Enclosed is the fifth case which I wish to enter as testimony in the Senate Committee Field Hearing held in Missoula, Montana on April 7, 1980. This case represents the actual experience of a small business which had been established for over 30 years when suddenly faced with inflation, high interest rates, and continued high taxes all at one time. Our country, and Congress in particular, must seek to control these economic conditions if such firms are to continue operations in the future.

I wish to express my appreciation for having been asked to testify before this Senate hearing. I shall hope to hear from you in the future and look forward to receiving a copy of the hearing transcript when available. Please phone if I may be of any additional assistance to you or the Committee in the future.

Yours truly,

Clyde 1. Neu, Se

Clyde W. Neu
President

CWN:sc

CC:

Senator Max Baucus

CASE #V

A & I DISTRIBUTING COMPANY

SITUATION: HOW TO SURVIVE AS A LAST RESORT WHEN FACED WITH INFLATION, HIGH
INTEREST RATES AND HIGH TAXES

HISTORY:

A & I Distributing Company had been a distributor of industrial and automotive oils and accessories for better than thirty years; but business conditions had never been quite as they were by the summer of 1979. Don Lord, sole owner of the company, had just reviewed his financial statements for the end of his fiscal year. His sales had increased by better than 70% over the past two years; yet, his real business growth was disguised by inflation. Each time he reordered it seemed, his cost of replacing merchandise literally jumped. Often times, he was replacing his shelves with the same quantity of products at 10% to 12% higher value. Further, his costs of distribution and interest had jumped. Overall, his firm's break-even point of operation had risen at 90% over the past two years, faster than the growth rate in sales.

A brief review of comparative financial ratios highlighted the trends. Net profits had declined from 3.1% of sales to less than 1.0% in two years. His return on investment had declined from 25.7% to 10.2% with the end of the current fiscal year. His investment had increased tremendously inventories had doubled and accounts receivable had increased by 106%. His average collection period for outstanding accounts now exceeded 52 days and he was faced with his first significant write-off of bad debts in years.

To finance his business, he had borrowed heavily from the bank. Bank debt was now equal to 2.7 times that which prevailed just two years earlier. Accounts receivable were 3-1/2 times the level which prevailed two years ago. Total debt which had equaled 57% of total investment in 1977 now equaled 75% of total investment. Credit relationships were strained with both his suppliers, some of whom were ready to ship only on a C.O.D. basis, and with his bank.

UNDERLYING
PROBLEM:

It seemed to Don that he had no control over these problems. Inflation was the basic cause. He had continued to maintain the same rate of inventory turnover and all of his operating expenses excluding interest, distribution costs, and salaries had been controlled as sales increased. Perhaps his financing problems were unique to his business. After all, the rate of inflation has escalated in the oil industry faster than in others. However, other wholesalers and retailers with whom he visited told of similar problems.

THE A & I DISTRIBUTING COMPANY, PAGE TWO

POSSIBLE
SOLUTION:

Clearly, additional capital was urgently needed for his firm. He owned a small farm, originally homesteaded by his great-grandmother in 1913, and could borrow money personally to put into this business using this farm as collateral. However, the business simply couldn't afford to increase his salary to compensate him for the increased debt payments. Further, any salary increase would substantially increase his individual tax rate leaving him with less after tax income than

necessary.

Don could consider another alternative he could sell his company at a distressed price to salvage what he could. Conditions could get worse. The business had an excellent reputation and could serve a growing trade area. Looking around, he noted that other companies had taken this route and sold out recently to larger, better financed companies.

Neither of the above two solutions seemed desirable. Don was in his mid-forties and had two children just entering college. Perhaps he could hang on, hoping to outlast what he believed to be short-term trends in the economy. After all, projections were then being made that double digit inflation would subside, that interest rates would peak out at 15%, and that relief would come in the money market in the 'form of loans for small businesses. The date was September 1, 1979.

THE ULTIMATE SOLUTION (Actual):

Don finally opted to sell the farm that had been in his family for nearly seventy years. He used these proceeds to personally purchase the building and land occupied by the business and lease the facility back to the firm, thus injecting approximately $50,000 of new cash into the business. With the additional financing, the firm now qualified for added bank debt. Suppliers were paid for all past due accounts and the firm made a commitment to stay current with its suppliers in the future.

In addition, a new employee stock ownership plan (ESOP) was structured for the firm and three key employees were brought into the company by virtue of converting their vested interest in the company's previous profit sharing plan to shares of common stock in the company. Don gave up a portion of ownership of his firm to the employee stock trust, but in the process created a way to retain earnings in the company to help finance future growth. An additional $50,000 could be injected into the company in this manner in the first year followed by $20,000 annually in the future.

For the immediate future, the critical capital shortage was solved. But how long would this last? Continued inflation would surely give rise to the same problems again in the future. Corporate and individual income tax rates continued high. Finally, interest costs did not peak out at 15%; they had soared past 20% by April 1, 1980.

Clyde W. Neu
April 14, 1980

Senator BAUCUs. Wally, will you go ahead?

STATEMENT OF WALLY EDLAND, FARMERS HOME ADMINISTRATION STATE DIRECTOR, BOZEMAN, MONT.

Mr. EDLAND. Thank you, Senator, for an opportunity to appear before this committee.

Montana, the fourth largest State in the union, but with only a population of approximately 750,000 people, has suffered endlessly due to the lack of investment capital. This has curtailed Montana's industrial growth when new ideas and needs arise which are necessary to our tax base and the utilization of our agricultural related business, agriculture itself, and energy.

It may seem untimely to be addressing the need for venture capital for new or expanding business when we are in a period of history where we have the highest inflation and interest rates, but I believe we must address these important questions, not sweep them under the rug, and look at the future with optimism. This great Nation of ours not only has unlimited resources and the ability to produce, its greatest asset is the ingenuity of its people to overcome all odds if given a chance.

Montana is known throughout the country as an export State of its raw products. Exporting to those other States who in turn refine and finish these products capitalize on them and return them to us and others, here and abroad, at a profit that could have been retained in Montana if adequate capital had been available. Our livestock, grain and minerals are only a few of our resources, the most important is our youth. We raise and educate them with more versatility and knowledge in a variety of career fields only to have them, out of necessity of employment, move to other States. I do not mean to imply that we should build industry in Montana and have capital available to retain our youth, but when needed and applicable, business and industry is identified, and adequate capital, many times, is not available.

At a time of energy crisis which we must continue to live with, we should concentrate in utilizing the production from the raw to finished products of everything we can within those areas. In many cases this constitutes a redirection in our development of where some industries should be located and specifically, new ones.

I do not mean to imply that the Federal Government should make all these decisions. It can only come about with a close working relationship of local, State and Federal Governments; however, the Federal Government's tax policy as it relates to small business, taxations and capital formation sets the stage for all other avenues to follow. A redirection in our taxations to allow businesses to reinvest those dollars is one form of venture capital that can be used and the incentive for additional capital to be made available.

Through the business and industry program of the Farmers Home Administration, I have become very aware of the needs of new and existing businesses for capital in Montana. Ours is a program similar to the Small Business Administration with guaranteed loans with one major exception and that is we do not have a ceiling of lending authority. Because of this authority we have been able to address the needs for larger businesses and manufacturing that never before was

possible. Banks that due to their smaller size than their larger metropolitan counterparts can now participate and have in these ventures.

In 1977 and 1978 we made $2 million each year in guaranteed loans. In 1979 we made $14 million and if they do not cut us back in 1980 we will do even better because the need is there. At the present time many applications we have had are not forming their final application due to the high interest rates because it is just impossible for them to balance out.

Senator BAUCUs. In what range are those rates?

Mr. EDLAND. We are looking of course at secondary money rates when you are looking at 16, 17 and 18 percent on that secondary money out there. They are just looking at it and they are just saying nothing doing. When we were looking at 12 percent, it looked feasible. And that's why a lot of the real good businesses right now that we anticipated on applications are just saying, "No, we are not going to go that unless the interest rates turn around."

Senator BAUCUS. What determines the secondary rate?

Mr. EDLAND. That's your money market.

Senator BAUCUS. Does Farmers Home have any authority to go lower?

Mr. EDLAND. No. The interest rate is determined between the lender and the borrower, and that was determined by a secondary borrower at which a bank or lending institution can sell on the secondary market. When you are looking at long term, you are looking at 17 to 20 percent interest. A lot of those guaranteed loans are going to take and follow that, that's what they are going to be for the long-term loans. Senator BAUCUs. Who ordinarily buys the secondary loan?

Mr. EDLAND. We have a lot of investors who take and buy, they buy the 90 percent guaranteed. The bank retains the 10 percent guaranteed portion, and we have many investors that buy that because it's the same as bonds, and it's a good return.

Senator BAUCUS. Thank you.

Mr. EDLAND. Many of these are in energy-related businesses. We have recently approved the first large gasohol plan in the United States to be funded through Farmers Home Administration. This is a $2 million guaranteed loan at the Glascow Air Force Base with 51-percent ownership by women. So, it was considered a minority loan. And we would have more if venture capital were available.

Senator BAUCUS. Are there more women than men in the country? Mr. EDLAND. No, but they now hold some leverage. But the unusual thing here, the families, they have mortgaged and put up their entire farms as a guarantee against this, so they are risking a lot. Had they not had that amount of capital, it would have been difficult, and also to assist in that, in part, in the form of a venture, was the $100,000 grant from the Department of Natural Resources. Now, there are a number of applications that have been funded that we are waiting to work through, but that is a form of energy that is not available; many other things, it's energy related. But the need of venture capital or front-end investment has been critical to numerous projects in the Farm Home Administration business and industry program.

Venture capital is needed to make viable, potentially sound business proposals such as (a) Feasibility; (b) prototypes: (c) market structure; (d) equity requirements; (e) loan costs; and, (f) management