Small Business Investment Company (SBIC)

Small businesses and other young companies often raise outside funding to help support their growth or otherwise finance their operations. Small Business Investment Companies (SBICs) can be a critical source of that funding for U.S.-based companies that meet certain criteria. 

What is an SBIC?

A SBIC is a type of private investment company—an investment fund—that can provide debt and/or equity financing to small businesses and startups. All SBICs are licensed and regulated through the Small Business Administration (SBA). Many different types of investment funds can and do register as SBICs, including venture capital, private equity, and private credit vehicles. 

Like traditional private funds, SBICs raise some of their capital from traditional limited partners (LPs), who invest in SBICs for the purpose of generating a financial gain. Unlike traditional funds, SBICs are also eligible to raise additional capital from the SBA through government-guaranteed loans, which can be used as leverage to help boost a fund’s potential returns. These loans typically come in the form of debentures, a type of long-term debt instrument that is usually unsecured. 

Another potential benefit for fund managers is that SBICs are eligible to raise capital from banks, who invest in SBICs as a way to gain exposure to private markets and improve their standing under the Community Reinvestment Act (CRA). Banks are not allowed to invest as LPs in traditional VC, PE, and private credit funds. 

From a policy perspective, the purpose of the SBIC program is to stimulate private investment in small businesses. The SBA operates on the fundamental principle that small businesses have a critical role to play in building and maintaining a dynamic economy, with SBICs serving as a key tool for providing financial support and operational guidance to American entrepreneurs.

Since they frequently raise capital from the U.S. government, in the form of guaranteed loans, SBICs are more closely regulated than traditional VC, PE, or private credit funds, with specific reporting requirements and regulations around the types of companies they are allowed to back. 

The SBA also regulates the amount of leverage that SBICs are permitted to take on. An SBIC can raise a maximum of $175 million in debt funding for a single fund or $350 million across multiple funds. The most common type of SBIC (called a standard debenture SBIC) is required to maintain a debt-to-equity ratio of no greater than two to one. 

Eligibility for SBIC funding

In order to raise capital from a fund that’s managed by an SBIC, a small business must meet certain criteria related to its size, its location, its planned use for the investment, and other factors. 

• Size: Eligible companies must meet the SBA’s definition of a small business. In most cases, this means companies with a tangible net worth of less than $24 million and average net income of $8 million over the preceding two years. Most manufacturing companies with fewer than 500 employees and less than $7.5 million in average annual receipts also qualify as small businesses. The SBA lays out specific size standards by industry for each industry described in the North American Industry Classification System (NAICS). 

• Location: Eligible companies must be based in the U.S. If more than 49% of a company’s employees or tangible assets are located outside the U.S., it is ineligible for SBIC funding. 

• Type of business: SBICs are restricted from investing in several industries or companies pursuing certain business models. These restrictions include real estate businesses, banks or other lenders, and companies related to gambling or speculation. 

• Use of funds: Eligible companies must plan to use the capital they raise from an SBIC fund to support business growth in some way, such as supporting operations or financing some type of expansion. Companies cannot raise SBIC funding to support passive investments or pay out dividends to shareholders. 

• Ownership: The vast majority of companies that raise capital from SBICs are privately held. 

Benefits of an SBIC fund

For both fund managers and LPs, using SBICs to invest in small businesses can offer a few distinct advantages. 

Perhaps the main benefit of investing through SBICs is the ability to use government-backed loans as leverage, which can lead to higher returns. The use of leverage allows investors to write larger checks than they would be able to with equity alone. If those leveraged investments are successful, they can produce commensurately larger gains. A report by the Institute for Private Capital found that, from 2000 through 2020, SBIC funds outpaced comparable non-SBIC funds in key performance metrics like internal rate of return (IRR) and multiple on invested capital (MOIC). 

In addition to improved performance, access to this sort of debt capital means that managers typically spend less time fundraising for an SBIC fund than a traditional VC or PE fund. This can allow investors to spend more time with their investments and help them deploy capital more quickly. SBICs are also exempt from both standard SEC registration and the Volcker Rule.

Another major benefit for fund managers is that SBICs are able to raise capital from banks, which are not legally permitted to invest in traditional private funds. For fund managers, this ability to access a potential new source of capital may be especially attractive considering the tightening of the fundraising environment that has occurred across the private markets since 2022. 

Many banks are eager to invest in SBICs as a way to gain financial exposure to the private markets, allowing them to diversify their own investment portfolios. Investing in SBICs can also be a way to improve regulatory standing under the CRA, a U.S. law enacted in 1977 as a way to encourage investment in low- and moderate-income areas. All FDIC depository institutions are assessed every few years for compliance with the CRA. Investing in certain SBICs may help banks improve their ratings in these assessments.

For banks and other LPs, investing in SBICs can be a way for investors to diversify and derisk their portfolios. Depending on the strategy of the fund, SBICs may provide access to a different slice of the private market than traditional VC, PE, or private credit. 

Types of SBIC funds

The SBIC program issues a few specific licenses to different types of SBIC funds. These types of funds can vary in a few key areas, including the types of loans they can receive, the way they pay back those loans, and their investment strategy.

Standard debenture SBICs

The most common type of SBIC fund is a standard debenture SBIC. These funds primarily invest by raising government-backed debt capital in the form of debentures and then using that capital to make debt investments in small businesses. The interest on these government-backed loans is semiannual, meaning that SBICs make two interest payments per year. Most loans issued to SBICs have a standard 10-year term.

In terms of an investment model, standard debenture SBICs are designed to align with the cash-flow timelines of private credit and other strategies that measure success by their IRR.

Accrual SBICs

The primary difference between standard debenture SBICs and accrual SBICs is related to interest payments. While standard debenture SBICs make semiannual payments to service the loans they receive from the government, accrual SBICs aren’t required to make any payments on either the principal or the interest of a loan until the loan matures in full. This aligns accrual SBICs more closely with longer-duration investment funds that don’t focus on annual performance. 

Accrual SBICs have a maximum leverage ratio of 1.25x, which is lower than the maximum leverage ratio of 2x for standard debenture SBICs. As with standard debenture SBICs, the typical term length on loans made to accrual SBICs is 10 years. 

Reinvestor SBICs (fund-of-funds SBICs)

Instead of investing directly in small businesses themselves, reinvestor SBICs use the capital they raise to invest in funds managed by other investors, following a standard fund-of-funds model. Funds with a reinvestor SBIC license raise debt funding through the accrual debenture instrument, which means that repayment is not due until maturity, and they typically have a leverage limit of 2x. A reinvestor SBIC must invest at least half of its available capital in other underlying funds. 

Non-leveraged SBICs

SBIC funds that do not apply for debt funding from the SBA and instead invest only the equity capital they raise from other LPs are called non-leveraged SBICs. As an investor, structuring a fund as non-leveraged SBIC rather than a standard investment fund can still have several advantages, including the ability to raise capital from banks, improved market credibility (because the fund is licensed by the government), and potential tax credits for certain investors. 

About the SBIC program

The SBIC program was created as part of the Small Business Investment Act of 1958 as a way to foster investment in young companies during the rapid post-war economic expansion of the Eisenhower years. 

In its own language, the legislation declared that the purpose of the program was “to stimulate and supplement the flow of private equity capital and long-term loan funds which small-business concerns need for the sound financing of their business operations and for their growth, expansion, and modernization, and which are not available in adequate supply.” The SBIC program is administered by the SBA, which was founded in 1953. 

Since its founding, SBICs have combined to invest some $130 billion across nearly 200,000 small businesses, according to the SBA. As of Sept. 30, 2024, there were 318 licensed SBIC funds within the U.S. Many of these SBICs are managed by experienced investors and company operators, such as venture capitalists, private equity managers, and asset managers. 

In its latest fiscal year, the SBIC program issued nearly $4 billion in debenture commitments to qualified SBICs. 

SBIC in the market

The U.S. has expanded the SBIC program in key ways in recent years, including the introduction of new licenses for accrual SBICs and reinvestor SBICs in 2023. Thanks in part to these additions, interest in the SBIC program has begun to surge. 

Recent growth

From 2019 through 2023, investors submitted an averaged of 35 applications each year for new SBIC licenses. In fiscal year 2024, that number rose to 127 applications, up 285% on a year-over-year basis. 

The SBA is still adjusting to this upswing in interest. Among those applications, there were just 33 new SBIC licenses issued in fiscal year 2024, a 27% increase from the previous year. At the same time, the average time to process a new application has spiked, climbing to nearly a year. This backlog of pending applications means that the number of new SBICs in the market could be poised to swell in the years to come. 

Breakdown of SBIC fund types

Official government data categorizes each licensed SBIC fund into one of five fund styles. These styles describe the type of investment that each of these funds primarily pursues. 

Just over 69% of SBIC funds are hybrid funds, making this the most common of the five types. These funds are hybrid in the sense that they can make both debt and equity investments in small businesses; each of the other four fund types is focused on one of the two. Many of these hybrid funds specialize in mezzanine investing, which often involves debt instruments that can convert to equity in the future under certain conditions.

The next most common category is private credit funds, which comprise 15.6% of SBIC funds. Some of these funds pursue mezzanine investing, but the majority build their investment strategy around direct lending. 

Another 7.8% of SBIC funds are venture funds, which focus on equity investments in young companies. Many of the venture funds registered with the SBIC are managed by established venture firms that are also experienced in running non-SBIC funds.

Lastly, some 3.9% of SBIC-registered vehicles are private equity funds, and another 3.6% are growth equity funds. Both of these fund types are centered around equity investments, with private equity funds tending to prefer more mature target companies. Combined, there are less than two dozen registered SBIC funds focused on private equity and growth equity. 

How to become an SBIC

In order to form an SBIC, an investor must apply for a license with the SBA. When reviewing these applications, the SBA looks at several criteria, including the applicant’s management qualifications, their investment track record, their strategic plan, and their proposed fund structure. Investors who receive SBIC licenses are often experienced private fund managers with a history of successful investment in small businesses.

Application process

The SBA recommends that first-time applicants to the SBIC program conduct a pre-screening review to assess their initial suitability. This optional step involves filling out a document called Prescreen Form 2181 (or Short Form 2181), which includes quantitative data about the proposed SBIC fund as well as longer prompts about the proposed fund’s strategy and the track record of the fund managers. Once submitted, the SBA provides informal feedback to applicants on each pre-screening. 

The first required step of the application process is to submit the Management Assessment Questionnaire (MAQ). This consists of a full Form 2181 (or Long Form 2181), which is a full version of the Short Form 2181 submitted during optional pre-screening, as well as various supplementary materials and the payment of an initial licensing fee. Within the SBA, legal counsel and a licensing analyst review each MAQ submission and then submit recommendations to the SBA’s investment committee on whether the application should be approved. 

If the SBA’s licensing team, legal team, and investment committee all agree that an applicant might be suitable, the investment committee brings in the management team for a formal one-hour interview. If all parties within the SBA still vote to approve an application, the applicant may submit a final license application. Once the fund holds a first close, it can be formally issued its SBIC license. 

Each SBIC must pay a licensing fee to become officially licensed. This includes a base payment plus an additional fee that’s dependent on the amount of leverage that the fund aims to deploy. 

Costs and timeline

The cost of applying for and receiving an SBIC license varies depends on the fund’s management team, investment experience, and fund strategy. The SBA categorizes each proposed SBIC fund into one of four fund sequences, with less experienced fund managers typically paying a smaller fee:

In its application, each SBIC fund lists the amount of debt capital it is requesting from the government, which is called the proposed total intended leverage commitment. To determine the full licensing fee owed, an SBIC takes this total intended leverage commitment, multiplies that figure by 1.25 basis points—or 0.000125, if expressed as a decimal—and adds the product to the final licensing base fee.

For example, consider an SBIC fund that proposes to use $50 million in government-backed debt capital and is the third fund in its fund sequence. The final licensing base fee for this fund would be $25,000. The total intended leverage commitment ($50 million) multiplied by 1.25 basis points gives us a product of $6,250. Add this to the base fee, and we get a total final licensing fee of $31,250. 

From 2019 through 2023, it typically took an average of six to eight months for the SBA to process an SBIC application. In 2024, as the number of SBIC applications rapidly increased, the average application timeline extended to 12 months. 

SBIC reporting requirements

Because they invest capital that they receive from the federal government, SBIC funds are subject to a stricter regulatory and reporting regime than typical venture capital, private equity, or private credit funds. This includes reporting to the SBA on both fund-level and company-level investment activity.

Form 468

Funds licensed by the SBIC must submit both a Quarterly Form 468 and an Annual Form 468 to the SBA. Both of these forms are audited financial statements that provide insight into the fund’s balance sheet and other fund-level performance, including metrics like income and portfolio company valuations. The SBA uses these forms to make sure that licensed funds are in compliance with SBIC requirements and regulations. 

Form 1031

Each time they make a new investment, SBICs must submit an accompanying Form 1031, also known as a portfolio financing report. This form includes business information about the target company, it’s current financial status, and details about the new financing, including the purpose of the investment. SBICs must submit a Form 1031 within 30 days of the end of the quarter in which the investment closed. 

How Carta supports SBIC funds

Reporting support

Carta’s platform supports the unique and demanding SBIC reporting regime. Furthermore, Carta’s brand and policy engagement may signal to the SBA that the fund is partnering with a credible and effective fund administrator that can help them manage not only normal fund operations but the more stringent SBIC demands. This can help during the application process as well as during the ongoing SBA engagements. 

Policy thought leadership

The policy framework for private funds continues to evolve, and the SBA and its SBIC program are part of that framework. Carta’s policy team serves as the connective tissue between the private fund ecosystem and policymakers—our team directly engages to inform policy outcomes, including testifying and working directly with the SBA to bolster programs. The Carta policy team also shares policy insights and opportunities with funds and stakeholders, helping them better understand and navigate everything from the licensing approvals to regulatory requirements to broader policy trends.