‘It’s Been a Very Strange Economy’

Good luck reading these tea leaves: Job growth remains strong, the unemployment rate falls further, more small banks are in trouble, credit is tightening, and then there’s that debt-ceiling thing.

Good Morning!

Here are today’s highlights:            

• It’s less risky to buy a business than to start one—and there are plenty of businesses for sale.

• There appears to be a movement to bring back child labor.

• Silicon Valley is promoting sobriety in both its people and its startups.

• New York City has introduced a version of “Shark Tank” for residents of public housing.

OPPORTUNITIES

The head of entrepreneurship at the Kellogg school says entrepreneurship through acquisition, or ETA, is still entrepreneurship: A lot of entrepreneurs, “when they think of entrepreneurship, they picture starting something from scratch, building it with sweat and tears to stand triumphantly atop a newly minted startup that fills a key market gap. This narrow view makes sense because that's the romanticized version of business-building fed to us by media coverage, biographies/biopics, and other sources--the something-from-nothing narrative. This archetypical view of entrepreneurship even fits into several of the seven ‘basic plots’ of storytelling: the hero's journey, rags-to-riches, overcoming the monster, and the quest. But does that mean entrepreneurship is exclusively about building something new? No! Far from it.”

• “One of the biggest reasons ETA is attractive is that it represents lower risk. Not surprisingly, buying an existing business that has already achieved product-market fit and recurring revenue is a safer bet than wading into uncharted waters with a startup.”

• “But along with that added safety, ETA still provides the entrepreneurial autonomy many seek, as more and more of my MBA/EMBA students do. Running a company you've acquired provides freedom from seemingly-oppressive hierarchies, bad bosses, and sudden layoffs.”

• “Moreover, it's a very good time for ETA from supply and investment perspectives. For example, many Baby Boomers are running businesses they own but don't have heirs, and will be looking to sell before long. And despite recent financial-services travails, money is still relatively cheap, and you can finance the purchase of a business with debt, rather than give equity away to investors.”

• “It's a myth that you need independent wealth to buy a business: for not much more than $60,000 in cash, you could buy a business with $1.5M million in EBITDA, thanks to SBA programs and others that enable you to use leverage to limit personal exposure.” READ MORE

THE ECONOMY

Job growth remains robust: “Hiring picked up as employers added 253,000 jobs last month. The unemployment rate fell to 3.4 percent. Other signs show the red-hot labor market is modestly cooling this spring. That in part reflects a return to a more normal job market after a rapid rebound from pandemic layoffs three years ago. But some employers are now also slowing hiring out of caution about the economic outlook.”

• “Demand for metal parts has slowed over the past 18 months at Birmingham, Ala., manufacturer DSW Cutting, President Chris McIlvaine said. DSW makes parts used in tractors, lawn mowers and electrical hardware.”

• “Weaker sales and production volumes mean less need for workers. The 75-person company is looking to hire four employees, fewer than it sought to hire in 2021 when business was booming. ‘Things are not terrible, but they’re not nearly as active as they were,’ Mr. McIlvaine said. ‘It’s been a very strange economy.’”

• “The company finds hiring becoming easier as more people enter the labor force. DSW’s recruitment agency can now fill factory-floor positions within two to three days of searching, compared with two to three weeks a year ago, Mr. McIlvaine said.” READ MORE

More small banks may be in trouble: “A pair of banks whose shares have been hammered rushed to address investors’ concerns as the spiraling crisis for smaller lenders entered a new phase — one that pits the banks against investors who are betting against their viability. The effort came as shares of PacWest Bancorp and Western Alliance Bancorp, along with several other regional banks, skidded on Thursday, drops that reflect skepticism that the lenders are on sound financial footing after the collapse of three of their larger peers since March.”

• “After its share price suddenly dropped late Wednesday, following a Bloomberg News report that it was evaluating its strategic options, PacWest said it was continuing to look to sell assets to shore up its finances. It said that it had not seen an ‘out-of-the-ordinary’ outflow of deposits in recent days.”

• “Western Alliance, in Phoenix, also tried to reassure investors, saying late on Wednesday that it was not seeing deposit outflows. As of Tuesday, the bank said, deposits stood at $48.8 billion, compared with $47.6 billion at the end of March. In a second statement, on Thursday, the bank also denied a report that it was considering a sale, describing that as ‘categorically false in all respects.’” READ MORE

It’s getting harder for businesses looking to borrow: “George Xouris was burned out and looking for a new challenge after 27 years as an IT salesman — which is why he and his wife launched what is now Andia’s Ice Cream in 2013. They began by making homemade batches of ice cream in a rented kitchen and selling it at local farmers markets and events, but have since opened two retail locations in Cary, North Carolina, with a third under construction in nearby Raleigh. Xouris Initially self-financed the business with a home equity loan and eventually turned to a traditional commercial small-business loan to expand — but they are now at the crossroads of what to do next. The dream? Twenty new shops within eight years, and while Xouris is not sure if they want to ultimately franchise, they want to make sure at least the first six or seven will be company-owned. That means they will need to decide how to finance Andia’s continued retail expansion. But it’s getting more complicated for business owners like Xouris.”

• “With the bank sector in turmoil, they’re now facing the prospect of a capital crunch as lenders turn cautious to protect their balance sheets. It’s a dynamic that threatens to limit growth opportunities for entrepreneurs and widen the gap between small businesses and their larger counterparts.”

• “Small-business loan approval rates at large banks declined for the ninth consecutive month in February, according to the Biz2Credit Small Business Lending Index, landing at 14.2 percent. The National Federation of Independent Business found the net percentage of small-business owners anticipating easier credit conditions in the next three months hit its lowest point in five years in January.” READ MORE

Economist Justin Wolfers says our economic discourse has become detached from our economic reality:

READ THE THREAD

THE DEBT CEILING

What would default actually look like? “I spent recent days talking to financial market experts and former government officials about the potential fallout. I wanted to better understand the channels through which panic and losses could spread and precipitate ‘financial Armageddon,’ as one former Federal Reserve official dubbed it. To be clear: There are many unknowns. Be skeptical of ultra-precise forecasts that quantify down to a tenth of a percentage point how much, say, unemployment would rise. Consequences will also vary depending on what markets think will happen. A 24-hour default during which a debt-limit deal appears imminent is different from one in which everyone believes lawmakers may have repudiated some debt forever. ... On to the consequences, in seven terrifying steps:”

• “Treasurys get downgraded — as does virtually every other asset on earth. U.S. Treasury debt has long been considered risk-free, with the relative riskiness of other assets benchmarked against it. So the sudden realization that Treasurys are unsafe cascades through other assets, including bonds of U.S. corporations. These bonds would be downgraded, making it more expensive for companies to borrow.”

• “Interest rates rise for U.S. consumers, businesses and the government. It becomes more expensive to buy a house or invest in new equipment. Our federal debt problems — the concern supposedly motivating default threats in Congress — also worsen as debt-service costs rise.”

• “Global investors likely would sell U.S. dollar-denominated assets as confidence in them evaporates; the dollar might lose value in foreign-exchange markets.” READ MORE

HUMAN RESOURCES

The governor of Iowa will sign a bill rolling back child-labor protections: “The measure would permit children as young as 14 to work in roofing, construction and demolition, provided they are part of educational or apprenticeship programs and a parent has granted permission for the work. They would also be allowed to do light assembly work and assist customers in businesses that sell fireworks, as long as no machines are present. The legislation eliminates state regulations on the number of hours 16- and 17-year-olds can work and allows them to serve alcohol in restaurants with parental permission. It also bars workers younger than 18 from working in ‘establishments where nude or topless dancing is performed.’”

• “The bill lifts ‘unnecessary restrictions’ on minors who wish to work and creates new opportunities for young people ’to work to get ahead in life or save money for college,’ Reynolds (R) said in a statement to The Washington Post.”

• “‘Iowans are proud to be known for our strong work ethic, and we want to instill those same values in the next generation,’ Reynolds said.”

• “The measure — championed by conservative lobbying groups, the state restaurant association and the state industry group for home builders, among others — is the latest in a raft of state measures passed or under consideration that loosen restrictions on minors’ work.” READ MORE

Three McDonald’s franchises are being fined more than $200,000 for breaking child labor laws, including employing but not paying 10-year-olds: “Three McDonald's franchisees are being fined more than $200,000 after breaking federal child labor laws, including employing, but not paying two 10-year-olds, the Department of Labor said Tuesday. Bauer Food, Archways Richwood and Bell Restaurant Group – which operate 62 locations across Kentucky, Indiana, Maryland and Ohio – collectively had 305 minors working at their restaurants illegally, the agency found. They must pay $212,544 in civil penalties, the DOL said.”

• “Bauer Food had two 10-year-olds cleaning the restaurant, manning the drive-thru window and preparing and sending out food orders, the DOL said. They sometimes worked until 2 a.m., and one was operating the deep fryer, a duty that is only allowed by employees age 16 and up. Bauer Food additionally had 24 minors under the age of 16 working longer hours than legally permitted. Bauer Food must pay $39,711.”

• “Fourteen is typically the minimum age required to be employed, though can vary ‘Depending upon the particular age of the minor and the particular job involved,’ the DOL said.” READ MORE

STARTUPS

A new competition encourages New Yorkers who live in public housing to pursue their own businesses: “Sarah Adams, a teacher, started a side business selling her Jamaican grandmother’s rum cake in 2015 with $5,000 from her husband’s retirement savings. Soon, she was handing out samples at markets and street festivals, building her company, Ms. Macs, one tin at a time. But when the pandemic crippled her growing business in 2020, Ms. Adams, who lives in a public housing complex in northern Manhattan, was forced to pivot. Teaching remotely, Ms. Adams put the money that she saved by not commuting toward trying out recipes for vegan muffins, reduced-sugar cookies and low-carb pizzas. A few months ago, Ms. Adams received a newsletter from her landlord, the New York City Housing Authority, which announced a new competition for entrepreneurs living in public housing. It offered cash prizes of up to $20,000 and free business development classes.”

• “Ms. Adams, 47, owns one of the nine businesses that won ‘NYC Boss Up,’ a ‘Shark Tank’ style competition that invites some of the city’s poorest residents to propose business ideas for further development and funding.”

• “A total of 279 applications were submitted, of which 23 were selected for the final round. Those entrepreneurs went on to pitch their business plans and field questions from a panel of judges at the Central Library in Brooklyn in March.”

• “The Boss Up program was funded for five years with a $1 million grant from the family foundation of Ron Moelis, a real estate developer who got the idea after reading a 2022 report by the Center for an Urban Future, a nonprofit. The report highlighted an untapped opportunity to increase entrepreneurship among public housing residents.” READ MORE

SILICON VALLEY

Startup founders and investors are going sober: “From founders to investors, members of the startup community are eschewing booze in the name of staying sharp — and healthy. ‘About six months ago, I stopped drinking alcohol. I feel much better, and I'm mad as hell about it,’ the prolific investor Marc Andreessen wrote on Substack in March. He said that going sober had helped his productivity skyrocket and that he now slept better and had more energy when he worked out. Andreessen's not alone: In a 2023 survey from the National Institute on Alcohol Abuse and Alcoholism, 33 percent of people 18 and older said they hadn't had a drink in the past year.”

• “In addition to going fully sober, some people embrace ‘damp’ lifestyles, in which they drink occasionally and in moderation. This lifestyle shift is even more striking in the alcohol-soaked tech industry, where booze and ‘frat-boy culture’ have contributed to workplace issues and mistreatment at startups such as WeWork.”

• “The tech community's sobriety boom has also ushered in a frenzy of nonalcoholic startups catering to dry drinkers, including the nonalcoholic aperitif Ghia, which has raised $6.7 million from Convivialité Ventures and Cleo Capital; the zero-proof alcohol replacement Seedlip, which was purchased by the alcohol giant Diageo in 2019; and Katy Perry's De Soi, which raised a $4 million seed round earlier this year from investors including Sellers.” READ MORE

THE 21 HATS PODCAST

Bonus Episode: Not Sold on ESOPs? There’s a New Alternative: This week, two special guests who have built highly successful companies talk about what they ultimately plan to do with those companies. Ari Weinzweig is co-founder of Zingerman’s Community of Businesses, a collection of mostly food-related companies that are an iconic part of Ann Arbor, Michigan. Brad Herrmann is co-founder of Text-Em-All, a software firm based near Dallas that helps organizations deliver personalized, informational, and emergency messages by text and by phone. Both Zingerman’s and Text-Em-All consider themselves purpose-driven. Both practice open-book management. And so, not surprisingly, the founders of both companies took a hard look at selling to an employee stock ownership plan, or ESOP, in the hope that the cultures they’ve created might live on.

But both companies, independently, soured on the notion of creating an ESOP, one after spending more than $200,000 and coming within a week of closing the deal. And now, both have settled on a little known alternative, what’s called a perpetual purpose trust. So far, only a handful of companies have tried to create a purpose trust for this particular purpose, but Zingerman’s and Text-Em-All are taking the leap. As both Ari and Brad acknowledge, they’re kind of figuring it out as they go.

• You can subscribe to the 21 Hats Podcast wherever you get podcasts.

Thanks for reading, everyone. — Loren