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As President Bush celebrates his victory, startup companies are skipping the party. The White House is expected this year to try to end the Small Business Investment Company program, a decades-old federal initiative to bolster venture capital funding for new businesses. The Bush administration objects to government investment in private business and to helping the SBIC cover losses incurred when the technology bubble collapsed in the late-1990s. Opposing the president is a well-known nemesis. Sen. John F. Kerry, the ranking member of the Senate Small Business Committee, advocates saving the SBIC program, which he credits with creating new jobs and economic growth. “The SBIC program fills the gap between the availability of venture capital and the needs of small businesses in startup and growth situations,” the Massachusetts Democrat and Bush’s recent presidential election opponent said in a policy statement on his Web site. How the fight plays out could have a major impact on venture capitalists and startups. Although Bush signed a stop-gap measure in October to keep the SBIC program running; it expires in mid-November. The SBIC program, which the Small Business Administration administers, dates to 1958 and has 190 participants ranging from behemoths such as J.P. Morgan Chase & Co. and Bank of America Corp. to minnows such as Monmouth Community Bank NA of Long Branch, N.J., and Heritage Community Bank of Danville, Ky. While the SBIC initiative is little known outside the venture capital establishment, its supporters say it has been a major boon for the U.S. economy. Getting off the ground with SBIC funding have been such corporate household names as Apple Computer Inc., FedEx Corp. and Staples Inc. The program provides venture capitalists with up to $2 in public funds for every $1 raised in private funds. In exchange, the government gets repayment priority if the business succeeds and earns an annual return on its investment. The catch is that the venture fund must invest only in startups or similar early-stage enterprises. Eligible companies must have a tangible net worth of less than $18 million and average net income of less than $6 million for the preceding two years. Yet the capital these venture funds obtain from the government can be crucial, enabling larger and more numerous investments, supporters say. For instance, New York-based Founders Equity Inc. received its SBIC license in July 2003 and announced closing of a $120 million fund just more than a year later. John Teeger, a partner at Founders Equity, said the government’s $80 million investment gives the fund greater leeway to chase deals. “The biggest issue for us was what size of a fund we could end up with,” he said. “With our current fund, we’re at a nice size to do deals.” Founders Equity has invested in Glass America, a Chicago company that operates automobile glass replacement and repair businesses in 14 states, and in Petroleum Place Inc., a Denver information technology provider for the energy industry. Jim Parsons, a managing director of New Canaan, Conn.-based private equity firm RFE Investment Partners and former head of the National Association of Small Business Investment Companies, said the SBIC program is set up to be self-funding, meaning returns to the government from successful investments are used to fund other small business investment plans. Although the SBIC program is designed to break-even, from 1994 to 2000 it generated $450 million in excess cash flow. Then the tech bubble burst and SBIC-backed venture funds suffered serious losses. SBA estimates that from 2000 through 2004 the program has incurred $1.2 billion in losses, a figure it projects will rise in the coming years to $1.8 billion to $2.4 billion. The Office of Management and Budget, which recently evaluated the effectiveness of the Small Business Administration for Bush, has reacted to the shortfall by proposing that the SBA institute larger fees and demand a greater cut of the profits. The idea is to ensure the agency receives sufficient returns from successful funds to offset losses from failures. Currently the program gives the agency a preferred return tied to the 10-year Treasury Bond rate — the return has averaged around 7.5 percent in recent years — before private partners get a penny. The program also is entitled to 10 percent of profits until its investment is recouped. Once the venture fund repays the government, it stops having to pay SBA a share of the profits and does not have to share any gains earned by selling the business or taking it public. The SBA would adjust the formula for the preferred return to produce an average of about 10 percent. It also would give the government half of all profits until its investment is recovered. Obligations to the government would end once the funds are repaid. One investment banker who used the SBIC to raise a $140 million fund said he would have declined the government’s help if the new terms were in effect because it would be impossible to earn a profit. “Unless there was an advantage to it, why would anyone want the government as a limited partner?” the banker asked. A report issued by the SBA’s Office of the Inspector General in May states that the SBIC program places too much risk on taxpayers. It urges that SBA increase its share of profits, though it warns that it could result in the creation of fewer SBIC funds. “If SBICs pass on the increases to small business concerns, the latter may be discouraged from using the program,” the report says. SBA spokesman Evan Keefer said there are no plans to scuttle the SBIC program. The agency is working with participants to devise a reasonable alternative to the current repayment formula. Keefer, however, emphasized that the SBIC needs to fund itself, so something has to give. “The program is losing $1.8 billion to $2.4 billion,” he said. “To keep it we have to increase fees.” But Lee Mercer, president of the Washington-based National Association of Small Business Investment Companies, said the SBA has rejected its plan because they claim it would result in an average loss of 30 cents to 35 cents for every dollar investment. That prediction is absurd on its face, he said, noting that pension funds and others would not invest in funds that lost a third of their investment. “When they have that view of the world, no one could have a structure that will work for them,” Mercer said. One source said the SBA is rejecting the plan because it might actually save the SBIC program rather than end it, which is what the Bush administration favors. “Republicans haven’t embraced the SBIC because, philosophically, the government shouldn’t be involved in private capital markets,” the source said. Despite its reservations, the SBA might have no choice but to find a way to restore the program. The House is considering a bill that would codify the changes advocated by venture investors. Sen. Olympia J. Snowe, chairman of the Senate Small Business Committee and a Maine Republican, also has drafted a similar bill with Kerry. Craig Orfield, a spokesman for Snowe, said the committee is talking to the administration, NASBIC and the SBA about developing a system that runs more efficiently, performs better and still meets budgetary restrictions. “That’s going to be a difficult task, but nonetheless Sen. Snowe is trying to come up with a reasoned compromise to address concerns on all sides,” he said. “What the administration is going to accept, however, is really the wild card.” – With Vipal Monga in New York Copyright �2004 TDD, LLC. All rights reserved.

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