[Senate Hearing 110-330]
[From the U.S. Government Publishing Office]
S. Hrg. 110-330
SBA REAUTHORIZATION: SMALL BUSINESS VENTURE CAPITAL PROGRAMS
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ROUNDTABLE
BEFORE THE
COMMITTEE ON SMALL BUSINESS
AND ENTREPRENEURSHIP
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
June 21, 2007
__________
Printed for the use of the Committee on Small Business and
Entrepreneurship
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COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
JOHN F. KERRY, Massachusetts, Chairman
CARL LEVIN, Michigan OLYMPIA J. SNOWE, Maine
TOM HARKIN, Iowa CHRISTOPHER S. BOND, Missouri
JOSEPH I. LIEBERMAN, Connecticut NORMAN COLEMAN, Minnesota
MARY LANDRIEU, Louisiana DAVID VITTER, Louisiana
MARIA CANTWELL, Washington ELIZABETH DOLE, North Carolina
EVAN BAYH, Indiana JOHN THUNE, South Dakota
MARK PRYOR, Arkansas BOB CORKER, Tennessee
BENJAMIN L. CARDIN, Maryland MICHAEL B. ENZI, Wyoming
JON TESTER, Montana JOHNNY ISAKSON, Georgia
Naomi Baum, Democratic Staff Director
Wallace Hsueh, Republican Staff Director
C O N T E N T S
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Page
Opening Statements
Kerry, The Honorable John F., Chairman, Committee on Small
Business and Entrepreneurship, and a United States Senator from
Massachusetts.................................................. 1
Committee Staff
Berger, Matthew, Professional Staff Member, Minority Staff....... *
Wheeler, Kevin, Deputy Staff Director, Majority Staff............ *
Participants
DeBow, Charles H., III, Director of Special Projects, National
Black Chamber of Commerce...................................... *
Ferreira, David, Director of Government Affairs, U.S. Hispanic
Chamber of Commerce............................................ *
Gorman, Thomas W., Managing Director, Seacoast Capital........... *
Hager, Michael, Associate Administrator, Office of Capital
Access, U.S. Small Business Administration..................... *
Harmeyer, Greg, President, Tier I Performance, LLC............... *
Haskins, Harry, Deputy Associate Administrator, Investment
Division, U.S. Small Business Administration................... *
Mercer, Lee, President, National Association of Small Business
Investment Companies........................................... *
Moncrief, L. Ray, Executive Vice President and Chief Operating
Officer, Kentucky Highlands Investment Corporation............. *
Rowe, C. Edward ``Tee'', III, Associate Administrator, Office of
Congressional and Legislative Affairs, U.S. Small Business
Administration................................................. *
Rubin, Dr. Julia Sass, Professor, Edward J. Bloustein School of
Planning and Public Policy, Rutgers University................. *
Sohl, Dr. Jeffrey E., Director of the Center for Venture
Research, Whittemore School of Business and Economics,
University of New Hampshire.................................... *
Tesdell, Kerwin, President, Community Development Venture Capital
Association.................................................... *
Tierney, Edward F., President, BISCO Environmental............... *
Vivian, Steve, Partner, Prism Capital............................ *
................................................................. *
* Comments, if any, are located between pages 4 and 41.
Prepared Statements and Appendix Material Submitted
Gorman, Thomas W.
Prepared statement........................................... 44
Sohl, Dr. Jeffrey E.
Handout, The State of the Seed Market........................ 5
Tierney, Edward F.
Prepared statement........................................... 47
Vivian, Steve
Prepared statement........................................... 49
Comments for the Record
National Black Chamber of Commerce, position paper............... 57
SBA REAUTHORIZATION: SMALL BUSINESS VENTURE CAPITAL PROGRAMS
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THURSDAY, JUNE 21, 2007
United States Senate,
Committee on Small Business and
Entrepreneurship,
Washington, D.C.
The Committee met, pursuant to notice, at 10:00 a.m., in
room SR-428A, Russell Senate Office Building, the Honorable
John Kerry, Chairman of the Committee, presiding.
Present: Senator Kerry.
OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY, CHAIRMAN,
SENATE COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP, AND A
UNITED STATES SENATOR FROM MASSACHUSETTS
Chairman Kerry. Well, good morning everybody.
We'll come to order as if you were not already unbelievably
quiet and well-behaved.
I appreciate everybody being here, and I apologize for the
small delay, but I am in the middle of negotiations on CAFE
standards on the energy bill on the floor, so I am sort of
being tugged and yanked in a lot of different directions. We
have a vote shortly here, so we are trying to balance the
equities.
I really appreciate you being here to discuss the
reauthorization of the SBA's venture capital programs, and the
general state of access to venture capital money for small
businesses. And we appreciate you taking part in a roundtable
in this way.
This has proven to be very, very helpful to the Committee,
a terrific way to build the record: a better way, frankly, to
sort of give all the staffs an opportunity, and the Senators,
those who have the time to get here, to dig into these issues
with a little less formality than the normal hearing process
provides us. And it also allows for a little more give-and-
take, which I think is good.
So we want you to feel free to jump in, either by raising
your hand or by flipping your name tag up there onto its end
like that, and you'll be lined up.
And Kevin Wheeler will run this when I am not here, which
will be a large part of it because of what is happening on the
floor. That is the way that we have run it previously, and it
has really been, by far, the most productive way to get at
things here.
Now, I am happy to welcome all of you here, but I am
particularly grateful to Ed Tierney, the president of BISCO
Environmental and Taunton, and Tom Gorman, the managing
director of Seacoast Capital in Danvers, which are examples of
a successful small business that got help through the SBA's
SBIC Program and a successful SBIC fund.
We are also fortunate to have with us today an example of a
New Markets Venture Capital Fund and a company that it invested
in. Ray Moncrief, the executive vice president and chief
operating officer of Kentucky Highlands Investment Corporation
in London, Kentucky, and Greg Harmeyer, the president of Tier 1
Performance in Covington, Kentucky. And we really appreciate,
very, very much, your being here.
It is obviously important--I mean, your experience and your
firsthand knowledge of this in sort of seeing how it works,
what the impediments are, what the hurdles are, the hoops you
have to jump through, where the red tape is that we can get rid
of, what we could streamline, what we could simplify, what we
could leverage more effectively. I mean, all of these kinds of
things would be really helpful to the Committee. So we look
forward to hearing that.
And if there are reasons that you think things ought to be
tweaked and changed, let us know, because that is the purpose
of the reauthorization, to try to make it more effective.
It is interesting that, since the SBIC's inception in 1958,
almost 50 years ago, which is rather amazing, SBIC firms have
invested some $48 billion in more than 100,000 small
businesses. And for fiscal year 2006 alone, 30 percent of all
the SBIC investment dollars went to companies that had been in
business for 2 years or less. Overall in that year, SBA
financing supported 2,000 small businesses and employed a total
of 286,000 Americans. That's pretty darn good. And I think it
speaks to the job creation start-up capacities, which is
exactly what it was targeted for.
Many successful companies have received SBIC financing.
Some of them are now household names, as we know: Intel, FedEx,
Jenny Craig, Outback Steakhouse. They are all SBIC success
stories. And I think, Callaway Golf.
If you looked at the tax revenues and tax base created by
the success stories, it probably funds close to the entire SBA
budget. It is a pretty darn good return on investment for the
Federal tax payer, and people need to know that. People need to
have a better sense of what a good return on investment it is.
Companies receiving SBA financing have also consistently
appeared on a variety of prominent business lists, including
the ``Inc. 500'', ``Business Week's'' Hot Growth Companies, and
Hot Growth Hall of Fame, ``Fortune Magazine's'' Best Companies
to Work For, and Most Admired Companies, and the FSB 100. And
these companies also provide tens of thousands of jobs, and
create wealth for a lot of folks who might never have dreamed
they would have that kind of wealth. So it is really the
American Dream.
Given the important contribution that SBIC funds have made
to our economy, Senator Snowe and I worked with a number of you
here to draft a bill to reauthorize the program for another 3
years, through 2010, ensuring the availability of this business
financing tool.
Beyond mere reauthorization, the legislation simplifies the
program's regulations, as I mentioned earlier, to try to
attract new investors and allow existing investors to be able
to go out and increase their involvement.
We increased the leverage cap for small businesses owned by
women and minorities, as well as those located in low-income
areas. And finally, we have included a provision which ensures
that SBICs licensed under the participating securities program
will be able to easily make up follow-on investments in
successful companies.
Unlike last year, in our comprehensive SBA Reauthorization
Bill, we have not attempted to restructure SBIC participating
securities program. As much as this type of straight equity is
missing in the market for small firms, as we will hear from Dr.
Sohl today--and I would like to see it reinstated, personally--
the political reality is that we just cannot, in this
environment--with the Office of Management and Budget--we just
are not able to get over that hurdle, so to speak, to get OMB
to assess any version of an equity program fairly and to give
it a reasonable cost. So we are stuck.
So we are going to focus on making the debenture program
more user-friendly, restore confidence in the market that the
program is here to stay and worth getting into.
Like the SBIC Program, we can speak of important
contributions, also, for the New Markets Venture Capital
Program. It is still in its infancy, but nevertheless, in many
ways, as of March 31, 2006, we have received very encouraging
news.
The six new market venture capital companies currently
licensed by the SBA invested more than $26 million in 75
financings to more than 39 small businesses in low-income areas
across the Nation. These funds leveraged $136 million in
additional investments from other sources, and they created or
maintained more than 1,600 jobs in areas where people had been
suffering from chronic unemployment.
As Dr. Rubin will tell us today, without the SBA's program,
this type of investment just would be nonexistent. And we need
to build on the good start that we have for that reason.
Senator Snowe and I also introduced a bill this week to extend
the New Markets Venture Capital Program another 3 years,
allowing it to start from 10 to 20 more funds, hopefully.
So we make small but important changes to the program so
that it is aligned with the New Markets Tax Credit Program, as
Congress intended, and also aligned with its younger, and in
some ways, more advanced, sister program at the Department of
Agriculture.
These changes should make it easier to attract investors,
easier to attract interested fund managers, and that leads to
more investments in areas that need it. So hopefully, that will
be a positive outcome.
Last, we have included some provisions to diversify the
reach of New Markets Venture Capital so that it is available in
more areas around the country, and perhaps focus on small
manufacturers. These ideas were proposed by my colleague in the
House, Congresswoman Moore from Wisconsin, and I'm happy that
we are able to include them here.
So we have a lot of voices to hear from. We appreciate your
being here. Let me turn now, if I can, to Dr. Sohl and Dr. Sass
Rubin to tell us about the state of venture capital for small
businesses, the need for developmental venture capital, and
then all of you begin the process of weighing and we will build
our record.
Thank you.
Dr. Sohl. For those of you who want it, there is a handout,
not a PowerPoint.
[The referenced handout follows:]
[GRAPHIC] [TIFF OMITTED] T9927.001
Dr. Sohl. But I wanted to point out a couple things, namely
the loss of the seed capital, and I think that dovetails nicely
into the New Markets and the SBIC.
And the key people that individuals--or the key source of
capital in this whole equity field and seed stage is Business
Angels. And if you see from the data, Business Angels last year
put in about $26 billion in the U.S. equity markets, and more
importantly, funded a little over 50,000 startup companies.
Now, some of those are in later stages, but most of them are in
startups.
The misnomer with the venture capital industry, they are
predominantly later-stage deals. They did a total of about
3,500 deals last year, and their average deal size is about $7
million, whereas the Angel deal size is around $400,000.
And if you break up the venture capital numbers by just
seed and startup, the entire venture capital industry did
about--well, exactly 312 startup companies last year. Almost
all of them are follow-on funding.
So any legislation certainly should, in my opinion, be
directed to where the needs are, namely at the seed and
startup. And the VC market certainly handles that later stage
quite well.
In that little chart that I have there, you can see that
there are actually two gaps now, in that roughly under $1
million range, $500,000, or even as low as $50,000 to $1
million is where there are some real private sector with the
seed stage. And then, because of another gap in this $1 to $3
million range, that Angels are in fact redistributing some of
their capital into that later stage--still very early, but
later stage $1 to 3 million, which exacerbates that seed and
startup gap. And this is especially acute, certainly under
certain markets.
Now, I guess, if the one message I would like on this
overview--is that, you know, the seed stage without the seed,
obviously we are not going to have any later stage for anybody
to play around with.
And the Angel numbers that we see show a slight
restructuring and possibly a slight retreating from seed, with
about half of their deals now going in a later stage.
So I think any legislation--I would say the two things I
would like to see a focus on is certainly at the seed startup
stage, as the SBIC, in some cases, does. And also, there is the
great potential for co-investing with Angels in both the New
Markets and in the SBIC, because now a lot of the new flavor-
of-the-month deals are with the Angels is some debt and equity.
So in fact, the debentures in the SBICs could in fact possibly
be combined with some of the Angel Money.
So I think that is the potential to leverage some existing
dollars that are there, and at the same time, get, really, a
handle on that acute seed gap in the United States.
Thank you.
Chairman Kerry. Thank you very much, Doctor.
If we could, Dr. Sohl, just reinforce for me the sort of
equity importance here.
Dr. Sohl. Well, at this very early stage, it is hard for
them to service debt, because they need all the money to stay
with the company and to fuel the growth for that company.
And debt servicing is money that is going out the door. So
what, ideally, with the equity is--the Angels and the equity
dealers at the early stage are in there for a good 5 to 7
years. They don't get out until the entrepreneur and many of
the workers get to cash out their equity also.
Chairman Kerry. Isn't that longer now than most venture
capital cycles are looking for?
Dr. Sohl. Absolutely. The venture capital industry is a
much shorter cycle, and they tend to do a much later stage--
deal sizes around $7 million. And they are trying to flip those
companies in a good 3 years or 4, because they have the life of
a fund of, really 10 years, but only 5 years to invest.
Chairman Kerry. That also is the reason--that underscores,
because the equity capital in the mainstream are looking for a
faster return, and usually a larger one.
It leaves a lot of these more traditional kinds of business
that don't promise that kind of a large return, but also are
going to take longer to get that return--it leaves them hanging
out there, doesn't it?
Dr. Sohl. You are absolutely right. And that is where the
Angels tend to provide, and some other sources--what we call
``the patient capital.'' They are willing to wait, and wait the
ride, and then cash out when everybody does so everybody can
make a decent return.
But again, they are managing their own money. As a venture
capitalist you are a money manager, and somebody has your feet
to the fire to get that return pretty quickly.
So you are absolutely right.
Chairman Kerry. I appreciate it.
Kevin, do you want to----
Mr. Wheeler. Dr. Rubin, you want to talk to us about
developmental venture capital?
Dr. Rubin. Thank you. Thank you for inviting me.
My comments are based on my research, which is about a
decade of research on venture capital and developmental venture
capital, but I am also right now conducting an evaluation of
the New Markets Venture Capital Program. So I am speaking
specifically to that program, as well.
And I just wanted to follow up with what Professor Sohl
said. He talked about the need for seed and early stage money.
But as he alluded to, there are two other dramatic needs that
the private equity markets are not touching on:
One is for capital in rural and low- and moderate-income
areas, and the other is for, as he mentioned, smaller
investments, particularly $3 million and less, and even more
so, $1 million and less, for a bunch of reasons that we have
touched upon, and I'm sure we will discuss more.
The Catch-22 is that, if you wanted to raise a fund to
focus on low- and moderate-income in rural areas, you are in a
bind to do so, even if you are an experienced venture
capitalist, because the sources of capital for venture capital
want to see a record of performance. And to have a record of
performance in a particular geography, there have to be
existing venture funds in that geography. So by definition, you
are kind of caught in a bind.
Now, what I am finding is that the New Markets Venture
Capital Program has helped address this for the funds that
exist in two ways--through the incentives that it offers,
through both the grant incentive and the debenture incentive.
And because it provides a grant incentive in particular, it
has been able to attract some very high quality venture
capitalists who would not otherwise have been interested in
doing a program like this, particularly to target low-income
areas, because it is so difficult to raise a fund.
The grant has enabled them to offset a lot of the market
imperfections that exist in these markets, which is why
traditional folks don't want to touch them. And particularly
the lack of deal flow, traditional venture capitalists have 300
and up deals a year that they are looking at, and they are
selecting one or two to invest in. So they can really cream
those deals. They can really take the best of the lot.
If you are working in an area with a distressed location or
rural location, by definition, you do not have that kind of
deal flow. So what you have to do is provide a lot of technical
assistance to the companies that do exist to get them to the
point where they are ready to really take advantage of the
equity investment and succeed.
And without that grant, it is almost impossible to do that.
In particular, a smaller fund, say, under $30 million, just
does not have the ability to do any sort of extensive technical
assistance out of its base. It needs that grant. And that is
what--the role that it has played is to attract folks who would
otherwise not be interested in these markets, because they
understand it enables them to do that technical assistance.
The debenture is really critical, because it is
extraordinarily difficult to raise money, as I mentioned
earlier. And actually it has gotten even more difficult, as Ray
will probably attest, in the last 5 years for a number of
reasons having to do with Bank consolidation, et cetera. And
so, just to raise $5 million is very challenging.
Now, what the debenture does is it enables you, obviously,
to leverage that $5 million. A $10 million fund is still very
small, but at least it is kind of on that threshold of being
able to be a viable fund. A $5 million fund is really not
viable anymore.
So the grant and the debenture are critical. Now, what I am
finding is there a couple areas where the program needs to be
tweaked. Overall, it seems to be working quite well,
surprisingly well, but I'll just throw these out there, because
I am sure we are going to come back to them:
One is targeting. The restrictions that currently exist
around investing in census tracts are very, very challenging
because census tracts are such a blunt instrument. They change
dramatically over the course of 10 years in between censuses,
and areas that used to be better off might become poorer, and
yet the census track doesn't reflect that. Census tracts are
large, so you can have pockets of concentrated poverty that are
not reflected in the overall designation of that track.
So it is very challenging to make investments when you have
a limited geography if the criteria is one of just location and
whether the census track is low-income or not. So some kind of
modification on the targeting is really quite necessary. And I
heard this very loudly from all the funds.
The other piece that is very challenging is the grant
match, because the existing program requires folks to raise a
matching grant. You are taking people who are good venture
capitalists and asking them to be good at raising grant
capital, which are two very different things. And particularly
you are asking them to raise grant capital to subsidize a for-
profit vehicle. It is just not a very compelling argument when
they go out to try to raise that money. So what it has done is
it has forced them to spend a lot of valuable time that they
could have been raising equity or actually making investments
trying to scrounge up this money, and I don't think it is a
very good use of resources.
The other issue is that--I would recommend increasing the
debenture. And I know that the bill on the table right now has
a 1.5-to-1 ratio like the original New Markets legislation. I
would argue that is not sufficient.
Because it is so hard to raise money right now, a $10
million fund, which is the smallest that would exist under this
legislation, is really almost too small. So I would strongly
encourage an increase, at least, to a 2-to-1 leverage ratio,
which does not--it is not really 2-to-1, because you have the
loss on the debenture discount, but it would at least give the
funds a bit more money to actually invest in these regions, and
particularly in light of the difficulty of raising capital, in
the increasing difficulty of raising capital, for under-served
markets, this is a real need.
So I have some additional comments that I will hold for
now.
Chairman Kerry. Should we be thinking--when you have this
tension in the country, in the body politic, about the
ideology: Should the government be doing this or shouldn't it,
and so forth?
Would there be a benefit to--in addition to the fund
itself, to the SBIC and what we do to target, to creating a
better incentive to draw some of that private capital?
I keep hearing how much money is out there looking for
deals.
Dr. Rubin. Right.
Chairman Kerry. But obviously it is not looking for these
deals here. It is going to China, to India, to wherever--
Greece. You name it. It is very high-flying stuff.
Should we, therefore, be thinking about an incentive
outside of the SBIC, i.e., a tax benefit or some kind of a deal
that draws that capital, or write that into the SBIC?
Dr. Rubin. Well, I think when the New Markets tax credit
was being put together there was an expectation that it would
provide an incentive for equity capital in distressed areas.
Unfortunately, because of the way some of the regulations have
work, that has not panned out.
I think a tax credit or a vehicle like that would be
tremendously helpful. It really is a crying need----
Chairman Kerry [continuing]. Low-income housing credit,
which has been a critical component of the syndication of
housing to the billions of dollars. And we have had huge
benefits as a consequence. If you did that, also, perhaps, on
this side of things, it could be conceivably very exciting.
Dr. Rubin. Yes.
Mr. Wheeler. Ray, do you want to make a comment?
Mr. Moncrief. I do.
A couple of comments that Dr. Rubin made, specifically in
the area of deal size. Quite frankly, there is a lot of money
out there in America looking for deals. The problem that we
have in the New Markets Venture Capital arena is that there are
deals out there with quality entrepreneurs, such as one sitting
next to me that runs a very successful company, except that the
deal size that he needs to finance his company--he does not
need $5 million in venture capital.
Typically, he does not need $5 million in venture capital
on low valuation, where he ended up being the vast minority
shareholder in his company. So consequently, the New Markets
Venture Capital Program provides, in socially and economically
disadvantaged areas, of whether he is in downtown HUBZone
Covington, Kentucky--he was looking for a small round, a
$750,000 Series A round.
Most traditional VC does not do that because of transaction
costs. We do that in the New Markets Venture Capital for all
the reasons that Dr. Rubin talked about.
So there needs to be an incentive, No. 1, for more of these
New Markets Venture Capital funds to exist. The biggest drain
is not the ability to raise the money. The biggest drain is not
the ability to invest it. It is having the capacity or the
practitioners that are willing to work in low-income areas as
opposed to traditional areas, which is the most significant
issue that we face.
And I do echo all that Dr. Rubin said. I would ditto
everything she said as far as the way that the bill needs to be
tweaked, or the industry needs to be tweaked.
Chairman Kerry. That's interesting. You're saying that it
is difficult to find the employees who are willing to come into
whatever that geographic location is?
Mr. Moncrief. No, sir. I don't think it is difficult at all
to get the employees.
For example, we have an investment----
Chairman Kerry. Well, what did you say?
I'm sorry. I misinterpreted what you said, then.
Mr. Moncrief. I am talking about the capacity of the
practitioners to invest in these areas, not the employees to
work in the companies.
Dr. Rubin. Venture capitalists.
Mr. Moncrief. Most of the venture capital practitioners.
You know, you have to ask the question: Why would a venture
capital practitioner that has the ability to run a $150 or $300
million fund want to move into a low-income census track and do
deals from $500,000 to $1 million?
Well, there has to be something else besides a cash on cash
return that motivates people to do that. And consequently,
there need to be incentives for people to move into that arena
from traditional funds.
Chairman Kerry. What do you think those appreciation
incentives are?
Mr. Moncrief. That's a good question.
No. 1, there have to be old guys like myself that are in
the careers that have made enough money and that are willing to
spend their time investing this type of money in low-income
census tracts. That is No. 1. And there needs to be a reason
for that, such as the operational assistance component.
I agree that the leverage needs to be more than one and-a-
half, it needs to be at least two to kind of marry it up with
what we are doing under the RBIC Program.
Those sorts of things that would give us the cash to do
reasonable deals in low-income census tracts would be a great
attractor.
Chairman Kerry. Interesting.
Any other economic incentives?
Mr. Moncrief. Well, there can always be a tax consequence--
--
[Laughter.]
Mr. Moncrief [continuing]. On capital gains and things of
that nature that would incentivize--much akin to what happened
in the legislation with the Empowerment Zones.
Investments in Empowerment Zones, as you might recall,
there are no tax consequences to gains on companies that are
sold in Empowerment Zones. And consequently that, in a rural
market that I work in, has been profoundly successful of
investments in companies--to forming in those rural census
tracts.
Chairman Kerry. We could always give you a discount on the
ARP Guard or something, right?
Mr. Moncrief. That would work.
Chairman Kerry. I have to run in a moment, because I just
got my language on this CAFE thing, but why don't you keep
running here.
Mr. Wheeler. OK. As Senator Kerry said, our purpose here is
to build a record to justify the need for SBA's VC programs,
both the New Markets Venture Capital and the SBIC.
We want to discuss--we have already been through the
general state of VC and that of developmental capital. We also
want to touch upon the need of VC for businesses owned by women
and minorities.
Now that we have heard from Dr. Sohl and Dr. Rubin, let's
go ahead and open it up to the Small Business Investment
Company Program.
We'll let Lee Mercer begin--do you want to just give us a
brief overview of the SBIC program?
Mr. Mercer. I am going to let Steve go ahead.
Mr. Wheeler. Let Steve go ahead?
Just give us a brief overview of the program, and then we
will open it up to talk about proposals that are out there that
you are asking for.
Mr. Vivian. Thanks. And thank you, Chairman Kerry, for
inviting us and for your long support of the SBIC Program, and
all that you have done over the years for it.
I am just going to spend a couple of minutes on the
overview of the SBIC Program. Before I start, we have done
everything from early-stage investing to late-stage investing.
We run two SBICs in Chicago. And there is a discussion period
later. And since I do not know what is going to happen in the
discussion period, our attorneys have advised that I am
supposed to say that I would not like to see this on YouTube. I
do not give video permission distribution to YouTube.
The SBIC Program really has three legs of a stool. A lot of
people think it only has one program; there are actually three
programs. The program that started in 1958 is the debenture
program, which is still very strong today.
That program allows 2-to-1 leverage against private capital
that general partners like myself and my five partners will go
out and raise to invest debt, primarily, into small businesses.
And there are currently 135 debenture SBICs managing just under
$6 billion of capital. And they invested $1.2 billion in fiscal
year 2006 into small businesses.
The second component of the SBIC Program consists of
unleveraged bank-owned SBICs, which was really much more
popular back in the late 1950s and early 1960s. However, in
1999, the passage of Graham-Leach-Bliley allowed bank holding
companies to have their own subsidiaries that could do venture
capital and private equity investing. And so today there are
only 58 bank-owned licenses left on the books, and they
invested about $188 million in 2006.
The third leg of the stool, which Senator Kerry has
mentioned, is the participating securities program. I am from
Prism in Chicago. We have one of each license: both the
participating securities license and the debenture license.
That program is really in wind-down phase. It was started in
1994. It ended, really, from a new license standpoint, in 2004
when the SBA stopped licensing, due to a couple of reasons:
losses and the determination, as Senator Kerry mentioned, that
the program no longer qualified for the Federal Credit Reform
Act.
However, the leverage that is available expires in 2008.
And so we are pleased to see that there is some effort to allow
PS funds to draw new leverage. There are currently 167
remaining PS licensees, and they manage about $11.6 billion in
capital. They invested about $1.5 billion in 2006.
Lee is going to talk a little bit about the proposals in
the bill, but I just thought maybe it would be interesting to
hear from Ed Tierney, who is an SBIC-backed company, to have
him comment on what it was like to raise capital, and what it
has been like, and why he took SBIC money.
Mr. Tierney. Sure. Thank you, Steve, and thank you,
Chairman Kerry.
Our company, BISCO Environmental, was founded in 1990, and
we had reached a critical mass of a growth period in the year
2005. I say a critical mass, where our growth had stressed our
infrastructure, our ability to raise capital, during a period
within the industry where opportunities were abound, because
our industry had matured as a relatively new industry. This
environmental cleanup industry really got its start in the late
1980s and early 1990s. So there were a lot of competing
companies looking to reach their goals and come out on top,
while others were struggling.
At that critical point, we looked for avenues of capital to
continue to support our growth. And through an extended search,
we went into a relationship with Seacoast Capital, an SBIC
company.
My background, of course, is engineering and running a
business. This is relatively new to me, but this has been an
enlightening experience. They have been an exceptional firm to
work with. We have realized a substantial improvement in our
infrastructure--we have hired staff. We have been able to
obtain a new facility. We have brought additional jobs into our
local area. We have made an acquisition and are looking at a
couple other acquisitions right now that I believe will allow
us to truly come out on top in an industry which is really
looking for a leader and lacking a leadership right now as it
goes through a change or a flux period, as the market matures,
and the industry matures, and the competition stiffens, and the
margins become a little tighter, it is--this relationship has
helped us in that area with the infusion of cash to help us
realize our goals.
One other side note beyond the money has just been sort of
the mentoring aspect of this, I'll call it, where Seacoast
Capital has allowed us access, through their network of
contacts, to work with professionals and get some professional
insight into methods of management, methods of operation and
finance that a company of our size may not have had access to
previously.
Mr. Vivian. And he's not saying that because his board
member is sitting beside him, either.
[Laughter.]
Mr. Tierney. Well, he may be.
Chairman Kerry. Thank you all again. I appreciate it,
thanks.
Mr. Mercer. Well, NASBIC has made three proposals.
And the proposals that we have made are in keeping with the
goal that we have set for ourselves--that the Board of
Governors set for itself at the beginning of the year, which
was really to improve the reputation of the SBIC Program, which
had been damaged by the participating security situation, and
to find areas where we could simplify and rationalize either
laws or regulations we have developed, over the past year.
Because of this, I think our relationship with the SBA has
become much, much better than it had been in the past. And we
have worked successfully with the SBA to identify several areas
where changes could be made in the regulations that will meet
the goal that we have set for ourselves, which is to, again,
improve their reputation, to simplify, to eliminate unnecessary
work.
There are three areas where we believed it was necessary to
change the law. And the first one that I want to focus on goes
by the arcane name of aggregate limitations, or overlying
limit. And what it really means is: How much can a single SBIC
invest in a portfolio company? What percentage of its
investment capital can an SBIC invest in a portfolio company
without seeking an exception from SBA?
The purpose of putting in limits like that, and the limit
in the current law is no more than 20 percent of private
capital, is to make sure that SBICs have diversified portfolios
to mitigate risk where possible. Obviously, you don't want
people having the ability to go to Atlantic City and let it all
ride on 00 in one investment.
So it is a reasonable thing to have in the law. And in
fact, in non-SBIC private equity funds, there are also limits
found in those agreements to protect investors or to make sure
that investors are satisfied that there will be a diversified
fund.
In the private market, the limit that is--today's limit is
no more than 20 percent or 25 percent in some funds, if they
are really later stage funds--no more than 20 to 25 percent of
total capital invested in any one portfolio company.
The SBIC law is far under-market. Twenty percent of private
capital is the rule. And what that means is that, in a company
that is leveraged 1-to-1, in other words, draws a matching tier
of leverage to match its private capital, it equates to more
than 10 percent of total capital in any one portfolio company.
A company that is leveraged 1.5-to-1, which is probably the
average in the--remember that, in the SBIC Program, the law
contemplates as much as 3-to-1 leverage, but the average, and
SBA can speak to this, is probably around 1.5- to-1, the
effective average. Under that, no more than 8 percent can be
invested in any one portfolio company. And if you are lucky
enough to get to 2-to-1 leverage, it is no more than 6.7
percent.
So if our goal is to make the debenture program attractive
to a greater number of investment professionals and their
investors, the current law is just too far under market. It
stresses management teams.
I know that some people might say, well, if we keep the law
the way it is it will force them to invest in more and more
companies that are smaller and smaller. It is just not the
truth. What it will do is force them--because they can only
stretch their management time so far, it just will end up that
companies will not take as much leverage, will not grow as much
as they normally might be able to under the program. And
therefore, the total dollars flowing into the small business
community will actually be reduced.
And we have addressed the smaller enterprises in another
proposal by suggesting that the limit be increased from 20
percent to 25 percent. So we are hopeful that both SBA and the
Committee will look at the current market and--what we have
proposed is not even taking it up to current market level in
terms of amount of money that can be invested in one portfolio
company, but at least would be--the compromise that we have
proposed is an increase of 25 percent from the current limit.
Mr. Wheeler. But of only private capital or total fund?
Mr. Mercer. Well, the most recent language that I shared
with you and SBA would be, let's keep it simple and keep the
law the same, and just say that 20 percent of private capital
is raised up to 25 percent of private capital. And then you can
do--you know, so, in a 1-to-1 leveraged fund, instead of 10
percent it would be 12.5 percent of private capital. In a 1.5-
to-1, it would be about 10 percent of private capital. It would
still be below market, but at least it would be an indication
to the SBIC community and those who might consider it, that
there is at least some recognition that the market has passed
by the SBIC law at this time.
Mr. Wheeler. SBA, do you want to comment on that, because
we would like to work with you to find a compromise on this?
As Lee said, it is not in the current legislation that was
introduced this week, but if you have any comments----
Mr. Hager. We are looking at what Lee shared directly with
us, which is the package sent to you, plus the two proposals
that we received last evening--late yesterday afternoon.
And I think we certainly have lots to evaluate. We are
working on the package that Lee gave us actively. It is still a
little early for us to say we are going to recommend the
following. But Lee does bring to the table lots of merit, but
again, we just have to sit back and evaluate--of course, do our
budgeting, to see what kind of impact it might have to our
modeling, and then come back with some compromises.
I would like to, if I may--could I make just a couple of
comments just to lead into that?
Mr. Wheeler. Sure.
Mr. Hager. You know, it has been challenging the last few
years, particularly driven by the participating program. As we
all know, out of $8.5 billion, we are looking at losses,
currently, at about $2.5 billion.
We have another roughly $2 billion yet to go that we are
committed, and we are going to honor those commitments. And
that will likely yield another $300 to 700 million in losses,
bringing that loss number to about $3 billion.
We have spent a lot of time working on what we can do to
stabilize that product, that environment. And I am pleased to
say that, with a lot of solid management steps, that the
current portfolio has stabilized. While some additional losses,
as I say, are likely to occur, we have seen the overall program
stabilized.
Bond holders received distribution of almost, between the
SBA and the bond holders, $1.5 billion.
The debenture program is, we think, doing very well. Solid
performance. In 2006, the guaranteed amount over $400 billion.
We, again, see 20 percent of the venture going to the LMI
areas. We are real pleased about that.
Additionally, our efforts to serve the under-served markets
continues to foster lots of economic developments in LI areas.
The New Markets Venture Capital program is based on, as you
know, the SBIC Program. It is unique, and the fund managers in
the New Markets Venture Capital area received grant funding to
provide operational assistance.
Again, we are real pleased with what has happened to date.
You have already heard Senator Kerry make reference to it: $40
million in equity investments over 50 portfolios, creating 400
new jobs in addition to about 1,100 we have sustained.
It will also provide over $10 million in no-cost
operational assistance to over 170--I am reading this, as you
can see, the numbers--170 actual potential portfolio companies.
Again, we are very pleased with what is happening there.
It is still early. We want to see the program mature, and
see where we go from here with that program, but we are
encouraged at this point. Thank you.
Mr. Wheeler. Thank you.
Mike, may I just ask you to submit your statement--we are
really just trying to get to a markup on Tuesday, and so we
would like to go through the proposals. And just quickly, on
what Lee said, that from NASBIC--get SBA's feedback--their
proposals.
Even if SBA is not prepared to take a stand on aggregate
limitations, could you at least tell us what would be your
concerns about it, because we would like to decide whether we
are going to go to markup with it or not?
Mr. Rowe. I think a lot of what you are getting at here is
very welcome to us.
Let's face it, over the years, folks have recognized both
in the industry and at SBA that there are areas that are just
unduly complicated, whether it is some of the overlying
structure or some of the other investment limitations that make
it difficult for fund managers to spend the time looking at the
merits of the investments, rather than wondering, well, what's
my percentage in the smaller enterprises today?
That being said, as well, while our maximum leverage levels
are set based on the CPI, you obviously would have to note that
the average deal size is not linked that way. And what Lee
talked about, where we would go from, say, 10 percent of
private capital to 12.5, obviously, that means that the average
deal is going to increase slightly.
But when you look at when that law was written going
forward to today--I mean, 2 percent is not an outrageous
increase if you thought about it in terms of average deal size
as a result.
I think Harry can speak a lot better to the mechanics of
what we deal with at the Agency.
Mr. Mercer. Can I just----
Mr. Wheeler. Sure.
Mr. Mercer. I just want to break in and just reiterate that
it does not mean that every deal is going to get the maximum
amount of capital, because deals are done in stages: There is
an initial investment, and then an amount of money is reserved
for follow-on investments. And some of those early deals, some
of the original deals will not merit further support, or will
need further support.
But the ones, the few, that do, that is where the maximum
comes in. And I even understand--Seacoast can speak to this. I
think they are up against the limit right now with Ed Tierney,
and they will not be able to fund his need for more capital.
Mr. Wheeler. Because you would pass over the 20 percent
investment in one company of your entire fund?
Mr. DeBow. Right.
There are some very attractive investment opportunities
that we have, that BISCO has, as opportunities to grow the
company, and if we are going to go forward with that, we are
either going to have to find a co-investor or someone else to
support it.
And frankly, from an investment standpoint, you know, we
have spent the time and effort to kind of get the company to
where it is today, and to essentially hand that opportunity off
to someone else does not make a lot of sense, from an
investment standpoint.
Mr. Wheeler. So would you not make the deal? Is that the
risk, that you would not put the extra money in?
Mr. DeBow. Right. The risk is that we would basically
choose not to--first of all, we can't support the company,
because we would go over the limit, and either the company--we
either find capital from somebody else to support it or the
investment does not happen.
Mr. Mercer. Well, they can apply to the SBA for an
exception. And I know exceptions--Harry will tell us that
exceptions are granted.
But I have to tell you, and I want to be brutally honest
about this, and we have said it at the SBA before, that SBA is
not known for timely attention to requests for exceptions, and
you cannot be certain that they will be granted at all times.
So our proposal to increase it to something that is still
less than market, with, still, the ability to go back for an
exception, would eliminate, in my view, a whole bunch of
requests for exceptions that are probably granted, or would be
granted, and leave the exception process for something that is
truly either at market or far above market.
Sorry, Harry.
Mr. Moncrief. I'd like to--excuse me. I would like to
piggyback on Lee.
I think Lee's comment is extraordinarily pertinent to this
situation, especially for the smaller New Markets Venture
Capital fund, because 20 percent of private equity for a fund
my size is a whole lot different than other SBICs.
And the real impact that it has on a New Markets Venture
Capital Fund is that, if the company really heats up and does
extraordinarily well and needs a Series B round, a Series C
round, I have to throttle back what I can invest just like Tom
is throttling back in limiting what he can do in the company.
Or if he goes ahead and puts his balance all the way up to the
20 percent, then on a subsequent round he is going to be
diluted. And he will end up getting less of a takeaway in an
ultimate liquidation process.
So it is very important, and I think a 5 percent increase
of the regulatory capital is extraordinarily modest. As a
matter of fact, I say it is overly modest, quite frankly. I not
only think that it is necessary, I think it demands to be
discussed.
Mr. Wheeler. Harry, would you like to make a comment?
Mr. Haskins. I think we support efforts to simplify the
program and make it more attractive and reduce the
administrative burden.
A concern that we have, and I am not saying that it is a
concern that would lead us to oppose a provision, is that the
25 not now act as a base, and that we now get the same number
of exception requests starting from 25 as opposed to 20. We
don't want to just change the threshold level to which people
come in, to the extent that it actually does limit the amount
of exception requests I think is one we would definitely
consider. We would like to look at what our experience has been
in terms of overlying approvals that have been granted.
But we definitely share the goal of NASBIC in trying to
reduce the administrative burden and make the program more
attractive.
Mr. Vivian. I think, Kevin, if the goal is to make the
debenture program more attractive to GPs that run funds, it is
well below market.
I mean, it is well below market. So if your desire is to
attract talented GPs to the program that want to invest capital
in these small businesses, which Tom, and I, and do, it is a
real--it is a challenge. I think every manager sitting here
will tell you they have faced that challenge.
And to play on your point, you know, in Ed's case, Tom can
go to Ed and say, you are not going to make the acquisition. So
he can stultify the growth of a small business because he is
capped and he does not want to get diluted and does not want to
have somebody else come in and put onerous terms in on the
investment, and that happens all the time, unfortunately.
Mr. DeBow. I guess the additional point I would like to
make is a slightly different point, which is: OK, we have a
pool of capital to invest, and if you look at the mechanics of
it--OK, we have roughly $30 million of private capital. So we
can invest up to $6 million in any single deal.
Like many debenture deals, we are levered 2-to-1. So it is
essentially a $90 million, but in order to invest--OK. So if $6
million is our cap, we certainly do not really want to go above
four or five at the most at the initial investment, which is
still well below the average kind of venture capital investment
you said of $7 million.
And the issue becomes, how many deals, frankly, can we
manage? If you have to invest $4 million a slug, that means,
for us, something, anywhere from 25 plus deals to manage and
invest and to work your way through.
And it is very difficult, frankly, for me to manage that
number. We have four partners in our firm. And so, when you
start doing the math, that means five or six deals per partner,
which is, frankly, hard to give the company the amount of
attention that it needs.
And very often, frankly, Ed will call me and it is 2 days
before I get back to him, because I am traveling or something
on two other things. Now, that 2 days usually is not critical,
but it is the overall--the more attention that we can give to
certain portfolio companies, the stronger they are going to
become, because that is really--I don't know if Ed would agree
with this, almost more than our capital, it is the advice that
we bring to get the company from stage A to stage B is equally,
if not more, important than the capital.
Mr. Wheeler. So the cap is inadvertently watering down the
fund a little bit.
Mr. DeBow. Yes.
Mr. Wheeler. Greg--sorry, Greg wanted to make a comment.
Go ahead, Matthew.
Mr. Berger. Is there any risk to the proposal in the sense
that you could have good money chasing a bad investment if you
increase the cap?
Mr. Haskins. That is a concern of the overlying
investments, is that you would have that situation, and we have
not analyzed what our experience has been to indicate whether
that has been a result--an inordinate amount of times.
We would like to perform that analysis before we take a
position on the specific proposal.
Mr. DeBow. Anecdotally--I'm sorry. We had--we are now
investing our second fund.
In our first fund, we had two overlyings approved. And in
each case, frankly, they worked out very well for the investor
and for the SBA.
Mr. Harmeyer. I was just going to make a comment from the
company's perspective and kind of echo some of what you are
saying.
When you are looking at investors, it is an enormous effort
to manage an investor, to find an investor, and to find a
relationship that works. I mean, it is a marriage.
And if you are limited by follow-on investment to say, you
are going to have to find somebody else, that is a big drain on
the company's resources to be able to manage multiple investors
who may have different interests, who have different, competing
thoughts of where they want to go with the company. And so I
think that is a detriment to the company if the investor is
limited.
I also would completely agree that the more an investment
company is diluted and has too many companies, the less
attention they are going to give you in helping you grow your
business. So that is another thing that companies are going to
look at. And I think it is worth considering from that
perspective.
Mr. Wheeler. That is a good point, a very good point. Thank
you.
Mr. Haskins. I would just like to follow up on that.
This is an issue that provides a heavy administrative
burden on the Agency, and it is one where we would like to find
a way to reduce that burden. So we are very interested in
working with the industry to address the issue.
So we haven't taken a specific position, but we do want to
try and resolve this issue favorably to all of this.
Mr. Vivian. We'll say 40, you say 30, and we can be done.
[Laughter.]
Mr. Mercer. Deal or no deal.
Mr. Wheeler. Let's let Dr. Sohl make a comment. He wanted
to weigh in here.
Dr. Sohl. There is one comment--and I understand the need
for the dry powder and do less structured round, and I
understand all that.
But I get this undercurrent that dilution--we don't want
any dilution, and I think that is unrealistic. I mean, I think
we all know that.
If you are an equity investor, there will be dilution. Not
all dilution is bad, just as long as the valuation goes up. The
cram-downs are what kills you. So if you make a good deal and
values go up, there is nothing wrong with dilution. Again, it
is the cram-downs.
So it just seems like we are trying to tweak this to--and I
am not going to make a lot of friends right now, but tweak it
to invest in and play in a crowded field. And I agree with you,
you need some dry powder, but I don't want to go crazy. I do
not think it would be, for the market and, really, the
entrepreneurs, to say that I am going to have one marriage to
one person for the entire life of this deal. You actually have
three or four wives as you go through different stages, just
like you have three or four entrepreneurs because the
management team, often, is not there at the exit.
So I think we are competing with a very later stage. It is
just making me nervous. I just would rather see it a little bit
earlier. And yes, dilution is not a bad thing. Have some for
dry powder, but do not expect to take the deal without
dilution.
Mr. Wheeler. One last question----
Mr. Mercer. Remember, we are talking about debenture
program.
Dr. Sohl. Right.
Mr. Mercer. This is a debt program. It is a later stage
focused program.
Dr. Sohl. Oh, I know.
Mr. Mercer. We are not talking about early stage active
investments.
Dr. Sohl. But there has to be equity in the company
somewhere, right?
Mr. Mercer. The equity slice may come at some times from
the SBIC, but in all likelihood, the equity slice is coming
from another investor.
Dr. Sohl. Right, but still--well, dilution is----
Mr. Mercer. That investor is not going to be an SBIC,
because the participating security program, the equity program,
is going out of business.
Dr. Sohl. We know that. We know that. We heard that at the
beginning.
Mr. Wheeler. May I just ask one more question of the SBA.
In general, how many of these requests to go over are
granted? Is it in the majority of the cases?
Mr. Haskins. I believe it is the majority, yes.
Mr. Wheeler. OK. Well, thank you.
Lee, did you want to go over the other two proposals that
you had?
Mr. Mercer. There are two other proposals.
The first takes a look at the hodge-podge of laws that grew
up about the maximum amount of leverage that could be drawn by
any one SBIC or group of co-managed SBICs. And it also involves
what percentage of funds capital has to be invested in, smaller
enterprises, which are a subset of qualifying small businesses.
And it also talks to the part of the statute that increases
the maximum leverage each year by reference to an increase in
the Consumer Price Index.
And so our feeling that this was an area where, (a), it
could be simplified, and (b), could give Congress back the
control that it probably should have with regard to increases
in maximum leverage limits, particularly if we are going to be
heading into an era of much higher increases in the CPI.
And (b), could provide a ramp, if you will, for second
funds, and more and more of the debenture funds are second
funds, so that if an original fund draws the maximum leverage
and gets a second license, it may be restricted in its use of
leverage until the first fund pays down a significant portion
of its original leverage.
And so for all those reasons, we made the proposal. We also
thought that, because of SBA's interest and the Committee's
interest in seeing the SBIC program perhaps do more for
investing in women- and minority-owned companies that, if
nothing else, perhaps an incentive of more money being
available would do the trick. So that is in the proposal as
well, and I think it is well set out in the draft legislation.
The third proposal is our last attempt to try to help the
existing participating security SBICs that are in good
operating condition--these are not companies that are in
capital impairment or in liquidation. They are operating well.
The have leverage commitments that run through September 30,
2008. They are drawing against--the only way they can draw
against those commitments is if they need money within--that
they can show SBA that they need money some time in the next 90
days before they draw it.
And what is going to happen is, at the normal investment
rates, many of these funds will get to the September 30, 2008
date and will lose the remaining capital that would otherwise
have been available to them, because, by its terms, the
commitment will expire.
So as this last attempt we decided, let's try to figure out
a way where we do not have any new leverage. There is no new
leverage involved. And we just try to find a way that would be
protective, hopefully, of SBA's interest, but still allow these
SBICs to draw a greater percentage of the leverage from their
existing commitments than would otherwise be the case under
current law.
And under current law, in order to draw leverage, a company
must draw in at least one part of private capital against
private commitments, and those commitments do not expire until
the end of the funds life. And once that capital is drawn in,
they can draw two parts of leverage, and end up with three
parts for investing.
So our proposal is that, just for those participating
security funds that hold these valid participating security
commitments, that, instead of requiring them to--if they need
$3.00, instead of requiring them to draw one of their remaining
private dollars into publicly guaranteed dollars, you allow
them to draw the $3.00 still supported by private commitments.
And those private commitments have been validated by SBA. If
they become unsure of them, they can take action against the
SBIC.
And if the SBIC gets into financial difficulty, the SBA has
the right, under the law and the regulations, to call all those
private commitments and pay them directly to SBA. Do not pass
go.
So this was our attempt to just use more of the money that
the SBICs have already paid a commitment fee for, and reserve
the private capital that remains to support the portfolio after
the September 30, 2008 date. And many of these SBICs had
anticipated being in business through 2014. So that is the
proposal.
Mr. Wheeler. Would SBA like to comment on the last one?
Mr. Mercer. Deal.
[Laughter.]
Mr. Rowe. That one, actually, because we are changing the
legislation and actually going in and looking at the terms of
drawing the leverage, we are just not sure at this point
whether it might have a budget implication. Then again, it may
have a technical budget implication and then be budget neutral,
in which case it does not matter.
But we just don't know, because we are trying to figure
out--we are understanding this as essentially being a timing
issue, where the funds will draw the leverage on the
commitments, but the regulatory capital, rather than becoming
paid in, simply just stays regulatory.
So it is still there, it is just not invested in the same
ratio relationship with the leverage that is drawn down, the
way it currently works. It is just, at this point, from a
purely budgetary standpoint, we are not sure whether this has
any effect at all. So we have to reserve judgment on that.
We understand completely what the point of view is, and all
along the SBA's position is, we will always honor the
commitment. I mean, we know that people have paid commitment
fees, and we know we have an obligation there. What this is, is
a change that--I give Lee credit. It is a great idea, it has
just caught us with a, gee, I do not know how that works.
Mr. Mercer. Deal.
Mr. Wheeler. But you are saying that you will just go ahead
and let them do it, but you do not want us to change the law?
Mr. Rowe. Well, no.
What I am saying is, we don't know what that change in the
law and the change in the way the leverage is drawn down
without the regulatory capital becoming paid in, how that had
an budgetary effect, if any. We are just trying to figure that
out right now. It is kind of a new idea.
Mr. Wheeler. But isn't there a risk that if we do not do
anything to help these funds, that we could cause them to fail
and there would be an even bigger budgetary cost? Should there
be any budgetary cost to this legislative change?
Mr. Rowe. Yes. It is not a question of--obviously there is
a potential to be penny wise and pound foolish.
And again, as I said, we are never in a position of denying
someone's wanting to draw the leverage for which they have paid
a commitment fee. That is not the issue.
The whole issue is, if we make this change in the
legislation, does that act as a modification in the budget
rules? And if it is a modification, is it a modification that
is budget neutral, or does it have an effect, positive or
negative?
And that is just what we haven't had a chance to figure out
yet.
Mr. Wheeler. What is the cost if we don't do this?
Mr. Rowe. I don't know if that is----
Mr. Wheeler. For instance, these firms will never be able
to draw on that money.
Mr. Rowe. No. I don't think the situation is that they
would never be able to draw on the money. I think the situation
is this lets them draw the money earlier perhaps and reserve
their private capital for follow-on investment at later dates.
The question is, and it is purely hypothetical and
prospective is we are looking forward to say--and Harry,
correct if I am wrong--I think the last of these commitments
expire in 2008 some time?
Mr. Haskins. Yes. September 30, 2008.
Mr. Rowe. Yes. So the question is, what investments need to
be made after that? And I don't think we are in a position to
make that estimate.
Now, obviously, the funds have been obligated. The
commitment fees have been paid. What we are just trying to
figure out is, if this goes forward, what if any budgetary
effect can we foresee this having? And again, it is the same
question. We can't foresee what need they do or do not have.
Mr. Wheeler. But SBA is not concerned about a financial
risk of allowing them to change it from paid in to just their
commitments?
This is not a risk question. This is a budgetary issue.
Mr. Rowe. I'm not sure it is a risk question.
Mr. Wheeler. Harry, do you want to comment?
Mr. Haskins. I don't think we have made that determination
yet. I think clearly there is a risk factor associated with the
proposal, but we have not evaluated whether--what that level of
risk is.
Mr. Wheeler. But Lee said you can still go after the money.
If these funds were to go bad, you can still go after the
money, right?
Mr. Rowe. Yes. I am speaking purely from a philosophical
point of view.
Is there a risk factor between reserving the private
capital and not having it pay in with the leverage in the same
ratio? Does that have a moral hazard effect? I don't know. I am
not an economist.
Mr. Wheeler. It sounds to me like this is not a risk issue,
that it is really a budgetary issue.
Mr. Rowe. There is definitely a potential budgetary issue.
Mr. Wheeler. And there are more pros to doing it than
downside.
Mr. Rowe. Whether or not a fund--you know, what investments
a fund makes now and in the next year, and I think there are
twenty-some-odd funds with commitments outstanding.
Mr. Haskins. Well, there are 29 participating security
funds licensed in 2004 that would potentially benefit from this
provision.
When I say there is a risk element, I don't know that the
risk is good, bad, or indifferent. We just have not evaluated.
So I do not think we are prepared at this time to indicate one
way or the other on that question.
I think it is an effort to deal with a looming problem, and
I think it is an effort we need to evaluate. We recognize the
issue that these funds face, and we are sympathetic to the
problems that they are encountering. And we would like to be
part of a solution if it is one that is--financially is not
going to raise a cost that is inappropriate, but we have not
made that evaluation yet.
Mr. Wheeler. And would SBA stop the bill if it went forward
with any of these three proposals in it?
Mr. Haskins. I can't comment on that at this point.
I think we look at it as a package and reach a decision. I
would just like to turn the focus slightly on the aggregate
area and just raise one potential concern we have there, is
that within the existing law, there is a tiering structure on
the leverage ratio.
At the lower levels, it is 3-to-1, at the highest levels it
is 2-to-2. One concern we would want is to make sure we would
retain the administrative ability to limit leveraged laws based
on credit issues, notwithstanding the law allowing a higher
leverage. So we want that to be understood, I think.
Mr. Wheeler. And that, you are talking about the change we
have in the bill to raise the maximum single fund from 127
based on CPI to 150?
Mr. Haskins. Correct.
Mr. Wheeler. And the varied--the ratios.
Mr. Haskins. Right, that would use the tiering ratios.
Mr. Wheeler. Right. But I thought it already existed that
you all control that, and so that is why the Committee was
comfortable----
Mr. Haskins. We do. We want to make sure we would retain
that control.
Mr. Wheeler. And does the language still keep that
provision? I didn't think we eliminated it.
Mr. Haskins. I know that within the provision on the LMI
and women/minority owned investments there is a caveat at the
end that makes it clear that the Administration or the SBA is
allowed to make adjustments on a case-by-case basis, based upon
credit concerns.
I am not sure that provision applies to the prior one. I
assume--we would hope that we would retain the flexibility to
manage the program from a credit perspective in a way that
makes sense financially to the taxpayer.
Mr. Wheeler. Does anyone at the table have a problem with
that?
Mr. Mercer. I don't think it is an issue, because they
control the licensing process. And if I come to the licensing
process with a business plan that says 2-to-1 and Harry looks
at me and says, 1.5-to-1 and we got a deal, I guess I either
walk out or they have put their mark in the sand.
Mr. Haskins. As long as there is an understanding that we
manage the credit aspects of the program appropriately we are
not as concerned with that provision as we might otherwise have
been.
Mr. Wheeler. Thank you.
Are there any other comments on the SBIC Program, any other
proposals or just general observations that we need to consider
in trying to increase access to venture capital for small
businesses?
Mr. Rowe. Yes. Well, there is this one concern that I would
like to raise.
Mr. Wheeler. Are you speaking from the bill, or just
general?
Mr. Rowe. I am speaking from the bill. This is S. 1662.
Mr. Wheeler. OK.
Mr. Rowe. Under the investments in low-income geographic
areas--I mean, the current statute is clearly low-income
geographic areas.
The bill has added women-owned and minority businesses. The
only concern that I would raise is there is--the
Administration, particularly the Department of Justice, always
has a consistent concern with what could be viewed as
preferences in finance programs that are based on race and
gender.
We've always felt the low-income geographic determination
essentially covers the same areas, both rural and lower income
urban. And we target the same communities without triggering
potential constitutional issues, particularly if we are setting
leverage levels and putting preferences in a license in that
fashion.
Mr. Wheeler. But----
Mr. Rowe. Again, that is something that the Department of
Justice has always raised through us to the Hill.
Mr. Wheeler. Because our concern is that we would not
capture, necessarily, all of those small businesses by women or
minorities because we do not assume that they are all in low-
income areas.
And we thought it was an important aspect to try to get at.
If you have a better proposal for us, we would like to know it.
When we looked at the SBIC data, for all the good it does,
since 1998, the investments in firms owned by minorities and
women has gone down. And also, the licenses to funds managed by
minorities and women has gone down.
So we were trying to come up with something that was
reasonable to provide a little bit of an incentive here. And
so, if you have a different proposal, we would like to hear it,
otherwise, we feel strongly that only trying to address this
issue by looking at low-income geographic areas we risk the
potential of missing investments or potential fund managers.
With that, should we move on to the New Markets? I'm sorry,
did you----
Mr. Rowe. No.
Mr. Wheeler. I mean, we can talk about it----
Mr. Rowe. Well, I mean--yes. I am not going into the
licensing, because this isn't really licensing oriented, it is
just the investment level.
Mr. Wheeler. True.
Mr. Rowe. But yes, we can continue to work on it. There is
more than one way to skin a cat.
Mr. Wheeler. OK. Thank you.
Well, with that, if we could turn to New Markets Venture
Capital Program.
Kerwin, do you want to, representing the Community
Development Venture Capital Alliance, give us an overview of
the program?
Mr. Tesdell. Sure. Thanks very much, Kevin, and thanks to
Senator Kerry and to Senator Snowe for having us here and
focusing on this program.
I thought it would be helpful first to put things in
context of the Community Development Venture Capital industry
and then talk a bit about the program and some changes that we
are interested in.
This Community Development Venture Capital industry is
relatively new, when CDVCA was started 10-15 years ago, there
were just a handful of funds managing in the tens of millions
of dollars. People who intentionally went to economically
distressed urban and rural areas of the Nation to practice the
art of venture capital to create jobs and wealth in lower
income communities.
We started discussions in 1999-2000 with the SBA, thinking
about how the Federal Government can get involved to push this
field forward from a public policy standpoint, for all the
reasons that Dr. Rubin just gave. This industry was important
to the Nation, and we looked at how the Federal Government
could get involved in small ways to push the field forward.
And I think the New Markets Venture Capital Program does
that very well. First of all, it provides the incentive, and
really, the possibility for experienced venture capitalists to
come to economically distressed lower income urban and rural
areas and practice their art, and particularly people who are
in the middle of their earning period who can make many
millions of dollars elsewhere.
Even those who want to do that generally are not going to
want to run a $5 million fund. They are going to want a larger
fund. The leverage is very important for that. The other piece
that is quite important is this Operational Assistance Grant.
And just to piggyback on what Dr. Rubin described and maybe
go a little bit deeper, in these areas, often you do not find
the sort of perfectly formed management team, with the CEO, and
the CFO, and the marketing person, and all the intellectual
property is all pulled together, and so forth.
Very often these are sort of diamonds in the rough, and
that is what you find in the areas where Ray operates, and they
need a little polishing. And that is what this operational
assistance money does.
So maybe you have someone who really knows how to produce a
product, but is not so good on the marketing side and needs
some help with a marketing plan. Maybe you have a good team
that is weak on the CFO position and you need a recruiter to be
hired--to help hire--to find that person, recruit someone from
outside of the area to make this company successful. And that's
what that operational assistance money does. It really makes it
possible for people to practice venture capital, something that
works very well in Silicon Valley and Route 128 near Boston,
and bring it to rural Kentucky, or inner city Baltimore and
make funds viable. So that is really a crucial component and
real difference with the SBIC Program.
Looking at some of the changes, minor changes, we are
looking for in the program as it is being reauthorized, one is
focusing on this operational assistance money. When we first
designed this program, a very small number of funds, and there
were several national foundations that were really focused on
these funds, providing grant support for this new experiment.
This is no longer a new experiment. There are now 70 funds
instead of 6 funds. And that kind of grant money is just not
available. And the New Markets funds have found it very, very
difficult to raise that operational assistance match. They have
just been spending tremendous amounts of time out there as
grant raisers as compared with venture capitalists, which is
not where we want them to be spending their time. So that's one
change.
The second change is just the targeting, just bringing that
in line with the New Markets Tax Credit Program, which, as you
know, was originally intended to work in tandem with the New
Markets Venture Capital Program. They had the same name. There
are several reasons that hasn't worked out so well, but this
targeting alignment is an easy change to bring these two
programs together.
And then third, giving funds a full 2 years of time to
raise their private capital, particularly raising this kind of
capital in economically distressed areas is a difficult thing
to do, and once the starting gun shoots off when you have been
conditionally approved, experience has shown that at least some
of these funds need a full 2 years to raise the capital. So
that's the third point we are looking for.
Mr. Wheeler. But in the overview of the program, Ray, do
you just want to speak very quickly on why these differ--how
these differ from other funds? You have a double bottom line.
Mr. Moncrief. We do. And quite frankly----
Mr. Wheeler. And you have an SBIC Fund and a New Markets
Venture Capital Fund.
Mr. Moncrief. I do. As Lee Mercer says, I have one of
everything.
[Laughter.]
Mr. Moncrief. Quite frankly, this is a parallel to the SBIC
debenture program. As a matter of fact, there are areas that
traditional SBICs, debenture-based SBICs just do not go because
of deal size.
And consequently, what is interesting is that where I do
what I do in Appalachia, there are not a lot of venture funds
there doing it. And the ones that are there are looking for
deals where they can do a first round of $5 million, a second
round of $5 million, et cetera.
Greg didn't need that much money. Interestingly, what we
are finding is that we do need these funds in these areas to do
the smaller transactions, and actually to syndicate with
traditional VC.
As a matter of fact, on many of my deals, I syndicate with
traditional SBICs, because they do not necessarily have the
segue way there. I have the segue way there. I am on the ground
there. The deals are not inferior, they are just smaller. And I
agree with that.
The other things is, I want to talk about this operational
assistance. Having raised that type of money, I can literally
burn up all of my management fee flying across this country
asking people to contribute to operational assistance. And I am
telling you, that does not exist. That money does not exist.
You can get a $5,000 grant here, a $1,500 grant there--those
sorts of things. And I can assure you that is the most brutal
money there is to raise. I can raise five venture funds before
I can round out 30 percent of regulatory capital that is
required to match the SBA.
It just does not work, Kevin.
Mr. Wheeler. And to demonstrate how difficult it has been
to raise, have any of the funds been able to raise the full
$1.5 million, or 30 percent.
Mr. Moncrief. As a matter of fact, of mine, for example, I
have a small regulatory capital on my New Markets Venture
Capital Fund. That's 30 percent of $5 million, or $1.5 million.
Those that have a larger regulatory capital have to raise
30 percent of that regulatory capital. So it is up from 1.5 to
2, or 3, or 4, or 5, whatever their regulatory capital is.
I don't think any of them has raised their full match for
the Operational Assistance Grant.
Mr. Wheeler. And recognizing that, if you want to say there
was a flaw in the program, when the Department of Agriculture
created a similar program, they did away with the match.
Mr. Moncrief. They did. As a matter of fact, when they were
constructing, in the 2002 Farm Bill, the RBIC Program, they
asked some technical issues that were the most challenging in
the New Markets Venture Capital area.
And that was one of them, and they chose to draft in 10
percent of the private equity, up to $1 million, which is by
far the better route to go, which is being proposed, as you
well know.
Mr. Wheeler. Julia, do you want to make a comment, and then
we will go to Greg and he will explain to us what a New Markets
Venture Capital investment company has the potential to do?
Dr. Rubin. Yes, I was actually going to say that I--I mean,
I already mentioned that I thought the debenture in this
legislation is too low.
I would actually propose another change to this legislation
around operational assistance. I think, instead of saying the
lesser of 10 percent or $1 million, I would make it a flat $1
million, like the RBIC Program, because the lesser of ends up
being on the smallest fund possible, which is $5 million in
private equity and a $5 million match in the debenture, which
is a $10 million fund. You end up with $500,000 in operational
assistance, and that is just not enough. You are looking at
$50,000 per company, assuming about a 10-company portfolio,
which is about what you are ending up with.
That's not a lot of money to play with when you
potentially--you know, a lot of folks that are running the
program now are ending up spending $250,000 easily getting the
company to the point where it is ready for investment, and then
doing work with them subsequently. And in a $10 million fund,
you don't have the management fee to spare to do that kind of
work. There is just no money there to play with. So the grant
is just so critical.
So I would propose both raising the debenture piece to 2-
to-1 leverage, and increasing the grant, and just making it a
flat $1 million, which would not have, I believe, any
significance budgetary impact, because you are still looking at
$20 million, if I am not mistaken, as a program level.
Mr. Wheeler. We did reduce the authorization level from $30
million to $20 million based on the change.
Dr. Rubin. Right. I'm sorry. You could do it with the $20
million if you are looking at----
Mr. Wheeler. Right. Because we did factor in the maximum $1
million per possible 20 funds.
Greg, do you want to tell us your story--you have New
Market Venture funding. Tell us what this meant to your
company, the jobs you provided and what the program does, and
where you are located--why it made such a difference.
Mr. Harmeyer. Sure. Thanks for having me here today. I
really appreciate the opportunity to discuss these programs,
and I have become very educated on some of this.
Honestly, I am not an expert on the programs themselves. I
am coming at it more from the other side of this.
We are--I will give you a brief thumbnail of our company so
you have some context. Our company, Tier One Performance
Solutions, we are about a 4\1/2\-year-old company, a software
and services company, that works with large organizations.
FedEx is our largest customer. You mentioned that they were an
SBIC company. So there is obviously some derivative effect--but
Proctor and Gamble, Wendy's International, large companies like
that, helping them with online learning and knowledge programs
to get their workforce educated, to get their customers
educated.
Most recently, we have begun working with the United States
Air Force on helping transition knowledge within their
engineering ranks as their engineers begin to approach
retirement.
One of the things we found--we were about 2\1/2\ years into
the company when--first of all, we started the company with
personally guaranteed debt, which is not uncommon.
I think the comment that venture capital is a misnomer I
agree with completely. I think your options really are debt or
Angel investment, typically. We went the debt route. There are
limitations to that in a capital market for a company that is
small, because most banks will--you have to have multiple
guarantees and collateral. And you have limitations to that,
and many banks still won't lend you what you need.
And so we reached a size growing that model where we
realized, and it was really when the government opportunities
began to open up to us that we needed more capital to be able
to grow effectively.
The options for you at that point are to look at Angels and
to look at larger private equity firms. Most private equity
firms you talk to will say to you, OK, it is great that you are
looking for $500,000-750,000, what would you do with $5
million?
Well, there is not an alignment there. What they want out
of $5 million--we can take in $5 million, but it doesn't make
sense for our people, for our customers, for what we are trying
to do, and the timing of their investment is not right.
So our options were really limited, and it is one of the
reasons I think the New Markets Venture Capital Program is
critical. Our options were limited both by the size of the
investment we were doing, so there are a limited number of
investors willing to do that, and also limited by our location.
We are in Covington, Kentucky, you know, a rural State, and the
issue there is deal flow.
There are not enough investors there. There are not enough
deal opportunities for investors to want to be there, and so it
is a chicken and egg thing. There are some good companies
there, but there are not enough of them. And so there is not
enough attention from private equity investors to want to
invest in those areas.
So we happen to be located in a HUBZone, in a very
developing area of Covington, Kentucky. So the opportunity to
work with the Southern Appalachian Fund, which, as you know, is
part of the New Markets Venture Capital Program, was a very
appealing one to us.
It was also appealing because working with purely Angel
investors, which is essentially the alternative, you do not get
access to the expertise, the networks, and the experience in
helping grow businesses that a professional fund will have, and
like Ray's company would have. And that expertise is
significant in and of itself, especially when we were looking
at growing into the government sector.
Angel investors, this a generalization, but often tend to
be passive investors, or they know a limited area of what they
do, but they are interested in getting a return. They believe
in you as a person or as an individual, but they are not
necessarily there to help foster and develop the company. So
that is a limitation of that approach.
So the fit, I think, was significant. Another limitation we
had in raising capital is--you mentioned job creation. Well,
our business is partially software, and a large part services-
based. A lot of investment companies do not want to invest in
services-based companies because they do not scale very well.
They particularly have a perception that they will not scale
well in a rural area, because of the access to the people that
you need to grow.
Of course, that is where a lot of job creation comes. I
think over 90 percent of the job creation in the U.S. is in
services-based companies. And so there is another issue there.
The Southern Appalachian Fund obviously has other interests
in mind, and one of them is job creation. And so it is very
much aligned with what we are trying to do.
And so the fit there--I honestly do not know, if we had not
had the option to work with the Southern Appalachian Fund, that
we would have aggressively pursued additional capital. We could
have been found growing at a much more limited pace without
raising capital, but the opportunities for a company in
Kentucky to bring in Federal dollars to do work for the
government are few and rare, but it was there. And so it gave
us an opportunity to grow.
We are now around 40 full-time people. We do a lot of work
with other contractors, which is just a different form of
employment. So if you count all the people that we pay, it is
probably in the 40 to 50 range, you know, in a small growing
area of Covington, from three people when we started.
We've also been very fortunate and honored to win the
Kentucky Small Business Persons of the Year from the U.S. SBA.
So we are thankful for that. We were named the U.S. Chamber of
Commerce Blue Ribbon Award winner. So we have been honored to
have a lot of successes, but it really has been largely because
of the partnership we have been able to get--both the funding
and the assistance that we have gotten from our investors.
Mr. Wheeler. And what does it mean to your community, your
company to have this presence there?
Mr. Harmeyer. It is very significant. I am glad you asked
that.
We actually relocated. And because we are invested in from
a New Markets Venture Capital Program, we were limited to stay
in the HUBZone area, which was a good thing. We weren't
necessarily looking to leave, but it certainly kept us there,
which I think is worth noting.
We moved into what was a 150-year-old building that has
been renovated and is the centerpiece of downtown Covington.
We've made the headlines of the local paper two or three times
because of that building. And it is very much a sign for
everybody who goes through there that the area is developing,
that there is growth.
Within our block, there are probably at least a dozen
technology companies, most of them a little younger and smaller
than us, and we are helping lead the charge, but we
collaborate--many of us collaborate on multiple deals.
So it is fostering other things as well. We probably
collaborate with a half dozen other companies within the same
block on various opportunities. So it is a virtual cycle: The
more you can get businesses there that are going to succeed,
the more it is going to help others succeed and attract more
businesses there.
Mr. Berger. What about job creation?
Mr. Harmeyer. Well, as I mentioned, I think job creation
is--it is a primary focus of your business because the large
part of what we do is professional services, and we draw on the
many universities in the region to get our people.
I do think that is a limitation in many private equity
firms, is that they--I don't think this is literal, but I think
a private equity firm's typical best deal would be infinite
scalability and no people.
And not out of any--I don't think that is bad. It is just
you are looking for very high growth velocity that you can turn
over in 3 or 4 years.
That is not the pace that we are on. And again, the
interests of the Souther Appalachian Fund are more aligned with
the job creation and what it does for the community, which I
think is a very positive things, because, again, for managing
investors in a relationship and common ownership in a company,
you have to have the same interests in mind all along. And if
we had an investor who was opposed to job creation and we were
actively looking to grow our workforce, it causes tension in
terms of where you are going to go and what you are going to
do.
Mr. Wheeler. And it makes the point that if the SBA's
programs are supposed to bridge the gap, fill a need, that the
private sector is not doing it. Even though they are doing good
things, they are doing other things, and therefore, without
this, there would not be----
Mr. Harmeyer. There is no question in my mind that the
statistics that Dr. Sohl put forth--I have never seen these
before, but it absolutely typifies the experience that I have
seen out there, is that there is this capital gap.
I mean, we want a startup, but we are not--we may do a
Series B someday with a private equity firm of a much larger
round, and that is certainly something we will consider, but we
were not ready for that. And there is this gap--a shortage of
companies willing to invest at that time.
Mr. Wheeler. Thank you.
Dr. Rubin.
Dr. Rubin. I just had one quick comment as a follow-up to
what Mr. Harmeyer said.
I think if you look at the companies that have received New
Markets Venture Capital money, I do not know the exact number,
but it is well over half that have actually moved into a low-
income area, which is great for developing those areas.
I think where the problem has, for me--is, in terms of
targeting, and why I support some modification is you cannot
move a manufacturing concern 100 percent of the time. What it
pushes the funds to do is technology and some manufacturing
that is easier to move. But if you have a company that is
larger and that really has a reason why the facilities cannot
be moved at that time, it precludes those investments.
So I think it is really great to be able to move those
firms that you can to where they can really have a great
economic impact, but it is nice to have that flexibility too
for when you cannot do that to invest in manufacturing, which
is what you are trying to do with this legislation.
Mr. Wheeler. You are speaking to the change in the
legislation that we would line the program with the New Markets
Tax Credit so that you could hit not only geographies but
targeted populations----
Dr. Rubin. Right. Right.
Mr. Wheeler [continuing]. To a certain extent.
Dr. Rubin. Right.
Mr. Harmeyer. I would like to comment on that.
It is a good point, and I do not know the specifics of what
you guys are talking about from a legislation standpoint, but
we literally were on the border of whether we qualified or
not--literally on the street block border of whether we
qualified or not and, in moving--two things. One, we were not
sharp. First we had to do some research. It would have been
unfortunate if we did not qualify, because it was such a
natural fit.
Two, in moving, it did very much limit us to--we ended up
in a good place, but it very much limited our ability to look
at alternatives. And so I think there probably is--it does
provide some limitations that may be taxing at times and
constricting.
Mr. Wheeler. But you are in a HUBZone?
Mr. Harmeyer. Yes, we are.
Mr. Wheeler. That is going to make Senator Bond very happy,
since he is the father of the HUBZone Program.
Mr. Moncrief. As a matter of fact, Kevin, every one of our
investments are in a HUBZone.
Mr. Wheeler. I'm sorry he's not here. It would be very
popular.
SBA, would you like to make any comments just to summarize
what they said.
Mr. Rowe. There are a couple. We were just talking--looking
at this overnight, and all.
There are a number of just technical points we would raise
with you guys, because--trying to figure out, particularly
under the Operational Assistance Grants.
What we understand here is that this would set the amount
at 10 percent of private capital or $1 million, whichever is
less, and remove the matching requirement.
But what it doesn't do, and this goes to what Mr. Moncrief
was talking about, is that it does not change the 30 percent of
capital operational assistance from outside funds requirement.
Mr. Wheeler. I thought that we--are you saying that it is a
drafting error?
Mr. Rowe. Yes.
Mr. Wheeler. OK. Thank you.
Mr. Rowe. If that is what you are trying to do, it did not
do that.
Mr. Moncrief. He is exactly right.
Mr. Wheeler. Thank you. We will change that. I am happy
that you support it.
Mr. Rowe. Just pointing that out to you.
One of the other issues that we just noted with the small
manufacturer participation agreements, the only concern we have
on something like that is locking a fund into a participation
agreement that might limit their, one, opportunity to invest
outside that area of, say, small manufacturers, and two,
because it might limit their diversity, you know, limit their
liability. So we always have a concern with that.
That being said, we do not have a problem with the idea
that small manufacturing businesses in particular should be a
target. I don't know whether that is better served as a larger
programmatical, in some sense, rather than an individualized--
--
Mr. Wheeler. Make it a goal? I see.
Mr. Rowe. Rather than individualized to particular funds
and particular participation agreements.
Mr. Wheeler. Well, John Kerry mentioned this in his opening
statement, and he is concerned about that, too. And I think
that is why the language differs from the House side in the
sense that it says, ``To the extent practicable.'' I think that
is in there.
And then there is also a construction qualifier. But maybe
doing it as a goal is a better way to approach it.
Congresswoman Moore felt very strongly about it, because in
Wisconsin they have been bleeding manufacturing jobs, and so
they were trying to use this as a tool.
Mr. Rowe. Absolutely. And the only other thing is when we
were looking at the change from low-income geographic area--
this might create an administrative problem for the Agency,
just simply because the programs that we have now help us
geocode New Markets Venture Capital firms, and we are not sure
whether we can make it work this way, but that would be an
administrative burden for us rather than anything else.
Mr. Wheeler. If you want to put the money in your budget we
will support it for you to be able to afford that.
Mr. Rowe. The whole thing is we were thinking, we are not
even sure you can make a computer program that will tell you
that.
Mr. Wheeler. But if we can do it for the New Markets
Venture Capital Program, can it not be possible--and they are
doing it for RBIC, too.
Mr. Rowe. Honestly, they have a whole licensing division at
Treasury that does New Markets Tax Credits. So I do not know
how they do that.
Mr. Wheeler. OK.
Mr. Rowe. That's the only other thing, is linking to New
Markets Tax Credits--you will have to ask the Treasury folks
what sort of budget impact they think that would have expanding
it.
The only other thing I would point out, and maybe Ray can
speak out to this a little better, the timing on a New Markets
Tax Credit is, as I understand it, 7 years, and I do not know
how that matches up with the life cycle of a fund and whether
that affects its utility at all.
Mr. Wheeler. Would anybody from the industry like----
Mr. Tesdell. Sure.
I mean, you are absolutely right. There are other
difficulties with making these two programs work, but this was
one that we thought was a simple fix, and I think it has other
benefits, as Dr. Rubin mentioned.
So it seemed like a good time to do this.
Mr. Wheeler. Right, because it is more attractive to the
investors, it makes it simpler, also, you get to those targeted
populations where it is needed.
So those benefits outweigh the possible out-of-sync fund of
a tenure fund versus a 7-year credit, right?
Mr. Tesdell. Those are other issues that we will have to
deal with other Committees, and so forth, but bringing the
market area definitions together seemed like a good step.
As to the administrative burden of doing this, the New
Markets Venture Capital Program does it, the CDFI Program does
it. At least this work has been done by other agencies that you
folks will be able to piggyback on.
Mr. Wheeler. Can you answer just one question, because some
people are concerned about adding targeted populations.
Why is it important to also reach the targeted populations
and not just the geographic area? What is the justification for
that?
Mr. Tesdell. Sure. Just on a very broad level, there are
low-income people who need jobs that do not necessarily live in
particular census tracts. So this addresses that issue.
Mr. Wheeler. Or the businesses that could provide the jobs
to those people that need it that are not necessarily located
there.
Mr. Tesdell. Yes. Yes, I am sorry. That is correct. You
said it better than I did.
Dr. Rubin. There is another issue, which is that census
track designation changes every census, and 10 years is a
really long time. So fund managers I spoke with highlighted
that, when they were looking at the geography, it had a
completely different qualification than when they actually
started making investments because things changed on the
ground. And there might have been a lot of eligible areas at
the time that they were putting a fund together, and by the
time that they actually started investing, that eligibility
lapsed, because the new census came through, and suddenly they
were not eligible.
So it is just a very blunt instrument with which to target.
And sometimes it works great. Sometimes the company is in the
right place and it works wonderfully, but it just does not
always work.
Mr. Wheeler. OK.
Mr. Moncrief. One comment about the geography, as well.
Tier One is a classic example of just that point. I am the
only New Markets Venture Fund that used the New Markets Tax
Credit to partially capitalize the regulatory capital.
And consequently, I have multiple tests when I do a deal. I
mean, I have a lot of tests. One of which is the geography.
In this particular case, to Tee's point, the New Markets
Venture Capital piece recognized Greg's address as a qualified
area. On the other hand, the New Markets Tax Credit geo-
plotting software said it was an ineligible census track.
And so consequently, I had to make the decision, and I was
able to do some investment outside the NMTC area and
consequently made the investment regardless.
So there are a lot of incongruencies just in the base
definition of what the geography is. And you are right, there
are many times a situation where we get investment on a company
that is sitting on a corner, and the people that are going to
work in it are across the street, and we cannot make an
investment.
Mr. Wheeler. But Greg qualified because of the HUBZone
piece, which is separate than those tracts that are created in
the definition. And the Committee intends to preserve the
HUBZones, the Empowerment Zones, and the Community
Reinvestment----
Mr. Moncrief. For the venture capital piece?
Mr. Wheeler. For qualified areas. The Committee intends to
keep that.
Mr. Moncrief. Absolutely.
Mr. Wheeler. So while you said that it was not--he would
not have been an eligible investment by the tax credit.
Mr. Moncrief. That's correct.
Mr. Wheeler. If we adopted the tax credit, my fear is that
you are telling us that now we could not make the investment,
but I am saying the part that made him eligible--he would still
be eligible. We are preserving that.
Mr. Moncrief. Yes.
Mr. Wheeler. So we are simplifying it. We are getting the
advantage of simplifying it by lining it up with the tax
credit, but we are preserving those pieces that capture--we are
preserving those eligibility requirements that captured Greg's
company.
Mr. Moncrief. Yes.
Mr. Tesdell. Just to add a couple of other points. One is
that I understand in many rural areas, you have very large--
geographically large census tracts that often combine very low
income areas with higher income areas.
So for example, in Maine, along the coast, you may have a
number of high-income people along the water. You move in 10
miles inland and you have very low-income areas.
You combine those two together, and that is not a low-
income census track, even though you have pockets of poverty
elsewhere. So that's an important issue.
And then also, just to reassure everybody here, the process
that a fund has to go to satisfy the regulatory requirements
approving that you are--it is sort of the flip side of your
administrative burden. There is a big burden on the fund. Funds
generally are not going to do this unless they are sort of
mission-driven community development venture capital funds.
Not a lot of them are doing this in CDFI or New Markets Tax
Credit. So this is not some big loophole that someone is going
to drive a big truck through. It is actually a small opening
for very mission-driven funds to do what they need to be doing
in communities.
Mr. Wheeler. Matthew, did you have any questions?
Can we also talk about the legislation--there is a
provision that would create an office within the SBA's
investment division that focused strictly--it is a New Markets
Venture Capital office, and it would have a director who is not
a political appointee. And it is in the bill because we have
heard concerns over the years that there have not been the
resources dedicated to this office.
And I wondered if anyone here could explain to us why they
see the need for this office, or if SBA wants to comment--you
don't need to, but if you want to say you would not like it.
Mr. Rowe. I think the only comment I would have is that as
long as there is a program there is going to be an office. I
would definitely say we have a problem with it being senior
executive service, simply because there are a limited number of
those positions in the agency by OPM rules.
And GS-15, 14, something like that, but SES is--people like
Mike----
Mr. Wheeler. OK. But you are OK that it is not political.
Mr. Rowe. Yes. I mean, we are not going to worry about
that.
Mr. Hager. I guess the issue--would be interested in the
issues driving that, that recommendation.
Mr. Wheeler. For instance, where do the funds go now in the
SBA when they have questions or if somebody is overseeing them.
Who do they talk to at the agency? How many people are
overseeing this?
Mr. Moncrief. There is one individual. I guess Harry can
answer that.
Mr. Haskins. We have one individual working directly on the
program. That individual reports to me.
Mr. Wheeler. And is one person really sufficient to oversee
and manage six funds, particularly if the intention of this
legislation is to grow as many as 20 more?
Mr. Haskins. I think, if this program were to grow, the
answer is no, one individual would not be sufficient.
We are trying to develop some redundancy within the office
to deal with the issues, such as if the employee were to leave
or go on vacation or what have you.
As a practical matter, we also administer the SBIC Program
and the individual analysts within the SBIC Program may well
handle 25 to 30 funds.
So we are not sure there is a workload imbalance on a
relative basis between the two programs.
Mr. Moncrief. The one thing that does beg to be commented
about is the uniqueness of the New Markets Venture Capital
Program versus the traditional SBIC debenture program.
Things, for example, the approval cycle of the operational
assistance.
The individual that reports to Harry does an analysis, an
in depth analysis and comments back on his approval of an
operational assistance program. And I don't know what
redundancy is in the investment division for that, but those
are extraordinarily important to be delivered on a timely
basis.
And so, having someone that is truly knowledgeable about
the New Markets Venture Capital Program is extraordinarily
important.
Mr. Wheeler. Well, I think it is important to have the
institutional knowledge there. And it is a specialized program.
So I think that is a very good point about having a backup. I
am glad SBA is looking to put that in place. I think it is a
very important protection.
In general, is SBA supportive of reauthorizing the New
Markets Venture Capital Program?
Mr. Hager. You know, it is still in its harvesting stage.
We need to make sure that we continue to monitor it. We are
really pretty early in the program right now, but so far, we
have no reason to believe it is not a very good program, and we
like what we see so far.
Mr. Wheeler. Have you been able to, Mike, visit any of the
New Markets Venture Capital companies that they have invested?
Mr. Hager. I have not physically been in any of those six.
It is something that I would like to do.
When you stack up all the other things that we have going
on right now, it--that is a good idea.
Mr. Wheeler. And has the administrator been able to visit
any of the companies like Greg's?
Mr. Hager. I don't know.
Mr. Wheeler. We just think it is important because, while
the current administrator is very supportive of investments in
these areas, it was very hard to get this program implemented
and the Committee had a lot of struggles.
And so our concern is that there was lack of support, even
though no one was really going out to see what these funds were
accomplishing.
Mr. Hager. I will make this easy. I will commit to do that
soon.
Mr. Moncrief. Let me be the first to invite you.
[Simultaneous discussion.]
Mr. Haskins. The analyst working on the program has visited
some of the portfolio companies.
Mr. Wheeler. Oh, good.
Mr. Haskins. And we have an examiner that has also visited
both the funds and the companies as well. So we have not
completely forgotten.
Dr. Rubin. And the assessment I am doing is for the SBA. So
they are very supportive of that.
Mr. Berger. I have one more question for SBA.
But does SBA have an issue with changing?
I know, Tee, you gave us a technical correction on the
Operational Assistance Grant piece, to remove the 30 percent,
which I think you were spot on about, but does SBA have an
issue with changing the Operational Assistance Grant formula to
more align with the RBIC formula.
Mr. Rowe. Honestly, we realized, as Ray said, that is
probably the biggest hurdle that a New Markets fund has.
You know, when the licensing occurred and we had the
conditional licenses and they raised their private capital,
that was where everybody was scrambling to get things done to
get their final license.
So I couldn't give you a categorical yes, but obviously it
appears that, if we looked back at lessons learned, that is--it
is pretty pointless to have a program with a hurdle that is
almost impossible to overcome.
Mr. Wheeler. Thank you.
Kerwin.
Mr. Tesdell. If I could just follow on from that. Thanks
very much.
Just sort of big picture, the public policy interest is to
get experienced venture capitalists to do venture capital in
these areas where they are not currently doing it. And without
operational assistance, or if the Operational Assistance
Program is too difficult to use, that incentive goes away.
Otherwise, why not just--not just--why not start an SBIC in
these areas?
If you want to provide incentive, it is the operational
assistance that does that. If operational assistance does not
work, you do not have incentive.
Mr. Wheeler. So we can build capacity.
Mr. Tesdell. Right. So this is absolutely key to the
program.
Mr. Wheeler. And there was a component of this when this
issue came up in 1999. The late Senator Wellstone had a
provision that was specifically for capacity building.
Mr. Tesdell. Yes.
Mr. Wheeler. So while that didn't get adopted,
unfortunately, I think it shows the importance of why we should
keep the grant, so that you can spawn more.
Mr. Tesdell. Yes.
Mr. Wheeler. You know, may I ask one other question of SBA?
Ray piggybacked on what Lee was saying about changing the
20 percent maximum investment in a fund. Does that limitation
also apply to the New Markets Venture Capital Funds?
Mr. Haskins. It does.
Mr. Wheeler. It does. OK.
Are there any more comments that anyone would like to make
before we wrap up the roundtable?
Mr. Ferreira. My name is David Ferreira, Director of
Government Affairs at the Hispanic Chamber of Commerce.
We are an organization. We have over 250 affiliates--
chambers, locally, and our members of our chambers amount to
less than half a million. We try to represent over 2 million
Hispanic-owned businesses nationwide.
Obviously, our perspective is we suspect similar to the
Black Chamber of Commerce: One of looking from the outside in.
So obviously, our encouragement would be to find ways to
educate and promote. And obviously promotion is not always
equal, and not all forms of promotion are equal.
We would like outreach that is genuine and can lead to
actual minority-owned SBICs. We are unaware of any Hispanic-
owned SBICs. I am not saying that there are not any. And we
believe some of the issues, whether they are by construct.
We believe that those some of these issues, whether by
construct, assigned coin, sit-ins, outreach, education--we
believe that those issues should be addressed towards trying
to--lead to at least a minimal number that is more
representative of our minority business community.
Mr. Wheeler. And the Committee is concerned about that,
too.
We talked a little earlier about that. To the businesses
that got the SBIC and the New Markets Venture Capital Funds,
how did you find out about the programs?
Mr. Harmeyer. I'll answer.
There is an organization in the State of Kentucky that
manages some of the grants on behalf of the State of Kentucky.
And they do a good job of staying attuned to all the investors
throughout the State. And so they did the introduction for us.
But I will quickly add to that marketing and promoting
these things is very much needed, because I do not know how
many small business owners I talk to who do not know about
programs like this and where to go.
Mr. Wheeler. So you don't think it was just luck that you
stumbled upon them? You knew to go to this State resource and
ask them to do the matchmaking or help you identify sources?
Mr. Harmeyer. Well, we invested quite a bit of time in
networking with those organizations, and it is a big investment
of time.
So our relationship with that organization in the State was
probably directly attributable to this, but most small
businesses probably cannot afford to do that or do not do it or
whatever the case may be.
It is hard to make the connections. There is no question.
Mr. Wheeler. So how would somebody promote it? What do you
think would be an effective way for the SBA to increase
outreach and make people aware of them?
Mr. Harmeyer. That is a good question. I suspect doing more
through the local chamber of commerce organizations, because
that is one area that small businesses do stay pretty connected
to, to make sure that people understand what the programs are,
why they are valuable, who they are fit for.
I mean, a lot of this, for small business owners raising
capital for the first time--there is a lot to learn, and to
understand all the differences--and so I think just trying to
simplify it and try and educate people in simple terms on what
the options are and why these programs exist and who they are
suited for I think is helpful.
Mr. Wheeler. For instance, we found an issue in
Massachusetts where--when we started dealing with the Hispanic
business owners--they were not going to go through the
universities. They were really networking through their
churches. And they were telling us, please--sometimes the
university campuses are not in the right location for us.
There is not a trust factor there. And so you need to find
a way for separation of church and state somehow to do outreach
and build awareness through that.
That was just in Massachusetts, but that speaks to your
issue that they were--we weren't really looking at the issue of
who we were trying to reach. We just had one way of trying to
advertise it.
And this is not a criticism of SBA. It is something that we
are all struggling with of how to--if we believe that these
programs serve a purpose, how do we make sure that more people
know about them.
And so possibly that is one way that chambers of commerce--
Ed, how did you find out about it?
Mr. Tierney. Well, we had an associate, too, that was
familiar with the program and had reached out.
But I would emphasize again what Mr. Harmeyer said, that we
are small businesses, and there is a tremendous amount of
multiple hat-wearing and responsibility at every level in
senior management.
And it is difficult to invest the time and to reach out and
to search out--and for somebody who has not been through the
process of a capital partner, it is a tremendously demanding
learning experience.
So I can imagine for people trying to access this without
that previous knowledge can be tremendously difficult. and I
would suspect through chambers of commerce or the like, or
something similar, community-based, would enhance the chances
that somebody might find out about these programs.
Mr. Wheeler. Does SBA have tutorials on how venture capital
works for companies and what they should be looking for?
Mr. Haskins. I believe, on the web page, there are
tutorials on securing financing, an element of which is
addressing the venture capital industry.
How helpful it is, I really don't know.
Mr. Wheeler. Because Greg had mentioned how important the
relationship is and just how difficult it is to find that
match.
It is not just about money, but there are other elements
that you should be looking for.
Mr. Harmeyer. No question. No question about that.
One other question would, I think--most communities, or
many communities, certainly in our region. I suspect it is true
across the country--have incubators of different sorts, and
strengthening the connections of these programs to these
incubators, I mean, that is one place that small businesses who
really think they are going to grow will start in terms of
looking, because they have heard about this and so that is one
are that they can get educated through.
Mr. Wheeler. OK.
Mr. Harmeyer. I don't know what is being done.
Mr. Wheeler. The Hispanic Chamber just mentioned the need
for more licenses to go to, say, Hispanics. We have been
concerned about it. We talked about them getting access, but we
need to talk about access for women.
Dr. Sohl, you just completed a study on women in venture
capital. What were the findings there?
Dr. Sohl. Actually, women in SEED state capital. There was
not much venture capital because they do not do SEED. But it
did include some SBIC fundings and did include Angels.
And it turns out--and it was interesting from some of the
comments. When women got in front of investors, they did quite
well. In fact, they did better than their male counterparts.
The problem was getting them in front of the women.
So I think it is the same issue as you said, trying to draw
out--these are sources of capital that you should consider
applying for and/or actually following through, because we
measured this seek and yield rate.
If you are looking, they were actually yielding quite well,
but they just were not looking at the high levels. So I think
there is this big information gap that is floating around.
One possibility--most States have SBDC offices, too, right?
I mean, that's another one. And plus the State's securities
offices. Businesses have to register somewhere. Usually that is
another stop gap. Those are two places I know.
I know--I am actually on the board of a double bottom line
fund, and we deal with that information through the State
securities offices and the SBDCs. And those are in place
already.
Mr. Wheeler. OK. Thank you.
Any other comments before we wrap it up?
Just one last word, if anyone has any technical changes,
please let us know. We do plan to mark this bill up at 10:00
a.m. on Tuesday, and we want it to be as good as it can.
Thank you.
[Whereupon, at 12:16 p.m., the roundtable was adjourned.]
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