The SBA’s revamped SBIC program has some emerging managers pursuing it as a means to augment fundraising
When capital began to become more and more scarce in 2008 and 2009, Francisco DeJesus, a partner with Dallas-based 21st Century Group LLC, knew it was time for a strategy change. Business was far from “usual,” with the capital markets drying up and the national economy rocked hard by recession.
“At the lower to middle range of the market, debt capital completely disappeared,” recalls DeJesus, who defines that “range” as including companies whose sales vary from $5 million to $10 million. Those opportunities are the meat and potatoes for leveraged buyout firms like 21st Century, which participate in the form of debt security in such transactions.
“We also control the equity,” DeJesus says. “That’s one way that we take advantage of the yields while giving sellers confidence in our ability to put together complete transactions.” But even the most comprehensive approach to the small and midsized market wasn’t taking hold in 2009. With the markets in a decidedly uncooperative state, 21st Century began investigating new funding options. During that exploratory stage, DeJesus and his team pinpointed the SBA’s Small Business Investment Company (SBIC) program as a good potential alliance for the firm.
Breaking it Down
Since 1959, SBICs have supplied equity capital, long-term loans and management assistance to qualifying small businesses. The program’s goal is to improve and stimulate the national economy in general and the small business segment, namely by stoking and supplementing the flow of private equity capital and longterm loan funds. The SBIC’s mission is accomplished through the following means:
• Licensing top fund managers with exceptional deal flow;
• Seeking participation from major private investors;
• Managing risk to taxpayers through standardized risk management procedures;
• Communicating understandable program ground rules;
• Offering funds time to develop results, given the cyclical nature of venture investing; and
• Focusing on profit maximization.
In addition to investing capital, SBICs provide hands-on involvement in their portfolio companies, including board participation, corporate governance, strategic planning and marketing, recruitment, financial support, capital raising and company exit support. Since its inception, the SBIC program has put more than $56 billion into 100,000 small firms.
Currently finishing up its SBIC application process, 21st Century may soon get a share of that capital, plus the support that comes along with it. DeJesus says the firm kicked off the application process by attending a preliminary meeting with the SBA, and then talking to its investors about the potential market opportunity.“We walked through the process with the SBA to make sure we understood the program and how to apply for it,” he says.
DeJesus’ next step was to fill out a Management Assessment Questionnaire (MAQ). The MAQ consists of SBA Form 2181, together with the Exhibits in SBA Form 2183 (both are available on the SBA website).“The MAQ is very similar to what you would get from a pension fund, with some extra questions in it that are specific to the U.S. government and the SBIC program,” he says.
The firm was then invited to attend an SBIC management presentation, where 21st Century’s participation strategy was laid out for the approval committee to either approve or deny. “There’s no in-between, they just make a decision,” DeJesus says.After getting a thumbs-up, 21st Century moved onto the second step, which the SBA calls the “formal licensing phase.”
The SBIC formal license application consists of the same SBA Form 2181 used in the MAQ (to be updated by the applicant as needed), together with the exhibits found in SBA Form 2182. Exhibits include (but aren’t limited to) a legal proceedings questionnaire; business experience and education of principals; declaration of significant investors; and an organizational chart.
So far, DeJesus says the application process has been seamless, and hasn’t presented any significant challenges or surprises.“From our point of view, everything has gone exactly as planned,” he says.“We submitted what we needed to submit, the SBA answered us like they said they would, and we moved onto the next step. It was pretty simple.”
If and when 21st Century’s final stamp of approval comes from the SBA, DeJesus says the firm’s SBIC business will serve as a “drop down” to its existing private equity activities. “We’re not looking to turn our company into an SBIC; we’re just taking a portion of the capital,” he says. “On the strategic side, we see an opportunity to provide both debt and equity to middle market companies, and we think that the SBIC program will help us achieve that goal.”
The fact that emerging managers like 21st Century are warming up to the idea of the SBIC program comes as no surprise to Lawrence Manson Jr., chairman and CEO at NexGen Capital Advisors, a Chicagobased firm with offices in Washington, D.C., and Seattle. In existence since 2008, NexGen helps banks (among other institutional investors) ferret out interesting, high-quality, investment opportunities. It just so happens that SBICs are a CRA-eligible investment.Banks that have assets greater than $277 million have a CRA investment requirement that generally represents more than 1percent of total assets.
As part of its mission, NexGen has developed a proprietary, pre-packaged fund-of-fund of SBICs and also helps SBIC sponsors develop financial institution marketing strategies. “We’re in the market, raising a $100 million fund and, in turn, have agreed to invest that capital in as many as eight SBICs,” says Manson, who sees the SBA program as a great way to augment Private Equity firms fundraising.
“Sponsors really need to think about the SBIC platform as an alternative to, or augment for, their current fundraising activities,” Manson says.He sees licensing as the top challenge for private equity firms looking to become SBICs. He adds that having a strong track record that’s aligned with a thoughtful business plan can go a long way in helping applicants secure a license.
The process can take anywhere from four to six months or longer to complete, says Manson, noting that the SBA considers those applications with the greatest likelihood of success first. “It’s not necessarily first come, first serve. If the SBA believes that you can raise capital, or if you already have capital committed, it will improve the likelihood and speed at which you get through the licensing process.”
Citing Goldman Sachs’ need to access leverage from the federal government, Manson says the SBIC program is a natural choice for emerging managers looking to gain an edge in a competitive capital-raising environment. “The money essentially comes from the same place. The SBIC doesn’t have to drive 100 percent of your firm’s strategy, but it can definitely be a valuable component of it.” EDM