The American Recovery and Reinvestment Act of 2009 (“ARRA”), signed into law by President Obama on February 17, 2009, contains significant revisions to the Small Business Investment Act of 1958 (the “Act”), which governs Small Business Investment Companies (“SBICs”). ARRA makes four key changes: (1) it increases the leverage cap for both individual SBICs and SBICs under common control, (2) it further increases the leverage cap for SBICs that certify that 50% or more of their investments will be in companies located in low-income geographic areas, (3) it modifies the formula for determining the overline limit, and (4) it adjusts the aggregate amount of financings that SBICs must provide to smaller enterprises. The Small Business Administration (“SBA”) released an interim final rule implementing these ARRA provisions on July 14, 2009, and this interim rule was made effective immediately. A copy of the interim final rule is attached to this article.
Increased Leverage Cap. ARRA increases the maximum amount of leverage available to SBICs as well as simplifies the leverage cap formula. Previously, an SBIC could receive leverage equal to approximately three times the SBIC’s first $22.8 million of leverageable private capital, two times the amount of the SBIC’s leverageable capital from $22.8 million to $45.7 million, and one time the amount of leverageable capital in excess of $45.7 million—up to an aggregate maximum cap of $137.1 million. ARRA increases the maximum amount of leverage that an individual SBIC may obtain from the SBA to the lesser of $150 million or 300% of the SBIC’s private capital. (Please note that more than two tiers of leverage will only be available after an SBIC has demonstrated exceptional performance.)
ARRA also increases the maximum amount of leverage that a group of SBIC funds under common control may have outstanding from $137.1 million to $225 million. For any leverage draw that would result in a group of SBICs under common control having aggregate outstanding leverage in excess of $150 million, each SBIC in such group must certify that it does not have a condition of capital impairment. This will make it easier for investment firms to operate more than one SBIC at a time, easing the transition for groups winding down one SBIC fund and raising another.
Investments in Low-Income Geographic Areas. In addition to increasing the leverage cap for all SBICs, ARRA provides that additional leverage may be granted to an SBIC licensed after October 1, 2009, if it invests at least 50% of its investment dollars in companies located in low-income geographic areas. (Section 108.50 of the SBA’s New Market Venture Capital program regulations sets forth the definition of “low income geographic area.”) If an SBIC wishes to take advantage of this increased leverage cap, half of the total amount invested by the SBIC at the time of its draw request must be in qualifying businesses. Further, the SBIC must certify that at least half of the total dollar amount that it will invest in the future will be in qualifying businesses. If an SBIC satisfies these two requirements, it will be eligible to receive leverage equal to the lesser of $175 million (instead of $150 million) or 300% of its private capital. In addition, the aggregate cap on outstanding leverage for all of the SBICs that are under common control with the SBIC making the certification will be increased from $225 million to $250 million, but if a requested draw would result in a group of SBICs having aggregate leverage in excess of $225 million, then each SBIC in the group must meet the two requirements set forth above.
Increased Overline Limit. ARRA also modifies the formula for determining the maximum amount of money that an SBIC can invest in any one portfolio company (otherwise known as the “overline limit”). The overline limit was previously 20% of an SBIC’s private capital, regardless of its leverage. ARRA changes the formula to 10% of the sum of an SBIC’s private capital plus the total amount of leverage projected by the SBIC in its business plan, as approved by the SBA at the time of licensing. For most SBICs, this will result in an increase in the overline limit: an SBIC with two tiers of leverage now has an overline limit equal to 30% of its Regulatory Capital, and an SBIC with one and one half tiers of leverage now has an overline limit equal to 25% of its Regulatory Capital, however, an SBIC with one tier of leverage continues to have an overline limit equal to 20% of its Regulatory Capital. If an SBIC wishes to invest more than the permitted overline limit in a company, it must now seek SBA consent as a regulatory exemption under §107.1920 of the Regulations. The modified formula for determining an SBIC’s overline limit will provide most SBICs the flexibility to make larger investments and to increase their investments in portfolio companies that are performing well or otherwise need additional investment capital.
Investment in Smaller Enterprises. Finally, ARRA adjusts the amount that an SBIC must invest in Smaller Enterprises. Previously, an SBIC was required to invest at least 20% of its aggregate dollar amount of financings in Smaller Enterprises (defined as having a net worth of not more than $6 million and average net income after taxes for the preceding two years no greater than $2 million). In addition, for SBICs receiving leverage in excess of $90 million, 100% of any investments financed in whole or in part by that excess leverage had to be invested in smaller businesses. Pursuant to ARRA, however, the two-tiered rule has been eliminated in favor of a single requirement that 25% of an SBIC’s aggregate dollar amount of financings must be invested in Smaller Enterprises. For SBICs with less than $96 million in leverage, this revision will have the effect of increasing the amount that the SBIC must invest in Smaller Enterprises. For funds with more than $96 million in leverage, however, that amount will actually decrease.
At the close of each fiscal year, and at the time of any application to draw leverage, an SBIC must satisfy the smaller Enterprises requirement as follows:
(A) If an SBIC is licensed after February 17, 2009, whether leveraged or unleveraged, it must invest at least 25% of its aggregate financing dollars in Smaller Enterprises as of the date the SBIC applies for a leverage draw and as of the close of each fiscal year;
(B) If an SBIC is licensed before February 17, 2009, and:
i. the SBIC received a new leverage commitment from the SBA after February 17, 2009, then the SBIC may divide its investments into two categories: (a) investments made prior to the date of the first leverage commitment issued after February 17, 2009 (which investments must meet the old 20% requirement (plus 100% for leverage over $90 million)), and (b) investments made after the date of the first leverage commitment issued after February 17, 2009 (which investments must meet the new 25% requirement); and
ii. the SBIC has not received a new leverage commitment from the SBA after February 17, 2009 (which will include unleveraged SBICs), then the SBIC must meet the old 20% requirement (plus 100% for leverage over $90 million).