New SBIC rules facilitate early-stage investment

The U.S. Small Business Administration (SBA) is implementing a final rule, effective Aug. 17, that adds a category of Small Business Investment Company (SBIC) that will make the program a better-fit for early-stage investment strategies. The most significant change in this direction is the creation of an accrual funding mechanism that enables licensed SBICs to receive a loan from SBA that is repaid only upon distribution events or at the end of a 10-year term. Additional changes include allowing fund investment strategies through a reinvestor SBIC license, modifying license fees, clarifying elements of nonprofit participation, and attempting to reduce program paperwork.

The SBIC program both licenses companies and offers loans, called debentures, to eligible licensees—a structure that parallels the Community Development Financial Institution (CDFI) Fund’s model of certifying CDFIs and offering financial assistance awards. For most of the past 20 years, the debentures available from SBA entailed regular interest payments, requiring participating SBICs to have access to consistent cashflow. Some SBICs have made venture capital investments, but either as a small portion of their strategy or through a fund not backed by an SBA debenture.

Under the new rule, SBA will offer an accrual license that recognizes an SBIC’s ability to access an accrual debenture. This debenture will accrue interest over its 10-year term. Recipients are required to pay an annual fee and accrued interest to the SBA any time there is a distribution event or at the end of the term.

The new reinvestor license is designed for fund-of-funds investment strategies. These SBICs will make investments into funds that invest in small, U.S.-based businesses. Reinvestor SBICs may use any debenture type, including the new accrual debenture.

Teams applying for an SBIC license must be organized through a for-profit company, and the team must have management and investment experience related to the type of license sought and investment strategy proposed. Fees to receive an SBIC license are structured so that initial fees for first-time SBIC funds will be $5,000, with a final license fee for encouraged funds that begins at $10,000 plus a percentage fee based on the size of the proposed debenture.

The rule clarifies that while the SBIC licensee must be a for-profit entity, a nonprofit may serve as the management company, although it may own no more than 70% of the licensee’s SBIC capital. However, there are several criteria that SBA will use to determine whether the for-profit licensee has sufficient control of the SBIC-related capital, and the details of what structures will and will not be allowed are not yet clear.

SBA has published a discussion of how the final rule addresses each of the 15 substantive comments received by the agency and what changes have occurred since last fall’s proposed rule — read SSTI’s coverage of the initial rule and our comment letter. The agency’s press release also offers a useful, high-level summary of the rule.

SSTI is planning further resources on the new SBIC rule, including a deeper explanation of SBIC history and requirements, and intends to continue the conversation with SBA about how SBIC can be a greater tool for tech-based economic development strategies in the future. Share your questions, concerns, and interest by contacting Jason Rittenberg (rittenberg@ssti.org).

Need additional insight into rules and how they affect risk capital?

The new SBIC rule will also be one of the topics discussed during the Risk Capital Roundtable taking place as part of Coming together for your region’s economic future: SSTI’s 2023 Annual Conference. Learn more about the agenda and register today at 2023.ssticonference.org.

This article was prepared by SSTI using Federal funds under award ED22HDQ3070129 from the Economic Development Administration, U.S. Department of Commerce. The statements, findings, conclusions, and recommendations are those of the author(s) and do not necessarily reflect the views of the Economic Development Administration or the U.S. Department of Commerce.