New Source of Limited Partner Capital: SBA Proposes $1 Billion Investment Allocation

June 30, 2010

The House of Representatives recently passed legislation for the Small Business Early-Stage Investment Program (the SBIC Early-Stage Program). A revival of the Participating Securities Program, the SBIC Early-Stage Program will provide $1 billion in grants for certain control and non-control equity investments. The SBIC Early-Stage Program intends to provide assistance to capital-starved small businesses with special attention to small businesses in nine designated industries, including: energy technology, agricultural technology, life sciences, environmental technology, digital media, clean technology, defense technology, photonics technology and information technology. The SBIC Early-Stage Program will combine funds from the Small Business Administration (SBA) with private capital to increase available equity funding and reduce small businesses’ reliance on traditional asset-based lending.

Under the SBIC Early-Stage Program, the SBA will make one or more equity commitments to a participating fund, with aggregate financing not to exceed the lesser of the fund’s private capital or $100 million. Each commitment from the SBA under the SBIC Early-Stage Program may be drawn on (i) for new investments during a 5-year investment period; and (ii) for follow-on investment and management fees during a 10-year period commencing on the date of the first drawdown. All SBA commitments made in connection with the SBIC Early-Stage Program must be made within 2 years of the date on which funds are appropriated for the SBIC Early-Stage Program.

The SBA will receive a limited partnership interest in exchange for its investment allocation. This interest will not entitle the SBA to control or voting rights, but will entitle it to a pro rata portion of distributions made by the SBIC fund to all investors. All distributions are to be made in cash. The SBIC Early Stage Program also caps the carried interest held by fund managers at 20 percent.

Participation in the SBIC Early-Stage Program is open to any entity approved by the SBA. Interested applicants will be required to submit (i) a business plan describing how the applicant intends to make successful venture capital investments in small businesses in the early stages of development, (ii) the applicant’s venture capital qualifications and the backgrounds of those individuals who will be responsible for investment management, and (iii) a description of how the applicant meets the targeted criteria. Current SBIC fund managers will benefit from an abbreviated application process.

The SBA will conditionally approve select applicants within 90 days after receiving their applications. Consideration will be given to several criteria, including:

  • the likelihood that the applicant will meet the goals specified in its submitted business plan;
  • the likelihood that the applicant’s investments will create or maintain jobs, directly or indirectly;
  • the character and fitness of the applicant;
  • management experience and background, including with respect to a track record of profitability;
  • the extent to which the applicant will focus investments in early-stage small businesses;
  • the likelihood that the applicant will be profitable; and
  • the extent to which the applicant will invest in small businesses within targeted industries.

SBIC fund managers with partnerships or management that conform to SBA-approved models will receive final approval no more than 30 days after satisfying certain additional conditions. All other approved applicants will be approved within 90 days. Failure to meet conditions in a timely fashion may result in revocation of conditional approval.

The Private Equity Practice at McGuireWoods LLP is dedicated to keeping our clients advised of new legislative and business developments as they occur. We are continuing monitoring the landscape so that we may assist clients as soon as possible with the preliminary application and licensing process. If you have any questions regarding these issues, please feel free to contact Mark A. Kromkowski (312.849.8170), your primary attorney at McGuireWoods LLP or any of the authors.