Small Business Investment Companies: Financial Characteristics and Investments
Brewer, Elijah, Iii., Genay, Hesna, Journal of Small Business Management
In the United States, small businesses rely on commercial banks and the Small Business Administration (SBA) guaranteed loan program to satisfy their short-term and intermediate-term financing requirements. Unlike larger firms, small businesses have difficulties accessing long-term debt and equity markets. In general, their lack of tangible assets that can be pledged as collateral, higher business and financial risks, and greater operational flexibility have combined with other factors to limit the availability of long-term debt and equity sources of funds.
Small Business Investment Companies (SBICs) offer some relief from the scarcity of financing for small firms. The SBIC program was established in 1958 to provide long-term funds to small businesses, not only through loans and other debt instruments, but also through equity investments (see U.S. SBA 1992). Individuals, banks, and other financial institutions, as well as nonfinancial firms, can form SBICs. During the first few years of the program, the number of SBICs increased rapidly; by the end of 1966, 794 SBICs had been licensed, and over $1 billion had been dispersed to small firms. The subsequent oil crisis led to extensive bankruptcies both among the SBIC-backed small firms and SBICs themselves (Gompers 1994). After languishing for several years, the program has shown renewed vigor since the mid1980s.
The driving force behind the recent surge in SBICs' activities has been the SBICs owned by banking organizations. While banks cannot make direct equity investments, they can do so indirectly by establishing SBIC units. SBICs are also unique in that they have access to government subsidies and thus can leverage their private capital with government funds, unlike other venture capital firms. Such leverage is supplied through guarantees or direct purchases of SBICs' debt obligations by the SBA.
This article examines whether SBICs are able to resolve the conflict between the types of investors and financing that are most appropriate for small businesses. The economics of financing small businesses is explored and the characteristics and investments of SBICs are described. Two hypotheses are examined. The first hypothesis is concerned with whether the type of financing provided by an SBIC varies according to the riskiness of the project and the identity of the SBIC. The second hypothesis examines whether SBICs that are associated with banking organizations behave differently than other SBICs. In addition, an SBIC's performance is related to its financial characteristics to further examine whether SBICs that are associated with banking organizations have chosen to take advantage of the SBIC program in such a way as to produce return possibilities different from other SBICs.
With their own capital and funds borrowed at favorable rates from the U.S. Small Business Administration, SBICs provide venture capital to both new and established small firms. Apple Computer, Compaq Computer, Costco Wholesale, Symbol Technologies, Cray Research, Federal Express, Intel, and Staples are examples of companies that were partly financed by SBICs in their adolescence (Zweig 1992). Osborn (1977), using SBIC data filed with the SBA from the beginning of the SBIC program in 1958 through March 1970, examined the nature of the small firms which have been financed by SBICs and the character of the financing that has been provided. He found that over the sample period 39 percent of SBIC funds went to manufacturing industries, while 61 percent went to non-manufacturing industries. Of the funds supplied to manufacturing, 68 percent were used for operating capital, compared with only eight percent for fixed assets. Acquisitions utilized 14 percent of this financing, and seven percent went into refinancing. In comparison to manufacturing, a smaller proportion of SBIC financing to non-manufacturing was absorbed by operating capital and acquisitions; more was supplied for fixed assets and for refinancing. …