The Small Business Administration (the “SBA”) is a source of low cost investment capital for investment companies with an investment strategy that complies with the SBA’s capital requirements and regulations. The SBA was established in 1953 as an independent agency of the federal government to, as indicated on the SBA’s website, “aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation.” Born from an awareness of the contributions small business makes to our country that trace back at least to the Great Depression, the SBA has evolved substantially.
The SBA has its roots in the Reconstruction Finance Corporation (the “RFC”), created by the Hoover Administration in 1932, in response to the Great Depression, to assist suffering businesses of all sizes. The RFC provided low interest federal loans to businesses of various sizes. The RFC was not an effort specifically targeted towards helping small businesses, but it was an early example of government backing of private enterprise.
As military spending helped to fuel a national economic recovery during World War II, some larger U.S. businesses grew exponentially. Small businesses that were unable to take advantage of large scale mechanization to compete for government contracts were left behind. To help small businesses compete for war contracts, Congress created the Smaller War Plants Corporation (the “SWPC”) in 1942. The SWPC encouraged financial institutions to provide small businesses with credit, government agencies to grant them contracts and larger businesses to subcontract work to them. The SWPC also provided limited loans directly to entrepreneurs.
After World War II, the SWPC was dissolved and an arm of the Department of Commerce called the Office of Small Business (the “OSB”) was created to continue the advocacy of the SWPC. Government lending to small business continued during this period under the control of the RFC.
During the Korean War, the RFC retained the authority to issue small business loans, but advocacy was handled by the newly created Small Defense Plants Administration (the “SDPA”). The SDPA certified small businesses that it determined were qualified to perform government contracts. During this time of economic prosperity, the RFC, which was designed to help elevate the nation from the Great Depression, was seen as outdated and ineffective. In 1953, Congress passed the Small Business Act of July 30, 1953, consolidating the education, advocacy and lending duties performed by these earlier organizations into the SBA. In its early years, the SBA provided funds to small businesses in the form of direct loans to entrepreneurs and victims of natural disasters, as well as guarantees of loans from traditional lending institutions. It also educated entrepreneurs and encouraged other government agencies to grant contracts to smaller businesses. However, within a couple years of its creation, administrators at the SBA determined that the greatest impediment to small businesses was their inability to access the funds necessary to compete with the technological advancement of larger enterprises and that the most efficient way to assist small businesses was to help them access capital, rather than education.
In 1958, Congress passed the Small Business Investment Act, establishing the Small Business Investment Company (“SBIC”) program, which is overseen by the SBA. An SBIC is a private equity fund that is licensed to receive government loans or other investments under the SBIC program. The SBIC program is charged with stimulating long-term investment in small U.S. businesses by providing low interest loans and (until recently) equity to SBICs for investments in certain types of small businesses. Since it was created in 1958, the SBIC program has provided approximately $46 billion in debt and equity capital to more than 90,000 small businesses, making it the largest single investor in U.S. businesses in the nation.
The SBIC program effectively serves several goals: for investors willing to comply with the SBA regulations – an economical source of additional investment capital; for small businesses – critical funding for early stage development and growth; and for the SBA – an efficient vehicle through which to accomplish its mission of assisting small business. The SBIC program requires SBICs to obtain a substantial portion of their funding from private sources. By doing so, the program effectively leverages the government dollars going to small businesses and provides a market safeguard for federal funds by ensuring that its funds go only to businesses that pass muster with private investors.
In the 1960s, SBICs were prolific, but many were short-lived, unsuccessful entities used to invest in real estate. During the 1970s, the number of SBICs declined, but those that remained tended to be more successful. The extremely high interest rates of the 1980s made SBIC loans, all of which included currentpay debentures, less attractive because they required large interest payments to the SBA on capital that was tied up in long-term investments. By the early 1990s, this problem and the rise of pension funds as a competitive source of capital for small businesses led to a dramatic decrease in the popularity of SBICs. The SBA needed to be revamped.
In 1992, Congress approved the Small Business Equity Enhancement Act of 1992 (the “1992 Act”). The ensuing regulations, which went into effect in 1994, provided an answer to the current-pay debenture scheme problem. The solution was called “Participating Securities” – preferred limited partnership interests. Through these securities, the SBA could be repaid using the proceeds of an exit, rather than through regular payments. Among other changes, the 1992 Act increased the maximum loan amount it would provide to an SBIC to $90 million and increased minimum capital requirements to $10 million (for Preferred Securities) and $5 million for the traditional debentures.
During the mid-1990s, billions of dollars were invested using SBICs, with much of their leverage coming from Preferred Securities. However, the failure of several SBIC-backed small businesses during the downturn in the technology industry that followed the turn of the millennium proved to be too much for the SBA to stomach. In 2004, the SBA announced that it would not issue new Participating Securities. Since then, the SBA has and says it will continue to honor only existing Participating Securities that expire on or before September 30, 2008. While there has been much speculation about the return of a program similar to Participating Securities, the future of SBA equity investment remains unclear.
Although SBICs have become less popular in recent years, the SBA continues to provide various types of loans to small business, including particularly low interest loans reserved for investments in small businesses located in “Low and Moderate Income Zones”. In addition to loans, the SBA continues to provide educational resources to entrepreneurs and promotes numerous initiatives to assist small minority and women owned businesses. The SBA will likely continue to provide support for U.S. small businesses for years to come.