Editor’s note: This is the first of a two-part series on the performance of the EDC’s Small Business Loan Fund and a related micro-loan fund.
Jobs are the primary objective of the R.I. Economic Development Corporation’s Small Business Loan Fund, says EDC Deputy Director J. Michael Saul.
“At the end of the day, I don’t care how many metrics you want, take 10, take three – jobs, jobs, jobs … it’s all about jobs,” Saul told Providence Business News.
Yet the agency at best has only an incomplete picture of the jobs its primary loan fund has created or maintained over the years because it doesn’t track and tabulate that information once loans are awarded.
And despite many successes, the loan fund has also had its share of misses. Its failure rate on loans awarded since 2005, when the agency created a micro-loan fund within the larger fund for small businesses, is about 19.5 percent, nearly double the current charge-off rate for Bank Rhode Island and other leading commercial banks involved in small-business loans.
Still, EDC officials believe the loan fund has been a success. And, in a state desperate for job growth, they want it expanded with an additional $5 million federal earmark. A proposal to add another $5 million to the loan fund as part of a larger economic-development general revenue bond, which had been discussed with legislative leaders and the governor, was recently removed from consideration by EDC Executive Director Keith W. Stokes. It would have represented the first state money committed to the loan fund.
“You know you’re a successful program if you lend out $13 million [the fund’s initial capitalization when it was started in 1986], and collect back $13 million, and do it four times over 24 years,” Saul said, defending the fund’s performance. “A lot of capital went out, a lot of credit got extended.
“When credit gets extended, it’s either associated with a business start or business expansion, and with that, comes jobs,” he said.
Replenishing the loan fund, he explained, would continue a crucial secondary financing source for small businesses.
“We have very few private equity lenders” in the state, Saul said. “We have no mezzanine players. We have two subordinated loan funds – ours, and the Business Development Company. We have no alternative lenders, and we have no nouveau lenders – someone who will lend to [businesses with] soft balance sheets. This is where we play; this is where this fund plays, so we have this major gap here.”
Yet equally important for economic-development agencies as they struggle to obtain new financing, says venture capitalist Michael Gurau, president of Clear Innovation Partners in Freeport, Maine, is whether the old-style, economic-development model many still follow is the right one for the 21st century. “When compiling statistics, jobs are always created, none are destroyed,” he said. “Many old economic-development entities are going through agonizing funding crises. The taxpayer rightly wants to know: ‘What do I get for this money, and what measurement are you guys offering us?’ ”
From January 2005 through January 2010, EDC statistics claim that loans totaling $16.7 million have created 869 new jobs – and retained 2,047 jobs.
EDC officials say the figures are based upon the point in time when the loans were made – both for new jobs created and jobs retained. Many of the job numbers are based on projections made by companies in their loan application. But no follow-up computations have been made in the last five years, EDC officials acknowledge.
Companies in Rhode Island that receive Small Business Loan Fund loans are asked once a year to update the number of people employed, said EDC officials.
As the state’s economy makes a transition toward more reliance on growth of the knowledge economy, Richard G. Horan, senior managing director of the state-funded Slater Technology Fund, says it will require a fundamental shift in the way that the state thinks about its investments in small-business startups.
“It’s not just about the money,” Horan said. “It’s about the competence to deploy the money in a prudent and constructive way.”
Horan says that the Slater Fund, which was created in 1997 to stimulate the creation of new technology-based companies in Rhode Island, has developed new metrics to measure job creation, focusing on “man-years of employment,” following questions raised in December 2009 by Providence Business News about its aggregate job figures. “We’ve taken that experience to heart,” Horan said. “As a result, we’ve gone back to tally up the man-years of employment in our database. It’s the right way.”
The EDC does not use such metrics, however, for its Small Business Loan Fund. Out of the 2,926 jobs that are still being reported as created and retained by the EDC from January 2005 through January 2010, at least 255 jobs – about 8.7 percent – were from companies that have gone out of business.
Employment figures for Narragansett Pellet Co. in East Providence, for example, which ceased operations and laid off all of its employees in October 2007, were still included in the employment data provided by the EDC to PBN in March 2010, two and a half years after the company closed its doors. The company received two loans, one in 2006, one in 2007, for a total of $325,000. Under the first loan, the company was credited with having created 36 new jobs. Under the second loan, made seven months later, the company was credited with having created 24 new jobs and retained 10 jobs. Some 60 new and retained jobs, which were included in the EDC statistics, are nonexistent today. Further, the $325,000 in loans was charged off in June 2009.
Loans for more successful small businesses may also have problematic job figures. SafeLight Security Advisors of Providence, which received a loan of $150,000 in June 2009 from the Small Business Loan Fund, as well as another $150,000 loan from the Business Development Company of Rhode Island, is a software company that provides educational training on computer security issues for clients, including State Street Bank in Massachusetts, as well as the U.S. State Department. It has grown its business in 10 out the last 11 quarters, according to Michael Maziarz, the chief operating officer of the company. Without the loan, said Maziarz, who lives in Lincoln, the company was planning to open an office in Massachusetts.
Under the job figures provided by the EDC, the loan retained three jobs and created five new jobs. To date, a year after the loan was made, it has “retained” three jobs – for Maziarz and his two founding partners, one living in upstate New York, the other living in Somerset, Mass. As well as the company is doing, the only new job created in Rhode Island by the company to date is a part-time administrative and financial assistant, according to Maziarz.
More positive results are also missing from the EDC’s jobs equation. A June 2008 $30,000 micro-loan to A Family Tree to help the startup day care center in Warwick buy a building to accommodate increased demand for its services was projected to create four new jobs and retain two. However, the company now employs 25 people at three locations – four times the number contained in the EDC job statistics.
Karl Wadensten, president of VIBCO Inc., in Richmond, a new EDC board member serving a four-year term, said that he wanted to see “tangible data metrics” applied as part of the ongoing practices for the EDC’s Small Business Loan Fund, in order to find out what worked, and what didn’t work.
Beyond job statistics, there are also questions about the Small Business Loan Fund’s performance. Between January 2005 and January 2010, 23 loans totaling $3,296,607 made by the Small Business Loan Fund were charged off, according to figures provided by EDC officials – about 19.5 percent of the $16.77 million loaned during that same period.
That charge-off rate is nearly double the current rate for commercial banks involved in small-business loans, such as Bank Rhode Island, which said that its charge-off rate is currently below 10 percent, according to Mary Leach, senior vice president in charge of operations for consumer lending at the bank.
“Because the loans are riskier, 20 percent [charge-offs] is not unusually high,” insisted Claudine M. Tikoian, vice president at the Business Development Company of Rhode Island, and a former loan officer at the EDC working on the Small Business Loan Fund. No one in Rhode Island has been left untouched by the economic crisis, and defaults are going to happen well into the economic cycle after the initial loans have been made, she said.
The Business Development Company is a private lending company seeded with money from banks to support small businesses, and frequently pairs its money when lending with EDC’s Small Business Loan Fund.
By comparison, in 2009, Business Development Company loan charge-offs were about 10 percent, said President Peter C. Dorsey Jr., higher than its normal annual average of 2 to 3 percent for charge-offs, due to the difficult economic climate.
Since its inception in 1986, the capital in the EDC’s Small Business Loan Fund has come from the U.S. Economic Development Administration. The agency’s basic jobs-formula guideline is that one new job needs to be created for every $30,000 made in loans. The program in Rhode Island is targeted at small businesses that cannot obtain financing through commercial banks. The ticket of admission to apply is a rejection letter from a commercial bank for a loan.
To Saul, quantifying jobs data is, in his words, “a process, not a science.” Jobs, he continued, are measured at the time of the loan, the applicant certifies to the number of jobs, and, as a follow-up, they are supposed to report changes in job status. “That is the extent of the reporting requirement.”
At the Slater Fund, which differs from the EDC in that it takes equity positions in its companies as opposed to simply providing loans, Horan said the focus has been on honing its competence in specific sectors. Equally important is changing focus as those sectors evolved. In the information technology sector, for instance, “our presence is beginning to evolve in the direction of the green economy, and smart grid management,” Horan said.
Business sectors identified at the Small Business Loan Fund include categories left over since the fund’s inception two decades ago, such as “fisheries” and “defense and core,” according to EDC documents. The only oversight requirement is filing a biannual report to the federal Economic Development Administration, under the auspices of the U.S. Department of Commerce, officials said.
Saul and other EDC officials said they see no need to develop any metrics or benchmarks based upon loan performance.
“The market picks the winners and the losers, and we provide the companies with capital to grow and create jobs,” Saul said.
EDC’s role in helping create new jobs can only be expected to grow in a state still suffering double-digit unemployment.
A $125 million state-backed loan guarantee program for small businesses – loans would be made by commercial lenders but guaranteed by the EDC in case of failure – was expected to win General Assembly approval late last week.
“It increases the capital continuum that we need to have in this state to support the business community,” said Dorsey.
As of May 13, the EDC’s Small Business Loan Fund had only $500,000 in cash on hand to lend to small businesses after considering outstanding loan commitments, reserves for expenses and its loss reserve, according to Melissa Chambers, senior communications manager at the EDC.
Despite the recent withdrawal of the economic-development general obligation bond from the General Assembly’s agenda, Stokes believes the state is working hard to fill the need for capital. “We have been very creative with the limited resources that we have,” he said, citing the increase to $60 million in the Industrial Redevelopment Bond Authority funds and the $125 million in small-business loan guarantees lawmakers were considering last week. These efforts, he continued, “will create jobs, create wealth, but in the most fiscally responsible way.”
Sen. Joshua Miller, D-Cranston, chair of the Senate Committee on Corporations, on the other hand, says the withdrawn general-obligation bond for economic development, including $5 million for recapitalization of the Small Business Loan Fund, is “something I think is a good idea, and I would still support it.”
In terms of additional oversight for the loan fund, Miller said, “I don’t think it needs a whole lot of change. If oversight were a concern, I wouldn’t be against adding something like that.”
Gov. Donald L. Carcieri voiced support for the current way the loan fund is being run. “Gov. Carcieri is very happy with how the Small Business Loan Fund has been working,” said Amy Kempe, the governor’s spokeswoman.
U.S. Rep. James R. Langevin, in light of the request for $5 million as a federal earmark to recapitalize the fund, said he supports oversight and review protocols for any program supported by taxpayer funding. At the federal level, the Democrat said, “Congress has made the appropriations process as open and transparent as possible. The Appropriations Committee evaluates each request before deciding where to direct funding.” ••
[Coming next week: How the EDC’s main loan fund works, where the money has gone in recent years and what some recipients think of the requirement for personal guarantees for most loans.]
