What Is a Small Business Investment Company (SBIC)?
A small business investment company (SBIC) is a type of privately-owned investment company that is licensed by the Small Business Administration (SBA). Small business investment companies supply small companies with both equity and debt financing. They provide a viable alternative to venture capital firms for many small enterprises seeking startup capital.
- Small Business Investment Companies (SBIC) provide small businesses and startups with unique financing options.
- SBIC's are typically more forgiving and offer better terms than traditional banks and lenders.
- Debentures are used to lay out the terms of the interest and repayment, with a standard repayment term of 10 years.
How a Small Business Investment Company (SBIC) Works
Small business investment companies supply money to small businesses, using capital they have raised along with funds they have borrowed at favorable rates thanks to loan guarantees provided by the SBA. The SBA does not make direct investments in small businesses. Its role is to help SBICs obtain leverage by guaranteeing their loan obligations, called debentures.
Requirements for an SBIC
There is a commitment fee of 1% that the SBIC must pay to the lender upfront, as well as a 2% drawdown fee at the time of issuance. There is also a semiannual, variable charge of about 1%. Investments are typically not permitted for project finance, real estate, or passive entities such as a nonbusiness partnership or trust. Proceeds from a standard debenture can only be used to invest in small businesses per the regulations and parameters defined by the SBA's Office of Size and Standards.
The number of entrepreneurs and small business startups grows larger each year, making Small Business Investment Companies are more important than ever before.
Debentures are either standard or discounted. There are two types of discounted debentures: low-to-moderate income (LMI) and energy saving. The discounted debenture enjoys preferential payment and interest terms compared with the standard debenture. Under the LMI debenture, SBICs must make investments in small businesses that have at least 50% of employees or assets in low-to-moderate income zones, or in which 35% of full-time employees live in an LMI zone. Under the energy saving debenture, the proceeds must be used to invest in a business focused on the reduction of nonrenewable energy.
Congress established the Small Business Investment Company program in 1958 in order to create another pathway for long-term capital to be made accessible to small businesses. After an SBIC is licensed and approved, the SBA will provide it with a commitment to provide a set amount of leverage over several years.
Once this fund is established, a debt security called a debenture will be issued when an investment is to be made. The holder of that debenture is then entitled to principal payments and interest over time. This is one of the most commonly chosen long or medium-term debt formats.
The standard debenture has a term of ten years or more, and it is available as an amount equal to or less than two times the private capital committed to the fund. In some cases, the SBA will allow the debenture to be less than three times the committed private capital, but only for those licensees who have previously managed more than one fund. The upper limit that SBICs may be granted access to is a maximum of $175 million for a single fund and $350 million for multiple funds.