SBA Issues Proposed Rules for Impact SBICs

In the February 3 Federal Digest, the U.S. Small Business Administration (SBA) issued proposed rules affecting Impact Small Business Investment Corporations (SBICs) and is accepting comments. In addition to codifying the existing, temporary guidelines, the proposal would add new investment certifications, change the expedited processing benefit for reduced fees and replace the branding penalty for non-compliant SBICs with the threat of imposed default.

The SBIC program enables the SBA to license funds that invest in small businesses to issue debentures that effectively leverage two public dollars[*] for every dollar of private investment. Standard SBICs are comparable to private equity or mezzanine finance funds and achieve similar returns. At various times, the SBA has been authorized to license special types of SBICs in order to achieve targeted investment goals.

In 2011, as part of the White House's Startup America initiative, the SBA dedicated the Impact Investment Fund and authorized the Impact SBIC as a new license type. The designation recognizes that the fund is committing to make at least 50 percent of its investments for social impact, which can be met through SBA-identified targets or according to SBA-approved fund-identified targets. To date, seven SBICs have received the Impact license. 

The Impact Investment Fund was initially designed with a five-year term and is now being made permanent. To this end, the SBA's proposed rules are primarily intended to codify existing practice but do introduce several changes. The most direct is the addition of the G4 Sustainability Standards and the Sustainability Accounting Standards Board to the currently accepted Impact Reporting and Investment Standards that SBA will permit to assess fund-identified impact investments. Another modification would allow SBICs to seek Impact and Early Stage Innovation licenses simultaneously, in an attempt to encourage the number of funds targeting both social impact and very early stage businesses.

Other changes in the proposed rules seem to modify the cost-benefit equation for seeking an Impact license. Under current guidelines, the primary benefit of the Impact SBIC license, as provided by the SBA, is expedited application processing. The proposed rules would replace the expedited processing with a reduction in fees the SBA describes as "not material." The current penalty to licensees that fall below the 50 percent investment threshold is the removal of the "Impact" designation and processing preference. The proposed rules would also give the SBA the ability to put an Impact SBIC that did not meet the investment threshold into default, although this penalty could only be applied to SBICs with outstanding leveraged debentures. 

The context for these proposed rules makes the cost-benefit imbalance in the proposed rules particularly noteworthy. SBA estimates that Impact SBICs will have 3 percent greater losses than traditional licensees. Funds that define their own impact targets will have annual assessments costs up to 10 times greater than the expected fee reduction benefit. Together, the potential costs to licensees seem to run much higher than benefits. Further, the SBIC program's recent efforts to target investments for social impact have not been particularly successful. Since the end of Specialized SBIC licenses in 2011, the proportion of low- to moderate-income (LMI) businesses receiving investments has decreased by one-third. Similarly, the Federal Register notes that SBA's target debentures for LMI businesses have been used rarely and energy savings debentures have not been used at all. 

Comments on the proposed rules can be submitted to the SBA through March 4 online at www.regulations.gov or through the mail. SSTI intends to host a conference call on the proposed rules for interested members. Contact SSTI at 614.901.1690 about participating.