In fact, in the home stretch to the November election, President Barack Obama may have trouble ripping into the private equity record of Mitt Romney (should Romney secure the nomination). The Obama administration has been quickly ratcheting up its own participation in the market—and no, I don’t mean the government’s takeovers of AIG or General Motors.
I’m talking about the more than 50-year-old Small Business Investment Company program, administered by the Small Business Administration. In increasing numbers, firms have been taking advantage of low-interest leverage provided by the debenture SBIC program to raise senior loan funds, mezzanine funds and even buyout funds.
In an interview late last month, Sean Greene, a former entrepreneur and venture capitalist who supervises the SBIC program, said that one of the hallmarks of the post-financial-crisis economy has been the struggle that small businesses, often seen as the key to job creation in the United States, have had securing debt financing.
The SBIC’s debenture program is designed to get small businesses the capital they need, be it senior debt, mezzanine debt or equity, as part of growth financings and buyouts, often with a sponsor at the helm. Greene is particularly interested in helping what he calls “gazelles”—fast-growing companies that account for a disproportionate amount of job growth. “Long-term, more patient capital is critically important to those kinds of companies,” Greene said.
In the fiscal year ended Sept. 30, debenture SBIC funds provided $2.59 billion in financing to small businesses, according to the SBA. That was up 63 percent from the prior fiscal year and nearly double the average volume for the previous five years. All told, the SBA committed a record $1.8 billion to 22 debenture SBIC and unleveraged licenses in fiscal 2011, and Greene said that more than 50 applications are in the pipeline. (The legislative cap is $3 billion in any one year.) The number of SBIC funds stands at nearly 300, with more than $17 billion under management.
Credit Greene and his team at the SBA with a good part of this expansion. One of their biggest achievements has been to reduce license processing time from more than 14 months in fiscal year 2009 to five and a half months in fiscal year 2011. Zia Uddin, managing director at Monroe Capital LLC, said that altogether it took two years from beginning the application process in early 2009 to reach a first close of about $200 million on its first SBIC fund early this year.
Under Greene’s leadership the SBIC licensing committee also appears to be approving a wider variety of investment strategies than in the past. That’s proving tempting to buyout firms that might have previously seen debenture SBICs as mainly suitable for subordinated debt investments. The Riverside Company, a lower-mid-market shop that’s more than 20 years old, structured its latest micro-cap buyout fund as an SBIC—its first time participating in the program. It raised $137 million last this year in private capital, and secured access to $150 million through the debenture program, for a total fund of $287 million.
The debenture SBIC program has also benefited from some significant tailwinds. A tight fundraising market, for example, has more sponsors thinking creatively about ways to raise money. The SBIC program not only lets them leverage the amount of money they can raise from private investors, it also makes them more attractive to banks, which can use their commitments to meet requirements of the Community Reinvestment Act of 1977. Among the Riverside SBIC fund backers are BMO Harris Bank N.A. and Key Community Development Corp.
The economics for both sponsors and private investors in SBIC funds are compelling. For single SBICs, the amount of leverage available from the debenture SBIC program is the lesser of $150 million per fund or three times private capital, although two times is the normal cap, according to the Small Business Investor Alliance, formerly known as the National Association of Small Business Investment Companies.
Consider Monroe Capital, which through the last pooling of debentures is paying the holders of the 10-year bonds about a 2.9 percent coupon and (counting fees) an effective rate in the four to six percent range. The firm has then gone out with a uni-tranche product and made loans with rates somewhere between the Libor plus 350-550bps offered by asset-based lenders and the 14 to 15 percent rates offered by mezzanine firms, in some cases also taking warrants, according to Uddin. Greene estimates that SBIC funds get a 300-600bps pop in returns compared with unleveraged funds.
Is it conceivable that SBIC funds are using some of the money for quick flips, asset-stripping and ill-conceived leveraged dividends? It’s a fair question, Greene said. However, he added, the SBA’s vetting process, and the nature of lower mid-market deals, helps to ensure that most of the money goes into growth financings and growth-oriented buyouts. (The SBA, he said, plans to do a better job of tracking job growth and retention.)
Truth be told, were President Obama to attack Romney’s private equity track record, Romney would be hard-pressed to answer in kind by finding fault with a self-funding program whose main mission is to help small businesses gain access to capital. In fact, he might be better served pointing out the good work done by the debenture SBIC program. Surely that would help make a point about his own record of creating jobs at Bain Capital.
(CORRECTIONS: The Riverside Co. closed its SBIC fund this year, not last year as originally stated in article. Also, debenture SBICs provided $2.59 billion in financing, both debt and equity, in the fiscal year ended Sept. 30; the original version of the story stated this was entirely debt financing.)