[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]





   PROPOSED SOLUTIONS FOR THE CAPITAL FUNDING NEEDS OF START-UP AND 
                       EMERGING GROWTH BUSINESSES

=======================================================================

                                HEARING

                               before the

               SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

                                  and

    SUBCOMMITTEE ON WORKFORCE, EMPOWERMENT, AND GOVERNMENT PROGRAMS

                                 of the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                     WASHINGTON, DC, JUNE 26, 2001

                               __________

                           Serial No. 107-15

                               __________

         Printed for the use of the Committee on Small Business




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                      COMMITTEE ON SMALL BUSINESS

                  DONALD MANZULLO, Illinois, Chairman
LARRY COMBEST, Texas                 NYDIA M. VELAZQUEZ, New York
JOEL HEFLEY, Colorado                JUANITA MILLENDER-McDONALD, 
ROSCOE G. BARTLETT, Maryland             California
FRANK A. LoBIONDO, New Jersey        DANNY K. DAVIS, Illinois
SUE W. KELLY, New York               WILLIAM PASCRELL, New Jersey
STEVEN J. CHABOT, Ohio               DONNA M. CHRISTENSEN, Virgin 
PHIL ENGLISH, Pennsylvania               Islands
PATRICK J. TOOMEY, Pennsylvania      ROBERT A. BRADY, Pennsylvania
JIM DeMINT, South Carolina           TOM UDALL, New Mexico
JOHN THUNE, South Dakota             STEPHANIE TUBBS JONES, Ohio
MIKE PENCE, Indiana                  CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey            DAVID D. PHELPS, Illinois
DARRELL E. ISSA, California          GRACE F. NAPOLITANO, California
SAM GRAVES, Missouri                 BRIAN BAIRD, Washington
EDWARD L. SCHROCK, Virginia          MARK UDALL, Colorado
FELIX J. GRUCCI, Jr., New York       JAMES P. LANGEVIN, Rhode Island
TODD W. AKIN, Missouri               MIKE ROSS, Arizona
SHELLEY MOORE CAPITO, West Virginia  BRAD CARSON, Oklahoma
                                     ANIBAL ACEVEDO-VILA, Puerto Rico
                  Phil Eskeland, Deputy Staff Director
                  Michael Day, Minority Staff Director
                                 ------                                

               Subcommittee on Tax, Finance, and Exports

                   PAT TOOMEY, Pennsylvania, Chairman
STEVEN J. CHABOT, Ohio               JAMES LANGEVIN, Rhode Island
DARRELL ISSA, California             GRACE F. NAPOLITANO, California
EDWARD SCHROCK, Virginia             ANIBAL ACEVEDO-VILA, Puerto Rico
TODD AKIN, Missouri                  DANNY K. DAVIS, Illinois
FRANK LoBIONDO, New Jersey           ROBERT A. BRADY, Pennsylvania
JIM DeMINT, South Carolina           MIKE ROSS, Arizona
JOHN THUNE, South Dakota
                     Sean M. McGraw, Staff Director
                                 ------                                

    Subcommittee on Workforce, Empowerment, and Government Programs

JIM DeMINT, South Carolina,          JUANITA MILLENDER-McDONALD, 
    Chairman                             California
FRANK LoBIONDO, New Jersey           DANNY DAVIS, Illinois
MIKE FERGUSON, New Jersey            STEPHANIE TUBBS JONES, Ohio
FELIX GRUCCI, New York               CHARLES GONZALEZ, Texas
DARRELL ISSA, California             MIKE ROSS, Arizona
ED SCHROCK, Virginia                 DONNA M. CHRISTENSEN, Virgin 
SHELLEY MOORE CAPITO, West Virginia      Islands
                  Nelson Crowther, Professional Staff




                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on June 26, 2001....................................     1

                               WITNESSES

Brinson, John, President, Lehigh Valley Racquet & Fitness Centers     6
Rankin, Ed, Founder & CEO, People Solutions, Inc.................     8
Tatum, Doug, CEO, Tatum CFT Partners.............................    10
Kerrigan, Karen, Chair, Small Business Survival Committee........    12
Morgan, Bob, President, Council of Growing Companies.............    14
Mercer, Lee, President, National Association of Small Business 
  Investment Companies...........................................    15

                                APPENDIX

Opening statements:
    DeMint, Hon. Jim.............................................    26
    Millender-McDonald, Hon. Juanita.............................    30
    Toomey, Hon. Patrick.........................................    36
Prepared statements:
    Brinson, John................................................    40
    Rankin, Ed...................................................    42
    Tatum, Doug..................................................    47
    Kerrigan, Karen..............................................    70
    Morgan, Bob..................................................    79
    Mercer, Lee..................................................    84

 
   PROPOSED SOLUTIONS FOR THE CAPITAL FUNDING NEEDS OF START-UP AND 
                       EMERGING GROWTH BUSINESSES

                              ----------                              


                         TUESDAY, JUNE 26, 2001

          House of Representatives,        
           Committee on Small Business,    
 Subcommittee on Tax, Finance, and Exports,
             Subcommittee on Workforce, Empowerment
                                   and Government Programs,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 2:05 p.m. in 
room 2360, Rayburn House Office Building, Hon. Pat Toomey 
(chairman of the Subcommittee on Tax, Finance, and Exports) 
presiding.
    Mr. Toomey. The subcommittee will come to order.
    In light of the fact that we have a vote, I believe we have 
two votes right now, I will adjourn the hearing. We will do the 
votes, come back as quickly as we can and then get underway and 
hopefully we will have time to get through this uninterrupted 
from there, but no promises. So the meeting is adjourned for 
now.
    [Recess.]
    Mr. Toomey. The meeting will come to order. I would like to 
thank everyone for their patience as we went through the votes. 
It is my understanding that we do have some time now before any 
subsequent votes, so hopefully we will be able to get much of 
this done.
    This afternoon, the Small Business Subcommittee on Tax, 
Finance, and Exports convenes in a joint hearing with the 
Subcommittee on Workforce Empowerment and Government Programs 
to address an important challenge facing small businesses 
throughout the nation and that is access to capital.
    This hearing follows the full committee hearing conducted 
on May 17, 2001 which focused on results from a Federal Reserve 
U.S. bank survey which supported evidence of tighter loan 
standards for businesses attempting to obtain commercial and 
industrial capital.
    Capital is, of course, the lifeblood of small businesses. 
For a citizen with a dream of becoming an entrepreneur, a small 
business owner looking to more efficiently bring goods and 
services to the marketplace, or a small or mid-size business 
attempting to maintain profitability, access to capital is 
imperative for growth, in many cases, for survival.
    There are a number of potential solutions to the shortage 
of capital for small business and I want to especially 
recognize and thank my colleagues Mr. DeMint and Mr. Baird for 
their work in crafting legislation that might very well 
substantially alleviate some of these problems. Let me just 
briefly touch on the SUSA act and the BRIDGE act.
    The SUSA stands for the Start-Up Success Accounts. This is 
an act that would allow small businesses with gross receipts of 
up to $2 million to deduct and place up to 20 percent of 
taxable income into an account for each of the first five years 
of a business operation. If enacted, this legislation would 
allow small businesses to draw down on the funds from these 
accounts over a five-year period from the time of deposit, 
thereby stabilizing the flow of capital and equipping the 
start-up to save for the future.
    The BRIDGE act would allow a firm experiencing sales growth 
of 10 percent or more to temporarily defer a portion of its 
federal income tax liability.
    Both of these measures could be extremely helpful. Clearly 
the two gentleman who worked together in developing this 
legislation understand the challenges facing small business and 
I commend them for the creative approach they have taken to 
addressing this challenge.
    On a personal note, I would like to suggest that I think 
one of the most effective ways that we can help facilitate 
small business access to capital would be providing relief from 
the capital gains tax. Personally, my conviction is that we 
ought to eliminate the capital gains tax all together. That 
serves as an impediment which is an obstacle to small business 
and all business attracting capital. It is a punishment for 
people and businesses that save and invest and therefore it 
deters economic growth. Having said that, this solution is in 
no way exclusive as an approach to helping business access 
capital.
    I think Messrs. DeMint and Baird have some very good 
suggestions as well.
    I would also just remind everyone how critical small 
business is to our nation's economy. It has been the 
cornerstone of our economy for decades. Small businesses 
continue to provide so many critical job opportunities and 
access to the American dream for so many folks. That is why I 
think it is very important that we have this hearing today, 
that we hear from the folks who are on the front lines actually 
operating small businesses.
    I look forward to the testimony of all of our witnesses 
today, but I want to particularly thank those of you who have 
traveled a long distance to be with us, in particular, my 
friend and constituent Mr. Brinson, who is here from the Lehigh 
Valley, a small business owner, who has a great deal of 
expertise in this area.
    At this point, I will yield to my good friend from South 
Carolina, Mr. DeMint.
    Mr. DeMint. Thank you, Chairman Toomey. I appreciate as 
well the opportunity to join with you in bringing these two 
subcommittees together today to examine more closely some of 
the issues and questions raised at the full committee hearing 
on access to capital earlier this year.
    Inc. Magazine commented in its annual State of Small 
Business issue this year that ``If small business were a boxer, 
the blows of the past 12 months might have left it on the 
ropes.'' That same issue cited financing as the second largest 
reason for small business bankruptcy.
    The overall problem of access to capital and capital 
retention is what we are focused on here today. However, those 
challenges manifest themselves differently for start-up 
companies and for emerging growth businesses. From a public 
policy standpoint, I am pleased that we have the opportunity to 
examine the different financing needs of these types of 
businesses and explore legislative solutions.
    New businesses have the potential to create hope and 
opportunity for many Americans. They are an integral part of 
the renewal process that defines market economies. New and 
small firms play a crucial role in experimentation and 
innovation which leads to technological change and productivity 
growth.
    They also provide an essential path for many to enter the 
economic and social mainstream of society. Small business is 
the vehicle by which millions access the American dream by 
creating opportunities for women, minorities and immigrants. In 
fact, minority and women-owned businesses make up two of the 
fastest growing segments of new small businesses.
    While this is encouraging, a large number of these new 
businesses fail in the first few years, often for a lack of 
capital. A primary cause of this is that our tax code does much 
to discourage capital retention. The ultimate result is the 
loss of staying power. Operating with no capital, evenin a 
small downturn in sales can put a new company out of business.
    Earlier this year, as Chairman Toomey mentioned, 
Representative Baird and I introduced H.R. 1923, the Start-Up 
Success Account Act of 2001 which we call SUSA. The purpose of 
this legislation is to give new small businesses an additional 
tool to manage finances and retain capital. H.R. 1923 would 
allow a start-up to place up to $100,000 of taxable income into 
a SUSA account over the course of the first five years of 
business operation. This would allow new businesses, new small 
businesses, that are profitable in one year to set aside some 
profits to prepare for a downturn in later years.
    This bill is similar to a bill by our colleague, Kenny 
Hulshof, which would help farmers and ranchers manage capital 
with FARRM accounts.
    Fewer people may be familiar with the emerging growth 
businesses that we will also discuss today that are crucial to 
the U.S. economy. Emerging growth businesses are a precious 
national asset. They are America's job generator, producing 
over 90 percent of the net new employment in the last 10 years. 
Evidence also indicates that they are the only firms that 
provide new jobs during suppressed economies, like the present 
one.
    Emerging growth companies confront a unique threat in the 
area of obtaining and retaining capital and ironically are most 
vulnerable to failure in the period in which they are quickly 
expanding. Although seemingly counter intuitive, when these 
firms enter a high growth phase and are experiencing increased 
profits under accrual accounting standards, they often face 
transitional cash flow shortages or negative cash flow due to 
the need for increasing investment in working assets and new 
personnel as sales expand. The tax code compounds the 
difficulty in retaining capital during the high growth phase 
because it forces an expanding business to pay taxes on accrued 
income during this period of cash shortfall.
    Because these firms are not big enough to attract outside 
asset-based financing, they fall into a capital funding gap. 
The result is that emerging growth companies may not generate 
sufficient cash flow even as they enter their profitable years 
to cover income tax liability. This capital funding gap has a 
measurable and detrimental impact on the U.S. economy.
    To help resolve this capital funding problem for emerging 
growth businesses, Congressman Baird and I have been working 
closely with Doug Tatum, who you will hear from today, on what 
we call the Business Retained Income During Growth and 
Expansion Act or BRIDGE which we hope to introduce within the 
next few days or weeks. In order to provide emerging growth 
firms with needed capital cash flow as they expand sales 
revenue, the BRIDGE act will allow a firm that meets the growth 
test to temporarily defer a portion of its federal income tax 
liability.
    The deferral would be limited to $250,000 of tax, which 
would be repaid with interest. The tax-deferred amount would be 
deposited into a separate BRIDGE account at a bank and the firm 
could use the account as collateral for a business loan from 
the bank.
    Now, this proposal could bring tremendous national benefits 
as a way to create a significant job creating sector of the 
economy. We anticipate the BRIDGE would also have a modest 
revenue effect initially which would become neutral over a long 
period of time.
    As one who owned a small business before coming to the 
House, I am aware of the devastating effect that capital 
shortage can have on a business.
    I, too, would like to thank all of the panelists and yield 
the time back to the chairman.
    Thank you.
    [Mr. DeMint's statement may be found in appendix.]
    Mr. Toomey. Thank you, Chairman DeMint.
    At this time, I will yield for five minutes to the ranking 
member, Mr. Pascrell.
    Mr. Pascrell. Thank you, Mr. Chairman. I think this is a 
great joint hearing whose purposes I absolutely support.
    The access to capital hearing is particularly timely, given 
the nation's current economic uncertainty. The economic boom is 
slowing down, I think we would all agree. Financial losses are 
mounting for many companies and job cuts are affecting every 
industry in America. To make things worse, in recent weeks we 
have read studies that suggest the tightening of credit 
standards by a variety of banks. This is a real problem.
    Small businesses need convenient access to capital 
resources and that is our primary job, I would think, on all of 
the committees, all of the subcommittees, whether it is start-
up costs, expansion purchasing or employee costs, there are 
always new expenses for businesses.
    And small businesses certainly need financing in order to 
stay competitive with larger companies in the marketplace--we 
have heard that over and over again in the last few weeks--
because traditionally many small businesses have limited assets 
and uncertain earnings. That is one thing for sure.
    Because of this, they have a more difficult time than 
larger companies when it comes to finding the financial fuel to 
make their ventures successful. The tragic result is that these 
small companies, particularly minority and women-owned 
businesses, with enormous potential end up closing their doors 
due to lack of capital.
    So I welcome the hearing and I welcome hearing the various 
proposals before this subcommittee that address these issues. 
With access to capital issues on our mid, let us not forget 
that we must make certain that as Congress debates funding 
priorities for the next fiscal year we include a comprehensive 
discussion on the impact of these decisions upon the small 
business community, particularly given the Bush 
administration's proposed cuts in 7(a) and small business 
investment companies programs, a proposal which eliminates the 
program appropriations for each loan program and replaces them 
with fees. Unacceptable.
    I thank you for coming here today and I thank the chairs 
and I look forward to a lively discussion.
    Mr. Toomey. I thank the gentleman from New Jersey.
    At this time, if he has an opening comment, I would like to 
recognize for five minutes the gentleman from Washington who 
has been participating in the drafting of this legislation, Mr. 
Baird.
    Mr. Baird. I thank the co-chairs and the ranking member.
    Just very briefly, my good friend and colleague Jim DeMint, 
I think well described the situation. It was pointed out to me 
first, before I was elected, I put together a panel of small 
business folks and asked what is the number one thing we could 
do and what they pointed out to me was there are a lot of 
government programs to help businesses get on their feet, but 
as we know, high percentages of brand new start-up businesses 
have a failure rate.
    The real jobs, as Congressman DeMint mentioned, are the 
jobs from the existing businesses that have been successful 
enough to start growing, yet paradoxically we have almost no 
government programs to help provide capital or support for fast 
growth businesses and yet the private sector, for reasons 
described well in our previous hearing, often cannot make up 
that gap.
    It is as if we give people a car but then we put a governor 
on the accelerator. Just as you try to move forward, the 
governor takes in and puts the brakes on. That lack of capital 
is the governor and I think the SUSA act that Congressman 
DeMint and I have already introduced combined with this BRIDGE 
act, if we can get it passed, would go a very long way toward 
providing incentives and support for small businesses and that 
would enhance employment and I commendthe chairs for their 
efforts and I look forward to the testimony of the panelists.
    Thank you.
    Mr. Toomey. Thank you, Mr. Baird.
    Ms. Napolitano, do you have any opening comments?
    Ms. Napolitano. Only that it is one of the most salient 
issues in my area in dealing with small businesses' ability to 
succeed. Myself being in small business many years ago, that 
was one of the issues we encountered, is the assistance from 
being able to move forward and grow.
    I was reading one of the reports that it indicates that 
small business has been the engine of the economy of 50 
percent. I would venture to say it is over 75 percent. And I 
think we are not giving small business its due and the 
assistance it needs to be able to have the growth, the 
potential it has. And I think the more we hear about the issues 
directly from small business that we can then be able to move 
forward with an agenda, with legislation that is going to 
really impact and have the ability to help small business 
growth through assistance in funding.
    Thank you.
    Mr. Toomey. Thank you.
    At this time, I will recognize Ms. Millender-McDonald.
    Do you have an opening comment?
    Ms. Millender-McDonald. Yes. Thank you, Mr. Chair.
    And to both chairs, as one of the ranking members who are 
poised to convene this hearing, we understand and recognize 
that the impediment to growth and expansion of any small 
businesses is that of access to capital. And so we also 
recognize that there is a lack of access to capital with 
reference to small businesses. Today, our hearing focuses on 
such a lack.
    Recent studies have documented that the greatest growth in 
employment has resulted from small businesses with less than 
100 employees. In order for small businesses to grow, we have 
to expand so that we can employ folks. And with my position on 
workforce and empowerment, it is critical that we look into 
access to capital.
    Mr. Chairmen, I will not read my statement, but merely ask 
unanimous consent that we place this in the record and I look 
forward to the testimonies today.
    Mr. Toomey. Without objection.
    [Ms. Millender-McDonald's statement may be found in 
appendix.]
    Mr. Toomey. Does the gentleman from Ohio have an opening 
statement? No?
    Okay. In that case, we can begin with the testimony. I 
would just like to briefly explain the clock system we will 
use. Everybody will be operating on a five-minute rule. The 
light will be green for the first four minutes. It will go 
yellow with one minute remaining and we will try to stick to 
that so we can move things along.
    At this point, I would like to recognize Mr. Brinson from 
Lehigh Valley, Pennsylvania.

 STATEMENT OF JOHN BRINSON, PRESIDENT, LEHIGH VALLEY RACQUET & 
            FITNESS CENTERS, ALLENTOWN, PENNSYLVANIA

    Mr. Brinson. Thank you, Congressman Toomey, Congressman 
DeMint, Congressman Baird, and all the rest. I know some of 
you.
    I know Pat very well, I have known him since before he ran 
for Congress and he used to work out in my clubs on a pretty 
regular basis, but he tells me he is too busy to work out now.
    Mr. Toomey. Occupational hazard.
    Mr. Brinson. Yes. Yes.
    I am chairman, CEO and majority owner of a small business 
in the Lehigh Valley of Pennsylvania and without going through 
all my testimony in detail, our business has four locations. We 
have 10,000 members and we employee 300 people, 45 of them 
full-time employees and 250 plus are part-timers.
    We have had a good record. We have basically been with the 
same bank for 22 years. The problem that I want to talk about 
today has to do with access to capital for expansion. Back in 
1998, I began to talk--and our bank is First Union and, by the 
way, I have to say for the record I am very pleased with First 
Union Bank, if there are any First Union Bank employees in the 
room, I love First Union. And, honestly, I am not here to say 
anything disparaging about the bank. We have a very good 
relationship with them and we have had a very good relationship 
with them.
    In 1998, I told them that the west end of our market was 
expanding rapidly and that we needed a new location. They were 
cool. They said, well, ``let us see your proposal''. I gave 
them a proposal for a new club to be located about five miles 
to the west of our westernmost club at the time. We have sort 
of a linear market in the Lehigh Valley.
    Anyway, I suggested that they lend us $500,000 and we would 
put up $300,000 or whatever else was necessary to do the club.
    They passed it up the line, the answer was no.
    I went back and I asked again, the answer was no.
    I asked why, and they said, ``well, it is because, you 
know, your business is a high risk business and we have enough 
risk and we do not want any more risk''.
    And so they turned us down.
    So I told them that we would go to another bank and see 
what we could do and they said,'' well, you cannot do that 
because of loan covenants''.
    We have a large mortgage with First Union Bank and they 
have covenants upon covenants. I mentioned before the meeting 
to a couple of reporters that I need to call them to get 
permission to go to lunch. They really--it is almost like--the 
lawyers would understand, a contract of adhesion. If you want 
the money, you are going to sign away your life and permission 
to do anything and everything.
    Anyway, they told me I could not go to another bank.
    So I said, well, ``I will round up a new group of owners''.
    And they said, well, ``it cannot include you, so you will 
have to find a new group of owners not including yourself''.
    And I said, well, ``all right, I will do that''.
    And they said, ``you still cannot do it because your 
existing clubs cannot have anything at all to do with the new 
club''.
    But, of course, the reason we wanted the new club was to 
have it be a part of our chain.
    So they tried to stop us at every turn.
    Anyway, I sat down with my lawyer and we read the loan 
covenants and we found a way around it and we did it anyway. We 
went out and we raised all the money without one single penny 
of bank money from private investors, none of whom own any part 
of our existing business. And so we have a new club. I do not 
own a penny's worth of it and we are managing the new club 
under a management contract.
    It is a good deal for us to do this, but I sure wish the 
bank had participated.
    I want to say that I think the reason the bank did not was 
because bank regulations are extremely difficult. They have all 
kinds of ratios and tests to meet, they have all kinds 
ofbusinesses that are classified as high risk and medium risk and so 
forth and so I think bank regulation is a big problem.
    As I mentioned in my testimony, I would like to see some 
provision for income taxes to be deferred to help business such 
as ours with expansion.
    Thank you very much.
    [Mr. Brinson's statement may be found in appendix.]
    Mr. Toomey. Thank you, Mr. Brinson.
    At this time, I would like to recognize the founder and 
chief executive officer of People Solutions, Inc., Mr. Ed 
Rankin, our next witness, for his testimony.

 STATEMENT OF ED RANKIN, FOUNDER & CEO, PEOPLESOLUTIONS, INC., 
                         IRVING, TEXAS

    Mr. Rankin. Thank you, Chairman Toomey, Chairman DeMint and 
members of the subcommittee. My name is Ed Rankin. I am the 
founder and chief executive officer of PeopleSolutions. We are 
a Dallas based company. We have offices in Austin and Houston.
    We were an early entrant into a disruptive industry, 
disruptive in terms of we are changing how American industry, 
U.S. industry, is managing people and we are really providing a 
more efficient relationship between people and their employer 
through this human resource management outsourcing industry.
    This is a complete start-up. I went to the bank on February 
14, 1994. I remember it because it was Valentine's Day. And I 
deposited $1000 into a commercial bank, a large regional 
commercial bank, and we started the business in an executive 
suite office with an ink jet printer and a notebook computer 
and some borrowed furniture.
    The first year, we did about three or four hundred thousand 
dollars in revenue. We were profitable. We started to get 
feedback from our clients that this was real and we got some 
large corporations as clients, large multi-nationals who were 
asking us for more and more work. We started investing in the 
business a little.
    In the second year, in 1995, we did slightly more than $1 
million in revenue. And all through this time period we had 
been very profitable. Our profit margins were strong, our net 
income was good, we were running about 10 percent net income, 
which we probably could have done much better, but I was trying 
to grow and we were growing at 100 percent a year.
    I tried during this time period to get loans from 
commercial banks, just for growth. There was nothing there. No 
one even wanted to talk with us. Literally, banking officers 
would not even return calls.
    The third year, we really, really took off. And our 
workforce is predominantly well educated, highly paid people. I 
have many people working for us that earn more than $100,000 a 
year. We are some creating really good jobs for people. In the 
third year, we had to invest again. We were ranked among the 25 
fastest growing privately held companies in the Dallas-Fort 
Worth area. Again, we were profitable. Our revenues exceeded $2 
million. So we went from a half million to a million to two 
million. But I had no cash. I literally had no cash.
    Some of our clients, the large companies, were paying us in 
30 days, some were paying 45, some would pay in 60. No bank 
would lend money to me, even though these were large 
international corporations because we were young and the loan 
was considered too risky.
    Unbeknownst to me, the woman who was acting as controller 
failed to pay my employment taxes because, as she told me 
later, ``well, we just did not have the money''. ``I told her, 
you know, that really is not an optional thing, we probably 
have to go find it, maybe we need to go talk to our suppliers 
and ask them if they can negotiate with us''.
    So, an IRS agent showed up one day and he said, ``Mr. 
Rankin, by our records it looks like you owe us around 
$90,000''.
    I said, ``yes, sir, that is about right''.
    He asked, ``when are you going to get it paid?''
    I told him where we were and what we were trying to do and 
he said, ``well, I will give you ten business days to find the 
money.''
    And we had probably at that point half a million in 
receivables which were good as gold because they were large 
companies and we were doing good work. I found a factor and 
sold my receivables, got the cash, paid off the IRS and we 
started growing again. While the factoring was essentially 
usury rates from an unregulated lender, it allowed us to 
continue to grow.
    The fourth year, we again doubled the size of the business 
and went from 2 million to 4 million in revenue. We were ranked 
among the 25 fastest growing privately held companies in the 
Dallas-Fort Worth area again and among the 100 fastest growing 
owner-managed businesses in the area. Our revenues approached 
about 4 million. We remained profitable. We invested in the 
business that year, putting in new accounting systems and 
restructuring the business.
    In 1999, we were placed on the Inc. 500 list by Inc. 
Magazine, quite an honor. Our large commercial bank, now merged 
with another large commercial bank, decided without any warning 
to discontinue our receivables financing line. My controller 
called me one day and said ``I tried to move money over from 
our credit line and there is nothing there.'' I had payroll 
going out on Saturday.
    Fortunately, through all this, we found a way to maneuver 
our way through it and in early 2000 we were able to borrow $1 
million from an SBIC lender which has given us the leverage 
now. We are tracking at 10 million in revenue for 2001.
    I believe if we had had legislation like this, giving us 
the ability to defer some taxes, which is money which we had 
earned already, that we would have either been able to get 
financing from a conventional lender or we would have been able 
to use our own capital to fund our own growth.
    So I think, unfortunately, I am one of the few lucky people 
who were able to make it out of ``no man's land'', but I know 
there are millions of businesses out there who are not making 
it and who are creating lots of jobs, good jobs. So I would 
urge you to get this legislation moving.
    Thank you.
    [Mr. Rankin's statement may be found in appendix.]
    Mr. Toomey. Thank you very much for your testimony, Mr. 
Rankin.
    At this time, I would welcome and recognize the CEO of 
Tatum CFO Partners, Mr. Douglas Tatum.
    Thank you for being with us.

  STATEMENT OF DOUG TATUM, CHIEF EXECUTIVE OFFICER, TATUM CFO 
                   PARTNERS, ATLANTA, GEORGIA

    Mr. Tatum. Mr. Chairman, members of the subcommittees, I 
would like to start with giving you a little perspective. As 
CEO of the largest CFO firm in the United States, we have over 
300 partners located geographically in 24 offices and we 
provide CFO assistance and serve as CFOs--
    Mr. Toomey. Excuse me, Mr. Tatum. Could you bring the 
microphone a little bit closer toyourself, please?
    Mr. Tatum. I apologize. Is that better?
    Mr. Toomey. Much better.
    Mr. Tatum. Our partners serve as CFOs and provide CFO 
assistance to companies, many companies like you have heard 
from already this afternoon.
    Our experience with these emerging companies led us to 
publish a small brochure which we have provided to you entitled 
``No Man's Land: Where Growing Companies Fail''. We hope that 
this will provide you some context with my statement today. We 
have found that the issue that these two gentlemen have talked 
about ``No Man's Land'', strikes a resonant chord with 
entrepreneurs all across the country.
    I would like to limit my comments specifically to the 
BRIDGE act and summarize those, rather than go through my 
written testimony, around the two charts before you here today. 
``No Man's Land'', in summary is a stage of growth where a 
company is ``too big to be small and too small to be big''. And 
what you are hearing when the gentlemen talk about the 
difficulties they have had going through there relate to two 
very specific issues that we would like to discuss with the 
committee.
    The first one is the microeconomics of growth. This 
particular illustration is built from an economic model that 
accounts for the typical asset growth characteristics of a 
rapidly expanding business on accrual accounting and 
transitioning through what we refer to as ``No Man's Land''. 
What is very important to understand is that, as you can see 
from the chart, revenue in this case went from $2.8 million to 
$6.4 million over a five-year period. Profitability grew in 
each one of those years.
    What is counter intuitive and what we would like to make 
sure that the committee members understand is that even though 
the company is growing, even though the company is profitable, 
it is cumulatively negative cash flow.
    To summarize our intent about the BRIDGE Act is that it 
would correct an unintended consequence in the tax code that 
currently has enormous detrimental effects on the economy, and 
on job growth in particular, because it asks a taxpayer who is 
growing and profitable under the accrual method to dispense 
cash that it does not have.
    The second area that I would like to draw your attention to 
in summary of my written comments is the issue of the ``capital 
funding gap''. We heard a little bit about that in the 
testimony just before mine. What we discovered is that there is 
a capital funding gap, we estimate, between about a quarter-
million dollars and a million dollars in terms of the 
availability of capital to emerging growth businesses as 
contrasted to ``small businesses''.
    It appears that, as indicated earlier, many businesses are 
able to accumulate the capital to get a start-up going. They 
get that from credit cards, from friends and family, from 
relatives that pledge assets to the bank, and they are thereby 
able to get the business started.
    Those businesses that, for whatever reason, get that 
combination of items together that all of a sudden cause it to 
grow enter into a ``Capital No Man's Land'', where the business 
requirements--the requirements for capital--exceed the personal 
assets of the individual.
    The primary financing in the U.S. economy in the early 
stages relates to the personal assets of the individual. When 
the business grows to a certain level, the capital requirements 
for that business exceed the personal assets of the individual 
and it falls into a capital funding gap. What we have 
discovered in interviews with major regulated and non-regulated 
capital providers, including a detailed review of their 
internal economic models, is that because these businesses are 
risky they have to assign account management and collateral 
management to those businesses in order to make that loan.
    What they have determined is that with financing smaller 
than a million dollars, that the cost of an account manager, 
with a senior loan officer or a loan officer that execute 
judgment, and the cost of the collateral management can be 
upwards of 1400 basis points, or as much as 14 percent before 
you even add the cost of the money. Therefore, the lenders that 
you see in this capital base are typically lending money from 
25 to 30 percent interest rates, which is self-liquidating to 
the business.
    Until the business gets large enough where the business 
assets are significant enough to attract the kind of account 
management and collateral management to oversee the loan and 
significant enough for that management to be at a low enough 
cost to provide adequate capital, these two gentlemen faced a 
funding gap in growing their businesses. The proposal in the 
BRIDGE Act simply would allow that business to retain the 
capital for a temporary period that normally would be paid in 
taxes in the business until it is large enough to obtain 
external financing.
    I know a little bit about Ed Rankin's business in 
particular. Once he received the million dollars in SBIC 
financing, he was able to grow his business to the size where 
he is now attracting attention in the major capital markets. He 
could be at 50 employees soon, and he could very well have 500 
in five years.
    [Mr. Tatum's statement may be found in appendix.]
    Mr. Toomey. Thank you very much for that very lucid 
explanation of the cash flow crunch that growing businesses 
face.
    At this time I would like to welcome and recognize Ms. 
Karen Kerrigan. Ms. Kerrigan is the chairman of the Small 
Business Survival Committee.
    Thanks for being with us.

  STATEMENT OF KAREN KERRIGAN, CHAIR, SMALL BUSINESS SURVIVAL 
                   COMMITTEE, WASHINGTON, DC

    Ms. Kerrigan. Thank you, Chairman Toomey and Chairman 
DeMint, for holding this joint hearing today on this most 
important issue for America's small business and 
entrepreneurial sector. Let me also thank the ranking members 
of the committees, Congressman Pascrell and Congresswoman 
McDonald, for their interest and concern about this topic 
before us today and other issues facing small business.
    I am pleased to have the opportunity to testify on the 
issue of capital access and funding solutions for start-up and 
emerging firms and, more specifically, how the Congress can 
address this enduring challenge through the Start-Up Success 
Accounts Act of 2001 and the BRIDGE act proposal. I applaud 
Representatives Jim DeMint and Brian Baird for their bipartisan 
perseverance on this issue in introducing the SUSA act again in 
this Congress as SBSC believes quite strongly that it would 
make a meaningful difference for many firms across this 
country.
    We are also encouraged by the creativity and the 
contemplation that has gone into the proposed BRIDGE act, a 
solution for entrepreneurial, emerging high growth firms which 
provide the bulk of innovation and job creation in our country.
    Access to capital remains an acute obstacle for many small 
firms, as the full Small Business Committee learned in its 
hearing on May 17th. The testimony and conclusions of witnesses 
serves to support the follow-up hearing today on specific ways 
that Congress can help firms tap the capital they need during 
start-up and high-growth periods where a capital gap exists.
    Accessing adequate capital is not only an issue for the 
entrepreneur who wishes to take his orher idea to the 
marketplace, but becomes an even more serious one for small firms that 
struggle through their tumultuous early years. And if a business takes 
off and makes it to the high growth stage, these firms, too, are 
continually burdened by the lack of capital or reasonably priced 
capital in general because the size of the loans are not economically 
viable from the lender's standpoint as well as other reasons, as 
identified by Mr. Tatum.
    The practical concept underlying both the SUSA and BRIDGE 
act will enable small start-up and emerging firms to more 
steadily manage their finances and, of course, retain capital. 
The beauty of both proposals are that they enable business 
owners to be more self-reliant, manage and plan better and more 
efficiently and, as several members of my organization have 
stated in responses to these proposals, become self-funding.
    The lack of capital for early stage and growth firms 
combined with the effects of the tax code which discourages 
capital retention in effect conspire to squeeze many of these 
enterprises ultimately leading to many business failures. That 
is why the proposals before the joint committee today are so 
worthy of consideration by the Congress.
    The SUSA option, H.R. 1923, whereby early stage businesses 
in their first five years would be allowed to place up to 20 
percent of taxable interest into tax-deferred savings accounts 
opens up new financial planning and financing opportunities for 
small firms. Most start-ups, even those demonstrating early 
success and profit, as this legislation is designed to target, 
will face cash shortfalls at critical phases.
    S.U.S.A. is targeted at the right problem, or should I say 
the right audience: early-stage businesses, firms in their 
first five years that are very fragile. The numbers speak for 
themselves, as 80 percent of businesses fail during the first 
five years.
    Even successful firms are going to hit road bumps and pot 
holes. This is where the safety net of having an alternative 
source of capital, being able to self-fund through the business 
owner's own SUSA account, can make a difference.
    If a start-up business is given the opportunity to retain 
more of its capital through a SUSA rather than engage in tax-
motivated spending, I believe more businesses will succeed. The 
BRIDGE act is a complementary proposal to SUSA, tackling the 
same problem faced by new and growing firms, yet its 
distinction is apparent in the type of business that it would 
benefit: the rapidly growing, entrepreneurial firms that create 
the bulk of new jobs in the U.S.
    The impressive success of a start-up to the level of an 
emerging company indeed is an exciting triumph, yet capital 
access challenges continue to dodge the company as it becomes 
more successful. And the health of the U.S. economy and the job 
growth created by these emerging businesses is dependent upon 
the ability of the company owners to successfully attract 
capital.
    The BRIDGE act proposal aims to help growth businesses, 
those growing by 10 percent or more above the prior two years, 
by retaining their own funds for a temporary period for 
continued growth. The additional capital provided by the tax 
deferral would allow the company to survive the capital gap 
that small growing firms go through in order to thrive as an 
ongoing business concern.
    There is a great need for both SUSA and the BRIDGE act. 
Both of these initiatives are sound approaches toward equipping 
firms with self-funding options, allowing small businesses to 
more independently address their own capital needs.
    Thank you again, Chairman Toomey, and we are certainly on 
board zeroing out capital gains. We think that is a wonderful 
proposal that gets SBSC's support. We are encouraged and quite 
pleased that the Congress, and in particular the House Small 
Business Committee and its subcommittees continue to remain 
hard at work exploring a range of issues that will create a 
better environment for entrepreneurship and risk taking.
    I look forward to the committee's questions.
    [Ms. Kerrigan's statement may be found in appendix.]
    Mr. Toomey. Thank you, Ms. Kerrigan, and thanks for your 
advocacy for small business.
    At this time, I would welcome and recognize Mr. Bob Morgan, 
president of the Council of Growing Companies.
    Thank you for being with us this afternoon.

    STATEMENT OF BOB MORGAN, PRESIDENT, COUNCIL OF GROWING 
                  COMPANIES, McLEAN, VIRGINIA

    Mr. Morgan. Thank you, Chairman Toomey, Chairman DeMint, 
and all the members, one, for your passion and one for your 
understanding of the issues small and growing companies 
experience.
    The Council of Growing Companies, we have 1200 heads of, 
CEOs----
    Mr. Toomey. Excuse me, Mr. Morgan. Could you bring the mike 
closer to you, please?
    Mr. Morgan. Sure.
    Mr. Toomey. Thank you.
    Mr. Morgan. Is that better?
    The Council of Growing Companies, I interact throughout the 
United States with 1200 heads of, CEOs of fast growing 
companies. We are trying to help these folks be successful. As 
you know, this is most of our job creation in the country.
    Our companies range from as small as 3 million in revenue 
up to a billion. They are all experiencing double-digit revenue 
and employee growth. They are on a rocket ride. Our focus is to 
help these CEOs and their companies with information and 
networking and best practices and sometimes just dealing with 
loneliness and not always being understood.
    We have chapters in major cities. Our overall mission is to 
help create a social, economic and political environment that 
actually does nurture and understand entrepreneurship. So let 
me comment just briefly about the BRIDGE act and why this is of 
such importance to the country.
    Small business has certain needs, as you have heard, as it 
begins to grow and emerging companies that begin to grow fast 
get into a little different arena where they have somewhat 
unique problems.
    Small business usually can obtain financing in relatively 
small amounts like under $250,000. But when this takeoff 
occurs, you quickly in a business outgrow any personal asset-
based source of financing such as are available to an 
entrepreneur or their family or friends or credit cards. This 
rapid growth actually just outstrips the revenue, as you have 
heard from Ed here. Profitable, growing and yet negative cash 
flow. Because as you start to grow, you have to invest in 
infrastructure, employees, equipment, inventories, and very 
fast, you in effect out drive your headlights.
    Access to capital for these companies becomes very limited 
at this no man's land because once a growing business begins to 
get more established, yes, then they can qualify for a credit 
line or a loan of like a million dollars or more. Capital 
markets start to open up. But prior to that, and getting that 
track record established, is just a crucial point in the life 
of a lot of companies.
    How does this happen? You know, here you have a growing 
company, it is profitable, and yet it owes income taxes, it is 
winning awards, getting a lot of publicity. What happens is 
that when you are on an accrual accounting basis, which you 
should be and must be for tax purposes, youstart to report a 
taxable profit and yet your sales growth outstrips your return on 
assets. And at that point you have a negative cash flow.
    And at that point, a growing company typically will use up 
all of its internal capital by trying to reinvest in the 
company's growth. So this BRIDGE act would be a wonderful 
solution for many companies that today would probably still 
have survived if this had been available as a resource.
    As I have talked to CEOs throughout the country about this 
idea, they have all reinforced that, wow, I wish we had had 
that when I needed it.
    This is not a tax deduction, it is not a tax credit, it is 
not a government giveaway. This is simply a deferral with 
interest paid. It has to be a win-win. And under the draft that 
has been proposed, there are plenty of safeguards as we have 
viewed those with the amounts being deposited in trust accounts 
at banks or other financial intermediaries. The account is used 
as collateral for a business loan and a deserved loan, because 
it is backed by money and profit that demonstrate the company's 
viability.
    We urge support of this BRIDGE act and we thank you for 
your attention in advancing this idea. I welcome your 
questions.
    Thank you.
    [Mr. Morgan's statement may be found in appendix.]
    Mr. Toomey. Thank you, Mr. Morgan.
    At this time, the chair will recognize and welcome Mr. Lee 
W. Mercer, President of the National Association of Small 
Business Investment Companies.
    Welcome.

  STATEMENT OF LEE MERCER, PRESIDENT, NATIONAL ASSOCIATION OF 
  SMALL BUSINESS INVESTMENT COMPANIES (NASBIC), WASHINGTON, DC

    Mr. Mercer. Thank you, Chairman Toomey and Chairman DeMint 
and members of the committee. It is an honor to be here today 
to present our views and my views on what steps Congress might 
take to increase the availability of capital to small 
businesses. In one way or another, it is an issue that I have 
dealt with since 1971 when I started my career representing 
small businesses as a practicing lawyer in Manchester, New 
Hampshire. The issue is the critical issue for most small 
businesses.
    The vibrant small business world in America fueled by the 
independent spirits of individual entrepreneurs is the envy of 
the world and the foundation of our nation's economic well 
being. Without it, we would be like most other countries in the 
world, looking for models to stimulate job and technology 
growth. Fortunately, we have it.
    That said, it is also amazing to consider the number of 
small businesses that fail each year. SBA estimates that over 
260,000 non-farm businesses failed in 1999. Fortunately, more 
than that by about 5 or 10 percent were started.
    It causes us to ask how many might have prospered if they 
had had ready access to capital in the range of $250,000 to $1 
million that the committee is considering here today.
    Congress has provided programs that address some of these 
issues. Certainly the SBIC program is one of the better known, 
most successful and, in fact, the fastest growing program right 
now. And SBICs, certainly leveraged SBICs, that have access to 
government-guaranteed capital invest in increments in the 
$250,000 to $1 million range.
    I have provided the committee with the FY 2000 statistics 
that speak to that point.
    However, not withstanding the program's success, more can 
be done and done at little cost to the government to increase 
the effectiveness of the SBIC program.
    First, I urge the Small Business Committee, the House Small 
Business Committee, and the House Appropriations Committee to 
agree on a mix of SBIC fee increases and appropriations that 
will make $3.5 billion in participating security leverage 
available in FY 2002. That is money that will go to equity-
oriented funds that make equity investments.
    That will immediately create a likely pool of about $5.5 
billion for small businesses and will lead to more senior debt 
being available to those companies as well.
    When the senior debt is factored in, you could have $20 
billion in additional capital created at a very minimal cost to 
the government, about $26.2 million, if the government were to 
flat fund the program for FY 2002.
    Second, I urge the committee to seek an amendment to the 
Internal Revenue Code for the very limited--and I mean limited 
purpose of excluding debenture leverage from the type of 
acquisition debt that under the tax code generates UBTI, 
unrelated business taxable income, for tax-exempt investors 
automatically, no matter how carefully the debenture SBICs 
structure their investments.
    U.B.T.I. effectively takes 60 percent of the private 
capital that is potentially available to debenture SBIC fund 
managers in fundraising off the table. If Congress were 
creating a debt-oriented small business program today that 
relied on private capital as its foundation, I am sure it would 
not take 60 percent of that capital out of play.
    Amending the Internal Revenue Code as proposed will see 
more SBIC debt capital available to small businesses. This is 
subordinated debt capital, not bank loans. This is a more risk-
oriented debt. This is particularly important because the types 
of businesses that seek and obtain this type of subordinated 
debt financing are generally community businesses like 
restaurants, hardware stores, local manufacturing companies and 
the like. They may not be the go-go companies that attract 
major equity infusions, but they are good and steady employers. 
The amendment we propose will address capital access for these 
companies at virtually no cost to the government.
    Finally, I commend to the committee and to Congress the 
approach represented by the proposed BRIDGE act and SUSA acts. 
NASBIC has endorsed the BRIDGE concept and the SUSA concept as 
in the same category, albeit slightly different in focus and 
manner of implementation. Both acts declare the government's 
support for growing small businesses and make it clear that the 
government will not permit technicalities of law or accounting 
principles to punish someone for success, especially in the 
early fragile years of a growing business.
    Whether structured as an income deferral or a low cost loan 
for a calculated tax liability, both concepts are self-
executing, require no government bureaucracy to administer and 
represent the best of selection efficiency.
    No entrepreneur could ask for more and neither could the 
country that benefits from the collective efforts of all 
America's entrepreneurs.
    Thank you, Mr. Chairman, and I look forward to your 
questions.
    [Mr. Mercer's statement may be found in appendix.]
    Mr. Toomey. Thank you, Mr. Mercer.
    And let me thank all the witnesses for their testimony this 
afternoon. Thank you very much. It was very informative.
    I will recognize myself for five minutes of questioning and 
we will try to stick to the five-minute rule so that we can 
give everybody a chance to ask their questions and then if 
there is interest to do so we can do a second round of 
questioning.
    First, Mr. Brinson, first of all, thank you for coming, 
thank you for your testimony. In yourwritten testimony, you 
advocate a provision in the tax code that would permit the deferral of 
federal income tax such as is contemplated by these bills.
    In your experience, as you grew your business, can you 
share with us how that would have facilitated or accelerated 
the growth of your business and looking forward, if you have an 
interest in further expansion of your business, can you see how 
this would specifically help your business to grow?
    Mr. Brinson. Yes. As I pointed out in my written testimony, 
we did pay considerable income tax in 1999, the year that we 
were trying to get this new business, this new club, together. 
If we had been able to defer that, that would have helped a 
great deal, I think, to help us get the new club started. So I 
like the idea a lot and I think it could benefit a lot of 
businesses.
    Mr. Toomey. Thank you.
    Mr. Rankin, your business is in the service sector of our 
economy and, like many service businesses, my assumption is 
that most of your assets are the intellectual capacity of your 
employees, more so than hard assets of plant and equipment.
    Mr. Rankin. Correct.
    Mr. Toomey. In that capacity, of someone in the service 
sector, do you think it is particularly difficult for service 
companies to acquire capital? Is that an additional burden that 
you face that perhaps others with greater sources of collateral 
might not face and could you share with us a perspective of how 
the service sector might benefit from this legislation?
    Mr. Rankin. It has been a subject of conversation I have 
had with some of the bankers that I am familiar with and know. 
There seems to be no recognition in the traditional financing 
circles of the transformation of our economy from a brick and 
mortar economy to a service business where assets of businesses 
like mine really reside in the brains of the people who work 
for me and the receivables that they generate.
    There are very few good sources of financing for that. If I 
were a hard asset business with inventory, buildings, plant and 
equipment, it would be much easier to secure traditional 
financing, but I really see this as even a more serious problem 
for our economy as we go forward because we are increasingly 
becoming more and more service oriented and our population is 
becoming better educated and the work that we do here is 
becoming more sophisticated, more technologically driven. So, 
yes, I think we do face different challenges.
    Mr. Toomey. Thank you.
    Mr. Tatum, in your testimony, you talked about the cost 
that an account officer or bank incurs in simply managing the 
account and if a transaction is not large enough to justify the 
cost, then presumably there is an incentive not to provide the 
transaction.
    Is that an argument for increased fees? Is that an argument 
for banks to find another way to be compensated for that? Are 
there small businesses that would happily pay larger fees if 
they could get this access to capital? What perspective do you 
have on those issues?
    Mr. Tatum. I think that the banks recognize that as they--
and I say banks and non-regulated lenders, because we 
interviewed both--want to loan capital in that sector. When 
they project the cost of the account management and the 
collateral management, they run into a cost problem that means 
that for them to make money it becomes a significant interest 
expense to the business, which we refer to as self-liquidating.
    I do not think there is an incentive for them to lend money 
to a business where their cost of capital now exceeds their 
return on capital. What you are basically doing at that point 
in time is lending money to a business at a rate that is self-
liquidating. They have negative EVA, ``Economic Value Added'', 
if you will. Most of these large lenders are not very 
enthusiastic about charging a business what they believe maybe 
usurious interest rates to the detriment of the business, even 
if they could make money on it. It is a structural capital 
funding problem related to risk management.
    Mr. Toomey. Thank you. I would like to follow up that 
question with a question about whether some kind of equity 
participation would not be a way to ameliorate that, but I am 
going to run out of time, so I will do that on my second round 
and I will now recognize Chairman DeMint for his questions.
    Mr. DeMint. After all the work with some of you and the 
testimony today, one has to ask who could possibly oppose this 
idea, but everything here has opposition and nothing seems to 
be easy. I am sure as you have talked about this idea, you have 
probably gotten a few folks who have played devil's advocate 
with you and said this will not work because of this or that.
    I, frankly, have a hard time finding problems with it. 
While some would say there may be some cost to the government, 
the worst case is there is some deferral of taxes. In reality, 
the increased employment and growth of companies are likely to 
make this a revenue windfall for the government.
    Have any of you, and I will just open it to all of you, as 
we look at both the start-up idea as well as the BRIDGE act, 
what could we anticipate as far as objections or what type of 
objections do we need to be prepared to handle with these 
ideas?
    Yes? Mr. Morgan?
    Mr. Morgan. Some folks have commented, including the 
Associated Press, who are doing a story on this hearing, what 
if a company goes bankrupt or defaults and cannot pay the loan, 
therefore the assets that are tied up securing that loan, you 
know, who is holding the bag, does that end up as a cost to the 
government?
    And my comment to that is, yes, there is a risk. There is a 
risk to almost everything that we are doing, our business 
community is doing, but when you compare the risk of this plan 
to a lot of other sources, the risk to me seems much smaller. 
But as an early warning system, I think that is a criticism or 
a concern or an issue that might be tossed at the BRIDGE act, 
for instance.
    Mr. DeMint. Mr. Tatum, can you answer that for us?
    Mr. Tatum. I would like to add to that. The definition of 
bankruptcy is that your liabilities exceed your assets, which 
means you no longer have any retained income in the business. 
Our tax code allows us to go backwards and to write-off the 
losses incurred and also to deduct the losses against taxes 
going forward. So that by the time a business becomes bankrupt, 
it annually does not owe any taxes.
    I think if you would go to Treasury and look at the number 
of firms when they file their tax returns, when they are 
bankrupt, I would suggest to you that a very limited number of 
them actually owe any taxes. In fact, those firms may actually 
have an asset called an NOL, ``Net Operating Loss'',that 
certain businesses try to obtain.
    So there is a very specific technical answer to that, and 
we believe that there is very little risk that the government 
would incur any cost related to that. I agree with my 
colleague.
    Mr. DeMint. That it would not have lost anyway, right?
    Mr. Tatum. Right. If you had taxable income and you incur a 
tax and then you end up losing money over time, the amount of 
tax you owe goes down and by the time you are bankrupt, there 
are no taxes due.
    Mr. DeMint. Mr. Mercer, did you have a comment?
    Mr. Mercer. I would concur. The beauty of the legislation, 
the way it has been drafted in both cases, is that by 
definition it does not do you any good unless you are 
successful, so thatreduces the risk substantially. Also, I 
agree with what Mr. Tatum has just said.
    I think inertia is always the single greatest hurdle in 
government. When I think about what the accrual method of 
accounting does to small businesses in this area, is not this 
akin to the marriage penalty for small businesses? And 
everybody would agree that, gee, we ought to get rid of the 
marriage penalty, but it does not seem that that happens very 
easily, probably more because of inertia more than anything 
else, not because people would argue with the principle. That 
may well be the case here as well.
    Mr. DeMint. Good.
    Yes, Mr. Brinson?
    Mr. Brinson. I think to look at a potential loss is just 
negative, and I think a great deal more tax revenue will be 
generated by helping businesses to grow. One of my mottoes is 
that you are either growing, or you are dying, and small 
business needs to grow just to survive. And it would produce 
more revenues, not less.
    Mr. DeMint. Thank you.
    I yield back.
    Mr. Toomey. Thank you, Mr. DeMint.
    I recognize Mr. Pascrell.
    Mr. Pascrell. Thank you, Mr. Chairman.
    Mr. Rankin, I was curious. The difficulty you had with your 
bank, did you go to an SBA office before that?
    Mr. Rankin. No, I did not. Actually, I consulted an SBA 
lending specialist in Dallas who told me that the probability 
of an SBA loan was probably 50/50 for me and it was going to 
take too long, so we were going in that direction, but I did 
not have time.
    Mr. Pascrell. The experience that we have indicates that 
that office, that local office, can be a tremendous help. There 
are many banks, of course, that participate in the program. We 
know that. But many times the people are trained in the SBA 
office to reach out beyond the banks that we ordinarily reach 
out to. I find them to be very, very, very helpful.
    I was anxious to find out whether you went through that 
bank because that is what we spend taxpayers' money for, to 
establish these offices so that they will be of help to people 
like yourself who deserve it. I mean, that is what your taxes 
pay for.
    Mr. Rankin. We were looking at it, but we were moving so 
quickly and our cash needs were so urgent that based on what I 
learned about it and, with the very limited time, I had to 
focus my time where I felt that we had the highest probability 
of a faster success.
    Mr. Pascrell. Okay.
    Mr. Mercer, over the last several years, Congress has 
passed a variety of different laws designed to spur investment 
in minority-owned businesses and businesses located in low 
income areas. I am talking about some risk here, which is quite 
obvious. Some of them have worked, some of them have not, like 
everything else.
    What types of policy should we be looking at, should 
Congress be considering, to spur investment in low income and 
minority-owned businesses, in your opinion?
    Mr. Mercer. Well, one of the interesting things about the 
proposal on UBTI is that it would be a boon to the remaining 
existing specialized SBICs, which, of course, by law, can only 
invest in minority enterprise. They are debenture SBICs and 
because of UBTI, they, like everybody else in the debenture 
program, have a great deal of difficulty raising private 
capital from tax-exempt investors. And I suspect that they, and 
perhaps even more than regular debenture SBICs, would benefit 
from that change in the tax law.
    The new markets venture capital program, of course, is 
aimed in that direction and is just getting off the ground. It 
is perhaps too soon to know whether that will be as effective 
as Congress hopes it will be.
    I do note that the SBIC program, interestingly enough, in 
FY 2000 invested in low income areas: 14 percent of all dollars 
were invested in low income areas and if you increase that to 
moderate income, so low and moderate income, it jumps to 25 
percent. So the interesting thing is I think that the market in 
a sense is working.
    S.B.I.C.s will invest in good businesses wherever they are 
located, but they sometimes have difficulty finding them. I 
think one of the single greatest things that SBA could do is to 
examine and explore why small businesses located in these areas 
that may have good business plans have difficulty getting those 
business plans on the desk of a financing source, an SBIC, for 
example, that can consider them. Deal flow is what an SBIC or 
other financing source lives by, is the quality of its deal 
flow. So to the extent that SBA could tackle that issue, and it 
is a hard one, it would be important.
    Mr. Pascrell. As a follow-up, do you think that the banks 
are going to embrace this idea, the BRIDGE idea, the BRIDGE 
accounts? In your opinion?
    Mr. Mercer. Would the banks embrace it? In other words, the 
money placed into the banks? The banks will embrace it if they 
have first security interest on it. Unfortunately, the banks 
are not in the business to take a huge amount of risk. If the 
account is going to be there and serve as collateral for a bank 
loan, my view is the bank is going to want first position 
versus the IRS.
    The biggest problem I see there. A combination of these two 
may be the best way to go because when you are deferring 
income, maybe it works in a different way. Either one of them 
can work, but, as you correctly point out, the big problem with 
that account is who is going to claim first whack at it.
    Mr. Pascrell. Can I just ask one quick final question?
    What do you--anybody for this one--what do you think about 
the idea of--I know Mr. Greenspan does not think highly of it, 
but what do you think about it--of business accounts accruing 
interest?
    What do you think about that? They cannot right now under 
the law. Checking accounts. What do you think about that? 
Support it? Good idea? Bad idea?
    I mean, we have been under this system since 1930, I think. 
What do you think of that idea?
    Mr. Brinson. Why not?
    Yes. I would say why not?
    Ms. Kerrigan. Yes.
    Mr. Pascrell. Thank you, Mr. Chairman.
    Mr. Toomey. I thank you the gentleman from New Jersey.
    I would point out I had a bill earlier this year to repeal 
the ban and we have been successful thus far with this. We have 
the other body that we have to get some cooperation from.
    At this time, I recognize for five minutes the gentleman 
from Washington.
    Mr. Baird. I thank the chair and I thank the witnesses. I 
was particularly impressed with the business owners who have--I 
cannot imagine how frustrating it must have been to you to have 
a demonstrated, successful model, to have the potential to 
further grow, to employ more people, to go to the bank only to 
be told we cannot help you gather the capital. I could not 
imagine a more clear testimony to the merits of the bill that 
Congressman DeMint has led the way on and I appreciate that.
    Let me ask you how the BRIDGE act--it seems there are two 
problems. You have the issue of the negative cash flow 
situation and you have the issue of the banks themselves not 
wanting to allocate the human resources to process the 
difficult loans and the point that Mr. Tatum raised about the 
costs.
    How will this BRIDGE act affect that second issue of the 
banks wanting to allocate the human resources to process it? 
Could you walk us through that part from your understanding?
    Mr. Tatum. One of the ways that we used to obtain capital 
through a bank was to have the entrepreneur place some 
collateral from friends or family, in a bank and borrow it back 
for the following reason. It created a risk-free loan, and it 
also created a relationship earlier than would normally be the 
case because of this situation.
    If you talked, as I did, to a senior executive of a 
community bank holding company, he said just about all the 
loans that they do in this capital gap they do because the 
entrepreneur received collateral outside of the business to 
take the risk out of it, removing the need for loan judgment, 
and thereby removing the need for account collateral management 
costs.
    By creating an account with these deferred tax funds that 
can then be borrowed against, you create a banking relationship 
sooner than normally would be established. Our experience has 
been that as the bankers have more experience with that 
company, they tend to expand those lending relationships 
quicker.
    We believe that banks will compete for the BRIDGE accounts. 
When that happens, what you will end up having is lending 
institutions who want to lend to these businesses--by the way, 
they just do not know how to handle them cost effectively--
banks will compete by saying if you bring your BRIDGE Act to my 
institution we will also make an equipment loan on top of the 
loan for your working capital.
    The other thing I would suggest--back to the issue of whose 
position is first and second--the tax code recognizes 
philosophically these types of issues. For example, when a 
business is asked to go from a cash basis to accrual, it 
creates an immediate tax burden. That tax liability is owed by 
that business and it does not affect the loans that are 
associated with that business.
    So all we are saying philosophically is that the tax 
amounts due be deferred placed into an account, and allow that 
business to borrow it back. The IRS does not have a first lien, 
if you will, on the business assets when the business owes 
taxes when it allows the business to pay that off over time 
when going from cash basis to accrual accounting.
    Mr. Brinson. There is another problem that faces us, too, 
and I have included it in my written testimony, and that is 
that there seems to be some requirement that when bank loans 
are secured by mortgage liens that there be a repayment of 
principal, and this is ridiculous.
    I have a friend in England who owns a whole bunch of small 
businesses and they have no such thing as this mortgage loan 
idea where you pay down principal every month.
    I think it is rooted in the fact that small businesses in 
this country originally were in homes, located in homes, and 
when the small business owner died the business died. So the 
idea was ``let's get the mortgage paid down''.
    A business that wants to expand, as I do, does not want to 
pay a quarter of a million dollars a year in principal 
repayments. If there is some way that your committee could look 
into the banking rules that require mortgage amortization, it 
would be a great relief.
    I had a $5 million mortgage two and a half years ago and 
now it is down close to $4 million. What happened to that 
money? It went to the bank and they had to send their loan 
officers out scurrying around looking for new people to lend 
the money to when they already have a good customer paying them 
interest. They already have all the papers, the guarantees and 
everything else. So this just does not make any sense at all. 
It would be a great help to many, many small businesses if we 
were not faced with this requirement.
    And our assets do not actually depreciate. If we keep our 
buildings in good repair, the asset is not depreciating, so 
that it really makes no sense to require principal payments, 
mortgage amortization.
    Thanks.
    Mr. Rankin. Can I make one quick comment?
    Mr. Baird. Sure.
    Mr. Rankin. Three years ago, a quarter of a million dollars 
in the bank account would have been like $5 million today. And 
when we received a $1 million sub-debt loan from an SBIC 
lender, we had lots of banks interested in talking with us. 
Just that little bit of quasi-equity, I refer to it as, really 
made a world of difference for us in terms of how we could 
operate our business.
    Mr. Baird. Mr. Chairman, if I might add, I think that is 
precisely the notion of the SUSA premise that Mr. DeMint and I 
introduced last year. The SUSA allows you to defer the tax on 
your profits, you can set that aside in the tax deferred 
account and that then provides precisely that kind of seed 
capital that, as Mr. Tatum described, would provide further 
incentive for the banks to move you into a BRIDGE type account. 
I think it is very synergistic and that is the benefit of the 
two bills.
    Mr. Toomey. The gentle lady from California, Ms. 
Napolitano.
    Ms. Napolitano. Thank you, Mr. Chair.
    To Mr. Morgan, Ms. Kerrigan and Mr. Mercer, one of the 
things that I have heard, especially from the small business 
community in my area, women-owned business and minority-owned 
businesses, that they have a hard time being able to get 
assistance, bank loans, even SBA sometimes because because 
because.
    What have you found in minority-owned and women-owned 
business? Is that an issue in being able--would you address it, 
please?
    Ms. Kerrigan?
    All three of you. Any of the three of you.
    Ms. Kerrigan. You mean just the general access to capital 
issue? Absolutely. For start-up firms, it is a huge problem, 
whether you are a minority-owned business or any type of 
business owner in the start-up phase. Generally, what happens 
when you do start a business, the start-up capital is generally 
the easiest type of capital to get and sometimes it is the most 
costly because the use of credit cards and, of course, you go 
to your family and your friends and associates and things like 
that. But it is this start-up period where the banks need a 
demonstrated track record of success, they view the business or 
the enterprise as being too risky to provide the type of loan 
and type of capital that is needed.
    Ms. Napolitano. Do you see this particular bill being of 
assistance to those entities?
    Ms. Kerrigan. Well, I do. If those entities show some signs 
of success and they are profitable, they can put aside this 
money to be used in the second, third, fourth year, whenever 
that need develops to have this cash on hand. You have to--with 
the 600,000 to 800,000 businesses that are started each year, 
many of them minority and women-owned businesses, women are 
starting businesses at three times the rate of men, there has 
to be an assumption that some of those businesses are 
successful and very successful. But even the most successful 
firms are going to run into some cash problems, maybe not the 
first year, but maybe the second or the third year they may 
want to expand. And I am speaking mostly to the SUSA account 
right now.This is designed for those types of businesses and I 
think it makes practical sense.
    I have talked to a lot of my start-up members about this 
and they think it is a wonderful idea. They can become self-
funding and self-reliant and they do not have to depend on the 
banks or any other outside resources.
    Ms. Napolitano. Gentlemen?
    Mr. Morgan. I am delighted with your question and your 
sensitivity to these areas. It has been a problem----
    Ms. Napolitano. Do I look like one?
    Mr. Morgan [continuing]. That is getting better, but one 
specific way that the BRIDGE act would help here, banks can 
even hide behind their obligation, their fiduciary 
responsibilities to protect the deposits of their depositors. 
You know. And risk is always a reason for a bank to decline.
    The BRIDGE act, for instance, gets at two key elements to 
reduce that risk. One, it reduces the cost to the bank of 
papering, of processing, analyzing, all of that. And, second, 
it reduces the risk factor itself because the money that is 
being used for a loan to keep growing the business is money 
that has already resulted from a profitable, well managed 
institution that is showing a lot of promise.
    Mr. Mercer. I think one of the things we have to remember 
is for the types of businesses that you are mentioning their, 
their capital needs may well be and probably are under the 
$250,000 threshold that is specifically mentioned with regard 
to this hearing. A lot of the businesses are self-employment, 
so it is probably not even recognized as a non-farm business by 
statistics.
    I think what is appealing and may be--I am not an expert on 
the provisions of the SUSA act, but it seems to me that the 
SUSA Act would be particularly applicable there. Most of these 
businesses are probably started on a cash basis, not an accrual 
basis, of accounting, and literally run out of shoeboxes, cash 
in, cash out. I think as I read the SUSA act, it would 
basically allow them in a successful year to defer recognition 
of that income and essentially average income over a bumpy two 
or three-year period while they are getting started. Then maybe 
they branch off and make use--they may grow enough to go into 
accrual method of accounting, which they definitely will have 
to switch to if they are going to be a successful growing 
company and attract outside capital sources. Then maybe the 
BRIDGE Act takes them from there up to the next level. So I do 
think it would be of help.
    Ms. Napolitano. Well, one of the reasons, if I may just 
comment on that, there was a young man who started a small--it 
was a start-up and did so well that he wanted to expand and he 
was having problems getting some assistance in funding, so 
rather than do that, he and his partner sold it for $2.1 
million. I mean, that is not a small entity to start off and 
they did it at home and did beautifully well, but there were 
problems for him and he decided it would not be worth his while 
to spin his wheels trying to find the funding, the financing.
    So there are all kinds of cases. So to me, we need to be 
able to help those new entrepreneurs be able to become more 
successful. It does mean jobs in our areas.
    Mr. Tatum. Just one quick comment. I think the Kauffman 
Foundation research indicated that of the G-7, that the 
participation by women in start-up and emerging growth 
businesses exceeded all the other G-7 countries combined. So 
specifically, these two proposals will uniquely impact an 
emerging trend, which is women growing businesses.
    Ms. Napolitano. Right. And they work twice as hard because 
to them it is their life support, in many instances, their 
whole support.
    Ms. Kerrigan. And I would just like to echo that. Last year 
about this time, I was at the National Women's Small Business 
Summit in Kansas City and the access to capital--these were 
successful women business owners, some of them in their tenth 
year, many of them in their start-up years, who said this was a 
serious problem and echoed this concern. And they talked about 
tax credits or any type of tax deferrals. They were talking 
conceptually about the things that we are talking about here 
today that can help them survive and grow and become viable 
entities.
    Mr. Toomey. Thank you. Thank you.
    Let me congratulate and thank Mr. DeMint and Mr. Baird for 
the creative and constructive ideas that they have developed 
which could really, I think, from what we have heard today go a 
long way to alleviating a very real challenge, but most of all 
let me thank the witnesses.
    All of you have provided some very informative, very useful 
information and let me assure you your testimony will help us 
to develop the support that this legislation will need to move 
in this Congress.
    The hearing is adjourned.
    [Whereupon, at 4:00 p.m., the subcommittees were 
adjourned.]
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