Budget May Boost Available Capital
President Bush’s budget proposal could increase the supply of capital available to small businesses beginning in the fall, good news for companies struggling to find expansion capital in a slowing economy.
The budget proposes a small increase in certain fees paid to the government by small-business investment companies, or SBICs. Although it may seem counterintuitive, the stiffer fees should allow SBICs to raise an estimated $1.4 billion in additional capital for equity investments next year. If that happens, it would increase the pool of SBIC equity capital targeting promising small businesses by about 70%.
SBICs are private investment firms licensed by the Small Business Administration to invest in businesses employing fewer than 500 people and showing a net worth not greater than $18 million and after-tax income not exceeding $6 million over the two most recent years.
Some SBICs do only equity deals, others only debt deals; some do both. The increases in the Bush budget apply only to SBICs doing equity deals.
At present the National Assn. of Small Business Investment Companies, or NASBIC, a trade association and lobbying group in Washington, counts about 410 SBICs nationwide, among them 39 licensed to operate in California.
Last year these SBICs invested $5.5 billion in 3,050 small businesses nationwide, including nearly $3.5 billion in businesses not more than 3 years old. The deals averaged $1.2 million, but the median was less than $250,000, meaning that half the deals done by SBICs last year involved relatively small numbers, according to Lee Mercer, president of NASBIC.
Not surprisingly, California attracted more SBIC capital last year than any other state--$1.4 billion in 856 deals. New York came in second with $592 million, according to NASBIC.
SBICs typically raise one-third of their capital from private investors and two-thirds through the sale of government-backed securities to banks, insurers and other institutional investors.
To hedge its exposure to those guarantees, however, the federal government limits how much capital SBICs may raise via this mechanism--and therein lies the key to understanding the impact of the new fees in the Bush budget proposal.
Last year Congress appropriated $26 million to cover expected losses on those securities, Mercer said. Under the arcane rules by which the government dictates these things, this meant that SBICs could raise only $2 billion from the sale of these securities. The $5.5 billion that SBICs actually invested last year included some of this $2 billion plus additional funds raised in previous years but not invested right away.
The new fees on SBICs would raise about $26 million, or the same sum appropriated by Congress last year to cover losses to holders of the securities underpinning the nation’s SBICs. Thus the new fees in effect underwrite the risk that the government otherwise faces in backing those securities, making a congressional appropriation to cover losses unnecessary, Mercer said. The result: Given no other change in the rules governing how SBICs raise their capital, they should be able to raise $3.4 billion in the fiscal year beginning in the fall, up from $2 billion in the current year, he said.
“By raising the fees, the Bush budget front-ends the reserve account for losses,” Mercer said. “Hence it reduces the expected losses to zero--and the government doesn’t care where it gets that $26 million, so long as it gets it. So the Bush budget could make it possible for SBICs to raise another $1.4 billion to invest.”
Ming-Min Su, president of Calsafe Capital Corp., an Alhambra-based SBIC founded in 1987, said he doesn’t believe that the higher fees will hurt his business. His firm has invested about $5 million in biochemical companies and community banks in California.
According to Mercer of the national trade group, SBICs pay the government annual fees equaling 1% of the government-backed securities underpinning their capital structures; the Bush proposal seeks to increase this to about 1.37%--all in all a minor hike.
“The biggest determining factor is what the market dictates when investors buy the guaranteed securities,” he said. “The annual ‘all-in’ rate for SBICs, including interest paid to buyers of those securities plus all fees to the government and others, was about 9.4% a year ago. This year interest rates are down overall such that, even if the Bush budget is implemented with the increase in fees, the all-in rate would go from 8.15% to 8.52%--less than it was a year ago.”
A listing of SBICs licensed nationwide is available free from the SBA (https://www.sba.gov/INV/opersbic.html). For $35, NASBIC (https://www.nasbic.org) will sell you a list describing the underwriting criteria of its members and the investments they like to make.
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Juan Hovey can be reached at (818) 709-6420 or via e-mail at jhovey@socal.rr.com.
