Small Businesses Get Venture Capital Bailout

A trial balloon floated by the Obama administration late last week sparked speculation that small businesses may be next to benefit from a government bailout of sorts. The debate eclipsed an initiative coming out of the federal government's Small Business Administration.

As of July 10, small businesses that might otherwise have difficulty securing private equity or venture capital may find funding easier to obtain as a result of changes made as part of the American Recovery and Reinvestment Act to the SBA's Small Business Investment Company program.

SBICs are privately owned and managed venture capital firms, licensed and regulated by the SBA, that make equity and mezzanine capital investments in small businesses. There are 338 SBICs with $17.4 billion in capital under management. Since the SBIC program's formation in 1958, it has invested $56 billion in more than 106,000 small businesses.

Well-known companies have benefitted from SBIC capital as they ramped up, including Staples ( SPLS), FedEx ( FDX), Whole Foods Market ( WFMI), Intel ( INTC), Apple Computer ( AAPL) and JetBlue Airways ( JBLU).

But the new Apples and Intels have been relegated to toiling in obscurity or unprofitability, given that private equity firms such as Blackstone Group ( BX) and Apollo Management ( AINV), and investment-banking units of Bank of America ( BAC) and Citigroup ( C) have reined in spending.

The change makes SBICs eligible for greater SBA-guaranteed funding and requires them to invest 25% of their investment dollars into "smaller" businesses and, by adjusting caps, effectively offers a 50% increase in funding available to a single business by an SBIC. Maximum SBA funding levels to SBICs will increase up to three times the private capital raised by the SBIC, up to a maximum of $150 million for single SBICs, or as much as $225 million for multiple SBICs that are under common control. The cap for all licensees was set at $137.1 million before the Recovery Act.

"It is all-around good," said Brett Palmer, president of the National Association of Small Business Investment Companies. "There is not much capital out there for small business. This does provide capital, a lot of capital. It is market-driven, it is profitable, it doesn't cost the taxpayer a dime, it makes the taxpayer money and there is a need for it."

Michael Gurau, managing general partner of Clear Venture Partners, a New England venture capital fund-in-formation, is hopeful additional efforts will be made to support businesses that are at the earliest stages of their lifecycle.

For years, SBIC funding was split into two camps. Debenture, or debt-oriented, SBICs are designed to fund later-stage companies while participating-securities SBICs infuse capital into early-stage companies that, although riskier, have a greater upside in terms of innovation and growth potential. The latter was effectively shut down during the bush Administration following losses it suffered during the dotcom meltdown.

"The venture SBIC program, while it is a successful and good program, is not the same as a securities program that invests in much earlier-stage, loss-making, classic venture capital opportunities that don't have positive cash flow," said Gurau, who for the past six years served as president of CEI Community Ventures. "Venture capital is really about funding those early years of losses, so that you can break even and get to profitability."