Significant changes to the Small Business Investment Company program

ARTICLE | September 07, 2023

Authored by RSM US LLP

On July 18, the Small Business Administration (SBA) published a rulemaking update significantly revising the regulatory framework for Small Business Investment Companies (SBICs).

The update, titled Small Business Investment Company Investment Diversification and Growth, has a broad impact on the current SBIC program and represents the most significant change to the program in decades. Among other changes, it creates new types of SBICs, modifies existing regulations to improve operational aspects of managing an SBIC, and updates the licensing process to encourage more fund managers to apply to the program.

The SBA indicated it hopes that the regulatory updates will expand the universe of private investment fund managers interested in the SBIC program, increase the flow of capital to underserved small businesses, and promote investment in businesses that are capital-intensive and critical to national security. This summary highlights certain key changes.


The SBIC program’s stated mission is to encourage private capital investment in American small businesses, allowing them to grow, expand and modernize. This is accomplished through the SBA’s licensing and monitoring of private investment companies, which are commonly investment funds organized as limited partnerships that raise capital from private limited partners. The private capital raised is typically leveraged using SBA guaranteed debentures, which can often increase the fund’s deployable capital and enhance private capital returns.

Created by the U.S. Congress in 1958, SBICs have cumulatively invested over $123 billion in American small businesses since the inception of the program. There were 308 active SBICs as of Sept. 30, 2022, and approximately 78% utilize debenture leverage. SBICs made $7.9 billion of investments in 1,217 small businesses during the federal government’s fiscal year ended Sept. 30, 2022, with SBICs that utilize debentures making approximately 20% of these financings as equity-only investments. Highlighting a focus area for the SBA, only 7% of all financings were to small businesses owned by women, minorities or veterans.

The regulatory framework for SBICs has evolved over the years, with different license and leverage types becoming available and then later being modified or withdrawn. The last effort focused on equity investment, the Participating Securities Program, was launched in the early 1990s and created a form of nondebt SBA financing. Under that program, the SBA’s investment took the form of a preferred limited partnership interest, where the SBA earned a preferred return and a profit share. The lack of debt service encouraged licensees to invest in equity instruments, particularly for venture capital and growth-stage investments. This program suffered losses in the early 2000s in connection with the dot-com bubble, and the SBA stopped licensing these funds shortly after.

Since the Participating Securities Program ended, the primary way the SBA has provided capital to SBICs is through issuing SBA-guaranteed debentures. Debentures generally have a 10-year term, are non-amortizing and can be prepaid without penalty. Interest rates for newly issued debentures are set semiannually and are based on market pricing, typically ranging from 0.4% to 0.7% above the current 10-year Treasury rate. Interest payments are due semiannually, encouraging SBICs to invest in securities that generate current cash returns. The most recent debentures, priced in March 2023, carry a 5.168% rate, the highest since September 2008. The SBA typically commits to provide leverage to an SBIC, which the SBIC can then draw upon as needed through its life. Leverage may be committed to an SBIC at a 1:1 ratio to private capital, up to a 3:1 ratio to private capital, though 2:1 is most common. A single SBIC may use up to $175 million in debentures, while a fund family may use up to a combined total of $350 million at any time.

SBICs have been limited to investing in companies that meet certain criteria, chiefly being small or “smaller” businesses, as defined by the SBA. Portfolio companies must also be based in the United States, and prior to the July revision could not be primarily re-lenders, reinvestors, real estate projects or companies that will use the proceeds outside of the United States. SBICs have to abide by certain regulatory restrictions when structuring an investment, including limitations on interest rates charged to borrowers.

SBICs are subject to periodic reporting requirements, including filing quarterly and annual financial statements, notifying the SBA upon the occurrence of certain events and reporting certain information related to the financing of a new investment. The SBA requires that SBICs follow an SBA basis of accounting, which differs from U.S. generally accepted accounting principles (GAAP) in several key areas, and has published specific SBA model valuation guidelines. Most SBICs will also prepare financial statements on a U.S. GAAP basis for non-SBA purposes, such as to meet private investor obligations under their limited partnership agreement or to satisfy requirements of the Securities and Exchange Commission if the SBIC is associated with a registered investment advisor.

The SBIC program has a long track record of operating with a zero taxpayer subsidy rate, and the SBA monitors its licensees to address potential credit concerns. SBICs are subject to annual examinations for regulatory compliance, must prepare calculations that provide insight into the their current financial position, and are subject to enhanced monitoring or other remedial actions for noncompliance.

“The SBA’s now-effective updates represent a fairly significant modernization of the SBIC program. The creation of the accrual debentures program and reinvestor SBICs will not only provide a new funding source for SBICs, but also allow them to operate an investment strategy commensurate with many of their non-SBIC peers.”

Steve Johnson, Partner, RSM US LLP

Regulatory changes

Accrual debentures

One of the most significant changes to the SBIC program is the creation of a new form of debenture, the accrual debenture. In contrast with existing debentures, accrual debentures will not have a current interest pay component and will instead accrue interest over the debenture’s term. SBICs will need to indicate if they intend to use traditional debentures or accrual debentures at the time of licensing, and SBA approval is subject to the same licensing process. Accrual SBICs may borrow up to 1.25 times their regulatory capital, and maximum leverage will be determined by aggregating total expected principal and interest over the life of the debenture.

The final rule describes a schedule of distributions that an accrual SBIC must use when distributing the proceeds from the sale of an investment:

  • First, proceeds are paid to the SBA to the extent the SBIC owes the agency accrued and unpaid annual charges and accrued debenture interest.
  • Second, proceeds are allocated among the SBA and private investors. The SBA’s sharing percentage is calculated as follows. The amount paid to the SBA must be at least their sharing percentage multiplied by the total distribution amount.

    Total leverage commitment
    (Total leverage commitment + Total private commitment)

  • Third, any remaining amounts are paid to private investors.

The introduction of accrual debentures is intended to provide a source of SBIC financing that aligns better to equity-focused investments due its lack of a current pay interest obligation. Venture capital, growth capital and buyout investment

Reinvestor SBICs

Another significant change to the SBIC program is the introduction of reinvestor SBICs. These SBICs are allowed to invest in other, non-SBA-leveraged investment funds, whether or not the investees are SBICs. Those investee funds do need to have an investment strategy that aligns with current SBIC requirements, including that they invest in companies that meet the SBIC’s portfolio company size standards, have at least half of their employees in the United States and are controlled by entities or individuals in the United States. Reinvestor SBICs may also make co-investments into portfolio companies alongside investee funds, subject to certain conditions.

Reinvestor SBICs further expand the investment strategies that fit into the SBIC model and may increase the amount of capital allocated to SBIC and non-SBIC funds, and in turn to the portfolio companies they invest in. 


The current licensing process may take up to 18 months, and is similar for both first-time applicants and returning applicants. Under the final rule, SBIC fund managers seeking an SBIC license for a subsequent fund may have an easier path. Subject to certain requirements, subsequent SBIC license applicants may submit a short form Management Assessment Questionnaire (MAQ). The short form MAQ is intended to expedite the licensing process and reduce the burden on fund managers. To be eligible for a short form MAQ, an applicant must meet certain criteria, including the following:

  • The applicant must have a generally consistent: (1) investment strategy, (2) limited partner base, (3) limited partnership agreement, and (4) fund size. The new fund being raised may not be more than 133% larger than the applicant’s most recent fund, and the two largest limited partners must have at least verbally committed to invest in the new fund.
  • The most recent fund must meet certain performance metrics relative to appropriate industry benchmarks.
  • The manager of the licensee must be stable, demonstrate internal advancement and have no significant regulatory violations.

Additionally, SBA will prioritize applications from under-licensed states and will lower the fees for new or unleveraged applicants. A state’s under-licensed designation will be based on an SBA calculation that compares the licenses per capita for a given state versus a median figure for all states. A listing of such under-licensed states will be provided by SBA periodically.

Capital call lines of credit

Current regulations require that licensees obtain the SBA’s permission prior to entering into a secured line of credit facility with a third-party financial institution. The final rule exempts SBICs from needing that approval if the credit facility meets certain conditions:

  • The line of credit is limited to 20% of the total unfunded capital commitments of the SBIC’s institutional investors.
  • The line of credit has a term of no more than 12 months, and borrowings are required to be repaid within 90 days. The line of credit must have no outstanding balance for at least 30 consecutive days during the year.
  • The lender is a federally regulated financial institution.

Reporting and monitoring updates

The final rule provided a variety of modifications to an SBIC’s reporting obligations, including the following:

  • SBICs are required to file Portfolio Financing Reports on Form 1031 following investment activity.
  • Form 1031 filings previously had been due within 30 days of a financing, but SBICs will now have the option to file them quarterly.
  • Leveraged SBICs now must report investment valuations quarterly using the SBA accounting basis. Unleveraged SBICs may use U.S. GAAP as their accounting basis for their valuations.
  • SBICs report their quarterly and annual financial statements on SBA Form 468. The SBA is updating the form to accommodate the changes in the final rule, including the need for additional information from reinvestor SBICs and the inclusion of additional reporting metrics such as total value to paid in (TVPI), multiple of invested capital (MOIC) and internal rate of return (IRR).

Additionally, there are changes to how the SBA will conduct its ongoing monitoring of SBIC’s. Most notable are the creation of a watchlist for timely identification of potential credit issues and more oversight when issues are identified. An SBIC may end up on the watchlist if its performance is sufficiently poor relative to an industry benchmark or if it faces regulatory or other issues. While on the watchlist, an SBIC may be required to report to the SBA more frequently and conduct portfolio reviews. It may be removed from the watchlist when the performance factors or other conditions are alleviated.

What’s next

These changes to the SBIC program are significant, and additional guidance will be needed in certain areas as they are implemented. The final rule became effective Aug. 17 and the SBA issued an updated standard operating procedure (SOP) Aug. 23, which provided additional guidance relative to these final rule changes and replaced some preexisting policy notes. The SBA anticipates operating under the new regulations promptly, including beginning the licensing process for accrual and reinvestor SBICs.

This article was written by Ryan Hurley and originally appeared on 2023-09-07.
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