During President Obama’s first term, the U.S. Small Business Administration’s Small Business Investment Company program has committed more capital to investors backing growth plays at the current—and dirt cheap—interest rate of about three percent.
It’s because investors are increasingly seeking out SBIC funding to support mezzanine deals, growth plays and smaller buyouts. The SBIC program lent $1.2 billion last fiscal year (each ends Sept. 30) and will surely approve funds exceeding that amount this year, but it still has hundreds of millions of dollars that go unused thanks to too few applicants and too few approvals. Yet, the capital committed by the program over the past full fiscal year represents an increase over the four prior years’ commitment levels by a whopping 55 percent. Experts believe the gap in capital allotted to the program and the amount it actually deploys will continue to shrink; difficulty raising debt has turned more investment firms that would usually sneer at the prospect of partnering with the government instead into eager recipients of discount debt.
In fiscal year 2010, there were 23 new SBIC funds approved, more than double the number that the SBA gave the OK to the 12 months prior. For the current fiscal year, set to expire at the end of September 2011, there have already been 50 more funding packages pipelined, says Sean Greene the SBA’s associate administrator for investment—though not all of these are guaranteed approval.
“The interest is incredibly high” from growth investors looking to cash in and lever up while rates are low, Greene, also the co-founder of investment firm Rock Creek Ventures and seed investment program LaunchBox Digital, said. “They’re screaming out for access to capital.”
The program’s typical participants have come to the SBA in their first—or first few—funds. Prior to the SBA’s switch to a debenture-only program, venture investors turned to SBICs to support their funds. But now, experts say, more experienced investment veterans are seeking out SBIC debt as financing markets remain restrictive.
One of them is Bill Dyer. He joined several of his colleagues from American Capital when the listed investment firm’s Philadelphia office shuttered in summer 2008. The group launched
distressed lower middle market mezzanine and equity fund Boathouse Capital with a $100 million inaugural fund, which includes the SBA’s contribution. Buyout funds applying for or receiving SBIC support include Perseus LLC, The Riverside Co. of Cleveland and LongueVue Capital. Plexus Capital, which earlier this week, revealed it has closed its second fund, will rely on SBIC capital as well.
Some of the program’s rules are relatively simple. Target businesses cannot operate in the real estate or project financing (there are other government programs to stimulate this) and cannot run operations that are not in the public interest. This definition is not fully clear, but the usual suspects ought to rule out themselves (Hint: if your business contains the term “… Gone Wild,” don’t bother applying). No mostly-foreign entities either; this includes companies with more than 50% of employees or assets based overseas. The program won’t support lending operations, including payday lenders, and the Small Business Administration—not unlike LPs—expects quarterly updates.
There are some financial requirements, as well—this is only to support small business. As long as investment targets’ net worth is less than $18 million and the business has $6 million or less of net income, SBIC funding is attainable. And, investors can continue pumping cash into a successful company once it has crossed that threshold. The SBA matches on a 2:1 ratio up to $150 million from one fund, or $225 million from a family of funds, via a 10-year non-recourse loan.
Other portions of the application process are not as clear. Reasons for applicants’ rejection can include the SBA’s determination a management team or portfolio is not well-managed, or does not have a track record putting it in line with the program’s objectives. It typically takes about six months for an applicant to get approval, provided they can prove cash reserves.
It isn’t just private equity funds elbowing their way to the front of the new SBIC crowd—typically, funds smaller than $75 million make up the applicants. Business development companies also seek out loans from the SBA. However, the average size of the private equity firm seeking out capital has grown after the recession restricted access to debt.
As the SBA increasingly pumps capital into developing companies, it also has been doing it faster. From fiscal 2009 to fiscal 2010, SBIC licenses were granted 60% faster, according to the program’s figures.
SBA officials only acknowledge the SBIC program’s annual capital commitments will be $3 billion in the near term, and there are no plans to alter this. However, this does not suffice for program advocates who say the increased pressure for government capital for small business growth will not only put a strain on SBA resources, but on the community that has come to increasingly depend on it.
“As the program grows, there may not be enough availability of capital,” says Alan Roth, chairman of Wildman Harrold Allen & Dixon’s SBIC practice in Chicago, who suggested that the program be expanded up to 40%, to $5 billion annually.
**Clarification: An earlier version of this column identified Pamlico Capital as successful SBIC applicants; the private equity firm had an SBIC license when it was affiliated with Wachovia and known as Wachovia Capital Partners but has not renewed its license.
Jonathan Marino is the editor of peHub.com. The opinions expressed here are entirely his own.