Because an SBIC involves private capital, the decision-making process is aimed at maximizing investor returns. That is, the SBIC has stockholders (or limited partners) who’ve contributed capital in anticipation of making competitive returns on their investments.
One disadvantage of dealing with an SBIC is that government (actually the SBA), to protect the taxpayer’s money, has imposed certain restrictions on what an SBIC can do. Thus, conflict-of-interest restrictions, plus limitations on, for example, the firms in which an SBIC may invest or to which it may loan money ‘” only small businesses ‘” are involved. The interest rate an SBIC charges to a small business concern is limited by law. This can be good news. Note, however, that regulations govern the types of eligible equity investments the SBIC may make.
The main advantage that an SBIC enjoys is in its ability to leverage other capital, meaning the availability of capital from the government at favorable cost leverages returns for the private owners. A regular SBIC leverages its private funds up to 3 to 1 with borrowings funded by the proceeds of debentures sold in the public markets and guaranteed by the United States government. The SBIC’s capital carries an interest rate that compares favorably to commercial rates (generally 75 to 100 basis points more than the Treasury yield for comparable maturities), with the repayment principal of the debt postponed until maturity. For the venture capital-type (those in the participating securities program), an SBIC leverage of 2 to 1 is available and is in the form of a so-called participating security, such as a preferred stock. What does the SBIC’s favorable cost of capital get you? The savings are passed through to the applicant ‘” you.
All this is a little complicated, of course, but the underlying message is clear. Money from SBICs is available for all types of businesses as long as the business qualifies as a small business concern. The capital can take the form of debt on favorable terms, a package of equity and debt or common and/or preferred stock. The managers are private individuals with experience in making investments, like bank credit officers and venture capitalists. In fact, the SBIC managers usually are graduates of venture capital funds and commercial or investment banks. Because SBIC financing involves government money, restrictions with detailed provisions are placed on the form and substance of the investments made by an SBIC. Some technically carry criminal penalties, to ensure that the government isn’t being ripped off. The conflict of interest regulation is one example.
Again, stating the obvious, the way to find out whether SBIC capital is available is to visit the SBA offices, get a list of the SBICs in your area and knock on some doors just the way you’d knock on the doors of your local bank or a VC.