SBICs Offer Ready Capital to Small Businesses
What do Costco, Sun Microsystems, FedEx and the Build-a-Bear Workshop have in common? When these companies were in their early stages of growth, they received financing from lenders licensed by the Small Business Investment Companies (SBICs) program. The SBIC program, which is part of the Small Business Administration (SBA), has helped thousands of small businesses obtain financing since it began in 1958. In 2016, SBIC licensed lenders managed more than $28 billion in assets and provided $6 billion in financing to 1,200 small businesses.
The SBIC program was established in 1958 to ease the flow of long-term capital to small businesses in the United States which lacked access to more traditional sources of capital. The SBIC program partners with the SBA, who guarantees debt being used by the SBIC licensed fund as a funding source for the loans and equity investments they make in middle market companies. The amount of debt that the SBA will guarantee is limited to two times the amount of private capital the SBIC fund raises from private investors, such as banks, pension funds, insurance companies, foundations, and high net worth individuals, as well as the general partners. The SBIC licensed funds provide loans, debt securities (mezzanine debt with equity features, such as warrants) and equity.
The SBA spends a significant amount of time vetting a fund prior to approving a fund manager’s participation in the program and issuing a license. They will do background checks on the general partner and reference checks to validate their experience and track record in this type of investment. The manner in which the SBIC qualifies participants and manages this program results in it including some of the best investment professionals in the middle market, and being a successful and profitable investment for the government.
According to the SBA, SBIC funds typically provide financing over a three-to-five year period and investments range in size from $1 to $15 million. SBIC funds will provide debt or equity, or a combination of the both, depending on the profile. Most SBICs are looking for companies with earnings before interest, taxes, depreciation, and amortization (“EBITDA”) between $3 million and $20 million. The funds use their own capital along with low-cost borrowed funds that carry an SBA guarantee. They seek healthy net returns, of course, so each one uses its own criteria and processes to make investment decisions in line with their respective investment thesis, which are not always consistent across each SBIC fund in the program.
Investment profiles can vary by type of business, industry segment, size and stage of development, and geography. Some SBICs are seeking to partner with private equity groups, and others are searching out entrepreneurs in need of an investment partner to elevate their company to the next level, or make an acquisition. If your company is looking for sources of capital beyond traditional bank financing, SBIC licensed funds could be a viable alternative or complimentary to bank financing. Many debt structures include bank lenders teaming up with SBICs to provide a comprehensive solution to pursue short and long term goals. The first step is to determine if you are eligible and consider which funds may be the best fit for your business.
Does your company qualify?
The SBIC program limits investments to U.S.-based small businesses with $18 million or less in tangible net worth and average net income for the last two years of $6 million or less. They do not finance foreign operations or businesses that have more than 49% of their employees or tangible assets outside the United States. And while the SBIC program allows investments in many industries – from manufacturing and agriculture to retail and professional services – SBIC funds are not permitted to invest in passive businesses, finance companies, most real estate businesses, farmland, project financings or businesses contrary to the public interest.
Most SBIC funds target profitable businesses with sufficient cash flow to pay associated interest. In addition, the funds will make equity investments in some companies, both control and minority, that are not yet profitable but have significant prospects.
Find and apply to the right SBIC
If it looks like your business is a good candidate for the type of debt and equity that SBIC licensed funds can provide, there are several steps to take before you approach lenders.
First, research SBICs to identify those whose investment profiles best fit your business needs. Consider the growth stage of companies they invested in, the size of their financing and any areas they choose to focus on, including certain industries or regions of the country. Verify that the SBIC is actively investing – the typical lifespan for SBICs to invest in small companies is about five years after the SBA licenses them and many fund managers have multiple funds over time, providing valuable insight as to their track record and history of portfolio companies. Many fund managers have invested in more than one fund, resulting in extensive experience and the availability of a track record through various economic cycles.
Here are four sources for finding active SBICs:
- The SBIC Directory, which lists active SBICs by state
- The Small Business Investor Alliance, an association of private equity funds and investors that target the lower middle market
- The National Association of Investment Companies, which supports investment in an ethnically diverse marketplace
- Individual SBIC websites
Second, create a business plan or tailor your current one to appeal to SBICs that target your market. The business plan should not only look to the future, but also tell the story about how the company progresses from its recent financial performance to the forward looking one you envision. Most SBIC funds will seek a well-thought out plan.
Finally, use a strategic approach to make initial contact with select lenders and be prepared to send them information on your company. The process should start with a one-page “teaser” which highlights the company and the investment opportunity, which should be accompanied by a confidentiality agreement drafted by your counsel, which should be executed before moving to the next step of the process with interested parties. After a confidentiality agreement is completed, a more detailed information package should include historical financial statements, a business plan including projections, and a narrative on the background of the business, its management team, and unique niche. We recommend you at least have reviewed financial statements provided by an outside, accredited accounting firm. An investment in audited financial statements may separate your company from the crowd and pay for itself.
This process is a little like movie directors who receive headshots from hundreds of actors to cast just a few roles in their next big film. SBICs receive hundreds of business plans from companies each year for limited financing. A qualified introduction to fund managers is far more effective than simply emailing them your plan or calling their office. Ask your banker, accountant, attorneys, business associates or other executives in your industry for referrals and help in establishing a connection with an SBIC.
According to the Small Business Investor Alliance, SBICs provide the “patient” capital that small companies need to develop their products and services and grow. To reach the size of Costco or FedEx takes many years, of course, but SBICs’ patient capital and expertise can help small businesses make their own breakthroughs and potentially define their markets in ways they may not be able to accomplish on their own.