No Hot Air

Good News

At the most basic level, this means there's more money out there and more places for entrepreneurs to turn to when they're looking for true equity capital. To date, more than $500 million has been pumped into companies by SBICs using participating securities. And the $284 million of participating securities leverage provided to SBICs in 1998 meant that the SBICs themselves had to come to the table with a minimum of $140 million of their own capital. All told, an estimated $440 million was added to the national pot for start-up and early-stage companies.

Another benefit, notes Klass, is that SBICs aren't supposed to control com-panies. "It's not uncommon that an entrepreneur starts a company," he says, "and the investors take it over, leaving him or her little more than a grub-stake. Or worse, the founder is ousted altogether." While SBIC investors can have board seats, they can't have a majority. In addition, they are generally prohibited from owning more than 50 percent of the company. As a result, there's less risk of losing control of the company.

Third, and most important, says Klass, is that SBICs are supposed to invest in small companies, which are defined as companies with assets of less than $18 million and after-tax income of less than $6 million. This adds a welcome replacement to traditional institutional venture funds, which have in many instances shifted their focus toward larger enterprises. "Overall," notes Klass, "the trend in venture investing has been toward bigger investments in larger companies."

The downside, however, continues Klass, is that if an SBIC makes several investments that turn out badly, the SBA could step in and force liquidation to recover the borrowed funds. "This could cause some discomfort for companies that the SBIC had invested in and were doing well," Klass says. "All of the sudden, they might find themselves scrambling to buy out the government."

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This article was originally published in the May 2000 print edition of Entrepreneur with the headline: No Hot Air.

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