SD25 - Report of the Joint Subcommittee Studying Capital Access and Business Financing in the Commonwealth

Executive Summary:

As traditional manufacturing industries continue to decline and large corporations continue resizing, rightsizing, and downsizing initiatives, small and emerging businesses are playing an ever-increasing role in our nation's economy. Virginia, in particular, must address ways to foster the development of these businesses as defense spending falls and the federal government shrinks.

It is estimated that over the next ten years, more jobs will be created by small businesses (those with less than 500 employees) than all other businesses combined. Moreover, the majority of today's workers are employed by companies that did not exist ten years ago. To support this wave of new businesses and ensure economic growth, the issue of providing capital to spur the development and expansions of these businesses has become critical.

In 1994, Governor Allen signed Executive Order 16 (94) which launched the "Opportunity Virginia" economic development strategic planning effort. As part of this initiative, over 800 business and community leaders participated in meetings across the state to assess Virginia's strengths and weaknesses in promoting economic development in order to create jobs and bring investment to the Commonwealth. The state's existing economic development policies were closely examined, particularly its programs that promote business development, to determine if gaps exist that must be addressed if the state is to move forward.

"Opportunity Virginia" also outlined ten key industry sectors which will be the most important to Virginia's future economic growth. Among these industries are aerospace, biotechnology, and information technology and telecommunications. Because these industries have only recently developed, they are among the most in need of capital to fund their growth.

Among the goals outlined in "Opportunity Virginia" for promoting the state's economic development initiatives relating to capital access issues were the need to focus on improving the economic success and competitiveness of Virginia's established and emerging base of companies and to capitalize on Virginia's technology assets and infrastructure to compete in the 21st century. In order to achieve these goals, several strategies were outlined in the report. Two of the most important strategies, and the most relevant to the issue of capital access, were that the state should seek to make working capital and financing for expansion more accessible for Virginia's smaller established firms and to evaluate the availability of "risk capital" and develop strategies to attract additional seed and venture capital to Virginia.

The most common concern voiced by the participants in the Opportunity Virginia effort and by entrepreneurs and business owners to Virginia's economic development professionals is that there is a lack of capital available for firms which want to begin or expand. These people often cite what is perceived as an unwillingness on the behalf of banks and other traditional sources of capital to lend to ventures where the risk is high and there is often little or no track record upon which to base repayment of a loan. Despite initiatives in the past decade by financial institutions to address the needs of small business, particularly in order to meet federal Community Reinvestment Act requirements, businesses still overwhelmingly feel that they are being denied access to funding.

Banks and other financial institutions, however; are not the only source of funding for these businesses. During the past thirty years, a network of seed and venture capital funds have emerged to link investors with new businesses. These funds are usually more willing to accept higher risk than financial institutions, but they are not nearly as accessible. It is often very difficult to bring together a fund manager with a business in need. Moreover, it appears that these funds like to be near the companies in which they invest. Because there are so few venture capital firms in the Commonwealth, there are few opportunities for seed and venture fund managers to "kick the tires." Another source of funding, usually for companies that have been in existence for several years, is a private offering of securities to a limited number of individuals. Such offerings, because of their small size, can be a lucrative source of funding without significant regulatory barriers. Initial public offerings of stock are also one of the ways that fast-growing companies take to access large amounts of capital.

It is unfair, however, to blame capital access problems solely on financial institutions and other sources of capital. A poorly developed business plan can significantly reduce the chance of an entrepreneur receiving funding from any source. Also, few entrepreneurs are willing to invest the time, or have the time, to fully investigate all funding options that are available to them. The large number of small businesses and a fixed amount of capital available to help them naturally means that some are funded while others cannot be, often leaving those business owners who do not receive loans frustrated and disappointed. Finally, many business owners are unwilling, to surrender a portion of the ownership of their company in return for start-up financing as is often required by seed and venture capital organizations or when securities are sold.

In order to meet the need for capital, state governments have developed a variety of programs to increase the availability of capital and to strengthen existing businesses to make them more "acceptable" to traditional funding sources. These programs include the creation of loan funds, guarantee programs, technical workshops and seminars, and other resources to spur the development of new businesses. While the state has a role to play in promoting business development, it should not replace the private sector as the primary provider of financing. Instead, the state must find the balance between facilitator and provider of loans and other business funding programs. The state needs to work closely with the private sector to create opportunities for the development of capital and link them with those businesses which need capital in order to grow.

In 1995, the General Assembly passed Senate Joint Resolution 370 and House Joint Resolution 591 to more closely examine these issues. Specifically, these resolutions created the Joint Subcommittee to Study Capital Access and Business Financing to examine "various new initiatives and existing state programs which increase the accessibility of private financing for business development and attract investment and working capital, including seed, operating, and expansion capital, to the Commonwealth in order to support economic development efforts; programs pursued in other states targeted at increasing the availability of private capital; and the appropriate role of the state in facilitating business financing."

For the purposes of this study, capital access and business financing programs have been differentiated from standard economic development incentives such as tax credits, grants, and infrastructure support. While incentives can promote capital access and business financing is an incentive, the Subcommittee focused on those ways in which the state either provides direct financing to businesses in need or on market-oriented solutions to promote lending to these businesses by private entities.

This report outlines the programs already offered by Virginia, other states, and the federal government to address capital access issues and explores several options for creating new opportunities to ensure that the Commonwealth is able to compete in the 21st century.