0.2.5: Federal Grants And Loans

The most significant program of federal government assistance to small business is the loan and loan guarantee program run since 1953 by the Small Business Administration (SBA), coupled in 1958 with the creation of privately owned concerns called Small Business Investment Companies (SBICs), which utilize funds obtained from the federal government at soft rates to finance small business. The SBA administers both programs but have different impacts on early-stage financings.

An SBA loan (whether in the form of a direct loan from the SBA, or, more commonly, a bank loan guaranteed by the SBA) is, despite the favorable terms, the equivalent of bank financing. Although interest rates can be soft, a loan entails a promise of repayment within a finite period of time and an interest cost from the date the loan is made. Further, it introduces a partner to the enterprise with a lender's mentality. In the typical case, a guaranteed bank loan, the fact that the SBA guarantees 90 percent (or less) of the loan should give no encouragement that the bank is likely to relax its attitude toward repayment. A 90-percent guarantee is not a 100-percent guarantee; a commercial bank that routinely loses 10 percent of the principal of the loans it makes would soon be out of business. The administering bank takes the 10-percent exposure very seriously, and its officers can be expected to work hard to make sure it will be repaid. Moreover, the SBA ordinarily requires the founder(s) to guarantee loans personally, and on occasion its collection efforts are rigorous. If a $150,000 loan is secured by a second mortgage on the founder's home and all of his personal assets, there is always the question whether the government assistance is worth it in the first place. (Most banks are not set up to make SBA-guaranteed loans because of the red tape involved; most of the relatively small number that do have been designated by the SBA as "small business lending companies," meaning that processing time has been shortened.) The principal advantage of an SBA guaranteed loan is that the bank is likely to go higher in the loan-to-value ratio on tangible assets and to extend maturities. Much of the financing for franchises in recent years has been arranged with the benefit of SBA guarantees.

Small Business Investment Companies (SBICs) are privately organized corporations (or partnerships) licensed and regulated by the SBA. They are entitled to obtain leverage from the SBA, but, until recently, SBICs obtaining funds from the SBA had only one choice - to pay interest, albeit at favorable rates, meaning that an interest element is usually included in the investment made in each portfolio company. Compelled to achieve a return, SBICs had been, accordingly, typical late-round investors, advancing loans coupled with equity options, often subordinated convertible debt. That situation has now changed with the preferred securities program, which entails the licensing and funding of private equity pools sponsored by experienced VCs. The government's capital is in the form of preferred equity versus debt and matches private funding on a 2- or 3-to-1 basis. The regulatory constraints can be a nuisance but the program has been a success, although more for small buyouts than emerging growth companies, however.

The principal source of the federal-grants mechanism for start-up companies originated in 1982 with the Small Business Innovation Development Act, which inaugurated the Small Business Innovation Research Program (SBIR). SBIR grants range from $50,000 to $500,000 and a number of government agencies, including particularly the Department of Defense, participate in awarding grants to firms with fewer than five hundred employees. Start-ups in and around Rockville, Maryland, where the National Institutes of Health are located, and in and around northern Virginia, where ex-Department of Defense technicians tend to spin off, are known occasionally as the "Beltway Bandits" and are often first in line for SBIR grants.