Aquila’s engineering and data science team monitored over 20,000 small business bank accounts, in 2017. Today, we still work to clean that data and assemble quality insights that will benefit small business owners, small business investors, and ISOs. Our first post The top five most profitable, small business US industry SIC Codes of 2017 proved to be our most engaging content for the entire year. As such, we wanted to follow-up with more helpful insights that would bring folks back. Today, we’re going to share the top five (5) small businesses SIC categories that we’ve learned are currently at the highest default risk in 2017 and possibly 2018. These business sectors make up the bulk of business loan losses that we identified in our customers bank transaction data. We think that awareness of the risks and causes of defaults in these categories will help the ecosystem make better decisions and lower the total, small business borrowing defaults and bankruptcies, overall.
Number 5: Construction (NAICS CODE: 23)
There’s an old joke that is known around the business financing circles that goes: The best time to default is when you fund a North Eastern US construction company in winter. In our analysis of commercial and residential construction, we noticed that construction companies successfully secure some of the most financing of any SIC code in the United States small business population. Construction companies, whether sole proprietors or larger companies have compelling cash flow volume that highlight the strength of their businesses during economic boom times as well as construction-friendly season. Also, due to their long accounts receivables payouts, they appear to have large A/R balances which make for attractive financing targets. However, irrespective of the high demand for their services, and their large overdue invoices, these companies rank fifth in our highest default risk categories. It’s our view that construction companies are very sensitive to acute cash flow problems that arise from the following surprises in their businesses:
- Dramatic Winter slow downs and slow Spring pickups
- Equipment damage and replacement
- Customer defaults and slow-pay receivables
- Staffing turnover and customer disputes
Companies that sell unsecured financing to this group need to keep business financing extremely short, possibly not much longer than 60 to 90 days. The risk of cash flow problems are simply too high for longer duration financing. Ideally, construction small businesses should secure their funding via equipment or real estate financing for longer durations. As the United States economy continues to unwind from low-cost credit, in 2018, we expect this group to enter into possible business activity contraction. Small business owners in this space should begin to enforce their receivables payments quicker and use caution in taking on new financing.
Number 4: Other Services (including funeral homes, salons, pet care) (NAICS CODE: 81)
Other Services companies in this NAICS code consist of companies that are, according the Bureau of Labor statistics, establishments that “are primarily engaged in activities, such as equipment and machinery repairing, promoting or administering religious activities, grantmaking, advocacy, and providing drycleaning and laundry services, personal care services, death care services, pet care services, photofinishing services, temporary parking services, and dating services”. These companies provide services that are not defined in the other NAICS industry codes. Although this list may be a moving target, we think the cash flow risks of these businesses tend to follow a similar pattern. The low barrier to entry or startup of these businesses, their store-front requirements to perform the services, and very defined-activities makes this industry group extremely open to competition, via low-skilled to medium-skilled workers. As such, most of these businesses usually struggle to adequately anticipate and adjust for adverse cash flow changes. In our dataset, we have a high number of spas and hair salons that were launched by first-time entrepreneurs. Many of these businesses suffered location problems, shifting customer demand and tastes, as well as increased competition from other entrants into their markets. It’s our view that merchants in these businesses should be funded only after they have proven mastery of their business structural patterns. In short, small business owners with less than 1 year of business should avoid seeking unsecured financing or receivables factoring. The risk of default due to merchant inexperience, and industry structural risks, may just be too high for lenders to recover their business financing, either receivables or business loans.
Number 3: Administrative support and waste management (NAICS CODE: 56)
This group description is misleading. It may sound vague and possibly just about waste management. However, you are most likely familiar with the companies that make up this group. These include the following industries:
- Temporary Help and Staffing agencies
- Travel agents and Tour Operators
- Security guards and Security systems
All companies in this grouping had strong cash flows. They all showed compelling volumes of receivables and ongoing business deposits to their bank accounts. So why do they make our #3 in the list? When we analyzed the incoming and outgoing cash flows, we noticed that companies in this SIC code had usually high negative days or low average daily balances, in spite of the high volume of income deposits. When we interviewed these merchants, they informed us that their margins were usually quite low due to the large payables for employee labor that make up their businesses. Low margins contributed to ongoing cash shortages which drove them to acquire business financing. However, these companies consistently showed trouble in repayment due to limited margins to cover their financing costs. Ongoing and troubled payment usually resulted in defaults and company closure.
Number 2: Wholesale and retail trade (NAICS CODE: 42, 44, and 45)
The activity of wholesale and retail trade is mostly weighted toward retail trade due to the high number of retailers relative to wholesalers. The companies that may secure receivables factoring and financing usually fall in the familiar categories that include:
- Automobile dealership and repair
- Furniture and home furnishings
- Gasoline stations
- Food and beverage stores
- Clothing and General merchandise stores
The cash flow of the successful firms in these companies looks attractive, but there are numerous risks that cause companies, in these SIC codes, to struggle with business financing repayment. In the automobile sector, for example, many companies depend on consumer automobile demand to drive revenues. When automobile sales drop due to economic or cyclical trends, these companies usually are unable to recover previous strong incoming cash flows to cover their small business debts. In 2017, many banks and small business lenders stopped extending business credit to automobile dealerships. Increased levels of defaults and the soft consumer demand for new cars led to substantial portfolio losses. As for gas stations, they suffer from similar problems we outlined earlier in the Other Services sector: High cash balances but very low margins. Most gas stations struggle to secure credit from traditional banks. As such, they reach out to alternative lenders who may lack the data necessary to properly underwrite these companies, particularly in a changing credit cycle. At Aquila we are impressed by the number of alternative lenders we track on the bank statements of these companies. However, this group usually makes up one of our biggest groups of defunct bank accounts that eventually close due to business trouble.
Number 1: Transportation & Warehousing (NAICS CODE: 48 and 49)
If you’re reading this you’re most likely nodding and saying to yourself: “I wonder when he was finally going to get to the trucking section!” Surprisingly our data set of transportation companies is heavily weighted to trucking, passenger transportation, and small businesses that support the freight industry. We believe this is because most transportation business owners are unable to secure traditional bank credit and must turn to alternative receivables financing companies. When we analyze the bank transaction data of this group, we notice that nearly 1 in 2 business loan and receivables financing contracts from this sector usually ends in default. Similar to construction, merchants suffer from equipment damage and failure that is costly to the business. If you are a trucker and your only truck is stolen or in an accident, you are unable to generate revenues and continue business. Also, the sole proprietor nature of this business compounds default risk to the highest of any industry segment analyzed. Of course, we do see trucking and transportation companies that survive with the same bank accounts for more than 6 months to a year. However, they are the exception. Lastly, the low cost to exit this business means that many truckers simply walk away from their business debt obligations or take their business into bankruptcy. We expect as the US economy continues through this cycle, defaults in this space will rise, keeping it at the top of our list the Five Highest Default Risk SIC Codes of 2017.
Aquila shares its default information with all stakeholders, including business customers, brokers, and receivables investors. If you missed our top 5 Best Performing SIC codes, just click that link and grab a copy.
We particularly encourage affiliate and channel marketers to use our list above to guide their marketing dollars and efforts to the industries that will generate the highest return for their marketing dollars. Aquila offers a flat 10 points for all closed deals in this group to new partners. To get started, login to your Aquila Cash Flow ISO dashboard and share your ISO referral link with merchants that are from the best performing industry segments.