Small Business Investment Companies (SBICs)

Over forty years ago an entrepreneur looking for the capital to launch a small business had very few sources to turn to. There was no institutional resource to back up promising but untried ideas. Again and again, businesses with great potential for innovation failed - or never got off the ground.

To help solve this problem, in 1958 Congress created The Small Business Investment Company (SBIC) program. SBICs, licensed by the Small Business Administration, are privately owned and managed investment firms. They are participants in a vital partnership between government and the private sector economy.

With their own capital and with funds borrowed at favorable rates through the Federal Government, SBICs provide venture capital to small independent businesses, both new and already established.

All SBICs are profit-motivated businesses. A major incentive for SBICs to invest in small businesses is the chance to share in the success of the small business if it grows and prospers.

Today there are two types of SBICs - the original, or "regular" SBICs and SSBICs -- Specialized Small Business Investment Companies. SSBICs are specifically targeted toward the needs of entrepreneurs who have been denied the opportunity to own and operate a business because of social or economic disadvantage. The Small Business Program Improvement Act of 1996 repealed Section 301(d) and the result, no new SSBIC license are being issued. However, existing 301(d) licensees were "grandfathered" and still in operation.

With few exceptions, the same rules and regulations apply to both "regular" SBICs and SSBICs. Therefore in general, the SBIC name is used to refer to both SSBICs and "regular" SBICs simultaneously.

Who Benefits from the SBIC Program?

Small businesses which qualify for assistance from the SBIC program are able to receive equity capital, long-term loans, and expert management assistance. Venture capitalists participating in the SBIC program can supplement their own private investment capital with funds borrowed at favorable rates through the federal government.

Most important, the U. S. taxpayer benefits. Tax revenue generated each year from successful SBIC investments more than covers the cost of the program.

Additionally, the Nation's economy benefits as the small businesses financed by SBICs have created hundreds of thousands of jobs over the program life.

Principal Advantages to the SBIC

The foundation of a SBIC is its management team; people who have venture capital expertise and capital, and who want to form a venture capital investment company. By law, an SBIC can be organized in any state, as either a corporation, limited partnership, or a limited liablilty company. Most SBICs are owned by relatively small groups of local investors. Many, however, are owned by commercial banks. Some SBICs are corporations with publicly traded stock.

Private capital requirements

SBA requires a minimum private capital investment of $5 million for an SBIC; $10 million if they intend to utilize participating securities. A minimum of 30 percent of this capital must come from sources unaffiliated with the management

Government Leverage

An SBIC in good standing, with a demonstrated need for funds, may receive leverage equal to 300 percent of its private capital. However, in no event may any SBIC or SSBIC draw down leverage in excess of $108.8 million. If you intend to seek leverage, you are eligible to seek a commitment for up to two tiers that is good for 5 years (one tier is equal to the SBICs regulatory capital. Once leverage is comitted, funds are drawn down as deals close.

To obtain leverage, SBICs issue their debentures which are guaranteed by SBA. Pools of these SBA- guaranteed debentures are formed, and SBA-guaranteed participation certificates, representing an undivided interest in the pools, are sold to investors through a public offering. Under current procedures, the debentures have a term of ten years, and provide for semi-annual interest payments and a lump sum principal payment at maturity. The ten-year debenture does allow prepayment during the first five years. Thereafter, the debenture may be prepaid without a penalty. In either case, the rate of interest on the debenture is determined by market conditions at the time of the sale.

Tax Advantages

Besides the opportunities for government leverage, all SBICs can benefit from a number of tax advantages. Tax counsel should be consulted regarding tax laws and regulations.

Advantage to Banks

Bank ownership in an SBIC subsidiary permits banks to invest in small businesses in which they could not have otherwise invested, because of banking laws and regulations. A bank may invest up to 5% of its capital and surplus in a partially or wholly-owned SBIC.

Financing Small Business Concerns

It is the function of the SBIC to act as a financier for small business concerns. SBICs have great flexibility in terms of financing options, which result in financings specifically tailored to the needs of each small business concern.

Loans and Debt Securities

SBICs can make long-term loans to small business concerns in order to provide them with funds needed for their sound financing, growth, modernization, and expansion.

An SBIC may provide loans independently, or in cooperation with other public or private lenders. SBIC loans to small business concerns may be secured, and should be of sound value. Such a loan may have a maturity of no more than 20 years, although under certain conditions the SBIC may renew or extend a loan's maturity for up to 10 years.

An SBIC may elect to loan money to a small business concern in the form of debt securities - loans for which the small business concern issues a security, which may be convertible into or have rights to purchase equity in the small business concern. These securities may also have special amortization and subordination terms.

Equity Securities

By law, the SBIC must provide equity capital to small business concerns, and may do so by purchasing the small business concern's equity securities. The SBIC may not, however, become a general partner in any unincorporated small business concern, or otherwise become liable for the general obligations of an unincorporated concern.

Licensing Requirements

A Corporation, limited partnership, or limited liability company may apply to the Small Business Administration for a license to operate as a Federal Licensee under the Small Business Investment Act of 1958, as amended, and the rules and regulations issued thereunder.

The two primary criteria for licensure as an SBIC are qualified management and sufficient private capital. SBA reviews and approves prospective management teams based upon both their professional capabilities and character. If both of the above creteria are met, and the organizational and legal documents of the Applicant are in conformity with SBA's regulations, the SBIC Applicant will receive its license.

Once licensed, each SBIC is subject to annual financial reporting and biennial onsite compliance examinations by the SBA, and is required to meet certain statutory and regulatory restrictions regarding approved investments and operating rules.

Regulatory Requirements

The SBA, in the regulatory process, seeks to minimize its role in the day to day operations of SBICs. The regulations listed below exist to protect the interests of small business concerns and the integrity of the program, and to ensure its overall effectiveness.

Types of Businesses

SBICs may invest only in qualifying small business concerns as defined by SBA regulations. SBICs may not invest in the following: other SBICs, finance and investment companies or finance-type leasing companies, unimproved real estate, companies with less than one-half of their assets and operations in the United States, passive or casual businesses (those not engaged in a regular and continuous business operation), or companies which will use the proceeds to acquire farm land.

Conflict of Interest

An SBIC may not engage in "self-dealing" to the advantage of or with favoritism to its associates. The SBA defines associates broadly to include:

- Certain of its shareholders, officers, directors, and employees;

- In an unincorporated SBIC, its members, control persons, and employees.

The SBIC may not directly or indirectly provide financing to any of its associates. It may not borrow money from a small business concern it has financed, nor from the small concern's owner or officers.


An SBIC is not permitted to control, either directly or indirectly, any small business on a permanent basis. Nor may it control a small business in participation with another SBIC, or its associates. In certain instances, the SBA may allow an SBIC to assume temporary control in order to protect its investment. But in those cases the SBIC and the small concern must have an SBA- approved plan of divestiture in effect.

Overline Limitations

Without written SBA approval an SBIC may invest no more than 20 percent of its private capital in securities, commitments, and/or guarantees for any one small concern.

Cost of Money

The cost of money on SBIC loans and debt securities charged to small concerns is regulated by the SBA, and is governed by applicable state regulations, or by SBA regulations, whichever is lower.

Prohibited Real Estate Investments

An SBIC may not invest in farm land, unimproved land, cemetery subdividers or developers, or any small concerns classified under Major Group 65 (Real Estate) of the SIC Manual, with the exception of title abstract companies, real estate agents, brokers, and managers.

Prohibited Relending, Reinvesting

SBICs may not provide funds for a small concern whose primary business activity involves directly or indirectly providing funds to others, purchasing debt obligations, factoring, or leasing equipment on a long- term basis with no provision for maintenance or repair.

However, SBICs and SSBICs may finance Disadvantaged Concerns engaged in relending or reinvesting activities (except agricultural credit companies, and those banking and savings and loan institutions not insured by agencies of the Federal Government).

Proceeds of Financing

In general, investment funds used to purchase securities must go directly to the small business concern issuing the securities. They should not be used to purchase already outstanding securities such as those on a stock exchange, unless such a purchase is necessary to insure the sound financing of a small concern, or when the securities will be used to finance a change of ownership. The purchase of publicly offered small business securities through an underwriter is permitted as long as the proceeds of the purchase will go to the issuing company.

Minimum Period of Financing

Loans made to and debt securities purchased from small concerns should have minimum terms of five years. The small concern should have the right to prepay a loan or debt security with a reasonable penalty where appropriate.

Loans and debt securities with terms less than five years are acceptable only when they are necessary to protect existing financings, are made in contemplation of long-term financing, or are made to finance a change of ownership.

Miscellaneous Regulations

In addition to the specific regulations listed here, SBICs are subject to certain other regulations regarding activities, operations, and reporting, which must be followed to insure the continuation of the SBIC license and its related advantages.

The Basics of Setting Up a SBIC

- Commit the necessary capital. To qualify you must have a minimum of $5 million in private capitalization ($10 million if applying for participating securities). SBA may require additional capital in certain market areas.

- Prepare a well-structured business plan to be included in the license application, detailing the SBIC's plans for investing in small business concerns. Include information on the proposed types of investments, the types of industries in which the SBIC plans to invest, the developmental stages of these businesses, their geographic locations, and other factors relevant to the investment activities of the proposed SBIC.

- Make sure you have qualified management on your staff. To be licensed, your company must be managed by individuals with a real interest in serving small business concerns, and the necessary expertise to do so. A well-qualified manager would have a number of years of successful experience in a business involved with investing in business concerns - such as, a venture capital firm. Individuals with comparable experience and educational backgrounds may also be acceptable.

- Request a Management Assessment Questionnaire from the SBIC Program Development Office at the e-mail address: Be sure to review the Guidelines to Applicants, SBA Regulations and Small Business Investment Act of 1958, as amended. Also, please check the web site section "SBIC Licenses" for a detailed procedures on obtaining an SBIC License. The SBA is vitally interested in encouraging responsible individuals and organizations to establish SBICs.

- Although you are welcome to contact SBA yourself with any questions about preparation of required documents, legal counsel is usually advisable because of the complexities of organizing an SBIC.

- Submit the Management Assessment on diskette along with two hard copies to:

    Office of Program Development
    Investment Division
    Small Business Administration
    Washington, DC 20416.

-The Program Development Staff will review your Managment Assessment for presentation to the Investment Committee of SBA's Investment Division.

-After the Investment Committee has reviewed the Management Assessment, your Management Team may be invited to make a presentation before the Investment Committee. If the Investment Committee concludes that your Management team is suitable to operate an SBIC, you will be invited to file the Application for License.

-Expect that the time required to process your application may take some time. A significant portion of that time is required for background checks on the individuals who will be involved in the ownership and management of your prospective SBIC. During the application process the SBA may find that additional information is necessary and, if so, will notify you in writing. The quicker you reply, the quicker the SBA can process your application.

Additional Information

The SBA encourages responsible individuals and organizations to establish SBICs. For more detailed information, write:

Associate Administrator for Investment U.S. Small Business Administration 409 Third Street, S.W. Washington, D.C. 20416

or by e-mail:

The statements in this brochure contain, in many cases, simplified summaries of complex regulatory and statutory provisions. Before any business decision is made, relevant and current regulations and statutes should be consulted and, if necessary, legal counsel should also be consulted.

Information courtesy of the Small Business Administration.