You Can (Not) Take It To The Bank

With California's budget disaster showing no signs of progress, more and more small businesses that do contract work for the Golden State are having to take IOUs...IOUs that major banks will no longer accept. That means small businesses are going to have to start furloughing workers, slash costs, and even trim jobs.

A number of California's community banks and credit units plan to accept the IOUs indefinitely, but in many cases, the terms are tough.

"My community bank will redeem the IOU for a fee, but I have no choice but to do it," says the owner of an 11-person firm who asked not to be named. "It's not worth my while to wait for this thing to mature. I'd be losing money." His company, which does $10 million in annual business with the state, has been providing goods to prisons, state hospitals, and schools for more than 20 years. This is the first time he's been confronted with an IOU.

"If this situation continues to force us to take losses, I'll have to look into furloughing employees and laying some off," he says. Even before the latest crisis, California was firing off distress flares: Last month, he received a letter from the state asking if he would consider voluntarily reducing his company's charges by 15%.

The California Credit Union League reports that most of its member unions are willing to honor the IOUs, but at many branches, new clients would have to open an account to be able to cash in the warrant. The unions say they're offering as much flexibility as they can: Some are considering modifying the terms of loans they're made to small businesses affected by the IOU situation.

"We're a little different from banks," says Jim Ott, CEO of UNCLE Credit Union, a mid-size union based in Livermore, Calif. "We want to be able to help our members."

As a last resort, cash-strapped companies may be able to redeem the IOUs at check-cashing storefronts or via online marketplaces such as Craigslist or eBay, but small business advisors warn against that because of the large fees and face-value discounts that would be incurred.

"I would automatically find a bank that will redeem the IOU for 100 cents on the dollar rather than taking a haircut by going to a check-cashing facility," says Donna Childs, a business consultant and author of Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses. While businesses selling the IOUs might be able to haggle and receive close to face value, the California State Treasurer's office has mandated that the transactions must be accompanied by a notarized bill of sale signed by the payee whose name appears on the IOU.

For vendors that need cash sooner rather than later, losing a few bucks due to exchange fees might be the least of their worries. If California doesn't resolve its budget crisis soon, many more small companies will end up caught in the political crossfire.

And the disaster rolls on, unabated.