Investors whose funds are registered as SBICs (Small Business Investment Companies) have something to cheer, and something to fret about, under the Obama administration’s new stimulus bill, signed into law last month.
The good news first: as some readers will already know, the amount that the SBA allowed firms to borrow will see a modest increase. Prior, the most an SBIC could borrow from Uncle Sam was $137 million, as adjusted upwards based on changes in the Consumer Price Index (CPI) from a $90 million limit set in the early ‘90s. The new bill, however, bumps that cap up to $150 million, translating into $23 million in additional leverage for firms that, right now, have scare few other options.
There’s also been a meaningful increase for groups of affiliate funds. Before the bill’s passage, whether a fund family had one SBIC or several, it could borrow $137 million altogether — period. Post stimulus bill, a group of funds can borrow up to $225 million, an $88 million difference.
Now, the bad news. For one thing, under the new bill, annual upwards adjustments have been rendered a memory. “It’s a hidden problem,” says Mike Wyatt, an attorney who specializes in small business matters at the Washington law firm Hogan & Hartson.
“While $150 million is a modest increase, they deleted the adjuster provision,” says Wyatt. What that means is that if the Consumer Price Index continues on its path, that $150 million is going to become a limit at some point and not an increase. Hogan & Hartson “tried bringing this to the attention of the government, but everything was going so fast that no one would listen,” says Wyatt.
More, while the money is theoretically available immediately, the SBA will have to write implementing regulations, and right now, there’s nobody at the head of the SBIC division at the SBA. Indeed, there’s no one at the head of the SBA itself yet. President Obama’s choice to head the agency, venture capitalist Karen Gordon Mills of Maine, has yet to be confirmed.
When someone is appointed head of the SBIC program, who that person is will “be critical,” says Wyatt. “If that person comes in and promptly implements the stimulus statute provisions as literally written, then the SBIC program will be considerably enhanced. But someone could also come in and modify the provisions with regulations that say, you’ve got to do this and qualify that for that — they can regulate [the amounts] down considerably, which could generate a very different result.”
While I had Wyatt on the phone, I also asked him about the face of today’s SBICs. The government effectively stopped funding venture capital funds some time ago, and I wondered if that was about to change. Wyatt gave me a nice little overview of the program, one I thought readers might appreciate. (Unfortunately for struggling VCs, it still leaves venture firms out in the cold.)
Said Wyatt: “Here’s the scoop: the SBIC program began in 1958 with a so-called debenture-type leverage, designed primarily for funds which provide primarily debt infusions to later-stage small businesses. It operated that way until the early ’90’s.
“In 1994, SBA created an equity-type of leverage designed for venture capital funds who invest primarily in the equity of early-stage companies. This type of leverage had its interest cost deferred until the recipient fund generated a profit overall, when it then had to pay the accumulated interest. The interest-deferral allowed SBICs to put money into start-ups and early-stage companies who couldn’t service debt.
“The new equity program worked well until the tech crash, when many equity-type funds cratered. Ultimately, the Bush administration suspended the program in 2004, which remains suspended today. The statute, regs, forms, and so forth all remain, but it needs an appropriation. It has no funding.
“Meanwhile, however, the older debt-type SBICs continued to be licensed and leveraged, because their loss ratio was very low — about 3%. SBA covers that cost with modest fees, so the entire debenture leverage program is off budget — it doesn’t cost the taxpayers anything currently. The debt funds do some equity — about a third of their dollars, but they do primarily mezzanine debt with equity features. That program continues today.”