Capital | Policy Agenda

Make the SBA (Even) More Responsive to the Unique Nature and Needs of Startups

The Small Business Administration (SBA) administers several programs to support new and small businesses, including loan guaranty programs to enhance small business access to capital; programs to increase small business federal contracting opportunities; direct loans for businesses, homeowners, and renters to assist their recovery from natural disasters; and access to entrepreneurial education to assist with business formation and expansion.  The SBA also administers the Small Business Investment Company (SBIC) program (see below).

The SBA’s Technology Program Office also administers the Small Business Innovation Research (SBIR) Program and the Small Business Technology Transfer (STTR) Program.  Through these two competitive programs, the SBA ensures that the nation’s small, high-tech, innovative businesses are a significant part of the federal government’s research and development efforts.  Eleven federal departments participate in the SBIR program, five participate in the STTR program, awarding $2 billion to small high-tech businesses.

Under the leadership of Administrator Izabel Guzman, the SBA has taken unprecedented steps in recent years to more clearly distinguish between existing small businesses and young startups, and to make SBA programs, products, and procedures more responsive to the unique financing needs of startups.  CAE urges the Trump Administration to continue such efforts, including how SBA-backed lending and other programs can be even more tailored to the needs of startups (e.g., less complex, and less reliant on cash-flow and physical asset collateral).  To reinforce this expanded organizational and programmatic perspective, Congress should consider renaming the SBA the “New and Small Business Administration” (NSBA), or the “Small Business and Entrepreneurship Administration” (SBEA).

Increase the SBA Guarantee to SBICs

The SBA’s Small Business Investment Company (SBIC) program – established by the Small Business Investment Act of 1958 – is designed to “improve and stimulate the national economy in general and the small-business segment thereof in particular” by stimulating and supplementing “the flow of private equity capital and long-term loan funds which small-business concerns need for the sound financing of their business operations and for their growth, expansion, and modernization, and which are not available in adequate supply.”

The SBIC program was created in response to a Federal Reserve Board report to Congress that identified a gap in the capital markets for long-term funding for growth-oriented small businesses.  The report noted that the SBA’s loan programs were “limited to providing short-term and intermediate-term credit when such loans are unavailable from private institutions” and that the SBA “did not provide equity financing.”  Equity financing (or equity capital) is money raised by a company in exchange for a share of ownership in the business. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock.  Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time.

The Federal Reserve’s report concluded there was a need for a federal government program to “stimulate the availability of capital funds to small business” to assist these businesses in gaining access to long-term financing and equity financing.  Facilitating the flow of capital to small businesses to stimulate the national economy was, and remains, the SBIC program’s primary objective.

The SBA does not make direct investments in small businesses.  Rather, it partners with privately owned and managed SBICs licensed by the SBA to provide financing to small businesses with private capital the SBIC has raised, along with funds the SBIC borrows at favorable rates because the SBA guarantees the loan obligation.  Some SBICs specialize in a particular field or industry, while others invest more generally.  Most SBICs concentrate on a particular stage of investment (i.e., startups, expansion, or turnarounds) and geographic area.  Since 1958, SBICs have invested about $125 billion in nearly 200,000 companies.  Some of America’s most iconic companies have received investment capital from SBICs, including Apple, Tesla, Whole Foods, Staples, Intel, FedEx, and Costco.

As of September 20, 2022, there were 310 privately owned and managed SBA-licensed SBICs.  In fiscal year 2023, the SBA provided SBICs with more than $4 billion in commitments, and SBICs invested nearly $8 billion in financing for small businesses.  This resulted in a total of nearly $42.5 billion in combined SBA commitments and private capital for SBICs.

On June 21, 2018, the Small Business Investment Opportunity Act was enacted to modify the SBIC program, increasing the amount of outstanding leverage allowed for individual SBICs from $150 million to $175 million.  While a step in the right direction, CAE is of the view that the increase of $25 million was insufficient, especially since the cap was previously raised in 2009.  CAE urges Congress to increase the cap on the SBA guarantee to SBICs to at least $250 million.

Raise the Cap on the Reg A Exemption (or Mini-IPO)

The JOBS Act of 2012 sought to revive the Regulation A exemption – sometimes called a “mini-IPO” – which allows public companies to raise capital through general solicitation without the full burden of disclosures typically required of a conventional initial public offering (IPO).  The Act increased the amount of capital that could be raised under the exemption from $5 million to $50 million and instructed the Securities and Exchange Commission to reevaluate the cap every two years.

In 2015, the SEC adopted final rules to implement Section 401 of the JOBS Act by creating two tiers of Regulation A offerings: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period.  From June 2015 through December 2019, issuers in the Regulation A market reported raising approximately $2.4 billion in 382 qualified offerings.  The vast majority of capital raised under Regulation A, approximately $2.2 billion (91 percent), was raised under Tier 2, with only $230 million (9 percent) raised under Tier 1.

In March 2020, the SEC issued proposed amendments to simplify, harmonize, and improve the “patchwork” exempt offering framework under the Securities Act, with the aim of reducing potential friction points and to make the capital raising process more effective and efficient.  In proposing the amendments, the Commission noted that exempt offerings accounted for more than double the new capital raised by registered offerings in 2019 – $2.7 trillion in exempt offerings compared to $1.2 trillion in registered offerings.  The SEC approved the prosed amendments on November 2, 2020, which included raising the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million.

While the increase in the Reg A cap is welcome news, companies seeking to raise more than $75 million – say, $100 million, still a small amount by any standard – must resort to the conventional IPO process and the burden of standard disclosures.  With this in mind, and given the expanding importance of exempt offerings to the financing of young high-growth companies, CAE urges the SEC, or Congress, to raise the Reg A exemption cap to at least $100 million.

Pass the Community Development Investment Tax Credit Act

Entrepreneurs of color have historically encountered profound race-based obstacles to securing the capital they need – and, unfortunately, such obstacles persist.  Indeed, a 2022 analysis by the Joint Center for Political and Economic Studies found that six in ten business owners of color face major challenges securing capital. These findings echo the conclusions of a 2021 analysis by the Federal Reserve that found that entrepreneurs of color were less than half as likely as white entrepreneurs to be approved for bank loans– even when business owners of color have high credit scores compared to their white counterparts.

Given such difficulties, an important alternative for new and small business owners of color are community development financial institutions.  CDFIs are financial institutions that provide credit and other financial services to underserved markets and populations.  CDFIs are funded by private investors and– once certified by the Treasury Department– become eligible for financial awards and other assistance from the CDFI Fund (administered by Treasury), which was created by the Riegle Community Development Regulatory Improvement Act of 1994 to promote economic development in distressed urban and rural communities. Since their establishment, CDFIs have become a vitally important source of capital for business owners of color and other underserved populations, with 1,271 certified CDFIs operating nationwide with total assets of $152 billion as of September 30, 2021.

On September 28, 2023, Senators Mark Warner (D-VA), Roger Wicker (R-MS), Chris Van Hollen (D-MD), Cindy Hyde-Smith (R-MS), Gary Peters (D-MI), and Jerry Moran (R-KS) re-introduced their bipartisan Community Development Investment Tax Credit Act.  The legislation would create a new tax credit for private sector investors that make equity or equity equivalent investments in, or that provide long-term patient capital (i.e., loans with a minimum term of at least 10 years) to CDFIs.  The bill would benefit CDFIs of all types – bank CDFIs, credit union CDFIs, venture capital CDFIs, and CDFI loan funds – and provide those institutions with the maximum flexibility and financial support they need to accelerate economic development and build wealth in low- and moderate-income communities.

Pass the ICAN Act and the Expanding American Entrepreneurship Act

Many new businesses – particularly businesses that have the potential or intent to grow very quickly – rely on investors who provide early-stage capital in exchange for an equity stake in the company.  Unfortunately, the overwhelming share of equity capital has gone to entrepreneurs who are white and male.  Indeed, in recent years women entrepreneurs have received only about 2 percent of total venture capital while entrepreneurs of color have received less than 1 percent.

The inequitable distribution of equity capital is attributable to both explicit bias on the part of some investors, but also to unintentional bias.  Recent research has documented a phenomenon known as “homophily” – investors tend to invest in entrepreneurs who look like them, have similar backgrounds and life experiences, and who are launching companies that investors can relate to.  At present, startup investors are predominantly white and male, with the predictable result that most of the startups in which they invest are launched and run by white male entrepreneurs.

Greater diversity among those who invest in startups would result in more capital being directed to entrepreneurs of color and women entrepreneurs.  Indeed, research published in 2022 by Harvard entrepreneurship scholar Josh Lerner concluded that Black-led investment funds are three to four times more likely to invest in Black entrepreneurs.

The Investment Company Act of 1940 establishes the legal framework for the establishment, operation, and regulation of investment funds.  Most private investment funds are organized under section 3(c)(1) of the Act, which exempts investment funds not making a public offering of securities from registration as an investment company with the Securities and Exchange Commission and from the filing of costly disclosure requirements associated with registration, provided that all fund participants are accredited investors and that the number of participating investors is 100 or fewer.

The limit on the number of permitted investors reinforces deficiencies in diversity among startup investors – and, therefore, among entrepreneurs who successfully secure funding – because it keeps the contribution from each investor, except for very small funds, high.  For example, in the case of a $30 million fund – very small by industry standards – the average investment is $300,000, too large for many accredited investors, particularly investors of color.

In 2018, Congress passed and President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, which addressed certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The Act also amended section 3(c)(1) of the Investment Company Act to allow funds smaller than $10 million to have up to 250 investors.  The increase in the number of permitted investors improved circumstances for 3(c)(1) funds in two ways: 1) it helped get more capital to new companies; and, 2) it allowed more accredited investors to allocate smaller amounts of capital to a potentially lucrative asset class.

But the $10 million fund cap remains highly problematic.  First, funds of less than $10 million are simply too small to have a meaningful impact on the diversity of entrepreneurs who secure financing.  Moreover, funds larger than $10 million are still subject to the 100-investor limit.

The Expanding American Entrepreneurship Act: On November 16, 2023, after more than a year of work with the Center for American Entrepreneurship, Senators Jerry Moran (R-KS), Tim Scott (R-SC), and Mark Warner (D-VA) introduced the Expanding American Entrepreneurship Act. The legislation would raise the cap on funds organized under the 2018 sub-category of section 3(c)(1) from $10 million to $50 million, and double the number of permitted investors from 250 to 500.

Together, these changes will enable emerging fund managers to raise larger funds – a “bigger bat” to swing at the current inequitable distribution of capital – and facilitate greater participation by accredited women investors and investors of color, diversifying the investor base and thereby directing more equity capital to women founders and entrepreneurs of color. Using the same example of a $30 million fund, under the terms of the legislation the average investment from fund participants would be just $60,000 rather than $300,000.  Importantly, smaller required investments mean smaller risk exposures, promoting investor protection.

The Improving Capital Allocation for Newcomers (ICAN) Act: On March 8, 2024, the House version of the bill – the ICAN Act – was passed by the House of Representatives as part of a capital formation legislative package entitled the Expanding Access to Capital Act.  The ICAN Act would raise the cap on funds organized under the 2018 sub-category of section 3(c)(1) from $10 million to $150 million, and raise the number of permitted investors from 250 to 600.

The demonstrated phenomenon of homophily makes clear that which entrepreneurs get funded depends a great deal on who is doing the investing.  Getting more capital to women founders and entrepreneurs of color, therefore, requires greater diversity among those who invest in startups.  The Expanding American Entrepreneurship Act and ICAN Act will help accomplish that needed diversification.

Pass the New Business Preservation Act

CAE supports the immediate passage of the New Business Preservation Act, the purpose of which is to incentivize continued and more equitably distributed venture capital investment in America’s most innovative startups.  The Act was introduced in the Senate (S. 3515) on March 18, 2020 by Senators Amy Klobuchar (D-MN), Chris Coons (D-DE), Tim Kaine (D-VA), and Angus King (I-ME), and was introduced in the House (H.R. 6403) on March 26, 202 by Reps. Dean Phillips (D-MN), Terri Sewell (D-AL), Ro Khanna (D-CA), and Tim Ryan (D-OH).

Despite their unique economic importance, startups are also extremely fragile because they are new – with half of all startups failing within their first five years.  Because of their risk profile, many startups are unable to secure bank financing like existing small businesses and instead rely on venture capital, which has been a major source of financing for young innovative companies since the late 1940s.

Venture capital firms are long-term investors that provide early-stage capital – raised from institutional investors like pension funds, insurance companies, university endowments, and foundations – to new and rapidly growing companies in exchange for an equity stake in the company.  Venture firms also assist in the management and professionalization of the young companies in which they invest, typically taking seats on the board.  Venture capital has helped finance thousands of American companies, including Intel, Federal Express, Apple, Microsoft, Google, Cisco, Home Depot, and Starbucks.

At present, venture capital in the United States is highly concentrated, with about 80 percent of venture capital raised and invested in just three cities – San Francisco, Boston, and New York.  This concentration limits access to venture financing in many parts of the country with the effect of limiting the nation’s innovative capacity and economic vitality.

The New Business Preservation Act would address this problem by establishing a program, administered by the Treasury Department, which would allocate $2 billion in federal dollars ($1.5 billion initially, and $500 million in follow-on investment) to the states on a straightforward population basis to attract private venture capital by offering a 1-to-1 match of federal dollars with venture capital investment in promising startups, particularly in states outside the major venture capital centers.  The legislation is modeled on Israel’s “Yozma” program of the late-1990s, which successfully incentivized U.S. venture capital firms to invest in promising Israeli startups, and builds on other successful federal-state partnerships to support small businesses, such as the State Small Business Credit Initiative (SSBCI).

Importantly, the legislation is carefully structured so that the federal government will not “pick winners and losers,” but rather will rely on private entities to source and manage investments in promising early-stage companies in every state.  All investment decisions will be based entirely on private investor determination of the economic prospects of the new companies receiving equity capital.  Finally, the program authorized by the Act is intended to be “evergreen,” with any gains from investments following exits to be used to incentivize future rounds of private investment in heartland startups.

Mobilize More Angel Investors Through a Federal Tax Credit

In recent years, “angel” investors – individuals who invest in young promising companies – have become a major source of startup capital in the United States.  Like venture capitalists, angels invest in new, high potential companies in exchange for an equity stake in the business.  As with venture capital, angel capital is recovered and returns realized when financed firms either go public or are bought by another company.

Many angel investors – particularly those who are current or former entrepreneurs – also provide advice, mentoring, and other support to the management team of the new businesses in which they invest.  Perhaps for this reason, research has shown that angel investment significantly increases a startup’s chances of success.  A study conducted by William Kerr and Stanislav Sokolinski of Harvard University and Antoinette Schoar of MIT found:

“Startups funded by angel investors are 14 percent to 23 percent more likely to survive for the next 1.5 to 3 years and grow their employment by 40 percent relative to non-angel funded startups.  Angel funding affects the subsequent likelihood of a successful exit, raising it by 10 percent to 17 percent.  Having angel funding also seems to matter significantly for the ability of a firm to obtain follow-on financing.”

Angel investors also differ from venture capitalists in significant ways.  For example, unlike VCs, who invest institutional capital in amounts of $1 million or more, angels invest their own money, typically in amounts between $25,000 and $250,000.  Despite smaller individual investments, aggregate angel capital rivals that of venture capital.  In 2023, angels invested a total of $19 billion in 55,000 companies.  For every new company that receives venture capital, nearly 20 others receive angel capital.  Amazon, Home Depot, and Uber are just a few of the thousands of companies launched with angel capital.

Perhaps most importantly, whereas venture capital is typically invested during a later growth phase, angel investors have emerged as the principal source of outside “seed” or early-stage funding critical to the formation, survival, and growth of new businesses – providing 90 percent of such capital once entrepreneurs have exhausted their own resources and those of family and friends.

According to the Center for Venture Research (CVR), there are more than 422,000 active angel investors in the United States, nearly half of whom are women.  According to the SEC, another 12 million American households meet accredited investor criteria.  Most are likely unaware of what angel investing is and of the opportunity to participate in financing the next generation of great new companies.

To be sure, angel investing is risky and not appropriate for every accredited investor.  More than half of all angel investments lose money, and just 7 percent of all investments generate 75 percent of returns.  But given the importance of angel investors to startups – and the importance of startups to economic growth and job creation – the formation and commitment of angel capital should be responsibly incentivized.  If only 3 percent of the 12 million additional potential angels chose to allocate a portion of their financial portfolios to promising new companies launched in their cities and towns, the number of active angel investors would double to 650,000 – and, presumably, the amount of capital invested would double to $50 billion annually.

In CAE’s view, this objective can be best achieved by way of a federal tax credit, coupled with relief from taxes on any gains in the value of angel investments held for at least five years.  Twenty-six states have enacted tax credits to incentivize angel investing.  Details vary from state to state regarding the size of the credit, limits per investment, caps on total investments, and qualifying businesses.  Most states offer credits of between 25 and 35 percent.

And the evidence to date is clear – tax credits work.  For example, after Ohio created its Technology Investment Tax Credit in 1996, the program was used by 4,800 angels to invest more than $160 million in 668 companies through 2013, according to the state economic development agency.  Similarly, after Wisconsin enacted a 25 percent tax credit in 2005, total angel investments jumped more than 10 times and the number of angel investor groups in the state increased from just four to more than 20.  Other states have experienced similar success.

A federal tax credit equal to 25 percent of investments in startups would lower investment risk to angels by providing an immediate return.  While tax credits encourage investment, the majority of the angel’s money remains at risk, preserving the investor’s incentive to carefully examine potential projects and ensuring that scarce investment capital will be directed to only the most promising business ideas.

Exempting any returns on investments in startups held for at least five years from federal capital gains tax would maximize the pay-off on any successful investments.  Since total capital gains tax revenues have historically represented less than 5 percent of federal tax revenues, exempting gains on angel investments from taxation would have almost no impact on federal tax revenue while having a potentially dramatic effect on new business formation and growth.  Moreover, because most angel investors reinvest most or all of their returns into the next generation of innovative new companies, exempting such gains from federal taxes would have the further benefit of increasing the amount of seed capital available to startups.

Pass the Small Business Technological Advancement Act

In addition to its devastating toll in human lives, the Covid-19 pandemic careened through the landscape of America’s new and small businesses like a bulldozer.  Between February and April of 2020, the number of active businesses in the U.S. plummeted by 3.3 million, or 22 percent, the largest drop ever.  Hundreds of thousands never reopened.

Fortunately, most small businesses did survive, thanks in large part to the rapid implementation of government assistance like the Paycheck Protection Program and the Federal Reserve’s Main Street Lending Program – and thanks to technology.  Forced by local restrictions to limit foot traffic in stores or to close physical locations entirely, small businesses increasingly turned to online platforms like Facebook, eBay, Amazon and Shopify to open digital storefronts; social media sites like Instagram and Twitter to market to customers; video conferencing platforms like Zoom and Microsoft Teams to interact with suppliers and pitch potential investors; and financial tools like Intuit QuickBooks, PayPal, Venmo and Square.

Post-pandemic, there is no going back.  E-commerce sales as a percentage of total business sales jumped from 10 percent in 2019 to more than 15 percent by the summer of 2020 – a level that has persisted ever since.  E-commerce is now a major aspect of new and small businesses’ operation and success.

But government policy regarding small businesses has not been modernized to recognize the economic benefits of digitalization.  In particular, small businesses remain uncertain whether loans backed by the Small Business Administration’s flagship 7(a) program can be used to enhance their digital capabilities.  That uncertainty has slowed the adoption and integration of digital tools.

Fortunately, bipartisan legislation introduced on January 29, 2025 by Senators Todd Young (R-IN), Jacky Rosen (D-NV), Ted Budd (R-NC), and Jeanne Shaheen (D-NH) – the Small Business Technological Advancement Act (SBTAA) – would make clear that small businesses can use SBA-backed loans to pay for digital tools and technology.  Congress should pass the legislation immediately.