Time to Startup!

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Time to Raise Capital? Consider the SBIC

Published on Oct 26, 2012


Read 'Time to Raise Capital? Consider the SBIC' at 'Time to Start Up,' the small business blog by BizFilings.
When getting your business off the ground, you may have secured a bank loan guaranteed by the U.S. Small Business Administration. Now that your company is ready to expand, you may be seeking capital from private investors, and you may not be aware that government support is still available at this phase of growth. At this point, rather than looking for SBA-backed financing through banks, you can investigate which Small Business Investment Companies might be good candidates to help your business fulfill its potential.

What is the SBIC?

The SBIC program began in 1958, and operates as part of the SBA. Just the SBA encourages small business lending by guaranteeing loans that banks make to SMBs, the SBIC program encourages investment in small business by guaranteeing the capital that private firms invest in startups and small enterprises. Basically, an SBIC can borrow money from the government at low interest rates, and then invest that money, along with its own privately raised capital, in small businesses. To qualify as an SBIC, an investment firm must have at least $5 million from private sector sources. It can then receive up to three times its private capital in SBA-guaranteed securities. According to the SBA, there are currently more than 400 SBICs licensed in the United States. There are a variety of different types of SBICs, and they offer different types of financing:
  • Privately managed investment firms. Debenture SBICs offer debt financing and participating securities SBICs offer equity financing. In the case of debt financing, they make their money on the difference between the interest they pay the government on their SBA-backed capital and the interest rate they charge an SMB borrower. In the case of equity financing, they acquire an ownership stake in a business.
  • SBICs owned or backed by banks or insurance companies. Commercial banks are not typically permitted to make equity investments in private companies, but by owning or investing in an SBIC, banks can acquire more than 5 percent of voting stock in SMBs.
  • Specialized Small Business Investment Companies. These SBICs exclusively finance businesses owned by people deemed socially or economically disadvantaged.
In addition, most SBICs focus their investments in a particular industry or type of company, such as manufacturing, healthcare or business services. Many also invest in companies within a particular geographic area.

Am I eligible for SBIC investment?

Companies are eligible for SBIC financing depending on a few factors:
  • Size. Only small and mid-sized businesses are eligible for SBIC investment dollars. The SBA website defines a small business as having a net worth of $18 million or less and an average after tax net income of $6 million or less. Type of company. SBICs are not permitted to invest in other SBICs or any other investment companies, unimproved real estate, or a company with less than 51 percent of its workforce in the United States.
  • Status of company. Like any other venture capital firm, an SBIC is looking to make a profit. Therefore, SBICs typically invest in established companies with significant growth potential, which may be coming up on an acquisition, a public offering or some other significant milestone.
  • Type of investment. Companies cannot secure SBIC investment for the purpose of buying farmland, or for any purpose that is undertaking a project that the government considers "contrary to the public interest."

What are the benefits and drawbacks of SBIC investment?

Because SBICs are working in part with funds guaranteed by the government, they can sometimes invest in businesses that might not otherwise qualify for debt or equity financing. As with equity financing in general, SBIC investment comes with the potential benefit of bringing in investor partners that can provide valuable guidance, helping steer your business to even greater success. To be licensed as an SBIC, a firm's managers and directors have to submit credentials that show their business expertise and professional experience, so if you're working with an SBIC, there is peace of mind from knowing the investors have undergone a round of vetting. Still, as with any partnership, an incompatible relationship can turn a potential positive into a big negative, so it's important to work with SBIC investors who you click with. In addition, any dilution in the ownership stake of a business can cost founders money in the long-run, so it's important to analyze whether a bank loan or some other financing option might be advisable.

How do I secure SBIC investment?

There is no sure-fire process to ensure success when it comes to raising investment capital, but the following steps describe one strategy for securing SBIC dollars.
  • Research your options. You can find a list of SBICs in your area via the SBA website.┬áIt's a good idea to research your local SBICs to determine which of them offer the type of financing you need, and which work with your type of company.
  • Reach out. Once you've identified which SBICs to target, go through your contacts to see if there is anyone in your network who could refer you. The SBA website suggests accountants, attorneys, business executives and business colleagues as possible references. Though it will boost your likelihood of success to approach an SBIC with a referral, you can also simply submit your business plan for consideration.
  • Negotiate favorable terms. SBICs are limited by some government regulations, but they have a great deal of latitude in crafting specific deals. Therefore, you should feel free to negotiate to come to terms that are mutually acceptable and beneficial. Depending on the type of financing, some basic issues to consider are interest rates, ownership stakes and repayment timelines.
As with so many other aspects of business (and life), knowledge is power when it comes to raising capital. CFO magazine points out that many investment firms do not advertise they are licensed as an SBIC, so finance officers and other business executives might be working with an SBIC without even knowing it. The differences between an SBIC and a non-SBIC investment firm are minor, but the fact that a potential investor may be working with SBA-guaranteed capital is certainly something to be aware of going into a negotiation.