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Small Business | FINANCING AND INSURANCE

Capital Access Funds a Boon to Smaller Firms

October 14, 1998|JUAN HOVEY

Help is on the way for business owners who scratch for relatively small amounts of capital to expand their operations--say, $50,000 to $500,000.

Under legislation recently signed by Gov. Pete Wilson and taking effect July 1, the California Department of Corporations will begin licensing "capital access funds" to invest in small and mid-sized businesses.

If it works as expected, the new law will:

* Greatly increase the supply of capital available to businesses throughout the state.

* Expand the investment opportunities open to people of ample but not extraordinary means.

In effect, the new law will make venture capitalists out of the middle class--people who might risk, say, $20,000 in an investment pool that is organized like a traditional venture capital fund but targets small and mid-sized companies engaging in ordinary commerce.

At the moment, these investors don't register on the radar screens of big-time venture capital funds because they aren't rich enough. Ditto the owners of tens of thousands of small and mid-sized businesses in California in dire need of growth capital--because their needs aren't big enough.

But the middle class commands a lot of capital; according to one study, about 600,000 California households hold investable assets of $1 million or more. In all, the worth of these families probably exceeds $8 billion.

They invest their money in mutual funds, pensions, 401(k) programs--and in their homes. They invest nothing at all in the country's 650 or so venture capital funds, which get their funds only from institutional investors such as insurers, pensions and banks, plus a handful of very wealthy individuals, probably no more than 2,000 nationwide.

Big-time venture capitalists spawned Silicon Valley and they get most of the attention when people talk about the "new economy," according to Lee Petillon of Torrance legal firm Petillon & Hansen, which practices corporate and securities law for start-up and early-stage growth companies. (Petillon drafted the new California law; state Sen. John Vasconcellos [D-Santa Clara] sponsored it in the Legislature.)

But, in fact, the new economy consists of thousands of businesses whose owners founded them over the last decade and now itch to ramp them up to new levels of prosperity, Petillon says. These companies operate in many industries, some decidedly low-tech, even humdrum. But they need capital just as badly as high-tech companies, and they have a much harder time finding it.

The new law should greatly ease the job, Petillon says, by making the investment opportunities represented by these companies accessible to the capital held by the middle class.

"As venture capital developed over the 1960s, '70s and '80s, the funds kept reinvesting and became larger and larger," Petillon says. "I was general counsel for one fund in San Diego years ago with $45 million in investable assets.

"At the time, we were one of the largest funds in the U.S.," Petillon says. "Today, $45 million is a small fund; the typical fund in Silicon Valley these days has at least $100 million, and some have $1 billion under management."

As the funds grew larger, so did their average investments, Petillon says. Now the average venture capital deal goes down for $8 million.

This creates a kind of "capital gap" for the owners of many up-and-running businesses, according to Milt Lohr, a San Diego businessman who led an advisory group, appointed by the governor, to expand the financing options open to business.

Having long since outstripped the resources they tapped to found their companies--mainly their own savings and those of family and friends--these business owners don't come close to attracting venture capital, Lohr says.

"If you're looking for funds in that gap, you have considerable difficulty getting interest from venture capital people," Lohr says.

"Traditional venture capital firms want companies that will give them a return of three to five times their capital in three to five years, and they invest in only about 1% of the companies they look at."

They also want companies whose revenues can hit at least $70 million in that same period, making them candidates for a public stock offering, Lohr says.

"But there are a lot of companies too small for traditional venture capital that need help," he says. "Once this legislation creates 10 or 20 capital access funds, more companies will be able to get funds they couldn't get previously."

In addition, the new funds will give people of comfortable means the opportunity to take the same risks, in pursuit of the same rewards, as wealthy venture capitalists, Petillon says.

Since the 1920s, investors have earned something like 11% through thick and thin in the stock market--not enough for people who, now reaching their 50s, still have children in college and must save for retirement, Petillon says.

To get there, he adds, these people might well risk some of their assets in a capital access fund and in the process solve one of the biggest problems facing small business in California.

*

How to get financing will be one of the topics addressed at The Times' Small Business Strategies Conference on Saturday and Sunday at the Los Angeles Convention Center. Columnist Juan Hovey will be featured. He can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.

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