Who Needs the SBA?

by Stephen J. Glass

Last June at the White House Conference on Small Business, President Clinton praised the U.S. Small Business Administration (SBA). The loan-guarantee program of this small federal agency, he said, is the best way to get venture capital into the hands of America's entrepreneurs. The SBA followed up with a report identifying the most "small-business-friendly" banks in the country. Among the nation's very best: First Capitol, in York, Pa.

But First Capitol is no example of how the federal government builds what Clinton called tomorrow's Intel, Apple, and FedEx. Instead it shows how banks can boost small business better without government help.

With three branches in central Pennsylvania, First Capitol has lent more than $50 million to local small businesses -- 15 percent of which are headed by women or minorities. Their loan default rate is a meager 1.5 percent. By contrast, the default rate on SBA loans in the area is 6.2 percent. The SBA default rate nationwide is even higher.

First Capitol's clients include high-tech startups, construction companies, retail franchises, and mom-and-pop grocers. They write business plans for their clients and meet with the entrepreneurs monthly, if not weekly. All this made First Capitol the fastest-growing bank in the region, boosting assets 16-fold from $5 million to more than $90 million in just eight years.

And First Capitol does it without allowing the SBA or any government agency to guarantee its loans. "Why should we?" asks Tom Capello, First Capitol's president. "We pick winners."

Since the bank was founded in 1988, it has specialized in loans to small business start-ups. When Thom Anstadt showed up on First Capitol's doorstep with a proposal for his Colorgraphics Inc., a high-quality color printing firm, he had been turned down for a loan by countless banks. The reason: According to Anstadt's own proposal, Colorgraphics would lose money for at least one-and-a-half years because of its high start-up costs. Most scoffed. It was a loan, some bankers said, that the SBA would never guarantee.

But First Capitol did. The now-profitable printing firm has 22 employees and $2 million in yearly revenues. It not only has met every loan payment, but it has borrowed three additional times to expand. Anstadt's story is typical of First Capitol. York, according to a top city official, is having "a small-business renaissance because of that bank." How does First Capitol do it? By counting on character.

Unlike other banks, First Capitol doesn't get Washington to guarantee its loans. At other banks, if the small business fails, most of the lost money is reimbursed by government. These banks make money just by making loans. First Capitol only makes money if the start-ups succeed. And First Capitol has found the best way to determine if a business will succeed is to evaluate the owner's honor. While his competitors talk about the "two C's" of lending (credit and collateral), Capello has added another: "The first 'C' is character."

To this end, Tom Sauer, the bank's chief loan officer, personally reviews each application. He and his staff spend hours talking with each applicant about their business. He even meets with their families to make sure they'll have the necessary emotional support.

Most important, Sauer was not trained as a banker. Before coming to First Capitol, he had managed a local munitions factory. Although Sauer modestly says his background ensures he "won't bump into the machines" when he tours businesses, it also means he understands them. "The other [banks] I applied to just looked at my numbers," says a local grocer who got a loan from First Capitol. "That doesn't tell them much. [Sauer] would smell the fruit to make sure it was fresh. He walked the aisles. He knows what I'm about."

Ultimately, each loan applicant also meets with Capello. First Capitol has found that by letting even the smallest applicants meet with the bank's president strengthens their commitment to meeting the payments.

It works. Since March 1994, more than three-fourths of the bank's loans have gone to small businesses. In that same period, the bank's stock has risen more than 60 percent. And, the trend is upward: Profits in the third quarter were the best ever -- 48 percent better than 1995.

First Capitol thrives, not in spite of their SBA-free policy, but because of it. The rigidity, paperwork and snail's pace of SBA's textbook loans often invite failure in the real world. At First Capitol, flexibility and emphasis on character rather than business experience pays off. Even President Clinton has conceded that the SBA is holding small business back. Small businesses, he said, needed less paperwork and less regulation to thrive.

Banks like First Capitol prove small businesses can get what they need, without the SBA's help, in the private sector.

This essay by Stephen Glass is adapted from his article in the current issue of the Heritage Foundation's magazine Policy Review: The Journal of American Citizenship.