Investing in an SBIC
Advantages of an SBIC
Limited Partners (LPs) of SBIC licensed funds benefit from several advantages unavailable to other types of investment funds:
- Regulatory Benefits: SBICs are not required to register with the Securities and Exchange Commission, relieving them of a significant regulatory and compliance burden. However, LPs benefit from the oversight of SBA's Office of Operations, reducing the risk of fraud and abuse. The analysts with SBA's Investment Division understand the dynamics of the private equity industry and are solely devoted to monitoring the activities of SBICs.
- Rapid Deployment of Funds: With a leverage commitment from the SBA equal to two time, and sometimes three times the private capital raised, fund managers are able to minimize the time spent on fundraising and focus on making investments.
- Flexible Fund Structure: SBICs are permitted to organize themselves as stand-alone entities, drop-down vehicles or side-car vehicles.
- Strong, Stable Returns: The low cost of SBA capital provides fund managers with pricing flexibility across cycles while the 10-year term on SBA debentures avoids the problems of duration mismatch.
- Community Reinvestment Act Credits: Investments in SBICs may be eligible for Community Reinvestment Act credits.
- The Opportunity of Small Business: Despite being the bedrock of the American economy, U.S. small businesses remain underserved and represent a value opportunity for investors.
The LP Distributions Process:
SBA leverage is senior in an SBIC's capital structure and SBIC Program regulations are designed to protect the interests of tax-payers. However, like other private equity funds, SBICs do have discretion regarding the use of proceeds when an investment is exited. Three distinct options are available:
- Prepayment/Repayment of Leverage: An SBIC is able to prepay debentures any time after issuance, but must do so in full and not in part. With this restriction in mind, SBICs will often issue a series of debentures to finance a single investment, allowing them to pre-pay their debt in more manageable tranches.
- Recycle Proceeds: Subject to the provisions of an SBIC's limited partnership agreement, a licensee may recycle the proceeds from an exit back into new investments or follow-on investments
- LP Distributions: SBIC Program regulations permit distributions to LPs when the fund has positive "R.E.A.D.," which stands for "Retained Earnings Available for Distribution." Calculated as "Net Retained Earnings minus Unrealized Depreciation," this is a simple formula that takes into account the potential for future, realized losses.