Although the Small Business Investment Company (SBIC) licensing process has been streamlined and is more efficient than ever, the US Small Business Administration (SBA), which administers the SBIC program, remains hampered by the limited number of experienced personnel in its employ and by the increasing number of funds expressing interest in accessing its long-term, low interest 2-1 matching capital (leverage). Because a delay in licensing prevents timely access to SBA leverage, the only recourse many funds have to implement their investing strategy prior to licensing (and the associated availability of leverage), is to seek private capital from existing or potential investors and co-investors. Unfortunately, accessing private capital is not always possible for licensees, as many institutional and other limited partners have conditioned their commitments to the fund upon the issuance of the SBIC license. However, since nature abhors a vacuum, enterprising and innovative people often find a way to satisfy the business need. Enter capital call loans.
For many years SBA regulations permitted licensees to incur “secured third-party debt,” i.e., non-SBA debt secured by the assets of the SBIC, subject to the SBA’s consent if the SBIC had outstanding leverage. As a condition to its granting such approval, the SBA had the right to impose whatever conditions or limitations it deemed appropriate on the proposed financing, taking into account the SBIC’s historical performance, current financial position and the proposed terms of the debt, as well as the aggregate debt (including leverage) that would be outstanding. Under no circumstances would the SBA favorably consider a request for approval if the proposed indebtedness included a blanket lien on all of the SBIC’s assets or a security interest in the fund’s limited partner commitments in excess of 125 percent of the proposed borrowing.
The existing regulations notwithstanding, the SBA has recently taken the position (not codified anywhere) that it will no longer permit an SBIC to incur secured debt.
As a result, some lenders have begun to provide an unsecured line of credit for up to 364 days with aggregate availability limited to a percentage of the fund’s remaining uncalled limited partner capital commitments, less negotiated reserves. Loan proceeds may generally be used for any SBA-permitted purpose, including to finance qualified investments and management fees. A guarantee from the management company (not the general partner—which the SBA would probably object to) is typically required. As with most capital call loans, the loans are viewed as a bridge facility until limited partner capital is called and/or leverage is drawn under the SBA’s commitment to the SBIC. It is from these two sources that lenders expect to be repaid. Note that in these facilities, the lender has no security interest in the assets of the borrower; no UCCs are filed and there is no lien on the unfunded commitments of the limited partners. In addition, it is customary that no financial covenants are required, although covenants restricting senior secured or unsecured debt are also customary. Note also that the SBA’s unsecured claim as a debenture holder against an SBIC is subordinated to third-party lenders but only lenders that are not “associates” of the SBIC or its principals; and only if the SBIC’s indebtedness does not exceed US$10 million or 200 percent of the SBIC’s regulatory capital. Otherwise, the SBA’s claims will be treated pari passu with the claims of other unsecured lenders.
Another possible variation in the evolving structure of these loans is a facility created during the SBIC license process but before actual grant of the license, when an SBIC applicant intends to make a so-called “pre-license” investment. Such investments are permitted by the SBA after a “go forth” or “green light” letter has been issued by the SBA and an applicant’s license application has been “accepted for filing.” Given its limited personnel, the SBA does not process applications unless it believes that the applicant has raised sufficient funds to indicate that the targeted capital raise and stated investment thesis will be achieved. The SBA generally does not inform an applicant what that minimum financing threshold is until after it has examined the application fully, but as a rule of thumb, the SBA seems to believe that the less money raised, the less likely the applicant will be to succeed. Recent SBA activity seems to indicate that a minimum of at least US$20 million to US$25 million (and sometimes more) in limited partner commitments is the current standard to be “accepted for filing,” which is the pre-condition to permitting these prelicense investments.
In this pre-license structure, the lender would no longer have the benefit of two sources of repayment, as only partner capital would be available. Consequently, in these circumstances, the lender is likely to seek a traditional security interest in the applicant’s partner capital commitments, which would be required to automatically terminate upon issuance of the SBIC license.
The SBA has permitted such pre-license secured loans because during the time of the security interest it has no money at risk and doing so furthers the main purpose of the SBIC program, which is to make capital available to the deserving small businesses which create jobs in the US.
The availability of the SBA’s low-cost capital in an era of tight credit has incentivized many in the investment community to take a new look at an old program. A little creativity and flexibility by lenders and funds alike seem to be allowing access to this funding while complying with the SBA’s complex rules and regulations.