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An Overview of the Small Business Investment Company Program

A Small Business Investment Company (SBIC) is a privately owned and operated company which makes long-term investments in American small businesses and which is licensed by the United States Small Business Administration (SBA).

There are two principal reasons for a firm to become licensed as an SBIC -- access to SBA guaranteed financing (Leverage); and, for banks, the ability to own indirectly more than 5 percent of the voting stock of a small business and receive Community Reinvestment Act credit.

This memorandum provides a summary description of the two kinds of SBA Leverage and a general overview of other SBA regulations.

Historical Perspective

The SBIC Program has underdone significant changes since its creation in 1958 to stimulate small business and create jobs. During the 1960s, more than 1,000 SBICs were in operation, many of them specializing in real estate activities. Many of these were capitalized with the minimum private capital (initially $150,000) and were managed by people without significant prior venture capital experience. Many of these early SBICs were commercially unsuccessful and most were short lived. During the 1970s, the 300-500 operating SBICs showed considerably more investment expertise, and the SBIC Program played the leading role in the venture capital industry. During the 1980s, tremendously high interest rates (which later fell) underlined the structural problem of making long-term equity investments using current-pay Debentures as a financing source. That, and other regulatory features of the SBIC Program (such as total Leverage being limited to $35 million) which encouraged small private capitalization ($12 million being required to use all the Leverage) which in turn led to investments in very small businesses), coupled with the rise of large venture capital firms and the emergence of pension funds as significant providers of capital to the venture industry (which for Federal tax reasons are discouraged from investing in SBICs using Debentures), caused the SBIC industry to decline during the 1980s. By the early 1990s, only 180 SBICs continued in operation, of which approximately 80 were bank-related.

In 1991, SBA appointed an Advisory Commission which reviewed the SBIC industry's performance, determined that it had a significant role to play in building the U.S. economy, and outlined significant program changes required to make the program successful. The principal features of the Advisory Commission's report were embodied in legislation known as the Small Business Equity Enhancement Act of 1992 (the 1992 Act). The 1992 Act drastically changed the SBIC Program. It created the new form of SBA Leverage known as "Participating Securities" (preferred limited partnership interests); increased the amount of Leverage available to an SBIC to $90 million (which subsequently has been indexed to reflect changes in the cost of living since March 31, 1993); required minimum private capital of $10 million for SBICs using Participating Securities and $5 million for SBICs using Debentures; provided for stricter SBA licensing standards; and proposed other changes to make the program more consistent with the private venture capital industry. Regulations implementing the 1992 Act became effective on April 25, 1994. The Act and regulations have undergone several revisions since 1994, which have further streamlined and improved the program.

From the summer of 1994 through September 30, 1999, 187 SBICs were licensed. As of October 1, 1999, 91 SBICs had been licensed to use Participating Securities with aggregate private capital of $1.7 billion (approximately $18.7 million per SBIC) and 91 SBICs were licensed to use Debentures (with aggregate private capital of $1 billion). There also were 99 bank-owned SBICs with private capital of $5.4 billion (all but 3 not using Leverage) and 66 "specialized" SBICs (specializing in investments in businesses owned by socially or economically disadvantaged persons) with $154 million in private capital. SBA anticipates that over 60 new SBICs will be licensed by September 30, 2000. As of October 1, 1999, the 91 SBICs using Participating Securities had approximately $2.3 billion of outstanding Leverage commitments (of which $1.3 billion had been issued and was outstanding); and the 91 SBICs using Debentures had outstanding Leverage commitments of $1.2 billion (of which $800 million was issued and outstanding).

SBA Leverage

SBA presently provides financing (called "Leverage") to SBICs in two forms: "Debentures" and "Participating Securities." The form selected by the SBIC will be determined by the nature of the deals the SBIC intends to do and whether the SBIC has investors which are tax-exempt entities. Use of Debenture financings by an SBIC which is a limited partnership or limited liability company will cause unrelated business taxable income to investors that are tax-exempt entities, thereby effectively precluding investment by them. Debenture financing usually appears better suited if the SBIC plans to invest in portfolio companies with the ability to service debt. Participating Securities generally are better suited for SBICs investing in seed and early stage businesses or businesses which either do not have established cash flow or need to use available cash for other purposes.

Debentures are unsecured loans issued by the SBIC which have interest only payable semi-annually and a ten year maturity. The interest rate is established when issued, and most recently was 251 basis points in excess of the interest rate on Treasury Bonds with ten year maturities (the "Treasury Bond Rate").

Participating Securities are preferred limited partnership interests which are redeemable after ten years which provide SBA with both (i) a current return (which SBA calls a "Prioritized Payment") which is established when Participating Securities are issued, most recently was 246 basis points over the Treasury Bond Rate and which is contingent upon and payable only from cumulative realized partnership profits, and (ii) a modest share of the Partnership’s profits (expected to be from 7 percent to 12 percent).

In addition, SBA has issued final regulations authorizing the creation of "LMI Debentures" for use by SBICs making investments in Low and Moderate Income Zones ("LMI Zones") which are more fully described below under the heading "LMI Investments".

Leverage Availability

For the fiscal year beginning October 1999, SBA Regulations provided that the maximum amount of Leverage available to an SBIC is $105.2 million ($90 million indexed for increases in the Consumer Price Index after March 31, 1993). This amount will be adjusted effective on October 1, 2000 and on each subsequent October 1. The amount of Leverage available to a particular SBIC is limited to a multiple of its paid-in private capital which depends on whether Debentures or Participating Securities are used, as described below.

SBA obtains funds enabling it to supply Leverage by guarantying payment of Trust Certificates which are purchased periodically by traditional purchasers of government-guaranteed bonds. The amount of Trust Certificates which may be guaranteed by SBA each year is determined by Congressional appropriation of amounts necessary to cover anticipated losses (the "Subsidy Rate"). For the fiscal year ending September 30, 2000, the Subsidy Rate for Participating Securities is 1.8 percent, and for Debentures is 0 percent (down from 1.99 percent for the fiscal year ended September 30, 1999). If the Subsidy Rate is reduced, the same level of Congressional appropriations will support higher levels of Leverage to be made available to SBICs. For the fiscal years ending September 30, 1995, 1996, 1997, 1998 and 1999, Congress appropriated sufficient funds to enable SBA to issue $229 million, $267 million, $410 million, $700 million and $1.029 billion of Participating Securities, respectively, and $109 million, $110 million, $376 million, $600 million and $700 million of Debentures. Participating Security funding of $1.37 billion and $800 million in Debenture funding is available for FY 2000. On February 7, 2000, the Administration proposed a FY 2001 budget calling for $2 billion of Participating Securities (with a 1.31% Subsidy Rate) and $500 million of Debentures (with a "negative" Subsidy Rate of 0.82%; i.e. the Debenture program is expected to be profitable). $500 million of Debentures is an increase from the $352 million which was required to be supported by Congressional appropriations in FY 1999 (the higher levels of Debentures noted above for FYs 1997-1999 being the result of carrying over unused appropriations from prior years and FY 2000 being the level "authorized" which does not require an appropriation because of the zero Subsidy Rate).

Requesting Leverage

SBICs may obtain Leverage by obtaining a "Leverage Commitment" and then drawing down Leverage from the Commitment. Leverage Commitments may be obtained at the time of licensing for an amount up to two tiers of Leverage (subject to availability). Commitments also may be obtained periodically during each fiscal year (SBA presently makes them available in November, February and August). When a Leverage Commitment is issued, the SBIC pays a 1 percent commitment fee. Commitments expire on September 30 of the fourth Federal fiscal year following their issuance.

SBICs may draw down committed Leverage on one day’s notice through an interim credit facility provided by the Federal Home Loan Bank of Chicago. A 2 percent "user" fee payable to SBA and 50 basis points of underwriting fees are deducted from each disbursement. The SBIC pays an interim interest rate on Debenture Leverage and accrues an interim preferred return ("Prioritized Payment") on Participating Securities of LIBOR plus 150 basis points. Every six months all interim Leverage is pooled by SBA and a new interest rate (or Prioritized Payment Rate) is established which recently has been approximately 245-250 basis points over the U.S. Treasury Bond Rate. Participating Securities are pooled in February and August of each year, and Debentures are pooled in March and September of each year.

Debenture Leverage

Debentures have 10-year maturities, are not amortized prior to maturity, and bear interest (including a 100 basis point fee to SBA) payable semi-annually at a rate which, for Debentures issued in March 2000 was 251 basis points in excess of the Treasury Bond Rate. Debentures are unsecured, and the General Partner of the SBIC is not personally liable for their repayment. Debentures may be prepaid with a 5 percent penalty in the first year which declines 1 percent per year (i.e., 5-4-3-2-1 percent) so that the Debentures may be prepaid without penalty beginning in the sixth year following issuance. Repayment of Debentures is subordinate to repayment of loans from non-Associate lenders up to the lesser of $10 million or twice the amount of the SBIC's Regulatory Capital (i.e., its capital from private investors). SBA is able to issue Debentures with maturities shorter than 10 years, but has not done so since 1991.

The amount of Debentures used by an SBIC may not exceed approximately three times the initial $17.5 million(1) of the SBIC's private capital, twice the amount of private capital from $17.5 to $35.1 million, and one time the amount of private capital in excess of $35.1 million (up to the ceiling of $105.2 million noted above).

SBICs using Debentures may distribute their realized earnings to investors. However, without SBA's prior consent, they may not reduce their capital to investors by more than 2 percent in any fiscal year. This requirement causes the SBIC to work out a plan acceptable to SBA when it wishes to wind down its business. While SBA does not have formal guidelines for such plans, its principal concern will be to assure repayment of outstanding Debentures.

SBICs using Debentures may be structured as corporations, limited partnerships or limited liability companies.

Participating Securities- Distributions to SBA

SBA's regulations provide that an SBIC may use Participating Securities in an amount up to twice the amount of its private paid-in capital, subject to the ceiling of approximately $105.2 million noted above.

Participating Securities are issued in the form of preferred limited partnership interests pursuant to which SBA is admitted as a Preferred Limited Partner.(2)

As a Preferred Limited Partner, SBA is entitled to receive a preferred return (referred to by SBA as a "Prioritized Payment") prior to any distributions being made to private partners, and to a limited Profit Participation when distributions of profits are made to the private partners. The Prioritized Payment rate for Participating Securities issued in February 2000 was 246 basis points over the Treasury Bond Rate (compounded annually). Prioritized Payments are contingent upon and only payable from the cumulative, realized profits of the partnership, if any. Participating Securities (together with earned but unpaid Prioritized Payments) have priority in liquidation over other partnership interests. Participating Securities mature and are redeemable ten (10) years after their issuance.

The amount of SBA's Profit Participation is determined by a formula with two variables: the applicable Treasury Bond Rate, and the ratio of Participating Securities to the SBIC's Leverageable Capital (i.e., private, paid-in capital). If more than one series of Participating Securities are issued, the rate changes and thereafter is based on the highest Leverage Ratio (but may decline if additional private capital is paid in). The Treasury Bond Rate is adjusted for subsequent financings based on the weighted average of amounts of Participating Securities outstanding and the time periods involved. The following table illustrates the Profit Participation Rate at various Leverage Ratios and Treasury Bond Rates.

Ratio of Participating Securities to Private Capital10 Year Treasury Bond Rate

After SBA's Prioritized Payments are distributed to SBA, profits may be distributed to the private partners and SBA pursuant to so-called "tax distributions" and "returns on capital." The SBIC's profits are computed after deducting the Prioritized Payment payable to SBA. "Tax distributions" may be made on a quarterly basis.

The amount of the "tax distribution" equals the SBIC's profits multiplied by the sum of the highest individual or corporate Federal and state tax rate applicable to the type of income (capital gains or ordinary income) being distributed. However, the rate will be adjusted to reflect the deduction of state taxes on the Federal return. The tax rates used will be those of the state in which the principal office of the SBIC is located. SBA is entitled to share in each "tax distribution" in proportion to its Profit Participation Rate.

Once Prioritized Payments and "tax distributions" are made, an SBIC may distribute (during the year) and is obligated to distribute (annually) the remainder of its cumulative realized earnings (subject to retention of funds to satisfy its working capital needs pursuant to an SBA regulation requiring maintenance of "liquidity," and with SBA approval, reasonable reserves to meet contingent liabilities and protect existing investments). SBA defines Retained Earnings Available for Distribution as being the SBIC's net realized, cumulative earnings less unrealized depreciation on portfolio companies (but excluding unrealized appreciation). SBA's share of such distributions depends on its Leverage Ratio, as follows:

i. If the Leverage Ratio is more than 200 percent, distributions must be made in the ratio of Leverageable Capital to Leverage.

ii. If the Leverage Ratio is more than 100 percent but not more than 200 percent, distributions must be made in the ratio of one-to-one.

iii. If the Leverage Ratio is 100 percent or less, SBA's share of a distribution equals its Profit Participation Rate.

SBA may restrict distributions if it determines that the value of an SBIC's assets are materially overstated.

Distributions of an SBIC's cumulative profits to SBA will be applied first to its accumulated Prioritized Payments, next to its Profit Participation, next as a redemption of Participating Securities, and finally as repayment of Debentures (if any are issued).

After payment of Prioritized Payments, "tax distributions" and "returns on capital," the partnership may return capital to its investors (including SBA) if it does not have Capital Impairment, will not cause Leverage in excess of permitted levels, or decrease the SBIC's minimum capital below its required minimum. Such distributions are made to SBA and the private investors in proportion of Leverageable Capital to Leverage.

An SBIC may make in-kind distributions, but only if the securities distributed are "Distributable Securities", as defined by SBA Regulations, at the time of distribution. SBA regulations preclude using in-kind distributions for paying tax distributions. Gains or losses on the securities distributed will be imputed as if they had been sold, using the value of the securities as of the date of distribution. "Distributable Securities" are defined as being securities which SBA determines (with the advice of a third party expert in the marketing of securities) which are:

  1. Saleable immediately without restriction under Federal and state securities laws (including sales under Rule 144);
  2. Which are listed and registered on the National Securities Exchange or for which quotation information is disseminated in the National Association of Securities Dealers Automated Quotation System; and
  3. The quantity of which can be sold by SBA over a reasonable period of time without having an adverse impact on the price of the security.

SBA regulations provide that once a distribution is characterized as a Prioritized Payment, a "tax distribution" or a "return on capital", it may not be recharacterized as a "return of capital" if the Partnership subsequently proves unprofitable. This might cause SBA to receive distributions early in the life of the Partnership which are characterized as profits even though the partnership ultimately proves to be unprofitable, and, in addition, receive return of the full amount of its Participating Securities in priority to return of the Partners’ capital.


The following example illustrates how Participating Securities distribution regulations work.


  • Ratio of SBA Leverage to investor capital is 2:1
  • Accumulated contingent Prioritized Payment is $200,000 at time of distribution
  • Combined federal and state income tax rate is 40 percent
  • 10 Year Treasury Bond Rate of 6 percent; Prioritized Payment Rate of 8.35 percent
  • SBA Profit Participation Rate of 9 percent
  • $2,000,000 to be distributed of which $1,000,000 is Retained Earnings Available for Distribution, and $1,000,000 is a Return of Capital


$1,000,000Earnings before Prioritized Payment and taxes
($ 200,000)8.35% Accumulated Prioritized Payment
$ 800,000 Earnings available for distribution
($ 320,000) Total Tax Distribution (40% tax rate)

SBA $ 28,800

( 9.0 %)

Investors 291,200




$ 480,000 Amount available for profit distribution and
SBA Leverage redemption
($ 240,000)SBA (50%)
Profit distribution
($480,000 x 9%)
$ 43,200
Leverage redemption
($240,000 - $43,200)
($ 240,000)Private Partners (50%)


$1,000,000 Return of Capital
($666,667) SBA - Leverage Redemption(3)
($333,333)Private Partners



$ 200,000 Prioritized Payment
$28,800Tax Distribution
$43,200Profit Distribution
$196,800Leverage Redemption - Retained Earnings
$666,667 Leverage Redemption - Return of Capital
$1,135,467Total Distribution
$ 863,467SBA Leverage Reduction


$ 291,200Tax Distribution
240,000Profit Distribution
333,333Return of Capital
$ 864,533Total Distributions - Allocated betweenGeneral and Limited Partners as providedin the Partnership Agreement

Amounts distributed to the "Investors" in the illustration outlined above are distributable to the General Partner and Limited Partners of the SBIC as they privately agree and as provided in the Partnership Agreement.

The distribution example set forth above would generally not be typical of the first distribution made by an SBIC to its Partners. Typically, an SBIC accrues losses for several years from accumulating management fees, amortized organization costs and other miscellaneous operating expenses. These expenses usually amount to several million dollars before sufficient profits are realized which would entitle SBA to receive Prioritized Payments, "tax distributions" or "returns on capital." Thus, the first realized profits generally will be distributed as if they were a "return of capital" until realized profits exceed accumulated losses. Then, the next amount of realized profits are distributed to SBA until it has received the full amount of accumulated Prioritized Payments. Finally, "tax distributions" and "returns on capital" will be distributed.

Just in Time Financing

The SBIC Program permits the funds of investors and SBA Leverage to be taken down by the Partnership in "lock step", thereby delaying investor capital calls and increasing investor returns. An SBIC using Debentures is required to have total "Regulatory Capital" (paid-in capital plus unfunded binding commitments from "Institutional Investors") of at least $5 million, and an SBIC using Participating Securities is required to have total Regulatory Capital of at least $10 million. Only $2.5 million of the SBIC’s Regulatory Capital needs to be paid-in prior to issuance of the SBIC License. Once at least one-half of this $2.5 million is invested, the SBIC will be eligible to use SBA Leverage prior to having another capital call from investors.

SBA regulations describe the qualifications of "Institutional Investors". They can be most forms of business entities with a net worth of at least $10 million, or banks or savings and loan associations or their holding companies, insurance companies, pension plans for private or public sector employees, and tax-exempt foundations or trusts, in each case with a net worth of at least $1 million. Institutional Investors also include individuals with a net worth of at least $2 million (exclusive of the equity of their most valuable residence). Not more than 33 percent of the SBIC’s private capital may be invested by government entities. If an Institutional Investor has a net worth of less than $10 million, only that part of its unfunded commitment which is less than 10 percent of its net worth will be included in Regulatory Capital (unless such excess is backed by a letter of credit).

Unleveraged SBICs

SBICs not using Leverage (as is customary with most banks) are exempted from a number of SBA regulations. Most importantly, they may invest any amount of their private capital in a Small Business and are not restricted to investing an amount not exceeding 20% of their Regulatory Capital. Additionally, they have greater flexibility in investing their "idle funds," are not required to obtain prior approval of management expenses they incur (although they must notify SBA of them), may sell their assets to "Associates", and are relieved from certain other record-keeping and reporting requirements. Prior to obtaining Leverage, an unleveraged SBIC must satisfy the regulations which apply to Leveraged SBICs.

LMI Investments

On September 30, 1999 SBA adopted regulations providing incentives for SBICs to invest in Low and Moderate Income Zones (LMI Zones). Highlights of the regulations are as follows:

An LMI Zone is a geographic area which satisfies one of five definitions which currently are used by different Federal agencies in determining areas requiring special attention. SBICs making venture capital type investments (equity or certain subordinated loans) in small businesses with 50 percent or more of its employees or tangible assets in an LMI Zone, or to a small business which has 35 percent of its employees residing in an LMI Zone, will be eligible for certain benefits which include:

  1. The ability to obtain SBA financing in the form of a deferred interest Debenture. The regulations describe these debentures as being ten-year, non amortizing debentures with a "zero coupon" for the first 5 years. If the interest rate is 7 percent, this means that the SBIC would receive approximately $71,000 in proceeds for issuing a $100,000 Debenture. Interest would be payable semi-annually commencing in the 6th year.
  2. An SBIC would be permitted to assume temporary control of an LMI Enterprise (i.e., any eligible small business located in an LMI Zone).
  3. An SBIC would be permitted to structure a royalty return based on increased sales or revenues.
  4. LMI Investments could have maturities of as little as one year (rather than 5 years for other investments).

The Small Business financed by the SBIC must either satisfy the employee or asset test described above at the time of applying to the SBIC for financing, or within 180 days after the closing of the financing.

Community Reinvestment Act Credit

Current Community Reinvestment Act (CRA) regulations present banks (other than certain "small banks") with a continuing need to make investments that qualify for CRA purposes. Investment in an SBIC is specifically identified in the CRA regulations as a type of investment which will be presumed by the regulatory agencies to be a "qualified investment" for CRA purposes. The investment should be in an SBIC which is located in or doing substantial business in the region in which the bank's assessment area is located, but the SBIC is not required to be headquartered within the assessment area itself. The SBIC Act and other Federal statutes explicitly permit banks, bank holding companies and savings and loan holding companies to invest in SBICs.

SBIC Investments

An SBIC only may invest in "Small Businesses," and must invest at least 20 percent of its invested funds in "Smaller Enterprises." If an SBIC uses Leverage in excess of $90 million, the amount of such excess must be invested in Smaller Enterprises. SBA regulations define a Small Business as one with net assets of less than $18 million and average after-tax income (exclusive of loss carry-forwards) for the prior 2 years of less than $6 million. Companies failing that test may still qualify if they meet certain size standards for their industry group which are based on the number of employees (typically 500 for a manufacturing company) or gross revenues. A "Smaller Enterprise" must have a net worth of less than $6 million and average after-tax income for the prior 2 years of less than $2 million. Certain debt to equity ratios must also be met if the Partnership finances the change of ownership of a Small Business with more than 500 employees.

SBIC regulations provide that an SBIC may not invest more than 20 percent of the amount of its "Regulatory Capital" in any single company. SBA may approve a larger percentage if necessary to protect the SBIC's investment. This means that if the SBIC receives private investments of $10 million, it may not invest more than $2 million in a single company without SBA's approval (regardless of the amount of Leverage used by the SBIC).

SBIC regulations preclude investment in the following types of businesses: companies whose principal business is relending or reinvesting (venture capital firms, leasing companies, factors, banks); many kinds of real estate projects; single purpose projects which are not continuing businesses; for use outside of the United States; in businesses which are passive and do not carry on an active trade or business; and in businesses which use 50 percent or more of the funds to buy goods or services from an associated supplier.

An SBIC (or 2 or more SBICs acting in concert) and its Associates (controlled or related persons) may not control a Small Business except on a temporary basis (not exceeding 5 years) to protect the SBIC's prior investment or in the case of certain start-up companies.

SBICs are precluded from making investments in a Small Business if it would give rise to a conflict of interest. Generally, a conflict of interest may arise if an Associate of the SBIC has or makes an investment in the Small Business or serves as one of its officers or directors or would otherwise benefit from the financing. Joint investing with an Associate (such as another fund controlled by affiliates of the General Partner) may be made on identical terms or on terms which are fair to the SBIC.

Financing Terms

An SBIC may make investments in the form of debt, debt with equity features, or equity securities. Debt securities must be issued for a term of not less than 5 years (except for loans to "disadvantaged" small businesses which must be for 4 years) and must have amortization not exceeding "straight line."4 The permissible interest rate on debt securities depends on whether they are "straight debt" or debt with equity features. For straight debt, the permitted rate is the higher of (i) 19 percent, or (ii) 11 percent over the higher of the SBIC's weighted cost of Debenture Leverage or the current Debenture Rate. For debt with equity features, the permitted rate is the higher of (i) 14 percent, or (ii) 6 percent over the higher of the SBIC's weighted cost of Debenture Leverage or the current Debenture Rate. Regulations define an SBIC's weighted cost of Debenture Leverage and describe the permitted rate when more than one SBIC participates in the financing.

The applicable interest rate is calculated using all points, fees, discounts and other costs of money other than application and closing fees of up to 5 percent of the financing (if it is debt with equity features), which may be charged in addition to the permitted interest. In addition, an SBIC may be reimbursed for its routine closing costs (including legal fees).

An SBIC using Participating Securities must invest an amount equal to the original issue price of its Participating Securities in Equity Capital Investments (common or most forms of preferred stock; or Debentures which are not amortized for 5 years, are unsecured, and have interest contingent upon earnings).

An SBIC may require a Small Business to redeem the SBIC's equity investment, but only after 5 years4, and only for a price based on a pre-determined formula based on the book value and/or earnings or a third-party appraisal by a mutually agreed upon, qualified appraiser4. Mandatory redemptions not complying with these requirements will be treated as if they were debt securities. However, the Small Business may be required to redeem the SBIC's equity security if the Small Business has a public offering, has a change of control or management or defaults under its investment agreement.

An SBIC may retain its investment in a business which ceases to be small, and may continue to invest in such a "large" business until it has a pubic offering. Following a public offering by such a "large" business, the SBIC still may exercise rights to acquire securities which were obtained while the business was small.

SBIC Operations

SBA has adopted a number of regulations concerning operating requirements of SBICs intended to assure their proper management. Principal regulations include:

An SBIC using Leverage must invest its "idle funds" not invested in Small Businesses, in liquid, safe, short-term investments specified in the regulations (principally, U.S. government obligations, repurchase obligations, federally-insured deposits, and deposits in "well-capitalized" federally-insured financial institutions).

An SBIC and its Associates may provide management services to Small Businesses in which the SBIC invests, but only may charge for services at competitive rates for services actually rendered.

The General Partner or Board of Directors is required to value the SBIC's assets annually (semi-annually, if Leverage is used) pursuant to valuation guidelines approved by SBA. SBA has issued model valuation guidelines following consultation with the venture capital industry.

If an SBIC issues Leverage, it will be required to avoid "Capital Impairment" which will be considered to exist if the SBIC's "Capital Impairment Ratio" (calculated by subtracting the SBIC's realized losses and net unrealized depreciation from the SBIC's private capital and dividing the result by the SBIC's private capital) exceeds permitted levels detailed in the regulations which vary depending on the proportion of equity investments made by the SBIC.

An SBIC's ability to borrow funds from third parties is subject to SBA regulation. SBICs using Participating Securities only may incur unsecured, "temporary" debt. Debt incurred by Debenture-using SBICs may be secured only with SBA's approval (which routinely will be given if certain safe harbor parameters are met).

SBICs are required to file a variety of reports with SBA, none of which generally are considered burdensome. These reports include an annual financial statement which is certified to by the SBIC's independent certified public accountants, valuation reports as described above, reports as to changes in the SBIC's management, material litigation, a brief report describing each investment, and copies of reports sent to investors and, if applicable, to the SEC. SBA will conduct regulatory examinations of each SBIC on an annual basis.

SBICs issuing Leverage are subject to regulations which provide SBA with a series of remedies for violations of SBA's regulations. The remedies are graduated in severity depending on the seriousness of the SBIC's financial condition or its misconduct. For minor regulatory infractions, warnings are given. For serious infractions, restrictions on distributions and prohibitions on making new investments may be imposed. In severe cases, SBA may require the Limited Partners to remove the Partnership's General Partners or their officers, directors or partners, and SBA may obtain appointment of a receiver for the Partnership.


SBICs are organized under state law as corporations, limited partnerships or limited liability companies. However, SBICs using Participating Securities only may be organized as limited partnerships (although SBA is discussing changing its policy to permit limited liability companies). Unleveraged SBICs and SBICs using Debentures which are limited liability companies must be organized in Delaware.

Diversity of Ownership

SBA has regulations and policies designed to assure that an SBIC receives significant investments from investors who do not participate in or otherwise control its management. An SBIC must receive at least 30 percent of its private capital from a total of three or more investors who are unrelated to the management. Additionally, no single investor may own more than 70 percent of an SBIC’s private capital.

Management Fee

Management fees paid by SBICs using Leverage are subject to SBA’s prior approval. Leveraged SBICs are permitted to charge a management fee of up to 2.5 percent of three times "Regulatory Capital" (i.e. paid in capital plus unfunded commitments from Institutional Investors) for the first five years, and 2.5 percent of "Combined Capital" (outstanding Regulatory Capital and outstanding Leverage) thereafter. At any time that either three times Regulatory Capital (during the first five years) or Combined Capital (after the first five years) is less than $20 million, an SBIC is permitted to charge an additional $125,000 per year. If a management company is providing management services to more than one fund, SBA may limit the fees charged during the first five years to 2.5 percent of Combined Capital.

For the purposes of calculating SBA’s profit participation for SBICs using Participating Securities, SBICs must subtract "Excess Management Fees". This is any amount charged above an amount that equals 2.5 percent of an SBIC’s weighted average Combined Capital for the year, plus $125,000 if such Combined Capital is less than $20 million.


SBA adopted a new application procedure in the summer of 1998. To start the process, an applicant completes an SBA form entitled "Management Assessment". This contains the elements of the applicant’s business plan as well as detailed information concerning the experience of each of the "Principals" to carry out the business plan. The Management Assessment is then reviewed by SBA’s "Licensing Committee", after which the Principals are generally invited to meet with the members of the Licensing Committee. After the meeting with the applicant’s Principals, SBA’s Licensing Committee will either request additional information or issue a "go forth" letter to applicant indicating that it has passed the first part of the application process and now is authorized to file a formal application. Generally a "go forth" letter is issued six to eight weeks following submission of the Management Assessment. SBA only will process license applications seeking to use Debentures which have commitments for at least $5 million of private capital and seeking to use Participating Securities which have commitments for at least $10 million of private capital.

During the formal licensing process, SBA seeks to determine that there is a qualified management team and that the SBIC has a good chance of operating profitably. SBA reviews the applicant’s business plan, projections and legal documents, and conducts reference and other background checks on the management team. The process presently is taking from 6 to 10 months. SBA requires applicants to advise their investors that the investors are not entitled to rely on SBA’s review of the applicant in deciding whether to invest.

Investments made by a prospective SBIC prior to filing its formal license application with SBA will not be included in its SBA "Regulatory Capital" once it is licensed. However, after an application is filed, an applicant may make "pre-licensing investments" which will be included in the applicant’s Regulatory Capital if they are submitted to SBA for approval prior to the investment being made. SBA requires ten business days to review such pre-licensing investments. SBA does not seek to "underwrite" the investment, simply to determine if the investment is made in compliance with SBA Regulations. Once licensed, such pre-approval of investments is not required. SBA requires principal members of the management team to attend a one-day regulations class run by SBA and will only permit one "pre-licensing" investment to be made prior to at least one person from applicant attending the class.


1. The base amounts are $15 million, $15-30 million, and over $30 million, in each case indexed by the increase of the Consumer Price Index after March 31, 1993.

2. SBICs using Participating Securities may not be structured as corporations or, at the present time, limited liability companies.

3. The actual amount distributed to SBA will be slightly less since the leverage rates will be less than 2:1 following the $196,800 redemption of Participating Securities; and amounts to be distributed to the private partners will be approximately increased.

4. Pending legislation which industry leaders believe will be adopted this year will lower the minimum term to one year.

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