Wednesday, March 2, 2011

How I See It

Startup America Partnership deconstructed

By Michael Gurau, president of Clear innovation Partners

A month ago, a public-private partnership — Startup America Partnership — was announced, reiterating the Obama Administration's keen focus on small business innovation, entrepreneurship and access to capital. With organizational funding from the Kauffman Foundation and the (AOL Steve) Case Foundation, the initiative seems designed to coordinate a variety of existing and emerging (not yet funded) public and private sector resources and efforts focused on advancing Obama’s agenda as it relates to supporting strategic sectors (including energy, advanced manufacturing and information technology) and small, high-growth ventures with capital and counsel. The capital portion of the plan included statements that partners such as IBM Corp. and Intel Corp. would commit specific dollar amounts to supporting or investing in emerging growth companies.

Of greater note was Small Business Administration administrator Karen Mills’ announcement that SBA was repurposing its existing Small Business Investment Company (SBIC) debenture program to create two $1 billion matching fund commitments to risk equity venture funds seeking early stage capital, and to growth equity funds addressing underserved communities or clean energy ventures. The latter program is not too much a pivot for SBA in that debenture SBICs (a debt-like form of risk capital) have long been available to proven growth capital funds capable of uncovering established businesses with cash flow that can support regular interest payments; what’s new in the announcement is the twin focus on underserved communities and on clean energy ventures.
The former program seems a bigger deal; debenture SBICs have not generally been used to support early stage VC as these emergent ventures — typically loss-making early on — cannot support regular interest payments.

I’ve managed a debenture SBIC focused on early stage VC, so I viewed this prospective commitment to early stage debenture SBICs with great interest.
Here’s the way it’s likely to work: fund managers raise capital, then apply to SBA for a 1:1 match for early stage funds, 2:1 match for growth equity funds. If I raise $25 million, the government “lends” me around $37.5 million (representing 150 percent of the $25 million) but holds back $12.5 million as pre-paid interest for the first five years (I get a 1:1 cash match for the $25 million I raised but I incur a $37.5 million debt obligation.

Thereafter, the fund — starting in year six — starts making regular interest payments on debenture draws made during those first five years. Provided that the fund has generated a liquidity event, in the second five “harvest” years of its life cycle, it can service the debt interest payments on the loan until it has sufficient liquidity to pay off the debentures. This math works well for funds that deliver performance, in that returns in excess of debenture principal and low interest repayment accrue to private investors. Given the government’s apparent disinclination to resuscitate the equity version of the SBIC program, this is a creative way to get new capital flowing.

Startup America also announced support for entrepreneurship education and mentorship. The principals behind this program are referencing support organizations like Techstars, Mass Challenge and Jumpstart America, that have existing programs that Startup America will highlight. In all likelihood, participation in this partnership will be little more than showcasing for these organizations, raising their profile and their ability to raise capital and provide more services. While not new, this is not a bad thing.

I have great hopes for the partnership. While many would characterize it as fanfare without much new resource, I’m confident that the importance of small business to this president and the commitments of Case and Kauffman will have us concluding a few years down the road that it wasn’t just a high-test press conference.

 

Michael Gurau can be reached at mg@clearvcs.com.