Banks' Investment Firms Higher On New Ventures than Nonbanks'

Small-business investment companies affiliated with banks are more likely than their nonbank counterparts to invest in start-up ventures.

According to a January study from the Federal Reserve Bank of Chicago, the venture capital firms affiliated with banks make 24% of their investments in businesses less than one year old. Those not affiliated with banks make 17% of their investments in such firms.

Small-business investment companies are private venture capital firms, operated by banks or individual managers, that are licensed and regulated by the U.S. Small Business Administration.

The 69 small-business investment companies affiliated with banks make up less than a quarter of the total but provide more than two-thirds of the $4.5 billion invested through such venture capital firms, according to the SBA.

Federal law prohibits banks from owning more than 5% of the voting stock of another business, but small business investment companies can own as much as 49%.

Small-business investment companies can make debt or equity investments and generally finance fledgling firms that generate few tangible assets and may be difficult to monitor.

Bank-affiliated small business investment companies are more likely to finance small businesses with equity investments, rather than debt.

The study showed that venture capital units affiliated with banks put 90% of their capital in equity investments, whereas nonbank small-business investment companies directed less than 70% of their funds into equity investments.

Most companies use the venture capital money for operating capital, acquisition of other businesses, debt consolidation, and research and development.

Bank-affiliated investment companies tend to finance projects such as acquisitions or marketing campaigns that build relationships with other firms or potential customers, the study said.

Investment companies not affiliated with banks usually finance transaction-oriented projects such as new plant construction, debt consolidation, or the acquisition of machinery or land.

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