A Way To Hedge The Debts

With referrals from a coast-to-coast network of money managers, a new San Diego SBIC is specializing in loans that can be converted into equity.
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Among hundreds of money managers across the United States who oversee billions of dollars in pension and profit-sharing investments, Michael Stolper has become a familiar name by playing a somewhat peculiar role. While the San Diego-based Stolper neither handles nor invests any money himself, he carries a lot of weight among those who do. Over the past eight years, his stock in trade has been selecting the best fund managers for his clients, who include the Apache Indians, an Eskimo tribe, and about 250 other corporate and nonprofit employee-benefit accounts. The investment pool these clients control now totals around $350 million, and it is Stolper who determines which portfolio advisers get to manage the pieces.

Recently, however, the 37-year-old investment talent scout has taken a plunge into an altogether different corner of the financial universe. Through a newly licensed small business investment company (SBIC) he organized in late 1982, called Seaport Ventures Inc., Stolper and a dozen or so investors he recruited have begun building a portfolio of equity-oriented loans to young companies.

Like others in the risk-oriented venture capital industry, Stolper, president of Seaport Ventures, is shooting for lush returns of 30% or more -- far in excess of what Wall Street's most successful pension fund managers ever dream of earning on their pools of stocks and bonds. But rather than achieving these gains by taking early -- and highly speculative -- positions in the Apple Computers and Genentechs of tomorrow, Stolper intends to be more measured and mundane in his approach. Instead of seeking equity at the front end, he hopes to hedge his bets by doing financings that pay Seaport predetermined interest or dividend payments while offering it the option of converting to stock at a later date.

As vehicles for investing in smaller businesses, SBICs are certainly not new. lndeed, since 1958, the Small Business Administration has granted licensed SBICs special privileges not available to private venture capital firms. Chief among these advantages is the ability to leverage their private capital with government loans at favorable rates. An SBIC's ability to borrow up to four times its private capital and to invest up to 20% of its private capital in any one business was an immediate attraction to Stolper who had been looking for a way to put some of his personal funds in venture capital. But despite the appeal, says Stolper, "I wouldn't have set up an SBIC if I hadn't seen multiple tie-ins with my other business."

While he anticipated hearing about promising investment possibilities the way most SBICs do -- from local commercial bankers and other venture capitalists -- Stolper also figured his links with investment advisers from coast to coast would provide another important network for learning about interesting deals. "Entrepreneurs are always contacting money managers, even though they invest only in marketable securities of public companies," notes Stolper. "So we would have a natural source of referrals."

In addition, he saw his relationships with investment managers spinning off other vital benefits when Seaport was weighing specific financing opportunities. "Evaluating proposals can squander a lot of valuable time," says Stolper, who travels around the country about half the time to meet with investment people. "But instead of spending two weeks in the library researching CAD/CAM [computer-aided design and computer-aided manufacturing] or spending $10,000 on a consultant, I can call money managers who I know and who know the business and get 95% of what I need."

These specialists, says Stolper, already assist Seaport on a regular basis in providng basic market information about such hings as a company's competitors and industry pricing standards before Seaport has to commit much of its own time or any money. And while Stolper agrees that such investment analysts wouldn't be eager to furnish this kind of free telephone advice to any venture capitalist, he believes that his own position is different. "We're either sending these guys business or it's a possibility down the line," he says.

Since it received its license only last November, Seaport -- which has private capital of nearly $1.5 million from investors including Stolper and an agent representing professional athletes -- has put money in very few deals. Like other SBICs, it is legally permitted to provide companies with everything from longterm debt to equity.

Stolper expects, however, that as much as 80% of Seaport's investments will go to established businesses in the form of either subordinated debt or preferred stock, with special features permitting future conversion of the original securities into a more marketable common stock to achieve capital gains. Equity investments, which often take years before any payoffs are reaIized, can be a serious handicap for leveraged SBICs, which, unlike private venture capital companies, must pay the SBA interest on their borrowings on a semiannual basis. And while such debt service shouldn't be a problem for Seaport until it exhausts its private assets and begins borrowing money late this year or in 1984, Stolper says, "it's always nice to have the interest income while waiting for gains."

In its first investment last November, for example, Seaport bought $100,000 of subordinated convertible debt of Jet America Airlines Inc., a fledgling Long Beach, Calif.-based airline whose stock trades over the counter. The airline agreed to pay Seaport and other investors in the $10 million debenture an interest rate of 14% for five years. Under the terms, Seaport can convert the debt to equity any time it wants to at a share price of $4. "We liked the interest rate and the conversion feature," says Stolper, "and it's a very liquid investment."

At press time, in a similar transaction with a privately held company, Seaport was planning to lend $150,000 to a manufacturer of scientific monitoring equipment that is compatible with Apple computers. The $1.2 million financing, which was expected to be made final at about 12% for the initial 2 years of a 10-year term, was to be spread among a handful of other SBICs and the company's initial venture capital backers. These investors would be entitled to convert their loans into equity at a series of prenegotiated points over the next few years.

While neither of these early deals was originated by Seaport, in the coming months says Stolper, "we fully intend to originate our own deals and find SBICs and other venture capital to join us." Last February Seaport was assessing the feasibility of later-stage financings for several companies, including a California manufacturer of commercial wind-power generators and an East Coast company that makes simulators for training technicians at chemical plants. The initial referral for this second prospect came from a Connecticut money manager acquainted with Stolper. "We've already seen some good possibilities from that investment advisory network," says Seaport vice-president Carole Luther. "And if we decide to go ahead with the simulator company, we'll be the lead investor."

Despite its ambitious plans to invest about $100,000 to $150,000 in at least six deals per year, initially, at least, Seaport isn't eager to get involved in the types of risky start-ups that attract some of the larger and better-known venture capitalists. "We're not smart enough to pick who's going to find the cure for cancer," says Stolper. "For us, the ideal financing candidate is a company that's up and running and making money but is shipping product too fast for its working capital."

As crowded as the field of investors for this market seems to be, Stolper is confident that Seaport, with the help of its contacts, will find its share of good deals early. "Most venture capitalists are out there chasing opportunities they think are on their way to becoming $100 million companies," he notes. "But as long as we see some equity potential, we're very happy to finance a nuts-and-bolts operation that may reach only $10 million in sales."

Last updated: May 1, 1983




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