[Senate Report 110-199]
[From the U.S. Government Publishing Office]
Calendar No. 422
110th Congress Report
SENATE
1st Session 110-199
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SMALL BUSINESS VENTURE CAPITAL ACT OF 2007
_______
October 16, 2007.--Ordered to be printed
_______
Mr. Kerry, from the Committee on Small Business and Entrepreneurship,
submitted the following
R E P O R T
[To accompany S. 1662]
The Committee on Small Business and Entrepreneurship, to
which was referred the bill (S. 1662) to amend the Small
Business Investment Act of 1958 to reauthorize the venture
capital program, and for other purposes, having considered the
same, reports favorably thereon with an amendment in the nature
of a substitute and recommends that the bill do pass.
I. PURPOSE AND NEED FOR LEGISLATION
The purpose of the ``Small Business Venture Capital Act of
2007'' is to reauthorize and improve the Small Business
Administration's (SBA) Small Business Investment Company (SBIC)
program and the New Markets Venture Capital (NMVC) program so
that more small businesses, in number and diversity, have
access to venture capital. This type of financing is important
because it provides patient capital to firms that show
significant growth potential but need time for the business to
mature without the burden of monthly debt payments. As Dr.
Jeffrey E. Sohl, Director of the Center for Venture research at
the University of New Hampshire's Whittemore School of Business
and Economics, pointed out to the Committee during a June 21,
2007, roundtable, ``debt servicing is money that is going out
the door.'' Ideally, he says, ``the angels and equity dealers
at the early stage are in there for a good five to seven
years,'' because small businesses need ``all the money to stay
with the company and to fuel the growth for the company.'' \1\
Moreover, as explained by former Federal Reserve Board Chairman
Alan Greenspan: ``Credit alone is not the answer. Businesses
must have equity capital before they are considered viable
candidates for debt financing * * *. Continued efforts to
develop markets for private equity investments will be rewarded
by an innovative and productive business community. This is
especially true in lower-income communities, where the weight
of expansive debt obligations on small firms can severely
impede growth prospects, or more readily lead to business
failures.'' \2\
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\1\ Roundtable on ``SBA Reauthorization: Small Business Venture
Capital Program'' Before S. Comm. on Small Business & Entrepreneurship,
110th Cong. Page 10 (2007) (Transcript of Proceedings).
\2\ Federal Reserve System Research Conference on Business Access
to Capital and Credit, March 1999.
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Venture capital is a critical driver of our economy and job
creation, as well as an essential component in the continuum of
small business financing; it is, therefore, a necessary
function of the SBA. While there is sufficient capital in the
market available for investment, small businesses may have
difficulty accessing these funds, as venture capitalists only
act on one out of every 300 or 400 deals they see.\3\
Traditional venture capitalists focus primarily on high-
technology segments and larger, later-stage deals, concentrated
heavily in just five states (California, Massachusetts, New
York, Texas, and Colorado), and they are looking for faster and
larger returns on their investments.\4\ More specifically,
traditional venture capitalists typically make investments of
$7 million with exits within three to four years, instead of
deals of less than $3 million in which investors are willing to
stay for five to seven years. According to Dr. Sohl and Dr.
Julia Rubin, who also participated in the Committee's
roundtable on June 21, 2007, there is a dramatic need for deals
that range from $50,000 to $1 million, even for deals from $1
million to $3 million, as well as for deals in low-and
moderate-income rural and urban areas and equity for seed money
and startups. Finally, data from the SBA and the National Black
Chamber of Commerce and the U.S. Hispanic Chamber of Commerce
make clear that there is also a need for venture capital
managed by and invested in firms owned by minorities.
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\3\ Roundtable on ``SBA Reauthorization: Small Business Venture
Capital Programs'' Before S. Comm. on Small Business &
Entrepreneurship, 110th Cong. Page 13 (2007) (Statement of Dr. Julia
Rubin, Professor, Edward J. Bloustein School of Planning and Public
Policy, Rutgers University, Transcript of Proceedings).
\4\ Community Development Venture Capital Alliance, The New Markets
Venture Capital Program, Providing Equity Capital and Expertise to
Entrepreneurs in Low-Income Urban and Rural Communities, 4 (January
2007).
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The SBA's programs help to fill many of the gaps identified
above and, therefore, need to be continued. The Agency's SBIC
program targets investments between $250,000 and $5 million. In
FY2006, 40 percent of their investments were in low- and
moderate-income areas and 30 percent of their dollars went to
firms that had been in business only two years or less. Whereas
traditional venture capitalists concentrate their investments
in companies in communications, computers and life sciences,
approximately 50 percent of SBIC funds go to a more diverse
segment of businesses, including manufacturing and consumer-
related businesses. Moreover, SBIC investments impact more
parts of the country. While traditional venture capitalists
make most of their investments in California and Massachusetts,
SBICs have made as much as 71 percent of their investments
outside of those two states. Since the program was created in
1958, SBICs have provided approximately $48 billion of long-
term debt and equity capital to more than 100,000 small firms,
with $2.9 billion invested in more than 2,000 companies in
FY2006 alone. Many of the companies have gone on to become
household names, including Intel, Callaway Golf, Jenny Craig,
Outback Steakhouse, and Federal Express.
SBA's NMVC program addresses the market gap in venture
capital for companies located in low- and moderate-income rural
and urban areas, as well as the need for smaller deals that
neither traditional venture funds nor the SBIC program will
make. By law, NMVC funds are obligated to make 80 percent of
their investments in such areas, but, in FY2006, they surpassed
that target by making 92 percent of their investments in those
areas. Their investments are longer term, ranging from three to
seven years, and their deals range from $500,000 to $1 million.
As Mr. Ray Moncrief, the Executive Vice President and Chief
Operating Officer of Kentucky Highlands Investment Corp. in
London, Kentucky, and a manager of both an SBIC fund and an
NMVC fund, explained at the Committee roundtable on June 21,
2007, most traditional venture capitalists will not do deals of
$750,000 or less because of prohibitive transaction costs.
However, such deals can be done through the NMVC program
because it is structured with an SBA-backed debenture and an
operational assistance grant to offset the expensive cost of
intensive technical assistance to a portfolio company. Those
incentives allow the industry to attract experienced venture
capitalists who could potentially make many millionsof dollars
elsewhere. Attracting that level of expertise, in turn, helps to
attract investors to a field that does not yet have a track record for
investments in these areas. Six NMVC companies were formed and began
investing in 2003 and 2004, and, as of June 2007, the Community
Development Venture Capital Alliance reported that NMVC companies have
invested more than $48 million in 75 companies, all based in poor,
under-invested areas. They have leveraged $136 million in investments
from other sources, provided more than $6 million in operational
assistance to 163 companies, created 368 quality jobs with health care
and benefits, and created or maintained more than 1,600 jobs.
II. SUMMARY
S. 1662, the ``Small Business Venture Capital Act of
2007,'' incorporates S. 1663, the ``Securing Equity for the
Economic Development of Low Income Areas Act of 2005,'' or
``SEED Act,'' and reauthorizes through 2010 the Small Business
Investment Company Debenture and Participating Securities
programs and the New Markets Venture Capital program. There are
four objectives of S. 1662: (1) to simplify the SBIC Debenture
program so that it is more attractive and beneficial to
investors; (2) to tweak the SBIC Participating Securities
program so that the last operating funds have the flexibility
to maximize follow-on investments as the program is phased out;
(3) to encourage investment in firms owned by minorities and
women; and (4) to use the changes to restore the reputation of
and confidence in the SBIC program. S. 1663, as incorporated
into the Small Business Venture Capital Act, modifies the NMVC
program's targeted investment area (the definition of low-
income community) to mirror the New Markets Tax Credit program;
eliminates the matching requirement for the operational
assistance grants to mirror the U.S. Department of
Agriculture's community development venture capital program for
rural areas; and, clarifies that conditionally approved NMVC
companies have a full two years to raise the required private
capital.
III. HISTORY OF LEGISLATION AND VOTES IN COMMITTEE
The SBIC program was originally created almost 50 years
ago, with the enactment of the Small Business Investment Act of
1958, P.L. 85-699 (Aug. 21, 1958). Passage of the Act addressed
concerns raised in a Federal Reserve Board report to Congress
that there was a major gap in the capital markets for long-term
funding for growth-oriented small businesses. Facilitating the
flow of capital through the economy to pioneering small
concerns in order to stimulate the U.S. economy was and remains
today the main goal of the SBIC program. Congress needs to
reauthorize the program because the Small Business Investment
Act, which governs the program, has outdated authorizing
language (from 2006), leaving the program to operate under
appropriations bills and a temporary SBA authorization that
expires on December 15, 2007.
The NMVC program was introduced in 1999 by Senator Kerry
and enacted as part of the 2001 Consolidated Appropriations Act
(S. 1594/P.L. 106-554). The NMVC program addressed concerns
that, while most of the country was prospering, there were
still areas which suffered from chronic unemployment and high
poverty rates. The purpose was to take the power of venture
capital that had transformed the economies of Silicon Valley in
California and Route 128 in Massachusetts and use it to
transform local economies in low-income rural and urban
communities. Based on the SBA's successful SBIC program, the
legislation's goal was to create a separate program that
delivered a double bottom line: economic and social returns.
The program needs to be reauthorized because it has a sunset
date of September 30, 2006, and is currently operating under a
temporary SBA authorization that expires on December 15, 2007.
The ``Small Business Venture Capital Act of 2007'' (S.
1662) was introduced by Senator Kerry, for himself and Senator
Snowe, on June 19, 2007. As introduced, the bill reauthorizes
the SBA's venture capital programs under the Small Business
Investment Company (SBIC) program. During the markup of the
bill, the Committee unanimously adopted by voice vote a
bipartisan managers' substitute amendment offered by Chairman
Kerry for himself and Ranking Member Snowe. The substitute
amendment incorporated S. 1663, the ``Securing Equity for the
Economic Development of Low Income Areas Act of 2007,'' or
``SEED Act,'' a bill to reauthorize the New Markets Venture
Capital (NMVC) program. It also made clarifications and changes
to the bills as originally introduced based on feedback from
participants of the small business venture capital roundtable
held on June 21, 2007. The bill was subsequently adopted as
amended by a roll call vote of 19-0.
S. 1662 incorporated some of the SBIC provisions adopted by
the Committee in the 109th Congress as part of S. 3778, the
``Small Business Reauthorization and Improvements Act of
2006,'' which Senator Snowe, then chair of the Committee,
introduced on August 2, 2006. That bill was reported out of the
Committee unanimously, by a vote of 18-0, but was never
considered by the full Senate before the adjournment of the
109th Congress.
S. 1663 incorporated NMVC provisions that originated in the
108th Congress, as Senator Kerry proposed them for inclusion in
S. 1375, the ``Small Business Administration 50th Anniversary
Reauthorization Act of 2003.'' They were adopted by the
Committee and passed by the full Senate but were not included
in the provisions that were attached to the 2005 Omnibus
Appropriations Act because of objections by the SBA. Many of
the measures were then reintroduced by Senator Kerry in the
109th Congress as the ``Securing Equity for the Economic
Development of Low-Income Areas Act of 2006,'' or ``SEED Act''
(S. 3680), which was cosponsored by Senators Bayh, Landrieu,
and Lieberman. Some of the provisions in S. 3680 were included
in the Committee's comprehensive reauthorization bill, S. 3778,
which, as noted in the preceding paragraph, was reported out of
the Committee unanimously but was never considered by the full
Senate before the adjournment of the 109th Congress. The SEED
Acts in both Congresses were companion bills to H.R. 4303 and
H.R. 1719, respectively, introduced by Congresswoman Gwen Moore
of Wisconsin and Congressman Harold Rogers of Kentucky.
SBA's venture capital programs and the provisions in S.
1662 and S. 1663 were deliberated in a series of hearings and
roundtables in the 109th and 110th Congresses.
On March 9, 2006, during the hearing to examine the SBA's
Fiscal Year 2007 budget and the SBA's proposed legislative
package for reauthorization, the Committee questioned the
rationale for the Administration's proposal to impose
administrative fees on the small business participants of the
7(a) Loan Guaranty program, the 504 Loan Guaranty program, and
the Small Business Investment Company program. These proposals
were controversial and were not adopted by the Committee.
On February 28, 2007, the Committee held a hearing to
review the SBA's Fiscal Year 2008 budget. In addition to
concerns about frozen program levels for the credit programs,
including SBICs, some members were opposed to zero funding for
the NMVC program for the seventhconsecutive year, particularly
considering that the Administration at the same time proposed a new,
separate New Markets program, described as the ``New Markets Tax Credit
Pilot Loan program.'' Senators Kerry and Snowe were successful in
passing an amendment to the FY2008 Budget Resolution (S. Con. Res 21)
that provided funding for the New Markets Venture Capital program.
There was concern about the lack of a proposal or funding for an
initiative to reform the Participating Securities program. Members were
glad to see that the Administration did not recycle the previous year's
proposal to impose an administrative fee on the SBICs, and they were
cautious about the budget's proposed fee reductions for SBIC debenture
deals because there was concern about how the Agency would implement
the reduction while keeping the program at zero subsidy.
On April 26, 2006, the Committee held a hearing on the
``Reauthorization of SBA Financing and Economic Development
Programs.'' The Committee heard from lenders, small business
stakeholders, and SBA representatives on the benefits of SBA's
loan and venture capital programs and evaluated legislative
proposals that were incorporated in S. 3778, the ``Small
Business Reauthorization and Improvements Act of 2006.''
On June 21, 2007, to complement the reauthorization hearing
held on April 26, 2006, the Committee held a roundtable, ``SBA
Reauthorization: Small Business Venture Capital.'' The purpose
was to discuss the state of venture capital for small
businesses, the venture capital needs of small businesses, the
strengths and weaknesses of the SBIC and NMVC programs, and the
provisions in S. 1662, the ``Small Business Venture Capital Act
of 2007,'' and S. 1663, the ``SEED Act.'' The participants
included small businesses that had received venture capital
through the SBIC or NMVC programs, managers who run SBIC or
NMVC funds, experts in the field of developmental venture
capital and equity for small businesses, and representatives
from the Small Business Administration, the National Black
Chamber of Commerce, and the U.S. Hispanic Chamber of Commerce.
Finally, on May 22, 2007, the Committee held a hearing
entitled ``Minority Entrepreneurship: Assessing the
Effectiveness of SBA's Programs for the Minority Business
Community.'' As part of reauthorization, the Committee has
tried to address complaints from minority business owners and
organizations representing minorities that SBA's programs do
not effectively meet the needs of these entrepreneurs and that
the SBA needs to use its economic development tools to help
close the wealth gap between whites and minorities. The
Committee discussed the need to increase the share of loans to
minorities, which has remained largely stagnant since 2001, to
increase the SBIC investments in firms owned by minorities, and
to increase the licensing of SBIC funds to minorities because,
according to the SBA's data, they have been declining since
1998.
IV. DESCRIPTION OF BILL
The ``Small Business Venture Capital Act of 2007''
reauthorizes the SBIC Debenture program, the SBIC Participating
Securities program, and the New Markets Venture Capital program
through 2010. The SBIC Debenture program is reauthorized to
back leverage commitments of $2 billion in FY2007, $2.25
billion in FY2008, $2.5 billion in FY2009, and $2.75 billion in
FY2010. Based on estimates from the National Association of
Small Business Investment Companies (NASBIC), this should keep
pace with current investment levels of SBIC Debenture funds and
leave room for growth. The New Markets Venture Capital program
is reauthorized to back $150 million in debentures, the same
level that is currently authorized by law. In addition, the
legislation reduces from $30 million to $20 million the
authorization level for operational assistance grants. The
Committee estimates that $150 million in debentures would allow
the SBA to license up to 20 new NMVC companies and that the $20
million in operational assistance grants would allow the SBA to
provide each of those companies with up to $1 million in
operation assistance funding. The bill authorizes the SBA to
back up to $500 million in SBIC participating securities in
each of fiscal years 2007, 2008, 2009, and 2010. The Committee
debated whether to provide new authority for the SBIC
Participating Securities program because it is being phased out
and is all but certain not to need the authority. Not only will
the SBA not license new funds, but it is too expensive to fund
any new activity (OMB has concluded that the program no longer
meets the Federal Credit Reform Act standards and therefore
requires a dollar of appropriations for each dollar of
Participating Securities leveraged). Nevertheless, many on the
Committee believe that there remains a need in the market for
smaller equity investments to small businesses and want to see
the program reformed, rather than eliminated. Some of those
proponents thought it was important to signal to the investment
community that there was still support in Congress for the SBIC
program.
Instilling confidence in investors and potential investors
in SBA's SBIC programs was a priority for the Committee, and,
therefore, partial justification for all of the SBIC program
changes in this bill. The Committee agrees that the SBIC
Participating Securities program has flaws in its current
structure, leading to what the SBA estimates will be $2.8
billion in losses by the time all the funds have expired.
However, many on the Committee do not agree that the program,
or other iterations of the program, as adopted by the Committee
in the 109th Congress or proposed by industry, does not meet
Federal Credit Reform Act Standards. The lack of cooperation
and lack of transparency in assessing losses and determining
what meets the test of Federal Credit Reform led the private
sector to conclude that SBIC commitments with the SBA were
unreliable and one-sided, in favor of the government.
In addition to restoring the confidence of the private
sector in the SBIC program, the bill seeks to make the program
more attractive in several ways. It simplifies the rules
regarding the maximum amount of outstanding leverage allowed
for funds. Currently, the maximum amount of leverage available
to a management team from the SBA is determined by a complex
formula that is adjusted annually based on the Consumer Price
Index (CPI). The amount is the same whether the team has one
fund or multiple funds. For FY2007, the maximum amount of
leverage for one fund is $127.2 million. Adjusting the level
each year to the CPI has proven to be tedious for the SBA and
for the fund managers. To simplify the limitation and return
some oversight to the Congress, the bill eliminates the CPI
adjustment and assigns a fixed-dollar amount of $150 million
for one fund and a separate $225 million limit for multiple
funds under common control. Currently, SBA allows multiple SBIC
funds commonly controlled to exceed the maximum leverage amount
on a case-by-case basis. According to the SBA, the requests are
approved the majority of the time. Raising the amount would
streamline the process, saving time and money for the SBA and
the funds. Furthermore, it would accomplish this without
increasing the risk of taxpayer money, since the SBA retains
the right to reject any request to draw leverage if the fund is
not in good standing. Because the approval process for a
license is so rigorous, a fund that is approved for an
additional license is assumed to be astute enough to make
investments over the maximum amount. This change could also
encourage successful fund managers to apply for a second fund
because they would have access to what the industry refersto as
``uninterrupted capital'' for new investments as they are winding down
the previous funds and repaying that leverage.
In a combined effort to simplify the program and to
encourage investments in small businesses that are owned by
minorities or women or that are located in a low-income area,
S. 1662 increases the maximum leverage amount for a single fund
from $150 million to $175 million and, for multiple funds under
common control, from $225 million to $250 million. This change
is important to address concerns among Committee members that,
since 1998, the share of investments in firms owned by
minorities and women has gone down. For example, in 1998, the
share of financings that went to firms owned by minorities was
26 percent. In 2004, the most recent data available, the share
dropped to 10.58 percent. For that same time frame, the share
of financings to women dropped from 6 percent to 2.96 percent.
At the roundtable, both the National Black Chamber of Commerce
and the U.S. Hispanic Chamber of Commerce spoke out against or
submitted comments against the absence of SBIC companies
managed by African Americans or Hispanics.
In order to simplify the administration of the SBIC program
while increasing the percentage of investments in smaller
enterprises (net worth of $6 million or less and average net
profit over two years of $2 million or less), the Small
Business Venture Capital Act eliminates the current law's two-
tiered formula for a flat rate. Currently, firms that leverage
$90 million or less must invest a minimum of 20 percent in
smaller enterprises. Firms that leverage more than $90 million
must invest 100 percent of every dollar over the $90 million
threshold in smaller enterprises. According to the industry,
this system has made it hard to keep records, therefore
creating an unnecessary workload for the SBA and the funds. To
correct this inefficiency, the bill establishes a flat 25
percent requirement that funds must invest in smaller
enterprises. Because SBA estimates that the majority of funds
are $90 million or less, the Committee believes that, on
balance, this change will result in a greater share of
investments in smaller enterprises.
To make the SBIC and NMVC programs more attractive to
investors, more helpful to small businesses, and to bring them
more in line with private-sector practices, S. 1662 increases
the maximum percentage of private capital that an SBIC or NMVC
company may invest in one company from 20 percent to 30
percent. Typically, private investors place 20 to 25 percent of
their entire capital in one company. However, because SBIC
companies have three different leverage ratios available to
them--1:1, 2:1, and 3:1--(NMVC companies typically use a 1.5:1
leverage ratio) the 20 percent limit in practice equates to a
much smaller percentage. For example, a 1:1 fund would end up
with only 10 percent of its total capital available for one
investment and a 2:1 fund would end up with a maximum 6.67
percent of its total capital available for one company. While
the Committee acknowledges that the purpose of aggregate
investment limitations is to mitigate risk for taxpayers and
private investors by forcing SBIC companies to diversify their
portfolios, the Committee is concerned that present law has
resulted in less money for a small business receiving SBIC or
NMVC financing and also less management counseling because the
SBIC or NMVC company is spread too thin with additional
investments. Notably, the management counseling a small
business receives is often as important as SBIC or NMVC
financing dollars, as was attested to in the Committee
roundtable on June 21, 2007, by Mr. Greg Harmeyer, the founder
of Tier One Performance Solutions based in Covington, Kentucky,
a company that received NMVC funding. Companies that qualify
for NMVC financing by their very nature must be located in a
distressed or under-invested area, which means areas that
typically do not have networks and experts to counsel a
business. Consequently, these firms do not want an NMVC
company's money or expertise diluted among too many firms
because it is already hard to come by and they spend a lot of
time and money to find a firm that is a good fit. In fact, the
small businesses argued as strongly in favor of the change as
the investors. ``From the company's perspective,'' said
Harmeyer, ``when you are looking at investors, it is an
enormous effort to manage an investor, to find an investor, and
to find a relationship that works * * * if you are limited by
follow-on investment to say, you are going to have to find
somebody else, that is a big drain on the company's resources
to be able to manage multiple investors who may have different
interests, who have different, competing thoughts of where they
want to go with the company. And so I think it is a detriment
to the company if the investor is limited. I also would
completely agree that the more an investment company is diluted
and has too many companies, the less attention they are going
to give you in helping you grow your business.'' \5\
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\5\ Roundtable on ``SBA Reauthorization: Small Business Venture
Capital Programs'' Before S. Comm. on Small Business &
Entrepreneurship, 110th Cong. 40, 66 (2007).
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Last, among the SBIC provisions, the bill allows SBIC
Participating Securities funds to draw leverage based on SBA-
approved commitments rather than paid-in capital. The SBA is
phasing out the Participating Securities program, and the last
of the funds were licensed in 2004 and will operate through
2014, at a minimum. However, the authority to draw down their
leverage expires next year, at the latest by September 30,
2008, and, according to the industry, at the current investment
rate, most funds will not be able to use all their leverage.
Without access to that capital, many funds will not be able to
support the small businesses in their portfolios that require
follow-on investments. Allowing the funds to draw the leverage
and save their private capital for follow-on investments could
mitigate the unintended adverse consequences of shutting down
this program abruptly, which would harm small businesses and
their investors. The program was authorized in FY2004 to back
$4 billion in SBIC Participating Securities, and the
Participating Securities funds paid the fees for the
commitments. Because the program participants have already paid
for these funds through user fees and the government treats the
$4 billion that was committed in 2004 to be spent, the
Committee considers this provision to be a technical change
rather than a modification that would have significant cost.
The Committee considers this modification low risk because the
SBA could call the private commitments to cover potential
losses if they felt the fund was in trouble and the SBA would
retain the authority to approve or deny the request to draw
leverage from a fund. Furthermore, the exposure for the SBA was
low because there are only 29 funds that would even be eligible
to exercise this option, and not all of those would exercise it
because they can only do so based on need and if they are in
good standing. They could not draw the commitment merely to
hold it.
The Small Business Venture Capital Act also makes changes
to the New Markets Venture Capital program. In order to expand
access to community development venture capital across the
country, the bill adds a geographic requirement to the criteria
for selecting NMVC applicants. Building on the current
provision to seek ``nationwide distribution,'' it directs the
SBA, to the extent practicable, to license NMVC companies in
one of each of the SBA's 10 regions. The current six funds
cover parts of five regions. The program is missing a presence
in the Great Lakes, the South Central United States, the
Midwest, the Rocky Mountain Region, the Southwest, and the
Pacific Northwest. This section strengthens and harmonizes the
current statute so that the Administration is not only required
to establish the program but also toimplement the program. This
clarification was necessary because the program was not implemented in
a timely or reasonable way, which created hardships for applicant
investment groups and unnecessary oversight by the committee. To help
stem the disappearance of U.S. manufacturers, this portion of the
legislation also makes it a goal for the SBA to license one fund that
will focus on investing in small manufacturing firms. At the request of
the SBA at the roundtable, the Managers' substitute amendment changed
the geographic distribution and small manufacturer requirements to
goals.
To address concerns that the SBA does not devote sufficient
resources to the oversight and management of the NMVC program,
S. 1662 establishes an Office of New Markets Venture Capital.
The office would be dedicated to the management of the New
Markets Venture Capital program, and the legislation stipulates
that the director will be career staff, rather than a political
appointee.
One of the most significant legislative modifications to
the program addresses a concern, going back to the original
enactment of the NMVC program, when many community development
venture capitalists and community development venture
capitalist experts, such as Dr. Rubin, argued for the program
to target not only specific geographies but also populations.
They pointed out that, to have the intended impact, it was
important to allow New Markets Venture Capital companies to
invest in small businesses that are either located in a
specific geographical region or employ people who live in the
targeted areas and are very poor. While there was some support
in Congress for that combination, others were opposed to it and
contended that, if the investments were not place-based, the
program would not be effective in attracting venture capital to
the neighborhoods that need anchors to generate economic
development.
However, those concerns have proven unfounded because: (1)
there is a requirement in the current NMVC law that requires 80
percent of an NMVC company's investments to be ``located'' in a
low-income area, which provides a protection against abuses;
and (2) one of the companion New Markets programs, the
successful New Markets Tax Credit program, was enacted with a
definition of geographic area that included target populations.
As was pointed out in the Committee roundtable by Dr. Rubin,
the country's leading scholar in this field who was in the
final stages of assessing the progress of the NMVC companies
for the Agency and who helped craft the original program,
targeting by geography alone is too limiting to meet the
objectives of the program: ``The restrictions that currently
exist around investing in census tracts are very, very
challenging because census tracts are such a blunt instrument.
They change dramatically over the course of the years in
between censuses, and areas that used to be better off might
become poorer, and yet the census tract doesn't reflect that.
Census tracts are large, so you can have pockets of
concentrated poverty that are not reflected in the overall
designation of that tract * * * . So some kind of modification
on the targeting is really quite necessary. And I heard this
very loudly from all the funds.'' \6\
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\6\ Roundtable on ``SBA Reauthorization: Small Business Venture
Capital Programs'' Before S. Comm. on Small Business &
Entrepreneurship, 110th Cong. 14, 77 (2007) (Transcript of
Proceedings).
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Furthermore, if the program is to reach small
manufacturers, the definition must be changed, because even
most small manufacturers are too big to re-locate. Dr. Rubin
pointed out that, as a consequence of current law, the six NMVC
companies have made most of their investments in non-
manufacturing companies. Last, for practical purposes, there
was a need to harmonize the two programs' definitions of ``low-
income community'' so that the programs complemented each other
and were easier for investors to use, thereby attracting more
investors and leveraging more investment in small businesses in
under-invested areas. For these reasons, S. 1662 changes the
definition of low-income geographic area in the NMVC program to
match the definition of the NMTC program. It is important to
note that, while the Committee modified the definition of low-
income geographic area, it preserved HUBZones, Empowerment
Zones, and Enterprise Communities as eligible investment areas
for NMVC funds. There was a drafting error in the bill, as
introduced, that inadvertently eliminated HUBZones, Empowerment
Zones, and Enterprise Communities as eligible investment areas
for NMVC funds. The managers' substitute amendment fixed that
error and also clarified that the entire definition in the New
Markets Tax Credit, including ``targeted populations,''
applies.
Finally, the bill includes a provision to eliminate the
requirement for NMVC companies to raise matching funds from the
private sector to access operational assistance grant money
from the SBA. Specifically, NMVC companies were required to
raise an amount equal to 30 percent of the private capital they
had already raised for the NMVC fund, which amounted to a
minimum of $1.5 million. This proved virtually impossible,
wasting precious time and dollars flying around the country
fundraising. Consequently, when Congress adopted a bill by
Senator Harkin that established an NMVC program for rural areas
at the Department of Agriculture, it eliminated that
requirement. This brings the programs in line with each other.
This section of the bill also clarifies current law to provide
that NMVC companies have two years to raise the matching
private capital. Current statute says that they have ``up to''
two years. In the past, the SBA has interpreted this to mean
that it has the discretion to allow NMVC companies up to two
years and has set the time limit for raising the private
capital at shorter lengths, which the companies found
unreasonable and unrealistic.
V. COMMITTEE VOTE
In compliance with rule XXVI(7)(b) of the Standing Rules of
the Senate, the following votes were recorded on June 26, 2007.
A motion by Senator Kerry to adopt the managers' substitute
amendment, offered by Senator Kerry for himself and Senator
Snowe, to S. 1662 was passed by voice vote. The amendment
included S. 1663, a bill to reauthorize the New Markets Venture
Capital program.
A motion by the Chair to adopt the ``Small Business Venture
Capital Act of 2007'' as amended, to reauthorize the venture
capital programs of the Small Business Administration and for
other purposes, was approved by a unanimous 19-0 recorded vote
with the following Senators voting in the affirmative: Kerry,
Levin, Harkin, Lieberman, Landrieu, Cantwell, Bayh, Pryor,
Cardin, Tester, Snowe, Bond, Coleman, Vitter, Dole, Thune,
Corker, Enzi, and Isakson.
VI. COST ESTIMATE
In compliance with rule XXVI(11)(a)(1) of the Standing
Rules of the Senate, the Committee estimates the cost of the
legislation will be equal to the amounts discussed in the
following letter from the Congressional Budget Office:
October 2, 2007.
Hon. John F. Kerry,
Chairman, Committee on Small Business and Entrepreneurship,
U.S. Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for S. 1662, the Small
Business Venture Capital Act of 2007.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Susan Willie.
Sincerely,
Peter R. Orszag.
Enclosure.
S. 1662--Small Business Venture Capital Act of 2007
Summary: S. 1662 would authorize funding over the 2008-2010
period for the small business investment company (SBIC)
programs operated by the Small Business Administration (SBA).
The bill also would amend requirements for disbursing funds
under commitments made through the participating securities
program.
Assuming appropriation of the necessary amounts, CBO
estimates that implementing S. 1662 would result in
discretionary outlays of $245 million in 2008 and $1.6 billion
over the 2008-2012 period. Further, by modifying the
participating securities program, CBO estimates that enacting
S. 1662 would increase direct spending by $50 million in 2008.
CBO estimates that enacting the bill would have no significant
effect on revenues.
S. 1662 contains no intergovernmental or private-sector
mandates as defined in the Unfunded Mandates Reform Act (UMRA)
and would impose no costs on state, local, or tribal
governments.
Estimated cost to the Federal Government: The estimated
budgetary impact of S. 1662 is shown in the following table.
The costs of this legislation fall within budget function 370
(commerce and housing credit).
----------------------------------------------------------------------------------------------------------------
By fiscal year, in millions of dollars--
--------------------------------------------
2008 2009 2010 2011 2012
----------------------------------------------------------------------------------------------------------------
CHANGES IN SPENDING SUBJECT TO APPROPRIATION
Participating Securities:
Authorization Level............................................ 500 500 500 0 0
Estimated Outlays.............................................. 225 500 500 275 0
New Markets Venture Capital Program:
Subsidy Cost:
Estimated Authorization Level.............................. 9 9 9 0 0
Estimated Outlays.......................................... 4 8 8 4 0
Operational Assistance Grants:
Authorization Level........................................ 6 7 7 0 0
Estimated Outlays.......................................... 1 2 5 6 3
Administrative Costs:
Estimated Authorization Level.................................. 19 19 19 20 20
Estimated Outlays.............................................. 15 18 18 19 19
Total Changes:
Estimated Authorization Level.............................. 534 535 535 20 20
Estimated Outlays.......................................... 245 528 531 304 22
CHANGES IN DIRECT SPENDING
Estimated Budget Authority......................................... 50 0 0 0 0
Estimated Outlays.................................................. 50 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Basis of estimate: S. 1662 would authorize funding over
fiscal years 2008 through 2010 for several SBA programs
authorized by the Small Business Investment Act. The SBA
programs that the bill would reauthorize include the
participating securities program, the New Markets Venture
Capital (NMVC) program, and the debenture program. Each program
provides funding to small business investment companies that
make venture capital available to small businesses.
The budgetary accounting for SBA's loan guarantee programs
is governed by the Federal Credit Reform Act (FCRA) of 1990,
which requires an appropriation of subsidy and administrative
costs associated with loan guarantees and loan operations. The
subsidy cost is the estimated long-term cost to the government
of a loan guarantee, calculated on a net-present-value basis,
excluding administrative costs. Administrative costs, recorded
on a cash basis, include activities related to making,
servicing, and liquidating loans as well as overseeing the
performance of lenders.
The budgetary impact of the changes S. 1662 would make to
small business investment programs is measured in terms of
projected subsidy costs. The bill would not specify an
authorization level for either the subsidy or administrative
costs, if any, that could be incurred as a result of
implementing the changes proposed in the bill. CBO has
estimated those amounts based on information from SBA regarding
the historical demand for and costs of the agency's small
business investment programs.
S. 1662 would change the terms that control disbursement of
funds previously committed under the participating securities
program. The bill would allow SBICs to request funds from SBA
without providing a funded commitment from private investors as
required under current law. This change in the conditions of
existing agreements with SBICs would be treated as a loan
modification; under FCRA procedures, the cost of the
modification is estimated on a net-present-value basis and
recorded as a change in direct spending in the year the
legislation is enacted.
Spending subject to appropriation
For this estimate, CBO assumes that the bill will be
enacted in calendar year 2007 and that the necessary amounts
will be appropriated for each year.
Participating Securities. The bill would authorize SBA to
purchase up to $500 million in participating securities in each
of fiscal years 2008 through 2010. Under the participating
securities program, SBA would provide funding to privately
owned and operated SBICs to make venture capital investments in
qualified small businesses. SBICs would be required to share
any profits earned on those investments with SBA.
Prior to March 2005, SBA treated the participating
securities program as a credit program under FCRA, so costs for
the loan guarantees were recorded on a net-present-value basis.
SBA no longer treats the participating securities program as a
credit program, however, and now considers the program to be an
equity investment in the operation of an SBIC. Therefore,
rather than calculating the net present value of the cost of
the guarantees, the full cost of the authorized loan level
would be recognized in the year it is authorized.
Based on historical demand for guarantees under the program
and the gap in availability over the past few years, CBO
expects that demand for participating securities would be high.
Assuming appropriation of the authorized amounts, CBO estimates
that implementing this provision would cost $225 million in
2008 and $1.5 billion over the 2008-2012 period.
New Markets Venture Capital Program. S. 1662 would
authorize amounts sufficient to cover the subsidy costs for
$150 million in debenture guarantees under the NMVC program
over fiscal years 2008 through 2010. Under the program, SBA
would guarantee debentures issued by companies authorized to
invest in small businesses located in low-income areas. Based
on information from SBA, CBO expects that the subsidy cost for
the NMVC program would be about 17 percent and that demand for
guarantees would fall slightly short of the authorized levels.
We estimate that this provision would cost $4 million in 2008
and $24 million over the 2008-2012 period, assuming
appropriation of the necessary amounts.
NMVC Operational Assistance Grants. The bill also would
authorize the appropriation of funds for grants to companies
participating in the NMVC program to provide assistance to
small businesses that have received venture capital funding. S.
1662 would authorize the appropriation of $20 million over the
2008-2010 period for technical assistance grants. Assuming
appropriation of the authorized amount, CBO estimates that
those grants would cost $1 million in 2008 and $17 million over
the 2008-2012 period.
Debentures. S. 1662 would authorize SBA to guarantee
debentures issued by SBICs in the following amounts: $2.25
billion in fiscal year 2008, $2.5 billion in fiscal year 2009,
and $2.75 billion in fiscal year 2010. The debenture program
currently operates at a zero-subsidy rate; that is, the costs
incurred by SBA to provide the guarantees are offset by fees
charged to the borrowers. CBO estimates that reauthorizing the
debenture program through 2010 would not have a significant
effect on spending subject to appropriation.
Administrative Costs. As specified in FCRA, subsidy rates
do not reflect the administrative cost to service loan
guarantees. Based on the current administrative costs for SBA's
loan programs and accounting for the increase in the purchase
of participating securities authorized by the bill, CBO
estimates that the administrative costs related to the small
business investment programs authorized by S. 1662 would be $15
million in 2008 and $89 million over the 2008-2012 period,
assuming appropriation of the necessary amounts.
Direct spending
CBO estimates that enacting section 104 would modify the
terms of existing loan guarantees that would result in an
additional $250 million in SBIC loan guarantees and would
increase direct spending by about $50 million in 2008. Under
credit reform procedures, the costs of such loan modifications
are estimated on a net-present-value basis and recorded as
direct spending in the year in which the legislation is
enacted.
S. 1662 would authorize SBA to disburse certain funds
previously committed to SBICs through the participating
securities program under new terms and conditions. The bill
would authorize SBICs to request funds from SBA without
providing funded commitments of capital from private sources at
the time of the request.
Under the participating securities program in 2004, SBA
issued $4 billion in commitments to provide venture capital to
SBICs. The commitments are limited to a term of five years; at
the end of that period, the funds committed under the program
expire, and any unused amounts cease to be available to the
SBICs. During that initial period, however, an SBIC could draw
against the commitment after demonstrating an appropriate
business need that has been approved by SBA and commitments of
private funding equal to as much as half of the amount to be
used. The new terms under which funds may be requested would
apply only to commitments made in 2004--the last year SBA
offered guarantees under the participating securities program.
CBO expects that commitments made in prior years will expire
before S. 1662 is enacted.
S. 1662 would allow SBICs to request payment of committed
funds without obtaining a paid commitment from private sources.
Based on information from SBA, we estimate that an additional
$250 million in committed funds would be requested by SBICs and
disbursed under this provision.
While SBA began treating the participating securities
program as an equity investment in 2005, this budgetary
treatment has not been applied retroactively to commitments
already in place; therefore, credit reform rules would apply to
this transaction. Because enacting this provision would change
the cash flows associated with the participating securities
program, the funds requested by an SBIC under new terms would
be the result of a modification of the terms under which
existing participating securities commitments were made.
Based on information provided by SBA, CBO estimates that
the subsidy rate for the participating securities program prior
to the modification is about 16 percent; we expect that this
subsidy rate would change as a result of the modification.
First, the loan guarantees would become riskier because SBA
would be guaranteeing the full amount of the SBIC's request.
However, this risk would be somewhat mitigated by a higher
chance for profits to be realized because private funding would
remain available to SBICs for a longer period of time. We
assume the higher risk would slightly outweigh the prospect of
shared profits returned to SBA and estimate that the subsidy
rate for the additional disbursements would be about 20
percent, resulting in an estimated subsidy cost of $50 million
for the $250 million guarantee commitment.
Intergovernmental and private-sector impact: S. 1662
contains no intergovernmental or private-sector mandates as
defined in UMRA and would impose no costs on state, local, or
tribal governments.
Estimate prepared by: Federal Costs: Susan Willie, Impact
on State, Local, and Tribal Governments: Elizabeth Cove, Impact
on the Private Sector: Jacob Kuipers.
Estimate approved by: Theresa A. Gullo, Deputy Assistant
Director for Budget Analysis.
VII. EVALUATION OF REGULATORY IMPACT
In compliance with rule XXVI(11)(b) of the Standing Rules
of the Senate, it is the opinion of the Committee that no
significant additional regulatory impact will be incurred in
carrying out the provisions of this legislation. There will be
no additional impact on the personal privacy of companies or
individuals who utilize the services provided.
VIII. SECTION-BY-SECTION ANALYSIS
Section 1. Short title
This section specifies the short title of the legislation
as the ``Small Business Venture Capital Act of 2007.''
Section 2. Definitions
This section provides definitions for the legislation.
Section 3. Table of contents
This section provides the table of contents for the
legislation.
Title 1. The Small Business Investment Company Program
Section 101. Reauthorization
This section reauthorizes the SBIC programs through 2010
and establishes the program levels for each SBIC program. The
SBIC Debenture program is reauthorized, allowing SBA to back
SBIC debenture guarantees at the following levels: $2 billion
in FY 2007; $2.25 billion in FY 2008; $2.5 billion in FY 2009;
and $2.75 billion in FY 2010. This section reauthorizes the
SBIC Participating Securities program for $500 million a year
for each of FY 2007 through FY 2010.
Section 102. Leverage
The section simplifies the rules regarding the maximum
outstanding leverage allowed for funds: (1) the maximum amount
of outstanding leverage made available to any one SBIC may not
exceed $150 million; (2) the maximum amount of outstanding
leverage made available to two or more SBICs that are commonly
controlled may not exceed $225 million; (3) the $150 million
and $225 million are increased to $175 million and $250
million, respectively, for any SBIC that certifies that not
less than 50 percent of its investments are made in companies
that prior to the investment are owned by either women or
minorities, as defined by the SBA Administrator, or are located
in a low-income geographic area; and, (4) the Annual CPI
adjustments are eliminated.
Section 103. Investments in smaller enterprises
The section requires each SBIC, as a condition of an
application for leverage, to certify that not less than 25
percent of the fund's aggregate dollar amount of financings
will be provided to ``smaller enterprises.''
Section 104. Private capital
The section allows Participating Securities SBICs to draw
leverage based on SBA-approved commitments rather than paid-in
capital. The section clarifies that the provision applies only
to Participating Securities SBICs licensed prior to October 1,
2004, not debenture funds.
Section 105. Maximum investment in a company
The section increases from 20 percent to 30 percent the
maximum investment allowed in a company, and it applies to the
SBIC and the NMVC programs.
Title II. New Markets Venture Capital Program
Section 201. Diversification of New Markets Venture Capital program
This section adds a geographic goal to the criteria for
selecting applicants to the New Markets Venture Capital program
in order to expand access to community development venture
capital across the country. This section strengthens and
harmonizes the current statute so that the Administration is
not only required to establish the program but to implement the
program. To help stem the disappearance of U.S. manufacturers,
the section establishes a goal for the SBA, to the extent
practicable, to license one fund that will focus on investing
in small manufacturing firms.
Section 202. Establishment of Office of New Markets Venture Capital
This section establishes an office dedicated to the
management of the New Markets Venture Capital program. It
stipulates that the director will be career staff, rather than
a political appointee.
Section 203. Low-income geographic areas
This section harmonizes the definition of low-income
geographic area of the New Markets Venture Capital program with
the definition of low-income community used for the New Markets
Tax Credit, which includes targeted populations. And it
preserves HUBZones, Empowerment Zones, and Enterprise
Communities as eligible investment areas for NMVC funds.
Section 204. Applications for New Markets Venture Capital program
This section requires the SBA within one year to establish
a standard documents required from applicants for final
approval.
Section 205. Operational assistance grants
This section changes the law so that firms no longer need
to raise $1.5 million in matching funds to access operational
grant funding. Instead, they will be able to receive a grant of
the lesser of either 10 percent of the private capital they
must raise or $1 million. Also under this section, it clarifies
that conditionally approved NMVC funds will have a full two
years to raise the minimum $5 million in private capital.
Section 206. Authorization
This section reauthorizes the NMVC program for three years,
through 2010. The legislation freezes the debenture
authorization, allowing the SBA to back $150 million in
debentures, and reduces from $30 million to $20 million the
authorization for operational assistance grants, assuming a
maximum $1 million for each operational assistance grant for a
possible high of 20 new funds.