The Small Business Administration and the Defense Department are expanding an arrangement to foster new companies with national security technology. The latest joint effort is called the Small Business Investment Company Critical Technologies Initiative. SBA even has a brand new financial instrument. For the details, the Federal Drive with Tom Temin talked to SBA Associate Administrator Bailey DeVries.

Interview transcript:

Tom Temin
Tell us about the Small Business Investment Company Critical Technologies Initiative. That’s a lot, a mouthful. What is it designed to do?

Bailey DeVries
Yes. So we of course have an acronym for it, SBICCT. But yes, the underpinning of it is the SBIC program. I’ll give a little bit of background on that. The SBIC program was established in 1958, in response to a report published by the Federal Reserve Board. Acknowledging the important role of small businesses and startups in our country’s economic vitality, and also a lack of adequate sources of private equity and long term loan funds, to support the creation and growth of such businesses. So over the years, the program has helped to crowd more private investment into small businesses and startups in the U.S., well over $120 billion. Last year alone, the SBIC program contributed to about $8 billion of transaction financing for small businesses and startups. But it truly is a public-private partnership program where the U.S. government licenses and partners with private funds, that then work closely with small businesses and startup to help provide them with access to capital and networks and resources to grow and sustain their businesses. Their program currently is over $38 billion of committed public and private capital.

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Tom Temin
Did you say this goes back to 1958?

Bailey DeVries
1958.

Tom Temin
That’s almost as old as I am, but a lot older than you are. Tell us about the new features then, that are being launched now with you and [Defense] Secretary Lloyd Austin.

Bailey DeVries
What we are currently doing is partnering with the Department of Defense and their newly established Office of Strategic Capital. Which will seek to support bringing more innovation into the DoD and addressing those capital access challenges. And so this initiative is one of the first priority initiatives for the Office of Strategic Capital, in which we will take our long standing partnership, that we have had for many years, through the [Small Business Innovation Research (SBIR)] program. And look at ways that we can work together to license private funds, that will be focused on investing in technologies that have been identified as critical to U.S. national security. Really excited about that. So it is very directed. And we believe that by having this focus and intentionality around a particular area of the market and seeking to bring our capabilities and authorities together. That we will be able to increase the flow of private capital going to parts of the market, where we know that there’s constraints and limited capital available.

Tom Temin
And I wanted to ask you about that new financial instrument that is called Accrual Debenture. Like a type of bond, I guess? What is that?

Bailey DeVries
Yeah, historically, the SBIC program has pretty much offered what I’ll call one financial instrument, which is a debenture that requires repayment of interest on a semiannual basis to the SBA. So what is this? So a private fund raises money, they go to invest that money in portfolio companies, small businesses. The SBA would provide a loan to the fund. And the traditional loan that we provide has a requirement for semiannual interest payments. That is great for certain types of investment strategies, that might be investing in more mature businesses and businesses that are seeking to use a combination of debt and equity. But what we know is for more of the frontier tech, deep tech, early stage innovation and scale up investments that we know will be required in various industry sectors and technology segments, that these are long-term investments where semiannual interest payments might not work. So we are launching a second financial instrument under the SBIC program. That is our intention. It is called the Accrual Debenture. And that would be available to private funds that are interested in pursuing the SBIC’s critical technologies license, that may have more long duration investments.

Tom Temin
So they have to pay back a debenture, eventually though, correct?

Bailey DeVries
Eventually, yes. So the way it is designed, is that the interest would accrue has been named Accrual Debenture. The interest would accrue over the life of the loan to the fund. And our requirement would just be that when there is a liquidity event in the funds, a portfolio company is sold, fully exited, or partially exited, and there’s a distribution made to the investors in the fund, that a pro rata distribution of interest in principle would be made back to the SBA.

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Tom Temin
And just out of financial curiosity, what would happen if the company found another debenture that they could have your debenture subordinated to? Or is that not allowed?

Bailey DeVries
That is not permitted. Yes, that’s correct.

Tom Temin
We’re speaking with Bailey DeVries. She’s associate administrator of the Small Business Administration’s Office of Investment and Innovation. And these types of companies, since 1958, there has been the development of an enormous venture capital industry, especially on the west coast, but really, it’s national now. How do you identify companies that can’t simply go to the private venture markets and get funded that way?

Bailey DeVries
It’s an excellent question, we would assert that is not the role of the federal government, the SBA, to be identifying and selecting those companies. And that is why through the SBIC program, and with the SBIC Critical Technologies Initiative, we work with private sector partners, who have the deep relationships, and the skills, and knowledge and experience to source and perform due diligence on appropriate investments for these funds. What we do know, is that there’s a broad market trend within venture capital, where there certainly is not a lack of capital for what we might call a B2B SaaS companies. Companies that have strong recurring revenue profiles are capital light, there’s money flowing in those areas. But what we do know, is that there’s not adequate funding going to those investments that require a lot of upfront capital, that might be really long duration. Where it can be a long time until you are in a position to have strong recurring revenue streams or great customer diversification. But what we also know, is that those are some of the common themes and trends that we see in the volunteer areas, that are most vital to national security, most vital to climate change mitigation, are most vital to energy needs in the energy transformation, and also the transformation of our industrial base in this country. So a lot of common themes. And we believe that by partnering with the private sector, to effectively deploy capital into these areas, and to do so in a structure that has economic incentives for the investors, that we can position to increase the flow of capital into these critical areas.

Tom Temin
Climate and all of these different areas are nice. The military has a lethality and readiness mission, that I think still trumps the rest of it. And suppose someone could start a company for which there is very little commercial market. Say, a heavy duty drone that is capable of firing a 50 millimeter round. Only, maybe law enforcement, but only the military would need a thing like that. I’m just making that up. Would they, such a company be a good candidate? And how could you ensure that actually results in that revenue stream, from something the Defense Department would want and would buy?

Bailey DeVries
That’s an excellent question. And again, I would go back to either the overarching principle here, is that the role of the SBA is to support catalyzing the public private partnerships with private funds that then would select the portfolio companies that they would provide capital to. It is aligned to the mission of the DoD and work with the Office of Strategic capital in a number of different ways to support the success of companies that would be vital to our national security. So the role of the SBIR Program Office, in that equation, would be the due diligence, vetting, monitoring and regulatory oversight of the funds. So those asset management firms. So that way, they can effectively partner with the Department of Defense on their mission.

Tom Temin
It sounds almost as if in this context, the SBA is almost a funding broker more than a original funder of in loaner of money.

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Bailey DeVries
We provide a loan to the funds. It is a match on the private capital, and thats the way the program has worked for many, many decades. Many funds often actually think of us more akin to be being one of their largest LPs, although we’re not a limited partner ourselves. It is it is alone. But in many ways, we sit in a seat, very akin to that of a large institutional limited partner in a private fund.

Tom Temin
All right. So you’re just getting started with this, anything in the pipeline yet? The announcements only a few weeks old.

Bailey DeVries
It’s tremendously exciting. It has been wonderful, the amount of interest that we are hearing from the national security community. From the venture capital community and also from lower middle market investment community, as well around ways that they might be able to support the mission. There’s akin interest from our office and also from the Department of Defense Office of Strategic Capital, in hearing feedback and receiving input from industry right now. So that way, we are able to set a strong foundation as we go forward with this very exciting partnership.

 

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