How to Invest in Rising Stars Before Companies Go Public

SBICs funnel money to start-ups, from express-mailer to maternity shop

Do you ever wish you could have bought into Intel Corp. back when people hardly knew what a computer chip was? Thanks to the US Small Business Administration, there is a way.

Apple Computer, Federal Express, Compaq, America Online, Cray Research, and Intel are among more than 75,000 US companies that received early funding from a unique SBA investment vehicle, the Small Business Investment Company program.

It links private capital and federal loan guarantees in an effort that is is both socially laudable and down-to-earth: to stimulate venture-capital investments in fledgling businesses, says Don Christensen, associate administrator of the SBA in Washington.

Created in 1958, the program now includes more than 200 small-business investment companies (SBICs) that ante up investment capital. They invested it in small, privately held US companies, such as Apple Computer once was. A few firms receiving SBIC dollars may now be public, but first received help from SBICs back when they were private. SBIC investments have created more than 1 million jobs.

Here's the good news for investors: The little-known SBIC program provides a way for individuals to participate in venture capital, or small-business funding, says Lee Mercer, president of the National Association of Small Business Investment Companies (NASBIC), a trade group in Alexandria, Va.

Most SBICs are privately held investment firms. They are either owned by groups of investors who contribute a certain percentage of the firm's working capital, or they are owned by a bank. Buying into one of these is not easy, but it can be done with some legwork. You usually have to know about them just when they are getting off the ground, experts say. Sometimes local bankers can help direct you to a new SBIC.

A small handful of SBICs - perhaps a dozen - are publicly traded. Their shares are usually listed on the Nasdaq stock market or the American Stock Exchange (see accompanying list).

All SBICs are licensed by the SBA. In addition to their own funds, the SBICs can also use funds borrowed with SBA guarantees. Thus, an SBIC can "leverage" its working capital (say, $5 million) into much more ($10 million or $15 million). That money can then be loaned out to small growth companies. Not all will be successes, but if the SBIC lends money to one or two hot-shots, it might make tidy profits.

Publicly traded SBICs give investors substantial increases in the price of their stock shares, plus earn dividends, Mercer says.

Only a few stock analysts cover SBICs. One, who requested anonymity, says investors can often gain annual returns of 20 to 40 percent. Of course, that depends on getting into the right SBIC, which requires homework. "Obtain as much background information on the SBIC as possible," he suggests, "including their annual report and quarterly dividend reports. The investor should find out who the chief investment officer is," what his or her track record has been, and what companies the SBIC is investing in.

Also, some SBICs do their investing by making secured loans, a lower-risk approach than taking an equity position in small companies, the analyst says.

Each year the SBIC industry honors successful small businesses that received SBIC money. Last year, the spotlight fell on "Mothers Work," a specialty retailer selling maternity clothes. When the company was founded about five years ago, the owners went to an SBIC after failing to obtain a traditional loan. "It has now gone public, with over 2,000 employees in 44 states," Mercer says.

Finally, institutional investors can participate in the SBIC program by buying US Treasury securities issued by the SBA to help finance small businesses. The SBIC-linked debt securities are pegged to 10-year Treasury bonds, with a premium tacked on, says Mercer. Thus, if a Treasury bond is issued at 6 percent, SBIC debt might yield 6.75 percent, he says.

For more on SBICs, call NASBIC at (703) 683-1601.

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