Time to Fix the SBA

Maybe David Stockman was right.

Back in 1985, President Reagan's controversial budget director sparked a firestorm on Capitol Hill when he called for the abolition of a Washington institution: the U.S. Small Business Administration. By guaranteeing loans to small businesses unable to get credit privately, Stockman told a Senate committee, the SBA does little more than shift capital from creditworthy companies to less creditworthy ones. The agency, he charged, "sprays a faint mist of subsidized credit into the weakest and most prosaic nooks and crannies of the nation's $4 trillion economy."

A five-month battle ensued, with the anti-big-government, pro-deregulation forces in the Reagan administration scuffling with a hastily convened coalition of SBA's backers from across the political spectrum -- including the leadership of the House and Senate small-business committees, small-business advocacy groups, banks that administered SBA-backed loans, and entrepreneurs themselves. It was a politically potent group, and in the end, the agency was deemed too sacred a cow to kill. The SBA, created by an act of Congress in 1953, survived.

Now, 18 years later, the SBA is preparing to mark its 50th anniversary. But doubts about the agency, and how its more than 3,300 employees spend a $797 million budget, never really went away. "Their history is that they lose lots of money and don't do all that much," says William Dunkelberg, chief economist of the 500,000-member National Federation of Independent Business, the powerful small-business lobbying group that fought for the agency's salvation in the mid-1980s. Adds Mark Zandi, chief economist at Economy. com in West Chester, Pa.: "I question whether there is a need for the SBA, and who really benefits." Such skepticism is easy to understand. After all, the U.S. economy has undergone considerable change. Most of its innovation and dynamism now come from high-growth, idea-centric companies led by sophisticated entrepreneurs. Yet the SBA seems mired in the past. Just look at who's getting loans. In 2002, small retailers and restaurateurs represented about 20% of participants in the agency's two largest loan programs. And information technology entrepreneurs? Less than 2%. Clearly, an entire class of companies is not being served. "The reality is that the SBA never even comes up," says Verne Harnish, who as founder of the Young Entrepreneurs' Organization and chairman of the Birthing of Giants program spends much of his time talking to the founders and executives of fast-growth companies. "It's a nontopic."

And that's cause for concern. Small companies contribute 75% of net new jobs; account for more than 50% of the gross domestic product; and receive as many as 14 times more patents per employee than large firms, according to government figures. Indeed, in years past it's been innovative, growing companies that have led the economy out of recession. But that's not happening this time. In fact, small businesses actually shed jobs in 27 of the past 29 months, according to the NFIB.

The SBA is empowered to guarantee some $21 billion a year in bank loans and venture capital investments to small businesses. That's a lot of stimulus -- if applied correctly. Unfortunately, the SBA as currently constituted behaves more as a lender of last resort, funneling the bulk of its resources to marginal companies that can't obtain funding anywhere else. That's not an entirely inappropriate role, especially considering the extent to which many entrepreneurs, especially women and minorities, are shut out of the credit market. But the SBA could have a lot more impact if it also began behaving like a seed investor in the kinds of companies that will drive the U.S. economy forward.

The picture is not entirely bleak. Apple Computer, Staples, Federal Express, and Intel all participated in SBA programs when they were young, which proves the agency can get things right on occasion. And Hector Barreto Jr., current SBA administrator, has taken some encouraging steps (see "Mr. Small Biz," page 81). But if the government is to remain committed to spending money to help small businesses, it ought to do it right. With that in mind, Inc. has drafted a 10-point blueprint for reform, a series of concrete steps designed to bring the SBA in line with the realities of today's economy.

Bring investment into the 21st century

Over the past five decades, the SBA has developed a variety of strategies to aid small businesses -- helping them write business plans, offering loan guaranties to banks, providing matching funds to venture capitalists, training small companies to compete for government contracts. (The agency also makes low-interest loans for victims of natural disasters.) But this portfolio of services reflects the way we did business when these programs were created -- in the 1950s and '60s. The SBA needs a more contemporary set of investment tools. A good start would be creating a kind of government-backed angel investment fund.

Angel investors are usually wealthy individuals, often successful entrepreneurs, who make small (generally less than $500,000) investments in start-ups. They play a key role in fostering entrepreneurship because few venture capitalists are interested in such small deals and most banks balk at lending money to early-stage companies -- even with a partial SBA guaranty. Amazon.com, the Body Shop, and Bell Telephone all got their start thanks to angels. But these days, such funding is among the hardest to come by.

The SBA can help. It has the resources to create an angel fund, modeled on its Small Business Investment Company (SBIC) program, which is designed to encourage venture capital investment. Under that program, the SBA licenses private venture capital groups as SBICs, which then qualify for matching funds in the form of government loans at favorable rates. The problem is that the program requires SBICs to raise at least $10 million from outside investors before qualifying -- something that only about 20 funds have been able to do so far this year. As a result, the SBIC program has not taken full advantage of the $7 billion in guaranties Congress has authorized, awarding roughly $2.5 billion in each of the past two years.