Owners of privately held companies generally finance their businesses with their own capital, augmented with bank loans. An additional source of funding for Government Contractors is available from a Small Business Investment Company (SBIC).
The Small Business Investment Company Program was established by Congress in 1958 to supplement the long term capital, both debt and equity, available to small businesses. The SBICs are privately owned and managed investment funds, regulated and licensed by the U.S. Small Business Administration (SBA). With the SBIC licenses, SBICs can raise public funds at low cost by issuing SBA guaranteed debentures and are allowed to leverage up to three times the private capital they are able to raise. Despite certain SBA requirements for investment, working with SBIC is not much different from working with any other private equity firm or mezzanine lenders.
To be eligible for SBIC investment, the business must have a tangible net worth of no more than $18 million and an average of $6 million or less in net income over the previous two years at the time of investment. A business may also be deemed “small” based on its industry using SBA Size Standard. Most government contractors meet this requirement.
SBIC provides capital in one of three forms: loans, debt with equity feature and equity. According to the SBA quarterly update on SBIC program, the majority of SBIC financings use the first two forms. However, the majority of financing for government contractors with median annual revenue of $14MM use debt with equity feature which is also known as mezzanine debt. This debt is subordinate to bank loans and is based on the business cash flow. This provides the government contracting business owners an additional source of funding for acquisitions, change of ownership or recapitalization.
In addition to the cost benefit, this capital strategy adds the necessary capital for a company to grow with little to no dilution to the business owners
- Secure More Capital: Financing with a Bank loan is often limited by available collateral. Mezzanine debt with its subordination feature, interest-only period and sometimes deferred interest payments or payable in kind interest (PIK) is treated as equity from banks’ perspective; for this reason, the proposed bank loan amount could be higher with this additional equity-like capital. In the end, the company is able to obtain more capital.
- Retain the Control and Ownership: Mezzanine lenders’ investment horizon is typically up to five years; their goal is not to be a long term shareholder. Whether there is an equity feature such as a warrant or not, a typical mezzanine lender wants to achieve a target return over some specified time and payback the SBA guaranteed debenture that funds the investment.
The most important criterion for the SBIC mezzanine investor is the ability of its client to generate the required cash flow. This means the mezzanine investment applicant must have an established business with a competent management team, proven past performance, a strong contract backlog and potential pipeline. If these criteria describe your business, layering mezzanine debt with bank loans in your capital structure may provide the necessary funding to meet your strategic objectives.
Access National Bank is a business bank with dedicated bankers experienced in working with government contractors having $1 to $100 million in revenue. With our commitment to the Government Contracting Industry and our understanding of the business cycle of companies like yours, we stay on your side throughout the changes in the economic environment with the financing solutions to support your strategic goals. John McManus is an SVP, Relationship Manager and Linh Phu is an AVP, Commercial Lender in the Government Contractor Lending Group at Access National Bank.