Venture capital from the SBA

Emerging entrepreneurs absolutely must have access to capital in order to identify their prospects and achieve their goals.

by Bruce L. Hodgman — 

Emerging entrepreneurs absolutely must have access to capital in order to identify their prospects and achieve their goals. While many other tools and skills are indispensable to entrepreneurial success, the ability to access capital when required is supreme among them.

One of the many ways the U.S. Small Business Administration (SBA) helps emerging businesses obtain seed and growth capital is through its Small Business Investment Company (SBIC) program.

The SBIC program is a unique public/private partnership that has provided $46 billion in financing for small businesses since its inception in 1958. SBICs are privately owned and managed investment companies that are licensed and regulated by the SBA. Their primary mission is to make equity capital available to small, growing companies.

These firms often provide financing in the critical $250,000 to $4 million range. This type of equity capital is generally not available through banks or credit unions. SBICs fill that gap, supporting thousands of U.S. small businesses each year.

Successful long-term growth for small businesses depends on the availability of equity capital. Lenders generally require some equity cushion or security (collateral) before they will lend to a small business. A lack of equity limits the debt financing available to growing businesses. Additionally, debt financing requires the ability to service the debt through cash flow, reducing the cash available to grow the business.

Debt financing is defined as funds borrowed by a business that must be repaid over a period of time, usually with interest. Debt financing can be either short-term, with full repayment due in less than one year, or long-term, with repayment due over a period greater than one year. The lender does not gain an ownership interest in the business and debt obligations are typically limited to repaying the loan with interest. Loans often are secured by some or all of the assets of the company.

Equity capital is defined as funds that are raised by a business, in exchange for a share of ownership in the company. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time.

Although investors are committed to a company for the long haul, that does not mean indefinitely. The primary objective of equity investors is to achieve a superior rate of return through the eventual and timely disposal of investments — generally in five to seven years. A good investor will consider potential exit strategies from the time the investment opportunity is first presented and investigated.

Equity investments are often the seed money that helps small companies grow into big companies. Among household name companies that initially received help from SBA-backed SBICs in their early stages are America Online, Apple Computer, Callaway, Compaq Computer, Federal Express, Intel, Outback Steakhouse and Staples.

The secret to accessing capital from an SBIC, according to Mike Shields, partner in Phoenix-based Magnet Capital, is in the business plan. “The SBIC program is an excellent source of growth capital for small businesses. The program is friendlier to closely held and single-owner companies than traditional venture capital, but the financings are still complex and the business owner needs good legal advice in understanding and structuring the deal. A top-quality, comprehensive business plan with a well thought-out executive summary is necessary for us to consider any investing opportunity.”

A good business plan precisely defines your business, identifies your goals and serves as your firm’s resume. It helps you allocate resources properly, handle unforeseen complications and make good business decisions. Because it provides specific and organized information about your company, a good business plan is a crucial part of any equity investment process and the primary tool for selling your idea. Most, if not all, venture capitalists require an all-inclusive business plan before they will consider any investment opportunity.

A section of the SBA Web site is devoted to those seeking venture capital. Whether your business is in the early stages of development or already thriving and seeking growth capital, the SBA wants to help you determine if venture capital financing is right for your company — and if so, who in the SBIC community might be willing to consider an investment. Entrepreneurs interested in the SBA’s SBIC program can visit www.sba.gov/inv for more information.

There are more than 400 licensed SBICs in operation today, including two in Arizona. Most SBICs concentrate on a particular stage of investment (i.e., start-up, expansion or turnaround) and identify a geographic area in which to focus. Each SBIC uses a different form of SBA funding, and these distinctions will impact the type of investments they can make. Contact your local SBA office at 602-745-7200 or [email protected] about SBICs in Arizona.

Bruce Hodgman is the deputy director of the Small Business Association in Arizona. [email protected].

Reprinted from AzNetNews, Volume 25, Number 4, August/September 2006.