The US Experience in Assisting the Entire SME Spectrum

Innovation: Engine for Economic Growth

Sofia, Bulgaria October 30-31, 2014

Giuseppe Gramigna [email protected]

The statements, findings, conclusions, and recommendations in this study are those of the author and do not necessarily reflect his position as the Chief Economist at the United States Small Business Administration.

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Policy Objectives of the American Congress

“The essence of the American economic system of private

enterprise is

free competition

. Only through full and free competition can free markets, free entry into business, and opportunities for the expression and growth of personal initiative and individual judgment be assured. The preservation and expansion of such competition is basic not only to

the economic well-being

but to the

enterprise…”.

security

of this Nation. Such security and well-being cannot be realized unless the actual and potential capacity of small business is encouraged and developed. It is the declared policy of the Congress that the Government should aid, counsel, assist, and protect, insofar as is possible, the interests of small-business concerns in order to preserve free competitive

The US Small Business Act

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The SME Spectrum

1. At one end of the Spectrum one finds

Innovative SMEs

, which are particularly efficient in creating new economic activities, new economic modalities, that create new economic growth.

2. At the other end of the spectrum one finds

Traditional Firms

, that are slow-growth , but make up the bulk of firms in the US economy. Traditional Firms are central not only for absorbing innovation, but in their multitude are also central in fostering free competition and the ensuing benefits of economic well- being and security for the nation.

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Principles of a Comprehensive SME Policy

1. Having

a deep understanding of this spectrum

(who they are, where they are, and what they do) may be the guiding light determining not only the effectiveness but also the sufficiency for fulfilling Congress’ policy directive, and indeed any good SME policy.

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Implementing an SME Policy

Ensuring these complex policy objectives may imply: 1. providing subsidies to not only Innovative SMEs that have high potential for growth, but have some handicap solely attributable to their size; but in may also imply; 2. providing subsidies to Traditional Firms that are simply economically viable, but are handicapped solely due to their size.

How much subsidies should go to efficiency maximization and how much should go to maximizing competition, is a difficult question that economics can only provide analytical tools and calibrators. It may very well be that this decision is a fundamentally political one 5

The U.S. Government Role

SBA’s Role in Assisting Innovative SMEs

1. Basic Research & Development Funding (SBIR/STTR); 2. Venture Capital Markets, Especially in Seed and Early Stage Financing (SBIC); 3. Training of young, High-Potential SMEs (E-200 Initiative);

SBA’s Role in Assisting Traditional SMEs

1. Loan Guarantees for all SMEs (7(a), 504 and Microloans).

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The SBA Role: Basic R&D Funding

Small Business Innovation Research (SBIR) Program: Federal agencies with extramural R&D budget in excess of $100 million annually must reserve 2.5% for competitive bid to small businesses.

1. Small Business Technology Transfer (STTR) Program: Federal agencies having an extramural R&D budget in excess of $1 billion annually must reserve 0.3 percent for competitive bid to small businesses.

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SBIR Program Structure...

T he SBIR Program is structured in three phases: Phase I

months.

: Awards of up to $150,000 are made to evaluate the feasibility and scientific and technical merit of an idea, for a period of up to six

Phase II

: Phase I projects having the most potential are funded for further development, up to $1,000,000, for a period of up to two years.

Phase III

: No SBIR funding is provided. Private-sector investment and support are used to bring the innovation to market. However, Phase III funding may include follow-up contracts for production of Phase II innovations.

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The SBA Role: Risk Capital

• The Small Business Investment Company (SBIC) a, government sponsored investment fund to bridge the gap between entrepreneurs’ • • • need for capital and traditional sources of financing: SBA invests long-term capital in privately-owned investment firms, licensed by the SBA as SBICs; Guarantees and sells these investment assets to the private sector ; For every $1 an SBIC raises from a private investor, the SBA will provide up to $3 but typically $2 of debt capital, subject to a cap of $150 million Once capitalized, SBICs make debt and equity investments in some of America’s most promising small businesses.

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The SBIC Program Advantages.

For SBICs:

Patient Capital: Ten-year debenture with semi-annual interest payments

minimizes capital duration mismatch (short-term funding vs. long-term investments).

Rapid Deployment of Funds: Ability to raise typically two-thirds of a fund’s

capital from SBA, minimizing fundraising cycle.

Low cost of capital: Interest rates on SBA Debentures are based on the 10-year

treasury rate, plus a market-based premium for liquidity and prepayment risk.

Enhanced Returns to Private Investors: The low cost of capital increases

returns to private investors in good performing funds.

For Government

: Leverages SBIC investment expertise and capital to provide risk capital to SMEs.

No taxpayer cost.

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The SBA Role: Loan Guarantees

The SBA 7(a) and 504 Small Business Loan Guarantee Programs: Various types (working capital, project finance, micro, revolving, and of different size ($5,000 to $5.0 or $5.5 Mil.) 11

The Federal Government Role: Risk Capital

Jumpstart Our Business Startup Act of 2012 (Apr.)(JOBS Act). 1.Liberalizes small equity issuance by allowing SMEs to raise capital via the internet with minimal regulation (Crowdfunding). Increases the minimum issuance that requires SEC oversight form $5.0 Million/500 investors to $50.0 Million/2000 investors . 2.Introduces Emerging Growth Companies.

3. Allows marketing of issuance via the internet.

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The Federal Government Role: Innovation

Linking and leveraging government and private assets.

1.National Innovation Marketplace. A web-based portal to connect technology requestors and potential suppliers.

2.National Network for Manufacturing Innovation creates a network industry, academic institutions, federal agencies, and states to provide shared access cutting-edge capabilities, educate students and train workers in advanced manufacturing skills.

3.National Design Engineering and Manufacturing Consortium

enables small and medium-sized manufacturers to develop and test their products using advanced modeling and simulation tools that have historically only been available to large companies.

4.Advanced Manufacturing Jobs and Innovation Accelerator

Challenge, a cluster-based investments, bring together educational, research organizations, state and regional economic development authorities, and the private sector to conduct proof-of-concept and commercialization activities 13

• • • • • •

What’s Missing?

Accounting and legal framework to standardize the valuation of Intangible assets.

Intangible assets are an increasingly important part of the value of young, innovative, small firms, perhaps as high as 60 percent; Financial valuation difficulties have undermined the monetization, collateralization and trading of intangible assets; Thus trading of and borrowing based on intangible assets has so far been infrequent and customized; To effectively use intangible assets in the financial system, quantifiable metrics of their characteristics must be available so that markets can calculate those assets’ behavior over time.

Jarboe Kenan P. and Ellis Ian, Innovative Financing for Innovation, Winter 2010. Corrado Carol, Hulten Charles, and Sichel David, Intangible Capital and the U.S. Economy, The Review Of Income and Wealth, Series 55, Number 3, September 2009. Corrado Carol, Hulten Charles, and Sichel David, Intangible Capital and Economic Growth, NBER Working Papers 11948, January 2006. David Haigh, Brand Finance Global 500, Brand Finance, 2010.

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What’s Missing?

New, Creative Instruments that address the strong knowledge asymmetry between insiders and financiers .

• One idea: Create mutual guarantee societies made up of subject matter experts (scientists, successful innovative, entrepreneurs, etc.), who will rate and partially guarantee their ratings, thus addressing the asymmetry of knowledge with “skin in the game”.

• Governments, who are reluctant to make the credit decision, could leverage these ratings and co-guarantees to provide additional partial guarantees for these rated projects/firms.

• These co-guarantees could be used to incentivize private sector risk capital and mezzanine capital to co-invest in these projects/firms.

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