The Department of Defense (DoD) has long searched for ways to foster innovation in the defense industrial base by harnessing US comparative advantages like our capital markets and American technological innovation. The recent establishment of the Small Business Investment Company Critical Technology (SBICCT) Initiative aims to do just that as it adds another instrument to the DoD's tool belt in order to "build enduring advantages for the warfighter and for the taxpayer." Given the favorable terms offered, those looking to deploy capital should carefully review the benefits the SBICCT program has to offer.
On December 3, 2022, Secretary Lloyd Austin and the Small Business Administrator, Isabella Casillas Guzman, committed to a partnership that aims to advance the efforts of DoD's Office of Strategic Capital (OSC) and broadly outlined a plan to scale private investment in technologies of critical importance. In March of 2023, both Secretaries reaffirmed their partnership in Austin, Texas, signing a Memorandum of Agreement establishing the framework for the SBICCT program. On September 29, 2023, the DoD and SBA formerly announced the rollout of the new program.
The SBICCT initiative aims to bolster private capital investments in certain critical sectors that would strengthen US national and economic security and "increase private sector investment in component-level technologies and production processes vital to US national security interests." The initiative seeks to promote and support early investment in technologies that are critical to US national security which typically have high startup costs. It is managed by the SBA's Small Business Investment Company (SBIC) financing program which allows companies investing in small business to access low-cost financing.
Applicants who apply to operate as an SBICCT are given access to generous financing terms. Notably, these businesses can be issued a government-backed financial instrument known as the "Accrual Debenture," which the SBA says is "designed to align with the cash flow patterns of startups, and supports the long duration often required to incubate and scale technology investments." The Accrual Debenture, announced as part of a July 2023 final rule, allows the investment company to receive up to 1.25 times its qualifying investment in leverage. The maximum amount of principal SBICCTs may have outstanding is the aggregate of the total principal leverage and ten years of accrued unpaid interest on that leverage. In addition, while the debenture accrues interest over a 10-year term, the investment company is not required to pay back interest until after the 10-year term is up. Once the term is over, the company must pay the principal and any unpaid interest.
The SBA uses a similar financial instrument, known as a SBIC debenture, to assist private equity funds as they invest in small businesses. Unlike the Accrual Debenture, the SBIC debenture requires semi-annual interest payments. The difference is premised on the belief that the Accrual Debenture must be "designed to attract the patient private capital necessary to support these innovations."
Accrual Debentures are issued to long-term investors interested in equity investments which should bring new types of investors into the defense innovation ecosystem. In particular, the new Accrual Debenture should be enticing for private equity firms that are more growth-oriented and may not want to make semi-annual interest payments. In fact, on August 22, Bluestone Investment Partners announced it had finalized a strategic investment in Qualis Corporation, a missile defense and space systems company, using its SBIC fund. In June, Bluestone Investment Partners became the first fund to receive a license under the SBICCT initiative.
Going Forward
The SBICCT program and its new Accrual Debenture should be a popular financial instrument for certain venture capital and equity investors interested in long-term investments. Those private equity funds or investors that are ready to deploy patient capital should jump on the favorable terms offered by the program, especially with interest rates at their current levels. Whether it is through the Small Business Innovation Research (SBIR) program or Other Transaction Authorities (OTAs), for years, the DoD has attempted to increase investment in small businesses to promote innovation in certain technologies critical to economic and national security and the SBICCT initiative figures to be an important additional tool in their effort.
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