Time to Fix the SBA

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Patrick Lilly, vice president for commercial and SBA lending at Palm Desert National Bank in Palm Desert, Calif., calls the rule book his "biggest gripe" about working with the agency. "It's half a foot thick and has a lousy index," he grumbles. The unwieldy rule book is a serious disincentive for new, smaller banks to get into the SBA loan business, adds Steve Stultz, chairman of the National Association of Government Guaranteed Lenders. And if the bankers are deterred, imagine what it does to red-tape-loathing entrepreneurs, many of whom have been forced to hire consultants just to navigate the bureaucracy.

Fortunately, the SBA has taken some encouraging steps to cut through the morass of paperwork. In 1996, the agency launched something called SBAExpress, which guarantees just 50% of the loan but allows lenders to make loans of up to $250,000 by filing electronically. In spite of the lower guaranty, such loans are expected to account for nearly half of all SBA-backed loans in 2003, compared with 34% in 2002 -- strong evidence that the banks will step up and even assume more risk if the government gets out of their way. We just have one question: Why is it taking so long to streamline the SBA's other programs? Consider the 504 loan program. Borrowers are often required to submit 700 to 1,200 pages of paperwork to apply, says Barbara Vohryzek, executive director of California Statewide Certified Development Corp., a Davis, Calif., outfit that processes such loans. That's a disincentive, both to would-be borrowers and their bankers. Streamlining the process and allowing borrowers to file electronically would attract more banks to the program and enable the SBA to do more business, Vohryzek says.

Make larger loans

Banks want to make larger loans because they tend to be easier to administer and more profitable. Entrepreneurs want to receive larger loans because it costs more to start or expand a business these days. The only factor messing up this equation? The SBA. The Bush administration has actually lowered the average SBA loan size from $225,000 to $165,000. "A loan of $50,000 is much more able to create jobs than necessarily a loan of a million or $2 million," Barreto told us in a recent interview. "In fact, when you're doing loans of $50,000, it takes $14,700 to create one new job. So there's a great opportunity." Now, what type of job is created by $14,700? A job that is neither as well-paying nor secure as one created as part of a $2 million investment, we're willing to bet.

But last year, the administration dropped the cap on the government guaranty of loans in the 7(a) loan program to $500,000 from $2 million. After an outcry from the banking community, the old levels were restored. But we think the cap should be even higher. "We found that the larger loans were more secure," said Fred P. Hochberg, deputy SBA administrator during the Clinton administration. "They helped pay for the program and keep the cost down." A higher cap would also lead more sophisticated businesses to seek SBA assistance, particularly at a time when banks have tightened their credit and venture capital firms are returning money to investors rather than investing it in start-ups. Banks, after all, are in business to make money. "It costs money to do a loan, do background checks, process the loan," says Paul Merski, chief economist of the 5,000-member Independent Community Bankers of America. "By increasing the cap, we might actually get more loans being made. It's not as attractive to make a large number of small, costly loans."

Work with, not against, the VCs

Sometimes, SBA rules actually shut out companies that would otherwise make promising candidates for investment. Case in point: A number of small biotech companies backed by VCs have been shunned recently by the SBA's grant program, Small Business Innovation Research, which is designed to funnel federal research projects to small businesses, and help those companies bring their technologies to market. The problem? The companies were not majority-owned by "individuals," as the program requires. In other words, because they were able to attract seed capital from private investors (in exchange for equity) as start-ups, they are deemed unqualified for SBA funds to help turn their research into commercial products. That rule seems to run counter to the whole point of the SBIR program, which in 2002 awarded $1.5 billion in grants to 5,000 companies through 10 federal agencies. One of those agencies, the National Institutes of Health, in May disqualified Cognetix, a Salt Lake City biopharmaceutical firm with 27 employees that is majority-owned by institutional investors, including VCs and pension plans. It's been a huge blow, says Vicki E. Farrar, Cognetix's vice president of intellectual property. "The loss of this grant, as well as our ability to draw on previously awarded grants, severely limits our ability to continue basic research and could lead to layoffs," Farrar says.

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Elizabeth Wasserman

Elizabeth Wasserman is editor of Inc.'s technology website, IncTechnology.com. Based in the Washington, D.C. area, she has more than 15 years experience writing about business, technology, and politics for newspapers, magazines and websites. Her work has appeared in such publications as Congressional Quarterly, Business Week, Portfolio and Slate.