One of the great, unsung heroes of impact investing is the U.S. Small Business Administration and its Small Business Investment Company program (SBIC).
That's right -- a government agency.
Since 1958, the SBIC program has been providing publicly-guaranteed leverage to privately-owned and managed investment funds for the purpose of capitalizing small businesses, defined broadly as having up to 500 employees or $21.5 million in revenues, depending on industry sector. The program currently oversees more than 300 SBA-licensed funds with over $18 billion in capital -- $9.4 billion from private investors and $8.8 billion from SBA leverage commitments.
The program is having something of a renaissance. More than $3 billion was channeled to over 1,000 small businesses in 2012, the most ever. Thirty new funds were licensed.
Just as exciting, however, is what the SBIC program tells us about impact investing. Why? Because the overall program has characteristics that look similar to the way some investors approach investing for social benefit alongside market-rate financial returns, particularly large institutions, through emerging manager initiatives. This is above and beyond the $1 billion carve-out for an SBIC Impact Investment Initiative created explicitly in 2011 for underserved places and priority market sectors.
Specifically, the SBIC program as a whole tends to support intermediaries that are smaller (90 percent of SBICs have less than $60 million in private capital at licensing), relatively diverse (in 2012, 24 percent of SBIC applicants were women- or minority-managed), and invest outside of the more established private equity markets in the west and northeast (around 45 percent of SBIC financings from 2008-2012 were outside of the Pacific states, New England, the Mid-Atlantic, and the West South Central including Texas).
Because the program is so large and transparent, its performance provides a critical touchstone and some invaluable insights. Namely:
- Size matters a great deal. SBIC funds with less than $25 million of private capital (in addition to SBA leverage) underperform, financially. Larger funds delivered an average IRR of 13.7 percent to private investors from 1998 to 2006, versus 1.0 percent for smaller funds. Moreover, the SBA has lost almost none of its investments in SBICs with more than $17.5 million in private capital. This compares to losing 6.2 percent of its investments in funds with $10-17.5 million in private capital and 15.2 percent of its investments in SBICs with between $5-10 million.
- Investment strategy matters also. Among funds with over $25 million of private capital, the most successful were buyout funds, of which fully 50 percent were in the top quartile of all buyout funds, as measured by Preqin, with a median private investor IRR of 22.5 percent from 1998 to 2006. Larger mezzanine debt funds also performed relatively well, with 19 percent in the top quartile of all mezzanine funds with an IRR of 22.9 percent, and 41 percent in the second quartile with an IRR of 10.9 percent.
- A double bottom line focus does not undermine financial performance. According to the SBA, there is no correlation between the financial performance of SBICs, as measured by their loss rates, and the concentration of their investment portfolios in low- to moderate-income communities.
These findings are important for sure, and just three among a treasure trove.
But there's also a larger story here. Simply put, the SBIC program is extremely well-managed and a credit to the role of government in impact investing. Application processing time for SBICs has been reduced to around five months, from almost 15 months in 2009. And the program continues to be self-sustaining, operating at no cost to the taxpayer.
The SBIC program is not perfect. It does little to direct capital to new entrepreneurs, reinforcing the need for urgent solutions to the challenge of investing at the earliest stages of a company's development. Just 4 percent of new SBIC licensees in 2011 and 2012 were venture funds.
However with impact investing emerging as a valid, scalable, and complementary response to some of the growing social needs for which government has limited resources to address, the SBIC stands out as an example of exceptional, low-cost, public/private partnership.