Leveraging Influence: SBA's Role in Investment Capital

Understanding Equity Capital 

Equity capital or financing is money raised by a business in exchange for a share of ownership in the company. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock of that private company. Two key sources of equity capital for new and emerging businesses are angel investors and venture capital firms.

Typically, angel capital and venture capital investors provide capital unsecured by assets to young, private companies with the potential for rapid growth. Such investing covers most industries and is appropriate for businesses through the range of developmental stages. Investing in new or very early companies inherently carries a high degree of risk. But venture capital is long term or “patient capital” that allows companies the time to mature into profitable organizations.

Angel and venture capital is also an active rather than passive form of financing. These investors seek to add value, in addition to capital, to the companies in which they invest in an effort to help them grow and achieve a greater return on the investment. This requires active involvement and almost all venture capitalists will, at a minimum, want a seat on the board of directors.

Although investors are committed to a company for the long haul, that does not mean indefinitely. The primary objective of equity investors is to achieve a superior rate of return through the eventual and timely disposal of investments. A good investor will be considering potential exit strategies from the time the investment is first presented and investigated.

Differences Between Debt and Equity Capital 
Debt Capital: Debt capital is represented by funds borrowed by a business that must be repaid over a period of time, usually with interest. Debt financing can be either short-term, with full repayment due in less than one year, or long-term, with repayment due over a period greater than one year. The lender does not gain an ownership interest in the business and debt obligations are typically limited to repaying the loan with interest. Loans are often secured by some or all of the assets of the company.

Equity Capital:
 Equity capital is represented by funds that are raised by a business, in exchange for a share of ownership in the company. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time.

Angel Investors Business “angels” are high net worth individual investors who seek high returns through private investments in start-up companies. Private investors generally are a diverse and dispersed population who made their wealth through a variety of sources. But the typical business angels are often former entrepreneurs or executives who cashed out and retired early from ventures that they started and grew into successful businesses. These self-made investors share many common characteristics: 

♦ They seek companies with high growth potentials, strong management teams, and solid business plans to aid the angels in assessing the company’s value. (Many seed or start ups may not have a fully developed management team, but have identified key positions.)
♦ They typically invest in ventures involved in industries or technologies with which they are personally familiar.
♦ They often co-invest with trusted friends and business associates. In these situations, there is usually one influential lead investor (“archangel”) those judgment is trusted by the rest of the group of angels.
♦ Because of their business experience, many angels invest more than their money. They also seek active involvement in the business, such as consulting and mentoring the entrepreneur. They often take bigger risks or accept lower rewards when they are attracted to the non-financial characteristics of an entrepreneur’s proposal.

Venture Capital
Successful long-term growth for most businesses is dependent upon the availability of equity capital. Lenders generally require some equity cushion or security (collateral) before they will lend to a small business. A lack of equity limits the debt financing available to businesses. Additionally, debt financing requires the ability to service the debt through current interest payments. These funds are then not available to grow the business.

Venture capital provides businesses a financial cushion. However, equity providers have the last call against the company’s assets. In view of this lower priority and the usual lack of a current pay requirement, equity providers require a higher rate of return/return on investment (ROI) than lenders receive.


Small Business Bonds: Duties of Contractor

Contractors should apply for a specific bond with an agent or surety company of their choice, providing background, credit and financial information required by the surety company and the SBA.

The contractor must complete the following forms, which are available from participating agents (a list of agents is available from your local SBA district office)

SBA Form 994: Application for Surety Bond Guarantee Assistance

SBA Form 912: Statement of Personal History (on first application and once every two calendar years thereafter)

SBA Form 994F: Schedule of Uncompleted Work on Hand (required initially and then at least quarterly)

SBA Form 1624: Certification Regarding Debarment, Suspension, Ineligibility and Voluntary Exclusion Lower Tier Covered Transactions

SBA Form 1261: Statement of Laws and Executive Orders

Duties of Surety Company After the contractor completes the forms and furnishes the surety company with sufficient underwriting information, the surety company processes and underwrites the application in the same manner as any other contract bond application. The surety company decides whether to:

Execute the bond without the SBA's guarantee;

Execute the bond only with the SBA's guarantee; or

Decline the bond even with the SBA's guarantee.

If the surety company determines an SBA guarantee is required in order to provide the bond, it completes an SBA Form 994B: Underwriting Review and the SBA Form 990: Guarantee Agreement. If the guarantee is given under the Prior Approval program, these forms - and supporting documents - are submitted along with the Forms 994, 912, 994F, 1624 and 1261 to the appropriate SBA/SBG Area Office. If the guarantee is given under the PSB program, the forms are collected by the surety.

Duties of the SBA 
Under the Prior Approval program the SBA determines an applicant's ability to complete the contract based on the information, documentation and underwriting rationale provided by the surety company. If the review establishes performance capacity, and all other aspects of the application are approved, an authorized SBA official signs a guarantee agreement and returns it to the surety company. If the review fails to establish performance capacity, the SBA seeks clarification from the surety underwriter. If performance capacity cannot be reasonably assured, the SBA rejects the application.

Cost of an SBA Guaranteed Bond The SBA charges fees to both the contractor and the surety company, as described in the most recent edition of 13 CFR 115 :

SBA does not charge contractors an application or bid bond guarantee fee. If SBA guarantees a final bond, the contractor must pay a guarantee fee equal to a certain percentage of the contract amount. The percentage is determined by SBA and is published in notices in the Federal Register from time to time.

When the bond is issued, the small business pays the surety company's bond premium. This charge cannot exceed the level approved by the appropriate state regulatory body.

The surety company pays the SBA a guarantee fee on each guaranteed bond (other than a bid bond) in the ordinary course of business. The fee is a certain percentage of the bond premium, determined by SBA and is published in notices in the Federal Register from time to time. 

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