Published July 18, 2023 – The U.S. Small Business Administration (SBA) has taken a significant step towards modernizing the Small Business Investment Company (SBIC) Program. Administrator Isabella Casillas Guzman recently announced the finalization of a new rule, known as the SBIC Investment Diversification and Growth Rule, aimed at enhancing access to funding and diversifying opportunities for small businesses, startups, and investment management communities. Scheduled to take effect on August 17, 2023, this rule aligns with President Biden’s Investing in America Agenda.
Unlocking Potential and Strengthening Small Business Investment
Administrator Guzman emphasizes the critical role SBIC-licensed funds play in nurturing innovation and supporting small businesses across the United States. These funds have facilitated the growth of some of the world’s most successful and groundbreaking enterprises, enabling them to overcome capital gaps and establish resilient and innovative businesses. With the implementation of the SBIC Investment Diversification and Growth Rule, Administrator Guzman expects to unlock untapped potential and expand the network of SBIC licensed private funds. This expansion will address capital deficiencies that currently hinder underserved small businesses, startups, and key industries vital to the nation’s security.
Addressing Structural Limitations for Enhanced Funding Opportunities
The SBIC Investment Diversification and Growth Rule focuses on addressing structural limitations that have historically restricted the flow of equity and growth-oriented debt investments from SBIC-licensed funds. These limitations have primarily affected small businesses and startups operating in underserved communities, capital-intensive industries, and technology sectors crucial to national security and economic development. Due to various factors such as limited access, investment duration, risk profile, and capital requirements, private market investors have not adequately financed these communities, industries, and technologies.
Key Highlights of the Final Rule
To revolutionize the SBIC Program and maximize its impact, several key highlights have been incorporated into the final rule:
1. Addressing the Need for Long-Duration and Equity Funds
The introduction of the “Accrual Debenture” offers a new debenture instrument within the SBIC program portfolio. This instrument aligns with the cash flows associated with longer duration and equity-oriented investment funds. Funds licensed under this instrument will be known as “Accrual SBICs.” Accrual SBICs will enjoy eligibility for 1.25x tiers of leverage. Notably, the SBA will not share in the profits of Accrual SBICs. Instead, SBICs will pay SBA accrued interest and principal upon distribution event.
2. Improving Program Accessibility
To reduce the financial burden for new program applicants, licensing fees have been modified. Additionally, the final rule broadens the eligibility requirements for fund managers, allowing a more diverse group of investment teams and a wider range of investment strategies to participate in the SBIC program.
3. Fund-of-Funds to Increase Access
The final rule introduces a new type of SBIC called the “Reinvestor SBIC.” Operating on a fund-of-funds model, these SBICs invest equity in underlying funds with a focus on underserved areas. Consequently, these underlying funds directly channel investments into small businesses and startups. Fund-of-funds Reinvestor SBICs will utilize the Accrual Debenture instrument and enjoy eligibility for 2x tiers of leverage.
4. Expediting Subsequent Funds
Recognizing the need to accommodate new applicants while maintaining a high level of customer service for existing participants, the final rule introduces a risk-controlled expedited subsequent fund licensing process for eligible applicants. This process aims to create more capacity for SBA to license new-to-program applicants promptly.
5. Streamlining Paperwork
To minimize friction for program participants and investors, the final rule streamlines several administrative aspects. These include indicating the SBA’s intended financial commitment at the time of conditional fund approval, accepting FASB GAAP compliant valuations for non-leveraged Licensees, eliminating the need for SBA pre-approval of a capital call line, and granting safe harbor for eligible follow-on funding of a portfolio company through a non-SBIC vehicle managed by the principals of the SBIC.
6. Strengthening Controls
To enhance risk management, the SBA has implemented several changes. These include the establishment of a formal Watchlist for early identification of potential performance or compliance risks, enhanced reporting requirements to monitor investment performance and credit risk, and the implementation of a 40-basis point Annual Charge floor. The Annual Charge floor aims to provide SBA with a sufficient loss reserve to support the expansion of investment strategies within the SBIC program.
7. Clarifying Affiliation
The final rule brings clarity to the affiliation status of U.S. small businesses with equity investments from SBIC Licensees. According to Small Business Act regulations, a small business with such an equity investment is deemed “unaffiliated” from the licensed fund and its portfolio companies. Affiliation will only be triggered by specific relationships. Consequently, the portfolio companies of an SBIC Licensee are considered “unaffiliated” under SBA regulations.
Enabling Growth and Supporting National Success
Bailey DeVries, Associate Administrator for Investment and Innovation and Acting Associate Administrator for Capital Access, highlights the significant impact public-private SBIC partnerships have had on the growth of various industries. These partnerships have financed startups and small businesses vital to their communities and the broader national supply chain. The modernization of SBIC regulations positions the SBA as an enabling force, partnering with private investors seeking returns to fund businesses in key sectors critical to national security and economic success.
The Impact of the SBIC Program
Since its establishment in 1958 during the Eisenhower Administration, the SBIC Program has played a crucial role in the creation and growth of numerous successful American companies. Currently, the program comprises over 308 distinct private funds, covering mezzanine, private credit, buyout, growth, venture, and multi-strategy investments. Collectively, these funds manage more than $40 billion in public and private assets. In the previous year alone, SBICs invested $8 billion in over 1,500 companies, generating and sustaining more than 103,000 jobs across the United States.
In conclusion, the modernization of the SBIC Program through the SBIC Investment Diversification and Growth Rule marks a significant milestone in expanding funding opportunities for small businesses, startups, and critical industries. With enhanced accessibility, streamlined processes, and clarified guidelines, the SBIC Program is poised to continue fostering entrepreneurship, driving innovation, and supporting economic growth and national security.
Resources:
Small Business Administration: sba.gov
Original Article: Biden-Harris Administration to Establish Reforms to Transform Public-Private Investment Program
