1. What is the SBIC Program?
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.
2. What is the current size of the program?
It’s a little-known fact, but the federal government is the largest single investor in U.S. private equity funds. Since 1958, SBICs have provided over $50.6 billion of funding to over 100,000 small businesses. As of April 2015, the SBA had over $8.6 billion invested in 245 funds, plus another $3.088 billion in outstanding commitments. As of March 2015, private capital committed to those funds topped $10.6 billion.
3. 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 an SBICs portfolio management operations.
4. What are the requirements for obtaining an SBIC license?
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.
An experienced team of private equity managers must secure minimum commitments from private investors of $5 million (for a debenture fund), although the SBA can, and often does, require the fund to have secured $20 million or more of LP commitments.. For a debenture fund authorized to receive up to 2:1 public-private leverage, for every $10 million in private capital, SBIC licensees are eligible to receive up to a $20 million SBA commitment, which can substantially enhance prospective portfolio returns.
The total size of an SBIC typically ranges from $30 million to $225 million or more. SBICs may only invest in “small businesses” defined as: net worth less than $19.5 million and prior two years’ average after-tax income less than $6.5 million.
5. What investment styles and fund types fit best with the SBIC Program?
No particular style or type is preferred, although investing strategies that provide a fund with current pay income such as interest and dividends are common for debenture SBICs. Among the existing SBICs, SBA holds a diversified portfolio across multiple investment styles and fund types. It is important to note that the 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.
6. How do I know if I have what it takes to receive an SBIC license?
The first step is to evaluate your team and strategy relative to the SBIC Program’s general management qualification guidelines, including:
- Private equity investing experience and strong “deal flow” of the same type that the proposed fund would perform.
- 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.)
- Realized track record of superior returns, placing a fund in the upper half of performance for funds of the same vintage year and style.
- Managerial, operational or technical experience that can add value at the portfolio company level.
- Cohesive management team, with complementary skills and history of working together.
7. Can an SBIC have a single private LP?
No. An SBIC must have diversity in its private LP funding base. Investment by a single large LP is restricted to 70% of private capital. However, drop-down structures with a subsidiary fund wholly owned by a parent fund are permitted if the parent entity meets the LP diversity requirements.
8. What are Low/Moderate Income (“LMI”) Debenture Securities?
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.
9. What has the SBIC program done to expand the availability of capital in the private equity market?
SBIC investing 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. SBIC fund managers typically are “hands-on” investors, adding corporate value in many ways beyond financing growth.
10. What are the benefits to fund managers of forming an SBIC?
SBICs supplement their own private capital through guarantees of debentures of a multiple private capital. 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. In addition, banks and Federal savings associations (and their holding companies) are permitted to invest as limited partners in SBIC funds.
Additional benefits to fund managers include:
- Concentration of a large portion of funding in one LP 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.
11. What portion of state economic development or state government agency capital can be counted toward regulatory capital?
A maximum of 33% of regulatory capital can come from state or local government entities.
12. 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, since 2010, it has ranged between 41 and 92 basis points.
13. What are the historical returns of SBICs as an asset class?
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.
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 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.