What Is a Small Business Investment Company (SBIC)?

Small business owners should be aware of all the financing options that they can use to run and grow their business. Business owners might turn to U.S. Small Business Administration (SBA) loan programs for this funding. But the SBA also oversees the Small Business Investment Company (SBIC) program that can help small businesses get financing from venture capital.  

SBICs generally invest in growth-focused small businesses, and they often offer long-term funding to help fuel that growth. S Companies like Costco, Apple, Staples, and FedEx all used SBIC financing. 

How do SBICs work? 

SBICs are privately held and run investment funds that have a license from the SBA. SIBCs raise funds from investors – individuals, other funds, and organizations – and can also borrow money from the SBA. They use this pool of money to invest in qualified small businesses.  

A loan from an SBIC might be similar to small business loans borrowers can get from banks and lenders. But SBICs can also make equity investments – raising money by selling a stake in a business. Similar types of equity investments might come from private equity funds or angel investors, but they generally aren’t available from other SBA loan programs or traditional lenders.  

SBICs can choose how to structure their investment offerings and may extend separate offers from different funds. Here’s what typical SBIC investments can look like: 

• Debt investments: A $250,000 to $10 million loan with a 9% to 16% interest rate and three-year repayment term. 
• Equity investments: A $100,000 to $5 million investment in exchange for shares in the company. 
• Debt and equity: A $250,000 to $10 million loan with a 10% to 14% interest rate, plus equity – or an option to obtain equity – in the company.  

SBICs have to comply with the SBA’s rules when making investments. For example, the SBA can limit the interest rates and fees that SBICs charge.  

Similar to some venture capital funds, SBICs may have a particular focus or specialty. For example, a small business owner might find an SBIC that specializes in financing software as a service (SaaS) tech companies. Or there could be an SBIC that focuses on helping companies get through a particular period of growth, such as a startup or expansion phase. There are also SBICs that broadly invest in small businesses regardless of the industry or stage.  

What is a debenture? 

Within the context of SBICs, debenture refers to the loans that an SBIC can take from the SBA. The SBICs can generally borrow up to $2 in debt for each dollar the fund raises from investors.  

The standard debenture agreement allows SBICs to borrow money with unsecured 10-year loans and semi-annual interest rates. Here’s another example: an SBIC might receive an energy saving debenture from the SBA. The SBIC will then need to use the proceeds to invest in small businesses that focus on reducing nonrenewable energy use or consumption.  

How do SBICs make money? 

SBICs make money by getting a return on the investments they make in small businesses. The returns can come from loan and interest payments. Or, if the SBIC takes an equity stake, the SBIC can profit from the small business’ growth.  

What qualifies as a small business investment company? 

SBIC funds must be privately managed, for-profit investment companies that apply and receive a license from the SBA. The multi-step licensing process requires the fund managers to share details about their experience and investment strategy.  

Generally, SBICs will have fund managers with a history of working well together, at least two members with 10-year track records of successfully managing small business investments, and a strategy for earning enough on their investments to repay the debentures. Once an SBIC applicant receives an initial green-light letter, they have 18 months to raise at least $5 million from private investors.  

What can SBICs invest in? 

Once formed and funded, SBICs can only invest in small businesses, as defined by the SBA. Generally, this means a business has to fit in one of these categories 

• Have a tangible net worth under $19.5 million and an average net income, after federal income taxes, that’s under $6.5 million for the prior two years of operation. 
• Meet the industry size standards, which can depend on annual receipts (gross income plus cost of goods sold) or the average number of employees a business had over the last 24 months of operation.  

Additionally, business owners need to run a for-profit company that primarily operates and is located within the U.S. and is not part of certain industries, such as financing or real estate.  

What is an SBIC fund? 

Some larger investment companies or groups may create and manage an SBIC fund as part of an overall investment strategy. Each fund may have general partners who manage the fund’s operations and limited partners who passively invest in the fund. There are several types of SBIC funds, and the funds can be broadly classified in two ways: 

• Leveraged SBIC fund: An SBIC fund gets loans (debentures) from the SBA. Leveraged SBIC funds can generally raise $2 in debenture for each dollar they have from non-SBA investors. 
• Unleveraged SBIC fund. Unleveraged or non-leveraged SBICs don’t take loans from the SBA. This structure may allow them to make larger equity investments in small businesses and more easily receive investments from banks.  

SBIC funds invest in a portfolio of businesses, which sometimes share common characteristics. The SBIC may also offer mentorship or guidance to its portfolio companies, which the small businesses might not receive from other types of lenders or investors.  

As of 2022, there were around 300 SBICs and more than 200 SBICs that are actively investing. Most SBICs are debenture SBICs and owned by small investment groups. Though there are a few publicly traded corporations that run SBIC funds, and some commercial banks wholly own some SBICs 

What are the advantages of small business investment companies? 

SBICs are popular alternatives to traditional lenders and venture capitalists when starting a new business or experiencing cash flow problems. There are several other reasons that businesses may want to seek funding from SBICs: 

Regulatory advantages 

SBICs have several regulatory advantages that can help them attract investments from banks: SBICs are exempt from certain SEC registration requirements, they’re exempt from the Volcker Rule, and the bank’s investments may qualify the bank for Community Reinvestment Act credits.  

Financing comes quickly 

SBIC funds can arrive more quickly than funds from other sources because SBICs can borrow $2 to $3 from the SBA for every dollar they have from private capital. This allows the SBIC to quickly raise funds that it can use to invest in portfolio companies. 

Flexible fund structure and repayment terms 

Investment groups can form different types of SBIC funds based on their goals. They can also use the 10-year debenture to finance various types of investments in small businesses.  

Financing a small business through an SBIC 

SBICs can play an important role in helping small businesses that want to grow significantly and are having trouble finding financing that matches their goals.  

Many lenders don’t offer equity investments to small businesses, and some businesses may be too small to appeal to venture capital funds. But if a small business qualifies, and the business owner is looking for a large loan or equity investor, they could use the SBA’s SBIC directory to identify SBICs that are actively investing and could be a good fit.  

Working with an SBIC doesn’t always make sense, so business owners should remember to compare their options. They might want to get a business line of credit or small business loan if their business is having cash flow problems or if the owner wants to make a large business purchase. Online small business lenders can also be especially helpful if a business owner values a traditional application, financing, and repayment process.