Podcast Summary: E171 - SBIC Funds: How to Raise $175 Million for Private Equity & Credit Funds

Title: How I Invest with David Weisburd
Episode: E171: SBIC Funds: How to Raise $175 Million for Private Equity & Credit Funds
Release Date: June 6, 2025
Guests:

• Brett Palmer, President of Small Business Investor Alliance
• David Demeter, Managing Director at Davidson College Endowment

1. Introduction to SBIC Funds

In this episode, host David Weisburd delves into the intricacies of Small Business Investment Company (SBIC) funds, exploring how they raise substantial capital—up to $175 million—for private equity and credit strategies with government support. Brett Palmer and David Demeter join the conversation to shed light on the mechanisms, benefits, and attractiveness of SBICs in the investment landscape.

2. Performance of SBICs vs. Other Funds

David Demeter highlights a pivotal study by the Institute for Private Capital, a consortium comprising esteemed universities like Duke, UNC, Stanford, and Chicago. The study revealed that SBICs outperform their non-SBIC counterparts significantly.

David Demeter [00:39]: "SBICs outperform non-SBICs by about 4% on a net IRR basis and 0.68x on an MOIC basis, showing meaningful outperformance against the Burgess benchmarks."

This superior performance positions SBICs as attractive options for institutional investors seeking robust returns in the private investment space.

3. Government Leverage and Its Benefits

A key advantage of SBICs is the leverage provided by the Small Business Administration (SBA), which significantly amplifies returns for both General Partners (GPs) and Limited Partners (LPs).

David Demeter [01:58]: "The government leverage amplifies returns for both GPs and LPs, allowing small funds to scale and providing LPs with leveraged returns on their investments."

SBICs typically operate with a leverage ratio of 2:1, meaning for every dollar of private capital raised, an additional two dollars are borrowed from the government. This structure enables funds to manage portfolios effectively while enhancing potential returns.

4. Focus on the Lower Middle Market

The lower middle market emerges as a focal point due to its inherent inefficiencies and growth potential. SBICs thrive in this segment by professionalizing small businesses and driving substantial value creation.

David Demeter [11:10]: "In the lower middle market, there's more inefficiency and a lot of the things our GPs do—like building out management teams and establishing KPIs—create significant value."

This market segment offers numerous opportunities for growth, making it an attractive area for investment through SBICs.

5. Growth and Expansion of SBIC Funds

The SBIC program has seen remarkable growth, expanding from $2 billion in assets in 2008 to over $50 billion today, with projections suggesting an additional $15 to $20 billion influx in the near future.

David Demeter [06:13]: "Since 2008, SBICs have grown from about $2 billion in assets to north of $50 billion, with significant growth expected to continue."

This expansion is fueled by increased private credit market activities, regulatory changes limiting traditional banks, and a growing recognition of the lower middle market's potential.

6. SBICs in Private Equity and Private Credit

SBICs are versatile, encompassing both private equity and private credit strategies. Fund managers with proven track records can leverage SBIC funds to enhance their investment capacity and returns.

David Demeter [07:54]: "SBICs are used for both private equity and private credit funds, requiring managers to have a successful investment history aligned with their SBIC strategy."

This dual capability allows SBICs to cater to a broad range of investment preferences within the private capital sphere.

7. Structural Alpha Achieved by Davidson’s Investment

David Demeter explains how Davidson College's endowment leverages SBIC funds to achieve structural alpha, enhancing returns through strategic use of leverage.

David Demeter [08:40]: "SBICs outperformed their Burgess benchmarks by about 4%, and the leverage amplifies these returns, offering LPs net levered returns that surpass gross unlevered returns."

This approach not only boosts returns but also diversifies the investment portfolio, mitigating risks and enhancing overall performance.

8. Challenges and Licensing Process

Becoming an SBIC-backed manager involves a rigorous licensing process, ensuring that only experienced and reputable fund managers gain access to government leverage.

David Demeter [24:26]: "The licensing process requires experienced fund managers with a proven track record, thorough due diligence, and typically takes about a year, posing a significant barrier to entry."

Additionally, SBICs must adhere to strict investment criteria, such as exclusively investing in U.S.-based small businesses, which can deter some potential fund managers.

9. Portfolio Construction at Davidson

Davidson's investment strategy employs a barbell approach, heavily allocating to hedge funds (35%) and venture capital (25%), alongside SBIC funds (20%). This diversification aims to balance high-risk, high-reward investments with more stable, leveraged SBIC investments.

David Demeter [28:40]: "Our hedge fund program, comprising about 35% of the endowment, focuses on low beta and low correlation strategies, allowing us to take on more risk while maintaining diversification."

This strategic allocation seeks to maximize returns while managing overall portfolio risk through a mix of asset classes.

10. Future of SBIC Funds

Despite the growth, SBIC funds face limitations in scaling due to their smaller fund sizes, which can exclude larger institutional LPs. However, ongoing efforts to raise leverage caps and increase awareness among diverse LP bases signal a promising future for SBICs.

David Demeter [21:28]: "We're working with Congress to raise leverage caps, enabling larger investments and attracting a broader range of LPs, which will drive further growth in the SBIC program."

As awareness and regulatory support continue to evolve, SBICs are poised to play an increasingly significant role in the private investment landscape.

Conclusion

Episode E171 of "How I Invest with David Weisburd" provides an in-depth exploration of SBIC funds, highlighting their superior performance, leveraged return benefits, and strategic focus on the lower middle market. Through insightful discussions with Brett Palmer and David Demeter, listeners gain a comprehensive understanding of the mechanisms that make SBICs a compelling option for institutional investors seeking to optimize their private equity and credit strategies.

For those interested in exploring SBIC funds further, the Small Business Investor Alliance (www.sbia.org) serves as a valuable resource, offering information and matchmaking services for both GPs and LPs.

Notable Quotes:

• David Demeter [00:39]: "SBICs outperform non-SBICs by about 4% on a net IRR basis and 0.68x on an MOIC basis."
• David Demeter [01:58]: "The government leverage amplifies returns for both GPs and LPs, allowing small funds to scale and providing LPs with leveraged returns on their investments."
• David Demeter [06:13]: "Since 2008, SBICs have grown from about $2 billion in assets to north of $50 billion, with significant growth expected to continue."
• David Demeter [08:40]: "SBICs outperformed their Burgess benchmarks by about 4%, and the leverage amplifies these returns, offering LPs net levered returns that surpass gross unlevered returns."

Resources:

• Small Business Investor Alliance: www.sbia.org