[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
FULL COMMITTEE HEARING ON:
EXPANDING EQUITY INVESTMENT
IN SMALL BUSINESS
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
MARCH 26, 2009
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 111-013
Available via the GPO Website: http://www.access.gpo.gov/congress/house
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HOUSE COMMITTEE ON SMALL BUSINESS
NYDIA M. VELAZQUEZ, New York, Chairwoman
DENNIS MOORE, Kansas
HEATH SHULER, North Carolina
KATHY DAHLKEMPER, Pennsylvania
KURT SCHRADER, Oregon
ANN KIRKPATRICK, Arizona
GLENN NYE, Virginia
MICHAEL MICHAUD, Maine
MELISSA BEAN, Illinois
DAN LIPINSKI, Illinois
JASON ALTMIRE, Pennsylvania
YVETTE CLARKE, New York
BRAD ELLSWORTH, Indiana
JOE SESTAK, Pennsylvania
BOBBY BRIGHT, Alabama
PARKER GRIFFITH, Alabama
DEBORAH HALVORSON, Illinois
SAM GRAVES, Missouri, Ranking Member
ROSCOE G. BARTLETT, Maryland
W. TODD AKIN, Missouri
STEVE KING, Iowa
LYNN A. WESTMORELAND, Georgia
LOUIE GOHMERT, Texas
MARY FALLIN, Oklahoma
VERN BUCHANAN, Florida
BLAINE LUETKEMEYER, Missouri
AARON SCHOCK, Illinois
GLENN THOMPSON, Pennsylvania
MIKE COFFMAN, Colorado
Michael Day, Majority Staff Director
Adam Minehardt, Deputy Staff Director
Tim Slattery, Chief Counsel
Karen Haas, Minority Staff Director
.........................................................
(ii)
Subcommittee on Investigations and Oversight
JASON ALTMIRE, Pennsylvania, Chairman
HEATH SHULER, North Carolina MARY FALLIN, Oklahoma, Ranking
BRAD ELLSWORTH, Indiana LOUIE GOHMERT, Texas
PARKER GRIFFITH, Alabama
______
(iii)
C O N T E N T S
----------
OPENING STATEMENTS
Page
Altmire, Hon. Jason.............................................. 1
Fallin, Hon. Mary................................................ 2
WITNESSES
Hendrickson, Ms. Pamela, COO, The Riverside Company, New York, NY 5
Neff, Mr. P. Sherrill, Founding Partner, Quaker BioVentures, on
behalf of the National Venture Capital Association............. 7
Walker, Mr. Tom, Presidents & CEO, 12e, Oklahoma City, OK, on
behalf of the Biotechnology Industry Association............... 9
Mott, Ms. Catherine, Founder & CEO, Blue Tree Capital Group, LLC,
Wexford, PA.................................................... 11
May, Mr. John, Founder & Managing Partner, New Vantage Group, on
behalf of the Angel Capital Association........................ 13
Dalton, Mr. Patrick, President & COO, Apollo Investment
Corporation.................................................... 15
APPENDIX
Prepared Statements:
Hendrickson, Ms. Pamela, COO, The Riverside Company, New York, NY 24
Neff, Mr. P. Sherrill, Founding Partner, Quaker BioVentures, on
behalf of the National Venture Capital Association............. 36
Walker, Mr. Tom, Presidents & CEO, 12e, Oklahoma City, OK, on
behalf of the Biotechnology Industry Association............... 48
Mott, Ms. Catherine, Founder & CEO, Blue Tree Capital Group, LLC,
Wexford, PA.................................................... 54
May, Mr. John, Founder & Managing Partner, New Vantage Group, on
behalf of the Angel Capital Association........................ 59
Dalton, Mr. Patrick, President & COO, Apollo Investment
Corporation.................................................... 67
(v)
FULL COMMITTEE HEARING ON EXPANDING EQUITY INVESTMENT IN SMALL BUSINESS
----------
Thursday, March 26, 2009
U.S. House of Representatives,
Committee on Small Business,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:00 a.m., in
Room 2360 Rayburn House Office Building, Hon. Jason Altmire
[chairman of the Subcommittee] presiding.
Present: Representatives Altmire, Ellsworth and Fallin.
Chairman Altmire. I now call this hearing to order.
This hearing of the Investigations and Oversight
Subcommittee is called to order, and there is no question that
the recession has hurt the balance sheets of small businesses.
Profits are down in nearly every industry, and conventional
forms of financing from bank loans to credit lines are limited.
Under normal circumstances, accessing capital is something
of an obstacle. Since the dramatic meltdown of our financial
markets last September, accessing capital has become especially
challenging and not just for businesses seeking traditional
funding. Even high growth start-ups are struggling to secure
equity investment, such as venture capital.
Historically, high growth firms have relied on equity
capital to get their businesses off the ground. For
entrepreneurs who have solid business plans but lack immediate
marketable products, venture capital and angel investment
financing is crucial to the success of these companies. These
forms of financing allow these companies the time they need to
research and develop. In some cases funding may also come with
managerial and technical experience. These kinds of resources
have helped launch countless new businesses from software
start- ups to biotech firms.
Many of today's industry leaders and innovators from Apple
Computers to Sun Microsystems got off the ground with equity
capital, and yet today this important form of investment has
become increasingly hard to come by. In my home region of
Pittsburgh, we have had the opportunity to team up with
businesses in Cleveland Ohio to help facilitate venture capital
investments. This partnership has attracted over 80 national
venture capital funds to invest in more than 60 health care
venture capital investments in the tech belt region.
Cleveland and Pittsburgh are now ranked second and third in
national health care investment. Although this is one good
example of the high quality investments that can be achieved
through venture capital, it is important to consider how the
current economic situation is affecting these investments. By
one estimate the Small Business Administration leaves $60
billion in unmet capital needs annual, and in an economic
downturn these additional needs must be met elsewhere, such as
venture capital, angel investing and other equity investing
mechanisms.
In today's hearing we will discuss the decline in these
investments and look for ways to respond to this challenge.
Equity capital is the fuel that feeds the start-up communities'
best and brightest. These are the businesses that create new
jobs and revolutionize entire sectors of the economy. In 2006,
angel investment alone helped generate 200,000 positions.
Equity investment not only spurs small business growth, but
also sparks the development of new products and industries.
Unfortunately, however, the deepening recession has
dampened the equity capital markets and stunted small business
growth. Amid growing uncertainty in the economy, many venture
capital and angel investors are pulling back. In the last
quarter of 2008, venture capital investments plunged $5.4
billion. That is more than a 33 percent drop from the same time
last year.
Meanwhile angel investment has also declined considerably.
In a recent study by the Angel Capital Association, half of
those surveyed said they had invested less than expected in
2008 and one-third predicated their investments would decline
again this year.
The current investing climate is the most tentative we have
seen since the dot.com meltdown nearly a decade ago. Few
industries have been untouched by this downturn, and it goes
without saying that businesses of all sizes are suffering.
Of course, this will not always be the case, and once the
clouds begin to clear and the economy starts to recover, we
expect to see renewed growth in investment. In the meantime,
there are a handful of policy measures worth considering, which
we will touch on today. Those initiatives have the potential to
not only bolster the entrepreneurial community, but jump start
the economic recovery.
Small businesses will play an integral role as the country
continues to work its way out of this recession. Following the
downturn of the mid-1990s, entrepreneurs stepped up to the
plate to create 3.8 million new jobs. Much of that growth was
fed by equity capital, and many of those businesses, mere
start-ups at the time, have since grown into industry leaders.
Entrepreneurs can help initiate that same kind of
transformation today, but not without the resources necessary
to create the new products that unlock those new markets.
I look forward to hearing our witnesses' thoughts on how we
can help small businesses survive during this economic
downturn, and I thank them in advance for their testimony.
And with that, I would like to yield to Ranking Member
Fallin for her opening statement.
Ms. Fallin. Thank you, Mr. Chairman, and good morning to
all of our panelists. We appreciate you joining us today. We
know that you are all very busy trying to make money. So we
thank you for coming to testify.
And, Mr. Chairman, I want to say just thank you for calling
this very timely meeting on an important subject for our nation
and especially for our small businesses and for our venture
capitalists and our entrepreneurs of our nation who I believe
are the backbone of America and ones who generate our jobs and
help move our economy forward, and especially during these
challenging times for our nation. We need to do all that we can
to support our businesses and especially encourage innovation
and entrepreneurship.
So thank you all for coming here today and welcome to our
Small Business Committee. We want to listen to you to hear from
the experts in the industry and to be able to share this
information today with our colleagues here in the House.
Over the past several months this Committee has held
numerous briefings detailing the credit crunch that is
affecting America's small businesses, and due to the worsening
economy, small businesses are finding it is very hard right now
to find the capital that they need to purchase inventory to
make payroll, to pay rent, to support their businesses, and it
is a very tough time.
The credit crunch affecting small businesses has been well
documented. We know that it is an issue. No less of a problem
although and maybe somewhat less publicized is the current
shortfall in equity investment. We in Congress must look at all
ways that we can stimulate small business growth as this will
play a vital role in our nation's economic recovery.
Equity investment, which includes the venture capital, the
angel investing and private equity, has played a crucial role
for a long time in the formation of small businesses for many
decades. Unfortunately, these concepts are often some of the
most misunderstood in entrepreneurship.
Now, it was commonly held that venture capitalists are
involved only in early stage financing of relatively small,
rapidly growing technology companies. This type of investment
may be better viewed as a professionally managed pool of equity
capital in exchange for a piece of ownership in the pie.
Venture and angel capitalists provide a wide range of services
from finding additional investors to financial planning, to
providing very valuable skills to a firm and to a business, and
not surprising, the current economic conditions are having a
negative impact on the amount of money that is available, the
size of the venture capital investments in small businesses.
Global financial markets have constricted dramatically, and
there is little doubt that we are facing some unprecedented
economic times. And due to this ongoing turmoil, businesses
especially or small businesses are finding it very difficult,
as the Chairman just stated, to raise capital from banks or
even in the stock market. And there are times, I must say, I
wonder about how we are affecting that by some of our talk here
on Capitol Hill.
Following public exchanges have been having a double impact
on the companies seeking financing not only for the devaluing
of private stock values and holdings, but also wiping out vast
amounts of equity capital. When private investors see their
portfolios shrink, they become more conservative. Money that
might have gone to early stage private investments is sometimes
headed off to safer harbors like CDs, mutual funds, or even
bonds.
And the amount of money involved nationally fluctuates from
year to year, but over the past three years, venture capital
dollars invested in the total number of deals have remained
somewhat steady, around $28.6 billion and around 3,811 deals
per year.
That being said, 2008 saw the first yearly decline of total
investments of venture capital since 2003. Venture capitalists
investments in 2008 experienced an eight percent decrease in
dollars, a four percent decrease in deal volume from 2007, and
this decline in investments has reached all industries. I do
not think anybody has been immune from it in all stages of
development.
So this hearing today is to allow us as members of the
Small Business Committee an excellent opportunity to be able to
hear from you, those of you who are working every day in these
marketplaces, to know what we can do to better help you.
And, Mr. Chairman, I will just say as I mentioned a few
moments ago, I think sometimes our rhetoric here on Capitol
Hill and maybe in the national media, some of the policies have
really had an effect upon all of our investors, our
entrepreneurs in raising money. I had the opportunity to visit
with some of our small business owners from across our nation
this week, and one of the things they told me was they said in
these challenging times for our business community and with a
recession and the different policy changes that are being
debated here in Washington where they are dealing with
financial markets, where it is dealing with stability, Wall
Street, whatever it might be, they said just quit changing the
rules on us. You know, we do not know from day to day what is
going to happen with bailouts, stimulus, all the different
things that we are debating here in Washington. Just do not
change the rules. Just give us some certainty, and we will let
loose our money and we will spend it.
Right now we are scared. We are worried in a way that it is
talking about raising capital gains, talking about raising
corporate income taxes, taxes on small businesses. All of those
things concern our business and our investors, and the equity
markets.
So we are looking forward to hearing from you. We have been
very blessed in Oklahoma to have OCAST, Oklahoma Center of
Science and Technology, and some state funds and many different
venture capital funds in our state, and I know it is very
important to not only our state, but to our nation.
So thank you, Mr. Chairman, for bringing up this issue and
holding that hearing today. We appreciate you, and I will yield
back my time.
Chairman Altmire. I thank Ranking Member Fallin, and I also
want to thank Congressman Ellsworth for being here from
Indiana. We look forward to hearing from him later.
And I want to explain to the witnesses the process we have.
We are going to move from your left to your right across. We
are going to introduce you one at a time, and you have five
minutes to speak. The light that you see in front of you is
going to start on green. When you have one minute left it is
going to turn yellow, and when you are out of time, it is going
to turn red, which means sum up, but I will be lenient.
I thank you all for being here because you do have other
places you could be a this point, but this is an important
enough issue to you that you made the trip, and we do want to
thank each and every one of you for offering your expertise to
the Committee, and we look forward to hearing from you.
Now, Ms. Pamela Hendrickson is Chief Operating Officer of
the Riverside Company, a private equity firm with headquarters
in Cleveland and New York, which focuses on investments in
small and middle market companies.
Ms. Hendrickson.
STATEMENT OF PAMELA HENDRICKSON, CHIEF OPERATING OFFICER, THE
RIVERSIDE COMPANY
Ms. Hendrickson. Thank you.
Chairman Altmire, Ranking Member Fallin, thank you very
much for having me this morning.
As you said, I am Pam Hendrickson, Chief Operating Officer
of the Riverside Company. We're a private equity firm that has
spent the last 21 years investing in small companies around the
world. Recent newspaper headlines might have some people
believing that the private equity industry is made up of former
investment bankers who used black box financing to acquire
companies in big cities and then vaporized the assets and the
employees. That is not what we do.
We have invested $1.8 billion in 211 companies. We work
with them for about five years, and when we sell them,
typically their earnings have risen by 100 percent. Today I
want to talk for a few minutes about how we do that.
Unlike venture, which helps companies in the start-up phase
of their life cycle, we help companies that are in a bit of a
later stage. We have three mechanisms by which we create value.
First, we increase the earnings of the companies we buy.
Second, we earn a bigger multiple upon sale because we have
built a much stronger company.
And, third, on occasion we restructure the balance sheet.
I am happy to tell you only eight percent of our gains have
come from restructuring the balance sheet. For us it is all
about growth.
About 60 percent of the companies we buy are family owned
businesses in small communities, like Oneida, New York or
Paris, Kentucky. The founders and owners typically have most of
their net worth tied up in these companies, and when they
decide to sell their business, it is generally because they are
seeking liquidity for retirement or to secure the financial
future of their families.
For example, we purchased CPI, a training company based in
Brookfield, Wisconsin. The company was for sale because the
owner had been diagnosed with a terminal disease and wanted to
insure that his employees would be safe and his business would
be ongoing.
We quickly evaluated this opportunity and were able to
close this transaction in 30 days. Today, through the addition
of new programs, some international growth and some modest
price increases, CPI has increased its sales by 25 percent, and
the employees are prospering.
On other occasions we work with young management teams that
need both capital and additional expertise to grow, one in
Washington, Pennsylvania, in fact, and sometimes we actually
create a small business from what we affectionately call a
corporate orphan, a non-core division of a large company that
has suffered due to lack of capital and attention.
Such was the case with Just Right Manufacturing in Mattoon,
Illinois. Just Right was a division of Federal Signal, a
manufacturer of safety products that help prevent catastrophic
industrial accidents, and it really needed attention. We bought
it, founded a top management team, and realigned its pricing
strategy.
Since our acquisition, the company has grown earnings 40
percent and kept a lot of jobs in Mattoon.
We help our companies in many ways other than simply
providing capital. First, we give them access to our strong
lender network. In 21 years, our senior lenders have lost money
only once. So they like working with us. Our debt ratios are
low, 2.9 times operating earnings versus the industry average
of four and a half times.
Second, we pool the purchasing power of our 50 U.S.
companies so that they get the benefit of being part of
something bigger. For example, on a pooled basis, our company
spent $25 million with FedEx so that each of them gets treated
like Hewlett Packard.
Third, we have done a tremendous amount of work helping our
companies manage their health care benefit costs. Through our
programs we have held per employee per year cost nearly flat
since 2006 at $8,000. The industry average is 36 percent
increase.
Recently we actually got a nice compliment from the United
Steel Workers who were impressed that we were able to continue
offering such great benefits.
We also improve financial controls and bring in strong
outside directors. As the PE industry continues to contribute
increasing percentages of GDP, it is understandably gaining the
attention of the regulatory bodies just across the aisle, I
think. One area of particular concern to us are the new FASB
157 or mark to market regulations. While we fully support
marking to market and have always done so, the new regulations
require that we use outside resources and a more public company
approach. Last year we did a transaction every eight days. So
we are constantly in the market, and we really know how to
value companies.
Unfortunately, we are now being forced to value companies
during our hold period in a way that is different from how we
value them ourselves when we buy and sell them. In addition,
these regulations are costing our investors an additional
$500,000 per year due to the additional time required from our
auditors and outside consultants.
Getting the U.S. economy out of the doldrums will
undoubtedly be driven by the growth of small business, but we
need debt, and despite our great lending relationships, the
debt markets remain tight. We have wondered whether there might
be an opportunity for some form of public-private partnership
through which the SBA could provide some debt at the fund
level.
We have a lot of skin in this game, and the future of our
firm is based purely on our track record. Just as companies
compete for capital so we compete for investor capital. It's a
very democratic process, not based on status or where we went
to school, but based purely on our performance. So we have to
grow our companies.
Thank you.
[The prepared statement of Ms. Hendrickson is included in
the appendix at page 24.]
Chairman Altmire. Thank you, Ms. Hendrickson.
Now we will turn to Sherrill Neff. Mr. Neff is founding
partner of Quaker Bio Ventures, a venture capital firm located
in Philadelphia that invests primarily in life science
companies with outstanding growth potential. Mr. Neff is
testifying today on behalf of the National Venture Capital
Association, the leading trade association that represents the
U.S. venture capital industry with over 450 member firms.
Welcome, Mr. Neff.
STATEMENT OF P. SHERRILL NEFF, QUAKER BIO VENTURES, ON BEHALF
OF NATIONAL VENTURE CAPITAL ASSOCIATION
Mr. Neff. Thank you, Mr. Chairman, Ranking Member Fallin,
Mr. Ellsworth.
I am a founding partner of Quaker BioVentures, which is a
Philadelphia based venture capital firm investing only in life
sciences companies with outstanding growth potential across all
stages of development. We raise money from institutional
investors of many types and invest those funds for the long
term in innovative start-up companies. All of our funding and
efforts go toward company growth, not financial reengineering.
In most cases, venture capital is the only funding source
for these companies at their stage of development, as the risks
are way too high for traditional bank and other financing.
Venture capital is a relatively small asset class, and it
should probably stay that way, with approximately $28 billion,
as Representative Fallin mentioned, invested on an annual basis
over a fairly consistent period of time, with a notable blip in
the early part of the 2000-2001 period.
Last year that capital went into 3,800 different companies
in the United States. Despite our size, our industry has
created exponential value for that investment dollar. Venture
backed companies account for more than 10.4 million United
States jobs and $2.3 trillion in U.S. revenues, or 18 percent
of the entire GDP. And we estimate that one out of three
Americans have benefited personally and directly from venture
backed medical innovation.
Organ regeneration and development of drug therapies for
macular degeneration are just two of many, many innovations
represented in our portfolio of over 30 companies, which also
contribute thousands of jobs to the regions in which we invest.
While the venture capital community is not in need of
rescue by any means and, in fact, has money available to invest
in emerging growth companies, there are critical ways in which
policy makers can support our efforts to continue to build
innovative American companies.
First, we support maintaining capital gains tax treatment
for the carried interest portion of our investment return. This
tax policy has proven to motivate venture capitalists to make
long-term investments in creating new companies and jobs that
did not exist before. Encouraging this investment behavior is
exactly what Congress intended when it enacted capital gains
tax legislation many, many years ago.
It is critical that VCs continue to be rewarded in a manner
commensurate with the huge risks we take. Otherwise our risk-
reward equilibrium will be thrown off, and even highly
promising companies will not get funded because we cannot
justify the risk.
The President's budget has a provision to change the
carried interest tax rate to ordinary income effectively
tripling taxes of those most responsible for new company
creation. At a time when our country needs to create jobs, such
a change is counterproductive for economic growth. We ask that
you look very carefully at each industry impacted by the change
in the carried interest tax rate and enact policies that are
fair but continue to promote long-term investment rather than
to choke it.
Next, we need government funding for basic research to fuel
the innovation pipeline from which we draw to create our
companies. A great example in our portfolio is a company based
in Connecticut called Optherion, developing truly novel
therapies for macular degeneration.
Optherion was created from NIH funded technologies in four
universities, the University of Iowa, the University of
Pittsburgh Medical Center, Rockefeller University, and Yale
University. We have combined all of these technologies together
with an experienced management team, have raised over $30
million in venture capital funding, and the company's drugs
will begin human testing later this year.
We applaud the allocation of a significant chunk of
stimulus dollars to continuing basic scientific research in the
universities' academic centers.
In other areas, such as the SBIR grant program, venture
backed companies have been unfairly excluded, in our opinion,
from applying as there is a misconception that venture backed
companies are not small businesses. This, as you know, is not
true. Venture backed companies are often without revenues and
with employee counts in the single digits. Without federal
funding these companies often cannot move forward with basic
research projects.
We commend this Committee for passing legislation last year
addressing this issue and hope to permanently resolve this
issue this year.
Third, we ask that the government look at the many
instances where regulation has created additional burdens and
uncertainties that threaten the growth of small companies. For
instance, many companies are struggling with the cost of
Sarbanes-Oxley compliance, which continues to place a very
expensive burden on small entities.
In our sector, the life sciences sector, regulatory
uncertainty at the FDA continues to have an adverse impact on
our ability to make investment decisions. When the rules are
changing, you do not know what you are investing in, and it is
very, very difficult to decide that without clarity.
Lastly, the government can protect innovators better
through an approach to patent reform that recognizes the
disproportionate burden for smaller companies when defending
against patent infringement. This protection in our opinion
should include a post grant review process that is limited to a
very short period, 12 months, so that small companies are not
subject to endless patent challenges by large corporations.
It also involves meaningful infringement penalties in
situations so that we can really deter large companies from
infringement that today is not adequately costly to them.
Another area of protection that is important to us is the
protection of companies that have invested millions of dollars,
decades of development, bringing novel biologic therapeutics to
market. If generic alternatives are allowed to enter the market
shortly after the original is made available, the original
innovators will not be able to recoup their investments. No
investor will be able to fund them profitably, and innovation
will stop or slow.
The venture capital industry remains committed to investing
in the most promising innovative small businesses our country
has to offer, but we need to maintain an environment that
allows these companies to thrive. As Congress considers
policies that impact start-ups and the start-up community, we
appreciate the opportunity to offer an ongoing voice that
supports the viability and growth of these entities.
Thank you.
[The prepared statement of Mr. Neff is included in the
appendix at page 36.]
Chairman Altmire. Thank you, Mr. Neff.
And to introduce the next witness, Mr. Walker, I will turn
it over to Ranking Member Fallin.
Ms. Fallin. Thank you, Mr. Chairman.
We are very pleased to have a fellow Oklahoman up here
today, Mr. Tom Walker who is the President and Chief Executive
Officer of I2e. He brings tremendous energy and leadership to
the creation of commercialization and entrepreneur development
initiatives in Oklahoma's advanced technology sector.
And Tom is a founding member of the Board of Directors of
the National Angel Capital Association, serves on the board of
the Oklahoma Biosciences Association and the Oklahoma
Manufacturing Alliance, and has been a great leader in our
state in venture capitalism.
So, Mr. Walker, we are glad to have you here.
STATEMENT OF TOM WALKER, PRESIDENT AND CEO, I2e, ON BEHALF OF
BIOTECHNOLOGY INDUSTRY ORGANIZATION
Mr. Walker. Thank you. It is my privilege, Chairman
Altmire, Ranking Member Fallin, Mr. Ellsworth.
Thank you for this opportunity to testify today regarding
the difficulties facing the venture capital and angel capital
industries, and in particular, how it is impacting the
biotechnology industry.
My name is Tom Walker. I2e is a nonprofit corporation in
Oklahoma that assists advanced technology companies, and we
provide specialized commercialization services and access to
risk capital in the earliest stages of a company's life,
especially to those companies facing the funding gap that we
commonly refer to as the valley of death. We accomplish our
goals through the assistance of the State of Oklahoma actually,
through OCAST. We have invested in over 100 start-up companies
over the past ten years.
However, today I am testifying on behalf of the
Biotechnology Industry Organization, an organization
representing more than 1,200 biotechnology companies, academic
institutions, state biotechnology centers, and related
organizations involved in the research and development of
health care, agriculture, industrial and environmental
biotechnology products. The overwhelming majority of biomember
companies are small, early stage, research and development
oriented companies. America's leadership position in this
industry today is really threatened by the economic environment
that we find ourselves in.
The total capital raised by the biotech industry has fallen
56 percent in the last year. Almost half of all public U.S.
biotech companies have less than one year of cash remaining on
hand. The amount raised through initial public offerings has
fallen by 97 percent, from $1.9 billion to $5.8 million. The
slowdown in private investments has been dramatic as well, as
venture capital investors find they can no longer afford the
high risk that is characteristic of investment in biotech.
So I will briefly mention a few approaches to sustain
emerging biotechnology companies in this time of need. First,
allow small companies access to the NIH Recovery Act funds. As
part of the Economic Recovery Act, Congress appropriated $8.2
billion to the National Institutes of Health. These dollars
will largely be used for basic research and must be spent
within the next two years.
Historically, NIH grants go to research institutions. So if
we could just allow a small percentage of those funds, the
Recovery Act funds, to go to small businesses, it would have a
tremendous impact in this time of need in developing new
technologies and therapeutics, things of that nature in the
biotech industry.
Second, we should enact new tax incentives for investment
in biotechnology. One thing in particular, President Obama's
budget proposed to eliminate capital gains taxes on investments
in start-up companies. Yet details on this proposal have not
been forthcoming. So I would urge members of Congress to work
with the Obama administration to refine the proposal in order
to make it as useful as possible for small, capital intensive
companies greatly in need of new funds.
Third, I would like to bring up amending the SBIR
eligibility rules related to venture capital. This has been a
highly successful program for injecting government dollars into
small, innovative firms. The SBIR program currently excludes
companies that receive a majority of their funds from venture
capital investors. So enactment of the SBIR reauthorization and
considering changes to allow for greater participation of
companies that receive VC funds is more important than ever in
this current economic climate.
Fourth, I would like to consider creating a funding
mechanism for high growth companies, a new funding mechanism,
perhaps a grant, even a loan program that is really targeted to
high tech companies, really targeting a specific stage even for
those companies that are unable to raise funds should be
considered. This program need not be permanent or add to the
deficit, especially if structured properly. I think there are
terrific best practice examples at the state levels that we
could look at to really model a program for the SBA.
A private investors wait on the sidelines for the financial
markets to recover, government can help to fill the funding gap
through narrowly targeted measures. I would suggest that we are
far better off spending a little money today rather than seeing
a whole generation of America's most cutting edge, science
based industries decimated by the current capital environment.
Thank you.
[The prepared statement of Mr. Walker is included in the
appendix at page 48.]
Chairman Altmire. Thank you, Mr. Walker.
We turn to Catherine Mott. Catherine Mott is the founder
and CEO of BlueTree Capital Group, an organization located in
Wexford, PA, that provides the professional staff to facilitate
and manage the Allied Angels organization.
In 2003, Catherine Mott started Western Pennsylvania's
first business model angel network, BlueTree Allied Angels.
Welcome, Ms. Mott.
STATEMENT OF CATHERINE MOTT, FOUNDER AND CEO OF BlueTREE
CAPITAL GROUP, LLC
Ms. Mott. Thank you, Chairman Altmire and Ranking Member
Fallin and all of the members of the council.
I took the liberty to title my discussion today
``Entrepreneurs Can Lead Us out of the Crisis.'' Before I
elaborate on the title, please allow me to explain my company's
BlueTree Capital Group and BlueTree Allied Angels.
BlueTree Capital Group was created as an entity to
purposefully aggregate angel investors to invest in early stage
companies. We are a member of the Angel Capital Association,
our professional support organization whose testimony you will
hear from John May today. Because BlueTree is located in
Pittsburgh, PA, we are fortunate to be strengthened by three
outstanding universities that serve as very fertile ground for
a multiple spin-out of ideas into companies.
Please do not confuse us with Silicon Valley, Boston or San
Diego. We are Midwest town with a very small but vital venture
capital presence. The companies created in Pittsburgh are less
likely to be funded by VCs or even by super rich angles like
Marc Andreessen, who is the founder of Netscape, but instead
they are funded on the backs of hard working professionals
whose average annual salary is between 200 and $400,000.
I tell you this because most angel investors look like us,
not like Marc Andreessen, whose multiple millions lead people
to think that they can invest in start-ups under any
circumstance and in any economic climate.
The average angel investor in the U.S. is at the lower end
of the wealth spectrum and is not located in Silicon Valley or
Boston. This is an important distinction for the Committee. The
current economic crisis has crippled the average angel
investor's ability to invest because their net worth has
dropped to a point where they no longer can place marginal
capital at risk on start-up companies.
At BlueTree Allied Angels, since September 2008, two-thirds
of our 53 investors have ceased investing in early stage
companies. Why should this matter? Well, it matters because
they fund companies that banks or other sources of capital will
not or cannot fund. It matters because these investors are the
mechanism that fills the funding gap between friends, family,
and institutional financing. Without this mechanism, there
would be no Alcoa today. It matters because entrepreneurs are
the fertile soil for job growth and recovery. It matters
because funding entrepreneurs can lead us out of the economic
crisis.
This recessionary crisis is more than a downturn caused by
bad lending practices and Wall Street avarice. The greater
underlying dynamic is at work and it has been at work for some
time. A fundamental change is taking place in the global
marketplace. It is a rapidly changing, technology driven global
economy.
The United States, the nation that brought the world
electricity, the telephone, radio, TV, and the personal
computer, could be losing the race for its own history. China,
Germany and India and other countries are aggressively
encouraging and setting the stage for an economy that will
flourish in this new technology driven age.
For example, contrast the U.S. capital gains tax rate to
the zero percent capital rate and Hong Kong, Singapore, and
even Germany. The current U.S. economy and its tax policies are
not built for this rapidly changing, technology driven new
world.
In addition to fixing our U.S. debt and credit
infrastructure, the U.S. needs a healthy equity capital
infrastructure that can rapidly respond to the demands of a new
age and the new competitive forces of the world. The real
danger for the U.S. lies in merely fixing the old economy and
ignoring the new economy.
Only entrepreneurs have the flexibility, the freedom and
the risk everything ambition to find the path back to
prosperity, and it is the passion and commitment of angel
investors funding these entrepreneurs that makes it possible.
Yes, passion and commitment; about half of the angel investors
provide more than money to entrepreneurs. They provide
experience, guidance, business consulting, and contacts from
their Rolodex.
The passion and commitment also exist in tolerating
investment loss. Like our venture capital friends, in an
average angel investor portfolio of 18 companies, the angel
investor will see five of these companies go bankrupt and only
one or two will deliver an outstanding return. It might be
better explained metaphorically. Five will strike out, ten will
make it to first or second base and return a moderate amount of
capital to investors, and one and maybe two will be a Hank
Aaron home run.
The hidden cost of this economic crisis is that angels have
lost their wings. They are retracting as a result of the weak
market and a stymied economy. I greatly appreciate the
opportunity to speak with you today because as policy makers,
you can make a difference by setting a tone with legislative
initiatives that can help reverse the downward spiral of
investing in business building and job growth.
Regardless of where we fall in the political spectrum, all
of us in this room have to agree that innovation and building
businesses are imperative elements of American economic
strength. There have been recent policy initiatives to restore
our national communications and travel infrastructure, but that
infrastructure has no value unless we restore the financial
infrastructure for building sustainable companies. Nice, new
bridges do not mean a thing unless we are creating sustainable
jobs whose tax base can pay for the nice, new bridges.
If capital does not start flowing soon to start-ups and
early stage businesses in this country, we will be faced with
years of lost innovation. We will lose the good paying jobs and
the healthy tax base to other parts of the world that are
aggressively facilitating innovation and start-up companies. I
hope you will consider the six suggestions that are in my brief
that I have submitted to you, and I appreciate this opportunity
to speak.
Thank you.
[The prepared statement of Ms. Mott is included in the
appendix at page 54.]
Chairman Altmire. Thank you, Ms. Mott.
We will hear next from Mr. John May. He is the founder and
managing partner of New Vantage Group, a leading angel
investment firm that mobilizes private equity into early stage
companies and provides advisory services to both funds and
private investors. Mr. May is testifying today on behalf of the
Angel Capital Association, the leading organization of angel
groups with over 165 member groups and another 22 affiliate
organizations throughout North America.
Thank you for being here, Mr. May.
STATEMENT OF JOHN MAY, NEW VANTAGE GROUP, ON BEHALF OF ANGEL
CAPITAL ASSOCIATION
Mr. May. Thank you, Chairman Altmire, Ranking Member Fallin
and Mr. Ellsworth.
It is great to be here and to be included in this
discussion. I actually have enjoyed organizing angels, high net
worth individuals in this Washington, D.C. area, and it
occurred to me I should extend an invitation. Any time you want
to see the way we operate, come on and let us know and you will
come to attend a breakfast meeting with us. I will not charge
you for the first meeting, and we really would enjoy sharing
with you this new phenomena of angel groups as opposed to sole
practitioners.
The Angel Capital Association is only six, seven years old.
It came out of a great relationship with the Kauffman
Foundation in Kansas City, and it really is the organization
which is trying to professionalize and to learn best practices
on how to grow early stage companies with the time and money of
high net worth individuals, as opposed to institutional money,
to round out our community.
As you know, start-up companies and high growth companies
need capital beyond the customer, beyond bank financing, and
what is a uniquely American phenomenon over the centuries has
been individuals investing their own after tax dollars in
strangers' opportunities to try to get high growth companies to
provide jobs and economic development in their region. Ninety
percent of us invest within one or two hour drive time of our
own community, and we look for long-term capital gain, and we
will touch on that in the testimony.
We have been organizing the development of these angel
groups. We have realized in the little bit of research that is
done we are probably at about the same size in terms of capital
deployed as the institutional venture capital industry, about
25 to $30 billion a year, but our groups tend to do 50,000 or
100,000 transactions a year in all 50 states, whereas as you
know, the traditional institutional venture capitalists are
really looking for the cream of the crop and heavily are
dominated by larger transactions into a smaller number of high
growth companies.
What we are trying to do is to develop the local high net
worth individuals doing it (investing) to develop our own local
economy. We have a real problem in today's economy because the
engine of angels' activity is their own personal net worth, and
that is down, as you know, in the economy. So we mention that
the number of angel investors is going to be reduced by this
economic crisis. Their propensity to spend their wealth on high
risk, early stage ventures is down right now. That needs to be
reinvigorated, and just as entrepreneurs are finding people who
have left and been laid off are starting businesses, and
entrepreneurs are looking for capital, the banks, and
institutional venture capitalists and so forth are not as
robust as they were.
So what can we suggest? So in the testimony we just suggest
five areas that we would like to suggest that might be
appropriate for governmental attack, and we can hopefully have
a dialogue and talk about these in a few minutes.
One obviously is tax policy. Low long-term capital gains is
the underlying commitment that we have to spend our time and
our money for three, five, seven years. Obviously the most
important thing would be to not have that highly taxed when it
comes out. So angels are very dependent upon a 15 percent or
lower capital gains tax rate.
Second, the idea of many states, 22 states in the United
States, and many foreign countries have tax credits that are
applied to the investment that you make in a qualified company
so that you are incentivized and can diversify your portfolio
further because you get a 20, 25 percent tax credit for taking
this risky investment. It has been done at the state level
successfully in the United States, including some of the states
represented here. We would recommend that you look at not only
the capital gains tax rate, but the pros and cons.
Maryland, for example, has a 50 percent tax credit for an
investment in a biotechnology company, but it only has a
certain amount of capital, six million a year, and they sit in
line on July 1st to be able to have the company apply for its
position in that pool of six million, and it is exhausted
usually in the first half of the year. So there is something
here that incentivizes individuals.
Next, education training and awareness. Think of just a few
dollars were used at the university level, at our nonprofit,
the Angel Capital Education Foundation to further in all 50
states the development of angels, the encouragement of
entrepreneurs to approach high net worth individuals and have
less mystery and the whole idea of how to approach an angel,
how angels should develop their risk profile of making these
investments.
I am the lead instructor in one such Power of Angel
Investing Seminar, and you should just see the light go on when
people are sitting there in Charleston, South Carolina, in
Boise, in Chicago, and realize that you can do this with some
help.
Third, we really do think we should keep angel investing at
a private level. We do not see any need for a governmental
office or an SBA program to highlight angel education activity,
Website development. We think that is best done at the private
level. It is tax policy and some other things that might need
governmental hand.
Fourth, accredited investor standards have been very
constant over the last two decades. We would prefer not to see
any change in the sophistication standard that is used by the
SEC to allow for angels and entrepreneurs to deal with high net
worth individuals as accredited investors, the million dollars
of net worth, for example.
There has been some discussion of indexing that or changing
that. That would be detrimental to entrepreneurs because then
the sophisticated angels would not necessarily have that
position because it was raised.
And last, there is the idea of leveraging private equity,
and similar to Tom's discussion, we would urge you to think
about a loan program or a co-investment program similar to
Scotland and some of the other countries of the world where if
an angel or an angel group makes a commitment, does the due
diligence and has a relationship with an entrepreneur and takes
risk capital and makes the investment, the idea would be that
this loan program or a federal program would match that to some
degree and then would make the government entity an investor in
these companies, but would not need any bureaucracy, would not
need any administration. It would follow an angel group that
would make the investment, and it would increase the money that
was available to entrepreneurs.
I have gone on too long. I apologize, but I do want to
suggest that there is a lot of meat here that we would love to
have further discussion with you afterwards, and we are always
available at angelcapitaleducation.org to answer any questions
that you might have.
[The prepared statement of Mr. May is included in the
appendix at page 59.]
Chairman Altmire. Thank you, Mr. May.
Finally we will hear from Mr. Patrick Dalton. He is the
President and Chief Executive Officer of Apollo Investment, a
leading provider of investment capital for small, middle market
companies generating both current income and capital
appreciation through debt and equity investments.
Welcome, Mr. Dalton.
STATEMENT OF PATRICK DALTON, PRESIDENT AND COO, APOLLO
INVESTMENT CORPORATION
Mr. Dalton. Thank you, Chairman Altmire, Ranking Member
Fallin, Mr. Ellsworth.
I am very pleased to be here today. My name is Patrick
Dalton. I am the President and Chief Operating Officer of
Apollo Investment Corporation, an SEC regulated business
development company commonly known as a BDC. For five years
since our IPO, Apollo Investment Corporation has invested over
five and half billion dollars in 124 small and middle market
companies across the U.S., and today we have up to $700 million
of available capital on our balance sheet.
As successful as our company and our industry have been, I
am here today to let Congress know that the mission that this
body gave to BDCs 29 years ago to provide much needed capital
to small and mid- size companies is in danger unless prudent
policy steps are taken now.
I am not here to ask for money. Far from it, I am here to
ask for some common sense policy help so that we can use the
money that we already have to originate new loans and to
support the very companies that this Committee feels so
strongly about.
But first, the good news. We estimate that the nation's
BDCs currently have a combined loan- investment portfolio of
over $30 billion that provides capital to over 1,400 small and
middle market businesses. These loans are the life blood of
these Main Street businesses that support over 1.2 million U.S.
jobs. In 2007, we estimate that the BDCs provided approximately
50 percent of all the junior debt capital loans, known as
mezzanine loans to small and mid-size businesses throughout the
U.S.
As many of you know, Congress created the BDCs in 1980
under amendments to the Investment Company Act of 1940, in
direct response to the crisis in the capital markets that
threatened small businesses in the late 1970s. Today we are in
what many believe is a once in a century recession. Small and
middle market businesses have once again been abandoned by the
traditional sources of capital.
BDCs remain among only a few investment vehicles that are
continuously dedicated to lending to small businesses. Our
industry is lending in excess of $30 billion. None of us wants
to see capital of that magnitude withdrawn from or otherwise
unavailable to small and middle markets.
It is our strong belief that BDCs occupy a unique
regulatory space. Like banks, we originate, restructure, and we
make loans directly to companies with the intention of holding
most of these loans to maturity. However, unlike banks, we are
much less levered, with a maximum leverage ratio of debt to
equity of a mere one to one.
Further, we are required by statute to invest at least 70
percent of our capital in small and middle market U.S.
businesses, and while we make similar discrete, hold to
maturity loans as banks, BDCs are obligated to mark to market
100 percent of our loans, while the banks only mark to market a
minority of their loans.
We are regulated by the same division of the SEC as mutual
funds, but we are not a mutual fund. We do not trade liquid
securities. Instead, we make individualized loans.
BDCs have always used fair value principles to value our
portfolio. Prior to the implementation of FAS-157 in its
interpretive guidance, the industry used fair value
measurements based upon underlying credit fundamentals, that
is, the collectability of interest and principal in the pricing
of new mezzanine loans.
Unfortunately, we have been forced by changes in the
accounting rules in order to practice to fix what was not
broken. The accounting community now requires that our illiquid
assets be valued as if they were trading assets being sold into
a hypothetical market, too often drawn from a series of
distressed asset sales or other illiquid assets that are not at
all comparable to our individualized performing loans. We
believe that this practice has caused artificial asset value
write-downs for the BDCs without meaningful regard to the
credit quality of our underlying assets and has misled
investors.
And most important to the mission of this Committee, the
same accounting asymmetry results in many fewer loans and
perhaps the succession of all origination activities to the
small business community by the BDCs. Every BDC finds itself
hoarding cash rather than making loans so that they will not
trip their statutory one- to-one asset coverage test that I
mentioned earlier.
Apollo Investment Corporation I am very pleased to state
has recently reported that we are in compliance with all of our
covenants. Yet we still must be cautious about using any of our
$700 million of available capital toward making new loans. We
have, therefore, voluntarily chosen to curtail new lending
activities until such a time that there is a resolution to this
issue. This means that while we have the ability and the desire
to lend, we are unable to do so because of the policy and
interpretive guidance of FAS- 157.
As many of you know, the leadership of this very Committee
has written the SEC asking that regulatory reform be taken
quickly before further deterioration occurs, but as of today,
we are still in need of your help. We have made three
suggestions to the Commission, and it is to those three
suggestions that I want to return.
First and foremost, we ask that the BDCs be expressly
included in the work that the FASB and the SEC have been tasked
with by the House Financial Services Committee to respond with
improvements to mark to market accounting. If we are able to
offer true value accounting for a hold to maturity loans, we
could and we would resume lending.
Second, we ask that BDCs be given temporary authority to
raise preferred stock and treat those shares as equity rather
than debt.
And, third, we also ask you for temporary relaxation of the
asset coverage limits.
In closing, let me end where I began. I am not here to ask
for taxpayer money. I am not asking for a bailout of an
industry that made bad decisions. I am here solely to ask for
your help in returning us to the public purposes for which you,
the Congress, created BDCs 29 years ago. It would, indeed, be a
shame if common sense did not prevail.
Thank you.
[The prepared statement of Mr. Dalton is included in the
appendix at page 67.]
Chairman Altmire. Thank you, Mr. Dalton.
For questions we will go back and forth, and I wanted to
open up by asking Mr. Neff a question.
In your testimony you talked about the large investments
made by a small group of venture capitalists. Can you further
explain why venture capital is so important to the economy in
context with how what you do is different from the big buyout
groups and the hedge funds?
Mr. Neff. That is a lot to chew, but I will give it a try.
When we come upon an investment that interests us, it typically
has gotten either a terrific group of management around it if
it is a raw start-up, and the idea is so compelling that we
invest a lot of time and a lot of consulting help and a lot of
effort in trying to understand the opportunity.
And then when we do decide to try to put together a group
of venture capitalists to actually form a syndicate to make an
investment, at that point we give birth to that company or if
it is a company that has been funded through the angel networks
or through other programs, we then bring another round of
investment intensity to the company and help to propel the next
stage of growth.
The important point is that our companies are receiving our
capital in order to invest in research and development or in
order to invest in job growth, and in order to invest in
economic growth. These companies were not generally using any
of our capital to pay off other shareholders, to buy positions
of ownership from other shareholders, to repay debt and those
kind of things that are shuffling the financial deck, if you
will, but not being invested in core economic growth.
So I think that venture can be contrasted from the buyout
firms in that regard. Now, I do not mean to contrast ourselves
unnecessarily from firms like Pam's because they invest so much
in growth equity at a slightly later stage than we do, but I
think that there is definitely from a policy perspective; in my
mind, there is a real difference between firms who primarily
invest in job growth and in fueling company growth when
compared with firms that generally invest in highly leveraged
transactions and a reshuffling of the financial deck.
Chairman Altmire. Thank you.
And I am going to ask another question, and then I am going
to turn it over to Ms. Fallin. For this question I would like
all of your opinions who have an interest in answering. We will
start with Mr. Neff since we are on him.
And in your testimony in particular you focused upon the
President's proposal to apply no capital gains tax for
investments for small businesses, and from your perspective in
the investment of the entire panel, how broadly should this tax
be applied in order to maximize its benefits to the small
business community?
Mr. Neff. I think there will need to be a lot of discussion
in terms of what the parameters of its application are, but I
think that if we can adequately define what a small business is
and we can adequately define the purpose of the proceeds of the
investment so that it creates jobs, so that it creates funding
for research and development and early commercialization
activities, I think that that is where that tax incentive ought
to be focused. If it is focused instead on things that are less
productive to economic growth, then that is where it ought to
be cut off.
Mr. May. At the Angel Capital Association conference summit
that we had last year, about 380 credited investors
representing the different groups, all of us were there, and
this is herding cats. These are all very interesting people,
but they all have a lot of opinions.
The one common public policy position we came up with that
everybody agreed on was low or no long-term capital gains, and
we would be very happy with the venture capital standard or
whatever.
It is time that makes a difference to us. So whether you
make it two years, three years, five years, to have zero
capital gain, that is the key thing that will keep angels, we
believe, continuing to invest in start-ups.
Mr. Walker. I would just echo the other comments that were
made. It is a definitional issue on what is a start-up or a
small business that really needs to be defined, and then the
use of proceeds and make sure that the infusion of capital is
for economic development purposes.
The time factor on the capital gains is really key to
investors.
Ms. Hendrickson. I agree with that. I think it is the time
factor, and obviously private equity has been a little bit a
the vortex of this in terms of the carried interest discussion,
but you know, when you think about what we do, we are putting
both our money and our sweat equity into a company that makes
chimneys, and we are working with that company for five years.
So if that is not a capital gain, I am not quite sure what is.
Chairman Altmire. Ms. Mott.
Ms. Mott. If I might add, it is more than the time frame
element here at risk. We are competing with a zero percent
capital gains rate in Hong Kong, Singapore, China, other parts
of the world, and I do not think we can keep up with innovation
and funding innovation at the same rate if we cannot keep
attracting capital, and I think it is a very critical point.
Chairman Altmire. Mr. Dalton, do you have anything to add?
Mr. Dalton. We are a lender. We have 90,000 public
shareholders. So the conversation for our business is not
relevant.
However, I hear the panel's point, and I think it is a good
one. Private equity in general does put a lot of sweat equity
and does, you know, take a lot of time. We have the benefit of
seeing small companies get to a later stage and become middle
market companies. So I think that it is a worthwhile discussion
that ought to be had and not necessarily carving out specific
groups.
Chairman Altmire. Thank you.
We are going to have votes on the floor momentarily. So
what we will do is just keep asking you questions until they
call those votes and then we will adjourn.
So I will turn it over to Ms. Fallin.
Ms. Fallin. Thank you, Mr. Chair.
I was listening to some of your comments about who the
investors are and how much money they have and, in particular,
I heard one comment that the angel investors are not the
Silicon Valley type investors, but they are people who make
between 200 and 400,000 a year and have some extra cash that
they want to invest into venture capital. I think it was you,
Ms. Mott, who said that, and that two-thirds of you investors
now are strapped financially and many of you said they are
sitting on the sidelines waiting to see what the rules are here
in Washington and what the game is going to be.
And in light of all of that, when we look at some of the
budget proposals that we are seeing right now in Congress,
especially as it relates to people who make over 250,000 a year
and some possible tax increases on those people, it seems to
fall in that 200 to $400,000 range that you are talking about
for the angel investors.
So how would the proposals that we are seeing here with the
administration and Congress on raising taxes for those making
over 250,000 affect the ability or maybe the availability of
the angel investing funds from those people who are in that
market range?
and if I could ask all of you that.
Ms. Mott. We have already been impacted dramatically. When
you see your net worth decline by 46 percent, you know, it
impacts the marginal income you have to invest, but let me put
it this way. Typically what you can invest if you are doing
good, practical portfolio management, five to ten percent of
your investable assets is what you risk in this asset class. So
whether it is hedge funds or anything, because it is considered
a very risky asset class, suddenly you see that go down, and
that five to ten percent you had you no longer have.
And so additional taxes are only going to impact that
marginal piece that you can invest at risk because it really is
at risk. Five of these companies out of 18 you will lose. They
will go bankrupt. You will lose your money on.
Ms. Fallin. Okay. Mr. Walker.
Mr. Walker. Thank you.
I agree. We are taking essentially that money that would be
available for start-up companies away. There are other things
we could do. For example, Mr. May's testimony on a tax credit
or incentive to those private investors who make targeted
investments in emerging growth companies. So perhaps that is a
catalyst to help offset this discussion.
Ms. Fallin. Yes, sir. I like that idea.
Mr. May.
Mr. May. As I say, it is almost impossible to get three of
us, much less, you know, 380 at a conference or 12,000 to agree
on any one public policy area, but the key thing we find is
that these are people who are dedicated to doing this. They
love to recycle their funds and their time and give back to the
community.
So one of our concerns is that there are so few people that
are very wealthy that ever do this. I mean, it is just amazing
that it is in the blood of a lot of people and you are right.
We need to have as much capital in their hands as possible
because they know what to do with it and they take the risk of
multiple portfolio companies, but we have not ever sort of come
up with any one magic bullet, and so that is why we try to, as
you say, explore a variety whether it is sidecar funds, whether
it is encouraging the later stage money that will pick up when
we run out of money, whether it is low capital gains. I just
think all of the things you are exploring are important, and
yes, anything that would reduce our amount of capital is not
necessarily good, but that does not mean that they will spend
it on angel investing unless that level playing field is also
worked on.
Ms. Fallin. Sir?
Mr. Dalton. For our company and the BDCs in general, our
investors are really Mom and Pops who invest to get the
dividends, fixed income. So they are participating in private
equity. So I think what is important is that, you know, they
have transparency and the confidence and the appropriate sort
of rules so that they can understand what we are investing in
and where the credit worthiness of our portfolios are, yet the
accounting issues are making that transparency challenging for
us.
So I do think that it is less of an issue about sort of the
taxes at that level, but people are investing in BDCs as a way
to get access to private equity, but also wanting to sort of
get that current income, and because of the lack of
transparency, the entire BDC stocks have had a downward spiral,
and not because of book value but because the concern about
tripping covenants based upon assets that move every day, based
upon hypothetical markets, 100 percent of our portfolio.
Yet we hold over 90 percent as an industry to maturity for
the liabilities are fixed. So we have had to pull back our
capital to protect against that when we should be lending our
capital and have the desire to lend and available capital to
the middle market and small companies.
Ms. Fallin. Okay. Mr. Neff.
Mr. Neff. Let me try to be very direct. There is no
question that increased tax rates have an adverse impact on
capital formation. I do not think I need to say anything more.
Capital formation, whether it is institutional like I do or
whether it is individual like some of these folks do, is very
fragile and anything that increases uncertainty and anything
that increases a feeling that you have less capital available
to you has an adverse impact on the ability to pool that
capital and deploy it effectively.
Ms. Hendrickson. I agree with Mr. Neff. Most of our
investors are institutional investors, university endowments,
pension funds. So they are not directly impacted by that
particular tax provision. They are mostly impacted, frankly, by
the destruction in the equity markets and the fact that they
have no liquidity at this point.
Ms. Fallin. Mr. Chairman, if I can ask one more question if
possible, because I know we have got to go vote, one of the
things I am concerned about is we are talking about tax policy
as we are hearing various hearings about bonus money and
callbacks and retroactively taxing and things like that. Do you
ever get concerned, as I do, that some of our U.S. investment
money, some of our corporate money may go out of the country if
we start increasing capital, increasing capital gains tax,
increasing corporate tax I should say, increasing capital gains
tax, and changing the rules all the time; that they may just
take it to one of those foreign countries you were talking
about that had zero capital gains tax?
Mr. Dalton. Yes.
Ms. Fallin. Okay. That is good.
[Laughter.]
Ms. Mott. You know, some of my colleagues are already in
China. They are in Australia on the West Coast. So, yes, they
are already looking.
Mr. Walker. Yes, I think maybe another way to look at this
again is we should be doing things that are catalysts for small
business creation regardless of the industry, and the more we
can quit changing the rules and keep a level playing field and
provide some incentives as a catalyst to create companies is
the way to go.
Mr. Neff. I think what you have addressed has more of an
impact on foreign capital flowing into the U.S. than it does on
U.S. capital flowing outside of the U.S. because an individual
U.S. citizen making an investment in Hong Kong will have U.S.
taxes on that, not Hong Kong taxes on that.
But the other way around is definitely true. If big pools
of foreign capital, which traditionally do flow into this
country, can get much lower tax rates outside of this country,
they are not as likely to flow into this country.
Ms. Hendrickson. I agree with Mr. Neff. That is the same
issue for us.
Ms. Fallin. Thank you, Mr. Chairman.
Chairman Altmire. You are welcome. Thank you.
I am going to try to squeeze one more in before they call
this vote. It starts with a question that Ms. Mott brought up
in her testimony, but again I'll open it up for the whole
panel. She commented on the role that government can play in
helping to educate potential angels and grow angel networks,
and I was wondering if, in your opinions, does adequate support
framework exist for the industry to take up new resources and
implement these new education programs. So we will start with
Ms. Mott.
Ms. Mott. The framework exists in the Angel Capital
Association and the Angel Capital Education Foundation, but I
think additional funding is required to expand that reach. Like
Mr. May, as a matter of fact, on Monday I will be in Austin,
Texas teaching a course, an ACEF course, to angel investors for
term sheets and due diligence, but I know we have very limited
resources, and a lot of us do this out of the goodness of our
heart, not because we get paid.
But I can only imagine if the ACEF and the ACA could expand
those courses to Web based courses. I think we could reach a
greater number of people to learn about this asset class
because it is very convoluted, and the more people who become
comfortable with it, the more inclined they would be to engage
in it. So, yes, support for the ACA and the ACF because I think
the structure is already there in many ways and perhaps maybe
Mr. May could elaborate on that.
Mr. May. Well, I was just going to say whether it is
through the trade association, the nonprofit, or whether it is
through entrepreneurship centers at universities, the greatest
upswelling over the last several years in a lot of the graduate
programs have been in the entrepreneurship centers and programs
all over the United States, and this is a subcomponent of that,
is access to capital. We help train people to be entrepreneurs
and then we do not adequately show them how to write a business
plan, negotiate a term sheet, and understand valuation at this
stage because it is less transparent than the later public
companies.
So we definitely would recommend that tax policy is great
in some of these other areas, but anything that could be done
to increase public awareness and education would be
significant.
Mr. Walker. A key point to that question is as we talk
about the capital gap widening in the country and a lot of
areas in the U.S. are smaller population centers, but we are
still growing biotech companies and emerging growth companies,
and anything we can do to help organize those early stage
capital resources just helps the system start up more
entrepreneurial based ventures.
Chairman Altmire. Perfect timing.
[Laughter.]
Chairman Altmire. I ask unanimous consent that members will
have five days to submit statements and supporting materials
for the record. Without objection, so ordered.
Thank you all very much for being here. This was very
instructive. This is going to help the Committee as we move
forward and address these issues. We really appreciate your
time.
Mr. May. Thank you, and come to a meeting any time you
want.
Chairman Altmire. We will take you up on that.
This hearing is now adjourned.
[Whereupon, at 11:23 a.m., the Subcommittee meeting was
adjourned.]
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