Expansion Capital: The Critical Issue

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More than one small businessman has put down his morning paper after reading about the latest surge of money into venture capital and said to himself, "If that's all true, why can't I raise the money I need to expand my business?" In part it's because only a tiny fraction of the half-million businesses started in the United States each year promise the kind of returns on invested money venture capitalists need. More important, it's because venture capital, in its current form, is not meant to finance the kinds of needs most small businesses have as they struggle to grow. "We're in the business of financing losses, not plant and equipment," explains Morton Collins, who is president of the National Venture Capital Association.

Yet all venture capitalists agree that a lack of true "seed money" is a critical problem in our economy. Many point to the high-flying market in new stock issues as an example of the problem. "A lot of little companies with half-baked ideas are taking money from unwary investors," says Bill Chandler, a San Francisco venture capitalist. "Inevitably that means there will be a minicrash and a lot of people will get burned. If we had a proper seed-capital system, the bad apples would get sorted out long before they got into the public market, and we'd have more good small companies and more jobs."

Chandler believes one solution to the problem lies in forming Small Business Investment Companies with relatively small investments from groups of individual limited partners. In that way. Chandler thinks, more than the currently active 4% of the country's estimated 500,000 millionaires might come out of the closet and take part in helping to finance small companies. "The institutional investor support of venture capital is fine," he says, "but to prevent wild fluctuations in venture capital we need to underpin the institutionally supported community with a network of wealthy personal investors." Chandler has just completed forming one such SBIC and hopes to begin making investments soon.

Another alternative lies in publicly owned SBICs, a concept that flourished in the '60s but faded away during the "crash" of the '70s and is only just coming back into favor. Giving ordinary investors a way to participate in venture capital seems to be good idea, but skeptics wonder if the public SBICs won't go the way of Real Estate Investment Trusts, another great concept ruined in part by relentless pressure to perform early and often in the traditional bottom-line fashion of publicly owned companies. "Venture capital takes good instincts and most of all patience," says one veteran observer. "I wonder if the stockholders in public SBICs can or will wait as long as they'll probably have to for a real return on their investment."

These developments aside, even if all of venture capital's current resources were focused on more traditional small businesses, it would still be just a drop in the bucket. "We need so much more money funneled into taking advantage of our own innovations that it's frightening," says Chandler. "We're still running on about one and a half cylinders, while countries like Japan are targeting their dollars on developing products made with technologies we developed."

Until more Americans have real incentives to stop investing all of their liquid assets in inflation hedges like real estate, the innovation and expansion capital gap will continue to be the critical problem for small business. It's a problem born not just of high interest rates, but also from the shift of bank credit from the United States to foreign countries, multinational corporations, and to the current merger mania. The supply of expansion capital for small business has never been adequate in recent years, and is less so today. But venture capital cannot solve the entire problem.