Once licensed and qualified, a Small Business Investment Company (an "SBIC") may borrow funds ("Leverage") in the form of debentures ("Debentures") that are guaranteed by the United States Small Business Administration ("SBA"). These Debentures are structured as unsecured, non-recourse loans with a ten-year term, semi-annual interest payments and a lump sum payment of principal due at maturity. Debentures are typically pooled and sold to investors through securities offerings. An eligible SBIC can receive Leverage of up to three hundred percent of the amount of investment capital committed to the SBIC from sources other than the SBA or SBA-backed loans ("Private Capital"), depending primarily on the amount of Private Capital raised.[1] The focus of this article is to describe the process a typical SBIC undergoes to obtain Leverage.


In addition to being licensed as an SBIC and receiving a commitment from the SBA as discussed below, to be eligible to receive Leverage, SBICs must comply with the eligibility regulations provided in Part 107 of Title 13 of the Code of Federal Regulations (the "Code"). Also, the SBIC must demonstrate a need for Leverage by showing evidence of investment activity and a lack of funds for investment.[2] For an SBIC's first issuance of Leverage, a lack of sufficient funds for investment is presumed if the SBIC has already invested over fifty percent of its Private Capital that has been called to date.[3] For future issuances of Leverage, the fund will then have a track record with the SBA upon which funding decisions will be made. To continue to draw Leverage, the SBIC must have enough Private Capital available to provide reasonable assurance of its ability to operate soundly and profitably over the long term and to operate actively in accordance with its business plan, as approved by the SBA, and its organizational documents.[4] The SBA's discretionary determination of whether the SBIC has satisfied the requirements for financial viability takes into consideration actual and anticipated income and losses on the SBIC's loans and investments and the experience and qualifications of owners and management[5]; nonetheless, the amount of Private Capital an SBIC has raised and the SBIC's current Capital Impairment Percentage[6] are probably the most important metric used by the SBA to determine which SBICs will receive Leverage. To receive any Leverage, an SBIC must have raised at least $10,000,000 in Private Capital.[7] The SBIC must also certify in writing that Smaller Enterprises encompass at least twenty percent of its total investment financings.[8] Finally, the SBIC must demonstrate to the SBA that its management is qualified, having the knowledge, experience and capability necessary to invest in the business types contemplated by the Code and its business plan. These Code provisions give the SBA the authority to make Leverage decisions based on the reputation of the SBIC's managers, which should be a reminder of the vital importance of maintaining one's reputation throughout the tedious Leverage funding process. In addition to the eligibility requirements, SBICs can be classified as ineligible for Leverage commitments and Leverage draws if there is a pending merger, change of control, reorganization or if the SBIC is under investigation by the SBA's Inspector General. Once the SBIC seeking financial assistance has met all of the eligibility requirements, it may apply for SBA Leverage.

Commitment of SBIC Debentures

The first step in the Leverage application process is to apply for a Debenture commitment from the SBA. Historically, Debenture commitments were offered at a limited number of specified times each year. The SBA would announce to SBICs that it would accept commitment applications on certain dates. However, recently the SBA has stopped announcing such dates. Nonetheless, at the time of printing, the SBA's Investment Division is accepting applications for commitment requests at any time and anticipates that new regulations will be issued that allow for commitment requests at any time, but limit the number of requests from each SBIC to twice annually.

To request a Debenture commitment from the SBA, the SBIC must submit a letter requesting the commitment. The letter must include the name, address and license number of the applicant and the requested amount of the commitment, which must be a multiple of $5,000. In addition, the letter request must include specific language set forth in the memorandum of instructions available from the SBA[9] and several exhibits, including certain SBA forms, financial statements, an investment plan, an opinion of counsel and information necessary for the transfer to the SBIC.

After an extensive review by the SBA, successful applicants will receive a commitment letter that will automatically lapse on September 30th of the fourth year following issuance.[10] SBICs with current outstanding commitments should note that the shelf life of any outstanding commitments issued in 2004 is set to expire on September 30, 2008 if not yet drawn.

There are two main conditions accompanying any Debenture commitment. The first condition is the payment of fees. First, a non-refundable commitment fee, of one percent of the face amount of the Leverage must be paid to the SBA before any Leverage is drawn by the SBIC.[11] Second, a leverage fee of 2%, an underwriter's fee of 0.375% and an administrative fee of 0.05%, for a total of 2.425% of the face amount of the Leverage will be deducted from the Leverage proceeds at the time the Leverage is drawn.[12] Finally, each year that the Leverage is outstanding, the SBIC must pay to the SBA an additional fee (currently 0.717% for 2008 commitments) on the outstanding Leverage under the commitment.[13] Automatic cancellation of the commitment occurs unless the required fees have been paid by 5:00 P.M. Eastern Time on the 30th calendar day following the commitment's issuance.[14] Also, to remain eligible to draw down against an outstanding Leverage commitment, the SBIC is required to submit to the SBA a financial statement on SBA Form 468[15] as of the close of each quarter of the SBIC's fiscal year, filed within thirty days of the close of such quarter,[16] and remain in compliance with the regulations in the Code.

Drawing Down Against Commitments

By submitting a request for a draw against the SBA's Leverage commitment (a "Draw Request"), an SBIC authorizes the SBA to guarantee the Debenture and to sell it with SBA's guarantee.[17] In order for the SBA to consider funding a request, the SBIC must submit the following documents to the SBA: (1) Leverage Security Instruments; (2) Form 468 and Statement of No Material Adverse Change; (3) Statement of Compliance; (4) Statement of Need; (5) Smaller Business Financing Certification; and (6) Opinion of Counsel.[18]

Draw Requests, which may contain up to five takedowns made in increments of $5,000, may be submitted to the Funding Control Officer of the SBA's Investment Division twice a month (typically the first and third Wednesdays of the month). Generally, the Draw Request review process takes six days and, if approved, the SBA will send a separate approval notice for each approved takedown (an "Approval Notice"). Once the SBIC has received an Approval Notice it must complete Section II and fax the entire document to the Bank of New York by 2:00 P.M. the day before an anticipated takedown. Provided that these requirements are met, the funds should be available to the SBIC by the close of business on the day of its takedown. Funds can be received as early as the Friday following receipt of an Approval Notice and as late as fifty eight days following such receipt. Approval Notices expire if not submitted for funding, but the SBIC may make further Draw Requests so long as its Leverage commitment has not expired.

Funding of Draw Requests

When the SBIC submits a Draw Request, it authorizes the SBA to enter into any agreements on the SBIC's behalf as are necessary to sell the Debenture to a shortterm investor, to allow for the repurchase of the Debenture by the SBIC or another investor or to allow for pooling of the Debenture with other Debentures with the same maturity date.[19]

In the event that the Debenture is sold to a short-term investor by the SBA, the SBIC must pay interest (at a somewhat higher rate) to the short-term investor for the period of time the Debenture is held by such investor.[20] In order to repurchase its Debenture from a short-term investor, the SBIC must give the SBA written notice at least ten days before the cut-off date of the pool in which its Debenture is to be included and pay the Debenture's face amount plus interest to the short-term investor.[21] Otherwise, the Debenture will be pooled with other Debentures and sold to long term investors.

Pooling of the SBA-guaranteed Debentures is the final step of the Debenture funding process. Semi-annual poolings combine newly issued securities that are sold publicly. The interest rates applied to the Debentures are negotiated and based on market rates at the time of pooling.

SBA Leverage is a less expensive alternative to other sources of investment capital. Despite the additional administrative burdens that accompany SBA Leverage, this funding serves an important role for many investment funds whose investment strategies are compatible with SBA goals. By familiarizing themselves with the requirements and procedures involved in obtaining SBA-guaranteed Debentures, SBIC investors will reduce the time, cost and difficulty involved in obtaining these funds.