Our present capitalization-and the capitalization was increased in November of 1961-is $692,144, composed of: Private capital of $348,316 and subordinated debentures to the Small Business Adminis tration of $343,828. We have borrowed funds from the Small Business Administration under section 303 totaling $346,000. The original officers and directors of the company were: Philip M. Talbott, chairman of the board; James L. McIlvaine, president; T. Eugene Smith, executive vice president; Vincent A. Sweeney, secretary-treasurer; Carrington Williams, counsel; Bernard Steinberg, director; Edward M. Bostick, director; F. Carbery Ritchie, director; and Douglas R. Smith, director. Subsequently, Mr. Douglas R. Smith and Mr. Edward M. Bostick resigned from the board because of other business commitments. Mr. Bostick was replaced on the board of directors by Mr. Arthur M. Weid. The board now consists of eight members. In just over 3 years of operations, Potomac has invested $1,350,000 in 30 small business concerns. Currently we have approximately $1,050,000 invested in 25 companies. Our individual investments in dollar amounts have ranged from $6,000 to $120,000. In eight of our investments we have participated with other small business investment companies. However, the aggregate amount of the largest of these participation investments was approximately $360,000, with the exception of an investment by a large group of participating SBIC's, in which we invested $25,000, in the Washington-Baltimore Helicopter Airway, Inc., for which prior approval was obtained from the Small Business Administration. Our investments may be tabulated by groups as follows: Construction: Four investments in homebuilding companies. They total $156,500. Land development: Four investments totaling $200,000. Miscellaneous: Seven investments, totaling $193,400. The miscellaneous investments are broken down as follows: (1) A $60,000 participation in a loan of $200,000 to a community television antenna system in western Pennsylvania. (2) $35,000 to a grain storage concern. (3) $15,000 to an automatic carwash. (4) $20,000 to a drycleaner. (5) $7,650 to a retail men's store. (6) $43,750 to a small manufacturing concern. These aggregate $1,352,400. If you combine the construction, land development, and real estate categories, you will note that we have made 17 investments aggregating $963,000, or 71.4 percent of our total investments, in this field. This concentration is because of our management background in mortgage lending and real estate development. We are very pleased with the contribution these companies have made since our investment. We estimate that they have been responsible for approximately $7,750,000 in new construction to date. We feel that our investments in this industry have returned large dividends in terms of total economic activity. Potomac Small Business Funds, Inc., has been able to operate profitably since March 31, 1961. A résumé of our operations follows: As of the 31st of March 1961, in which we had been in operation 3 months, we had total investments of $113,232, income of $3,336, operating expenses of $5,853, for a loss of $2,487. As of March 31, 1962, our total investments had been increased to $652,418, we had income of $45,998, we paid interest to the Small Business Administration and others of $7,820, we had other operating expenses of $27,373, and we had a net profit before provision for loss of reserves of $10,804. As of the end of March 1963, we had $970,936 invested, our income was $79,166, we paid interest to the SBA and others of $24,259, other operating expenses of $36,713, and a profit before reserves of $18,194. We estimate that, as of the end of this month, we will have $1,050,000 invested, that our income for the year will be $133,000, our interest expense to the SBA $35,000, other operating expenses $39,000, and we anticipate a profit before provision for reserves of $59,000. This $59,000 includes a $25,000 capital gain. To date no dividends have been declared or paid by this company. (The résumé as submitted in tabular form by Mr. Smith is as follows:) Mar. 31, 1961. Résumé of operations of Potomac Small Business Funds, Inc. $5,853.94 Net profit or loss before reserves 1 ($2,487.47) 10, 804. 40 18, 194. 17 2 59,000.00 1 Corrected to agree with testimony. 2 Includes capital gains of $25,000. NOTE. To date, no dividends have been declared or paid. Mr. SMITH. Our modest earnings during the fiscal years prior to and ending March 31, 1963, were placed in a loss reserve, and we were able to charge off a loss of $24,500 on the small manufacturing concern during fiscal 1963. We are now nearing the end of our third full year of operations, and all of our portfolio companies are operating profitably and successfully. All of our loans are current with the exception of a loan to a small nursery concern, which has been in default for over a year. Our remaining investment in this company is less than $10,000, and we do not anticipate a loss. Prospects for fiscal year 1965 appear equally good. We expect to realize capital gains from a number of our investments within the new few years. We plan to accumulate a loss reserve in the maximum amount permitted under the new Internal Revenue Service regulations. We feel that a loss reserve of this amount is reasonable, but by no means excessive, in view of the nature of our business. In summary, we believe that Potomac Small Business Funds, Inc., after 3 years of operation, is a sound concern. We feel that we have gained some of the experience necessary to serve the small business community and at the same time make a profit for our stockholders. We also believe that, with the passage of the new amendments to the Small Business Investment Act, additional progress can be made. We hope to grow by retaining earnings and by, perhaps, the sale of additional capital stock to our present stockholders. We believe that a small business investment company with an investment portfolio in the range of $2 to $3 million, specializing in one or two industries in which its management has particular expertise, cannot only be successful but can make a real contribution to the economy. Indeed, we believe that unless an SBIC does specialize in one or two industries in which its management has experience and extensive contracts, the staff necessary to place and service investments in diverse industries would be uneconomical for all but the larger SBIC's. We also feel that the interests of the small business concerns are themselves best served by this specialization, because the specialized SBIC can give them sound guidance with their business problems. For example, our first investment was in a small manufacturing concern in a surplus labor area-caused by the closing of railway shops in the Valley of Virginia, approximately 120 miles from Washington. When they needed expert help with management, production, and sales problems, we were unable to give it to them due to our inadequate experience in the field. We took a $24,500 loss on this investment which, as I mentioned, we were able to write off out of earnings. On the other hand, when one of our homebuilding borrowers was hard hit by the removal of a nearby defense installation-this was in the Newport News area, moving NASA to Texas we could and did give them advice and refinancing assistance which enabled them to survive a threatened mortgage foreclosure, and they are now prospering. In effect, then, by specializing in real estate we have been able to subsidize our SBIC by low salaries, partially based on less time required in management. It may also be noted in passing that on the question of self-dealing, we have not yet had to ask the Small Business Administration for a waiver on any investment. There are two areas of the act or regulations that we feel need clarification or change. (1) We think that small business investment companies should be permitted to purchase limited partnership interests, because of the increasing use of partnerships, and (2) We feel that the act should be clarified so that if the capital structure of a small business investment company is increased by way of stock dividends from undivided profits, matching section 302 funds would be available on the same basis as they would be for paid in capital. We fail to see a proper differentiation between capital paid into the program and capital retained in the program. I appreciate very much the opportunity to appear before you. If there are any questions, I will be most happy to try to answer them. Thank you very much. The CHAIRMAN. Well, very fine, Mr. Smith. Thank you for a very nice, very concise statement. Your company, Potomac Small Business Funds, Inc., has been operating now into its third year? Mr. SMITH. Yes, sir. The CHAIRMAN. Your capitalization is less than $1 million? The CHAIRMAN. And yet you tell us by your testimony that you have $1,350,000 in investments. You are investing more than your capital structure, which shows that you are having a turnover and that is the way to operate successfully. Mr. SMITH. That is correct, sir. The CHAIRMAN. And you also indicate that you specialize in certain areas of investments; in particular, real estate. Do you recommend that? Mr. SMITH. I think that for us specialization is the answer. And since our experience is in the real estate area, this is where we should specialize. I would hope that there would be other managements with experience in other industries that would specialize in their particular industries. Now, you will note, however, that although we have a concentration in the real estate field, we have not passed up investments that are out of our area if we feel that they are reasonable risks. The CHAIRMAN. You have approximately $350,000 in private capital and approximately $700,000 in SBA funds, which is really a 2-to-1 leverage? Mr. SMITH. That is correct. The CHAIRMAN. This is what several of the witnesses have been seeking and asking for. Do you plan to take advantage of additional loan funds available under the new amendment? Mr. SMITH. I do not believe, sir, that at our present capital structure we would be entitled to additional loan funds. We could increase our capital, and then we would be. The CHAIRMAN. As you know, this committee of the Congress is interested in assisting truly small businesses, and this is the area in which you are concentrating your activities Mr. SMITH. Yes, sir. The CHAIRMAN (continuing). Your services. Do you have any recommendations with respect to the loan interest rate situation? Mr. SMITH. I think this is a real problem, in that the one thing that the truly small businessman, Mr. Chairman, does not want to give up is equity in the business. By and large, also, the truly small business cannot stand a great lot of high interest rate borrowings. And yet because of the risk involved, the SBIC's, by and large, have to have it one way or the other a relatively high interest rate or at least a chance to participate in growth. I have no specific recommendations to make, unless the committee wishes to consider amendments to section 303 of the act, which would provide that SBIC's could borrow on more favorable terms from the SBA, on the security of loans in amounts under, say, $30,000 or $25,000, that carried a cumulative interest rate of, say, less than 8 percent. The CHAIRMAN. Now, you make some recommendations with respect to buying into partnerships. Would you amplify on that a little bit? Mr. SMITH. Well, especially in the area of our specialty, and in other areas, I am told, there are a number of sound busines considerations that would indicate that a partnership is a much more workable vehicle than a corporation. As a matter of fact, we have been unable to The CHAIRMAN. Specifically, how would you recommend that this be implemented? From a corporation you buy stock and you share on a participating basis according to the number of shares of stock you buy. How would you buy into a partnership? Mr. SMITH. Mr. Chairman, I would like to ask Mr. Williams to answer that question, since he is an expert in this particular field. Mr. Williams. The CHAIRMAN. Mr. Williams, you are counsel. We will be glad to have your recommendations. Mr. WILLIAMS. Mr. Chairman, what has frequently come up in the real estate field, for example, which is what we are most conversant with, many ventures, whether they be in motels or apartments, office buildings, and so forth, are now put together as limited partnerships. Some of them are public offerings; I am not talking about that.~ I am talking about the private offerings, of limited partnership interests in which the builder and developer and perhaps one or two others of the general partners, they take the responsibility for going ahead and running the business, building the building and managing it, as a rule, and the investors come in and buy limited partnership interests, and their exposure is limited to the capital that they put into a limited partnership. We have had numerous applicants come to us and ask for participation this way, and we have great difficulty, because they do not want to incorporate. If they incorporate, they lose the benefit of the depreciation advantages under the internal revenue laws. Therefore, they insist on retaining their position as individual proprietors or limited partnerships. But we cannot come in and take a participation, an ownership participation, as an SBIC, because the regulations and the statute forbid it. They refer only to taking an equity position only in an incorporated small business concern. The CHAIRMAN. We understand that. But suppose you had some very strong individuals with whom you bought a partnership and you are engaging in the financing business. How would you take over and run the partnership with such an individual? Mr. WILLIAMS. Well, sir, we-I do not feel that the risks to the SBIC would be any greater in the partnership under a properly drawn limited partnership agreement. I do not think that the risks to the SBIC would be any greater, any more troublesome than with a corporation. The CHAIRMAN. Percentagewise, how many investments is your organization making in corporations through equity financing? Mr. SMITH. Yes, sir, I think I can answer that. Actually, the breakdown is about-roughly 60 percent of our total investments carry some equity rights, Mr. Chairman. The other 40 percent are straight loans. |