[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
FULL COMMITTEE HEARING ON INCREASING
INVESTMENT IN OUR NATION'S SMALL
BUSINESSES
=======================================================================
COMMITTEE ON SMALL BUSINESS
UNITED STATES HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
JUNE 21, 2007
__________
Serial Number 110-32
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Printed for the use of the Committee on Small Business
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HOUSE COMMITTEE ON SMALL BUSINESS
NYDIA M. VELAZQUEZ, New York, Chairwoman
HEATH SHULER, North Carolina STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona TODD AKIN, Missouri
MICHAEL MICHAUD, Maine BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas STEVE KING, Iowa
DAN LIPINSKI, Illinois JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa DEAN HELLER, Nevada
YVETTE CLARKE, New York DAVID DAVIS, Tennessee
BRAD ELLSWORTH, Indiana MARY FALLIN, Oklahoma
HANK JOHNSON, Georgia VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania JIM JORDAN, Ohio
Michael Day, Majority Staff Director
Adam Minehardt, Deputy Staff Director
Tim Slattery, Chief Counsel
Kevin Fitzpatrick, Minority Staff Director
______
STANDING SUBCOMMITTEES
Subcommittee on Finance and Tax
MELISSA BEAN, Illinois, Chairwoman
RAUL GRIJALVA, Arizona DEAN HELLER, Nevada, Ranking
MICHAEL MICHAUD, Maine BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana STEVE KING, Iowa
HANK JOHNSON, Georgia VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania JIM JORDAN, Ohio
______
Subcommittee on Contracting and Technology
BRUCE BRALEY, IOWA, Chairman
HENRY CUELLAR, Texas DAVID DAVIS, Tennessee, Ranking
GWEN MOORE, Wisconsin ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York SAM GRAVES, Missouri
JOE SESTAK, Pennsylvania TODD AKIN, Missouri
MARY FALLIN, Oklahoma
.........................................................
(ii)
Subcommittee on Regulations, Health Care and Trade
CHARLES GONZALEZ, Texas, Chairman
RICK LARSEN, Washington LYNN WESTMORELAND, Georgia,
DAN LIPINSKI, Illinois Ranking
MELISSA BEAN, Illinois BILL SHUSTER, Pennsylvania
GWEN MOORE, Wisconsin STEVE KING, Iowa
JASON ALTMIRE, Pennsylvania MARILYN MUSGRAVE, Colorado
JOE SESTAK, Pennsylvania MARY FALLIN, Oklahoma
VERN BUCHANAN, Florida
JIM JORDAN, Ohio
______
Subcommittee on Urban and Rural Entrepreneurship
HEATH SHULER, North Carolina, Chairman
RICK LARSEN, Washington JEFF FORTENBERRY, Nebraska,
MICHAEL MICHAUD, Maine Ranking
GWEN MOORE, Wisconsin ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York MARILYN MUSGRAVE, Colorado
BRAD ELLSWORTH, Indiana DEAN HELLER, Nevada
HANK JOHNSON, Georgia DAVID DAVIS, Tennessee
______
Subcommittee on Investigations and Oversight
JASON ALTMIRE, PENNSYLVANIA, Chairman
CHARLIE GONZALEZ, Texas LOUIE GOHMERT, Texas, Ranking
RAUL GRIJALVA, Arizona LYNN WESTMORELAND, Georgia
(iii)
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C O N T E N T S
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OPENING STATEMENTS
Page
Velazquez, Hon. Nydia M.......................................... 1
Chabot, Hon. Steve............................................... 2
Moore, Hon. Gwen................................................. 5
WITNESSES
Hager, Michael, U.S. Small Business Administration............... 4
Lerner, Josh, Harvard Business School............................ 7
May, John, Angel Capital Association............................. 9
Vivian, Steve, National Association of Small Business Investment
Companies...................................................... 11
APPENDIX
Prepared Statements:
Velazquez, Hon. Nydia M.......................................... 29
Chabot, Hon. Steve............................................... 31
Hager, Michael, U.S. Small Business Administration............... 33
Lerner, Josh, Harvard Business School............................ 38
May, John, Angel Capital Association............................. 44
Vivian, Steve, National Association of Small Business Investment
Companies...................................................... 50
(v)
FULL COMMITTEE HEARING ON
INCREASING INVESTMENT IN OUR
NATION'S SMALL BUSINESSES
----------
THURSDAY, JUNE 21, 2007
U.S. House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 2:04 p.m., inRoom
2360, Rayburn House Office Building, Hon. Nydia Velazquez
[Chairwoman of the Committee] presiding.
Present: Representatives Velazquez, Shuler, Moore, Altmire,
Clarke, and Chabot.
OPENING STATEMENT OF CHAIRWOMAN VELAZQUEZ
ChairwomanVelazquez. I am pleased to call this hearing to
order. I want to thank all the witnesses for being here today.
Today's hearing will examine the role of venture capital in
growing and sustaining our Nation's small businesses. There can
be little doubt that venture capital remains as important as
ever to our Nation's small businesses. This is particularly
true for a key segment of the business community, startup and
early stage businesses. These businesses are the engines that
generate new ideas and new products. Their contributions to our
communities and economy are frequently new, invigorating and
transformational. Venture capital represents the lifeblood for
these businesses, and without this vital resource, many startup
companies will not reach their full potential.
Yet, despite the obvious importance of venture capital, it
remains extremely difficult for startup businesses to attract
this investment. Over the last 5 years we have seen a steady
movement of venture capital toward later-stage small
businesses. Recent industry studies confirm this trend and show
that funding dollars for early-stage firms declined 30 percent
in the first quarter of 2007 to only $1.1 billion.
Today, private venture capital places a substantial focus
on later-stage businesses that have an established capacity to
generate investment returns immediately. While this focus makes
sense for investors, it is leaving many startups without access
to the equity capital they need to succeed. The result is less
innovation, slower economic growth and fewer new jobs for our
Nation's small businesses.
In order to fill these gaps, Congress created the Small
Business Administration's investment programs. However, many of
these programs are falling short, for a wide range of reasons,
of achieving their potential. Some lack support both
organizationally and financially, while others do not have a
clear purpose.
Today, we will be begin the process of reviewing these
programs to better understand how we can address these
problems. Foremost among the agency's investment programs is
the Small Business Investment Company program which has a
proven record of success. Together with private investment
topping $12 billion, the initiative totals over $23 billion in
financing resources dedicated to small businesses. It has led
to the creation of over 228,000 jobs and has brought investment
to virtually every State and across a wider range of industry
than has been served by the traditional venture capital
industry.
Despite its successes, more must be done to channel
investment to our Nation's small companies.
In 2005 the SBA ceased licensing new investment firms in
the Participating Securities SBIC program. This initiative was
the only SBA program focused on providing equity financing to
early-stage and startup businesses.
In the 1990s, SBICs made nearly 50 percent of their
investments in startup small businesses; over the past few
years, this number has dropped to less than 30 percent and
continues to decline. This development has been mirrored by the
lack of support for the New Markets Venture Capital program, a
program dedicated to bringing investment to small businesses in
low-income areas. Together, these developments have cast a pall
of uncertainty over the SBA's remaining investment programs and
have undermined confidence in the Administration's commitment
to its investment mandate.
One way to increase the availability of early-stage capital
is to draw on new investment strategies. In today's hearing we
will hear about one such approach, angel investment, which
holds a great deal of promise for helping our Nation's
entrepreneurs. It is my hope that we can help foster increased
angel investment in small businesses to fill the void for seed
capital that has been created by the elimination of the
Participating Securities program.
It is with this goal in mind that I am introducing
legislation this morning to support increased angel investment.
By doing so, we can make certain the small firms have the
capital they need to grow stronger.
It is important that we are here today to consider the
availability of venture capital for small firms. Without such
investment there will be less risk-taking and less innovation
in our economy.
As this country continues to rely on entrepreneurs to spur
economic development and create jobs, the need for equity
investment only continues to grow. I look forward to this
hearing and I want to thank again all the witnesses for their
testimony.
I now yield to the ranking member, Mr. Chabot, for his
opening statement.
OPENING STATEMENT OF MR. CHABOT
Mr.Chabot. Thank you very much, Madam Chair. Before I get
into my opening statement, I would just like to recognize a
young lady who is in the back of the room--back there.
Would you stand up?
Tyler Banks is a senior at the School for the Creative and
Performing Arts in my district in Cincinnati, Ohio, and she is
up here with the Congressional Youth Leadership Council's
National Young Leaders Conference. She is an excellent student
and I am sure that we haven't heard the last. She would like to
make a career up here and perhaps some day be living right down
the street at the White House.
ChairwomanVelazquez. Welcome, welcome.
Mr.Chabot. Thank you, Tyler.
I want to thank you, Madam Chair, for holding this hearing
here this afternoon. It is an important hearing on programs
designed to increase the equity investment in small businesses.
Small businesses may finance their operations through debt
or equity. Debt's primary benefit is that the owners maintain
control of the company, but that comes at the cost of increased
cash flow out of the company to service the debt. Equity
investment reduces cash needed, especially in the early years
of a business, but comes at the cost of reduced control by the
owners.
Federal assistance to small businesses has come in the form
of both debt and equity. Debt programs available through
Federal-private partnerships include the 7a guaranteed loan,
the microloan, and Certified Development Company, or CDC,
programs. Equity investment is available through the Small
Business Investment Company and New Market Venture Capital
programs.
The committee already has addressed necessary changes in
the 7a and CDC programs. Last week, the committee held a
hearing on the microloan program, and will be addressing
legislation on that issue soon.
It is now time for the committee to turn its attention to
the equity programs operated by the Small Business
Administration. First and foremost, the committee needs to
understand the nature of equity investment in small businesses;
then the committee must consider the quality of existing
programs that assist small businesses to obtain equity
investments. Finally, if those programs are inadequate, the
committee should consider changes to improve the efficacy of
existing programs or eliminate them and create more cost-
effective, new ones.
For example, if the committee finds that the largest equity
investment in small businesses comes from the personal assets
of the business owner, then Congress must adopt tax policies
that ensure the business owner keeps those assets rather than
returning them to the Treasury in the form of taxes.
On the other hand, if significant equity investment in
small businesses derives from investment firms such as small
business investment companies, the committee certainly needs to
make sure that the program meets its objectives without placing
undue risk on the public treasury.
The review of equity investment programs also must examine
where investment is lacking. I know the chairwoman has been to
my district and seen the need in certain areas to increase
investment as a component of economic revitalization. I would
like to work with all the members of the committee in finding
appropriate, cost-effective incentives that will raise the
amount of equity investment in areas that have sorely lacked
such investment.
Finally, I would like to thank the chairwoman for examining
the angel investment phenomenon. Although angel investors may
be an appropriate savior for small business, it is difficult
for many small business owners to find an angel investor.
Congress may have the opportunity to reduce the cost of raising
equity funds from angel investors by eliminating burdensome and
multiplicative Federal and State legislation.
Again, I would like to thank the chairwoman for holding
this hearing and look forward to the ideas offered by our
distinguished panelists here this afternoon. And I yield the
balance of my time.
ChairwomanVelazquez. Thank you, Mr. Chabot.
Our first witness is Mr. Michael Hager. Mr. Hager is the
Associate Administrator for Capital Access at the United States
Small Business Administration. The Office of Capital Access
manages the administration business loan programs and performs
lender oversight functions at SBA.
Welcome, sir.
STATEMENT OF MICHAEL HAGER, ASSOCIATE ADMINISTRATOR FOR CAPITAL
ACCESS, U.S. SMALL BUSINESS ADMINISTRATION
Mr.Hager. Thank you very much. It is nice to be here, Madam
Chair. I want to thank you for the opportunity to testify on
the status of small business investment company programs at the
SBA.
The past few years have been challenging for the SBIC
programs. Performance in the participating security programs,
as you have indicated, experienced significant financial
challenges over the last several years. Current estimates
continue to project likely losses of 2.4 billion on the more
than 8.5 billion that we have guaranteed through fiscal year
2006. Again, 2.4 out of 8.5.
Since the end of fiscal year 2006, the Investment Division
has taken significant steps and devoted the majority of the
management time for the SBIC program to manage the risk of the
remaining Participating Securities portfolio. I am happy to
report that with these solid management steps and the improved
economic conditions, the current portfolio of Participating
Securities licensees has stabilized. While some additional
losses are still predicted to occur, the majority of
liquidations have been recorded.
In fact, distribution activity among Participating
Securities licensees has been robust in the last 8 quarters and
the SBA and bondholders received distributions of almost 1.5
billion. For example, in December, the SBA issued a revised
policy that allows a capitally impaired SBIC to emerge from
restricted operations to resume normal investment activities.
In the debenture program the SBA continues to see solid
performance from the licensees and is now beginning to see
renewed interest in the SBIC debenture product.
In 2006, the SBA guaranteed over 400 million in SBIC
debentures, and we anticipate exceeding that level this year.
In the debenture program the SBA has been focused on making
capital available to small business in low- and moderate-income
areas more than ever in the past. Currently, almost 20 percent
of debenture funding goes to LMI areas.
Additionally, in our reference to address underserved
markets, the New Markets Venture Capital program continues to
foster economic development in low-income areas. The program,
based on the SBIC program, is unique in that the fund managers
of the New Market Venture Capital companies receive grant
funding about operational assistance to actual and potential
portfolio companies to reduce the risk of investing in these
nontraditional areas.
To date, we have made over $40 million in equity and
investments in over 50 portfolio companies, creating over 400
new jobs and sustaining some 1,100 jobs. The New Market Venture
Capital companies also provided over 10 million in no-cost
operational assistance to over 170 actual or potential
portfolio companies in their targeted geographic areas. While
these initial results are promising, it would be too premature
to judge the success at this early stage of investing period.
The Agency is working diligently to strengthen its
relationship with the industry. We have reinstituted our
quarterly meetings with industry leadership to address issues
and concerns on an ongoing basis. The SBA is actively seeking
industry input on making the SBIC program more attractive to
both venture fund managers and investors.
We continue to believe that the debenture program can have
a substantial positive impact on the communities where SBICs
invest, and we want to ensure the program is positioned to its
maximum potential.
Chairwoman Velazquez, the SBA has a long history with
venture capital and still views venture investment as an
important source of funding for the small business community.
The problems we see now are mechanisms available for the SBA's
involvement in venture capital efforts and balancing those
needs with the need to protect the taxpayers' investment.
We look forward to working with you to address these
issues. We thank you for the opportunity to testify before the
committee today. We look forward to questions from the
committee.
ChairwomanVelazquez. Thank you, Mr. Hager.
[The statement of Mr. Hager may be found on page 33 of the
Appendix.]
ChairwomanVelazquez. Before I introduce our next witness,
Dr. Lerner, I would recognize the gentlelady from Wisconsin,
Ms. Moore, for an opening statement.
OPENING STATEMENT OF MS. MOORE
Ms.Moore. Thank you so much, Madam Chair. I will try to be
brief.
I really did enjoy the testimony of Mr. Hager, and I am
glad to hear that he still thinks that venture capital is
extremely important. No guts, no glory. You really do have to
take risks in order to spur our economy along.
I just want to say to the Chair and the ranking member that
I am so appreciative of your having this hearing today. You
guys have had great stewardship over this committee. We hear
time and time again people talk about how aspiring
entrepreneurs need access to capital in order to fulfill their
goals and to stimulate the economy and to create new jobs, and
it is important to keep those things forward in our mind and
not try to always balance that off with, quote, unquote,
"protecting the taxpayers' dollars" because I think that we are
at a growth rate in our country where we have got to help our
entrepreneurs, who create 97 percent all new jobs, our small
businesses, and the taxpayers. We definitely need to be in the
position to help grow our economy for their benefit.
So many small businesses located in low-income and urban
areas and rural areas lack this venture capital because they
don't have angel investors and they don't have the three Fs--
family, friends and fools--to help them get into business. So
it really is important for us to realize that it is our
responsibility to help spur folks that are going to constitute
the majority of our economy.
President Clinton was really aware of this when he unveiled
the New Market Venture Capital program as part of the larger
initiative to meet this unmet challenge. I have to give
President Bush credit because he, in fact, did continue to
authorize this program for the past 7 years, although he
requested no money for this initiative. But it still is on the
books, unlike the Participating Securities program, which is
virtually shut down.
What are we going to do with urban and rural areas if we
don't, as you know, Mr. Hager, try to figure out ways to make
our products, our venture capital products really, really work?
In the first--in 2006, three regions, Silicon Valley, New
England, and Los Angeles accounted for approximately 60 percent
of all venture capital dollars invested and 50 percent of all
deals.
The reason I asked to make an opening statement is because
I am a really big stakeholder in what we do here. My district
of Milwaukee, that the New Market Venture Capital program has
not yet had time or resources to reach, ranks 48th out of 50th
of the largest U.S. cities in terms of venture capital dollars,
and we are in the midst of the Rust Belt. We need help with
venture capital.
So my question to you, Madam Chairperson, ranking member,
what is the best way to get equity capital to underserved
markets? And I believe we ought to look at funding the New
Markets program in another round as a potential solution.
Just briefly, because I realize that my time is waning, we
have invested more than $13.4 million in this patient capital
in 29 companies. They have provided $6 million in operational
assistance to 163 businesses and entrepreneurs, and they have
created or maintained 1,500 jobs in low-income communities. The
difference between this program and SBIC's is that New Market
Venture Capital specifically targeted low-income communities.
To build on this initiative, I introduced the Securing
Equity for Economic Development of Low-Income Areas, the SEED
Act, which would reauthorize a New Market Venture Capital
program. It would go further to incorporate small manufacturers
into the mission of the program, something that was really
important to our former chairman, Mr. Manzullo.
So, Madam Chair, with that, I would yield back. And I thank
you all for your indulgence.
ChairwomanVelazquez. Thank you, Ms. Moore.
I will ask any other member who wishes to open.
So I would like to introduce Dr. Josh Lerner. Mr. Lerner is
the Jacob H. Schiff Professor of Investment Banking at Harvard
Business School, with a joint appointment in the Finance and
Entrepreneurial Management units. Dr. Lerner worked for several
years on issues related to technological innovation and public
policy at the Brookings Institution for a public-private task
force in Chicago and on Capitol Hill before earning a Ph.D.
From Harvard's Economics Department. Much of his research
focuses on the structure and role of venture capital on private
equity organizations.
Dr. Lerner, welcome. You will have 5 minutes to make your
presentation. Thank you.
STATEMENT OF JOHN LERNER, JACOB H. SCHIFF PROFESSOR OF
INVESTMENT BANKING, HARVARD BUSINESS SCHOOL
Mr.Lerner. Thank you very much for the introduction and the
invitation to testify today as part of this review of the Small
Business Administration's equity investment programs.
In my testimony today I will emphasize two points, first,
that venture capital can play a powerful role in encouraging
innovation and economic growth; and second, that it is natural
to believe that government programs can boost venture capital.
At the same time, however, these efforts must be carefully
designed to work with and listen to the private venture capital
market and its dictates and to embody thoughtful evaluation of
the programs.
Financing of young firms is a challenging process. Young
companies, particularly those in high technology industries,
but also more generally, are often characterized by a
considerable degree of uncertainty and substantial information
gaps.
We have argued that specialized financial intermediaries
such as venture capital organizations can address these
information problems and these uncertainty problems. By
intensively scrutinizing firms before they provide capital and
then monitoring them afterwards, venture capitalists can
alleviate the information gaps and reduce the capital
constraints that several members of the committee have talked
about in their opening statements.
Venture capital seems to play a very important role in our
economy. While it is challenging to figure out exactly how much
innovation is caused by venture capital, there have been a
variety of studies which have tried to piece together this
relationship.
After looking at a number of considerations, venture
capital has a very strong positive impact on innovation. While
the estimates vary somewhat with the techniques used, on
average, a dollar of venture capital appears to be three to
four times more powerful in stimulating innovation than a
dollar of traditional corporate R&D. Since innovation is
closely linked to economic growth, rising productivity and
increased wages, venture capital is clearly playing a vitally
important role.
At the same time, the impact of venture capital on
innovation does not appear to be uniform. In many instances,
the levels of venture capital an promising technologies may
undershoot the desired levels. In these cases, promising
companies may be unable to get funding no matter how good their
ideas. Moreover, as Congresswoman Moore pointed out, venture
capital is highly geographically concentrated in a few regions
in the country.
Given these patterns, it is natural to view government
funding as a potential solution. The characteristics of a
venture capital market lead there to be a natural government
role in stimulating the evolution.
Venture capital is a business where there are increasing
returns. Put another way, it is far easier being a venture
capitalist if there are 10 other venture capitalists nearby
than if one is the first one. It is in these types of settings
where there are what economists call "externalities" that
government can often play a very positive role.
At the same time, however, governments must avoid the
common pitfalls that befall venture capital initiatives. One
common failing is to ignore the realities of the venture
capital process. For instance, many venture capital initiatives
have been abandoned after a few years. The programs' authors
have apparently not understood that these initiatives take many
years to become successful. In other cases, they have added
requirements that have proved to be counterproductive.
A closely related problem is the creation of programs that
ignore the market's dictates. Far too often government
officials have sought to encourage funding in industries or
geographic regions where the private interest is simply not
there. As a result, the result has been wasted resources.
Effective programs, such as the Yozma Program in Israel,
address this problem by demanding that credible private sector
players provide matching funds. Thus, when encouraging new
venture funds under the New Markets program it will be
important to ensure whether, through matching funds
requirements or other means, that these new funds are
fundamentally viable ones.
Finally, it is important to have careful evaluation, as
well, as part of these fund, scrutinizing not only the
companies, but also the venture groups themselves.
I want to thank you once again for this chance to testify.
ChairwomanVelazquez. Thank you, Dr. Lerner. I think that we
could do this in 5 minutes.
[The statement of Mr. Lerner may be found on page 38 of the
Appendix.]
ChairwomanVelazquez. Our next witness is Mr. May. Mr. May
is the Chair of the Angel Capital Association, a peer
organization of Angel Investing Groups in North America. Mr.
May is also the managing partner of New Vantage Group, a
Virginia firm that mobilizes private equity into early-stage
companies and provides advisory services to both firms and
private investors.
Mr. May's experience in private equity capital spans 15
years and ranges from venture capital fund management to angel
investing.
Welcome, sir.
STATEMENT OF JOHN MAY, CHAIRMAN, ANGEL CAPITAL ASSOCIATION
Mr.May. Thank you very much. I could do this in 2 minutes,
2 hours or 2 days, but I appreciate the 5 minutes.
I really appreciate being able to represent the early-stage
venture capital which is angel investors. I am part of a group
that has just been formed over the last year called the Angel
Capital Association, which just shows the maturation of the
group of angel investors who try to pool their capital and be a
more sophisticated resource to all 50 States.
We have grown to represent groups that have 10 or 12
investors, groups that have 270 investors. And there are about
5- or 6,000 high-net-worth individuals who belong to these
groups.
But my experience has been that the U.S. is struggling with
an absence of early-stage institutional venture capital. In our
written testimony, we talk quite a bit about this lack of
capital, and I really appreciate your attention at the
committee level, Madam Chairwoman.
The institutional venture capital industry is only at about
$260 billion and puts out about $25 billion a year. We estimate
with the little bit of research that has been done on high-net-
worth individuals, angels, that it is about the same size,
about $25 billion. But we think we probably put it out in about
50,000 transactions, whereas last year the venture capital
industry had about 3- or 4,000 transactions.
So there is an opportunity here if we can grow more high-
net-worth individuals to play in this risky space; and to feel
comfortable mentoring, that we have a chance to greatly
leverage the institutional venture capital that is out there.
Let me just quickly read this quote that talks about who an
angel is. They become an angel "for a variety of reasons,
including achievement of financial return," which is key, "to
support their community," which is also key, "to create and
grow companies, to find a new job, to learn new things, to make
use of their expertise," and a very important sidebar, "for
personal enjoyment."
So this is a giving back phenomenon, this is a patient
capital phenomenon, and it is a mentoring phenomenon. It is the
most valuable resource for the high-net-worth individual who
invests in a stranger for long-term capital gain and to grow
their regional economy. Ninety-eight percent of angel groups
invest in their local economy--in Milwaukee, Golden Angels. All
around the United States there are local groups that invest 1
hour drive time. They have to have some reward while they wait
for financial return, which usually takes 3, 5, 7 and 9 years.
So let me just tell you where I think there could be help.
This is a very touchy area, as Josh said, about how can
nonprofits and government direct the for-profit, the
individual, with their after-tax dollars to spend their time
and money? I think we should study this some more, but the key
to me is education, readiness programs, and awareness training.
The more we can help find ways to educate entrepreneurs
what an angel or venture capitalist is looking for--because the
most valuable resource we have is time, so if we waste time in
the hunt between the two parties, it is really deadly--and how
to educate more angels. There are some programs out there I
think we could support.
Also infrastructure and development of angel groups. There
are a lot of States, such as Wisconsin, Ohio, Pennsylvania,
that have found ways with six-figure investments to spread the
word on how to educate angels, how to match the right
entrepreneur with the right program--a very small amount of
dollars to get a lot of bank for the buck.
There is a lot of discussion about a Federal tax credit
program to enhance and to help. There is a lot of controversy
over the success of the 19 or 20 State programs that have
existed in the past. It is--just to note, the National
Governors Association is about to publish a 20-State report on
the effectiveness of State programs' funding, tax credit and so
forth. So we would like to support dissemination of that study
as soon as it is available in early July.
We definitely think leveraging private investors--and I
would suggest we go beyond supporting the wonderful work of
SBICs, which we have co-invested with and made money; and with
the New Markets Fund, in which we have co-invested as angels
with the one in College Park and made money, and we suggest you
look at coinvestment or matching fund programs. Scotland has
one, there are a number of States that have one.
If a group of angels or venture capitalists are willing to
put their dollars at risk, that should be enough to trigger a
matching amount from a leverage program. The UK has just
instituted that program, and very successfully, to try to build
on the experience.
So, as you know, I could go on. I am very enthusiastic
about this. AngelAssociation.org, everything you wanted to know
about angels in all 50 States. And thank you for this chance.
ChairwomanVelazquez. Thank you, Mr. May. You will have an
opportunity to expand when the members will have an opportunity
to make questions.
[The statement of Mr. May may be found on page 44 of the
Appendix.]
ChairwomanVelazquez. So now the committee will stand in
recess and we will resume right after the vote.
[Recess.]
ChairwomanVelazquez. The hearing is called to order.
Our next witness is Mr. Stephen Vivian. Mr. Vivian is the
Vice Chairman of the Board of Governors of the National
Association of Small Business Investment Companies, the
professional association for the small business investment
company, SBIC, industry.
Mr. Vivian is also a partner with Chicago-based Prism
Capital, Prism Opportunity Fund, one of only a handful of
groups in the country managing both Participating Securities
and debenture SBICs.
Mr. Vivian, welcome.
STATEMENT OF STEPHEN VIVIAN, VICE CHAIRMAN, BOARD OF GOVERNORS,
NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES,
AND PARTNER, PRISM CAPITAL
Mr.Vivian. Thank you. Thank you, Chairwoman Velazquez and
Ranking Member Chabot for inviting me to testify and for all
your hard work on the SBIC program over the years. I appreciate
the opportunity to testify on behalf of NASBIC; it is something
I am very passionate about, and also gives me the opportunity
to apologize for record to Barry, whom I called Michael during
the intermission.
Barry, I apologize for that.
As Chairwoman Velazquez mentioned, I am the incoming
Chairman of NASBIC, and we represent the over 350 licensed
SBICs across the country. As a brief background I just wanted
to touch on the three different aspects of the SBIC program and
give a little status update.
The debenture program, which is today the most thriving
part of the SBIC program, has approximately 135 licensees and
invests $5.8 billion in capital--or manages 5.8 billion in
capital and invested about 1.2 billion in fiscal 2006. That
program matches private capital raised by general partners,
such as ourselves, with a two-to-one match from the government
to invest, primarily debt, in small businesses. And the SBA
sets the rate, the hurdle interest rate, that we put on and can
maximize and charge the companies that we invest in.
The second component of the SBIC program consists of now
only about 58 bank-owned SBICs, which have traditionally been
nonleveraged, and since the passage of Graham-Leach-Bliley in
1999, most bank holding companies no longer invest through
their SBIC licensees.
The third component, as the Chairwoman mentioned, was the
Participating Securities program, which we do have a license
for, which was started in 1994; and as Chairwoman Velazquez
also mentioned, the SBA discontinued licensing new
Participating Securities funds after fiscal 2004, really due to
a couple of things--one, because of losses, and also because of
a determination that the program no longer qualified for the
Credit Reform Act.
Currently, the last of the SBA-guaranteed Participating
Securities leverage will expire on September 30, 2008. There
are currently 167 remaining Participating Securities funds.
They manage about $11.5 billion of capital and invested about
1.5 billion in 2006.
After chairing the legislative committee a couple of years
ago in attempts to revitalize the Participating Securities
program, NASBIC took a different course this year and decided
our mission for this year would be to try to work with the SBA
and with the committees to rehabilitate the reputation of the
SBIC programs that were remaining and thriving; and so, to that
end, we proposed and supported the legislative initiatives that
you all are considering to amend the SBIC program.
I just wanted to briefly go over the three things we talked
about relative to the legislation that we support, because we
do believe they help to improve the profile of the SBIC program
with both investors that could invest in the program and with
general partners that might want to run SBICs.
The first proposal is to increase the maximum amount that
SBICs can invest in any single company. Today, that hurdle rate
is low by market standards and artificially lowers the amount
of investing that SBICs do into small businesses as general
partners limit the amount of money and mete it out to the small
businesses that they invest in. An increase in that overlying
limit we believe would be very beneficial to funding small
businesses by debenture SBICs.
The second proposal deals with the amount of capital under
management by any single independent SBIC manager or multiple
funds under management by SBIC fund managers; and we believe
that increasing those rates which have been pegged and not
increased enough, in our estimation, in recent years will help
to promote further interest in the program over time and
continue to drive managers to the program.
The third piece of the proposal is really the last shot
that NASBIC has made in working with you all to try to solve a
little bit of the pain for the remaining Participating
Securities licensees that are left, and that is really a
technical change to allow Participating Securities funds to
draw leverage a little bit faster than they are currently able
to draw leverage, in hopes that the leverage, which they have
already paid for, will allow them access to slightly more
leverage than they currently would able to get under the
current legislative program.
So we really appreciate your support for the program over
the years and your support for these legislative initiatives;
and though they are technical in nature, we think they really
are a step in the right direction to help keep promoting the
debenture program and keep improving it so we can have it
remain attractive for both small businesses and general
partners.
ChairwomanVelazquez. Thank you, Mr. Vivian.
[The statement of Mr. Vivian may be found on page 50 of the
Appendix.]
ChairwomanVelazquez. Mr. Hager, I would like to address my
first question to you.
Can you tell us which of the SBA's existing programs help
early-stage startup small businesses with investment capital?
Mr.Hager. We have a number of instruments to use. I mean,
arguably the debenture program would work. We are also, of
course--
ChairwomanVelazquez. What do you mean by "arguably"?
Mr.Hager. There could be some push-back to say it is not
for startup, but clearly it has a 50-year history with all
sorts of applications, including startup. Some that would push
back to say "no."
ChairwomanVelazquez. What other the programs?
Mr.Hager. The New Market Venture Capital program that we
have, it is still early--we are about 5 years into the
program--but we also think that program would offer some
startup. The startup has obviously dropped off, as you have
indicated. However, the last couple of years it has been very
stable, and we hope that it will maintain the current level
that it is today.
ChairwomanVelazquez. Let me ask you, how can a startup
business with limited cash flow and a heavy need for capital
investment benefit, how will that benefit?
Mr.Hager. It would be--again, to go back, the debenture
program has been here for 50 years, and it has historically
been able to provide capital to startups.
ChairwomanVelazquez. Let's take the debenture program. If
you are using the debenture program to fill the gap left by
eliminating Participating Securities, can you explain to us,
then, why has your agency proposed to keep the program level
flat?
Mr.Hager. "the program level flat"? Help me with that.
Which program level are you talking about?
ChairwomanVelazquez. The authorization of 3.5 million. Did
you ask for that increase?
Mr.Hager. No.
ChairwomanVelazquez. How then can you fill the gap that
exists?
Mr.Hager. There will be some dropout from the participating
program that won't be filled.
ChairwomanVelazquez. So that shows the commitment of the
administration.
Mr.Hager. The commitment of the administration is as strong
as every. We have a 50-year--
ChairwomanVelazquez. The facts are there or?
Mr.Hager. The participating program was a program we could
not support for the future. Out of 8.5 billion, 2.4 billion has
been lost. Another 300 to 700 million is forecast to be lost.
It is a program that didn't have good balance as much as we
want to reach out, as much as we want to help. The
participating program is a program that clearly did not have
good balance.
ChairwomanVelazquez. Where are the forecasts when you talk
about the losses?
Mr.Hager. Our current forecasts in the SBA of the
participating program, we are right now 2.4 billion that we
know we are going to lose. We are looking at a commitment of
another 2.1 billion roughly.
ChairwomanVelazquez. You mentioned the $2.5 billion in
losses. So I just want to ask you: Has your agency actually
realized losses in the participating security program in the
amount that you quote, or are those projected losses?
Mr.Hager. Projected losses.
ChairwomanVelazquez. Okay. So Mr. Hager, one of the biggest
challenges that women-, veteran- and minority-owned small
businesses have to overcome is the inaccessibility of
investment capital in the conventional capital venture
industry. What is the SBA doing to increase equity investment
in women-, veteran- and minority-owned businesses?
Mr.Hager. No. It wouldn't take a lot to look at the numbers
to understand that there is a problem there. We don't deny that
there is not a problem there.
ChairwomanVelazquez. So, for the record, let me share with
you and the people here, the numbers.
In fiscal year 2005, only 3.4 percent of all financing in
the SBIC program that went to that were majority black owned.
For women-owned businesses, the numbers were worse with those
businesses receiving 2.37 percent of SBIC financing.
For Hispanic-owned businesses, the statistics were even
worse with only 1.39 percent of SBIC financing. And veteran-
owned small businesses faired the worst receiving only half of
one percent of all SBIC financing.
So if this is the result of the SBA current efforts to help
this group, wouldn't you agree that a lot more needs to be
done?
Mr.Hager. We agree that we have to do everything we can to
enhance those numbers. You know, when you look at the number
of--from 2002 through 2006, the number of businesses in women-
minority-owned--that are women-minority-owned, was roughly 20
percent.
Those numbers, not necessarily where we would like them,
but 20 percent is the number that was achieved for those years.
We have a number of programs that we are looking at. We have a
number of outreach programs that have been launched. We
recently conducted a symposium at the agency that was focused
on women and minorities.
ChairwomanVelazquez. We got a problem. You know that;
right? We have a problem. The administration has a problem with
those numbers. You have to do better.
Mr.Hager. We would like to see the numbers improve.
ChairwomanVelazquez. So let us talk about the New Market
Venture Capital Program.
As we all know, it was designed to increase investment in
small businesses in low-income areas.
Do you feel, Mr. Hager, that this is a worthwhile goal for
the SBI even if the program requires increased funding?
Mr.Hager. We believe that the funding level for the program
today is where it ought to be. It is a program that was
developed roughly 5 years ago. It was implemented. We are
tracking the progress. It is still in the harvest period, as we
call it. We don't know yet until we get some more experience
with the program. We do believe it offers hope for us. We do
believe that there is a potential here to expand it.
But we don't want to artificially, prematurely make a
recommendation on this program until we see the results.
ChairwomanVelazquez. And so can you tell us, where is the
funding level for the program? At what level?
Mr.Hager. We have committed some $7 billion for this
program; $40-some million has been, you know, committed, has
been allocated. There is still a balance in the program. It is
a new program, relatively new.
ChairwomanVelazquez. When was the last time that it got
funded?
Mr.Hager. I think the year for that--
ChairwomanVelazquez. I will help you, 2003.
Mr. Hager, the New Market Venture Capital was a
manifestation of Congress's belief that small businesses in
low-income areas need additional support in acquiring
investment capital.
What has the agency done to fulfill this mission?
Mr.Hager. We believe that we have, again, a number of
venues to address that issue both on the venture side--I keep
coming back to that. That program has served us well for 50
years. We maintain it is a strong program. We maintain there is
a good balance between taxpayers and recipients of those funds.
And we think it is a good approach.
We have a New Market Venture Capital Program that we talk
about. That offers a lot of hope for the future based on, you
know, the success of the program.
ChairwomanVelazquez. Without money? Without the
administration coming to ask for money?
Mr.Hager. Until we see what happens with the program, we
think we are where we ought to be right now.
ChairwomanVelazquez. You talk a lot about the New Market
Venture Capital Program a lot in your testimony, and then your
agency--you are saying that the agency is truly committed to
fostering development through this program. And I just cannot
understand, if you come here and say and talk about how much
this program can accomplish and how committed you are, and then
your agency does not request--hasn't requested any more money
for the program for the last 4 years, something is wrong with
this picture, sir.
Mr.Hager. We are passionate about what we do.
ChairwomanVelazquez. I can see that.
Mr.Hager. We are, and we work very hard at it. We don't
want to propose additional funding on a program that is new,
unproven. We don't want another participating security--
participating program where we have to come back to say we have
a problem here. Well, what kind of problem? $2.4 billion
problem. We don't want--we don't want to--
ChairwomanVelazquez. Sir, don't continue to say $2.4
billion when you answered to me my question about saying that
those are estimates. You don't know the numbers.
Mr.Hager. We can't guarantee it, but with great
predictability, those are real numbers.
ChairwomanVelazquez. I will now recognize Mr. Chabot.
Mr.Chabot. Thank you, Madam Chair.
And, Mr. Hager, I will follow up with you if I can.
Could you tell us which outreach efforts are in place so
that small business owners know more about possible angel
investors?
Mr.Hager. We have a whole host of outreach programs that we
have launched in the last couple of years. It would include
hosting work groups, brain storming meetings. We have done that
in a number of major cities throughout the country. Holding
frequent discussions with NAIC, 3 years in a row of supporting
events cosponsored by NAIC, participating in speaking at the
North American Alliance gathering.
I can go on and on, outreach programs that are underway,
including a symposium that was conducted back in December of
last year where we brought in industry leaders, academicians,
people that would be able to assist us in how we can come up
with new ideas in outreach.
We came up with a whole host of suggestions that are being
evaluated right now. And we will continue these outreach
programs.
Some of these suggestions will no doubt be implemented.
Mr.Chabot. Thank you.
Dr. Lerner, if I could move to you next.
You had mentioned in your testimony that venture funds tend
to sort of group together, and the first one is obviously
tougher environment and kind of breaking ground, and it is
easier if you have a group of them or if you are following. And
you had also mentioned that there has to be interest in the
private sector if it isn't--if the market isn't going to
support it, no matter how much money you dump into something,
it is just not going to ultimately work.
Could you expound upon that, both of those things, a little
bit?
Mr.Lerner. What you are getting at is one of the
fundamental challenges here. That, on the one hand, you know,
we just have this natural desire to see venture capital and
entrepreneurial activities taking place everywhere. And ideally
that would be the way that would be sort of spread out, you
know, very evenly and have activity taking place in all places.
Unfortunately, it seems that when governments have tried to
do this, and there are examples ranging from, you know, from
around the globe where they have said, let us just sort of try
and encourage activity evenly so everyone is saying it just
fundamentally doesn't work; this is an activity that seems to
be concentrated and lumpy in its nature.
Now that, when you first state that, it doesn't sound very
appealing. And in fact, when I have made statements like this,
I have been criticized in all corners of the globe from Finland
to China for having said something along those lines.
At the same time, though, I think there is hope. And it is
not--we don't need to take this sort of Draconian view, and
Silicon Valley and Massachusetts are venture capital; we can't
do anything anywhere else. But I think it does make sense to
say, rather than trying to duplicate Silicon Valley, rather
than trying to create a little high-tech cluster in every
region, we need to think very carefully about what are the
strengths of each given region and what are the things where
there is a real potential for private sector activity and real
vibrancy.
To just simply throw money in the hopes of duplicating
Silicon Valley is unlikely to be successful, but if we can
figure out ways and places where the--where there is potential
in getting the private sector involved in terms of providing
matching funds, is an important way of doing it. We can
duplicate features of the venture model in many different
places around the Nation.
Mr.Chabot. Mr. May, would you agree that an increase in the
tax rate for long-term capital gains would be harmful to
investors in two ways: It would reduce the return on angel
investments, and it would reduce the funds that angels have to
invest? And also, is the Angel Capital Association supportive
of extending the President's tax cuts?
Mr.May. Thank you for the question.
No high-net-worth individual doing long-term capital gain
patient investing in a high-risk environment would like to see
a higher tax rate on those long-term capital gains. When I go
around the world talking about, is the U.S. government
sponsoring and supporting angel and venture activity in the
United States, I say, no, except for 15 percent long-term
capital gains tax rates as an encouragement to take the risk on
that capital.
Because, in general, this has been a grassroots-up
phenomenon, not a top-down like in the EU, the Angel Capital
Association is so new, less than a year old, and just
formulating how it should approach policy among what we call
herding cats.
As you can imagine, we have angels from all walks of life
and all jurisdictions. We have not yet taken a policy position
on anything, but we are developing it. We would be glad to know
what areas we should be responding to these kinds of questions.
But as a group, it is too new to have a stated policy like
a trade association. You can imagine trying to deal with all of
those different individuals and get a vote.
So it is neutral on it to date.
Mr.Chabot. And, finally, Madam Chair, if I have time to ask
Mr. Vivian a question.
Are there specific industry sectors or geographic areas
that need more SBIC funding and cannot obtain it through the
limited programs operated by the SBA?
Mr.Vivian. My opinion, the answer would clearly be, yes. If
you go outside the regions that include Silicon Valley or Route
128 or Austin, Texas, there is a dearth of private equity. The
statistics will show well over two-thirds of the dollars
invested, and if you break it down by county, it is staggering
how much venture capital is concentrated in a handful of
counties.
So, clearly, there is a dearth of venture capital and
private equity outside of those regions. And quite frankly, one
of the very disappointing things to NASBIC, as it related to
the Participating Securities programs, was we could debate
whether the structure was right or wrong, but the intent and
the spirit of the program--the program worked, and it drove
capital. Our little firm in Chicago, and other people can say
Chicago is full of private equity, but we write checks and in a
range from $750,000 to $3 million in our equity fund, and that
money does not exist.
So, clearly, there is a need, and I think one of the things
that Josh mentioned I would also echo. If there are legislative
initiatives around programs, there needs to be a long-term
horizon and a vision to keep those around.
One of the problems that the Participating Securities
program was rolled into along with the rest of the venture
industry was they ramped the commitments into the teeth of the
recession and the economic bubble and the dot-com bubble.
Everybody lost money during that period. Not just the SBA. I
would argue that SBICs performed as well or better than the
vintage year funds that the rest of the private equity industry
put forth during those years, but you have to have a duration
and a perspective and a willingness which is why maybe do
tweaks to a program so that it won't result in a backlash if
there are losses, because if you are screwing around in private
equity, there are going to be losses. That is just the nature
of the beast.
Mr.Chabot. Thank you very much. I yield back.
ChairwomanVelazquez. Ms. Clarke.
Ms.Clarke. Thank you very much.
It is really disheartening to hear today that many of the
Small Business Administration's programs being discussed are
being eliminated from the Federal budget.
The administration must continue to fund these initiatives
in order for these programs to thrive and to flourish and, you
know, to hear that the 50-year track record that you have is
what you used to sort of substantiate success, it just doesn't
jive when we see so many businesses out there in need of our
support.
It is really an imperative, and I hope that you will really
reassess that and do some, what I believe, is some really in-
depth analysis. We have got so many businesses out there that
really need the help and the support at the same time that we
are cutting funds, it just seems counter-intuitive.
The SBA was created to aid and counsel and assist and
protect small business concerns.
As you already know, small businesses remain a critical
component of our economy in the 21st century, and your
administration must do all it can to make sure that women and
minority-owned businesses start, build and grow in the years to
come.
I would like to ask Mr. Hager.
It has been recently reported that SBA plans to reduce fees
for small business investment companies which use the
government-backed loans to make venture capital investments,
and according to the administration, these fee cuts will allow
small businesses to avail themselves to the SBIC program more
than they did last year.
The SBA, however, also has ceased issuing new leverage
commitments to many entrepreneurs due to your administration's
decision to move to the program to a zero subsidy, thus making
it virtually insolvent.
Why has the SBA continued to pursue a zero-subsidy policy
in the fiscal year 2008 budget which negatively impacts on
minority entrepreneurs in receiving capital investments?
Mr.Hager. The whole issue of zero subsidy is not only in
the capital markets group, but it is also in the loan area.
We strive, we work very hard at achieving zero subsidy to
eliminate the requirement to come forth and have various costs
created and covered by budgeting from Congress every year.
Many times the budget doesn't get approved on time. We then
have to cease programs.
We, by far, would rather see a program that is zero
subsidy, is paying for itself because we have proven time and
time again that, in the long run, we believe the programs are
far healthier; we don't expose ourselves to interrupted
capital; and we believe the end result--
Ms.Clarke. With all due respect, if that is what you would
like to see, why hasn't a real viable option been proposed by
SBA? To just stop it and not present a viable alternative
doesn't help the people of our communities, the entrepreneurs
of our communities. I am sure there is a lot of brilliance and
intellect over there at the SBA. With a little bit of
imagination and with all of the gentlemen sitting with you here
today, it shouldn't take coming before us to realize that, if
you stop this, it is going to have an adverse impact somewhere.
And it would seem to me that, before we make these type of
Draconian moves, we would, you know, consult with those and
say, look, you know, this is not the type of cost that we want
to absorb any longer, but we know that there are folks that
rely on this out there.
What can you come up with that we can present to these
communities, to the people of the United States, that will
substitute for what we will have to phase out?
Isn't there anyone thinking at that level at the SBA
currently?
Mr.Hager. We think about it a lot.
Ms.Clarke. Okay. You answered that question. I am glad you
think about it a lot.
Mr.Hager. Thank you very much.
Ms.Clarke. Where are we in proposing what the next steps
are going to be?
Mr.Hager. For example, the New Market Venture Capital
program is new. It is 5-years old. And by the way, that program
is well funded. If first payment doesn't occur, repayment for 5
years after the conception of the program. So that funding will
go out covering us for the next couple of years without a
problem at all.
The participating program is the one that we have indicated
we do not support it going forward. Why? We did not have a good
balance between the user of that program and the taxpayer. The
projected losses for that program that we have absolute
certainty will occur are Draconian. I mean, it is not fair, in
our opinion, to the taxpayer to be making that up.
Therefore, we have ceased supporting that program with
annual funds, and we have also indicated that, if we were to
apply fees to cover the expense of that program, nobody would
participate.
Ms.Clarke. But, Mr. Hager, I understand what you are
saying. At the same time, the alternative, if it is the New
Market Venture Capital program, which made over 40 million in
equity investments and over 50 portfolio companies creating 400
new jobs, you claim that it is premature to judge the overall
effectiveness of the program in your written testimony.
These numbers seem very impressive. Don't you think that
additional funding would not only bring new companies into the
program there by increasing equity financing to entrepreneurs
in low-income areas but also increase the companies' success
rate.
Mr.Hager. I totally understand where you are coming from.
Where we are coming from on the assessment of the program,
the first payments aren't due in for up to another year. And
until we start seeing what actually happens on the repayment,
we can't say we need more money to expand this program. It is
in a--we want to see what the--
Ms.Clarke. Is this like a pilot that you are running here
that says that, you know, we are going to have a control group,
and until that control group is manifested, we are going to
hold back on what we know is a need in the United States of
America; is that where we are at this stage?
Mr.Hager. It was not set up that way.
Ms.Clarke. I didn't think so.
So that is why I am a bit concerned about, you know, the
way that we are going about this. That is because business does
not operate in a static environment like that. It doesn't
thrive in a static environment like that. And certainly our
communities, you know, deserve better than that. And so if we
are going to set up these control groups situation, which is in
effect what we are doing--
ChairwomanVelazquez. Would the gentlelady yield to me for a
second?
Ms.Clarke. Okay.
ChairwomanVelazquez. Mr. Vivian, I would like to askyou, if
this is the way you invest, you invest and then you wait for 6,
7 years?
Mr.Vivian. No.
ChairwomanVelazquez. You have one more minute.
Ms.Clarke. I think the point has really been made.
I am just disappointed. I am a new Member here. And, you
know, I have been just dumbfounded, quite frankly, by the way
that we are not looking at using the best of our talent, skill
and ability to do what needs to be done to assist in our
communities and the SBA. So many people are looking to you for
your help and your guidance and your support. If in fact you
feel that there is a danger to the taxpayers' money, I think it
is also your obligation to look at other alternatives that can
be created.
Like I said, the talent expertise is sitting right next to
you there. These are folks you can draw on and say, listen,
right now this fund looks like, you know, it is going to be a
pain in the butt for all of us for the future, for the
foreseeable future, what can you suggest that we can do as a
product that we can get it to these communities immediately as
an alternative to assist those entrepreneurs?
I just don't hear that coming forth, and I hope that that--
ultimately, that is what I will be looking at.
Mr.Hager. But I hear you loud and clear, and to show you an
example, on a quarterly basis, we meet with the trade group to
say--we address a whole host of issues. But certainly as we
talk about product phase-out, you know, what can we do? What
are the options going forward? You know, certainly the New
Market program is one. Certainly we need to take a look at a
program that just started in 2001. What kind of risk are we
exposed to, to make sure that we have a good balance between,
again, the recipient of the dollars, the capital and the
taxpayer?
ChairwomanVelazquez. Time has expired.
Ms.Clarke. Thank you very much, Madam Chair.
ChairwomanVelazquez. Dr. Lerner, one of the shortcomings
you mentioned in the government investment program has been a
high emphasis on early results and a tendency to terminate
these programs prematurely had those results not been achieved.
So in the case of patient equity investment, what time
frame should we expect before a program begins to bear fruit?
Mr.Lerner. I think it is an excellent question, and we can
point to many examples where programs have been killed too
soon. I think a great example is France, where it seems every
time a new president has been elected, they announce a new
entrepreneur program. And then, 2 years later, they say France
doesn't have an entrepreneurship, so let us get rid of the
program.
But clearly doing evaluation is important in understanding
what is going on. But it is simply the process of growing--when
you think about creating a new venture industry, particularly
in an area where it hasn't been there beforehand--is going to
take a while for this to happen. You are not just creating
companies, you are creating a whole system in terms of not only
the financiers but the lawyers to help them with the process,
the accountants who understand working with these firms and so
forth.
So I do think that to think about this as something that
can be done in a couple of years is, you know, probably naive;
that we are talking about more like the length of a decade or
even longer. It is obviously challenging in the sense that, in
the position of a steward for public funds, one doesn't want to
waste money or throw good money after bad. But at the same
time, you have to realize that even if we look at some of the,
you know, very successful programs that have been very--that
have been out there, such as the original SBIC program, the
first 10 years of it were not a great success. In fact, there
were numerous hearings where Congressmen sitting in this very
room berated people for having set up the program in the first
place.
So one really needs to think about it in the time frame of
a decade or longer rather than a couple of years.
ChairwomanVelazquez. In your testimony, Mr. May, you say
that government leverage, if appropriately structured, could
play a role in increasing angel investment in small businesses.
How should this leverage be structured and what should be
avoided if the SBA's involvement in angel investing is to be
successful?
Mr.May. That is a great question we are struggling with.
And as we do that, I am going to keep you all informed.
The only thing that I have seen as a new initiative that I
think has some merit that I have seen in other countries is a
matching approach as opposed to a an entirely new bureaucracy
or a new attempt at raising capital.
And the State of Ohio, for example, has a wonderful program
that the Ohio Tech Angels have one-third of a side car fund
from Nationwide Insurance, one-third from the Ohio State
University and one-third from the State of Ohio, putting its
funds on a dollar-by-dollar basis side by side with risk
capital directed solely by private angel investors.
So I guess what I am saying is the kind of discussion that
we are going to have over time now that, you know, we are
taking a little bit more public role, would be to explore some
of these creative things being done at the State and local
level and see if they were used at the national level, whether
it be underserved markets or national, whether that has some
fruit as opposed to a new bureaucracy.
ChairwomanVelazquez. Dr. Lerner, you mentioned that a
common failing in government investment programs is a tendency
to focus on unrealistic metrics to measure the program's
success.
How should an investment program's success be measured?
Mr.Lerner. I think it is a great question.
I mean, clearly, at the end of the day, one thing that you
do want to look at is financial return. Now it is important, as
we talked about before, to look not look just simply at
absolute return but at return relative to what other funds in
the market are doing.
But I think it is also clear that, if we are spending
public money, it is not simply because of financial return.
We have a much broader set of social goals as well. And
these include things where it is alluded to earlier in terms of
employment creation, in terms of creating, you know, creating
an environment where it is easier for the next generation, for
entrepreneurs and so forth.
And certainly when we have--when I have been in a situation
advising governments about undertaking evaluations of programs,
what we have tried to push for is both a quantitative and a
qualitative side and saying, let us not just look at things
that can be easily measured, but let us also look at the
broader kind of investments. And, of course, those make us a
little nervous because it is hard to necessarily quantify all
of that stuff.
But it is important to take that broader view and to get a
sense of success and failure.
Mr.May. I just wanted to mention, I really do think a way
to get at some of the current data would be this study that I
know is about to come out from the National Governors'
Association recommending to the Governors what they have found
at their Center for Competitiveness has been the experience of
different tax credits systems at the State level, funding, seed
level. Our comments are due back to them at the end of June. So
as early as July, I would hope that the staff and the SBA avail
themselves of that recent research.
ChairwomanVelazquez. Mr. Vivian, you heard me when I was
asking Mr. Hager, in terms of the numbers regarding the SBIC
success, the program continues to have difficulty in providing
investment to small businesses that are majority owned by
women, minorities or veterans.
What more can be done to increase investment in this group?
Mr.Vivian. I think--there is no simple answer to that
question. The challenge always comes back to, when we have been
asked that question as either an association or as investment
professionals, we have never turned a business down based on
the gender or nationality of the entrepreneur. We look at the
merits of the business.
And I think the challenge that SBA has is the programs that
have been called in the past directed or targeted programs have
never really caught fire, for whatever reason. I don't know the
answer to that question as to why the more directed programs
have not received as much interest among the investment
community or investors.
And, you know, I don't have a great answer to that
question, Chairman. I wish I did. I do know that, in the
broader limited partner community, which is the pension funds
and endowments and foundations that are really the drivers of
investment into private equity and capital communities, there
is a major focus now on what they are calling double bottom
line investing where they get both financial return and social
return for what they do.
And I think the leadership within the investment community
and discussion and education and leadership by SBA in those
initiatives, I believe, is starting to make a difference. And,
you know, the proxy that I use is the number of women and
minority general partners that I see and that we see at
conferences, in fact, there was a conference held in New York
about a week ago on minority- and women-owned venture capital
and private equity firms and investing in those firms.
I believe there is a building wave of interest amongst the
financial community to recognize that there is a problem there.
And there is--something needs to be done, and it needs to
probably be a collective effort on a public-private partnership
to figure out how to solve those problems.
ChairwomanVelazquez. Thank you.
Mr. Chabot.
Mr.Chabot. Thank you.
Dr. Lerner, does the amount of Federal and State
regulations impede the capacity of small businesses to obtain
equity financing? And do you think that Congress should take
any action to eliminate the duplicative regulation of
securities markets by Federal and State regulators, and would
such an action improve the capability of small business owners
to obtain such capital?
Mr.Lerner. What you are raising is a set of really
important issues.
Clearly we have seen, you know, a decline in terms of the
share of, for instance, initial public offerings taking place
in the United States on a worldwide basis, a pretty dramatic
pattern over the last 5 years.
Now part of that probably just simply reflects the growth
of entrepreneurship in markets like India and China and more
recently in Europe and probably was inevitable. But it is hard
not to feel that the failure of companies to go public and
access the public markets here reflects a combination of
regulatory constraints, some of which are associated with
Sarbanes-Oxley, but others which aren't; fear of litigation and
particularly the proliferation of, you know, the continued role
of shareholder litigation against young companies and simply
more structural changes in terms of the investment banking
industry where there has simply been less time and resources
for analysts to cover young growing companies.
All of these factors have combined to make going public
less attractive, and this has also made it much more difficult
for companies to get earlier stages of financing because you
don't have the promise of ultimately being able to go public.
So I think that regulatory issues are part of the story,
but I don't think they are all the story. And certainly there
is a variety--it is probably one of a number of things that
fits into this which is the brew of what is going on.
Mr.Chabot. Let me follow up with something that is totally
unrelated to that.
Do you think it makes sense that the vast majority of small
business owners start their business using credit card debt,
and if it doesn't make economic sense, that it really kind of
shows a market failure in small business financing that it
forces a lot of owners to finance the start-up of their
businesses using such expensive credit card debt which is
obviously much higher than one would hope that you start a
business at.
Mr.Hager. It is an important issue. I mean, clearly, when
you are at that stage of starting a young company, except for
the very fortunate few, most of whom have already been
entrepreneurs and been successful and made money for their
investors, except for that group, it is very hard to raise
money.
You have to just somehow get on the playing field any way
you can and sort of bring that idea along to the point where
you can--where you can sort of have the--have something to
really show to potential investors, like angels.
And I think here, again, we can think about, you know, some
of two difficulties particularly that minority investors face
in the sense that the challenges of being able to access
traditional capital markets in these instances often are going
to be greater due to a lack of information or simply outright
discrimination.
So I think it is clearly, this is a very expensive--credit
cards are a very expensive form of financing. And you can think
about many examples of entrepreneurs who ran up huge amounts of
credit card debt and had very difficult situations.
But I don't think there is an easy solution or an easy way
to get around this. Simply because that initial phase, it is so
tough to raise money because you really have nothing but a
dream to convince people to give you funding.
Mr.Vivian. Just to echo a little bit.
I think there are some endemic challenges in growing small
business. I don't think it is a problem. The beauty of being an
entrepreneur, you believe passionately in what you are doing
and you don't care if anybody else believes in what you are
doing. And the challenge is endemic to the private equity
community; even if there were an abundance of seed capital,
there are a lot of businesses that just aren't good venture
capital investments.
The investments that we need to make into venture funds to
drive returns that allow us to stay in business don't align
with the vast majority of the companies and small businesses
that get started.
Equity investing of the professional kind is driven at
high-risk, high-return, and a lot of businesses--it doesn't
mean they are not fine businesses that create jobs and add a
lot of value to our country, but they are just not good venture
capital investments just by the nature of the fact that they
are unlikely to make someone 5 to 10 to 15 times their invested
capital on a return basis in a short period of time.
ChairwomanVelazquez. Ms. Clarke.
Ms.Clarke. Thank you very much, Madam Chair.
I wanted to ask Mr. May.
Angel investments have accounted for more than 51,000
entrepreneurial investments a year and are rapidly becoming a
way for investments to obtain early seed capital. The need for
the early stage start-up capital for small businesses is being
unmet by the SBA's existing investment programs, Particularly
since the elimination of the funding for the SBIC securities
program.
Angel investments have been great for job growth, mainly in
the health care services industry. But individual investors
tend to focus more on profits and not on community growth.
How can Congress make angel investing a more probable
choice in many communities since it could help improve the
economy?
Mr.May. I am not sure I have the answer to that. I am not
sure that there is a one-stop-shop way to do that. But it is
true that it is so clear that there is this widening gap of
institutional funding that is not available for high-growth
companies, and that is really what we are talking about is the
tip of the iceberg of these high-growth entrepreneurs that can
never get funding from any of us.
But, yeah, it has gotten where there is less than a
thousand transactions a year by the mainstream institutional
venture capitalists in the same space that, as you say, there
are 40,000 or 50,000 from angels and angel groups.
The problem is trying to force an individual to take the
risk through any kind of government program is tough. I think
what is needed, and we are looking at, is upstream. What we are
doing is getting them to a stage that we need, if they are
successful, to hand them off to somebody else who will provide
follow-on financing.
The New Market Growth Fund we have co-invested with, and I
think from the one example I have had here, is a successful
program and might well merit expansion because when we need to
find a $2 million investment after our $600,000 investment, if
those kind of sources are available, that is good for the
economy. And, again, whether it should be government-backed or
whether there should be CRA credits or whatever it is, I think
you are more likely to have the ability to help move the SBIC
money than you will ever be able to push the angel money.
But we are trying, and we will continue the dialogue.
Ms.Clarke. Mr. Vivian, I wanted to ask you, NASBIC, you
heard some of the conversation I had with Mr. Hager. And there
has to be some, you know, unconventional thinking going on
right now given what we know is going to be a real hardship in
the market of trying to fund start-ups and assist
entrepreneurs.
Are there any legislative proposals that Congress should
consider in order to improve the current SBIC program that you
have given consideration to?
Mr.Vivian. I think that is an excellent question.
NASBIC worked for over a year, and I chaired the
legislative committee when we tried to restructure the
Participating Securities program. And, you know, there were
arguably flaws in the way that program was structured. It
didn't mean it didn't work. And this is your world. It is not a
world I understand. But in this political climate, it did not
appear that there was a lot of broad support to push that
initiative through.
Would the initiative have kept the program alive and
arguably kept licensing and kept seed and early-stage capital
going? I believe, as a practitioner, because we did it, yes. So
if there is something to consider for the future, perhaps it is
a structural change to a program that, in my opinion, worked.
And it worked well, and it drove a lot of capital to small
businesses that needed it.
Just a real quick aside on your question to John as it
relates to, what can the government do for angels?
The other place to look is something like tax breaks
because these angels are wealthy individuals, and if they are
looking to--if you want to spur their investment in a certain
area, if give them a break for investing however you codify
that to invest in seed and early-stage companies or seed and
early-stage funds or funds of a specific size, you can incent
people to take the risk.
I am not sure matching dollars incents a wealthy individual
to take a risk in backing an entrepreneur.
If you juice their return, that might be a way to do it.
ChairwomanVelazquez. I would like to add to your question
to him, that is part of the angel investment legislation that I
introduced today. And hopefully, Ways and Means will consider.
Ms.Clarke. I am finished.
ChairwomanVelazquez. Mr. May, I would like to ask another
question.
You talk of a need for education on line infrastructure and
other frameworks to support angel groups and develop angel
networks. This is this type of support needed at the Federal
level?
Mr.May. I am not sure--I know for sure it is needed at the
local and the State level. I don't know, and I would have to
look at your legislation and talk to you and your staff as to
what mechanism you think administratively this legislation
would penetrate to get to us, but what I know is that
communities that have had successful educational seminars and
other activities have then tended to get more activity. What I
am amazed about in the United States is that there are 4 to 6
million millionaires; there are only 250,000 to 300,000
practicing angels by any of the research that we have done,
about 5 percent. And there are only 5 percent of those that are
practicing in groups that have a Web site, that meet monthly.
So it is not as if everybody is doing it.
So we need a lot of help, and we are working on this
personally. The academics are helping us with some of the
research, but maybe there is something we can do together
because there are a lot of people that have the capacity; they
have the will.
ChairwomanVelazquez. Would you like to add, Dr. Lerner?
Mr.Lerner. I think there is a need for a great deal of
education on both sides. I think that this certainly is one of
the barriers, is that I frequently will encounter people who
are very enthusiastic and very passionate about their
entrepreneurship dream, which is great, but in many senses,
there are a lot of landmines along the road to entrepreneurial
success.
And, you know, while certainly some things you have to
learn by doing, there are other things that can be taught and
sort of understanding, you know, how you go about the process
of structuring a deal or how you look at people who are
potentially giving money and trying to figure out whether they
are serious or not. There is a lot that could be done.
And, again, I am not sure what the right level or the right
place is for it, but I think it could certainly very much boost
the entrepreneur success rate.
There have been a lot of academic studies that suggest that
one of the main barriers to minority entrepreneurship has been
the fact that people didn't grow up in families where a father
or a mother were an entrepreneur already, and somehow it seems
that when you grow up in that sort of family environment, you
absorb a lot of these lessons, sort of, you know, sort of
automatically. And it seems that education can play a really
important role in overcoming some of the gaps and trying to
make people in a position to be more effective entrepreneurs.
ChairwomanVelazquez. Mr. May, why does angel investing have
the capacity to generate investment in regions where there are
not currently large numbers of venture capitalists?
Mr.May. The statistics about where professional investors
are located, are just staggering. The National Association of
Seed Venture Funds found that 26 States had zero or only one
venture capital investment in their State last year; 77 percent
of institutional venture capital over the last 10 years went to
23 States.
So it is true, you can't force the money in there. But it
is true that, if we could find ways through the angel programs
and through maybe some of these educational programs--I am
finding that in Lexington, Kentucky; Kalamazoo, Michigan;
Milwaukee--there is a lot of interest in keeping their people
home, transfer from their universities. A lot of people are
realizing, not everybody can go to Silicon Valley and Boston.
So one of our efforts is try to have a lot of educational
seminars and work in helping people to understand how to do it
in their backyard and not to feel inferior because they are not
at MIT.
ChairwomanVelazquez. Dr. Lerner, you spoke about the
program in Israel as an example of a successful government
venture capital program.
Could you talk about--could this program be duplicated in
the United States, and if so, what characteristics of this
program were most important to its success?
Mr.Lerner. Well, I think that, in many senses, it does
provide a model that we could think about for trying to
encourage venture activity in a variety of regions as well as
in a variety of industries which are under-served. And in
particular, the crucial elements were, first, that it relied on
matching funds, so there was no amount of having to get funds
from the outside. But they also structured in a way that made
it very attractive, which is that not only did the government
put in some money, a dollar to match the private money, but
they then limited how much money the government could make as a
return.
So they had this feature where the government's stake could
be bought out once you got to a return of somewhere around 15
percent.
So, in other words, if you had a big winner. You would just
simply go and buy out the government's half of it. The
government would make a nice return, which is, you will get us
money back for 15 percent.
But the view of the people in the Israeli government was
saying we are going to win in any case. If we get successful
companies, these are people who are going to be employing
people, who are going to be paying taxes and many other things.
We don't need to make sure that we get some huge--
ChairwomanVelazquez. That is the type of mentality that is
lacking sometimes in our government.
Mr.Lerner. Certainly the idea of having multiple metrics
and looking at having broader social returns is an important
aspect.
ChairwomanVelazquez. Any members of the panel would like to
add anything else?
Mr.Vivian. That sounds an awful lot like the Participating
Securities program.
ChairwomanVelazquez. Exactly.
Well, here we are.
It has been quite an insightful and very interesting
hearing. Definitely we are going to move forward with
legislation that will try to address some of the concerns that
have been raised here this morning.
So members have 5 legislative days to enter a statement or
other materials into the hearing record.
And with that, the hearing is adjourned.
Thank you.
[Whereupon, at 4:25 p.m., the committee was adjourned.]
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