On October 19, the U.S. Small Business Administration (SBA) published proposed rules in the Federal Register to significantly amend the regulations governing the Small Business Investment Company (SBIC) program. The proposal, titled “SBIC Investment Diversification and Growth,” is open for comment by the public until December 19, 2022.

According to the SBA’s press release , the proposed rule “seeks to address structural aspects of the SBIC program which have historically limited the flow of SBIC regulatory capital to small businesses and startups not adequately served by private investors alone” and is designed to “reduce barriers to program participation for new SBIC fund managers and funds investing in (i) underserved communities and geographies, (ii) capital intensive investments, and (iii) technologies critical to national security and economic development.”

One of the most significant changes in the proposed rules is the creation of “Accrual SBICs” and “Accrual Debentures.” An Accrual SBIC fund will be a new type of fund licensed by the SBA that is focused on making long-term equity investments that do the following:

  1. Invest at least 75% of its total financings (based on dollar amount) in “Equity Capital Investments.”
  2. Will generally own no more than 50% of the small business concern at initial financing.
  3. Elect at the time of licensing to issue Accrual Debentures.

If enacted, the Accrual Debenture will be a new type of debenture issued by the Accrual SBIC fund at face value that accrues interest over ten years, at which point the accrued interest and principal are due. This contrasts the standard Debenture in which interest payments are due and payable semi-annually.

Only Accrual SBICs would be authorized to issue Accrual Debentures. If the Accrual SBIC cannot repay the principal and accrued interest after the ten-year maturity, it may apply for a five-year rollover Accrual Debenture. The SBA would guarantee the principal and all accrued interest of the Accrual Debenture.

According to the SBA, its intent in creating the Accrual SBIC and Accrual Debenture is to provide an alternative borrowing structure that “is constructed to align with the cash flow patterns of equity-oriented investment funds and longer-duration strategies” as it noted that SBIC funds focused on making equity investments, as opposed to those focusing on debt or credit strategies, currently only represent approximately 18% of leverage under the SBIC program.

If you have any questions about the SBIC program and how the proposed rules may affect your business, please contact one of the authors.