Investing In SBICs

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It's no longer news, but the concept of SBICs is rooted into our financial structure. This historical piece offers some great insight in this financial sector.

If you can’t afford the time necessary to develop your own portfolio or the expenses involved in professional management, a new investment vehicle called SBIC (Small Business Investment Company) might be your answer.

An SBIC is a finance company organized under the Small Business Investment Act of 1958. This was specifically designed to stimulate the growth of the nation's economy by supplying small businesses with private equity capital and long-term loans. In addition, SBIC's offer unique tax advantages plus a degree of leverage on invested capital not found in any other form of investment.

SBIC's have two unique built-in growth features: (1) a high leverage factor; (2) tax shelter. "The high leverage factor," in the words of Hanns E. Kuehner of Laird, Bissell & Meeds, "rests in the Act's provisions for an SBIC's capitalization. Private interests need a minimum equity of $150,000 of their own in order to obtain a like amount by selling 5 percent debentures to the SBA (Small Business Administration). Having thus a minimum paid-in capital of $300,000, an additional $ 150,000 may be borrowed at 5 percent from the SBA and four times the amount of paid-in capital or $ 1.2 million in private, nongovernmental funds. An original investment of $150,000, therefore, creates a borrowing as well as lending capacity of $1.5 million or 10 times as much."

In addition to this high leverage factor SBICs enjoy the following unique tax advantages as summarized by Filor, Bullard & Smyth analysts:

(1) Should a stockholder of a privately or publicly owned SBIC sell his shares at a loss, he may offset this loss against his ordinary income to the full extent of the loss, rather than as an offset against a comparable capital gain. This particular tax feature is of relatively greater significance to the individuals in the higher income tax brackets.

(2) Realized gains on the sale of SBIC shares are taxable at the usual capital gains rates, i.e., long or short term.

(3) Should an SBIC incur a loss on one of its investments, it may offset this loss against ordinary income instead of against capital gain.

(4) Any SBIC may elect to be taxed as a regulated investment company under the Investment Company Act of 1940. If such an election is made there is no corporate income tax on the amounts distributed to shareholders as ordinary dividends provided that at least 90 percent of the SBIC's gross income is derived from interest, dividends and capital gains, and is distributed to shareholders.

(5) Dividends received by an SBIC upon stock of a domestic small business concern are nontaxable (except in a year in which the SBIC elects and qualifies to be taxed as a regulated investment company).

No wonder the number of SBICs licensed by the SBA reached 260 by June, 1961, as compared with 175 at the 1960 year-end or only 61 at the 1959 year-end.

This dramatic growth of SBICs is basically due to the unprecedented demand for long-term equity financing by business concerns to keep pace with the rapid expansion in the nation's economy. Before the appearance of the SBICs, small companies had a difficult time in obtaining adequate financing. Realizing the vital importance of small business to the nation's economy, Congress passed the Small Business Investment Act of 1958, authorizing the establishment of a new type of small business banking institution—the SBIC.

Initially, an SBIC was allowed to finance small companies only through the purchase of convertible debentures or by making long-term loans. Now, they may invest through various other means: common stock, debentures with or without conversion features, some form of debt with common stock warrants. Formerly not allowed, investments can now be made in companies whose securities are traded on stock exchanges or over-the-counter.

Smart investors are always looking to the past for new ideas, hidden insights and lessons learned. The story of the SBICs is a good one to know if you plan on getting involved in any financial investment vehicles.

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