Mr. ROBISON. I have been interested in the fact that your SBIC, like many others, perhaps, is pretty much a specialist, as indicated by the fact that you have over 70 percent of your loans in the real estate field, speaking generally. Is this a trend, from your knowledge of the SBIC field, that is taking place elsewhere? Are SBIC's becoming sort of specialists depending on the expertise of their directors, for instance?

Mr. SMITH. From conversations with officers of other SBIC's at meetings around the country, I believe it is, especially the smaller ones. Now, the large publicly held companies can have the staff necessary to evaluate lots of industries, but-at least, this is what the SBIC executives that I talked to tell me. I have no statistical information to back it up.

Mr. ROBISON. Let me ask you to explain for me, if you can, since I am not familiar with it, the so-called "waiver provisions" with respect to self-dealing, which apparently you have to obtain from SBA in connection with some of these loans in this particular field.

Mr. SMITH. If Potomac Small Business Funds, Inc., wanted to make a loan to a corporation in which one of the officers or directors or over 10 percent stockholders had an interest, then we would have to obtain prior approval from the SBA to make such an investment. Mr. ROBISON. And you have never yet, according to your testimony, had to ask for such a waiver?

Mr. SMITH. We have never yet asked for such a waiver.

Mr. ROBISON. That provision or restriction applies only if a director or a stockholder has

The CHAIRMAN. Ten percent or more interest.

Mr. ROBISON (continuing). Ten percent or more interest in your SBIC

Mr. SMITH. That is correct.

Mr. ROBISON. It does not make any difference what the size of his interest is in the corporation to which the loan is made?

Mr. SMITH. That is correct.

Mr. ROBISON. Do you foresee any problems in that area?

Mr. SMITH. No, sir. I agree with the regulation. I think it should be strictly enforced.

Mr. ROBISON. One other question and then I will yield, Mr. Chairman.

The CHAIRMAN. Go right ahead.

Mr. ROBISON. I do not understand exactly what you mean in one paragraph on page 5 of your statement in which you say, and I am quoting:

*** by specializing in real estate we have been able to subsidize our SBIC by low salaries, partially based on less time required in management. Will you expound on that a little?

Mr. SMITH. I will be very happy to explain.

I am also an officer and director of the savings and loan association. We are mortgage brokers and real estate developers. Potomac Small Business Funds is operated from my general offices, and we are involved in the financing of real estate and providing equity capital to other small business concerns. We have a reputation for doing this in our own business community. Therefore, a large number of investment opportunities come through our office. The ones that appear to

fit the SBIC pattern, then we use the SBIC like a tool—a tool in an overall box of tools. And by operating in that manner we are able to save on overhead, time allocated to it, and this can be shown in a relatively low operating cost.

Mr. ROBISON. Is there an interlocking connection between the directors of your savings and loan association and the directors of your SBIC

Mr. SMITH. No direct interlocking, although Mr. McIlvaine, Captain Sweeney, and I are all officers and directors of the two firms. The CHAIRMAN. Will your small business investment company, Potomac Funds, Inc., be able to operate successfully independent of your association with the savings and loan organization?

Mr. SMITH. We could, independent of the savings and loan. I doubt seriously if we could, independently of my other activities in the lending and investment field.

The CHAIRMAN. Mr. Multer.

Mr. MULTER. Very briefly, Mr. Chairman.

Are there any commercial bankers or other financial institution representatives connected with your institution other than those in the savings and loan field?

Mr. SMITH. Yes, sir. Mr. Philip Talbott, the chairman of the board, is the assistant to the president of the National Savings & Trust Co. here in Washington. He was former president of the U.S. Chamber of Commerce.

Mr. F. Carbery Ritchie is the chairman of the board of the National Bank of Fairfax, which is an old, 60-year-old bank in Fairfax County, which I am very proud to serve as a director.

Mr. Bernard Steinberg is a director of the Arlington Trust Co.

Mr. MULTER. Financial institutions as such have no stock interest in your associaiton?

Mr. SMITH. No, sir.

Mr. Arthur Weid is on the board of directors of Fairfax County National Bank, another national bank with a similar name to the one that I and Mr. Ritchie are connected with.

Mr. MULTER. Is your savings and loan association of which you are a director a national or a State association?

Mr. SMITH. It is a State-chartered institution, capital stock, Statechartered institution. Our accounts are insured by the Federal Savings & Loan Insurance Corp.

Mr. MULTER. Under your State law is the savings and loan association permitted to make any of the same type of loans as your SBIC may make, or are they restricted to home loans?

Mr. SMITH. They are not totally restricted to home loans. In the land development field I would say that the savings and loan company can make some of the same type loans that the small business investment companies can make.

Mr. MULTER. Is there any referral by the savings and loan association to the small business association of applicants for loans?

Mr. SMITH. Yes, sir; the same people are evaluating the loan applicants, and they are placed where they seem to best fit.

Mr. MULTER. In other words, a man comes in to the savings and loan association for a loan and you think that he qualifies for the SBIC company and send him to the SBIC company to make the loan there?

Mr. SMITH. Yes, sir.

Mr. MULTER. And charge the higher rate?

Mr. SMITH. Not necessarily. Obviously if the competitive situation were such that the lower rate that the savings and loan association can make of course, in a land development loan, let us just take that area, if you do not mind; the savings and loan is restricted by law from making a loan that is over 60 percent of the appraised valuation. And we would make this loan based upon our current lending policies in a range of 534 to 6 percent. Quite often the needs of the borrower in this area are for loans in excess of 60 percent of appraised valuation, and this is where the SBIC comes in.

Mr. MULTER. And there is no referral of loans by the savings and loan to the SBIC so they both can make the loans so far as the amount and terms are concerned?

Mr. SMITH. We have made loans where the savings and loan association has taken a first trust position and loaned at 6 percent, and the SBIC has taken a second trust position and loaned at a higher rate. Mr. MULTER. Have there been any instances, though, where the SBIC took the first trust and the savings and loan took no position? Mr. SMITH. I do not remember a single instance of the type you mentioned, where the savings and loan took no position, and we took a first trust, because the type of yields that we need in this SBIC program, Congressman, just are not first trust security type loans.

Mr. MULTER. I was just wondering whether or not there were any referrals of applicants by the savings and loan to the SBIC when the SBIC could take the greater return where the savings and loan could not make a charge over and above the interest and could not take an equity position in addition to making the loan?

Mr. SMITH. I think that more than likely the referral situation comes in when the savings and loan could not make the loan. Because they would have to turn it down, because it does not meet their lending pattern. But they feel that it is a loan that could perhaps be reasonably made by the SBIC. It is then referred to the SBIC.

Mr. MULTER. There is just one other thing, Mr. Chairman, that the witness has not developed. And that is his second recommendation. What clarification do you suggest there in order to be able to add undivided profits to your capital and have that included?

Mr. SMITH. We asked the SBA about this-it has been some time ago; a year and a half ago, I believe and we were told that as far as eligibility for 302 funds were concerned, that this meant paid-in capital. And I believe, sir, that the reason that they suggested was that it was an enforcement problem as far as being able to evaluate how the money got into the undivided profit account.

The specific example that the SBA gave me was: What if you have debentures that you paid $50,000 for and you convert them into stock that you say is worth $100,000. And then you bring this item down into undivided profits. And they say: What you have really done is you have swapped some apples for some oranges, and you have not really got any money, and yet you are asking us to put more money into your capital structure as a result of this transaction.

And I agree that this could happen, but it seems to me that it could also be avoided.

And what I have in mind, of course, is, if that $50,000 debenture was sold for $100,000 cash, or if just profits were made, and cash profits,

cash earnings, as we have this year in our company, are brought down to surplus, or undivided profits, and if we then declare a stock dividend out of that surplus which increases our capital, we do not see why we should not then be eligible to go to the SBA and ask them to purchase our 302 debentures in an amount equal to the stock dividend issue. We could pay out a cash dividend and the cash would be out of the program. If we elect to leave it in the company, we certainly see no reason why we should not be eligible to sell more debentures to the SBA.

Mr. MULTER. I am in agreement with you. I know of nothing in the law that says this cannot be done. It does present somewhat of an administrative problem, but they should be able to handle it administratively. If you are going to water down your stock by this stock dividend, I can see their coming in and saying: You may not do it. But if you swap $1,000 worth of oranges for $1,000 worth of apples, it is still $1,000.

Mr. SMITH. Right.

Mr. MULTER. I do not think that it should present any real problem, and I do not think the law needs any amendment. I may be wrong. I think the law is sufficiently broad now. And they can handle it administratively. And I do not think they ought to take the opinion-it is my opinion they should not take the arbitrary position that: We just will not permit this. If instead of giving you a cash dividend for $1,000, they issue a stock dividend, the $1,000 is there and remaining, I do not see why that should not be capital.

Mr. SMITH. This is our position, sir. I am very pleased that you agree with it.

The CHAIRMAN. Mr. Mitchell, our counsel.

Mr. MITCHELL. Mr. Smith, the law does state that it must be paidin capital and surplus. But do we understand that when you issue extra stock, whether it is through stock dividend or otherwise, that that is not paid-in capital surplus? Does SBA take the position that that would not be paid-in capital surplus?

Mr. SMITH. Mr. Mitchell, this was the position that they took when we posed the question to them. I admit it was a year or even maybe 15 months ago. They may have changed their minds since then, but I remember what they told me then.

Mr. MITCHELL. On page 3 of your statement, perhaps I misunderstood it, but it is the column underneath "Net Profit or Loss After Reserves." Is that correct? Is that correct? In your statement you refer to "before" provision for reserves or "before" reserves.

Mr. SMITH. That is a typographical error or editing error. That should be "before reserves."

99 1

Mr. MITCRELL. Thank you. That is all.

The CHAIRMAN. Thank you, gentlemen. Thank you very much, Mr. Smith, Mr. Williams. We appreciate your testimony.

Mr. SMITH. Thank you, Mr. Chairman and gentlemen.

The CHAIRMAN. The committee will call next Mr. Cummings. Is

Mr. Cummings here?

(No response.)

The CHAIRMAN. Brown Engineering Co., Mr. Cummings.

1 See tabular listing on p. 101 of this record.

Mr. Robert H. Pratt. Is Mr. Pratt here?

Mr. PRATT. Yes, sir.

The CHAIRMAN. Mr. Pratt, you may come around and be seated and give us your name and tell us about your organization and whom you represent. The committee welcomes you and is certainly pleased to hear your testimony.

Mr. PRATT. Delighted to be here, Mr. Chairman. My name is Robert H. Pratt. I am president of Virginia Capital Corp., which is located in Richmond, Va.

The CHAIRMAN. You may be seated, Mr. Pratt.

Mr. PRATT. I have a prepared statement which I believe has been distributed.

The CHAIRMAN. You may proceed as you wish, Mr. Pratt. You may highlight it or read it, as you wish.

Mr. PRATT. I regret I was unable to supply you with the statement in advance, so perhaps it might be more appropriate to read the statement, rather rapidly, if I may.

TESTIMONY OF ROBERT H. PRATT, PRESIDENT, VIRGINIA CAPITAL CORP., RICHMOND, VA.

Mr. PRATT. It is an honor to appear before your committee on behalf of Virginia Capital Corp., and discuss that company's history, present status, and projections. Virginia Capital was one of the first 20 companies to receive its license under the Small Business Investment Company Act of 1958. The organizers consisted of a group of Virginia businessmen, six Virginia banks, and the Norfolk & Western Railway Co. The company was incorporated July 1, 1959, under the name Small Business Investment Co. of Virginia, with private capital of approximately $375,000. Its name was changed to Virginia Capital Corp., August 18, 1960, and its capital and surplus increased to approximately $950,000 by means of a public offering of common stock in November 1960.

INITIAL OPERATIONS

Virginia Capital Corp.'s initial management staff consisted of one full-time employee assisted by a 4-man executive committee and a 15-member board of directors. During the first 15 months of operation, 36 applications for financing were received from small businesses, and 3 investments were made totaling $225,000. It became apparent within the first 8 months after organization that, notwithstanding the substantial management assistance provided without compensation by the directors and executive committee members, a staff of full-time personnel was absolutely necessary for effective operations. It became equally clear that at least 1 million in capital and surplus was necessary in order to afford a full-time staff and to provide a capital cushion that could absorb investment losses without the danger of a statutory impairment. Virginia Capital's board was sufficiently aware, even at that early point of this small business venture capital program, of the fact that if it were going to fulfill its mission, which was to provide equity—that is, risk-capital for small business concerns, losses would occur inevitably and that, if it were not prepared to run the risk of losses, it would not be carrying out the purposes of the Small Busi