Funding the SBIC Program: An Overview
Though it was created over five decades ago, The Small Business Investment Company (SBIC) Program remains one of the federal government’s most innovative programs. Over the years, the SBIC Program has successfully channeled billions of dollars of growth capital to small businesses across the United States. In fiscal year 2011 alone, investment funds licensed as SBICs provided financing to 1,300 small businesses in industries ranging from manufacturing to life sciences. The SBA itself licensed 22 new funds as SBICs and issued $1.8 billion in new capital commitments. Due to the unique public-private partnership at the core of the program, no annual appropriations are required from Congress to fund SBICs.
The process described below allows SBICs to access low-cost, government-guaranteed debt and increases the amount of capital they have available to invest in small businesses.
Step 1: Licensing and Private Capital
Before an investment fund can be licensed as an SBIC, it must first raise capital from private investors to demonstrate its viability. These investors often include pension funds, university endowments, insurance companies, banks and high-net-worth individuals. Once the fund has received binding commitments from these investors and the SBA’s Investment Division has issued its license, it then is eligible to receive an SBA guarantee commitment. An applicant usually submits an SBA commitment application sometime during its licensing process. However, once licensed, an SBIC may apply for a SBA commitment at anytime, as needed. An SBA Commitment is a letter agreement to reserve federal guarantee program level for up to five federal Fiscal Years (FYs), (current FY, plus four). The SBA will not provide a licensee with leverage in an amount greater than three times the private capital the licensee has raised, though most often funds are limited to leverage no greater than two times the private capital raised. (For example, if a fund raises $10 million from private investors, the SBA will commit up to $20 or $30 million of leverage, bringing the total fund size to $30 - $40 million).
Step 2: Drawing Capital for an Investment
As licensed SBICs begin making investments in small businesses, they must draw capital from their private investors and from the SBA in order to finance their activity. To access funds through the SBA, the SBIC will submit a draw application requesting that funds be withdrawn against its SBA Commitment. Draw applications are accepted by SBA twice a month. When draws are approved by SBA, payment vouchers are issued to SBICs. These vouchers (called “Approval Notices”) have a term of approximately 60 days and provide SBICs with the ability to draw funds on a daily basis. Once issued, Approval Notices may be submitted by respective SBICs on any business day prior to their expiration, as needed, to a funding agent by fax for funding on the following business day. A debt instrument called a debenture is executed in conjunction with each draw and is held by an agent of the bank providing the initial interim funding until the next debenture pooling (described below)., Once pooled SBICs have the right to prepay any of the debentures they’ve issued without penalty on any semi-annual payment date, but they must prepay in full.
Step 3: Pooling
As discussed above, to provide SBICs with the ability to receive SBA funding on a daily basis, funds are initially provided on an interim basis by an agent bank, The Federal Home Loan Bank of Chicago (“FHLBC”). The FHLBC provides the initial interim funding until the SBIC's debenture(s) can be pooled with others and sold to the public, a process that occurs every six months. During the interim period, the FHLB charges the SBIC the London Interbank Offered Rate (LIBOR) plus a 30 basis point premium.
Two weeks prior to each scheduled pooling date in March and September, the size of the pool size is determined. All of the debentures scheduled to be pooled are purchased and pooled together by an entity called the Investment Trust (the “Trust”), which is managed by the Bank of New York Mellon. As the pooling occurs, the SBA signs an agreement with the Trust to guarantee all the interest and principal payments due on each of the debentures in the pool. The Trust then securitizes the pool of debentures and issues new securities called "Trust Certificates." Underwriters are hired to sell the Trust Certificates to investors in the public market. (Please see DESCRIPTION OF PARTICIPATING CERTIFICATES Section in our latest SBIC Debenture Offering Circular).
Step 4: Sale of Trust Certificates
When the Trust Certificates are ready for sale, an offering circular is issued to notify investors of their availability, to explain the terms of the seurities and to provide information on how they can be purchased. The price for each pooling is determined approximately one week prior to each scheduled closing. The determined price for each pool is based on the 10-year Treasury rate on that date, plus a spread set by the market for liquidity and prepayment risk. A table of rates on the 10-year Treasury and Trust Certificates over the past ten years is available in our SBIC Licensee section.
Covering potential losses: Annual Charge & Leverage Fees
The SBA’s guarantee of the debentures underlying each Trust Certificate is not without risk. If SBICs default on their obligation to make any of the interest or principal payments due on their debentures, the Trust will not be able to make the payments it has promised Trust Certificate holders. The U.S. government would then have to honor its guarantee and cover any shortfall. (Please see the Debenture Pool Payment Summaries for the aggregate amount of SBA Accelerated purchases from each respective pool.)
By law, the SBA Annual Charge cannot be greater then 1.38%. It is set prior to each Fiscal Year as part of the Credit Reform modeling required to operate the program at a “Zero Percent” subsidy where cash flows are estimated to equal program losses. A table of the annual charge rates set over the past ten fiscal years is available in our SBIC Licensee section.
SBICs also pay a leverage fee that is 3% of SBA’s initial capital commitment to an SBIC. The fee is paid in two stages; the first is a 1% charge at the time SBIC obtains an SBA leverage commitment and the second is a 2% fee when SBICs make a draw against the commitment.
In addition to the leverage fee and draw fee, the SBICs must pay two additional fees to help cover the cost of selling their debentures. The first is a 0.05% fee to The SBIC Funding Corporation, a non-profit entity that acts as the designated selling agent of SBIC debentures. The second is a 0.375% fee to the underwriters that sell the Trust Certificates to investors