Back in 1980, one of the strongest recommendations to come out of the White House Small Business Conference was a proposal for a newfangled financing vehicle designed to encourage below-market-rate loans to smaller companies. The new securities, called "small business participating debentures," would provide a return based partly on low interest rates and partly on future corporate profits. And there would be various tax benefits to sweeten the pot.
The idea is still being kicked around in Washington (see "Bills, Bills, Bills" page 36), but Dean Treptow, president of Brown Deer Bank in Brown Deer, Wis., is not waiting. Since 1980, his $55 million asset bank has been building a lucrative portfolio of something very similar to participating debentures. In exchange for lending money to companies at relatively low rates, Brown Deer Bank gets a small slice of their profits.
In making such loans, Treptow looks at a company's market potential and management much as a risk-oriented venture capitalist would. "Since we don't want to be in the used equipment business," he explains, "we need to have confidence in the abilities of the managers and their approach to the business."
Early on, for example, the bank chose to support a commercial film-processing company that wanted to expand into computerized video production but could not service any additional regular debt Treptow lent the company $600,000 at the prime rate and negotiated to receive a 25% cut of its net aftertax earnings (not to exceed an 8% premium over prime) for a 10-year period. Subsequent deals have typically involved loans at, or around, the prime rate, plus about 2% of pretax profits over three to five years.
According to Treptow, Brown Deer Bank Stands to realize returns of 25% to 40% on such investments -- compared to 20% on conventional loans. Tax incentives would make the investments even more attractive, but Treptow doubts that traditional bankers will go for participating debentures in any event. "Most bankers prefer to look at numbers instead of [evaluating] a company's management," he says. Individual investors may be a different story, however. With sufficient incentives, Treptow believes that many wealthy individuals will invest in small business participating debentures as alternatives to such popular vehicles as oil and gas limited partnerships.
Meanwhile, his own bank will keep looking for unusual deals -- tax benefits or not. "We don't need formal inducements," he says. "If we get them, they'll just be a windfall."