Pension Money Can Fulfill the Need for Capital
Fact: Small-business owners, the heart and soul of the economy of Southern California, need money to grow.
* Fact: Time and again they seek a supply of same from the first source that comes to mind--banks--only to turn away in frustration because they can’t meet bank credit and collateral requirements.
* Fact: There’s another source of capital they might turn to but do not, a plentiful source commanded by people who understand very well the problems faced by small-business owners--people who know those problems firsthand.
Who are these people, and what capital do they command? They are small-business owners themselves--the very people frustrated by the difficulty of getting working and expansion capital from banks, which don’t want the risks represented by small business without ample collateral and pristine credit.
And what capital do small-business owners command? They command the $400 billion in their own pension plans.
That number comes from the Internal Revenue Service, incidentally, and it counts only the assets in the pension plans of companies employing fewer than 100 people. The Small Business Administration defines a small business as one employing fewer than 500 people, so the assets in the pension plans of small-business America as a whole come to a very big sum indeed.
Before you dismiss the idea that pension plan money might satisfy the demand from small businesses for working and expansion capital, listen to what Sam Gilbert, president of United Plan Administrators Inc., a Westlake Village pension consulting firm, has to say about it.
“An investment by a pension plan in small business is perfectly prudent as long as the investment fits the goals of the plan as part of a diversified portfolio,” Gilbert says.
“You can’t invest all of your assets in any one instrument because that violates the diversification rules. But it is certainly prudent to put money into investments that are good for the trust and that will give you a good return.”
Gilbert knows whereof he speaks. He served as a task force chairman for the third White House Conference on Small Business in 1995, heading a group promoting small business as a prudent investment for pension plan assets.
“I have a client, a physician, who called me saying he wanted to lend some of the money in his pension plan to another physician, who was just launching his practice and needed working capital.
“His question was: May his pension plan lend money in this fashion? The answer was: Absolutely.”
Other small-business owners--who, by and large, control the assets in their employee pension plans--might very well do the same, Gilbert adds. Instead, they invest in stocks, bonds and money market instruments, partly out of fear that they cannot legally invest it elsewhere and partly out of unwillingness to think outside the box.
But there is nothing in federal law limiting pension plans to those three investment vehicles. In fact, the “prudent man” dictum adopted by some states requires only that pension plan money go into vehicles likely to meet the investment objectives of the plan; it does not require that pension plan money go into risk-free investments--only that the risk match the investment objectives of the plan. Pension plan administrators invest in stocks, bonds and money market instruments in large measure because other administrators do. They follow the herd on the theory that you can’t violate the prudent-man rule if you presume that it’s impossible for all investors to act imprudently at the same time.
That’s not a bad presumption, and it’s a comfort to follow the herd, of course. But if you’re in the middle of a herd of horses heading north, you’ve got only one thing in view--the south end of the horse directly ahead of you.
Better to break away from the herd, right? Better to invest some small-business pension money where it will do real good--in small business. Better to create a marketplace in which small business could raise capital by selling debt instruments to pension plans controlled by other small businesses. After all, big pension plans do this all the time; along with life insurers, pension plans make a market for corporate bonds nationwide, including lots of private placement debt rated as risky, less-than-investment-grade paper.
In fact, you can make only one argument against the notion that small-business pension plans might well create a similar marketplace for the paper of small business, and it isn’t that pension plans must avoid risk at all costs--because that’s not true. The real impediment is cost. Big pension plans invest tens of millions of dollars at a whack to take advantage of economies of scale in underwriting their deals, including the cost of vetting the risks.
These economies of scale work against small deals; it costs money to buy and sell private placement debt instruments, and these expenses don’t diminish as the size of your deal goes down. You can’t do due diligence on the paper of ABC Widget Inc. as economically as you can on the paper of General Motors.
Which is not to say that you can’t do it at all. As detailed in this space Sept. 17, First New England Capital, a small-business investment company in Hartford, Conn., buys private placement debt instruments from companies seeking to raise as little as $1 million, sometimes less. Life insurers capitalized the company with $20 million specifically to invest in small businesses--and with the expectation of earning annual returns exceeding 20%.
This means that First New England Capital’s deals don’t come cheap; the company earns 10% to 14% on the paper it buys, plus additional capital in the form of equity in the companies issuing the paper, most of them based in New England.
If, however, First New England Capital can operate profitably in the Northeast, surely a similar effort could do so in Southern California, the nation’s biggest incubator of small business, by pooling not life insurer capital but pension money.
To be sure, whoever did so would not lack for business. Marketplaces form when buyers and sellers meet, the former armed with demand and the latter with supply. In this case, there is no end to the demand for capital from small business. And there is plenty of supply--from the same source.
What’s missing in this marketplace is neither buyers nor sellers of capital for small business. What’s missing is a mirror--so that small-business owners who want capital may look to themselves.
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Freelance writer Juan Hovey may be reached at (805) 492-7909 or via e-mail at Jhovey@compuserve.com
