This second installment of PilieroMazza’s blog series “Focus on SBA’s SBIC Program” explores regulations governing SBIC status and considerations for potential applicants. Please visit this link for Part 1 in the series. For small business government contractors looking to leverage the opportunities presented by the SBIC program, it is imperative to understand the related regulations to safeguard the interests of both investors and small businesses.
As discussed in the first part of this blog series, the SBIC program provides members with low-cost, government-backed capital to invest in small businesses. In conjunction with private capital, these government-backed loans come with a variety of benefits outlined in the first blog in our series. However, the SBIC application process is rigorous, and the SBA sets a high bar for certification. Application fees are considerable, the application is time-consuming, and applicants must demonstrate that their investment plan has a high probability of success. Before diving into the application process, it is critical for potential applicants to understand the various regulatory requirements associated with becoming an SBIC. These include organizational requirements, capitalization requirements, and other non-regulatory considerations for potential applicants.
Organizational Requirements for SBICs
Before beginning the SBIC application, a company interested in applying for SBIC status should first determine whether it qualifies as an SBIC. These criteria are set out in 13 CFR Part 107, Subpart C. However, potential applicants must ensure they comply with size standards for determining whether a business is considered “small” for the purposes of SBIC investment. These standards are established by the SBA and are set out in 13 CFR Part 121.
An SBIC must be privately managed, and it must be formed as a for-profit investment company. The applicant may be a corporation, limited partnership, or limited liability company, although a limited partnership structure is generally encouraged by the SBA. The reason for this is the clear separation between management and investors, which aligns with the SBA’s goal to have professional, experienced managers handling investment decisions, while also spreading the investment risk among a diverse group of investors. There are provisions specific to SBICs established as limited partnerships in 13 CFR 107.160.
Pursuant to 13 CFR 107.150, the SBIC program mandates a diversification in management and ownership to ensure there is a broad base of control and investment. The diversity requirements must be maintained throughout the lifecycle of the SBIC. These include the following:
- The percentage ownership requirement mandates that any single partner’s ownership percentage must be limited to no more than 70% of the applicant’s private capital. There are exceptions for certain wholly owned subsidiaries, to the extent such entities may act independently.
- The non-affiliation requirement mandates that at least 30% of the applicant’s private capital be owned and controlled by three unaffiliated persons, although certain institutional investors may substitute for these unaffiliated individuals.
- The voting requirements mandate that the investors required to satisfy diversity may not delegate their voting rights in a way that undermines these diversity requirements without the SBA’s prior approval.
Additionally, applicants must be aware that although the Federal Acquisition Regulation (FAR) provides guidelines for government procurement, the size standards for determining whether a business is considered “small” for the purposes of SBIC investment are established by the SBA in 13 CFR Part 121.
Capitalization Requirements for SBICs
In addition to the organizational requirements that an SBIC applicant must meet to qualify for a license, 13 CFR 107.200 through 13 CFR 107.250 includes certain capitalization requirements that an SBIC applicant must meet.
The SBA sets a minimum “Leverageable Capital” requirement of $2,500,000. Leverageable capital is generally the company’s private capital obtained via investors or owners. This leverageable capital cannot include: (i) funds borrowed from any source, (ii) funds obtained via leverage, and (iii) funds from federal, state, or local governments, with certain exceptions, such as funds obtained from a public pension fund or certain “qualified non-private funds.” There are also certain non-cash capital contributions that can be included in the leverageable capital calculation contained within 13 CFR 107.240.
Applicants must also maintain a minimum amount of “Regulatory Capital,” which is at least $5,000,000. Regulatory capital is the total amount of money that the applicant must have to assure the SBA that it is financially stable and able to cover its investments and operational costs.
The regulations also include a somewhat vague requirement that the SBIC licensee maintain sufficient capital to ensure that it will “operate soundly and profitably over the long term.” This language, in 13 CFR 107.200, is indicative of the significant discretion that the SBA has in granting an SBIC license. Ultimately, even if an SBIC applicant meets the organizational and capitalization benchmarks, the SBA has full discretion to deny an applicant’s license if the SBA does not believe the applicant and its business plan have long-term economic viability.
Additional Considerations for SBIC Applicants
The SBA will review applications carefully, and applicants must demonstrate their current or proposed management team is qualified and experienced, with a strong and considered business plan. 13 CFR 107.305 outlines the specific criteria that the SBA will evaluate when considering an application.
The SBA wants to see evidence of a qualified and experienced management team with a track record of success, particularly in the specific market in which the SBIC will operate. Often, PilieroMazza attorneys see individuals break off from large investment banks or hedge funds start their own private equity or venture capital fund, experience initial success, and apply for SBIC status from there. Applicants should emphasize any investment-related achievements of their leadership team. Potential applicants may also bring on an individual with a successful record of investments to bolster their application. The more specific and detailed the application is, the better. A data-driven analysis of past investment success tied to the decision-making and leadership of members of the SBIC management team is a strong indicator of a successful application.
In addition to the investment experience and past success of the management team, the SBA requires a clear, thoughtful, and rational business plan. Ideally, this business plan is aligned with the market success of the management team. The business plan must include a high-level vision for the SBIC, as well as a more nuanced strategy for execution. The SBA will demand sound financial projections, data-backed assumptions, compensation plans, and reasonable projections of profits and fees.
Lastly, we note that the regulations also include an expedited application process for experienced fund managers who have successfully managed SBIC funds in the past.
In conclusion, understanding the various regulatory challenges that are involved with pursuing SBIC status, and how the SBA approaches its review of SBIC challenges, is critical to preparing a successful SBIC application. As we delve deeper into the application process in the next blog in this series, this background will remain increasingly relevant for any potential applicants.
For contractors seeking to harness the potential that the above partnerships offer, understanding the SBIC program is critical. If you have questions about the SBIC program, please contact Cy Alba, Robert Troiano, or another member of PilieroMazza’s Business & Transactions or Government Contracts practice groups. The next blog in the series explores the intricacies of the SBIC application process and the benefits of acquiring an SBIC license.
Looking for practical insights on gaining a competitive advantage through a deeper understanding of the government’s compliance requirements? Check out PilieroMazza’s podcasts “GovCon Live!” and “Clocking in with PilieroMazza.”