SBICs: Deja Vu All Over Again

Joseph W. Bartlett, Founder of VC

The more things change, the more they stay the same. A couple of recent developments allow me to expose the contrarian streak which routinely influences my thinking. First, as we all know, interest rates are as low today as they have been since JFK was President. One of the interesting consequences of that phenomenon was exposed, to me anyway, in a recent conversation with Ralph Carmichael. Ralph and his organization manage private equity funds and he was discussing a new fund he was in the process of organizing. He mentioned that he was planning on applying for a license for the fund to function as an SBIC. I routinely remarked, "Oh sure, the participating securities program, I assume." I had in mind the highly successful program stimulated by thinking from Alan Patricof and Pat Cloherty in the early 90s which allows the SBA to license SBICs and provide capital in the form of preferred stock versus debentures, the idea being that the preferred stock nature of the investment would in turn allow the licensees to invest long term in, for example, venture capital opportunities where the chances of cash flow in the early stages are remote and therefore, the contribution of capital in the form of debt inappropriate.

I simply assumed Carmichael had that program in mind like 450 (or so) private equity funds which have taken advantage of government capital structured as equity and in turn have made equity investments.

Carmichael responded that, to the contrary, he was planning on applying under the traditional debenture program. This brought back memories. When I started in this business back in the very early 60s, several of the capital providers were in fact SBICs and I think particularly of Memorial Drive Trust which drew down capital in the form of debt and in turn invested debt and equity in venture opportunities. The reason that Memorial Drive and others could function were two-fold. First, since there were a lot more opportunities than there were professional VCs, the venture capitalists could follow the definition of early stage which was passed on to me by my mentor in this business, Bill Elfers: "Early stage means cash flow breakeven" meaning in turn that the VCs would pick firms which had ability to service some debt, and make a bundled investment of debt and equity in the firm.

Secondly was the fact that interest rates were so low that the debt burden was not severe. Since the SBIC did not pay the government much in the way of an interest coupon, it could afford to re-lend the debt portion of the investment to a portfolio company on terms the company could afford, even though it was still in its immature stage.

And, of course, that is the opportunity Carmichael sees with, say, a mezzanine fund that invests in later stage venture opportunities or in buyouts. Debt is now a realistic element of the financial package because interest rates have returned to the levels which existed when Memorial Drive Trust was organized. As they say, deja vu all over again.