of the businesses owners used their memory to document all or part of the value of their physical loss.

One-third of businesses with economic loss, could not document their monthly sales (other than saying they were one-twelfth of their annual sales), which was the basis for determining economic loss. Almost one-half of the businesses were unable to provide copies of their federal income tax returns without retrieving them from their tax preparer or the IRS. Given this lack of documentation, it could easily be understood if the READE 2 program declined the loan. In fact, most of the firms that applied for an SBA loan prior to applying for the READE 2 loan were turned down by SBA. However, by working closely with the SBTDC counselors, applicants were able to get approval in almost every case based upon expected future cash flows, supported by recovered financial records and knowledge of the local market conditions.

The findings of this study are subject to several limitations. First, the sample was drawn from a single jurisdiction in western North Carolina that was subject to a common natural disaster. Second, the loan files examined were prepared by a single agency, the North Carolina SBTDC. Third, there was incomplete information on applicants or potential applicants that did not obtain loans. Information on those cases was gathered anecdotally from interviews with loan counselors and from unprocessed files. To address some of these limitations, loan counselors that participated in other disaster funding programs in North Carolina and in the disaster loan programs in Mississippi after hurricane Katrina were interviewed. Consistently, their observations confirmed the findings of this study.

CONCLUSIONS

This lack of documentation did not prevent the businesses from receiving disaster aid. This implies that the disaster recover literature is wrong. Disaster recovery planning needs to put less emphasis on large scale disasters and give more weight to smaller, more localized disasters. Given the tendency of the state and federal governments to rescue businesses when a natural disaster occurs, businesses do not need the same level of planning and preparation as they do for disasters that will strike only their business. For businesses that serve a local community, large scale disasters so profoundly affect the economy that a rapid return to operation may be counterproductive. Operations should resume as infrastructure is restored and economic activity resumes. Preparing for a large scale disaster is generally not possible for small businesses that rely on providers in the local area for financial services and resupply, as those businesses may also be affected. Further, the disruption to the local area can result in the dislocation of a company's customer base. The question of the proper timing of the reopening of businesses in an affected area should be addressed in future studies and should guide disaster recovery loan programs timing.

It was clear from interviewing loan counselors, reviewing articles on the failures of the traditional lending programs, and from the timeliness and effectiveness of making loans to affected companies by the READE 2 program that a consultative lending approach resulted in quicker and more certain funding. The intention of this program is to continue to provide business counseling while the loans are outstanding. It will be interesting and informative to know if the ongoing involvement of the loan counselors increases the likelihood of repayment over the eight year terms of the loans. Working with businesses from the point of creating projections for operations after restarting their business, through the implementation of the plan, is expected to result in materially improved performance for the affected businesses. Time will tell.

REFERENCES

Bielski, Lauren. (2002). Thinking the Unthinkable, American Bankers Association. ABA Banking Journal, Jan, 94(1),. 44-49.

Daugherty, S (2001). Helping Small Businesses after Hurricane Floyd, Popular Government Summer.

Grant, E. & Leibs, S. (2006). Flirting with Disaster Recovery. CFO, May, 22(6), 35-38.

Kinkade, Brenden. (2005). Is SMB Disaster Recovery Really Within Reach? Computer Technology Review, Feb , 25(2), 28-29.

Klein, K (2005). Rebuilding: A Deluge At The SBA. BusinessWeek, December 5.

La Fazia, Tim, Ames, Jeff & Koch, Reinhard.(2004). Avoid Disaster Through Planning, Communication News, Nov. 41(11), 20-25.

Office of State Budget and Management (2006). North Carolina Disaster Recovery Guide. Raleigh, North Carolina

Pofcher, Steven. (2005). The SMB Users Guide to Data Protection, Computer Technology Review, Feb , 25(2), 30-33.

Runyan, R.C. (2006). Small Business in the Face of Crisis: Identifying Barriers to Recovery from a Natural Disaster. Journal of Contingencies and Crisis Management. 14:(1), 12-26.

Scarinci, Cynthia. (2002). Contingency Planning for Small Business, The CPA Journal, Aug., 72(8), 65.

Seck, K. (2006). Kerry Introduces Bill to Improve Disaster Loan Program; Legislation Adds Government Accountability, Assistance for Disaster Victims. Retrieved September 10, 2006, from U.S. Newswire website: http://releases.usnewswire.com.

Tiller, Michael J. (2005). Is Your Disaster Plan Effective? Management Review, Apr., 83( 4), . 57.

Yoshida, K. (2005). Determinants of Small Business Hazard Mitigation. Natural Hazards Review 6(1), 1-12.

Robert Carton, Western Carolina University

Frank Lockwood, Western Carolina University

William Richmond, Western Carolina University

Table 1: Descriptive Statistics for Explanatory Variables

 Relevant Variable Variable Number
 Topic Definition

 Race Owner is white 85

 Gender Business is more
 than 49% female 48
 owned

 Veteran Owner is a 14
 veteran

 Disability Owner is 0
 disabled

Demographics Start Year that the 88
 business was
 started

 Type Other Services 44

 Structure Sole 43
 Proprietorship

 Physical Amount of 80
 physical damage
 recorded

 Economic Amount of
 economic 65
Damage damage
 recorded

 Consolidation Amount of debt
 consolidation 17
 requested

 Applied 88

Loan Received 88

 SBA-Denied 20

 SBA- 10
 Withdrawn

 SBA- 15
 Disbursed
Funds
 Insurance 13

 Other 2

 Physical Inspection
 Loss 10

 Physical Other Vendor
 Loss Value Estimate
 9 17
 Economic

Documentation Loss
 Tax None
 Returns 5

Variable Minimum Maximum

Race

Gender

Veteran

Disability

Start 1946 2004

Type

Structure

Physical 321 2029532

Economic
 579 488924

Consolidation 1342 2518456

Applied 10000 402768

Received 10000 335254

SBA-Denied

SBA-
Withdrawn

SBA- 10,000 658,800
Disbursed

Insurance 2094 1238772

Other 2470 3000

Physical Picture Historical Record
Loss 54 15

Physical Replacement Record
Loss Value Receipts
 39 25

Economic Other Record

Loss 3 49

Tax Own CPA
Returns 58 38

Variable Average Std Dev

Race

Gender

Veteran

Disability

Start 1991 13

Type

Structure

Physical 111186 289400

Economic 46132 76902

Consolidation 172182 605078

Applied 76360 74349

Received 71360 60474

SBA-Denied

SBA-
Withdrawn

SBA- 186,980 196757
Disbursed

Insurance 202458 372743

Other 2735 375

Physical Memory Multiple
Loss 23 22

Physical Memory Multiple
Loss Value 31 35

Economic Memory Multiple
Loss 22 8

Tax Govt. Multiple
Returns 7 18

Table 2: Correlations Among Explanatory Variable

 4 8 9 10 12 15

Start Year 4 1.0
Bus
Type Other 8 1.0
Bus
Type 81 9 0.65 1.0
Bus Org l 10 1.0
Bus
Org Other 12 -0.68 1.0
Loan Amt 15 -0.64 1.0
Physical
Damage
Amt 16 -0.60 0.87
Economic
Damage
Amt 17 0.61
Debt
Consolidation 18 0.65
Total
Actual
Damage 19 -0.59 0.81
Loan Amt
Received 20 -0.64 0.95
Applied
for SBA 22
SBA
Declined 23
SBA
WithDrawn 24
SBA
Disbursed 25
SBA Amt 26
Insurance
Amt 27 -0.50 0.71
Other Amt 28
Other
Funding 29 -0.52 0.74
Picture 31
Memory 33
ELV Other 41
UoF
Moving 57

 16 17 18 19 20 22 23

Start Year
Bus
Type Other
Bus
Type 81
Bus Org l
Bus
Org Other
Loan Amt
Physical
Damage
Amt 1.0
Economic
Damage
Amt 0.59 1.0
Debt
Consolidation 0.75 0.71 1.0
Total
Actual
Damage 0.93 0.76 0.94 1.0
Loan Amt
Received 0.83 0.62 0.72 0.83 1.0
Applied
for SBA 1.0
SBA
Declined 0.5 1.0
SBA
WithDrawn
SBA
Disbursed
SBA Amt 0.55 0.56
Insurance
Amt 0.87 0.51 0.73 0.65
Other Amt
Other
Funding 0.87 0.55 0.64 0.81 0.71
Picture
Memory
ELV Other
UoF
Moving

 24 25 26 27 28 29 31

Start Year
Bus
Type Other
Bus
Type 81
Bus Org l
Bus
Org Other
Loan Amt
Physical
Damage
Amt
Economic
Damage
Amt
Debt
Consolidation
Total
Actual
Damage
Loan Amt
Received
Applied
for SBA
SBA
Declined
SBA
WithDrawn 1.0
SBA
Disbursed 1.0
SBA Amt 0.60 1.0
Insurance
Amt 1.0
Other Amt 1.0
Other
Funding 0.73 0.88 1.0
Picture 1.0
Memory -0.72
ELV Other
UoF
Moving

 33 41 57

Start Year
Bus
Type Other
Bus
Type 81
Bus Org l
Bus
Org Other
Loan Amt
Physical
Damage
Amt
Economic
Damage
Amt
Debt
Consolidation
Total
Actual
Damage
Loan Amt
Received
Applied
for SBA
SBA
Declined
SBA
WithDrawn
SBA
Disbursed
SBA Amt
Insurance
Amt
Other Amt
Other
Funding
Picture
Memory 1.0
ELV Other 1.0
UoF
Moving 0.57 1.0