IVCA Profile Q&A: Alan Roth, Chairman of Wildman Harrold's SBIC Practice Group

IVCA Profile Q&A: Alan Roth, Chairman of Wildman Harrold's SBIC Practice Group

January 20, 2010

CHICAGO - “  Alan Roth, the Chairman of Wildman, Harrold, Allen & Dixon LLP's SBIC Practice Group, sat down with the IVCA to explain this landscape and how his firm cuts through the sometimes complex licensing regulations associated with the SBIC agenda.
 
IVCA: What opportunities are there for funds or companies to participate in SBICs?
 
AR: Any fund or group of funds that has a strong track record, a cohesive management team, and an interest in investing in domestic small businesses should consider applying for a license. The dislocation of the financial markets and the contraction of credit available to lower middle market companies has created an opportunity for experienced fund managers to make investments in the lower middle market with excellent risk adjusted returns. Fundraising, however, continues to be a challenge for many groups. The two to one leverage available from the SBA to licensed SBIC funds remains one of the few readily available sources of capital. In addition, the application process has been streamlined for current SBICs seeking to have a second fund licensed. As a result, a qualified fund can be licensed in as little as 60 days after raising private capital.
 
IVCA: What type of Equity and Debt programs does the SBA operate for small businesses and what is difference between the two concepts?
 
AR: Until 2004, the SBIC program provided capital in two primary forms: Participating Securities, which made the SBA a preferred limited partner and were most effective for funds that primarily made equity investments, and the Debentures, which require semi-annual interest payments and are thus more effective for funds with debt investments generating income to service the debentures. In October 2004, the Participating Securities program stopped licensing new funds. Since that time, the Debenture program has become increasingly flexible. It now licenses a variety of funds, from those with straight mezzanine debt strategies to those with hybrid debt and equity strategies. There is currently legislation pending in Congress that would create a new program to license funds providing equity financing to certain qualified small businesses.
 
IVCA: The new administration has been in place for nearly a year. How has it affected the SBIC initiatives or operations?
 
AR: The Obama Administration appears to be dedicated to the continued growth of the SBIC program, pushing money out to new businesses, creating revenue and ultimately increasing the tax base. The administration's appointees to run the SBA tend to have significant investment experience and have already made changes to improve the program, making it more attractive for fund operators, yet maintaining the high standards for licensing qualifying groups. For example, SBA has enacted a ""Fast Track"" licensing process to accelerate licensing for second funds. In addition, the SBA responded to the difficult fundraising environment by extending from 12 months to 18 months the period that funds have to raise sufficient private capital for funds that are invited to apply for an SBIC license. In addition, SBA is temporarily permitting debenture funds to submit applications that include service SBA debentures with additional leverage in some cases. These changes show a willingness to work with the investment community that has frequently been absent in the past.
 
IVCA: It is interesting that so much has been done in such a short time with the administration. Do you find that SBIC programs are generally a bi-partisan effort? Have they ever been politicized in the past?
 
AR: Both political parties have had different philosophical approaches to the program but most everyone recognizes that small business is the lifeblood of job growth in our economy and in that regard there has been bi-partisan support to fund the SBIC program. I think it became obvious over the past few years that the program needed to be more agile and timely in its approval cycles, while still protecting the taxpayers dollars. The Obama Administration put a very strong team in place that was able to remove some unnecessary obstacles at a very early stage in the new administration. Those steps, and the attractive source of capital the SBIC offers, have made the program very active in the past year.
 
IVCA: Did the bailout process of the last year include more funding of SBICs? Is the government focusing more on this type of small business outreach?
 
AR: The stimulus legislation included many changes intended to make government funding available to small businesses, including increases of government funding to SBICs and SBIC funding to individual companies. Under the new rules, the maximum amount of funding that an individual SBIC may obtain from the SBA increased to $150 million, and the maximum amount of funding that a group of related SBIC funds may have outstanding increased from $137.1 million to $225 million. In addition, the SBA increased the amount that an SBIC may invest in a single portfolio company. When put together, these changes result in more government funding to small businesses through SBICs.
 
For the fiscal year that ended 9-30-09, SBIC did 2697 financings, with an aggregate dollar amount of $1.86 billion dollars. While this represents a decrease from the year before, it created more capital for small businesses, addressing a void that was not being met by the markets.
 
IVCA: Are there any upcoming rules or changes to SBICs in 2010 that investors or small businesses need to aware of?
 
AR: The Stimulus Act made several changes to the SBIC program in 2009, including increases in the amount of funding available to SBICs and the amount an SBIC may invest in a single portfolio company. In 2010, the SBA will likely be focused on the effective implementation of the Fast Track Process (discussed above). Additionally, the SBIC community will continue to lobby Congress to enact legislative improvements to the program such as the implementation of the new equity program, discussed above.
 
IVCA: Of these four categories - “ Transactions, Regulation/Compliance, Taxes and Fundraising - “ what are two that generate the most issues in SBIC practice groups and why?
 
AR: Regulation/Compliance and Transaction generate the most issues in SBIC practice groups, and both for the same reason. The SBIC regulations contain detailed requirements on the nature and types of investments that can be made and the make up of an SBIC's portfolio. The regulations on size, affiliation, overline investments, and cost of money limitations can often require the input from experienced regulatory counsel. In the current environment we have also seen an increase in the number of funds needing experienced counsel to help them navigate the SBA's financial covenant regulations. While these covenants are often similar to the types of covenants found in traditional financing arrangements, the scope and nature of remedies available to the SBA in the event of a ""covenant default"" are unique to these arraignments, and often unfamiliar to fund managers and investors more accustomed to traditional banking arrangements.
 
IVCA: So what kind of guidance are your clients generally looking for in regards to regulation/compliance and/or the transaction?
 
AR: In challenging times like these, you sometimes have to be creative to get deals done. SBIC regulations add a layer of complexity on top of business, tax, legal and relationship concerns in structuring transactions. Some terms that appear regularly in non-SBIC deals are not permitted for SBICs. We regularly work with our clients to craft solutions that get them where they want to be from a business and legal perspective and that also comply with SBIC regulations. These situations can arise in fundraising, making and exiting investments and ordinary fund operations. Our long-standing relationship with the SBA helps us as we work to create and secure SBA approval of novel transaction structures for our clients.
 
IVCA: What do most people still not understand about SBIC practice groups such as Wildman Harrold?
 
AR: A good SBIC practice requires expertise in both SBIC regulatory matters and general fund formation, operations and transactions. SBICs are governed by a complex web of statues, regulations, and published and unpublished interpretations, and these rules affect many aspects of a fund's operations. The SBA often provides two times a fund's private capital, but so large an investment comes with rules that must be followed. There are very few groups in the country that have enough experience in this area to provide efficient and effective counsel to SBIC clients.
 
But understanding the SBIC world also requires a deep understanding of private equity and mezzanine funds in general, of which SBICs are a part. A practice like Wildman Harrold's is able to provide our clients with a high level of service because we have extensive experience in both areas, and our attorneys know how those practice areas overlap and complement each other. Our deep experience with SBICs and traditional private equity and mezzanine funds, enables us to better understand and communicate how the SBIC regulatory framework affects what fund professionals are accustomed to doing, and we are able to help our SBIC clients relate more effectively to their investors and other parties such as the SBA.
 
IVCA: What are the advantages and disadvantages of being a Midwest based firm?
 
AR: The Chicago market is one of the nation's great legal markets and draws work as sophisticated as anywhere in the country. We benefit, however, from a lower cost structure than the New York and other legal markets. This translates into a bonus for clients in that they can get experienced, sophisticated representation at a reduced cost. While we work with clients across the country, we have a natural geographic and cultural connection to our Midwestern clients that gives us an advantage in our home market.