Senator MUNDT. Longer than your community loan development program?

Mr. BOUTIN. No.

Senator MUNDT. Not longer than that?

Mr. BOUTIN. No.

Senator MUNDT. So I can get it clearly before me, let us make the problem as difficult as possible. Let us say Morgan and Curtis and Mundt, three Republicans from the Republican State of South Dakota, are trying to form an SBIC. That is a pretty hard thing to get done. How would we proceed?

Mr. BOUTIN. If you wanted to form an SBIC, you mean?
Senator MUNDT. Yes.

Mr. BOUTIN. You would come to SBA and file an application for a license. Where funds are borrowed to establish an SBIC, you would give us all of your own personal assets and liabilities and clear financial statements of exactly what your personal conditions were, where the money is going to come from, and I am talking now of current procedures, where the money would come from for your part of the investment. Now we have a minimum requirement on a new SBIC of $300,000 of private funds.

So let us say each of you were going to put in $100,000. If you were to borrow that money, we would require that your net worth be at least on the ratio of 2 to 1, or twice as much as the amount of money that you would be borrowing in order to provide your part of the funds.

We would also require you to come in with a plan for the next 2 years what area of loans you were going to concentrate in, equity capital, or the total plan. Who is actually going to be your business manager, and his complete background. Who is going to be your lawyer, and who is going to be your accountant.

Senator HARRIS. All of these things are new and current procedure; is that so?

Mr. BOUTIN. Some are a combination, Mr. Chairman.

Senator HARRIS. For example, you had a $150,000 requirement until it was changed to $300,000.

Mr. BOUTIN. That was changed administratively to $300,000.

Senator HARRIS. The requirements about the management and so forth, those are new?

Mr. BOUTIN. Those are new.

Senator HARRIS. Will you proceed?

Mr. BOUTIN. Then, after we had all of this information, we would run a name check with the agencies that I spoke of in my prepared statement to make sure that the applicants, in this case it would be very easy, would have nothing in their background which would show that they were not good credit risks and honest and upright citizens.

We also would go up to South Dakota. We would talk to people who have done business with you, who have known you, so that we would have a pretty good picture, as much as if we were going to appoint a Federal official. We would know all there is to know about you.

Then we could feel secure that we had, here, people who were knowledgeable, people who had a plan of operation, where they could meet

their expenses, and also fulfill the requirements of the statute. We would also go over it with you on a personal visit.

This used to be possible to delegate, but I have required Mr. Greenberg personally to talk with every single applicant, in a personal visit, where the regulations would be gone over, so that you would know precisely what is required of you, and you would know, for instance, that you were going to have an examination at the end of 6 months and annually thereafter.

We would take a look, too, at your earnings forecast to make certain that you weren't going to have to deplete your capital in order to meet these expenses.

Senator MUNDT. After we put in our $300,000, how much do we anticipate that the SBA would put in?

Mr. BOUTIN. We would put in, under section 302, up to $300,000. These are subordinated debentures that we would buy from you.

In addition to that, under section 303 you could get a loan for another $300,000. In addition to that, you could, with SBA permission, go out and borrow another $2,100,000 from private sources, so that you would have a total concern then, from your original investment of $300,000, potentially $3 million.

Senator HARRIS. Prior to the changes that have been instituted, there wasn't really any serious investigation to find out if the first $300,000 were borrowed.

Mr. BOUTIN. That was one of the problems.

Senator HARRIS. So you might go in through this whole chain reaction in the past, having borrowed all of the private capital involved. Mr. BOUTIN. Well, if we were to use Senator Mundt's example, he could have started one and borrowed the $300,000 and then he could have made a deal with Senator Curtis where he would loan from his SBIC-really we are talking pure Government funds-$300,000 to him, and he could use it to start another SBIC and they could have a whole chain of them without having one nickel of their own money involved.

Senator MUNDT. Now you have it corrected to the point where we would have to have our $300,000 in cash from our own funds.

Mr. BOUTIN. That is right.

Senator MUNDT. No we have it organized and we have the $600,000. What further directives do you give to control our operation, or are we on our own after that?

Mr. BOUTIN. Up to now you have been pretty much on your own. You had the prohibition that not more than one-third of your portfolio could be in real estate, that you could not make loans to speculators in real estate, particularly, now, land development-type loans.

You also would have had a prohibition on making loans of providing equity capital for any concerns that did not qualify within the definition of small business. Besides that, you were pretty much on your

own.

Now, we are formulating at present guidelines, and I think this was a whale of a good suggestion made by the General Accounting Office. I don't know why we haven't done it before, but we are doing it now.

Senator HARRIS. There were some requirements about conflict of interest.

Mr. BOUTIN. Yes, right from the very beginning. There are requirements of course.

Senator MUNDT. What percentage of your whole SBA program is represented by this SBIC program?

Mr. BOUTIN. Well, our total authorized ceiling, not counting the disaster loan program, is $2 billion. The ceiling on the SBIC program is $400 million, so it is about one-fifth, or about 20 percent of the total.

Senator MUNDT. What are presumed to be the advantages of the SBIC program which leads us to undertake it as against the other two programs which have been pretty spotless, so far as we know.

Mr. BOUTIN. The provision of equity capital. There is no other vehicle, Senator, in Government programs for providing this kind of capital injection.

Senator MUNDT. Do you get a separate line item appropriation for SBIC, or is this from a revolving fund?

Mr. BOUTIN. This comes from the revolving fund, and we go to our Appropriations Committees for authorization for administrative expenses from the revolving fund. There is no appropriation.

Senator MUNDT. In your experience, now, as to the ones going bad, have they gone wrong primarily because of bad judgment being exercised by the managers of the SBIC, or have they gone wrong because of bad character, people who went in there deliberately to milk their way through?

Mr. BOUTIN. It really covers the waterfront, Senator. The bulk of the companies that are in trouble, and have been in trouble, the vast majority are the minimum companies, the small ones. It was very easy, for instance, for a couple of bad loans, loans that may have looked good originally, to go sour and, in fact, get them into a capitalimpairment situation.

I would like to emphasize that I think the great majority of the people in the program, including the problem companies, have been fine, decent people. Many of them, however, did not have any experience and they didn't know the first thing about the program, and SBA made the mistake of letting them get in..

I could own Oak Ridge and never produce an atomic bomb. I don't know the first thing about it. These people couldn't run SBIC's because they didn't know the first thing about it. Then, of course, as the program gained publicity, for want of a better word, the "mugs" came in. They saw a chance for a fast dollar. They used all kinds of techniques.

Then others saw opportunities within the law, but, nevertheless, not practices that you and I would condone, to make a fast dollar by parlaying money and cross-dealing, and by self-dealing. It really covers about every possibility that one can imagine.

Senator MUNDT. Now, looking back at the record of the companies that have cost the taxpayers money, because they haven't succeeded, could you give any kind of a "guesstimate" as to what percentage of the ones that have gone sour have done so because of the inexperience and the lack of expertise in this loaning business, and what percentage have gone wrong because of unsavory characters who have seen thisand-that loophole and have moved in to make a fast buck?

Mr. BOUTIN. I would say, Senator, and this is just my best opinion as of this time, that when we have all of the story on the table, which

we will have soon, we will find in excess of 80 percent of those in trouble are in trouble because they simply made mistakes. They lacked experience and they didn't know.

The remainder will cover everything from intentional violation of regulations to criminal violations, and we are going to have some of

those.

Senator MUNDT. Taking the 80 percent, that is the hard part to correct. You can take steps to correct this 20 percent relatively easily by your increased surveillance. How big a factor in the 80 percent of defalcations is this item that you have stressed two or three times this morning, and that is that SBIC is authorized to make higher risk loans than you make in the Development Corporation or in your direct SBA interest?

Is there something that we should be thinking about in terms of reducing the element of high risk which they are entitled to undertake? Mr. BOUTIN. Senator, from my viewpoint, I don't think it would be desirable for the Government to even indicate that we want them to take only those risks that are really sure things, particularly in the equity capital provision.

Senator MUNDT. Between the sure thing and the open sky at the top there must be some rule of reason that you have to apply as to what is high risk.

Mr. BOUTIN. This is why guidelines are going to be very helpful. But the fellow with a new product, a new idea, and a new technique, who can't afford to borrow money, he has no collateral, but he has an idea, a new invention-this is the type of thing that I think we should encourage.

I think it would be interesting to the Senator and to the committee if I were to just say this: that our indications are that of the total dollars made available by SBIC's to small business, that it almost runs 50-50, equity-type financing and long-term loans. The prudence of that is best illustrated by the fact that all of these concerns have expenses, and they have to pay rent, and they have to pay office help, and so forth.

Well, from the loans they get sufficient interest, or should get sufficient interest to keep them in business.

On the other side of the coin, the equity capital may not produce for 3 years or 5 years, or sometimes more. But I think we have to give them better guidance. I think this is one of the real ingredients that has been lacking.

Senator MUNDT. Can you break down percentagewise now the area of trouble involved in the long-term loan aspect as against the equity capital aspect, from this 80 percent which goes wrong not because of any deliberate intent on the part of the operators but because of inexpertise?

Mr. BOUTIN. I am not sure that I understood the question.
Senator MUNDT. You said you had two kinds of operations.
Mr. BOUTIN. That is right.

Senator MUNDT. One was the long-term loan.

Mr. BOUTIN. Yes, sir.

Senator MUNDT. The interest from which should keep the business going, and the other was the equity capital, where there would be a delayed repayment because it takes some time to get it going profitably.

Between those two kinds of operations, which has caused you the most difficulty from the standpoint of failure to return the funds? Mr. BOUTIN. Really, not one more than the other, from what I can see, Senator.

Senator MUNDT. You think it is 50-50.

Mr. BOUTIN. I would say it is very close to that.

Senator MUNDT. Now, into a different line of questions, how does this happen? Is it an accident or why is it that such a big percentage of these SBIC loans are made in the metropolitan areas as against the American smalltown complex?

Mr. BOUTIN. I think to best answer that, Senator, I would like to point to the history of licensing of these companies. The major portion of those licensed were licensed in a period 1960 through 1963, where we had 93 in fiscal year 1960, 194 in 1961, 298 in 1962, and 101 in 1963. I think what actually happened was that large metropolitan areas where, of course, there are many of the small businesses, where there are many of the financial people who would understand the program, SBA on a nonselective basis was willing to really go all out on granting licenses. I think this has bred part of the problem.

I think in some of the major communities too many were licensed, so they were competing with one another, and there just wasn't enough, really, to go around. So some of them went bad.

I don't think from my observation that there ever had been a real, concentrated effort on the part of the agency to stimulate interest in the programs and the benefits that can come from the programs in the semirural areas.

Senator MUNDT. That leads to my next question.

One of the real problems in this country, and one of the problems SBA has been helping to meet, is the problem of keeping all of these businesses from becoming concentrated in the metropolitan areas and, in so doing, to preserve the small town. Now, a small town is a hard thing to define. I am thinking in terms of a community of less than 100,000 population, which out our way is a pretty good sized city. I am thinking in terms of the importance of keeping communities of 5,000, 20,000, 30,000, or near 100,000 in the economic picture. I think that we all recognize that would be good for society and good for America, to keep contracts from being made just to businesses in the big cities. I think the SBIC operation, as you have described it, provides an excellent device for helping to stimulate the growth of economic enterprises in these relatively small communities.

I am wondering whether any thought has been given to including in your guidelines some additional kind of a guideline which would provide that at least a certain percentage of the SBIC loans should be made available to these communities which are pretty well being overlooked at the present time.

Do you think that would be advisable, or do you think that that would be inadvisable, or do you disagree with my hypothesis that it is good to sort of get a part of America's economy moving more rapidly and sharing in the defense contracts, and so on?

(At this point Senator Muskie entered the hearing room.)

Mr. BOUTIN. On the last premise, I most certainly agree. As a matter of fact, we have reoriented within the last 30 days our 501 and 502 programs, where we are concentrating in those communities