These are exciting times for Small Business Investment Companies (SBICs). Among other things, the federal SBIC program significantly enhances SBICs' ability to provide equity and loan financing to new and established businesses. But if the landscape is marked by opportunity, it is also fraught with potential pitfalls. Venture capitalists are faced with such pitfalls when applying for their SBIC Licenses. Even after an SBIC License is granted, care must be taken to comply with SBIC regulations to maintain good standing and avoid legal complications.
Cognizant of the new legal terrain, Wildman Harrold’s SBIC practice provides a full range of specialized counseling services to SBICs in both the pre-licensing and post-licensing arena. Practice group members possess experience in this unique area of the law and work closely with attorneys from other practice groups within the firm, including corporate, securities, tax, employment, environmental and intellectual property. Many of these attorneys are certified public accountants, MBAs, or have significant outside business experience. Members of the Wildman Harrold SBIC Group have worked with a number of venture capitalists to form Small Business Investment Companies.
Our attorneys assist venture capitalists in the preparation and documentation of the Management Assessment Questionnaire ("MAQ"), License Application, Business Plan and related offering documents required in the licensing process. Our experience working with SBICs and our skills at offering innovative business solutions ensure that the licensing process will be managed in an efficient and cost-effective manner.
Our services continue after the license has been issued. Members of the Wildman Harrold SBIC practice group work with the SBIC in its ongoing investment activities and compliance obligations. Our SBIC group works with the newly licensed SBIC to structure, negotiate and document the investment, in order to meet its SBA compliance obligations and capitalize on its investment strategies. We take special pride in our skill in representing SBICs and in our excellent working relationship with the Small Business Administration (SBA) and the National Association of Small Business Investment Companies (NASBIC). Guided by the philosophy that whenever possible it is better to prevent a problem than deal with one after it arises, we strive to keep our clients advised of developments in this fluid field.
On the investment side, we also represent numerous venture capital firms, several of which have formed drop-down, or side SBIC, funds. We advise these firms in the formation of investment vehicles and in structuring the inter-relationships among the investment vehicles, their investor partners and the portfolio companies. Wildman Harrold has particular skill in the structure, documentation and negotiation of investments in portfolio companies. Our venture capital clients also rely on us to assist in exiting their investments.
In a world where "business-to-business" has become an important descriptive phrase, we would like to reintroduce a phrase that all too often is forgotten: "person-to-person." We know that clients are not only looking for good law firms; they are looking for good lawyers. Allow us to introduce the attorneys of Wildman Harrold’s SBIC/Venture Capital Practice.
Venture Capital Practice
Wildman Harrold has developed substantial experience in private placements of securities. We act as issuer’s counsel in private placements for a number of corporations, partnerships and limited liability companies in a wide variety of industries including companies involved in e-commerce, biotechnology, manufacturing, distribution, health care and financial services. We assist entities in all stages of capital development from formation to later stage venture capital financing, initial public offerings and workouts.
Our attorneys also counsel a number of venture capital funds and private and institutional investors. Members of our venture capital group have been involved in all stages of investment activity on behalf of venture capital firms and investors, from structuring early-stage financing to implementing exit strategies.
SBIC Practice Wildman Harrold has developed a nationally recognized
expertise in Small Business Investment Company (SBIC) practice. Wildman Harrold
provides a wide range of services to our SBIC clients including: drafting the
Management Assessment Questionnaire (MAQ), preparation of the SBIC’s presentation
before the SBA Investment Committee, drafting of the SBIC’s private placement
offering memorandum, completion of the SBIC License Application, preparation
for SBA audits, and documents needed for funding of pre-licensing and post-licensing
investments.
As a result of the large volume of investments
by our SBICs and other clients, we have extensive knowledge of current market
trends in venture capital financing and regulatory issues facing majority and
minority investors. Through our experiences, we have developed practical solutions
for many of these issues.
Corporate Practice Wildman Harrold’s corporate practice attorneys
represent purchasers and sellers in the acquisition, recapitalization and disposition
of businesses. Many of these transactions have involved special regulatory issues
and innovative structures. Typically, our attorneys draft and negotiate acquisition
or disposition documents, organize transaction structures, analyze tax implications,
conduct due diligence and assist with other aspects of a transaction. We are
prepared to accomplish all aspects of any given transaction necessary to meet
our client's goals. We have also worked successfully with company counsel in
completing selected aspects of transactions or in assisting with closing previously
negotiated transactions. Our goal is to provide targeted, quality services for
our clients in the most efficient manner possible.
For additional information regarding Wildman
Harrold, please visit our Web site at www.wildman.com.
What is an SBIC? An SBIC is a small business investment company licensed by the Small Business Administration. SBICs are privately organized and privately managed profit motivated investment firms which, with their own capital and with funds obtained through the Federal Government, provide venture capital to small, independently owned and operated businesses.
The SBIC Program The SBIC program was created by Congress in 1958
to assist entrepreneurs looking for capital to launch small business. Small
businesses qualifying for assistance for the SBIC program are able to receive
equity capital, long-term finance loans and expert management assistance.
Licensing Requirements In order to obtain a license to act as an SBIC,
the partnership must raise a minimum of $10 million in capital for a
Participating Securities SBIC or a minimum of $5 million in capital for a
Debenture SBIC.
Types of Investments SBICs must invest only in small businesses,
defined as companies with net worths of less than $18 million and average
after-tax income for the prior two years of less than $6 million. Failing this
test, a company still may qualify as a small business under certain other
conditions.
For additional information regarding Wildman Harrold's SBIC practice, please
contact Alan Roth at (312) 201-2633 or rotha@wildman.com.
Participating Securities SBICs Participating Securities SBICs are
most suited for acquisitions, and venture capital investments in companies that
lack established sources of cash flow. Participating Securities SBICs can
receive from the SBA up to twice the amount of private capital they raise, with
a ceiling of approximately $111.7 million. The SBA will receive a preferred
return for the participating securities, plus a profit participation.
Participating Securities are preferred limited partnership interests which
provide the SBA with (1) a current return equal to approximately 2.0% to 2.5%
over the interest rate on Treasury Bonds with a ten-year maturity, contingent
upon and payable only from cumulative realized partnership profits, plus (2) a
share of the partnership’s profits.
Debenture SBICs Debenture SBICs, because their payment obligations
start immediately, generally make loans to companies with reliable and
predictable cash flow. Depending on the amount of private capital raised, SBIC
venture funds organized as Debenture SBICs can borrow different amounts from the
SBA: up to three times private capital if less than $17.5 million is raised, up
to twice the amount of private capital if between $17.5 million and $35.1
million is raised, and up to one time the amount of private capital if over
$35.1 million is raised. The most a Debenture SBIC can borrow is approximately
$111.7 million. The debentures, or unsecured loans, issued by the SBA have
ten-year maturities and bear interest payable twice a year. The general partner
of the SBIC is not personally liable for their repayment.
Bank SBICs Many banks with venture capital programs choose to
organize their efforts through SBICs. One of many reasons to do so is that an
SBIC allows a bank to use depository capital—rather than more expensive
borrowed capital—to make venture investments. Bank SBICs are also called
"unleveraged SBICs" because they do not borrow money from the SBA.
For additional information regarding Wildman Harrold's SBIC practice, please
contact Alan Roth at (312) 201-2633 or rotha@wildman.com.
Applicants for an SBIC license must complete several required forms. The SBA provides electronic versions of some of these forms on its Web site. Click on the SBA link provided below to access these forms. Some forms, however, are not available for electronic transmission from the SBA. Wildman Harrold can assist applicants in obtaining any forms that are unavailable on the SBA website.
Embarking on the SBIC
licensing process can be a daunting task. As a federal regulatory program,
applicants must be willing to work within a detailed regulatory scheme. Below
please find a brief description of some of the required parts of the SBIC
licensing program. This list is not all-inclusive as to the entire SBIC
licensing process; instead, it is meant to give potential applicants an idea of
what the program requires. Due to the complexities of this process, legal
counsel is advisable.
Management Assessment Questionnaire The Management Assessment Questionnaire or "MAQ" (pronounced "mac") is a series of structured questions concerning the applicant’s plans for the prospective SBIC and the experience and qualifications of the proposed management team. The MAQ consists of two electronic files and is available through Wildman Harrold or the SBA. Wildman Harrold provides detailed guidance and support throughout the completion of the MAQ and will serve as contact person for the SBA in the evaluation process.
The SBA recently issued a Memorandum regarding the necessary management team qualifications. Please click here to view.
License Application After the SBA has approved the initial MAQ filing and given a "go forth" letter to the applicant, the preparation of the license application begins. The license includes information gathered on the MAQ, more detail concerning financial commitments and several legal documents needed to create an SBIC. When the applicant begins the application, it should be highly confident of minimum capital levels required by the SBA. Firm commitments of $10 million of Regulatory Capital are necessary if the applicant wishes to utilize participating securities leverage and $5 million if debenture leverage will be used. If the applicant intends to be non-leveraged, it will need commitments of at least $3 million plus a plan for getting to $5 million. In order to file an application, the applicant must have received signed commitments from qualified investors for the appropriate minimum.
SBIC Regulations Classes SBIC Regulation training classes are held about nine times per year in Washington and twice during the summer, either on the West Coast or in the Midwest. The purpose of this course is to familiarize the applicant with the ins and outs of investing within the SBIC regulatory framework. The classes are critical and required by the SBA for licensing. At least one principal of the proposed SBIC must attend the regulatory training before a license will be issued. In addition, all principals must attend the training before any leverage will be issued.
SBIC Audit The SBIC requires each Licensee to submit an audited Annual Financial Report at the close of its fiscal year. The Annual Financial Report consists of the financial statements and other schedules included in SBA Form 468 and can be located on the SBA’s Web site. A link to this form is located on the "SBIC Forms" page of SBICLaw.com. The preparation of the Annual Financial Report is the responsibility of the Licensee. SBA regulations require that an Independent Public Accountant perform the audit and express an opinion on financial statements and supplementary schedules based on the audit.
For additional information regarding Wildman Harrold's SBIC practice, please
contact Alan Roth at (312) 201-2633 or rotha@wildman.com.
The first step in determining whether the SBIC program is right for you is to read "Is the SBIC Program Right for You?" drafted by the SBA. Below please find a link to this document in pdf format. In it, the SBA has summarized the key elements of the process for obtaining an SBIC license. This document is a great starting point to determine whether this program fits your individual needs. While it answers many SBIC questions, it will no doubt raise a whole host of other issues.
For additional information regarding Wildman Harrold's SBIC practice, please
contact Alan Roth at (312) 201-2633 or rotha@wildman.com.
The Small Business Investment Company (SBIC) program, part of 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.
It’s a little-known fact, but the federal government is the largest single investor in U.S. private equity funds. At the end of FY 2003, SBA had close to $5.5 billion invested in 435 funds, plus another $3.7 billion in available commitments. Together with private capital topping $12 billion, the program totals over $21 billion in private equity capital dedicated to America’s entrepreneurs.
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 an SBIC’s portfolio management operations.
SBICs must be privately managed, for-profit investment companies formed to provide equity and/or debt capital to U.S. small businesses. SBICs are licensed by the SBA, which invests alongside private investors.
An experienced team of private equity managers must secure minimum commitments from private investors of either $5 million (for a debenture fund) or $10 million (for an equity fund). For every $10 million in private equity, SBIC licensees are eligible to receive up to a $20 million SBA commitment (2:1 public-private leverage), substantially enhancing prospective portfolio returns.
The total size of an SBIC typically ranges from $30 million to $170 million. SBICs may only invest in “small businesses” defined as: net worth less than $18 million and prior two years’ average after-tax income less than $6 million.
No particular style or type is preferred. Among the existing SBICs, SBA holds a diversified portfolio across multiple investment styles and fund types. It is important to note that both the Participating Securities and Debentures are a 10 year obligation. Therefore, strategies with investment time horizons in excess of 10 years, such as early stage (pre-FDA approval) bio-tech, are often not a good fit for the Program.
Our SBIC Program Overview (under the About Us section of the website) summarizes your fund’s structure choices.
The first step is to evaluate your team and strategy relative to the SBIC Program’s general management qualification guidelines, including:
o
Private
equity investing experience and strong “deal flow” of the same type that the
proposed fund would perform.
o
At
least two general partners who have five or more years of “decision-making”
experience as a principal in a private equity fund (rather than as an agent
such as consultant, investment banker, broker, etc.)
o
Realized
track record of superior returns, placing a fund in the upper half of
performance for venture funds of the same vintage year and style.
o
Managerial,
operational or technical experience that can add value at the portfolio
company level.
o
Cohesive
management team, with complementary skills and history of working together.
No, “claw back” provisions to protect private limited partners are not permitted. For more information on acceptable provisions refer to the Model Debenture SBIC Partnership Agreement
Profit distributions are applicable to Participating Securities SBICs only. As a Preferred Limited Partner, the SBA is entitled to receive a preferred return (referred to as the “Prioritized Payment”) prior to any distributions being made to Private General and Limited Partners. The rate for the Prioritized Payment is a function of the 10 Year Treasury Bond Rate plus a spread (current rates posted at http://www.sba.gov/idc/groups/public/documents/sba_program_office/inv_rates.xls) plus an annual charge by SBA (current rates posted at http://www.sba.gov/aboutsba/sbaprograms/inv/forsbic/inv_annualcharge.html).
SBA also receives a Profit Participation when profit distributions are made to the Private General and Limited Partners. The amount of SBA’s Profit Participation is determined using two factors: the 10 Year Treasury Bond Rate and the ratio of Participating Securities to Private Capital. For example, if Rates are 4.00% and an SBIC has utilized two full tiers of leverage, the Profit Participation rate charged by SBA would be 6.00%.
This structure differs from a traditional fund structure in that the SBA has an interest in a substantially lower portion of the investment company profits than a traditional LP.
Licensed debenture 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.
SBIC
investing, as a subset of the overall venture capital industry, is
responsible for the creation of millions of jobs, billions of dollars in
corporate revenues, billions of dollars in federal and state taxes paid, and
countless improvements to our health, safety and way of life. Venture
capitalists are very “hands-on” investors, adding corporate value in many
ways beyond financing growth.
SBICs
supplement their own private capital through guarantees of debentures or
participating securities up to three times private capital, depending on
which security the SBIC chooses. 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:
o
Concentration
of a large portion of funding in one LP reduces fundraising burden and
administrative / reporting requirements
o
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
o
Enhanced
deal sourcing through network of over 400 SBICs
o
SBIC
MAQ application process helps to crystallize strategy and can be presented to
private investors as part of a larger marketing package
o
SBA’s
financial reporting criteria help SBICs develop standardized and
comprehensive investor relations processes
o
SBA’s
licensing process is well defined, with early milestones which help potential
licensees assess their likelihood of funding early on.
In
exchange for a substantially lower portion of the SBIC’s profits, the SBA
requires a liquidity preference ahead of the other private partners of the
fund. This liquidity preference mandates that the SBA receive its principal
plus Prioritized Payments prior to any distributions being made to private
Limited or General Partners.
The
amount of SBA’s Profit Participation is calculated using two factors: the 10
Year Treasury Bond Rate and the ratio of Participating Securities to Private
Capital. For example, if Rates are 4.00% and an SBIC has utilized two full
tiers of leverage, the Profit Participation rate charged by SBA would be
6.00%.
The
SBIC program is involved in a medium term project to develop historical
returns of SBICs as an asset class, particularly since the inception of the
Participating Security (equity) funds in 1994.
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.
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 operate in conformance with the regulations or
to uncover those instances when they have failed to do so. Potential fraud is
most usually uncovered after an SBIC has been transferred to the Office of
SBIC Liquidation. These cases may be referred to the Office of the Inspector
General for investigation and possible referral to the Assistant US Attorney
for prosecution.
In 1958 Congress created the Small Business
Investment Company (SBIC) program. SBICs, licensed by the Small Business
Administration ("SBA"), are privately owned and managed investment
firms. They are participants in a vital partnership between government and the
private sector economy. With a combination of private capital and funds borrowed
at favorable rates through the Federal Government, SBICs provide venture capital
to small independent businesses, both new and already established. All SBICs are
profit-motivated businesses. A major incentive for SBICs to invest in small
businesses is the chance to share in the success of the small business if it
grows and prospers.
The National Association of Small Business
Investment Companies (NASBIC) is non-profit organization dedicated to building
and maintaining a strong and profitable Small Business Investment Company (SBIC)
industry. NASBIC has played a pivotal role in promoting the growth and vitality
of the SBIC business sector through representation in Washington and several
professional programs.
NASBIC cooperates closely with other
independent business associations to forward the interests of small business at
the federal level. A 30-member Board of Governors sets the policies and
priorities of the Association. NASBIC’s activities are managed by five
national officers elected from the Board. Chosen annually by their peers, these
Governors and officers are active industry executives who represent a variety of
SBIC licensees throughout the country.
Wildman Harrold takes special pride in its
working relationship with NASBIC. The firm is a member of NASBIC and our
attorneys regularly attend NASBIC conferences.
For additional information regarding Wildman Harrold's SBIC practice, please
contact Alan Roth at (312) 201-2633 or rotha@wildman.com.
The material on this website has been provided by Wildman,
Harrold, Allen & Dixon LLP for informational purposes only and should not be
construed as legal advice or opinion on specific facts. Do not act upon this
information without consulting with an attorney.
