Barbarians at the Fund
“I think of the TDF as having opened its doors on June 26, 1998, when our Web site went up,” declared Ginger Lew, managing director of the fund created by Congress to assist small businesses to enter and to compete in the telecommunications marketplace. In fact, the Telecommunications Development Fund (TDF) was created as part of the Telecom Act of 1996.
The idea for the TDF was borne of the recognition that the federal government usually is not allowed to make interest on accounts placed in commercial banks. Don’t ask why. I think it has something to do with Andrew Jackson and a fight with the National Bank around 1832. So, someone conceived taking the interest from deposits of up-front payments submitted for participation in an FCC auction and using the money to help small business. That brainchild became law, and we have the TDF.
In a recent interview with Ms. Lew, I sought to discover the status of the fund. Like many people, I wanted to know where the fund was and in what direction it was headed. And on a hot, steamy, August day in Washington, I traveled the few blocks from my office to the headquarters of the TDF, located at 1899 L St. The headquarters are located on the fifth floor. A winding staircase leads down to additional offices on the fourth floor. The ceiling above the staircase is painted with a round, blue mural that looks like a dark, starry night, giving the sense of a skylight open at midnight. Although the square footage looks impressive, the furniture is typical office stuff with a medium-sized conference room encased behind glass doors. Although we didn’t discuss it much, I got the impression that the space was lent or shared and really amounted to temporary, albeit nice, quarters.
“There’s about $25 million in the fund, now,” Lew replied to the most obvious question. “We didn’t reach critical mass in funding until the C-block PCS auction. That’s when the big investment came from participants in that auction, in about February of 1998.”
Lew reported that the TDF board consists of Don Cornwell, chairman; Debra Lee, president of Black Entertainment Television; Richard Fields, of Allen Investment Group; Thomas Hart Washington telecommunications attorney (who is the “father” of the TDF); Jere Glover, an official of the Small Business Administration; and FCC Chairman Bill Kennard. Kennard was nominated to the board by former Chairman Reed Hundt. There is one vacant spot on the board which was, and remains, to be filled by an official of the U.S. Treasury Department.
The make-up of the board, four private-sector people and three government officials from the FCC, the SBA and Treasury, is consistent with the statute creating the fund. The four private members are hand-picked by the chairman of the FCC. Lew reported that the board has voted to serve without compensation. When asked whether a future vote could result in compensation to board members, she indicated that such a vote was possible.
Goals and objectives
Having confirmed that the fund has $25 million at its disposal from interest, which Lew said was achieved at nominal rates, the questions turned to the fund’s use: How would the money be used to help small business? The answers were surprising.
“Our goal,” said Lew, “is to make money on our investments. We want and need to be self-sustaining. Therefore, we are seeking investment-worthy companies for making equity investments which will return from 30% to 40% to the fund.” Lew’s description is consistent with the information in the TDF Web site.
The fund’s web address is www.tdfund.com. That’s the spot where you’ll find the friendly greeting that says, “Welcome. The Telecommunications Development Fund (TDF) is a private venture capital firm..” This description is your first indication that the fund has become something unexpected. Somehow, between 1996 and 1998, the fund has become private and a venture capital firm.
The Web site explains the TDF’s mission statement as investing only in small businesses in the communications industry-provided the companies meet TDF investment criteria. The amounts to be invested by the TDF in any one deal will range from $250,000 to a million bucks (higher, if it’s a good deal). Loans and other financing vehicles are not available at this time. Grants are definitively not happening. Yep, sounds like a private VC firm to me.
The criteria for applying for financing from the TDF are as follows: o submit a business plan that shows you have an experienced management team with personal investment in the venture that can be relied on to devote its full energy to the success of the venture.
* if you’re a minority or a woman, it doesn’t matter; the law says the fund has to be race- and gender-neutral.
* be willing to have the TDF nominate people to sit on your board. Oh, did I forget to mention that this is equity financing? The TDF wants to own a piece of every company in which it invests. Well, not forever. The TDF wants an articulated exit strategy for its investment, which will happen between four to eight years out. Lew describes the TDF participation as a “patient investment.”
And what are these small businesses that the TDF will fund? The Web site tells us that the definition of a qualified small business is, “a business that may have annual revenues (actual or booked) of at least $250,000, but not exceeding $50 million on average over the past three years prior to application for funding.” The TDF does not explain why a company making $50 million bucks would have to seek $250,000 in financing.
Lew confirmed that the information on the Web site was an accurate picture of how and where the board believes the fund should spend its money. “We studied the market and decided that one of the largest problems for small business was in filling the capital gap on the equity side. We decided to fill that gap along with providing management assistance,” she said.
When asked why the fund wasn’t making loans, Lew explained that the law requires that all loans must be fully collateralized, therefore, the fund is in no better position than a bank for lending money. “We tell people seeking a loan to see their banker,” she said.
So, in what kinds of investments is the fund interested? Lew said that a qualified, investment-worthy company should have the ability to make a true profit, not just show strong earnings. The company should have strong, committed management, with some financial investment in the company coming from the management team. The TDF would like to see at least $250,000 in revenues being produced annually, but Lew said the TDF would be flexible on this point.
What the deuce happened?
That the TDF views itself as a private venture capital firm was news to me. Nowhere under Section 714 of the Telecom Act do those words appear. Section 714 states, instead, that “…the Fund shall be used solely for the making of loans, investments, or other extensions of credits to eligible small businesses.” A plain reading of the law states that the TDF is to be a lending institution.
It could be that the board has decided to exercise discretion and broadly interpret the statute to includes equity financing. Wait a minute. It can’t. The statute is part of the Telecom Act, which may only be interpreted by the FCC, Congress and the courts. The TDF is none of those, and the FCC only has one vote on the board. So, I ask in a calm voice, how the hell did this happen?
Somewhere along the line, the TDF decided that it didn’t like the mission codified under the law and came up with something else. If the board was playing only with its personal money, and not money raised on U.S. Treasury funds, nobody could complain. But the TDF was created from funds that are automatic, free, and derived from FCC auction participants. If I had participated in the auction, I’d demand a few shares of this corporation. I paid for them.
At the core of this problem is the makeup of the board. The board members from the private sector were supposed to be chosen based on their acumen in relevant fields and their ability to represent or understand the needs of small businesses. They weren’t. They were hand-picked for political reasons. They were chosen because they were minorities, or female or both. In fact, the original board had no member, either from the public or private sector, who did not fit the racial and gender profile for membership. At present, only Glover of the SBA is a white male.
When the board was to be selected, I placed my name in nomination. I can report that neither Mr. Field nor Ms. Lee participated in the formal, public nomination proceeding. Among the selectees, only Mr. Hart (the inventor of the TDF) received public support greater than mine. Yet, the Lee and Fields selections were made over mine. Why? In a letter sent to me from then-FCC General Counsel, Bill Kennard, it was explained that the public nomination proceeding was rejected in favor of then-FCC Chairman Reed Hundt’s personal discretion. Supposedly, Hundt looked over the results of the nomination process and rejected it in favor of Lee and Fields.
Do I care whether I was chosen to sit on the TDF board? Not really. But the makeup of the board lacks any representative of small business, other than Glover. And he’s only one vote. The majority of the board consists of high-flying financial types and one lawyer from a big, well-heeled firm. I have to make payroll every two weeks, watch cash flow and make sure that my little firm keeps chugging along. These guys are focusing on leveraged buyouts, the Asian money crisis, and return on investment. Forget gender and race. The only significant color is green, as in greenbacks, and those people who are used to having plenty quickly lose touch with the concerns of those who don’t.
It should, therefore, be no surprise to anyone that if left alone, the TDF would do what the board members are used to doing, making money-BIG money. Consider how much money would be generated by a company that automatically received revenue in the millions and was able to invest that capital in a way to receive 30% to 40% per year-without ever having to pay out dividends to shareholders.
A not-so-slight adjustment
The TDF needs to reexamine its charter under Section 714 and create lending vehicles for small business. That’s what the law says, so that’s what the fund should do. It should replace some of its board members with private sector people who have demonstrated concerns for small business. It should not be used to obtain de facto control of the small businesses it is supposed to be helping. Criteria for offering assistance should not be based on standard lending or investment practices. The TDF’s funding isn’t standard, so its mission should recognize the largesse upon which the fund was built. Stated simply, the TDF should do the job for which it was created.
It doesn’t matter whether the board members are compensated for service. What does matter is whether the board members are allowed to glean proprietary information through their service-information that could be employed privately. Think about it. At present, a board member will also serve on the board of maybe 10 companies. Each of these 10 companies is a source of market information. That information has to be shared with the board for investment decision-making.
That means every member of the board is made privy to the proprietary information garnered from each member’s service on the other boards. Has the board created the necessary precautions against private use of that information?
Another problem: If a board member discovers that a company in which the TDF has invested has run afoul of the FCC rules, does that wrongful act have to be revealed to the TDF board, on which sits-the chairman of the FCC? If so, what obligation does Bill Kennard have in receiving that information? Does he close down the company and destroy the TDF’s investment potential, or look the other way and violate his duty as FCC chairman? If information isn’t shared with the TDF board, is that board member fulfilling his or her duty to the TDF board? See what can happen when the TDF “morphs” from a smaller version of the SBA into a smaller version of KKR?
The TDF is headed in the wrong direction. No one envisioned that the TDF would be operated as a profit-making, private, venture capital fund. The law doesn’t read that way, the public didn’t expect it, and the board does not have the authority to change it. Its mission statement got changed because the board decided that the law didn’t fit its needs. Too bad. The Telecom Act and the FCC rules in all their parts do not fit the needs of a lot of small businesses, but the rest of the industry is stuck with them.
Welcome to the real world, Mr. Kennard. How does it feel?