Small Business Investment Companies (SBIC)
By WORLDLawDirect [January 25th, 2011]
Licensed by the Small Business Administration (SBA), SBICs are privately owned and managed investment firms. They are participants in a vital partnership between government and the private sector economy. With their own capital and with funds borrowed at favorable rates through the Federal Government, SBICs provide venture capital to small independent businesses, both new and already established.
Small Business Investment Companies (SBIC) Program
Frequently Asked Questions
1. What is the SBIC Program?
The Small Business Investment Company (SBIC) program, administered by the U.S. Small Business Administration (SBA), was created in 1958 to fill the gap between the availability of venture capital and the needs of small businesses in start-up and growth situations.
2. What is the current size of the program?
At the end of FY 2005, SBA had over $6.3 billion invested in 418 funds, plus another $5.1 billion in outstanding commitments. Together with private capital topping $12 billion, the program totals over $23 billion in capital resources dedicated to America’s entrepreneurs.
3. How does the SBA fund the SBIC Program?
No tax dollars are appropriated to fund SBIC debentures. Rather, SBIC debentures are pooled periodically and sold in the public markets to private investors in the form of SBA Guaranteed Certificates.
4. How does the SBA participate in an SBIC?
The government itself does not make direct investments or target specific industries. Essentially, the SBIC program is a “fund of funds” – meaning that portfolio management and investment decisions are left to qualified private fund managers. As a result, SBA has very minimal direct involvement in a SBIC’s portfolio management operations.
5. What are the requirements for obtaining an SBIC license?
SBICs must be privately managed, for-profit investment funds formed to provide equity and/or debt capital to U.S. small businesses. SBICs are licensed by the SBA. For more information refer to The SBIC Program: Application Process
6. What is the status of the Participating Securities Program?
The Participating Securities program, which was established in 1994 to better match how SBICs were funded with the equity needs of entrepreneurs, ceased issuing new leverage commitments on October 1, 2004. Based on projected losses in excess of $2.7 billion, it was decided that while the Participating Securities program has provided benefits to small businesses in the past, the structure of the current program and related cost to the taxpayers cannot be supported. The Debenture Securities program, which dates back to the inception of the SBIC program in 1958, continues to issue new leverage commitments and is most appropriate for investment management funds focused on providing later stage, expansion capital to cash-flow-positive or nearly cash-flow-positive companies.
7. What investment styles and fund types fit best with the SBIC Program?
Historically, no particular style or type of SBIC was preferred. Among the existing SBICs, there are multiple investment styles and fund types. Today, because only the program is only issuing debenture leverage commitments, the best fit for the program is funds focused on providing later stage, expansion capital to cash-flow-positive or nearly cash-flow-positive companies.
8. How do I know if I have what it takes to receive an SBIC license?
The full SBIC licensing process is outlined in detail at “SBIC Program: Application Process”
9. Can an SBIC have a single private partner?
A leveraged SBIC must have diversity in its private partner funding base. Generally, investment by a single large LP is restricted to 70% of private capital. This restraint does not apply to non-leveraged SBICs.
10. What are Low/Moderate Income (“LMI”) Debenture Securities?
SBICs are eligible to use LMI Debentures, which are deferred interest debentures that are issued at a discount and require no interest payments or SBA annual charge for the first five years. LMI Debentures are available in 5 and 10 year maturities. The use of LMI Debentures is restricted to LMI qualified investments. Qualified investments are small businesses in which 50% or more of the employees or tangible assets are in a LMI Zone (as defined by applicable government agencies) or 35% of the full time employees of the small business have primary residences in a LMI Zone.
11. What are the benefits to fund managers of forming an SBIC?
SBICs supplement their own private capital by issuing debentures securities up to three times private capital, although typically this is limited to two times. This capital is provided at a significantly lower cost than traditional limited partner equity investments. The effect of the leverage can have a very powerful impact on return enhancement to fund managers.
Additional benefits to fund managers include:
- Concentration of a large portion of funding from one source reduces fundraising burden and administrative / reporting requirements.
- Community Reinvestment Act credits available to financial institutions that invest in SBICs open up a source of private funds to SBICs that they might not have otherwise.
- Enhanced deal sourcing through network of over 400 SBICs.
- SBIC MAQ application process helps to crystallize strategy and can be presented to private investors as part of a larger marketing package.
- SBA’s financial reporting criteria help SBICs develop standardized and comprehensive investor relations processes.
- SBA’s licensing process is well defined, with early milestones which help potential licensees assess their likelihood of funding early on.
12. Is there a limit on the amount of state economic development or state government agency capital that can be invested in an SBIC?
A maximum of 33% of regulatory capital can come from state and local government entities.
13. How is the Debenture rate of interest calculated?
The rate of interest is based on the 10-year Treasury rate plus a market-driven spread, currently about 65-75 basis points.
14. What are the rules governing control situations by an SBIC?
An SBIC is permitted to control, either directly or indirectly, a small business for a maximum period of 7 years. With SBA’s prior written approval, an SBIC may retain control for such additional period as may be reasonably necessary to complete divestiture of control or to ensure the financial stability of the portfolio company.
15. How does SBA protect against fraud and other wrongdoing in the SBIC program?
Prior to receiving an SBIC license, the applicant must undergo a rigorous licensing process. Upon receiving a license, the SBIC is subject to an annual regulatory audit by the Office of SBIC Examinations. These audits are designed to ensure that SBICs are in compliance with the regulations or to uncover those instances when they have failed to do so. Potential fraud is often uncovered after an SBIC has been transferred to the Office of SBIC Liquidation. These cases are referred to the Office of the Inspector General for investigation and possible referral to the Assistant US Attorney for prosecution.
16. Who benefits from the SBIC Program?
Small businesses which qualify for assistance from the SBIC program are able to receive equity capital, long-term loans, and expert management assistance. Investment managers participating in the SBIC program can supplement their own private investment capital with funds borrowed at favorable rates through the federal government. Most importantly, the Nation's economy benefits from the program as the small businesses financed by SBICs continue to create hundreds of thousands of jobs and generate tax revenues over the program’s life. Source: U.S. Small Business Administration (SBA)