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ARTICLES
Business Week "Small Business" March 20, 2001 Smart Answers by Karen E. Klein The ABCs of SBICs The government-backed financing program can be an alternative to venture-capital funds -- if your business qualifies Q: My 2-year-old startup needs second-round financing of about $500,000 to keep our product line evolving. We need some advice on approaching a small-business investment company (SBIC). In what situations is it appropriate to use an SBIC for funding? Are there any inherent disadvantages in using SBICs? What opinions do experts hold about SBICs? ---- J.W., Washington, D.C. A: Let's start with some background: SBICs are a subset of the venture-capital industry, part of a Small Business Administration program created in 1958 to funnel investment money to small businesses. In fiscal year 2000, there were 395 licensed SBICs in the U.S. that participated in 4,636 financings of 3,060 companies -- a total of nearly $5.5 billion in investments. SBICs are for-profit entities that use their own capital and matching funds borrowed at favorable rates by the government to provide venture funding to small independent businesses, both new and those already established. Like any VC fund, SBICs invest in growth companies with the expectation of seeing their equity investment grow, and within three to six years receiving their principal and profits -- usually when the company is sold or goes through an IPO. By law, an SBIC can be organized in any state as either a corporation, limited partnership, or a limited liability company. Most SBICs are owned by relatively small groups of local investors, though a good number are operated by commercial banks, and some are corporations with publicly traded stock. STRINGENT RULES. Guidelines state that any business an SBIC adds to its portfolio must have tangible net worth of $18 million or less, have average net profits of less than $6 million over the two years prior to the investment, and have the majority of its assets or employees in the U.S. The regulations also preclude "passive" businesses, such as banks, and project-based businesses, such as oil refiners, from obtaining SBIC funding. Also, they cannot be in the business of buying and selling real estate, or solely involved in farming. The government also insists on a rigorous vetting processing before accepting a fund as a source of SBIC financing. "SBIC managers are highly respected, experienced, value-added investors who are carefully screened by the SBA before receiving their licenses, examined on an annual basis by the SBA, and required to have audited financial statements," says Loren Busby, who makes and manages investments for Walden Capital Partners, a $60 million, New York-based SBIC. It can certainly be appropriate to use SBIC financing when a company needs capital for growth, experts say. "In most cases, the company cannot obtain sufficient capital through traditional sources, like bank credit lines or leasing, and the entrepreneur does not have his or her own resources to invest," says Busby. DO YOUR RESEARCH. Not all companies are going to appeal to SBICs -- and not all SBICs are going to be the right match for your company. "You should approach an SBIC fund the same way you approach any equity investor: Look at their past investments and their stated investment criteria. SBIC funds vary by the types of businesses they prefer -- technology vs. nontechnology, local vs. national, and average size of the deal -- $250,000 vs. $5 million," says Peter Cowen, a Westwood (Calif.)-based investment banker. The potential disadvantages to SBICs mirror those of most institutional equity funds: They have a timetable to be repaid. If this schedule proves to be shorter than your business plan, there is potential for conflict. On the other hand, most SBIC funds are business-savvy, have valuable contacts, and can provide expertise in helping you grow your business, Cowen says. Before you approach an SBIC, make sure that you have a strong management team, says Janis Machala, of the venture-capital firm Paladin Partners, in Kirkland, Wash. "Management team, market size and opportunity, and technology underpinnings are all considerations for a venture fund or an SBIC fund when looking at you as a likely investment," Machala says. AIM YOUR PITCH. You should also investigate what kinds of companies the SBIC you approach has previously backed, she says, explaining that companies matching the traditional interests of a particular SBIC will probably have a greater chance of funding. You can get more information and listings of SBICs at www.sba.gov/inv. You should know that there are two types of SBICs: debenture and participating securities. Deciding which type of SBIC to approach will depend on whether you are seeking debt or equity financing. Debenture SBICs generally make investments in the form of debt instruments (such as term loans or sub-debt), which require interest to be paid on a current basis. Securities SBICs, on the other hand, tend to make investments in the form of equity or equity-like instruments, which allow interest and dividends to be deferred. |
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