Congress established the Small Business Investment Company program in 1958 to create another pathway for long-term capital to be made accessible to small businesses. After an SBIC is licensed and approved, the SBA makes a commitment to provide a set amount of leverage over several years. The application process to become a registered SBIC is rigorous, but once registered, fund managers have the ability to leverage federal money to capitalize their investment funds at a matching rate of 2:1 for every dollar of private capital raised. This uniquely subsidized capitalization structure, paired with the stringent fund requirements, ensures that SBICs can provide small businesses with various capital products that are often more favorable than traditional bank loans or venture capital investments.
Since its inception, the SBIC program has provided over $100B in capital to entrepreneurs across the country.
These funds have helped transform small firms into powerhouse job-creators. Early-stage small businesses that received SBIC investments include Apple, Costco, FedEx, and Intel. In fiscal year 2020, SBICs financed 1,063 small businesses, with an average amount of just under $2M. These funds helped entrepreneurs acquire new companies, refinance debt, conduct R&D, purchase equipment, and generally operate their enterprise. In 2020, the SBA licensed 26 new SBICs, up from 18 in 2019. And, in 2021, they broke the record again, licensing 32 new SBICs.
One common and important criticism of the SBIC program is its lack of demographic diversity — both among fund manager participants and small businesses funded. In 2007, the SBA formally acknowledged that women and minorities participated in the program at low rates. Today, the diversity numbers haven’t budged; for example, in 2020, SBICs only made up around 5% of their total financing to minority-owned small businesses. The numbers were even worse for businesses owned by women and veterans.
What is a SBIC?
SBICs are licensed private fund managers who receive low-cost, government-backed capital from the SBA to invest in US small businesses. Roughly 300 exist currently, and a full list of all current SBICs can be found on the Small Business Administration’s website.
SBIC Funds can offer the following types of capital for small businesses:
- Debt: A typical SBIC loan ranges from $250,000 to $10M, with an interest rate between 9% and 16%.
- Equity: SBICs invest in a business in exchange for a share of ownership in the company. Typical investment amounts range from $100K to $5M.
- Debt/Equity Hybrid: Financing includes a combination of loans and ownership shares. Loan interest rates are typically between 10% and 14%. Investments range from $250K to $10M.
Key features of SBICs:
- Under the most common and broadest “standard” SBIC license, SBA provides up to 2x leverage to private LP capital in a fund, up to $175M max fund size.
- SBICs may invest in companies using debt, equity, or “debt with equity features.” SBICs may control a small business for up to seven years (or longer with SBA approval).
- At least two managing members of the SBIC must have 10+ years of experience investing in or supporting small businesses.
- Application to register as an SBIC is highly competitive, and lasts at least 1 year. Further application FAQs can be found on the Small Business Administration’s SBIC web page.
- Benefits for “Impact SBICs” include potentially accelerated application process and additional support.
- SBICs are typically not permitted to invest in project finance, real estate, or passive entities such as a nonbusiness partnership or trust. Proceeds from the SBA’s capital match “debenture” can only be used to invest in small businesses per the regulations and parameters defined by the SBA’s Office of Size and Standards.
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Benefits of forming an SBIC
In addition to having a positive impact on small businesses and the economy, the SBIC program offers multiple benefits to fund managers:
- Rapid Fund Deployment: The potential to capitalize as much as two-thirds of a fund with SBA leverage means managers spend less time fundraising and more time investing.
- Flexible Terms: The duration of SBA’s financing instruments can easily be matched up with short or long term investments.
- Exempt from SEC Tegistration: SBICs are exempt from SEC registration, yet LPs benefit from SBA’s careful monitoring of each fund’s performance and regulatory compliance.
- Exempt from Volcker Rule: SBICs are exempt from the bank investment limitations set forth in the Volcker Rule as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
- Increased Financial Scale: SBA leverage allows funds to scale up their strategies and extend their financings to more businesses.
- Enhanced Returns Potential: SBA-guaranteed capital is low cost and does not participate in profit.
- CRA Credit: Investments in SBICs are presumed to be a “qualified investment” for Community Reinvestment Act credit.
SBIC Benefits to Investors
For more than a decade, SBICs have delivered returns to their investors that are in line with those available from other private equity funds in the market. Since 1998, SBICs that benchmark in the top half of private equity funds have delivered a 5- to 10-point boost in the IRR delivered to LPs as a result of SBA leverage.
Costs of forming a SBIC
- The accounting, bookkeeping, and back-office rigor required to establish and maintain an SBIC fund is greater than that associated with a typical private investment fund. Therefore, an SBIC fund typically requires a more significant investment in the organizational entity itself, especially in staff time and outsourced legal and accounting.
- The timeline to establish and formally register an SBIC from idea to completion typically takes 12 to 24 months. For opportunistic investors, this timeline often is the major constraint that inhibits use of the program.