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SBIC Confusion
Chris Davis Christopher Lane Davis, Esq.
Co-Head, SBIC Program
McCarter & English, LLP
New York, NY

The small business investment company (SBIC) program has either been terminated or is about to go, according to some press reports. But those in the investment industry know that the SBIC program is also alive and well. These are confusing times for anyone interested in the federal government's support for small business.

The confusion comes from the fact that SBICs are run under two separate programs with the SBIC name. One type, the "debenture SBIC", has been operating continuously under a federal government program that began in 1958. With this program the government effectively provides private licensed SBICs with loans as "leverage" to supplement their private capital. The loans have currently payable interest, so debenture SBIC investments are typically income producing investments made in the more mature small businesses. More than 130 debenture SBICs are now operating with more than $2 billion in private capital. The SBA is continuing to license new SBICs for this successful program (five so far this year) and to provide leverage to existing debenture SBICs.

All the bad news in the press about SBICs is concerned with those run under the "participating securities" program. This program began operation as an experiment in 1994 and was intended to encourage SBICs to make equity investments in earlier stage companies. With this program the SBA provides capital to SBICs by purchasing a form of senior equity security called a "participating security".

It has been both a success and a failure. The program succeeded in attracting many new managers and new private capital for equity investment in early stage businesses. By the end of fiscal 2003, nearly 200 participating securities SBICs were operating with over $4.7 billion in private capital.

The program also succeeded in increasing the flow of capital to young small businesses. SBA's statistics for January-September 2003 show that, by dollar volume, SBICs represented about 11% of total venture capital financing provided to small businesses. But this amount also represented 59% of all the investment transactions. The striking difference came from the high number of smaller investments that SBICs made in earlier stage companies. In fiscal 2003 about 43% of all SBIC investments were in companies in existence for three years or less, and the remaining 26% were in companies in existence 3-6 years. (Note: the most recent SBA statistics on SBIC activities are for fiscal 2003. The statistics combine the activities debenture and participating securities SBICs, but participating securities SBICs represent more than two-thirds of the capital.)

The SBIC "participating securities" program failed because it has been much more expensive than the government projected. This past April SBA Associate Administrator for Investment Jaime Guzman-Fournier testified that that SBA estimated that it might sustain losses of $2.7 billion on the approximately $10.7 billion of outstanding and committed participating securities leverage. As a result the federal government has effectively terminated the participating securities SBIC program. After September 30, 2004 no new participating securities SBICs were licensed and there are no new commitments issued for participating securities leverage. However, existing participating securities SBICs can continue to operate and the government will honor existing leverage commitments to these existing SBICs.

Now the National Association of Small Business Investment Companies (the SBIC trade association), the U.S. House and Senate small business committees and the Administration (through the SBA and the Office of Management and Budget) are actively discussing whether some new form of restructured program should be created to meet the need for equity investment in small business. Their discussion involves several issues, some technical and budgetary. But the most important issues are directed to the fundamental question: Is there a need of a government program to promote equity investment in small businesses? The investment industry and others interested in the health of the nation's small business should listen closely for their answers.

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