The position can be taken that the market itself is the most practical judge, and that if we don't have more facilities for financing small business, it is because we don't need more facilities; or that there isn't sufficient attractiveness in the given small business to justify further investment therein.

On the other hand, we have no Nation-wide data on case histories that might show how many promising small-business ideas and ventures may be nipped in the bud by the unwillingness of investors to bother with small-enterprise financing. The fact that small-business men appear before congressional committees with legitimate complaints of unwarranted difficulties and hardships-even a few hundred such cases-may tell us little, from the standpoint of the overall scene covering more than 3,000,000 small businesses, with respect to how productively additional capital could be employed.

We do have some documentation in studies going back to the depressed 1930's, which indicate that apparently deserving enterprises were unable to get the credit that might have carried them financially over the hump. In the majority of cases of financial distress that have been investigated the deficiency in management appears to have been at least as marked as the deficiency in finances. Bankers, in discussing some of these cases, have made the point that the basic weakness of the capital structure of these cases did not warrant them in risking deposit funds that could only make the applicants get more deeply into debt before giving up the struggle. The kind of relief needed in such instances could be regarded as part of the public-relief measures applicable to a national emergency rather than a part of the problem of expanding the capital structure of the weak enterprises at the distress stage. Credit managers, as well as bankers, have pointed out that so far as mere numbers are concerned, the supply of those who are willing to enter business still exceeds the number who have the capacity to succeed through a positive contribution to the total economy.

Nevertheless, out of such meager coverage of the field as one man is able to make, in the study of this issue I have come to the strong conviction that there is a substantial core of small-scale enterprise-mainly in the area representing 5 to 100 employees per firm-for which there is a genuine lack of an orderly channel of financing designed to meet the requirements. The lack is not in short-term financing through current bank loans or current merchandise credit. It is in the creation of equity capital for small enterprise-not only for launching new businesses, but for expansion of enterprises ready for further development and for putting seasoned enterprises on a stronger base of fixed and working capital.

In this conviction one can find moral support from the testimony of others who have made similar studies. Mr. Roy Foulke, of Dun & Bradstreet, from his continuous study of the capital and credit position of small-business men, stated to the Senate Small Business Committee several years ago that "under the existing set-up of our economic structure we find no organized source or sources to provide long-term money or permanent capital to intermediate-sized concerns. The Filene Foundation, which studied the requirements for smallbusiness capital in the New England area in 1940, noted: "there is little or no disagreement that our financial mechanisms are not set up so as to provide equity capital for the smaller business units. *** The weight of the evidence and opinion presented is that the need is real and definite." The postwar efforts of the Federal Reserve Bank to obtain legislation extending its powers for longer term capital credit is likewise a recognition of deficiencies in existing facilities. The study of British experience by the Macmillan Committee, and particularly the studies of capital flotations made by the Securities and Exchange Commission, confirm similar views.

The difficulties of small enterprises in the floating of securities have been documented in the SEC study of May 1940, which showed that corporations attempting to sell bond issues of $250,000 or less, paid an average of $8.40 for each $100 of bonds sold: that they paid an average of $16.40 for each $100 of preferred stock; and that they paid an average of $22.80 for each $100 of common stock. These costs were nearly double those incurred for issues between a million and $5,000,000.

In the flotation of securities, such items as registration and underwriting expense, legal expenses, accounting, engineering, printing, listing, and so on, apply to large and small issues alike; and they pile up so that in the case of the small issue there is little left for the firm that is trying to obtain funds. It also means that in view of these expenses, the average large investment house takes the

position that there is no advantage in accepting underwritings below $5,000,000. Part of the reason for that reluctance is undoubtedly their poor experience with getting the issues of small companies sold. In studies made by the SEC before the war it was shown, even where there was effective registration of the issues for $250,000 or less, that within 1 year after the effective registration date the issuers were able to sell only 23 percent of the securities registered, and that of 584 companies studied by the Commission, about one-third failed to sell any part of their securities. Among those which reported sales, the new ventures sold only 27 percent of their issues. The established concerns sold 44 percent. Of all the reported sales, about 71 percent were made within 3 months after registration. Once the campaign period was over, the sales were reduced to a mere trickle.

Since the war the Federal Reserve Bank of Minneapolis has published a study of attempts by Minnesota corporations to float capital issues, over the past two decades, which confirms the difficulty of obtaining financing for firms that have not already established Nation-wide prestige.

The prewar and wartime efforts of agencies like the Federal Reserve System, under its section 13B, permitting direct industrial advances, the disbursements authorized by the RFC and the special war loans of the Smaller War Plants Corporation, undoubtedly came to the rescue of enterprises that were very much in need of such accommodation; but the aggregate of the advances made to small business by these three agencies is not too impressive. A break-down of the first 150,000 successful applications with the Federal Reserve banks, under section 12-B, shows that 3.1 percent of the aggregate amount advanced was in loans of $10,000 or less. As of December 21, 1941, the aggregate of all direct industrial advances by all Federal Reserve banks was $9,504,000. If the 3.1 percent applied, you can see that the amount involved per small business was extremely small. (There were, however, at the time, something under $15,000,000 of Federal Reserve guaranty commitments to member banks or industrial advances.)

In the case of the RFC, loan disbursements of some $460,000,000 were authorized during the 9-year period from 1932 to 1941; but while some 5,100 loans were authorized to small businesses in amounts of $10,000 and under, during that 9-year period, they represented a total of only $21,000,000 out of $460,000,000 loaned by the RFC.

The Smaller War Plants Corporation was of course a special agency to meet the special needs of the war period, though its operations frequently made for a healthy reexamination of traditional banking practices.

The commercial banks have remained by far the leading vendors of credit to the small business apart from its ordinary commercial credit on open accounts; but that type of lending is not an adequate substitute for equity capital which is the chief requirement of small business.

A number of noteworthy efforts have been made to fill the gap in equity financing for small business. I shall mention three, to point up the requirements. One type of agency with which there have been numerous experiments is the so-called community industrial development corporation. The general purpose of these corporations is to bring the enterprise that needs capital into contact with the sources of funds that are seeking investment outlets. They have attempted to supply a community fund from which investments may be made to new small businesses or to aid a business in obtaining additional financing. It is one of their laudable objectives to reproduce the equivalent of a practical neighborly interest in a local venture that used to develop spontaneously in the more simple social structure of an earlier period. At the same time the industrial development corporations recognizes the fact that technical expertness, and judgment that is respected, are under present conditions more vital than good will in attracting funds to new ventures.

All told, I have found records of some 55 community development corporations that range from small pools of capital offered by a few rich men, for propositions that they themselves would like to go into, all the way to civic funds that may be used for any type of development that will enhance the community, including some projects that were mainly of civic and cultural rather than of strictly business or profit-making value. A review of the histories of the leading industrial development corporations indicates that they have been highly selective in their search for ventures of unsual promise, with emphasis on the development of new manufacturing techniques, or of brand-new products. They have been helpful as far as their activities have reached, but when one adds up the total sum of the enterprises into which these development

corporations have entered, it amounts to a very negligible fraction of small business and its capital requirements. The effort to supply the capital needs of small business will obviously have to be made on a much broader front than the industrial development corporations have provided, if the total situation is to be met.

Near the end of the war, the Investment Bankers Association, through its Committee on Small Business, offered a proposal to encourage the establishment of local investment houses specializing in small-business financing. Under this proposal chartered investment companies could be started in local communities, with a minimum of $25,000 of paid-in capital, and the Federal Reserve Banks would be called upon to accept debentures of such chartered investment companies up to three times the amount of the paid-in capital. These special chartered companies were then to be permitted to take on any form of financing including ownership of small enterprises until their stock could be disposed of. A certain percentage of the loans or issues for the borrowing firms would be withheld to go in to a separate pool, to enable the financing company to cover the losses on those propositions that turned sour. It also suggested that such investment houses should at the same time maintain close managerial guidance provision over the borrowing companies while they were in debt.

That proposal while well conceived, gained scant acceptance among investment bankers; the framers of the plan themselves pointed out that investment bankers as such are not investors primarily, but are merchants of securities. They purchase new securities not to hold them but to sell as promptly as possible to others. Moreover, they are not primarily interested in securities that have a local market. Under the circumstances, nothing happened in the investment banking fraternity to push along the proposal of its small-business committee. In view of the lack of private enterprises, capable of filling in the gap in equity financing facilities, legislation has been proposed looking to the establishment of a Government agency that would undertake the financing of small business.

The establishment of a governmental financing corporation for small business raises dilemmas with which some members of this committee have already grappled. If the Government is to be significantly more liberal than are the private banking agencies in financing small business and if, in addition, the Government is to charge rates lower than are available to small business by the financing companies, the Government faces the prospect of a deficit enterprise with questionable risks. It will also be confronted with requests backed by political pressure as well as by the judgment of its staff. As it is, small-business mortality is high. It is hard to escape the conviction that we must expect to find in the lap of a Government agency to finance small business an accumulating residue of defualted debt and ownership paper of the enterprises which it will have assisted. And on foreclosure, the Government becomes the owner or auctioneer of small business. If the number of small-business failures is to be held down we must contemplate, along with the financing, the Government agency undertaking the continuous investigation and guidance of the firms to which funds are granted. If the Government is to offer investigatory services and counseling services of this sort without charge, then of course it becomes a subsidy program. If it doesn't yield to public pressure for liberalization, it will have failed in its avowed purpose.

In exploring the need for a suitable enterprise channel to carry the additional capital requirements of small business, may I now submit for your consideration the possibilities of finding the means of broadening the financial base for small businesses within our banking system. The logic of this suggestion lies first in the fact that the small business normally looks to the local banker for financing. Were there not the overriding concern for liquidity in the interest of demand depositors, the commercial bank would be the most natural agency through which to finance the growth of small enterprise.

The operation of investment affiliates by commercial banks was made illegal after the crash of 1929 because of the abuses that showed up from their unregulated practices. But that experience should not bind us to the potential value of capital banking protected by adequate sanctions and controls. It is essential to create an agency to which the commercial bank may readily refer the client whose needs go beyond current bank loans into the more specialized area of risk bearing capital financing.

With the precedent set in the capitalization of the Federal Reserve banks, it should be feasible for the commercial banks in each Federal Reserve District

to subscribe a percentage (say up to 3 percent) of their capital and surplus in a district capital bank with branches in as many communities as developing need warrants. Such a capital bank would operate under the authority of the Federal Reserve Bank in a given district, under general policies laid down by Congress and administered by the Federal Reserve Board.

Capital bank financing for small business would require a varied base. It could be supported by collateral, securities, accounts receivable or certificates of indebtedness, secured or unsecured as the conditions warrant. Such a bank should be permitted to purchase capital stock as well as the debt paper of an enterprise. But it should have regard for the objective of fostering independent ownership by the small enterpriser. To this end preferred stock should be made callable by the issuing firm on a prearranged program. In taking the common stock of a borrower the bank as stockholder should be permitted to share in the earnings and in the increase of equity values; but there should also be provision for redemption of capital stock by the issuing firm within agreed time limits and adjustments of the transfer value of the stock, so that the management of the small enterprise may regain its full control of the venture. Another logical extension of the plan would be for the capital bank, as an operation under the Federal Reserve System, to be permitted to place its debentures or rediscount paper with the Federal Reserve banks at such rates as would permit a fair return on the employment of the additional funds so otbained.

What such a bank may or should do is a matter that should be permitted to evolve through experience. While the capital bank is conceived in the first place as an accommodation to the bank depositor and his bank, there is no reason why its operation should be limited to clients referred by its commercial bank members. It may, with time, be permitted to accept long-term obligations of finance companies, trade associations, and other enterprises coming within the general area of small business and intermediate business. It is not a necessary part of the proposal that private investors should be excluded from subscribing to the capital of the bank, for the initial organization has been set up by the commercial banks of the district, if such expansion of the capital base appears desirable.

The proposal for a separate banking agency rests upon the conviction that the financing of capital operations of small enterprise involves a different approach from that which is normally taken in credit banking by a commercial bank of deposit. A capital bank that can serve small business must not be inhibited by orthodox banking traditions. As a specialist in permanent capital, the proposed type of bank should be in a position to develop new techniques for financing of small enterprise, as conditions demand. It need not for example, be hampered by the traditional procedure of regular payments of equal installments at each due date. It may well find that its clients can be better helped and kept more solvent by adjusting the size of payment, the interest rate and service charges for managerial guidance to the position of the enterprise, to the business cycle, or to changes in central banking or monetary policy at any given time. Where it is desirable to grant interest rates lower than the risk of the enterprise would justify, the bank could accept more liberal payments in stock.

A capital bank, to perform its function adequately, should be prepared to furnish the advisory services that must accompany the successful financing of small business. In this respect, the capital bank would have a valuable ally in the commercial bank, whose information and regular banking facilities would be joined with those of the capital bank in helping the given enterprise through its vicissitudes.

A capital bank serving more than one community would have the advantage of diversification. Many a small-town or neighborhood bank is limited to retailers or to a limited line of industry for its credit market. The capital bank could encompass an area large enough to permit diversification of investments and thus have a better chance of offsetting losses with profit.

A successful effort to preserve our system of private enterprise must provide expanding opportunities for the development of small, independent business enterprises. Big-business executives, as well as those directly engaged in small business, recognize the importance of the small independent enterprise as an essential leaven in the total business structure. Indeed, small business is much more than a leaven; in its own right, it accounts for more than one-third of the total output of goods and services that make possible the American

standard of living. It is in the public interest that small business should not lack for adequate facilities to maximize its contribution.

TABLE 1.-Gross private domestic investment in relation to total economic effort, selected years, 1929-48

Does not include public construction and foreign investment.

2 National income excluding compensation of Government employees.

Source: National Income and Product Statistics of the United States 1942-48, Survey of Current Business, July 1949, p. 10.

TABLE 2.-Gross private domestic investment, selected years, 1929–481

Senator CLARK. Mr. Brennan and Mr. Hurley, do you gentlemen wish to come up together?

STATEMENT OF F. P. BRENNAN, VICE PRESIDENT; ACCOMPANIED BY DONALD J. HURLEY, MASSACHUSETTS BUSINESS DEVELOPMENT CORP.

Mr. BRENNAN. Yes.

Senator CLARK. You gentlemen, I understand, do not have prepared statements?

Mr. BRENNAN. That is right. I have notes which we have changed and amended several times on our way down here.

Senator CLARK. Will you just proceed in your own way, Mr. Brennan?

Mr. BRENNAN. My name is Francis P. Brennan. I am vice president of the Massachusetts Business Development Corp. For the current year I am also chairman of the northeast conference of development credit corporations, which includes the 6 New England States and the State of New York.

I am here at the invitation of your committee to express our views on the bill S. 2160, particularly that portion which provides for the conversion of State development credit corporations to National investment companies.

First I would like to point out just a little bit of the background and the accomplishments of our own corporation. We were established in July 1953, and we commenced active operations in January