Accrual and Reinvestor Small Business Investment Companies (SBICs)
December 15, 2023
Accrual and Reinvestor Small Business Investment Companies
(SBICs)
The Small Business Administration (SBA) administers
Reinvestment Act (Title VIII of P.L. 95-128, as amended).
several programs to increase access to capital for small
These regulatory advantages have led some venture capital
businesses. Among those is the Small Business Investment
funds to seek an SBIC license but not draw on SBA
Company (SBIC) program. Under the SBIC program, the
leverage. These nonleveraged SBICs are often affiliated
SBA provides capital at favorable terms to SBA-certified
with banks, who are mainly attracted to the program for the
venture capital funds who agree to invest in small
regulatory incentives and use their own funds to make
businesses.
investments.
Congress and the SBA have expressed interest in the
In FY2023, SBICs reported financing 1,208 small
composition of SBICs and of the portfolio of SBIC
businesses for a total of $8.1 billion: $5.2 billion (65%) was
investments. In July 2023, the SBA finalized a rule,
debt only, $2.0 billion (24%) was equity only, and $0.9
effective August 17, 2023, that created two new types of
billion was debt with equity features.
SBICs. Accrual and reinvestor SBICs have access to a
special SBA funding instrument intended to increase
The SBA’s September 2023 SBIC program report identified
program investment diversification and patient capital
318 SBICs, of which 256 (81%) were debenture SBICs and
financing.
53 (17%) were bank-owned or nonleveraged SBICs. Of the
financed companies, 228 (19%) were located in low- to
SBIC Program Background
moderate-income (LMI) areas, and 82 (7%) were woman-,
The SBIC program is a long-standing SBA initiative
minority-, and/or veteran-owned businesses.
intended to increase the amount of medium-term and
equity-based financing (such as stock or partnership
For more information about the SBIC program, please see
interests) available to small businesses. In the SBIC
CRS Report R41456, SBA Small Business Investment
program, a private venture capital fund submits a detailed
Company Program.
application to the SBA, demonstrating that the fund’s
managers have extensive successful investment experience
Accrual SBICs
and a viable strategy of investing in small businesses. If
The SBA’s July 2023 final rule (88 Federal Register
initially approved by the SBA, the SBIC then must raise
45982) created accrual SBICs. Accrual SBICs are SBICs
sufficient private capital to be viable (generally $5 million)
that receive SBA financing from an accrual debenture. In
before submitting a final application for an SBIC license. If
the final rule, the SBA stated accrual SBICs are intended to
given final approval by the SBA, the SBIC license-holder
“increase program investment diversification and patient
may draw leverage from SBA funding sources.
capital financing.”
Currently, most SBICs receive SBA funding through a
Accrual debentures are debt securities for which the SBA
standard debenture, or debt securities. The SBA guarantees
guarantees 100% of the debenture principal and interest
100% of the debenture principal and interest payments with
payments. Unlike the standard debenture, semiannual
the full faith and credit of the U.S. government, allowing
interest payments are not required, and thus the entire
SBICs to borrow at favorable interest rates. For most
principal and all accrued interest payments are due at
standard debentures, SBICs can access $2 in SBA leverage
maturity.
for every $1 in private capital, up to $175 million in
leverage. The SBA has the discretion to approve up to $3 in
In the SBA’s October 2022 proposed rule (87 Federal
leverage for every $1 in private capital. The SBIC must
Register 63436), the SBA stated the belief that most SBIC
make interest payments on the debenture every six months.
financings include a debt component due to a need for an
The principal is repaid in its entirety when the debenture
SBIC to quickly generate positive cash flow to make the
matures in 10 years.
required semiannual interest payments. The SBA therefore
asserted that the flexibilities offered by an accrual
SBICs have other regulatory advantages. They are exempt
debenture align more closely with the cash flows of an
from certain Securities and Exchange Commission
investment strategy focused on longer-term equity
registration requirements for investment advisors. SBICs
investments.
are also exempt from the “Volcker Rule” in Section 619 of
the Dodd-Frank Wall Street Reform and Consumer
Accrual SBICs are not required to make any payments
Protection Act (P.L. 111-203), which prohibits banks from
before the debenture’s maturity date. However, if an accrual
conducting certain investment activities. SBIC investments
SBIC makes any distributions to private investors, it must
are also presumed to be qualified for the Community
pay a portion to the SBA. The regulations specify a
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Accrual and Reinvestor Small Business Investment Companies (SBICs)
distribution waterfall. First, the SBIC must pay all annual
business is one at least 50% owned, controlled, and
charges and accrued interest. Second, the SBIC must repay
managed by individuals who are socially or economically
the SBA leverage principal in an amount at least
disadvantaged. Identification with certain racial and ethnic
proportional to the SBA’s share of the SBIC’s total capital.
groups establishes eligibility as a disadvantaged business.
Only then may the SBIC distribute any remaining amount
Other individuals can establish eligibility by demonstrating
to private investors, and it must report the distribution to the
social or economic disadvantage by submitting a narrative
SBA.
justification (for social disadvantage) or personal financial
statements (for economic disadvantage).
Accrual SBICs have a lower leverage commitment multiple
than standard SBICs. Whereas standard SBICs can
In the proposed rule, the SBA said it was “expanding this
generally access up to $2 in SBA leverage for every $1 of
provision [to] significantly help improve [the SBIC
private capital, accrual SBICs may only access $1.25 in
program’s] footprint in underserved communities.”
SBA leverage for every $1 of private capital. Since
Additionally, the SBA said the change would “[help] SBA
leveraged investing is a relatively risky investment strategy,
grow its emerging fund manager pipeline.”
limiting the leverage multiple may reduce the SBA’s risk of
loss.
Cost Estimates for Accrual SBICs
Equity-based investments are generally riskier than debt-
In the proposed rule, the SBA sought to limit accrual SBICs
based investments. Therefore, a greater focus on equity
to only SBICs that committed to investing at least 75% of
investments may increase the risk of program losses that
their total financings (based on dollar amount) in equity-
could require higher participant fees or appropriations from
based investments. The SBA stated that it recognized that
Congress to cover.
this would restrict participants’ investment strategies, but it
believed that the equity investment requirement was a
The SBA provided information on its cost estimates for
reasonable trade-off for the SBA’s increased risk with
accrual SBICs in the final rule. The SBA acknowledged
accrual debentures. The SBA did not move forward with
that accrual debentures have “a higher default risk profile
the equity investment requirement in the final rule, with the
and net loss rate” compared with standard debentures. For
stated goal of giving program participants greater
the FY2024 cohort, the SBA estimates a lifetime default
flexibility.
rate of 36% of disbursements for accrual debentures
(compared with 17% for standard debentures) and a lifetime
Reinvestor SBICs
recovery rate of 68% of defaults (compared with 80% of
The SBA’s July 2023 final rule created reinvestor SBICs,
standard debentures).
which are SBICs that “provide a meaningful percentage of
equity capital investments to underserved small business
The SBA is statutorily required to charge an annual fee on
reinvestors” (13 C.F.R. §107.720(a)(2)(i)). In turn, the
debentures at a level that ensures the program has no
business that makes the reinvestment may only invest in
federal credit subsidy (15 U.S.C. §683(b); for the SBIC
small businesses that generally would have been eligible to
program, the primary cost is defaults). The fee varies each
receive an investment directly from an SBIC.
fiscal year based on program performance expectations.
Given the expected higher cost of accrual debentures, the
Reinvestor SBICs issue the same accrual debentures as
SBA could maintain a zero subsidy cost in several ways. It
accrual SBICs. Unlike accrual SBICs, reinvestor SBICs are
could charge a separate and higher annual fee for accrual
eligible for an SBA match of up to $2 in SBA leverage for
debentures, as it did for the Participating Securities
every $1 in private capital (equal to the match for standard
program. Alternatively, the SBA could consider accrual and
SBICs). Therefore, reinvestor SBICs similarly are not
standard debentures together for budgetary accounting, and
required to make any payment on the debenture before
charge a higher annual fee on all debentures. If the risk of
maturity. However, they must follow the same repayment
standard debentures did not change, then this would allow
waterfall as accrual SBICs if they want to distribute
cross-subsidization between the standard and accrual
earnings to private investors before the debenture’s
debenture programs. Standard SBICs would pay a higher
maturity date.
fee than their expected risk would require, while accrual
SBICs would pay a lower fee than their expected risk would
Standard SBICs must invest in small businesses directly—
require.
they are not permitted to invest in entities that will reinvest
or relend the funds. Under previous regulations, there was a
The SBA is charging the same annual fee for both standard
limited exception for investments in disadvantaged
and accrual debentures. For all debentures issued in
businesses that are reinvestors or relenders. The general
FY2024, the annual charge is 0.129% for the life of the
prohibition prevented SBICs from pursuing “fund of fund”
debenture. This is more than the FY2023 charge of 0.047%,
investment strategies, which may offer advantages due to
possibly as a result of adding accrual SBICs. However, the
greater diversification.
FY2024 charge is less than the FY2022 charge (0.173%)
and the FY2002-FY2019 average (0.625%).
The “underserved small business” concept is broader than
the “disadvantaged business” concept. Underserved small
Anthony A. Cilluffo, Analyst in Public Finance
businesses include disadvantaged businesses, as well as
businesses in rural and low- to moderate-income areas, and
IF12551
businesses owned by women or veterans. A disadvantaged
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Accrual and Reinvestor Small Business Investment Companies (SBICs)
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https://crsreports.congress.gov | IF12551 · VERSION 1 · NEW