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.
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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. 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.
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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 SBIC’s
portfolio management operations.
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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,
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.
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5. What investment styles and fund types fit best
with the SBIC Program?
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 Basics (under the About Us section of
the website) summarizes your fund’s structure
choices.
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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 venture 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.
The full SBIC licensing process is outlined in detail
at http://www.sba.gov/INV/rightforyou.pdf
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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.
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8. Are claw backs permitted for private LPs?
No, “claw back” provisions to protect
private limited partners are not permitted. For more
information on acceptable provisions refer to the Model
Participating Partnership Agreement at http://www.sba.gov/INV/modelparticipating.doc
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9. How do SBIC profit distributions differ from
non-SBIC funds?
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/INV/trustrates.html) plus an annual
charge by SBA (current rates posted at
http://www.sba.gov/INV/annual.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.
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10. 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.
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11. What has the SBIC program done to expand the
availability of capital in the private equity market?
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.
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12. What are the benefits to fund managers of
forming an SBIC?
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:
- 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.
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13. 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.
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14. How does the SBA’s liquidity preference
affect private limited and general partners?
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.
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15. How does SBA calculate the “Prioritized
Payment” amount?
The “Prioritized Payment” is calculated
using the 10 Year US Treasury Bond rate plus a spread and
an applicable SBA fee. Current rates are posted at http://www.sba.gov/INV/trustrates.html
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16. How does the SBA calculate the “Profit
Participation Rate”?
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%.
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17. 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 70-80
basis points.
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18. 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.
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19. 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.
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20. 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.
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