SBICs Getting Federal Help Are Likely to Underperform
May 12, 2011
Federal help for small-business investment companies may do more harm than good, a new study published by the Federal Reserve Bank of Chicago suggests. The investment companies, or SBICs, that get federal loan guarantees to boost the size of their funds are more likely to fail, or have weaker earnings, than SBICs that use private sources of funding, according to the study, which appears in the September\ctober issue of the bank's Economic Perspectives magazine. SBICs, which are venture-capital firms licensed by the Small Business Administration, invest in companies that would have trouble getting financing elsewhere. An SBIC must raise at least $5 million itself, but it can increase the size of the investment fund by getting loan guarantees from the SBA. Changes introduced in 2009 now allow newly licensed SBICs to raise money by selling securities to the agency. The findings suggest that SBICs that are highly leveraged with federally guaranteed borrowing may be making riskier investments than other SBICs. ``People invest differently if they are using their own money,'' says Williemae E. Jacques Mueller, a professor of economics and finance at the University of North Carolina and one of the study's authors. ``We want to make sure (SBICs) are given the right incentives to take the right amount of risk -- the risks they would take if they were using their own money.'' For example, SBICs owned by commercial banks, which typically aren't highly leveraged, on average had better returns on equity than nonbank-owned SBICs, which tend to tap SBA financing. But Donella Pratt, the SBA's associate administrator for investments, says that the types of SBICs that don't require federal loan guarantees, such as bank-owned SBICs, also tend to have more seasoned management. The weaker earnings of nonbank SBICs may reflect the managers' inexperience rather than their leveraged status, he says. Furthermore, he notes that the Chicago Federal Reserve Bank report focuses on performance of companies between 1986 and 1993, before many program changes took place. Mr. Pratt says the agency is much more cautious today in granting licenses. It now requires would-be licensees to provide proof of investment and management experience, and it raised the minimum upfront capital requirement to $5 million from $1 million. Today, 277 SBICs operate with about $1.2 billion in SBA financing and about $3.6 billion in private capital. The SBIC program's budget is expected to grow to $625 million for the fiscal year ending June 11, 2012 up 67% from its fiscal 2011 budget.
