Advantages of an SBIC
Limited partners (LPs) of SBIC-licensed funds benefit from several advantages that aren’t available to other types of investment funds.
Certain exemptions from registration requirements with the SEC are available to SBICs and their advisers.
Rapid deployment of funds
With a leverage commitment from the U.S. Small Business Administration (SBA) equal to two 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 allowed 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 credit
Investments in SBICs may be eligible for Community Reinvestment Act credit.
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 taxpayers. However, like other private equity funds, SBICs do have discretion regarding the use of proceeds when an investment is exited. There are three options.
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.
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.
SBIC program regulations permit distributions to LPs when the fund has positive READ, 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.