nesses, stick with them for 14, 15, and 16 years, put lots of money, sweat, blood and tears in them, and you have the same tax consequence. I feel that that is a presumed neutrality which is completely irrational. I would also point out that there is great frustration in the small business community. The first comprehensive set of field hearings held by the Senate Select Committee on Small Business were held in 1952. We went around the country in eight different cities at that time. We made a report to the Senate-the committee did-on June 18, 1953. Lo and behold-I have reviewed that report in getting ready for this statement. The Senate Small Business Committee, June, 1953, said, increase the surtax from $25,000 to $100,000; make depreciation allowances a more rational way of retaining earnings for small business; and allow corporations to be taxed as partnerships. Gentlemen, 22 years later you have heard a whole panoply of witnesses saying increase the surtax, amend Subchapter S, make a better capital recovery or depreciation plan. 22 year-that is a long time to wait. We hope that the new power group which has formed in the Senate will help us out. In capital formation, I would point out here that within the small business community of 10 million people, there is a vast range of business enterprise in size and type. The ones that the venture capitalists and the SBIC are supporting tend to be more in the medium size. Here we believe that present climate is very difficult. Profitable firms immediately get in the 48 percent tax bracket when they begin making some money, and that halves retained earnings. The new issues market is almost completely closed. I included a table on page 7 of my statement showing that almost 700 small businesses raised $1.4 billion in new issues in 1969. In the last 10 months, not a single business with net worth of under $5 million has been able to sell a public issue. Now, this indicates to me, unless we say that in the last 6 years the small business community has not given birth to any growth businesses, it shows a net equity gap. We believe that Congress must be aware of it and must do everything it can in a coordinated way to attack the problem. Senator LAXALT. What do you think the reason is that there have been no issues recently? Mr. STULTS. Obviously, the performance of the over-the-counter market, the quotation of the companies that went public in the 1968 to 1970 period, are down 80 percent or so. So that is one reason. Another reason is that it takes a pretty venturesome person to invest in a relatively small business, a high-risk situation, when he can get Government agency paper paying 10 or 12 percent, get CD's at 12 percent. Senator, this is a real problem. SBIC's have been in business now for 16 years. Beginning on page 9 of my statement, I show some data on the size of the industry today. There are fewer SBIC's than there were 10 years ago, but the assets at this point are the highest in history. SBIC's have roughly $1 billion in assets at this point, and we are disbursing approximately $200 million a year to small businesses. Between 2,000 and 2,500 small businesses divide up this $200 million. At the end of March 1974, the latest date for which we have data, the SBIC's had some $600 million outstanding in small business. Senator LAXALT. What percentage of the market does that represent, potential market? It is minimal, is it not? Mr. STULTS. If we say that 1969 represented any kind of a benchmark in terms of new issues, that was $1.4 billion, obviously that was abnormal. But I will go on here in the statement, Senator, and say that I believe that there are tremendous unfilled needs out in the countryside. Your State does not have a single SBIC, for example. I do not think that it has a single organized venture capital company. Senator LAXALT. No; it does not. Mr. STULTS. We had one small SBIC there, but it was too small to do the job. We are proud of the fact that the SBIC's have been able to pick up those small businesses which have made a mockery of the statistical tables showing that 80 percent of the small businesses will not survive the first 3 years of their life. We have been able to pick up better firms than that. As a matter of fact, SBA has done a program effectiveness study and has shown that SBIC-aided small businesses have achieved the following annual growth rates: In employment, 25 percent; in income revenues, 27 percent; in profits, 27 percent; an annual growth rate of 37 percent in net worth. Obviously, these portfolio companies of ours are growing far more rapidly, and not surprisingly, the owner-managers of those small businesses like the assistance they have received from SBIC's. More than 90 percent of all of them reported to SBA that they had benefited, and most of them said they had benefited to a major degree. And despite the fact that we have made loans to them, and making a loan is supposed to be the way to lose a friend, 87 percent of the small businesses that we helped said they would go back to an SBIC again, that their relations were such that they would be willing to bring in a partner because in most cases we take an equity interest in the small business. So for the first time here is a sole proprietor or a partnership, a limited group of insiders, and we come in from outside and take a piece of the action and they still like us. I submit that this indicates that Congress was very wise in 1958 when it passed the Small Business Investment Act. The SBA data show that our program has been very helpful to the small businesses. I am not certain that the statistics are equally clear in terms of what it has done for the shareholders in the SBIC. On page 13, I show some financial data on the profit rates of small business investment companies. In fiscal 1973, there was a net return on capital, a loss of 1 percent. In 1974, a plus 4.6 percent return, not very large, but I go on to point out on page 14 that there are distinctions which should be made between the bottom-line figure as shown on our financial statement and the actual results. Senator HASKELL. Mr. Chairman, could I ask a question just for clarification? I thought I heard you say that SBIC's profit had grown at an annual increase of 27 percent. Mr. STULTS. Small business concern profits, Senator Haskell. Mr. STULTS. The people we have helped. They have grown about 25 percent a year. We have, unfortunately, not had that kind of growth. Senator HASKELL. I see. Thank you. Mr. STULTS. To conclude this treatment of SBIC performance, a number of SBIC's have compiled outstanding investment records. They have been able to pick the good small businesses. They have worked well with them, and they have been able to exit from their successful investments with sufficient gains to overcome the inevitable losses and disappointments. On the other hand, the evidence indicates the bottom-line profit figure is still not high enough to attract the additional hundreds of millions of dollars of private capital which are needed to fill the equity gap which still exists. On pages 16 and 17, I try to give you a rather subjective analysis of why I believe there still is an equity gap and point out that despite the existence of the $1 billion SBIC industry and the non-SBIC venture capital industry, which is probably the same size, that gap still exists. We believe that it is impossible to place any sort of a figure on the magnitude of this gap because we just cannot tabulate the number of applicants who were refused financing because there is duplication, because a number of proposals were simply not realistic. As I pointed out to Senator Laxalt, there are areas of the country where there are no SBIC's and no venture capital firms. We are certain that in that part of the country a successful businessman who wants to grow just cannot even give any credence to his dream because there is not the ability to tap outside sources of capital. NASBIC has, in a sense, put its dollars where its mouth is on this. Our officers have directed the staff to devote a major share of our time and resources to recruiting and working with prospective and potential licensees. We are not afraid of more competition. We believe that there is room for much more money in the venture capital industry. We believe that each time a new, well-managed SBIC or venture capital company is set up, we are able to attract more local businessmen who want to grow. We are able to attract management teams who are frustrated by the corporate bureaucracy which keeps them from trying out new products and new services. They want to break loose. Right now we are seeing something very interesting. A major source of deals now are the anticonglomerators. Those who were taken in during the late 1960's, the independent businessmen who were merged with conglomerates. They were unhappy there; they were unable to perform well in a corporate structure. They are now coming to SBIC's and venture capital companies, saying, "Give us some money. We want to buy ourselves out from under this great conglomerate. We can be more effective; we can be more efficient; we can make more money." So obviously, all of the talk about economies of scale comes a cropper when a man says, "My company made $1 million as an independent and when nowhere as a division of a major corporation. We think we can make $1 million again as an independent corporation." That is pretty hard evidence. I think that there is a role for the independent sector. If Congress agrees with my statement that the equity gap for small business persists, it is important that SBIC's increase their assistance above present levels. To accomplish that goal, existing SBIC's must be encouraged to increase their capital, and new SBIC's must be brought into the program. We have drafted two complementary bills to provide the incentives to bring these people into it. One would amend the Small Business Investment Act and will be considered in mid-July by the Senate Banking Committee, and the other relates to the tax aspects of the SBIC industry. I summarize the seven provisions of that bill in my statement. We hope to have it introduced in the House, and we hope that it will be considered as a part of the House tax reform hearings, and that it will be over here in front of the Senate Finance Committee in the near future. Variable tax rates on capital gains income is a subject I have already touched upon. I wanted to point out that we are in long-term investments. Congress should recognize that. One of your witnesses yesterday gave you a graphic example of how capital gains were really taxing only inflation. There was no real gain at all and showed how the price level had changed so much that the man who had worked in his business for 10, 12 years came out with less buying power when he sold out 10 years after the formation of a very successful business. To summarize, the members of the National Association of Small Business Investment Companies maintain their strong beliefs that the economic system, which has brought such a high level of fulfillment to the United States, can and should be preserved. We can recite from our own experiences hundreds of instances where an ambitious and imaginative entrepreneur had made that better mousetrap and has brought the world to his doorstep. We hold, as a matter of faith, the concept that competition is the touchstone of our free enterprise order, and we have helped hundreds of small businesses compete successfully against the giants in their industries. We have called upon all of our logic, all of our experiences. all of our rhetoric, to convince Congress and the executive branch of the Federal Government that positive action must be taken quickly to guarantee the survival and vigor of the independent section of our economy. SBIČ managers are involved in the most exciting pursuit possible. The rewards of participating in the birth and growth of the successful business enterprise are a combination of the psychic and the financial. We are at the jugular of the free enterprise system, as one of NASBIC'S former presidents put it. In closing, we pledge our continuing cooperation in every possible way as your committees pursue their efforts to shape an equitable Federal tax policy which will encourage and not inhibit business growth and vitality. Thank you. Senator NELSON. Thank you very much. If the committee members would not mind, perhaps we would finish the presentations, and then have questions. Mr. Morgenthaler? [The prepared statement of the National Venture Capital Association follows:] STATEMENT ON BEHALF OF THE NATIONAL VENTURE CAPITAL ASSOCIATION SUBCOMMITTEE ON FINANCIAL MARKETS OF AND THE SENATE SELECT SMALL BUSINESS COMMITTEE CAPITAL NEEDS OF SMALL BUSINESS June 19, 1975 Mr. Chairman, and members of the Subcommittee on Financial Markets and the Select Small Business Committee: My name is Richard Hanschen. I am a resident of Dallas, Texas, and President of New Business Resources, Inc., and appear here today accompanied by David T. Morgenthaler from Morgenthaler Associates, and our counsel on behalf of the National Venture Capital Association NVCA. I serve as Chairman of NVCA's Incentives Committee and my colleague, I have also submitted a supplemental statement which is appended to this testimony. NVCA was formed as a result of our members' awareness of the same set of concerns respecting the nation's economic and industrial health which are the source of today's very vital hearings. Our goals are the fostering of a broader understanding of the importance of venture capital to the vitality of the United States economy and the encouragement of the free flow of capital to young companies. NVCA concurs completely with this Committee's recognition, in its public announcement of these hearings |