Concerns over funding for the U.S. Small Business Administration are not stopping one small business investment company from expanding.
Nashville-based Sirrom Capital Corp., an SBIC established in 1991, hopes to raise as much as $27.2 million through an initial public offering of its common stock next month. The issue is being underwritten by Robinson- Humphrey Co., J.C. Bradford & Co. and Equitable Securities Corp.
While the idea of selling shares in a small business investment company at a time when Congress has budget-cutting fever may seem chancy, the success of the offering may hinge on factors other than the ability of the SBA to fund the SBIC program.
In particular, Sirrom will become only the fifth company to take advantage of a special exemption in the Investment Company Act of 1940 that allows SBICs to raise capital by issuing debt beyond the strict limits set for other registered companies. That difference can add up to double-digit profits.
"When you combine a single level of taxation with low-cost government- backed leverage, you've got a winner for shareholders," said Cabell Williams, president of Allied Capital Corp., a publicly held 1940 Act SBIC. "That is assuming the company is conservative and doesn't have a lot of losses."
The advantages of the structure stem not only from the ability of the company to borrow, but also from the source of much of that borrowed money. SBICs are allowed to issue up to $90 million in 10-year debentures to the SBA at a cost of about 70 basis points over comparable maturity Treasury bonds. This compares with other long-term funding sources that may charge as much as 150 basis points over comparable Treasuries.
For a company with 75% of its capital coming from SBA debentures and a 2% management fee, a $1 million loan at 13% will earn 4%, or $30,000, on the $750,000 funded by the SBA debentures. The remaining $250,000, representing the equity investment, will earn 11%, or $27,500.
All told, the company will earn $57,500 annually on a $250,000 equity investment, for a 23% annual return.
"It is only in this type of company - a company that is exempt from the 40 Act's leverage restrictions - that this magic works," said Mr. Williams.
For companies like Sirrom Capital, the structure opens a new financing avenue as well. Whereas raising capital for a private venture partnership may take as long as two years, a public offering of common stock has appeal to both retail and institutional investors.
"Institutions that own growth stocks don't like owning partnerships," said George Miller, president and chief executive of Sirrom Capital. "There is a much bigger market for your company as a corporation."
This kind of stock offers retail investors a chance to participate in the growth potential of a venture capital fund without having to invest the huge sums often required by venture capital partnerships.
For fund managers, the offering provides a perpetual source of funds. While interest, principal, and capital gains are returned to investors in a partnership, the capital stock of an investment company can be reinvested.
Sirrom Capital is rapidly approaching the $90 million cap on its ability to sell debentures to the SBA. The company has already issued $51 million in debentures and has requested another $20 million this year.
"There are a lot of other places to borrow money," said Mr. Miller. "It just so happens that the SBIC market is the best place to borrow right now."
The company is looking for alternative funding sources of capital anyway and is hoping the sale of 2.27 million shares will open the doors to the capital markets for the small business lender and investor.
Even if investors think Sirrom and other 1940 Act SBICs are dependent upon the SBA for their capital, concerns about funding for the SBIC program may be overblown. Allied Capital's Mr. Williams thinks the program will survive even if Congress follows through on its promise to reduce the size of government.
One option available is to privatize the program in a structure similar to that of the Federal National Mortgage Association. The only tie to the government that would remain would be a government guarantee.
Whatever Congress decides to do, it is likely to make little difference.
"The SBIC program is like a rounding error on the federal budget," Mr. Williams said. "There's a real question about whether or not the Republicans are going to slay a sacred cow."