Sbic participating securities program

The ten-year debenture allows for prepayment without penalty, but it must be pre-paid in whole, not in part, and can only be prepaid on a semi-annual payment date. The rate of interest on debentures is determined by market conditions and the rate of the year treasury securities at the time of the sale. SBICs are eligible to use LMI Debentures, which are deferred interest debentures that are issued at a discount and require no interest payments or SBA annual charge for the first five years.

LMI Debentures are available in 5 and 10 year maturities. What are the requirements for obtaining an SBIC license? What is the status of the Participating Securities Program? The Participating Securities program, which was established in to better match how SBICs were funded with the equity needs of entrepreneurs, ceased issuing new leverage commitments on October 1, The Debenture Securities program, which dates back to the inception of the SBIC program in , continues to issue new leverage commitments and is most appropriate for investment management funds focused on providing later stage, expansion capital to cash-flow-positive or nearly cash-flow-positive companies.

Historically, no particular style or type of SBIC was preferred. Among the existing SBICs, there are multiple investment styles and fund types. Today, because only the program is only issuing debenture leverage commitments, the best fit for the program is funds focused on providing later stage, expansion capital to cash-flow-positive or nearly cash-flow-positive companies.

Instead, the SBIC Program is a public-private partnership in which qualified private equity fund managers access government-guaranteed capital to make investments in small businesses. The SBA is not involved in making investment or portfolio management decisions. What kinds of companies are eligible to receive financing from an SBIC? SBICs may not provide funds to a small concern whose primary business activity is deemed by the SBA to be contrary to the public interest.

What are the rules governing an SBIC's ability to take control of a small business? An SBIC is permitted to control, either directly or indirectly, a small business for a maximum period of 7 years. What are the benefits to fund managers of forming an SBIC?

SBICs supplement their own private capital by issuing debentures securities up to three times private capital, although typically this is limited to two times. This capital is provided at a significantly lower cost than traditional limited partner equity investments. The effect of the leverage can have a very powerful impact on return enhancement to fund managers.

Small Business Investment Companies SBICs are privately managed venture capital companies that use private funds sup- plemented with government funds to provide financing for small busi- nesses Hearing, In practice, the program helps small U. Both debt and equity capital are available through SBICs. The SBIC program finances small businesses, primarily in the private equity markets.

Private equity is investment in private, non public com- panies Center for Private Equity and Entrepreneurship, Venture capital financing is a component of the private equity market which has been described as patient and brave money, an apt description of the long-term investment horizon and high risk nature of investing in young, growing businesses. The SBA has a broad oversight and management role in the program.

It licenses the SBICs, acts as co-investor in these venture capital funds alongside private investors, provides regulatory oversight of the SBICs, and receives from these companies a return of interest or profit, in addi- tion to repayment of its investment principal. The SBA does not make di- rect investments in the ultimate beneficiaries, the small businesses. Some claim the program was the launching pad for the U.

The original program, the Debenture program, has been in existence since and is smaller in total capital and number of licensed funds than the Participating Securities program.

Academic studies of the Debenture program preceded the establishment of the Participating Securities pro- gram. This paper will focus on the newer and larger Participating Securi- ties program. The Equity Gap and Program Need According to the Government Accountability Office GAO, , Small businesses have four major sources of external equity capital: wealthy individuals, known as business angels; venture capital funds; private placement of securities; and public offer- ings of securities.

Researchers have noted the inefficient nature of the private capital mar- kets for venture investments, and such inefficiencies have the potential to leave gaps in the access to capital for entrepreneurs Center for Private Equity, It is structured so that a base of private investor capital is supplemented with government capital, known as leverage, of up to three times the private capital base.

Addi- tionally, the matching funds allow a small fund to substantially increase its total capital, which is important for those funds which may have lim- ited fund raising ability because they are not located near a financial cen- ter J. Blanchard, personal communication, October 16, The Debenture program is still funded this way. These loans carry a ten year term, and require semi- annual interest payments as well as repayment of the principal at matur- ity.

Many SBICs had to make equity or long-term investments which did not pay current in- come using borrowed funds, and they ran into trouble because they had to repay those loans on a regular basis Saddler, At this time, structural changes in the existing programs were also made to address some of the problems that became apparent in these programs. Relevant portions were incorpo- rated into the new Participating Securities program.

The changes accounted for an increased popularity in the program Selz, The new Participating Securities structure was also anticipated to attract new investors such as pension-funds which provided almost half the money used by the venture capital industry , because it simplified tax implications for investors Saddler, Yet, political risk was an issue from the begin- ning of the program. At the time, the George H. Bush administra- tion wanted to spur investment in businesses with high potential, yet its support for this new and relatively complex idea still was unknown Sad- dler, The term Participating Securities includes preferred stock, a preferred limited partnership interest, or a similar instrument…under the terms of which interest is payable only to the extent of earnings US House of Representatives, The gov- ernment pools these Participating Securities and sells them in the public capital markets through an investment trust.

In actual practice, the SBA makes an annual appropria- tion to cover the anticipated amount of leverage investments to be made in the SBICs that year, and makes those leverage investments with ap- propriated funds T.

Jamerson, personal communication, December 11, The SBA then recoups the investments through the sale of pooled securities.

Money for the debenture leverage used in the Debenture pro- gram is raised in the same way. This contingency later proved to be devas- tating to the program.

However, the Participating Securities structure along with a surg- ing stock market in the mid to late s created a mini-boom in SBICs Korn, A total of Participating Securities funds were licensed from , through October 1, when new licensing was discontin- ued. From through , the SBA licensed a total of SBICs with more new private capital than had been invested in the preceding 40 years Korn, In fact, vintage years represent a high point of the cycle and produced some of the best per- forming vintage years in venture history.

In general, the returns as measured by IRR of venture funds are tied to the rise and fall of the stock market SBA, This period represented the downward portion of the cycle in venture capital SBA, It is possible that the payback time could stretch anywhere from years for funds in the vintage years SBA, At fiscal year-end , with the market downturn beginning to show its long term effect, the SBA analyzed the performance of the 10 year old Participating Securities program and compared it with the Debenture program for cohorts SBA, By every measure, the Par- ticipating Securities program faired much worse than the Debenture pro- gram.

The low level of distributions was the result of the market downturn, and because of distribution rules which heavily favored private investors. The result of these distribution rules is that, through September 30, , SBA received less than a third of the capital it either guaranteed or ad- vanced not including distributions on prioritized payments. Even when including the residual value of existing investments, a shortfall would still exist and the SBA does not expect to recover all of its leverage in- vestment.

With distributions on prioritized payments included, the SBA received about half of its total investment. Yet, during the same period, private investors received about 1. The downturn in per- formance of the Participating Securities program negatively affected these subsidy costs, as well as budgetary estimates of future costs.

The subsidy cost is the estimated long- term cost to the government of a loan guarantee, calculated on a net- present-value basis, excluding administrative costs. Administrative costs, recorded on a cash basis, include activities related to making, servicing and liquidating loans as well as overseeing the performance of lenders CBO, Throughout its tenure, the George W.

In other words, the loan guarantees must pay for themselves, without being subsidized through appropria- tions. However, the Participating Securities program incurred costs in excess of the estimates used to run it at a zero subsidy rate, which was a problem for the program since remediation required additional appropria- tions.

In a sudden reversal of opinion, in March the Administration informed the Congressional Budget Of- fice CBO , that it no longer viewed the Participating Securities program as a credit program and that it would record its costs on a cash basis rather than a net-present-value basis under FCRA CBO, While the exact reason for such a reversal of opinion remains unclear, some have opined that the Bush Administration was ideologically opposed to the Participating Securities program because it competed with private sector capital sources L.

Mercer, personal communication, July 31, Whatever the reason, the increased costs seem to have provided an op- portunity for the administration to end the program. One of the main features of the Participating Securities program that merited this revision of budgetary treatment is that scheduled payments of principal and interest are contingent on profits earned by SBICs, and failure to make scheduled payments does not necessarily result in default CBO, Such appropriations levels were politically untenable and the issuing of Participating Securities leverage effectively ended.

The fears of SBIC managers a decade earlier had been realized. Administrative Considerations In addition to the problems with distributions, another factor that may have contributed to the performance woes of the program is the amount of licensing and associated leverage issued while market valuations were increasing. The timing of the licensing meant funds were investing dur- ing one of the most significant valuation increases in history. The SBA may have been able to anticipate the market up turn, but whether there was anything they could have done administratively to mitigate downside risk remains an open question and outside the scope of this paper.

By the end of , just three years after the SBIC program was signed into law, over li- censes had been issued. By , the number of active licensees peaked at , dropping to in before stabilizing Wilson, Cur- rently, that original program-the Debenture program-consistently main- tains approximately licensed SBICs.

SBA is further restricted by its dependence on the annual budget ritual, in which the SBIC program is a favorite sacrificial victim Wilson, The same might be argued for the equity investment por- tion of the venture capital industry. In the beginning of the program, it is not clear that SBA had the expertise to evaluate equity funds and their managers.

Its previous experience was in making loans to debt oriented funds and, as one fund manager noted, there is big difference from lender to investor J. One researcher noted that many SBIC funds are run by great individuals who are targeting underserved markets, but too many SBIC participants in recent years have been mar- ginal venture funds whose approaches did not really differ from their peers Lerner, Originally, the licensing application focused more on character than per- formance.

The process gave weight to background checks and character references. But with experience, the SBA began to amplify its emphasis on performance. In the early s, the SBA began to increase the im- portance of track record and in January of , the application was offi- cially revised to increase the focus on historical track record and invest- ment returns, a practice consistent with pension funds and other potential co-investors investors.

Pesumably, poor performers that may have slipped through early in the program would now be eliminated from con- sideration.

Future Direction In its current configuration, the Participating Securities program will run its course by about When it does, the only substantive iteration of the SBIC program will be the original Debenture program.

New versions of the Participating Securities program have been pro- posed, but none have gained traction in Congress. The most significant change proposed is eliminating the profit requirement for repayment of interest.

The new Participating Debentures program, as it has been called, would require repayment of interest regardless of profits. Throughout the life of the Participating Securities program, the SBA has made a number of internal administrative improvements which presuma- bly would be used in a future program.

Since , SBA has developed and maintained consolidated financial statements for the Participating Securities and Debenture programs corresponding with typical financial statement items SBA, These financial statements, along with en- hanced risk assessment and monitoring tools developed by SBA, have improved administrative oversight.