SBIC Program: Stop the Bleeding

Today's Wall Street Journal editorial page has an excellent piece on the use of taxpayer money to fund risky start-ups in the United States. The point of the piece is that Congress would be wise to stop using taxpayer money to fund start-up companies.

Since the Wall Street Journal is a subscription-only publication, I provide this extended excerpt:

"Venture capital is risky business in the hands of professionals. When done by the federal government it tends toward the disastrous, as the Small Business Administration is now admitting about its decade-long attempt to outsmart Warren Buffett.

The SBA launched its Participating Securities program in the early 1990s on the dubious premise that there wasn't enough venture capital for small start-ups. The program guarantees loans to venture-capital funds, and it has backed a few winners. But it has also backed more than a few dogs, such as the $60 million Zero State Capital VI fund, which invested in "new and emerging technology firms," though apparently not "emerging" enough. The fund is expected to go into receivership in May, and the Boston Business Journal recently reported that company executives now admit the fund, which was launched in 1999, was an "unmitigated disaster." No kidding.

After 10 years the entire Participating Securities program has estimated losses of $2.7 billion, SBA head Hector Barreto told Congress last month. Of that, "$I.7 billion ... are realized cash losses," he said. Actually, it's worse: We're still years away from knowing the program's ultimate burden on taxpayers because venture-capital funds are given 10 years to repay the money. The government's total exposure as of last September 30 was $11.25 billion.

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The good news is that the SBA's Associate Administrator for Investment, Jaime Guzman-Fournier, is expected to recommend that the program be killed when he appears today before the House Small Business Committee. But no bad idea ever dies an easy death in Congress. And at today's hearing, Chairman Don Manzullo (R., Illinois) is expected to promote "reform" instead of mercy killing.

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Republicans of all people should know better than to tax some Americans more so that the government can invest in businesses that couldn't raise enough private capital. Congress can't even balance the budget, much less pick a winning telecom or biotech stock. This one isn't even a close call."

I agree with the Journal and have written before calling for Congress to get out of venture investing. Indeed you need only glance at this Inspector General report to understand why.

Not that I'm against start-ups or small business -- of course not. But there is a right way to fund most start-ups and a wrong way. Most start-ups need to first fund themselves through bootstrapping, i.e., using their own money and money they bring in from customer sales. That way they prove the viability of their business. Later, when they get their legs, loans can help them expand.

Venture capital is for the tiny tiny tiny percentage of companies with high growth business models. Venture funding is necessary for this small group of start-ups. The investment costs to launch or grow a high-tech business can be huge. But let professional investors take the risk of funding this small minority of venture-eligible companies, not taxpayers.

In the heady days of the 1990s, a different attitude toward investing prevailed. The winds of venture investing are more conservative now. With the benefit of post-Dot-Com-bust hindsight, we should now be capable of putting venture funding into better perspective and realize how risky it is.