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74–304 2001

PROPOSED SOLUTIONS FOR THE CAPITAL FUNDING NEEDS OF START-UP AND EMERGING

GROWTH BUSINESSES

HEARING

BEFORE THE

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

AND

SUBCOMMITTEE ON WORKFORCE, EMPOWERMENT,

AND GOVERNMENT PROGRAMS

OF THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

WASHINGTON, DC, JUNE 26, 2001

Serial No. 107–15

Printed for the use of the Committee on Small Business

(

(II)

COMMITTEE ON SMALL BUSINESS

DONALD MANZULLO, Illinois, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

JOHN THUNE, South Dakota

MIKE PENCE, Indiana

MIKE FERGUSON, New Jersey

DARRELL E. ISSA, California

SAM GRAVES, Missouri

EDWARD L. SCHROCK, Virginia

FELIX J. GRUCCI, JR., New York

TODD W. AKIN, Missouri

SHELLEY MOORE CAPITO, West Virginia

NYDIA M. VELA ́ ZQUEZ, New York

JUANITA MILLENDER-MCDONALD,

California

DANNY K. DAVIS, Illinois

WILLIAM PASCRELL, New Jersey

DONNA M. CHRISTENSEN, Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

JAMES P. LANGEVIN, Rhode Island

MIKE ROSS, Arizona

BRAD CARSON, Oklahoma

ANIBAL ACEVEDO-VILA ́ , Puerto Rico

PHIL ESKELAND, Deputy Staff Director

MICHAEL DAY, Minority Staff Director

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

PAT TOOMEY, Pennsylvania, Chairman

STEVEN J. CHABOT, Ohio

DARRELL ISSA, California

EDWARD SCHROCK, Virginia

TODD AKIN, Missouri

FRANK LOBIONDO, New Jersey

JIM DEMINT, South Carolina

JOHN THUNE, South Dakota

JAMES LANGEVIN, Rhode Island

GRACE F. NAPOLITANO, California

ANIBAL ACEVEDO-VILA ́ , Puerto Rico

DANNY K. DAVIS, Illinois

ROBERT A. BRADY, Pennsylvania

MIKE ROSS, Arizona

SEAN M. MCGRAW, Staff Director

SUBCOMMITTEE ON WORKFORCE, EMPOWERMENT, AND GOVERNMENT PROGRAMS

JIM DEMINT, South Carolina, Chairman

FRANK LOBIONDO, New Jersey

MIKE FERGUSON, New Jersey

FELIX GRUCCI, New York

DARRELL ISSA, California

ED SCHROCK, Virginia

SHELLEY MOORE CAPITO, West Virginia

JUANITA MILLENDER-MCDONALD,

California

DANNY DAVIS, Illinois

STEPHANIE TUBBS JONES, Ohio

CHARLES GONZALEZ, Texas

MIKE ROSS, Arizona

DONNA M. CHRISTENSEN, Virgin Islands

NELSON CROWTHER, Professional Staff

(III)

C O N T E N T S

Page

Hearing held on June 26, 2001 ............................................................................... 1

WITNESSES

Brinson, John, President, Lehigh Valley Racquet & Fitness Centers ................. 6

Rankin, Ed, Founder & CEO, People Solutions, Inc. ........................................... 8

Tatum, Doug, CEO, Tatum CFT Partners ............................................................ 10

Kerrigan, Karen, Chair, Small Business Survival Committee ............................ 12

Morgan, Bob, President, Council of Growing Companies ..................................... 14

Mercer, Lee, President, National Association of Small Business Investment

Companies ............................................................................................................ 15

APPENDIX

Opening statements:

DeMint, Hon. Jim ............................................................................................. 26

Millender-McDonald, Hon. Juanita ................................................................. 30

Toomey, Hon. Patrick ....................................................................................... 36

Prepared statements:

Brinson, John .................................................................................................... 40

Rankin, Ed ........................................................................................................ 42

Tatum, Doug ..................................................................................................... 47

Kerrigan, Karen ................................................................................................ 70

Morgan, Bob ...................................................................................................... 79

Mercer, Lee ....................................................................................................... 84

(1)

PROPOSED SOLUTIONS FOR THE CAPITAL

FUNDING NEEDS OF START-UP AND EMERGING GROWTH BUSINESSES

TUESDAY, JUNE 26, 2001

HOUSE OF REPRESENTATIVES,

COMMITTEE ON SMALL BUSINESS,

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS,

SUBCOMMITTEE ON WORKFORCE, EMPOWERMENT

AND GOVERNMENT PROGRAMS,

Washington, DC.

The subcommittee met, pursuant to call, at 2:05 p.m. in room

2360, Rayburn House Office Building, Hon. Pat Toomey (chairman

of the Subcommittee on Tax, Finance, and Exports) presiding.

Mr. TOOMEY. The subcommittee will come to order.

In light of the fact that we have a vote, I believe we have two

votes right now, I will adjourn the hearing. We will do the votes,

come back as quickly as we can and then get underway and hopefully we will have time to get through this uninterrupted from

there, but no promises. So the meeting is adjourned for now.

[Recess.]

Mr. TOOMEY. The meeting will come to order. I would like to

thank everyone for their patience as we went through the votes. It

is my understanding that we do have some time now before any

subsequent votes, so hopefully we will be able to get much of this

done.

This afternoon, the Small Business Subcommittee on Tax, Finance, and Exports convenes in a joint hearing with the Subcommittee on Workforce Empowerment and Government Programs

to address an important challenge facing small businesses throughout the nation and that is access to capital.

This hearing follows the full committee hearing conducted on

May 17, 2001 which focused on results from a Federal Reserve U.S.

bank survey which supported evidence of tighter loan standards for

businesses attempting to obtain commercial and industrial capital.

Capital is, of course, the lifeblood of small businesses. For a citizen with a dream of becoming an entrepreneur, a small business

owner looking to more efficiently bring goods and services to the

marketplace, or a small or mid-size business attempting to maintain profitability, access to capital is imperative for growth, in

many cases, for survival.

There are a number of potential solutions to the shortage of capital for small business and I want to especially recognize and thank

my colleagues Mr. DeMint and Mr. Baird for their work in crafting

2

legislation that might very well substantially alleviate some of

these problems. Let me just briefly touch on the SUSA act and the

BRIDGE act.

The SUSA stands for the Start-Up Success Accounts. This is an

act that would allow small businesses with gross receipts of up to

$2 million to deduct and place up to 20 percent of taxable income

into an account for each of the first five years of a business operation. If enacted, this legislation would allow small businesses to

draw down on the funds from these accounts over a five-year period

from the time of deposit, thereby stabilizing the flow of capital and

equipping the start-up to save for the future.

The BRIDGE act would allow a firm experiencing sales growth

of 10 percent or more to temporarily defer a portion of its federal

income tax liability.

Both of these measures could be extremely helpful. Clearly the

two gentleman who worked together in developing this legislation

understand the challenges facing small business and I commend

them for the creative approach they have taken to addressing this

challenge.

On a personal note, I would like to suggest that I think one of

the most effective ways that we can help facilitate small business

access to capital would be providing relief from the capital gains

tax. Personally, my conviction is that we ought to eliminate the

capital gains tax all together. That serves as an impediment which

is an obstacle to small business and all business attracting capital.

It is a punishment for people and businesses that save and invest

and therefore it deters economic growth. Having said that, this solution is in no way exclusive as an approach to helping business

access capital.

I think Messrs. DeMint and Baird have some very good suggestions as well.

I would also just remind everyone how critical small business is

to our nation’s economy. It has been the cornerstone of our economy for decades. Small businesses continue to provide so many

critical job opportunities and access to the American dream for so

many folks. That is why I think it is very important that we have

this hearing today, that we hear from the folks who are on the

front lines actually operating small businesses.

I look forward to the testimony of all of our witnesses today, but

I want to particularly thank those of you who have traveled a long

distance to be with us, in particular, my friend and constituent Mr.

Brinson, who is here from the Lehigh Valley, a small business

owner, who has a great deal of expertise in this area.

At this point, I will yield to my good friend from South Carolina,

Mr. DeMint.

Mr. DEMINT. Thank you, Chairman Toomey. I appreciate as well

the opportunity to join with you in bringing these two subcommittees together today to examine more closely some of the issues and

questions raised at the full committee hearing on access to capital

earlier this year.

Inc. Magazine commented in its annual State of Small Business

issue this year that ‘‘If small business were a boxer, the blows of

the past 12 months might have left it on the ropes.’’ That same

3

issue cited financing as the second largest reason for small business bankruptcy.

The overall problem of access to capital and capital retention is

what we are focused on here today. However, those challenges

manifest themselves differently for start-up companies and for

emerging growth businesses. From a public policy standpoint, I am

pleased that we have the opportunity to examine the different financing needs of these types of businesses and explore legislative

solutions.

New businesses have the potential to create hope and opportunity for many Americans. They are an integral part of the renewal process that defines market economies. New and small firms

play a crucial role in experimentation and innovation which leads

to technological change and productivity growth.

They also provide an essential path for many to enter the economic and social mainstream of society. Small business is the vehicle by which millions access the American dream by creating opportunities for women, minorities and immigrants. In fact, minority

and women-owned businesses make up two of the fastest growing

segments of new small businesses.

While this is encouraging, a large number of these new businesses fail in the first few years, often for a lack of capital. A primary cause of this is that our tax code does much to discourage

capital retention. The ultimate result is the loss of staying power.

Operating with no capital, even in a small downturn in sales can

put a new company out of business.

Earlier this year, as Chairman Toomey mentioned, Representative Baird and I introduced H.R. 1923, the Start-Up Success Account Act of 2001 which we call SUSA. The purpose of this legislation is to give new small businesses an additional tool to manage

finances and retain capital. H.R. 1923 would allow a start-up to

place up to $100,000 of taxable income into a SUSA account over

the course of the first five years of business operation. This would

allow new businesses, new small businesses, that are profitable in

one year to set aside some profits to prepare for a downturn in

later years.

This bill is similar to a bill by our colleague, Kenny Hulshof,

which would help farmers and ranchers manage capital with

FARRM accounts.

Fewer people may be familiar with the emerging growth businesses that we will also discuss today that are crucial to the U.S.

economy. Emerging growth businesses are a precious national

asset. They are America’s job generator, producing over 90 percent

of the net new employment in the last 10 years. Evidence also indicates that they are the only firms that provide new jobs during

suppressed economies, like the present one.

Emerging growth companies confront a unique threat in the area

of obtaining and retaining capital and ironically are most vulnerable to failure in the period in which they are quickly expanding.

Although seemingly counter intuitive, when these firms enter a

high growth phase and are experiencing increased profits under accrual accounting standards, they often face transitional cash flow

shortages or negative cash flow due to the need for increasing investment in working assets and new personnel as sales expand.

4

The tax code compounds the difficulty in retaining capital during

the high growth phase because it forces an expanding business to

pay taxes on accrued income during this period of cash shortfall.

Because these firms are not big enough to attract outside assetbased financing, they fall into a capital funding gap. The result is

that emerging growth companies may not generate sufficient cash

flow even as they enter their profitable years to cover income tax

liability. This capital funding gap has a measurable and detrimental impact on the U.S. economy.

To help resolve this capital funding problem for emerging growth

businesses, Congressman Baird and I have been working closely

with Doug Tatum, who you will hear from today, on what we call

the Business Retained Income During Growth and Expansion Act

or BRIDGE which we hope to introduce within the next few days

or weeks. In order to provide emerging growth firms with needed

capital cash flow as they expand sales revenue, the BRIDGE act

will allow a firm that meets the growth test to temporarily defer

a portion of its federal income tax liability.

The deferral would be limited to $250,000 of tax, which would be

repaid with interest. The tax-deferred amount would be deposited

into a separate BRIDGE account at a bank and the firm could use

the account as collateral for a business loan from the bank.

Now, this proposal could bring tremendous national benefits as

a way to create a significant job creating sector of the economy. We

anticipate the BRIDGE would also have a modest revenue effect

initially which would become neutral over a long period of time.

As one who owned a small business before coming to the House,

I am aware of the devastating effect that capital shortage can have

on a business.

I, too, would like to thank all of the panelists and yield the time

back to the chairman.

Thank you.

[Mr. DeMint’s statement may be found in appendix.]

Mr. TOOMEY. Thank you, Chairman DeMint.

At this time, I will yield for five minutes to the ranking member,

Mr. Pascrell.

Mr. PASCRELL. Thank you, Mr. Chairman. I think this is a great

joint hearing whose purposes I absolutely support.

The access to capital hearing is particularly timely, given the nation’s current economic uncertainty. The economic boom is slowing

down, I think we would all agree. Financial losses are mounting for

many companies and job cuts are affecting every industry in America. To make things worse, in recent weeks we have read studies

that suggest the tightening of credit standards by a variety of

banks. This is a real problem.

Small businesses need convenient access to capital resources and

that is our primary job, I would think, on all of the committees, all

of the subcommittees, whether it is start-up costs, expansion purchasing or employee costs, there are always new expenses for businesses.

And small businesses certainly need financing in order to stay

competitive with larger companies in the marketplace—we have

heard that over and over again in the last few weeks—because traVerDate 17-AUG-2001 05:50 Aug 22, 2001 Jkt 074304 PO 00000 Frm 00008 Fmt 6633 Sfmt 6602 E:\HR\OC\A304.XXX pfrm13 PsN: A304
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ditionally many small businesses have limited assets and uncertain

earnings. That is one thing for sure.

Because of this, they have a more difficult time than larger companies when it comes to finding the financial fuel to make their

ventures successful. The tragic result is that these small companies, particularly minority and women-owned businesses, with

enormous potential end up closing their doors due to lack of capital.

So I welcome the hearing and I welcome hearing the various proposals before this subcommittee that address these issues. With access to capital issues on our mid, let us not forget that we must

make certain that as Congress debates funding priorities for the

next fiscal year we include a comprehensive discussion on the impact of these decisions upon the small business community, particularly given the Bush administration’s proposed cuts in 7(a) and

small business investment companies programs, a proposal which

eliminates the program appropriations for each loan program and

replaces them with fees. Unacceptable.

I thank you for coming here today and I thank the chairs and

I look forward to a lively discussion.

Mr. TOOMEY. I thank the gentleman from New Jersey.

At this time, if he has an opening comment, I would like to recognize for five minutes the gentleman from Washington who has

been participating in the drafting of this legislation, Mr. Baird.

Mr. BAIRD. I thank the co-chairs and the ranking member.

Just very briefly, my good friend and colleague Jim DeMint, I

think well described the situation. It was pointed out to me first,

before I was elected, I put together a panel of small business folks

and asked what is the number one thing we could do and what

they pointed out to me was there are a lot of government programs

to help businesses get on their feet, but as we know, high percentages of brand new start-up businesses have a failure rate.

The real jobs, as Congressman DeMint mentioned, are the jobs

from the existing businesses that have been successful enough to

start growing, yet paradoxically we have almost no government

programs to help provide capital or support for fast growth businesses and yet the private sector, for reasons described well in our

previous hearing, often cannot make up that gap.

It is as if we give people a car but then we put a governor on

the accelerator. Just as you try to move forward, the governor

takes in and puts the brakes on. That lack of capital is the governor and I think the SUSA act that Congressman DeMint and I

have already introduced combined with this BRIDGE act, if we can

get it passed, would go a very long way toward providing incentives

and support for small businesses and that would enhance employment and I commend the chairs for their efforts and I look forward

to the testimony of the panelists.

Thank you.

Mr. TOOMEY. Thank you, Mr. Baird.

Ms. Napolitano, do you have any opening comments?

Ms. NAPOLITANO. Only that it is one of the most salient issues

in my area in dealing with small businesses’ ability to succeed. Myself being in small business many years ago, that was one of the

6

issues we encountered, is the assistance from being able to move

forward and grow.

I was reading one of the reports that it indicates that small business has been the engine of the economy of 50 percent. I would

venture to say it is over 75 percent. And I think we are not giving

small business its due and the assistance it needs to be able to

have the growth, the potential it has. And I think the more we

hear about the issues directly from small business that we can

then be able to move forward with an agenda, with legislation that

is going to really impact and have the ability to help small business

growth through assistance in funding.

Thank you.

Mr. TOOMEY. Thank you.

At this time, I will recognize Ms. Millender-McDonald.

Do you have an opening comment?

Ms. MILLENDER-MCDONALD. Yes. Thank you, Mr. Chair.

And to both chairs, as one of the ranking members who are

poised to convene this hearing, we understand and recognize that

the impediment to growth and expansion of any small businesses

is that of access to capital. And so we also recognize that there is

a lack of access to capital with reference to small businesses.

Today, our hearing focuses on such a lack.

Recent studies have documented that the greatest growth in employment has resulted from small businesses with less than 100

employees. In order for small businesses to grow, we have to expand so that we can employ folks. And with my position on workforce and empowerment, it is critical that we look into access to

capital.

Mr. Chairmen, I will not read my statement, but merely ask

unanimous consent that we place this in the record and I look forward to the testimonies today.

Mr. TOOMEY. Without objection.

[Ms. Millender-McDonald’s statement may be found in appendix.]

Mr. TOOMEY. Does the gentleman from Ohio have an opening

statement? No?

Okay. In that case, we can begin with the testimony. I would just

like to briefly explain the clock system we will use. Everybody will

be operating on a five-minute rule. The light will be green for the

first four minutes. It will go yellow with one minute remaining and

we will try to stick to that so we can move things along.

At this point, I would like to recognize Mr. Brinson from Lehigh

Valley, Pennsylvania.

STATEMENT OF JOHN BRINSON, PRESIDENT, LEHIGH VALLEY

RACQUET & FITNESS CENTERS, ALLENTOWN, PENNSYLVANIA

Mr. BRINSON. Thank you, Congressman Toomey, Congressman

DeMint, Congressman Baird, and all the rest. I know some of you.

I know Pat very well, I have known him since before he ran for

Congress and he used to work out in my clubs on a pretty regular

basis, but he tells me he is too busy to work out now.

Mr. TOOMEY. Occupational hazard.

Mr. BRINSON. Yes. Yes.

I am chairman, CEO and majority owner of a small business in

the Lehigh Valley of Pennsylvania and without going through all

7

my testimony in detail, our business has four locations. We have

10,000 members and we employee 300 people, 45 of them full-time

employees and 250 plus are part-timers.

We have had a good record. We have basically been with the

same bank for 22 years. The problem that I want to talk about

today has to do with access to capital for expansion. Back in 1998,

I began to talk—and our bank is First Union and, by the way, I

have to say for the record I am very pleased with First Union

Bank, if there are any First Union Bank employees in the room,

I love First Union. And, honestly, I am not here to say anything

disparaging about the bank. We have a very good relationship with

them and we have had a very good relationship with them.

In 1998, I told them that the west end of our market was expanding rapidly and that we needed a new location. They were

cool. They said, well, ‘‘let us see your proposal’’. I gave them a proposal for a new club to be located about five miles to the west of

our westernmost club at the time. We have sort of a linear market

in the Lehigh Valley.

Anyway, I suggested that they lend us $500,000 and we would

put up $300,000 or whatever else was necessary to do the club.

They passed it up the line, the answer was no.

I went back and I asked again, the answer was no.

I asked why, and they said, ‘‘well, it is because, you know, your

business is a high risk business and we have enough risk and we

do not want any more risk’’.

And so they turned us down.

So I told them that we would go to another bank and see what

we could do and they said,’’ well, you cannot do that because of

loan covenants’’.

We have a large mortgage with First Union Bank and they have

covenants upon covenants. I mentioned before the meeting to a couple of reporters that I need to call them to get permission to go to

lunch. They really—it is almost like—the lawyers would understand, a contract of adhesion. If you want the money, you are going

to sign away your life and permission to do anything and everything.

Anyway, they told me I could not go to another bank.

So I said, well, ‘‘I will round up a new group of owners’’.

And they said, well, ‘‘it cannot include you, so you will have to

find a new group of owners not including yourself’’.

And I said, well, ‘‘all right, I will do that’’.

And they said, ‘‘you still cannot do it because your existing clubs

cannot have anything at all to do with the new club’’.

But, of course, the reason we wanted the new club was to have

it be a part of our chain.

So they tried to stop us at every turn.

Anyway, I sat down with my lawyer and we read the loan covenants and we found a way around it and we did it anyway. We

went out and we raised all the money without one single penny of

bank money from private investors, none of whom own any part of

our existing business. And so we have a new club. I do not own a

penny’s worth of it and we are managing the new club under a

management contract.

8

It is a good deal for us to do this, but I sure wish the bank had

participated.

I want to say that I think the reason the bank did not was because bank regulations are extremely difficult. They have all kinds

of ratios and tests to meet, they have all kinds of businesses that

are classified as high risk and medium risk and so forth and so I

think bank regulation is a big problem.

As I mentioned in my testimony, I would like to see some provision for income taxes to be deferred to help business such as ours

with expansion.

Thank you very much.

[Mr. Brinson’s statement may be found in appendix.]

Mr. TOOMEY. Thank you, Mr. Brinson.

At this time, I would like to recognize the founder and chief executive officer of People Solutions, Inc., Mr. Ed Rankin, our next witness, for his testimony.

STATEMENT OF ED RANKIN, FOUNDER & CEO,

PEOPLESOLUTIONS, INC., IRVING, TEXAS

Mr. RANKIN. Thank you, Chairman Toomey, Chairman DeMint

and members of the subcommittee. My name is Ed Rankin. I am

the founder and chief executive officer of PeopleSolutions. We are

a Dallas based company. We have offices in Austin and Houston.

We were an early entrant into a disruptive industry, disruptive

in terms of we are changing how American industry, U.S. industry,

is managing people and we are really providing a more efficient relationship between people and their employer through this human

resource management outsourcing industry.

This is a complete start-up. I went to the bank on February 14,

1994. I remember it because it was Valentine’s Day. And I depos- ited $1000 into a commercial bank, a large regional commercial

bank, and we started the business in an executive suite office with

an ink jet printer and a notebook computer and some borrowed furniture.

The first year, we did about three or four hundred thousand dollars in revenue. We were profitable. We started to get feedback

from our clients that this was real and we got some large corporations as clients, large multi-nationals who were asking us for more

and more work. We started investing in the business a little.

In the second year, in 1995, we did slightly more than $1 million

in revenue. And all through this time period we had been very

profitable. Our profit margins were strong, our net income was

good, we were running about 10 percent net income, which we

probably could have done much better, but I was trying to grow

and we were growing at 100 percent a year.

I tried during this time period to get loans from commercial

banks, just for growth. There was nothing there. No one even

wanted to talk with us. Literally, banking officers would not even

return calls.

The third year, we really, really took off. And our workforce is

predominantly well educated, highly paid people. I have many people working for us that earn more than $100,000 a year. We are

some creating really good jobs for people. In the third year, we had

to invest again. We were ranked among the 25 fastest growing priVerDate 17-AUG-2001 05:50 Aug 22, 2001 Jkt 074304 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 E:\HR\OC\A304.XXX pfrm13 PsN: A304
9

vately held companies in the Dallas-Fort Worth area. Again, we

were profitable. Our revenues exceeded $2 million. So we went

from a half million to a million to two million. But I had no cash.

I literally had no cash.

Some of our clients, the large companies, were paying us in 30

days, some were paying 45, some would pay in 60. No bank would

lend money to me, even though these were large international corporations because we were young and the loan was considered too

risky.

Unbeknownst to me, the woman who was acting as controller

failed to pay my employment taxes because, as she told me later,

‘‘well, we just did not have the money’’. ‘‘I told her, you know, that

really is not an optional thing, we probably have to go find it,

maybe we need to go talk to our suppliers and ask them if they

can negotiate with us’’.

So, an IRS agent showed up one day and he said, ‘‘Mr. Rankin,

by our records it looks like you owe us around $90,000’’.

I said, ‘‘yes, sir, that is about right’’.

He asked, ‘‘when are you going to get it paid?’’

I told him where we were and what we were trying to do and

he said, ‘‘well, I will give you ten business days to find the money.’’

And we had probably at that point half a million in receivables

which were good as gold because they were large companies and

we were doing good work. I found a factor and sold my receivables,

got the cash, paid off the IRS and we started growing again. While

the factoring was essentially usury rates from an unregulated lender, it allowed us to continue to grow.

The fourth year, we again doubled the size of the business and

went from 2 million to 4 million in revenue. We were ranked

among the 25 fastest growing privately held companies in the Dallas-Fort Worth area again and among the 100 fastest growing

owner-managed businesses in the area. Our revenues approached

about 4 million. We remained profitable. We invested in the business that year, putting in new accounting systems and restructuring the business.

In 1999, we were placed on the Inc. 500 list by Inc. Magazine,

quite an honor. Our large commercial bank, now merged with another large commercial bank, decided without any warning to discontinue our receivables financing line. My controller called me one

day and said ‘‘I tried to move money over from our credit line and

there is nothing there.’’ I had payroll going out on Saturday.

Fortunately, through all this, we found a way to maneuver our

way through it and in early 2000 we were able to borrow $1 million

from an SBIC lender which has given us the leverage now. We are

tracking at 10 million in revenue for 2001.

I believe if we had had legislation like this, giving us the ability

to defer some taxes, which is money which we had earned already,

that we would have either been able to get financing from a conventional lender or we would have been able to use our own capital

to fund our own growth.

So I think, unfortunately, I am one of the few lucky people who

were able to make it out of ‘‘no man’s land’’, but I know there are

millions of businesses out there who are not making it and who are

10

creating lots of jobs, good jobs. So I would urge you to get this legislation moving.

Thank you.

[Mr. Rankin’s statement may be found in appendix.]

Mr. TOOMEY. Thank you very much for your testimony, Mr.

Rankin.

At this time, I would welcome and recognize the CEO of Tatum

CFO Partners, Mr. Douglas Tatum.

Thank you for being with us.

STATEMENT OF DOUG TATUM, CHIEF EXECUTIVE OFFICER,

TATUM CFO PARTNERS, ATLANTA, GEORGIA

Mr. TATUM. Mr. Chairman, members of the subcommittees, I

would like to start with giving you a little perspective. As CEO of

the largest CFO firm in the United States, we have over 300 partners located geographically in 24 offices and we provide CFO assistance and serve as CFOs— Mr. TOOMEY. Excuse me, Mr. Tatum. Could you bring the microphone a little bit closer to yourself, please?

Mr. TATUM. I apologize. Is that better?

Mr. TOOMEY. Much better.

Mr. TATUM. Our partners serve as CFOs and provide CFO assistance to companies, many companies like you have heard from already this afternoon.

Our experience with these emerging companies led us to publish

a small brochure which we have provided to you entitled ‘‘No Man’s

Land: Where Growing Companies Fail’’. We hope that this will provide you some context with my statement today. We have found

that the issue that these two gentlemen have talked about ‘‘No

Man’s Land’’, strikes a resonant chord with entrepreneurs all

across the country.

I would like to limit my comments specifically to the BRIDGE act

and summarize those, rather than go through my written testimony, around the two charts before you here today. ‘‘No Man’s

Land’’, in summary is a stage of growth where a company is ‘‘too

big to be small and too small to be big’’. And what you are hearing

when the gentlemen talk about the difficulties they have had going

through there relate to two very specific issues that we would like

to discuss with the committee.

The first one is the microeconomics of growth. This particular illustration is built from an economic model that accounts for the

typical asset growth characteristics of a rapidly expanding business

on accrual accounting and transitioning through what we refer to

as ‘‘No Man’s Land’’. What is very important to understand is that,

as you can see from the chart, revenue in this case went from $2.8

million to $6.4 million over a five-year period. Profitability grew in

each one of those years.

What is counter intuitive and what we would like to make sure

that the committee members understand is that even though the

company is growing, even though the company is profitable, it is

cumulatively negative cash flow.

To summarize our intent about the BRIDGE Act is that it would

correct an unintended consequence in the tax code that currently

has enormous detrimental effects on the economy, and on job

11

growth in particular, because it asks a taxpayer who is growing

and profitable under the accrual method to dispense cash that it

does not have.

The second area that I would like to draw your attention to in

summary of my written comments is the issue of the ‘‘capital funding gap’’. We heard a little bit about that in the testimony just before mine. What we discovered is that there is a capital funding

gap, we estimate, between about a quarter-million dollars and a

million dollars in terms of the availability of capital to emerging

growth businesses as contrasted to ‘‘small businesses’’.

It appears that, as indicated earlier, many businesses are able to

accumulate the capital to get a start-up going. They get that from

credit cards, from friends and family, from relatives that pledge assets to the bank, and they are thereby able to get the business

started.

Those businesses that, for whatever reason, get that combination

of items together that all of a sudden cause it to grow enter into

a ‘‘Capital No Man’s Land’’, where the business requirements—the

requirements for capital—exceed the personal assets of the individual.

The primary financing in the U.S. economy in the early stages

relates to the personal assets of the individual. When the business

grows to a certain level, the capital requirements for that business

exceed the personal assets of the individual and it falls into a capital funding gap. What we have discovered in interviews with

major regulated and non-regulated capital providers, including a

detailed review of their internal economic models, is that because

these businesses are risky they have to assign account management and collateral management to those businesses in order to

make that loan.

What they have determined is that with financing smaller than

a million dollars, that the cost of an account manager, with a senior loan officer or a loan officer that execute judgment, and the cost

of the collateral management can be upwards of 1400 basis points,

or as much as 14 percent before you even add the cost of the

money. Therefore, the lenders that you see in this capital base are

typically lending money from 25 to 30 percent interest rates, which

is self-liquidating to the business.

Until the business gets large enough where the business assets

are significant enough to attract the kind of account management

and collateral management to oversee the loan and significant

enough for that management to be at a low enough cost to provide

adequate capital, these two gentlemen faced a funding gap in growing their businesses. The proposal in the BRIDGE Act simply

would allow that business to retain the capital for a temporary period that normally would be paid in taxes in the business until it

is large enough to obtain external financing.

I know a little bit about Ed Rankin’s business in particular. Once

he received the million dollars in SBIC financing, he was able to

grow his business to the size where he is now attracting attention

in the major capital markets. He could be at 50 employees soon,

and he could very well have 500 in five years.

[Mr. Tatum’s statement may be found in appendix.]

12

Mr. TOOMEY. Thank you very much for that very lucid explanation of the cash flow crunch that growing businesses face.

At this time I would like to welcome and recognize Ms. Karen

Kerrigan. Ms. Kerrigan is the chairman of the Small Business Survival Committee.

Thanks for being with us.

STATEMENT OF KAREN KERRIGAN, CHAIR, SMALL BUSINESS

SURVIVAL COMMITTEE, WASHINGTON, DC

Ms. KERRIGAN. Thank you, Chairman Toomey and Chairman

DeMint, for holding this joint hearing today on this most important

issue for America’s small business and entrepreneurial sector. Let

me also thank the ranking members of the committees, Congressman Pascrell and Congresswoman McDonald, for their interest and

concern about this topic before us today and other issues facing

small business.

I am pleased to have the opportunity to testify on the issue of

capital access and funding solutions for start-up and emerging

firms and, more specifically, how the Congress can address this enduring challenge through the Start-Up Success Accounts Act of

2001 and the BRIDGE act proposal. I applaud Representatives Jim

DeMint and Brian Baird for their bipartisan perseverance on this

issue in introducing the SUSA act again in this Congress as SBSC

believes quite strongly that it would make a meaningful difference

for many firms across this country.

We are also encouraged by the creativity and the contemplation

that has gone into the proposed BRIDGE act, a solution for entrepreneurial, emerging high growth firms which provide the bulk of

innovation and job creation in our country.

Access to capital remains an acute obstacle for many small firms,

as the full Small Business Committee learned in its hearing on

May 17th. The testimony and conclusions of witnesses serves to

support the follow-up hearing today on specific ways that Congress

can help firms tap the capital they need during start-up and highgrowth periods where a capital gap exists.

Accessing adequate capital is not only an issue for the entrepreneur who wishes to take his or her idea to the marketplace, but

becomes an even more serious one for small firms that struggle

through their tumultuous early years. And if a business takes off

and makes it to the high growth stage, these firms, too, are continually burdened by the lack of capital or reasonably priced capital

in general because the size of the loans are not economically viable

from the lender’s standpoint as well as other reasons, as identified

by Mr. Tatum.

The practical concept underlying both the SUSA and BRIDGE

act will enable small start-up and emerging firms to more steadily

manage their finances and, of course, retain capital. The beauty of

both proposals are that they enable business owners to be more

self-reliant, manage and plan better and more efficiently and, as

several members of my organization have stated in responses to

these proposals, become self-funding.

The lack of capital for early stage and growth firms combined

with the effects of the tax code which discourages capital retention

in effect conspire to squeeze many of these enterprises ultimately

13

leading to many business failures. That is why the proposals before

the joint committee today are so worthy of consideration by the

Congress.

The SUSA option, H.R. 1923, whereby early stage businesses in

their first five years would be allowed to place up to 20 percent of

taxable interest into tax-deferred savings accounts opens up new financial planning and financing opportunities for small firms. Most

start-ups, even those demonstrating early success and profit, as

this legislation is designed to target, will face cash shortfalls at

critical phases.

S.U.S.A. is targeted at the right problem, or should I say the

right audience: early-stage businesses, firms in their first five years

that are very fragile. The numbers speak for themselves, as 80 percent of businesses fail during the first five years.

Even successful firms are going to hit road bumps and pot holes.

This is where the safety net of having an alternative source of capital, being able to self-fund through the business owner’s own

SUSA account, can make a difference.

If a start-up business is given the opportunity to retain more of

its capital through a SUSA rather than engage in tax-motivated

spending, I believe more businesses will succeed. The BRIDGE act

is a complementary proposal to SUSA, tackling the same problem

faced by new and growing firms, yet its distinction is apparent in

the type of business that it would benefit: the rapidly growing, entrepreneurial firms that create the bulk of new jobs in the U.S.

The impressive success of a start-up to the level of an emerging

company indeed is an exciting triumph, yet capital access challenges continue to dodge the company as it becomes more successful. And the health of the U.S. economy and the job growth created

by these emerging businesses is dependent upon the ability of the

company owners to successfully attract capital.

The BRIDGE act proposal aims to help growth businesses, those

growing by 10 percent or more above the prior two years, by retaining their own funds for a temporary period for continued growth.

The additional capital provided by the tax deferral would allow the

company to survive the capital gap that small growing firms go

through in order to thrive as an ongoing business concern.

There is a great need for both SUSA and the BRIDGE act. Both

of these initiatives are sound approaches toward equipping firms

with self-funding options, allowing small businesses to more independently address their own capital needs.

Thank you again, Chairman Toomey, and we are certainly on

board zeroing out capital gains. We think that is a wonderful proposal that gets SBSC’s support. We are encouraged and quite

pleased that the Congress, and in particular the House Small Business Committee and its subcommittees continue to remain hard at

work exploring a range of issues that will create a better environment for entrepreneurship and risk taking.

I look forward to the committee’s questions.

[Ms. Kerrigan’s statement may be found in appendix.]

Mr. TOOMEY. Thank you, Ms. Kerrigan, and thanks for your advocacy for small business.

At this time, I would welcome and recognize Mr. Bob Morgan,

president of the Council of Growing Companies.

14

Thank you for being with us this afternoon.

STATEMENT OF BOB MORGAN, PRESIDENT, COUNCIL OF

GROWING COMPANIES, McLEAN, VIRGINIA

Mr. MORGAN. Thank you, Chairman Toomey, Chairman DeMint,

and all the members, one, for your passion and one for your understanding of the issues small and growing companies experience.

The Council of Growing Companies, we have 1200 heads of,

CEOs——

Mr. TOOMEY. Excuse me, Mr. Morgan. Could you bring the mike

closer to you, please?

Mr. MORGAN. Sure.

Mr. TOOMEY. Thank you.

Mr. MORGAN. Is that better?

The Council of Growing Companies, I interact throughout the

United States with 1200 heads of, CEOs of fast growing companies.

We are trying to help these folks be successful. As you know, this

is most of our job creation in the country.

Our companies range from as small as 3 million in revenue up

to a billion. They are all experiencing double-digit revenue and employee growth. They are on a rocket ride. Our focus is to help these

CEOs and their companies with information and networking and

best practices and sometimes just dealing with loneliness and not

always being understood.

We have chapters in major cities. Our overall mission is to help

create a social, economic and political environment that actually

does nurture and understand entrepreneurship. So let me comment

just briefly about the BRIDGE act and why this is of such importance to the country.

Small business has certain needs, as you have heard, as it begins

to grow and emerging companies that begin to grow fast get into

a little different arena where they have somewhat unique problems.

Small business usually can obtain financing in relatively small

amounts like under $250,000. But when this takeoff occurs, you

quickly in a business outgrow any personal asset-based source of

financing such as are available to an entrepreneur or their family

or friends or credit cards. This rapid growth actually just outstrips

the revenue, as you have heard from Ed here. Profitable, growing

and yet negative cash flow. Because as you start to grow, you have

to invest in infrastructure, employees, equipment, inventories, and

very fast, you in effect out drive your headlights.

Access to capital for these companies becomes very limited at

this no man’s land because once a growing business begins to get

more established, yes, then they can qualify for a credit line or a

loan of like a million dollars or more. Capital markets start to open

up. But prior to that, and getting that track record established, is

just a crucial point in the life of a lot of companies.

How does this happen? You know, here you have a growing company, it is profitable, and yet it owes income taxes, it is winning

awards, getting a lot of publicity. What happens is that when you

are on an accrual accounting basis, which you should be and must

be for tax purposes, you start to report a taxable profit and yet

15

your sales growth outstrips your return on assets. And at that

point you have a negative cash flow.

And at that point, a growing company typically will use up all

of its internal capital by trying to reinvest in the company’s

growth. So this BRIDGE act would be a wonderful solution for

many companies that today would probably still have survived if

this had been available as a resource.

As I have talked to CEOs throughout the country about this idea,

they have all reinforced that, wow, I wish we had had that when

I needed it.

This is not a tax deduction, it is not a tax credit, it is not a government giveaway. This is simply a deferral with interest paid. It

has to be a win-win. And under the draft that has been proposed,

there are plenty of safeguards as we have viewed those with the

amounts being deposited in trust accounts at banks or other financial intermediaries. The account is used as collateral for a business

loan and a deserved loan, because it is backed by money and profit

that demonstrate the company’s viability.

We urge support of this BRIDGE act and we thank you for your

attention in advancing this idea. I welcome your questions.

Thank you.

[Mr. Morgan’s statement may be found in appendix.]

Mr. TOOMEY. Thank you, Mr. Morgan.

At this time, the chair will recognize and welcome Mr. Lee W.

Mercer, President of the National Association of Small Business Investment Companies.

Welcome.

STATEMENT OF LEE MERCER, PRESIDENT, NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES

(NASBIC), WASHINGTON, DC

Mr. MERCER. Thank you, Chairman Toomey and Chairman

DeMint and members of the committee. It is an honor to be here

today to present our views and my views on what steps Congress

might take to increase the availability of capital to small businesses. In one way or another, it is an issue that I have dealt with

since 1971 when I started my career representing small businesses

as a practicing lawyer in Manchester, New Hampshire. The issue

is the critical issue for most small businesses.

The vibrant small business world in America fueled by the independent spirits of individual entrepreneurs is the envy of the world

and the foundation of our nation’s economic well being. Without it,

we would be like most other countries in the world, looking for

models to stimulate job and technology growth. Fortunately, we

have it.

That said, it is also amazing to consider the number of small

businesses that fail each year. SBA estimates that over 260,000

non-farm businesses failed in 1999. Fortunately, more than that by

about 5 or 10 percent were started.

It causes us to ask how many might have prospered if they had

had ready access to capital in the range of $250,000 to $1 million

that the committee is considering here today.

Congress has provided programs that address some of these

issues. Certainly the SBIC program is one of the better known,

16

most successful and, in fact, the fastest growing program right

now. And SBICs, certainly leveraged SBICs, that have access to

government-guaranteed capital invest in increments in the

$250,000 to $1 million range.

I have provided the committee with the FY 2000 statistics that

speak to that point.

However, not withstanding the program’s success, more can be

done and done at little cost to the government to increase the effectiveness of the SBIC program.

First, I urge the Small Business Committee, the House Small

Business Committee, and the House Appropriations Committee to

agree on a mix of SBIC fee increases and appropriations that will

make $3.5 billion in participating security leverage available in FY

2002. That is money that will go to equity-oriented funds that

make equity investments. That will immediately create a likely pool of about $5.5 billion

for small businesses and will lead to more senior debt being available to those companies as well. When the senior debt is factored in, you could have $20 billion

in additional capital created at a very minimal cost to the government, about $26.2 million, if the government were to flat fund the

program for FY 2002.

Second, I urge the committee to seek an amendment to the Internal Revenue Code for the very limited—and I mean limited purpose of excluding debenture leverage from the type of acquisition

debt that under the tax code generates UBTI, unrelated business

taxable income, for tax-exempt investors automatically, no matter

how carefully the debenture SBICs structure their investments.

U.B.T.I. effectively takes 60 percent of the private capital that is

potentially available to debenture SBIC fund managers in fundraising off the table. If Congress were creating a debt-oriented

small business program today that relied on private capital as its

foundation, I am sure it would not take 60 percent of that capital

out of play.

Amending the Internal Revenue Code as proposed will see more

SBIC debt capital available to small businesses. This is subordinated debt capital, not bank loans. This is a more risk-oriented

debt. This is particularly important because the types of businesses

that seek and obtain this type of subordinated debt financing are

generally community businesses like restaurants, hardware stores,

local manufacturing companies and the like. They may not be the

go-go companies that attract major equity infusions, but they are

good and steady employers. The amendment we propose will address capital access for these companies at virtually no cost to the

government.

Finally, I commend to the committee and to Congress the approach represented by the proposed BRIDGE act and SUSA acts.

NASBIC has endorsed the BRIDGE concept and the SUSA concept

as in the same category, albeit slightly different in focus and manner of implementation. Both acts declare the government’s support

for growing small businesses and make it clear that the government will not permit technicalities of law or accounting principles

to punish someone for success, especially in the early fragile years

of a growing business.

17

Whether structured as an income deferral or a low cost loan for

a calculated tax liability, both concepts are self-executing, require

no government bureaucracy to administer and represent the best of

selection efficiency.

No entrepreneur could ask for more and neither could the country that benefits from the collective efforts of all America’s entrepreneurs.

Thank you, Mr. Chairman, and I look forward to your questions.

[Mr. Mercer’s statement may be found in appendix.]

Mr. TOOMEY. Thank you, Mr. Mercer.

And let me thank all the witnesses for their testimony this afternoon. Thank you very much. It was very informative.

I will recognize myself for five minutes of questioning and we

will try to stick to the five-minute rule so that we can give everybody a chance to ask their questions and then if there is interest

to do so we can do a second round of questioning.

First, Mr. Brinson, first of all, thank you for coming, thank you

for your testimony. In your written testimony, you advocate a provision in the tax code that would permit the deferral of federal income tax such as is contemplated by these bills.

In your experience, as you grew your business, can you share

with us how that would have facilitated or accelerated the growth

of your business and looking forward, if you have an interest in

further expansion of your business, can you see how this would

specifically help your business to grow?

Mr. BRINSON. Yes. As I pointed out in my written testimony, we

did pay considerable income tax in 1999, the year that we were trying to get this new business, this new club, together. If we had

been able to defer that, that would have helped a great deal, I

think, to help us get the new club started. So I like the idea a lot

and I think it could benefit a lot of businesses.

Mr. TOOMEY. Thank you.

Mr. Rankin, your business is in the service sector of our economy

and, like many service businesses, my assumption is that most of

your assets are the intellectual capacity of your employees, more so

than hard assets of plant and equipment.

Mr. RANKIN. Correct.

Mr. TOOMEY. In that capacity, of someone in the service sector,

do you think it is particularly difficult for service companies to acquire capital? Is that an additional burden that you face that perhaps others with greater sources of collateral might not face and

could you share with us a perspective of how the service sector

might benefit from this legislation?

Mr. RANKIN. It has been a subject of conversation I have had

with some of the bankers that I am familiar with and know. There

seems to be no recognition in the traditional financing circles of the

transformation of our economy from a brick and mortar economy

to a service business where assets of businesses like mine really reside in the brains of the people who work for me and the receivables that they generate.

There are very few good sources of financing for that. If I were

a hard asset business with inventory, buildings, plant and equipment, it would be much easier to secure traditional financing, but

I really see this as even a more serious problem for our economy

18

as we go forward because we are increasingly becoming more and

more service oriented and our population is becoming better educated and the work that we do here is becoming more sophisticated, more technologically driven. So, yes, I think we do face different challenges.

Mr. TOOMEY. Thank you.

Mr. Tatum, in your testimony, you talked about the cost that an

account officer or bank incurs in simply managing the account and

if a transaction is not large enough to justify the cost, then presumably there is an incentive not to provide the transaction.

Is that an argument for increased fees? Is that an argument for

banks to find another way to be compensated for that? Are there

small businesses that would happily pay larger fees if they could

get this access to capital? What perspective do you have on those

issues?

Mr. TATUM. I think that the banks recognize that as they—and

I say banks and non-regulated lenders, because we interviewed

both—want to loan capital in that sector. When they project the

cost of the account management and the collateral management,

they run into a cost problem that means that for them to make

money it becomes a significant interest expense to the business,

which we refer to as self-liquidating.

I do not think there is an incentive for them to lend money to

a business where their cost of capital now exceeds their return on

capital. What you are basically doing at that point in time is lending money to a business at a rate that is self-liquidating. They

have negative EVA, ‘‘Economic Value Added’’, if you will. Most of

these large lenders are not very enthusiastic about charging a business what they believe maybe usurious interest rates to the detriment of the business, even if they could make money on it. It is

a structural capital funding problem related to risk management.

Mr. TOOMEY. Thank you. I would like to follow up that question

with a question about whether some kind of equity participation

would not be a way to ameliorate that, but I am going to run out

of time, so I will do that on my second round and I will now recognize Chairman DeMint for his questions.

Mr. DEMINT. After all the work with some of you and the testimony today, one has to ask who could possibly oppose this idea, but

everything here has opposition and nothing seems to be easy. I am

sure as you have talked about this idea, you have probably gotten

a few folks who have played devil’s advocate with you and said this

will not work because of this or that.

I, frankly, have a hard time finding problems with it. While some

would say there may be some cost to the government, the worst

case is there is some deferral of taxes. In reality, the increased employment and growth of companies are likely to make this a revenue windfall for the government.

Have any of you, and I will just open it to all of you, as we look

at both the start-up idea as well as the BRIDGE act, what could

we anticipate as far as objections or what type of objections do we

need to be prepared to handle with these ideas?

Yes? Mr. Morgan?

Mr. MORGAN. Some folks have commented, including the Associated Press, who are doing a story on this hearing, what if a comVerDate 17-AUG-2001 05:50 Aug 22, 2001 Jkt 074304 PO 00000 Frm 00022 Fmt 6633 Sfmt 6602 E:\HR\OC\A304.XXX pfrm13 PsN: A304
19

pany goes bankrupt or defaults and cannot pay the loan, therefore

the assets that are tied up securing that loan, you know, who is

holding the bag, does that end up as a cost to the government?

And my comment to that is, yes, there is a risk. There is a risk

to almost everything that we are doing, our business community is

doing, but when you compare the risk of this plan to a lot of other

sources, the risk to me seems much smaller. But as an early warning system, I think that is a criticism or a concern or an issue that

might be tossed at the BRIDGE act, for instance.

Mr. DEMINT. Mr. Tatum, can you answer that for us?

Mr. TATUM. I would like to add to that. The definition of bankruptcy is that your liabilities exceed your assets, which means you

no longer have any retained income in the business. Our tax code

allows us to go backwards and to write-off the losses incurred and

also to deduct the losses against taxes going forward. So that by

the time a business becomes bankrupt, it annually does not owe

any taxes.

I think if you would go to Treasury and look at the number of

firms when they file their tax returns, when they are bankrupt, I

would suggest to you that a very limited number of them actually

owe any taxes. In fact, those firms may actually have an asset

called an NOL, ‘‘Net Operating Loss’’,that certain businesses try to

obtain.

So there is a very specific technical answer to that, and we believe that there is very little risk that the government would incur

any cost related to that. I agree with my colleague.

Mr. DEMINT. That it would not have lost anyway, right?

Mr. TATUM. Right. If you had taxable income and you incur a tax

and then you end up losing money over time, the amount of tax you

owe goes down and by the time you are bankrupt, there are no

taxes due.

Mr. DEMINT. Mr. Mercer, did you have a comment?

Mr. MERCER. I would concur. The beauty of the legislation, the

way it has been drafted in both cases, is that by definition it does

not do you any good unless you are successful, so that reduces the

risk substantially. Also, I agree with what Mr. Tatum has just said.

I think inertia is always the single greatest hurdle in government. When I think about what the accrual method of accounting

does to small businesses in this area, is not this akin to the marriage penalty for small businesses? And everybody would agree

that, gee, we ought to get rid of the marriage penalty, but it does

not seem that that happens very easily, probably more because of

inertia more than anything else, not because people would argue

with the principle. That may well be the case here as well.

Mr. DEMINT. Good.

Yes, Mr. Brinson?

Mr. BRINSON. I think to look at a potential loss is just negative,

and I think a great deal more tax revenue will be generated by

helping businesses to grow. One of my mottoes is that you are either growing, or you are dying, and small business needs to grow

just to survive. And it would produce more revenues, not less.

Mr. DEMINT. Thank you.

I yield back.

Mr. TOOMEY. Thank you, Mr. DeMint.

20

I recognize Mr. Pascrell.

Mr. PASCRELL. Thank you, Mr. Chairman.

Mr. Rankin, I was curious. The difficulty you had with your

bank, did you go to an SBA office before that?

Mr. RANKIN. No, I did not. Actually, I consulted an SBA lending

specialist in Dallas who told me that the probability of an SBA

loan was probably 50/50 for me and it was going to take too long,

so we were going in that direction, but I did not have time.

Mr. PASCRELL. The experience that we have indicates that that

office, that local office, can be a tremendous help. There are many

banks, of course, that participate in the program. We know that.

But many times the people are trained in the SBA office to reach

out beyond the banks that we ordinarily reach out to. I find them

to be very, very, very helpful.

I was anxious to find out whether you went through that bank

because that is what we spend taxpayers’ money for, to establish

these offices so that they will be of help to people like yourself who

deserve it. I mean, that is what your taxes pay for.

Mr. RANKIN. We were looking at it, but we were moving so quickly and our cash needs were so urgent that based on what I learned

about it and, with the very limited time, I had to focus my time

where I felt that we had the highest probability of a faster success.

Mr. PASCRELL. Okay.

Mr. Mercer, over the last several years, Congress has passed a

variety of different laws designed to spur investment in minorityowned businesses and businesses located in low income areas. I am

talking about some risk here, which is quite obvious. Some of them

have worked, some of them have not, like everything else.

What types of policy should we be looking at, should Congress be

considering, to spur investment in low income and minority-owned

businesses, in your opinion?

Mr. MERCER. Well, one of the interesting things about the proposal on UBTI is that it would be a boon to the remaining existing

specialized SBICs, which, of course, by law, can only invest in minority enterprise. They are debenture SBICs and because of UBTI,

they, like everybody else in the debenture program, have a great

deal of difficulty raising private capital from tax-exempt investors.

And I suspect that they, and perhaps even more than regular debenture SBICs, would benefit from that change in the tax law.

The new markets venture capital program, of course, is aimed in

that direction and is just getting off the ground. It is perhaps too

soon to know whether that will be as effective as Congress hopes

it will be.

I do note that the SBIC program, interestingly enough, in FY

2000 invested in low income areas: 14 percent of all dollars were

invested in low income areas and if you increase that to moderate

income, so low and moderate income, it jumps to 25 percent. So the

interesting thing is I think that the market in a sense is working.

S.B.I.C.s will invest in good businesses wherever they are located, but they sometimes have difficulty finding them. I think one

of the single greatest things that SBA could do is to examine and

explore why small businesses located in these areas that may have

good business plans have difficulty getting those business plans on

the desk of a financing source, an SBIC, for example, that can conVerDate 17-AUG-2001 05:50 Aug 22, 2001 Jkt 074304 PO 00000 Frm 00024 Fmt 6633 Sfmt 6602 E:\HR\OC\A304.XXX pfrm13 PsN: A304
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sider them. Deal flow is what an SBIC or other financing source

lives by, is the quality of its deal flow. So to the extent that SBA

could tackle that issue, and it is a hard one, it would be important.

Mr. PASCRELL. As a follow-up, do you think that the banks are

going to embrace this idea, the BRIDGE idea, the BRIDGE accounts? In your opinion?

Mr. MERCER. Would the banks embrace it? In other words, the

money placed into the banks? The banks will embrace it if they

have first security interest on it. Unfortunately, the banks are not

in the business to take a huge amount of risk. If the account is

going to be there and serve as collateral for a bank loan, my view

is the bank is going to want first position versus the IRS.

The biggest problem I see there. A combination of these two may

be the best way to go because when you are deferring income,

maybe it works in a different way. Either one of them can work,

but, as you correctly point out, the big problem with that account

is who is going to claim first whack at it.

Mr. PASCRELL. Can I just ask one quick final question?

What do you—anybody for this one—what do you think about the

idea of—I know Mr. Greenspan does not think highly of it, but

what do you think about it—of business accounts accruing interest?

What do you think about that? They cannot right now under the

law. Checking accounts. What do you think about that? Support it?

Good idea? Bad idea?

I mean, we have been under this system since 1930, I think.

What do you think of that idea?

Mr. BRINSON. Why not?

Yes. I would say why not?

Ms. KERRIGAN. Yes.

Mr. PASCRELL. Thank you, Mr. Chairman.

Mr. TOOMEY. I thank you the gentleman from New Jersey.

I would point out I had a bill earlier this year to repeal the ban

and we have been successful thus far with this. We have the other

body that we have to get some cooperation from.

At this time, I recognize for five minutes the gentleman from

Washington.

Mr. BAIRD. I thank the chair and I thank the witnesses. I was

particularly impressed with the business owners who have—I cannot imagine how frustrating it must have been to you to have a

demonstrated, successful model, to have the potential to further

grow, to employ more people, to go to the bank only to be told we

cannot help you gather the capital. I could not imagine a more

clear testimony to the merits of the bill that Congressman DeMint

has led the way on and I appreciate that.

Let me ask you how the BRIDGE act—it seems there are two

problems. You have the issue of the negative cash flow situation

and you have the issue of the banks themselves not wanting to allocate the human resources to process the difficult loans and the

point that Mr. Tatum raised about the costs.

How will this BRIDGE act affect that second issue of the banks

wanting to allocate the human resources to process it? Could you

walk us through that part from your understanding?

Mr. TATUM. One of the ways that we used to obtain capital

through a bank was to have the entrepreneur place some collateral

22

from friends or family, in a bank and borrow it back for the following reason. It created a risk-free loan, and it also created a relationship earlier than would normally be the case because of this

situation.

If you talked, as I did, to a senior executive of a community bank

holding company, he said just about all the loans that they do in

this capital gap they do because the entrepreneur received collateral outside of the business to take the risk out of it, removing the

need for loan judgment, and thereby removing the need for account

collateral management costs.

By creating an account with these deferred tax funds that can

then be borrowed against, you create a banking relationship sooner

than normally would be established. Our experience has been that

as the bankers have more experience with that company, they tend

to expand those lending relationships quicker.

We believe that banks will compete for the BRIDGE accounts.

When that happens, what you will end up having is lending institutions who want to lend to these businesses—by the way, they

just do not know how to handle them cost effectively—banks will

compete by saying if you bring your BRIDGE Act to my institution

we will also make an equipment loan on top of the loan for your

working capital.

The other thing I would suggest—back to the issue of whose position is first and second—the tax code recognizes philosophically

these types of issues. For example, when a business is asked to go

from a cash basis to accrual, it creates an immediate tax burden.

That tax liability is owed by that business and it does not affect

the loans that are associated with that business.

So all we are saying philosophically is that the tax amounts due

be deferred placed into an account, and allow that business to borrow it back. The IRS does not have a first lien, if you will, on the

business assets when the business owes taxes when it allows the

business to pay that off over time when going from cash basis to

accrual accounting.

Mr. BRINSON. There is another problem that faces us, too, and

I have included it in my written testimony, and that is that there

seems to be some requirement that when bank loans are secured

by mortgage liens that there be a repayment of principal, and this

is ridiculous.

I have a friend in England who owns a whole bunch of small

businesses and they have no such thing as this mortgage loan idea

where you pay down principal every month.

I think it is rooted in the fact that small businesses in this country originally were in homes, located in homes, and when the small

business owner died the business died. So the idea was ‘‘let’s get

the mortgage paid down’’. A business that wants to expand, as I do, does not want to pay

a quarter of a million dollars a year in principal repayments. If

there is some way that your committee could look into the banking

rules that require mortgage amortization, it would be a great relief.

I had a $5 million mortgage two and a half years ago and now

it is down close to $4 million. What happened to that money? It

went to the bank and they had to send their loan officers out scurrying around looking for new people to lend the money to when

23

they already have a good customer paying them interest. They already have all the papers, the guarantees and everything else. So

this just does not make any sense at all. It would be a great help

to many, many small businesses if we were not faced with this requirement.

And our assets do not actually depreciate. If we keep our buildings in good repair, the asset is not depreciating, so that it really

makes no sense to require principal payments, mortgage amortization.

Thanks.

Mr. RANKIN. Can I make one quick comment?

Mr. BAIRD. Sure.

Mr. RANKIN. Three years ago, a quarter of a million dollars in the bank account would have been like $5 million today. And when

we received a $1 million sub-debt loan from an SBIC lender, we

had lots of banks interested in talking with us. Just that little bit

of quasi-equity, I refer to it as, really made a world of difference

for us in terms of how we could operate our business.

Mr. BAIRD. Mr. Chairman, if I might add, I think that is precisely the notion of the SUSA premise that Mr. DeMint and I introduced last year. The SUSA allows you to defer the tax on your profits, you can set that aside in the tax deferred account and that

then provides precisely that kind of seed capital that, as Mr.

Tatum described, would provide further incentive for the banks to

move you into a BRIDGE type account. I think it is very synergistic and that is the benefit of the two bills.

Mr. TOOMEY. The gentle lady from California, Ms. Napolitano.

Ms. NAPOLITANO. Thank you, Mr. Chair.

To Mr. Morgan, Ms. Kerrigan and Mr. Mercer, one of the things

that I have heard, especially from the small business community

in my area, women-owned business and minority-owned businesses, that they have a hard time being able to get assistance,

bank loans, even SBA sometimes because because because.

What have you found in minority-owned and women-owned business? Is that an issue in being able—would you address it, please?

Ms. Kerrigan?

All three of you. Any of the three of you.

Ms. KERRIGAN. You mean just the general access to capital issue?

Absolutely. For start-up firms, it is a huge problem, whether you

are a minority-owned business or any type of business owner in the

start-up phase. Generally, what happens when you do start a business, the start-up capital is generally the easiest type of capital to

get and sometimes it is the most costly because the use of credit

cards and, of course, you go to your family and your friends and

associates and things like that. But it is this start-up period where

the banks need a demonstrated track record of success, they view

the business or the enterprise as being too risky to provide the type

of loan and type of capital that is needed.

Ms. NAPOLITANO. Do you see this particular bill being of assistance to those entities?

Ms. KERRIGAN. Well, I do. If those entities show some signs of

success and they are profitable, they can put aside this money to

be used in the second, third, fourth year, whenever that need develops to have this cash on hand. You have to—with the 600,000

24

to 800,000 businesses that are started each year, many of them minority and women-owned businesses, women are starting businesses at three times the rate of men, there has to be an assumption that some of those businesses are successful and very successful. But even the most successful firms are going to run into some

cash problems, maybe not the first year, but maybe the second or

the third year they may want to expand. And I am speaking mostly

to the SUSA account right now. This is designed for those types of

businesses and I think it makes practical sense.

I have talked to a lot of my start-up members about this and

they think it is a wonderful idea. They can become self-funding and

self-reliant and they do not have to depend on the banks or any

other outside resources.

Ms. NAPOLITANO. Gentlemen?

Mr. MORGAN. I am delighted with your question and your sensitivity to these areas. It has been a problem—— Ms. NAPOLITANO. Do I look like one?

Mr. MORGAN [continuing]. That is getting better, but one specific

way that the BRIDGE act would help here, banks can even hide

behind their obligation, their fiduciary responsibilities to protect

the deposits of their depositors. You know. And risk is always a

reason for a bank to decline.

The BRIDGE act, for instance, gets at two key elements to reduce that risk. One, it reduces the cost to the bank of papering, of

processing, analyzing, all of that. And, second, it reduces the risk

factor itself because the money that is being used for a loan to keep

growing the business is money that has already resulted from a

profitable, well managed institution that is showing a lot of promise.

Mr. MERCER. I think one of the things we have to remember is

for the types of businesses that you are mentioning their, their capital needs may well be and probably are under the $250,000

threshold that is specifically mentioned with regard to this hearing.

A lot of the businesses are self-employment, so it is probably not

even recognized as a non-farm business by statistics.

I think what is appealing and may be—I am not an expert on

the provisions of the SUSA act, but it seems to me that the SUSA

Act would be particularly applicable there. Most of these businesses are probably started on a cash basis, not an accrual basis,

of accounting, and literally run out of shoeboxes, cash in, cash out.

I think as I read the SUSA act, it would basically allow them in

a successful year to defer recognition of that income and essentially

average income over a bumpy two or three-year period while they

are getting started. Then maybe they branch off and make use—

they may grow enough to go into accrual method of accounting,

which they definitely will have to switch to if they are going to be

a successful growing company and attract outside capital sources.

Then maybe the BRIDGE Act takes them from there up to the next

level. So I do think it would be of help.

Ms. NAPOLITANO. Well, one of the reasons, if I may just comment

on that, there was a young man who started a small—it was a

start-up and did so well that he wanted to expand and he was having problems getting some assistance in funding, so rather than do

that, he and his partner sold it for $2.1 million. I mean, that is not

25

a small entity to start off and they did it at home and did beautifully well, but there were problems for him and he decided it

would not be worth his while to spin his wheels trying to find the

funding, the financing.

So there are all kinds of cases. So to me, we need to be able to

help those new entrepreneurs be able to become more successful.

It does mean jobs in our areas.

Mr. TATUM. Just one quick comment. I think the Kauffman

Foundation research indicated that of the G–7, that the participation by women in start-up and emerging growth businesses exceeded all the other G–7 countries combined. So specifically, these two

proposals will uniquely impact an emerging trend, which is women

growing businesses.

Ms. NAPOLITANO. Right. And they work twice as hard because to

them it is their life support, in many instances, their whole support.

Ms. KERRIGAN. And I would just like to echo that. Last year

about this time, I was at the National Women’s Small Business

Summit in Kansas City and the access to capital—these were successful women business owners, some of them in their tenth year,

many of them in their start-up years, who said this was a serious

problem and echoed this concern. And they talked about tax credits

or any type of tax deferrals. They were talking conceptually about

the things that we are talking about here today that can help them

survive and grow and become viable entities.

Mr. TOOMEY. Thank you. Thank you.

Let me congratulate and thank Mr. DeMint and Mr. Baird for

the creative and constructive ideas that they have developed which

could really, I think, from what we have heard today go a long way

to alleviating a very real challenge, but most of all let me thank

the witnesses.

All of you have provided some very informative, very useful information and let me assure you your testimony will help us to develop the support that this legislation will need to move in this

Congress.

The hearing is adjourned.

[Whereupon, at 4:00 p.m., the subcommittees were adjourned.]

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