The form of security in most cases was debentures secured or partially secured with options or warrants for purchase of common shares and some direct investments in common stock as a part of the package. OPERATIONS The successful operation of an SBIC may be similar to the surgeon's operation, after which it was stated that the operation was a success, but the patient died. After a financial operation on a small business, unless there is a good healthy period of recuperation there is no ultimate success. The management, therefore, must in many cases be the financial doctor and the counselor which helps to rehabilitate the business. The success and growth of any business, in my opinion, depend about 90 percent on management, good planning, and good administration. This requires vision, ingenuity, patience, and confidence on the part of the directors as well as the officers and staff. The small business in which an initial investment is made as well as the SBIC itself must have enough capital to continue to grow and be in a position to obtain it as needed. Very few projected plans of growth work out exactly as planned and frequently require adjustments in terms. Advisory services, as provided in the act, are very important in most small businesses and should be provided as intended in the act on a continuing basis, although frequently the small businessman feels he doesn't need the service and doesn't want to pay for the added cost and sometimes the SBIC isn't properly staffed to provide such services. The purpose of the act is to take risks in investments which other lenders would not take, which means they need close watching. I think the results of the operations of most of the SBIC's has been very good under all the circumstances. The losses in weak investments will always show up before the profits on the long growth investments are realized. Some early losses have been discouraging to the SBIC managers. I am confident that the new legislation and particularly the new tax ruling by Internal Revenue will give new life to the program. INVESTMENTS As in the case of any prudent investor, although the SBIC's are supposed to take risks they should have a balanced portfolio, not all common stocks, not all first mortgage loans and usually they are balanced as to the type of industry and to some extent geographically. Although some SBIC's have specialized in certain industries, most of them prefer a broader diversification. If all investments were straight loans amortized with the additional burden of add on interest ranging from 10 to 30 percent, a small business has little chance to grow with that burden around its neck. Furthermore, this type of operation is simply duplicating the operations of the large finance companies and the finance departments of banks. It needs the use of equity money for long enough to earn a profit and repay the indebted ness. Theoretically, at least, investors in SBIC stocks initially were looking for capital gains rather than immediate income. For that reason, in my opinion, an SBIC which is placing too much emphasis on paying current dividends is losing its vision of the plan to grow as the small businesses grow. Some directors and officers have been too anxious to pay a dividend in order to help the market on the stock, and some shares were sold to the public with a promise of early dividends whereas the prospectus stated the exact opposite. Southeastern in its initial investments, as far as I was able to direct the policy, were made with these thoughts in mind, but we were no exception in having some early losses. It is my opinion, however, that its portfolio is balanced and has a good opportunity to continue to make money provided the company continues to invest its money and make use of its leverage by borrowing and reinvesting. PROBLEMS OF SBIC'S As a few of the problems of operating an SBIC, I would list the following: 1. Lack of public understanding and poor public relations. 2. Uncertainty regarding unpublished rules or regulations, or we might say anticipated rules and regulations, and frequent changes by the several Federal agencies. 3. Dual regulations and supervision with special emphasis on the 1940 act. I have previously testified and insist again that SBIC's should not be under the 1940 act as a mutual fund for SEC supervision. SBA is fully capable of employing such personnel and assuming the responsibility for protecting the stockholders. Of course, when any company makes a public offering, they must clear with SEC under the 1933 act, but only for that purpose. 4. Too much attention has been given to the stock market by brokers and directors rather than their portfolio investments. 5. Some boards of directors of SBIC's have been composed largely for the purpose of selling the stock to the public and have become too large. These are splendid gentlemen with considerable experience, but usually in big businesses rather than understanding the problems of small business operation. This sometimes leads to disagreement as to policy and procedures in any SBIC. 6. A continuing source of increasing capital must be available to SBIC's in order for them to grow with their portfolio companies and extend their financing to additional small businesses. The new legislation will be a great help to the small SBIC's by increasing the matching capital debentures to $700,000. The new provision for some type of SBA guarantee of investments will multiply the use of additional private funds. 7. Investments made in good faith to eligible companies which subsequently result in a merger or acquisition and thereby become technically ineligible for initial investment should not be so declared and the SBIC should not be forced to sell, any more than a small business growing beyond the eligibility terms should be a basis for a forced sale. The purpose of the act is to aid small businesses to grow. If the profit of the investor which makes it possible for small businesses to grow is to be restricted, limited, or penalized because the business is successful, it is small satisfaction to an SBIC stockholder. Unmarketable portfolio securities in an SBIC are unattractive to individual investors. Very few of the SBIC investments initially are liquid as in contrast to the investments by mutual funds. PROBLEMS OF SMALL BUSINESSES Many small businessmen do not want advisory services and see no reason to pay for it. They want to continue to own 100 percent of their equity. If an SBIC suggests a purchase of some shares or an option in connection with a loan, they frequently become discouraged or afraid that the investor wants to take over his business. Unfortunately some of the SBIC's have been a little greedy in this respect and the whole industry has suffered on account of it. The real problem of a little business, such as a small retailer, is that it is usually a oneman business with limited administrative or financial ability, little or no tangible collateral, very slim growth potential, and no depth in management. They frequently cut their margin of profit and operate very cheaply in order to compete. The net worth is usually very small. Many of these little businesses would be much better off to merge or for their principals to take a job with some other firm, but they like their independence and are willing to sacrifice for it. This, of course, is the basis of free enterprise. It is a well-known fact, however, that the cost of processing a small application is extremely high and the interest rates must also be high so that the added burden of repaying the loan principal and interest makes it very difficult to earn a profit and provides little opportunity for growth. SOME RECOMMENDATIONS 1. Better public relations to improve the SBIC image through educational processes sponsored by the SBA, the Congress, and the administration as well as the SBIC's. I congratulate Mr. Gene Foley for having already undertaken this through SBA-sponsored panel meetings throughout the Nation. The widest possible publicity should be given to these meetings. The program should be fast and to the point and not involved with detailed regulations and procedures. 2. Reduction in interest rate on funds loaned to SBIC's to a minimum to encourage use of this leverage to aid more small businesses. 3. Some plan for encouraging or requiring SBIC's to continue to invest their funds and make use of the leverage of borrowing and relending. 4. Some plan for creating a secondary market for SBIC investments. This would be another means of providing leverage and more funds for lending. If established by the Congress for operation by SBA, it would ultimately attract private funds from investors in the same manner as FNMA has done for home loans. Congress provided that plan and the RFC implemented it and now it issues marketable securities providing unlimited funds for home loans. 5. Encourage SBIC's to make smaller loans by adjusting the interest rate downward on loans to SBIC's on amounts which are in turn loaned to little businesses under a ceiling of $100,000 or less. 6. Tighter regulations spelling out procedures for approval of affiliated persons transactions and possible conflicts of interest or self dealings. 7. Some provision for protecting the small portfolio companies and the small stockholders of the public SBIC's. Control through the purchase of blocks of SBIC stocks permits subsequent changes of operating methods and different treatment of the borrowers and stockholders for the benefit of the controlling group. 8. Limit the size of the board of directors requiring each director to own a minimum investment of some amount so that they will assume a larger responsibility for carrying out the program. Outsiders would be less likely to undertake to purchase control of such a company. 9. Watch for changes or modifications made in the private SBIC for the purpose of making a public offering of its stock. See that such changes are not made primarily for the purpose of selling the stock, but for operating the company for the purposes intended in the act. 10. Finally, I strongly recommend the tax legislation presented in H.R. 583 and S. 297. Most of this is very technical, but means a great deal in the operation of an SBIC and avoids the possibility of frequent rule changes by the Internal Revenue Commissioner. Mr. Chairman and gentlemen, I appreciated very much this opportunity of expressing my opinion on these matters and I'll be very happy to answer any questions. The CHAIRMAN. Thank you, Mr. Davis. Thank you for a very fine statement. The list of investments approved in 1960 by Tennessee Investors, Inc., which you have submitted with your statement, will be received into the record at this point. (The list referred to follows:) Investments approved in 1960 by Tennessee Investors, Inc., prior to changing to Southeastern Capital Corp. 1. Beech Creek Homes, Inc., Rome, Ga. Real estate development of 600 acres; bank participation, $100,000, 6 percent, 1st mortgage 5 years; $75,000, convertible debentures, 6 percent, 2d mortgage 10 years; convertible into 49 percent stock. 2. Communications Service, Inc., Nashville, Tenn... Radio, telephone sales and service; debentures convertible into 25 percent stock, 7 percent 5 years. 3. Dr. R. L. Horton, hospital and clinic, Camden, Tenn. Bank participation $10,000, 1st mortgage, 6 percent 10 years. 4. W. H. Wooten Transports, Inc., Covington, Tenn.. Bank participation $25,000, chattel mortgage, 6 percent, 10 years. 5. Clinchfield Supply Co., Inc., Kingsport, Tenn... Wholesale and retail building supplies; bank participation, $15,000, mortgage notes $50,000, 6 percent, 10 years; convertible debentures, $20,000, 6 percent, 10 years; convertible into 15 percent stock. 6. Robert Craft & Sons, Inc., grain elevator, Memphis, Tenn. Convertible debentures, 10 percent, 5 years; convertible in 25 percent stock. 7. Space Missile Materials Corp., Cleveland, Ohio.. Convertible debentures, metal manufacturing; participation with 3 SBIC's in $300,000 for contracts with Red Stone, Huntsville, Ala., and Avco, Nashville, Tenn. Total. Less bank participation.. Total.. Less amounts not disbursed. Balance disbursed. Capital funds available before underwriting... The CHAIRMAN. You certainly are a man of experience and you are a pioneer in this field. I noticed by your statement that while you have had some losses and disappointing experiences you have not lost faith. Mr. DAVIS. No, sir. The CHAIRMAN. Tennessee Investors, Inc., as you pointed out, was one of the first small business investment companies started in the Nation, I believe. Mr. DAVIS. Right. It was the first chartered but not the first licensed. The CHAIRMAN. It was the first Mr. DAVIS. I will have to yield to Mr. Ruvelson for the The CHAIRMAN (continuing). But the first charter was issued to the Tennessee Investors, Inc. Mr. DAVIS. Yes, sir. The CHAIRMAN (continuing). A State corporation charter. Mr. DAVIS. Yes, sir. The CHAIRMAN. Why did Tennessee Investors, Inc., subsequently change to Southeastern Capital Corp. after being launched with such ceremony and promise? Mr. DAVIS. AS I indicated here, in connection with trying to sell stock to the public, the underwriters said that this does not have much appeal on a localized basis. Our stockholders were Tennessee stockholders practically in every case. Fifty-four banks in Tennessee had bought stock and about 20 individuals. So we had more than the $300,000 necessary. But the underwriters said we ought to broaden this base, that it will look better if we have a wide area of operation and the stock will sell better and I am sure it did. The CHAIRMAN. Was the purpose of this expansion to sell more stock only or was the purpose to aid and serve small business? Mr. DAVIS. Well, of course, our purpose was to get more money to do a bigger job. We started out with that program and that was our sales pitch to all the people in Tennessee, that this $350,000 we would start with and then we increased that slightly before we went public. The CHAIRMAN. What was the initial capitalization of Tennessee Investors, Inc.? Mr. DAVIS. It was $350,000 and then we increased it to about $400,000 before we went public. The CHAIRMAN. Did you find in your earlier experience that that was insufficient capitalization to really do an effective investment loan job? Mr. DAVIS. Yes, sir; and to stand the expenses of the overhead of an independent company. You see, we being independent and having a lot of bank investors, nobody was willing to absorb the expense of the management. So it had to come out of the income off of whatever leverage we could use with the initial money. The CHAIRMAN. After you went public and changed to Southeastern Capital Corp., what, then, ultimately became the capitalization of the company? |