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The Small Business Administration is getting into the start-up business, helping fund high-growth companies through licensed investment companies.

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United States Small Business Administration Chief Karen Mills

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The Small Business Administration is expanding its mandate to support the nation's small businesses by helping to fund start-ups.

Last week, the SBA announced the launch of its Early Stage Innovation Funds Initiative. The program is an offshoot of its Small Business Investment Company capital investment program, which licenses private equity firms to invest mezzanine capital in more established small companies. That program has existed for about 50 years and supported $3 billion of investment in 2012.

The SBA said it will commit up to $1 billion to start-ups from the program over the next five years. The current program lets investment firms draw down $50 million in government-guaranteed capital to invest in early stage companies.

SBA administrator Karen Mills has long talked about the need to support different types of small businesses with different types of funding. Slower-moving "Main Street" companies need more traditional financing, which the SBA supports through its 7(a) and 504 commercial loan programs, operated in partnership with banks.

Investment companies must first be licensed by the SBA to participate in the new program, and they must invest half of their capital in early-stage companies. The first licensee is Hatteras Venture Partners, of Durham, North Carolina. The firm invests in fast-growth human medicine and life sciences companies and has about $250 million in assets under management.

Fast-growth companies, known sometimes as gazelles, often need seed capital to continue growing. If they can get the funding to grow, these companies tend to create more jobs than Main Street companies, and they can have a significant impact on the economy.

"The availability of venture capital is critical to this ecosystem thriving, [especially as] the high tech entrepreneurial ecosystem and the nature of venture investments is much lower today, and it is harder for entrepreneurs to get capital for their new gazelle ideas," says Clay Thorp, a general partner at Hatteras.

In particular, there's a funding gap of between $1 million and $4 million for these small businesses, according to the SBA. Since 2006, less than 10 percent of venture capital at those amounts went to seed funding. And nearly 70 percent of that money went to companies in just three states: California, Massachusetts, and New York.

Because the funds are distributed via a licensing agreement, entrepreneurs will have expanded access to capital and taxpayers won’t be footing the bill, Mills said in a statement.

Licensees in the fund agree to be regulated by the SBA. Investments are structured giving equity a senior position, while the SBA portion is structured as subordinated debt that pays a quarterly interest back to the government equivalent to the rate of a 10-year Treasury bill plus 1.5 percentage points.

By contrast, the traditional SBIC program is structured such that debentures are senior to equity, meaning the SBA gets paid back first in the event of a default.

The fund will give Hatteras extra capital for its Hatteras Venture Partners Fund IV, boosting the value of its fund to $125 million from $88 million and allowing Hatteras to invest in more companies. In the next 30 days, Hatteras says it plans two investments from the SBIC portion of the fund. Thorp did not offer any details.

Last updated: Jan 18, 2013

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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