Small Businesses Especially Vulnerable to Extreme Weather

Small and young businesses today are especially vulnerable to extreme weather and other natural disasters, as recent flooding in North Carolina, Louisiana, the northern UK, and Chennai demonstrates.

And there’s no end in sight: The frequency and severity of disasters will continue to increase due to more volatile weather, rising sea levels, and increasing urbanization. These threats change the risk management calculus of firms hoping to succeed in a more turbulent world.

Small businesses and young businesses are especially vulnerable. Data from the U.S. Census Bureau shows that these businesses were more likely than the average business to close permanently after Hurricane Katrina, for example.

This is especially important because small businesses are not only the lifeblood of many communities, but central to broader national economies. In the U.S., they account for 50% of employment and 45% of GDP. Start-ups in particular, which almost always start small, are big contributors to economic growth.

Owning up to our own behavioral biases is a worthwhile starting point to discussing the problem of managing infrequent, severe events. Behavioral science research tell us that households, small business owners, and CEOs of multinationals alike are prone to overweight recent adverse events, follow the decisions of their peers, compartmentalize risks, and engage in many other behaviors that economists have traditionally considered peculiar.

Start-ups are particularly at risk today because of both their size and age. First, small businesses tend to be more productive than larger ones and may be especially unlikely to invest in risk management that diverts resources from production.

Second, young businesses tend to grow faster than older ones, but also fail at greater rates. Young firms face many existential threats related to managing internal financial and human resources and external relationships with customers, suppliers, investors and competitors.

Young firms may be especially unlikely to prepare for infrequent events such as major hurricanes since they are exposed to so many risks that occur with a higher likelihood.

Some of the findings and conclusions:

• Firms are frequently uninsured.  Almost one third of the firms negatively affected by the storm had no insurance of any   kind .  Consistent with our predictions, young firms and small businesses insured at much lower rates. For example, roughly 60% of firms that were less than five years old were uninsured. Moreover, insured businesses of any size frequently did not have coverage for the kinds of losses that Sandy created: 74% of businesses with property insurance, 72% with business interruption insurance, and 52% of businesses with flood insurance reported that none of their losses from the event had been covered by their insurance.
• Firms apply for credit to finance recovery.  Firms that were negatively affected by Sandy applied for credit at twice the rate of unaffected ones. Credit played such a prominent role in our study that, among negatively affected firms, more businesses increased their debt because of Sandy than received insurance payments.
• Negatively affected firms are often credit constrained.  These firms were more than twice as likely to report that their access to credit had decreased since before Sandy. Younger firms were especially likely to report that their interest rates increased after the storm. Larger firms were more likely to receive credit, which seems at least partially explained by their ability to secure loans with collateral.

Read full article: Harvard Business Review