of Business Communications Feature
Congressional Testimony in Support of SBIC
The House Small Business Committee of the US House of Representatives conducted hearings in Aril to determine the role -- and fate -- of the Small Business Administrations participating securities program currently under review by the Bush administration. The program, called Small Business Investment Companies (SBIC), are public-private partnerships designed to help American entrepreneurs create businesses that can flourish, thereby generating jobs, economic prosperity, and improvements to health and safety.
Dan O'Connell, administrator of the Golder Center for Private Equity, was invited to present testimony to the committee as the only practitioner among the presenters. He has made investments both through and outside the program. Other witnesses included Jaime Guzman of the SBA, Colin Blaydon of Tucks Center for Private Equity, Sue Preston from the Kaufmann Foundation, and Red Clark and Mark Redding, both CEOs of companies that have received funding from this type of SBIC.
O'Connell's Oral Testimony
"Chairman Manzullo, Ranking Member Velazquez, and Members of the Committee:
Thank you very much for this opportunity to testify. My name is Dan O'Connell. I am currently the director of the Stanley C. Golder Center for Private Equity studies in the College of Business at the University of Illinois at Urbana-Champaign. This Center focuses on the private equity community.
More than thirty years ago, I was introduced to the venture capital industry as a summer intern in 1973 at the then First National Bank of Chicago. Since then I have served as the venture capital asset class manager at First Chicago, co-founded Alpha Capital, which was one of the first licensed partnership-form SBIC's, made venture investments for the investment division of Allstate, and most recently at the end of 1999, I joined Capital for Business, an SBIC focusing on buyouts and expansion financings of primarily smaller Midwest-based manufacturing businesses. Over the years, I have been all around the venture table, acting at various times as a general partner, a limited partner and an investor in a wide range of private equity situations. During my time with Alpha, I was a NASBIC governor, and in the early 1990's, I had the honor to serve on a committee whose work ultimately led to the creation of the participating securities program.
These past thirty years have been a time of incredible expansion for our industry. Dollars under management, dollars invested, companies created, number and types of limited partner investors, number of investment professionals, and the size and character of supporting infrastructure have all grown dramatically.
During this period there has also been a huge broadening of investment strategies. Today, private equity, broadly defined, includes a broad spectrum of possible investments, ranging from angel and earliest stage start ups through and including huge international multi-billion dollar buyouts.
Yet while the industry has expanded dramatically, it remains fundamentally "granular." That is, there exists a immense matrix of possible investment strategies described across multiple dimensions: size of investment, size of company, stage of company, industry, geography, to name a few. Competition for the available LP dollars encourages general partners to identify niches in which they feel they can compete more successfully, and I can only see this trend toward specialization continuing. It was, and still is, true that successful execution of a private equity group's business strategy requires an underlying match of its human and financial capital to the needs of its chosen niche.
Over these years we have endured several venture cycles in which I have seen it, at one end, incredibly difficult for good investors to raise money and, at the other, incredibly tempting to compromise one's discipline and strengths in order to make investments in overheated, very challenging markets.
So what do these have to do with the participating securities program? In my experience at Alpha, it was conspicuous to those of us using SBA debentures that there was a problem when we wanted to invest in situations characterized by high risk, high growth and potentially high returns; i.e. venture or growth companies. From one perspective, it made little sense for an SBIC to borrow money - which implies some sort of reasonable expectations as to timing and probability of collection - to make an investment in a company that by its stage and character made such expectations unpredictable or unrealistic. Those companies required equity. There was a fundamental mismatch between our source of funds and our uses of those funds. Did we make those investments anyway? Yes, we did, but in less than optimal ways. In my opinion, the participating securities program was intended to provide a better match between the nature of the funds (i.e. long-term, patient, equity-like dollars) provided to the SBIC and the realistic dynamics of the businesses into which the SBIC would invest.
So, is there still a need today for this kind of program? Absolutely. If anything, the increasing specialization of our business suggests an even greater need. From my experience, SBIC's fill important pieces of the private equity matrix. They tend to be more geographically focused, and in regions under served by other sources. Because they have learned how to prosper from exits other than the public market, they are more comfortable with smaller businesses, and with businesses in industries or niches of a size that typically do not represent IPO potential. And once in an investment, SBIC principals often deal with value creation needs somewhat different than those of traditional vc's. Could and do traditional venture funds and the larger buyout groups make these kinds of investments? Yes, from time to time they do. But only when it is easy for them to do so. It is just not time or dollar efficient for them to aggressively make the kinds of investments that an SBIC was formed to do.
Regarding how the program might be more effective going forward, I wish I had more specific knowledge so I could make tighter suggestions. In any case, I would like to make a couple of observations. First, I believe it is absolutely critical that there be a match between a private equity fund's sources of capital and its uses as seen in the investments it intends to make. If you expect the SBIC managers to make relatively high risk, low liquidity, long term, but potentially high return, i.e. equity, type investments, then the SBA dollars that might be used should patient, long term, and risk tolerant.
In any company situation seeking funds from a diverse set of players, there are pricing and term issues. So it will be here. To be successful, all parties to the transaction must feel there is a fair and reasonable sharing of risks and rewards, and that there are reasonable oversight and controls consistent with a player's position in the transaction.
When I look at the SBA itself, my experience would suggest several things. First, because of the risks and illiquidity involved, it is essential that any pool of private equity investments be broadly diversified, both by character and over time. Second, there is a need to be patient. Interim results -- good or bad -- can be very misleading in the private equity business. It is only when you have finally and completely exited an investment that you are able to determine its success. A rush to decision in the middle of the investment process nearly always results in suboptimization over the long run. Both of these issues are portfolio management challenges which are best met by having a staff of experienced professionals. And to build and keep such a staff, it would appear to me, requires a long term commitment to the SBA itself.
Finally, if we in the industry are going to ask for patience and flexibility from our backers, we must do everything we can to earn and sustain their trust. It is thus incumbent upon us to rigorously adhere to the highest management and ethical standards, and to accumulate and share appropriate information that shows the continuing value of our efforts.
In conclusion, thank you, again, for this opportunity to share my experience and thoughts. I truly believe that there is a continuing need for SBIC's that leverage their private capital with equity -- like SBA dollars. I also believe that the SBA has been a productive and valuable partner. And while there are certainly things that can and should be changed, the goal of having a program to support the creation and support of America's small businesses is worth the effort.
At this time I would be pleased to address any questions the Committee might have."