Small business investment companies (SBICs) provide small businesses with debt financing and equity, filling the role often taken by venture capital firms. A small business investment company is privately owned and licensed by the Small Business Administration (SBA). If an entrepreneur is seeking startup capital then an SBIC will often be the simplest and most effective means of obtaining the funds needed.
How does a small business investment company work?
Loan guarantees provided by the SBA enable small business investment companies to borrow at favorable rates. These loans are then combined with other capital to create the funds that are available to small businesses. Note that the SBA itself does not invest directly in small businesses, but instead makes it easier for the SBICs to build their funds by guaranteeing the loan obligations involved. These loan obligations are known as debentures, a form of loan that is generally not secured by collateral.
Rules which apply to an SBIC
SBICs have to conform to strict regulations. An overarching rule is that 75% of the capital they invest has to be invested in small businesses in the US, and for these purposes a US small business is defined as follows:
The business has no more than 49% of the workforce based overseas
The business has a net worth of less than $19.5 million
The business has averaged a net income of less than $6.5 million over the previous two years
In addition, at least 25% of the capital invested by the SBIC has to go into smaller enterprises in the US, defined as follows:
The enterprise has no more than 49% of the workforce based overseas
The enterprise has a net worth of less than $6 million
The enterprise has averaged a net income of less than $2 million over the previous two years
The regulations state that SBICs are not permitted to invest in the following:
Small US businesses that have more than 49% of their employees based overseas
Real estate concerns
Businesses which re-lend
They are also forbidden from investing more than 10% of their capital in a single business.
The loans made by an SBIC
The loans made by SBICs are known as debentures and are either standard or discounted. As the name suggests, a discounted debenture has payment terms and an interest rate that are better than those of a standard debenture. The discounted debentures come in two different forms:
Low to moderate income (LMI) debentures – these investments have to be made to small businesses that have a minimum of 50% of their employees or assets based in low-to-moderate income zones, or 35% of full-time employees living in an LMI zone.
Energy-saving debentures – these investments have to be directed into businesses that are “primarily engaged” in activities that will reduce the use of non-renewable energy.
The two types of SBIC
There are two types of SBIC, leveraged and non-leveraged. The differences between the two are as follows:
Leveraged SBIC funds consist of private capital combined with money available through the SBIC credit facility. If an SBIC has managed to raise $50 million then it will be able to access as much as $100 million in SBIC leverage, on condition that the $150 million total is then invested in US small businesses.
Non-leveraged funds can provide more funding to small businesses because the SBIC doesn’t charge interest on the money borrowed.
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