NEWPORT NEWS -- Virginia is thinking about getting into the business of financing small business.

State officials believe small businesses may be being squeezed out of the loan market, said Cathleen M. Surface, executive director of the Virginia Small Business Financing Authority.

The authority, created in 1984 as part of the Department of Economic Development, is helping set up a venture capital fund that will eventually be owned by private investors.

Surface said her organization is just starting an in-depth study of the financing needs of small business.

"One of the things that is going to be a big concern is long-term, fixed-rate, low-interest financing for small business," Surface said.

Surface believes a state-run, long-term loan program might fit the bill. And she is hoping that the new venture capital fund that the state is getting started could begin helping Virginia businesses by the start of the new year.

Private investors have already put $11 million into the fund while the state has contributed $1 million to set up a loss reserve, as well as contibuting state employee's time to get the project going.

Eventually,the fund will be entirely in private hands and the state will be repaid. The fund would take an ownership interest in businesses it finances.

The idea is to find a hot investment prospect before Wall Street does.

Based on the experience of venture capitalists elsewhere in the United States, many of the fund's investments might not ever pan out -- but those that work could yield returns of about 15 percent, Surface said.

She said investors in the fund include large banks and utilities. Surface wants to work closely with banks to see if there is a real need for the loan program, as well.

The owners of small businesses say there is no doubt that money is tight for them, even with the loan guaranatees and other help offered by the U.S. government's Small Business Administration.

Earl Smith, who set up his custom golf club workshop in Phoebus last year, said he had to finance the business from his own pocket -- buying metal working equipment, setting up an indoor driving range and most recently paying about $4,000 for electronic equipment to help him analyze how well a given golf club shaft suits a given golfer.

It has been a strain, but Smith said he had to dig into his own savings because he couldn't get a small-business loan.

Tom Gear, owner of Gear Up Printing in Hampton, said it seems to be especially hard to borrow money to buy equipment and other capital goods.

One difficulty, small-business owners said, is that many banks are reluctant to commit loans for long periods. And rates are fairly high -- usually a percentage point or two above the prime lending rate, which now stands at 10 percent, they say.

It's also hard to get a fixed-rate loan -- and there are few things more nerve-racking for a small business than watching borrowing costs jump up unexpectedly for reasons completely beyond their control.

"We just can't offer fixed rate," said R.J. Holland, president of Farmers Bank in Windsor. He said the risk of locking in a fixed income on a loan is too great nowadays, with interest rates bouncing all over the place. And he said the bank is uncomfortable with longer term loans, as well.

But small businesses are emerging as a major market target for bankers, said Frank R. Bloxom Jr., Sovran Bank's Newport News-based regional executive officer.

"We like to work with small business," he said "We're actively looking for their business."

One reason is that the competition for bigger enterprises' banking business is getting hotter and hotter.

Many large firms, in fact, don't bother much with borrowing from banks, preferring to raise funds by selling commercial paper -- unsecured notes -- or other types of IOUs to investors, a pattern that bypasses bankers.

Bloxom said his eastern Virginia region, which covers branches from the Northern Neck to the North Carolina line, has four officers who specialize in small-business loans.

They basically offer variable rate loans for periods as long as six years along with longer-term mortgage loans secured by property.

For a fee, borrowers can get a "cap" that puts a ceiling on interest rate increases. And he said Sovran does make some fixed-rate loans, as well.

But Surface, at the small-business authority, is not sure that what banks are offering is enough. She said she's especially concerned because the federal government last month put a halt to sales of the tax-exempt industrial revenue bonds that dozens of businesses used to set up shop or to expand in Virginia.

Over the last decade, the Peninsula Ports Authority of Virginia has arranged the issue of 125 bonds, raising a total of $606 million for local industrial and commercial projects.

It played the role of intermediary for businesses. They pay the authority money that the authority then uses to repay investors for interest and principal on the revenue bonds they hold. Interest from the bonds was exempt from federal and state income taxes.

Surface wants her agency to take over that intermediary role but needs to find investors who might want to hold those bonds. She believes an agency like the Virginia Retirement System might be ideal.

Banks may be reluctant to lockup funds for 15, 20 or 30 years, but investors saving for retirement find that a steady, long-term stream of funds with the promise of a big lump sum payment in the future suits their needs.

Interest payments over time and a lump sum payment of principal is exactly what a bond promises.

If Surface can find an agency like the retirement system to buy the bonds, she would use proceeds from the sale to make loans to small businesses.

Rates on the loans would be high enough to cover the authority's bond payment requirements. But since both the authority and the bond buyer would be public bodies, interest would be exempt from income taxes.

Surface believes she should be able to pass that savings on in the form of low interest rates on small-business loans.