Capitalizing Main Street: The Past and Future of Small Business Investment Companies

Adam Smith’s invisible hand sometimes gets help from Washington’s visible one. A prime example of this is a little-known federal program that has helped fund some of America’s largest and most successful companies. Small Business Investment Companies (SBICs)—federally subsidized investment firms—invested in Apple, Tesla, and Intel before they became household names and funded retail giants such as Costco, Whole Foods, and Staples. Some have argued that these vehicles helped pave the way for modern-day venture capital (VC).¹ In 2024, SBICs invested $7.3 billion in American small businesses.²

SBICs are investment firms licensed by the Small Business Administration (SBA). In exchange for additional regulatory oversight and certain investment requirements, SBICs can borrow money from the SBA to launch their funds and invest. Their primary restriction is that they can only invest in small businesses, defined as businesses with less than $24 million in net worth or below the SBA’s size standards for their industry.³ This sets the SBIC program apart from many other government investment programs, which are typically narrower in scope.

At first glance, the SBIC program looks unusual. Why would the government give money to private equity or venture capital? The United States lacks the tradition of government equity investment found in countries such as France, Norway, the United Arab Emirates, and Singapore. While the United States has programs to spur investment, such as the chips Program Office in the Department of Commerce and the Loan Programs Office in the Department of Energy, these are loans for large businesses that historically did not involve equity stakes.⁴

In terms of programs for small businesses, the federal government has a science commercialization program in eleven agencies, and the SBA has loan programs to support small businesses. Missing between these two types of investment are programs meant for small businesses that want to grow. The SBIC program, in theory, is meant to fill that gap. Congress created the SBIC program in the 1960s primarily to fund innovative companies capable of producing technologies that would defeat the Soviets.⁵ Long removed from their Cold War origins, SBICs today solve an apparently more mundane but still vitally important problem: how to finance small businesses. Today’s variety of business financing options disguises the fact that easy access to capital is a recent development in American history.

A common thread tying these types of programs together is economic security. The chips Program Office was created to restore semiconductor manufacturing in America. The Loan Programs Office is meant to fund innovative energy technology. The Department of Defense is the biggest user of the Small Business Innovation Research program to turn ideas into technology that the military can use. Even the SBA’s loan programs have origins in efforts to ensure economic security: the SBA’s predecessor, the Smaller War Plants Corporation, was set up during World War II. New organizations and funding models show that the government is getting more involved in investment: Congress funded the Office of Strategic Capital, a Pentagon office that provides large loans to defense companies, through the 2024 National Defense Authorization Act.⁶

Then, in 2025, there were three groundbreaking events in economic security investment policy. First, the United States took a “golden share” in U.S. Steel as a requirement for Nippon Steel to buy out the company.⁷ A golden share is a type of stock that allows the holder, typically a government, to intervene on specific matters related to the running of the company. Second, the Department of Defense bought shares and became the biggest shareholder in MP Materials, a rare earth materials company.⁸ And third, the current administration took a 10 percent equity stake in Intel.⁹

The SBIC program, if it is to be effective in helping small businesses grow, needs to be refurbished for the twenty-first century. To avoid repeating past mistakes, however, one must know the history of the program and the problems it has encountered: these include issues arising from how SBICs raise money from the SBA, which has made it difficult for them to invest in innovative companies; and the story of how the SBA, in trying to solve the first problem, ended up losing billions in the dot-com bubble. Effective reform of the program also would require understanding SBICs’ investment patterns in order to determine whether or not they truly invest in the most innovative companies.

A Brief History of SBICs

Before the 1950s, venture capital did not exist. Commercial banks lent money, but they understandably would not finance pre-revenue ideas. Inventors commercializing new technologies either had to rely on inherited wealth or convince wealthy benefactors to invest in a speculative company. While investors made VC-like investments in automobiles, aviation, and electronics companies, it was only after World War II that firms recognizable as VCs began to appear.

After the war, the public and the federal government were both concerned about limited small business financing. During the Great Depression and World War II, government business financing was mostly focused on larger firms. President Herbert Hoover created the Reconstruction Finance Corporation (RFC) in 1932 to finance distressed businesses and stabilize the American economy. The RFC helped fund the New Deal recovery and industrial investment during World War II, but it fell into controversy after the war over claims of political favoritism, including accusations that politically connected companies received loans despite RFC officials’ objections.¹⁰ Facing charges of favoritism, Congress dissolved the RFC, but as a compromise, Congress passed the Small Business Act of 1953, which created the SBA to help provide small businesses with loans.¹¹

Even after the SBA’s creation, demand for small business financing persisted. A 1958 Federal Reserve study concluded that small businesses continued to have a financing problem.¹² The Fed identified new small businesses, and small businesses launching new products, as those with an unmet demand for capital.

Meanwhile, the Democratic opposition to President Dwight D. Eisenhower criticized his administration over its perceived lack of support for small businesses. Senate Majority Leader Lyndon Johnson led Democratic efforts to champion small business.¹³ Johnson proposed a bill that featured a government-controlled small business banking system to handle investments into small businesses. Eisenhower conceded the need for small business legislation, but he insisted on private sector involvement. Johnson, when speaking of the compromise version of the bill, called it “a significant program of aid to small business . . . that does no violence to free enterprise [and] does not raise the specter of Federal control of, and competition with, private business.”¹⁴ A second motivator for the creation of the SBIC program was the Cold War. After the launch of Sputnik by the Soviets, there was a massive need for investment in electronic equipment, which VCs could fund.¹⁵ In 1958, Congress passed a compromise version of the Small Business Investment Company Act, which created the SBIC program.

The program got off to a slow start because of awkward regulations.¹⁶ While SBICs could borrow from the SBA, the capitalization requirements made them too small to hire the staff they needed. Ownership caps also limited their ability to make follow-on investments. Despite these flaws, SBICs gained momentum in the mid-1960s during Silicon Valley’s first tech boom. SBICs helped spawn the first VC firms, including Sutter Hill Ventures, founded by William Draper III after he ran an SBIC. Draper credited SBICs with giving him the capital he needed to become an investor in the first place. Outside of Silicon Valley, another example of a successful VC firm that owed its existence to the SBIC program is Norwest Equity Partners, founded in Minnesota in 1961 as an SBIC.¹⁷ During this period, SBICs invested in companies such as Intel, FedEx, and Costco.

SBICs’ popularity cycled with market performance. Their formation peaked in the mid-1960s before crashing in the 1970s because of poor stock market conditions. The program became less popular as Congress added understandable but burdensome reporting requirements. Yet these increased requirements, along with a lack of oversight, created havoc for the SBIC program over the following decades.

SBICs surged in popularity in the mid-1990s because of regulatory changes to the program and the dot-com bubble. The Small Business Equity Enhancement Act, passed in 1992, created the Participating Securities program.¹⁸ This program aimed to make SBICs more effective in start-up investing. Unlike Debenture SBICs, which must make periodic interest payments to the SBA, Participating Securities SBICs only paid when they made money, giving the SBA a preferred return and profit share from successful investments. This structure enabled SBICs to invest in pre-revenue companies because they didn’t need immediate cash flow to service debt. By 1999, there were 332 SBICs, ninety-one of which were licensed as Participating Securities.¹⁹

The payment structure combined with equity investments set the SBA up for disaster. The dot-com boom and the Participating Securities program created a surge of new SBICs. Most failed within a few years because they invested in businesses whose stock crashed when the dot-com bubble burst. The program ended in 2004 after years of increasing losses. In total, the Participating Securities program cost $3.5 billion for the SBA.²⁰ In a study of the SBIC program in 2013, researchers found eighty-one Participating Securities SBICs still in liquidation.²¹

The Participating Securities disaster wasn’t the only controversy over SBICs. Lack of government oversight of SBICs in the late 1980s and early 1990s meant the SBA failed to track improperly managed SBICs and SBICs engaging in illegal activity. The Government Accountability Office (GAO) found that while the SBA could identify lawbreaking SBICs, it failed to pursue them.²² Poor staffing made matters worse: just twenty-nine employees oversaw 389 SBICs.²³ One low point involved an SBIC run by Arnold Kilberg, an accountant who ran multiple Rhode Island-based SBICs that were seized for unpaid debt and poor management.²⁴ Worse, Kilberg’s SBICs funded a housing development built by a member of the Patriarca crime family, and Kilberg himself served as accountant for Raymond J. “Junior” Patriarca.²⁵ SBICs are not allowed to invest in real estate, let alone real estate controlled by a member of the Mafia, and yet the SBA seemed oblivious to the abuse of the program.

SBICs also played a role in one of the biggest political scandals of the 1990s: the Whitewater scandal, which involved failed investments by Bill and Hillary Clinton and their associates. Failed investments aren’t criminal, but Bill Clinton’s friend Jim McDougal bought a savings and loan association and defrauded it, along with an SBIC, for millions of dollars.²⁶

The SBIC portion of the scandal was about questionable lending. Capital Management, an SBIC, gave a $300,000 loan to Jim’s wife, Susan McDougal.²⁷ Given that the McDougals had $3 million in assets, this violated the program’s requirement that loans be given to smaller businesses. In a 1995 congressional testimony, the GAO stated that the lack of oversight by the SBA allowed Capital Management to give to ineligible individuals and make illegal real estate investments.²⁸

Thankfully, Congress and the SBA cut their losses and reformed the program to prevent future embarrassments and financial disasters. Con­gress passed the Small Business Reauthorization Act of 2000, which required the SBIC program to achieve zero-subsidy status.²⁹ Under this requirement, the SBA must cover any losses by setting fees to ensure the program pays for itself. Next, to stop further bleeding, the SBA ended the Participating Securities program in 2024. The SBA has shown strong financial prudence with zero-subsidy: over the past twenty years, the program has returned profits to the U.S. Treasury. The SBIC program maintained its zero-subsidy status during the 2008 financial crisis. The SBA also tightened licensing standards, requiring applicants to demonstrate greater investment expertise.³⁰

Since the Participating Securities program collapsed, the program has only changed twice. During the Great Recession, the American Recovery and Reinvestment Act of 2009 (ARRA) made several changes to the SBIC program to encourage greater SBIC investment.³¹ First, leverage limits increased from $90 million to $150 million for individual SBICs, and from $150 million to $225 million for SBICs under common control.³² Second, ARRA created the smaller enterprises requirement, which says that SBICs licensed after 2009 must invest at least 25 percent of their future financing into smaller enterprises. These are defined as businesses with under $6 million in net worth. Finally, equity investment limits rose from 20 percent to 30 percent of any company.

While not radical, these changes helped SBICs invest more. Unfortunately, little public information exists on ARRA’s investment impact. Gauging SBIC program performance proves difficult for outsiders and even the SBA due to limited data.

The second, more important change came at the end of the Biden administration, when the SBA launched a new type of SBIC license: the Accrual license. This license was created through rulemaking and was an attempt to solve the Participating Securities program’s original problem while avoiding the failures that caused billions in losses.³³ Unlike previously, the SBA does not advance payments to the license holders. While semiannual payments are not required, SBICs instead must pay the entire principal and accrued interest payments by the end of the ten-year loan period.

The Accrual SBIC license program is notable because it is a venture into economic security-focused investment. Accrual licenses are the investment vehicle for a new partnership between the Department of Defense’s Office of Strategic Capital and the SBA: the Small Business Investment Company Critical Technology (sbicct) Initiative, which invests money into companies developing critical technologies.³⁴ The Office of Strategic Capital and SBA intend sbiccts to provide long-term, patient capital for companies with technologies that normal VCs avoid because of investment timelines, risk and return profiles, or capital requirements.

The SBIC program’s history offers clear lessons on congressional oversight and program implementation. Programs lacking proper congressional and agency oversight as well as thoughtful implementation create havoc, from political scandals to billions in losses. In contrast, thoughtful reform can transform fiascos into successes: the SBIC program has generated Treasury surpluses since the 2000s. While SBICs never became the VC funds Congress envisioned, they helped create the VC industry and funded numerous successful companies. The program proves the U.S. government can successfully administer financing programs targeting specific businesses and, through sbicct, specific sectors. This raises important questions: How do SBICs function today? What do they invest in? And why do they still attract interest?

Why SBICs Matter

Despite regulatory burdens and additional oversight, firms still seek SBIC licenses for several reasons. SBICs do not register with the Securities and Exchange Commission and only report their finances to the SBA. SBICs are exempt from the Volcker Rule, which restricts banks from investing more than 3 percent of their Tier 1 capital in private equity or hedge funds. This rule was created after the 2008 financial crisis to restrict the amount of speculative activity banks engage in to ensure that their customers aren’t harmed by such investments. Bank-run SBICs are not subject to the 3 percent capital limitation for private equity funds. This exemption can be very attractive to banks as it means they can invest a lot more capital into private equity. SBIC investments automatically satisfy the requirements of the Community Reinvestment Act, a law that encourages banks to meet the credit needs of low- and medium-income residents of the community in which a bank is based.

If an SBIC is located in a bank’s assessment area or does business in that area, the bank will get credit from investing in the SBIC. Bank-owned or non-leveraged SBICs operate in the SBIC program, with 15 percent of all SBICs in 2024 belonging to that category. Banks and other firms that had or have SBICs include JP Morgan, Silver Lake (Silver Lake Waterman), and Wells Fargo (Norwest Venture Partners). Out of the 318 SBICs that existed at the end of the 2024 fiscal year, fifty-two were either owned by banks or were non-leveraged SBICs.

If you are not a financial institution, the main reason to get an SBIC license is to acquire leverage to get the capital to invest in the first place. Leverage is the capital that SBICs borrow from the SBA to fund their investments. SBICs can borrow from the SBA up to 300 percent of their private capital (typically capped at $200 million), and individual SBICs face a $175 million leverage limit. How the SBA gets repaid from this leverage is simple: the SBA provides leverage to SBICs in the form of debentures, which are unsecured loans that require semiannual interest payments over ten years. Regular payment requirements push SBICs toward profitable companies. SBICs avoid pre-revenue companies because they need steady cash flow to service SBA debt.

The original setup of the debenture program is the key to the misalignment between a congressional intent to invest in new companies and the day-to-day reality of needing funds to pay off the leverage. The new Accrual license attempts to better align SBICs with start-up funding needs. Unlike the failed Participating Securities program, Accrual SBICs are designed to prevent another dot-com-like disaster, in which SBIC failures cost the SBA billions. Accrual SBICs avoid the problems that the Participating Securities had by using traditional debt that accrues interest over ten years instead of requiring periodic interest payments, reducing the risk of the SBA subsidizing failed investments. Repayment occurs either at the ten-year maturity or when the fund distributes proceeds to private investors, with SBA receiving a proportional share.

The SBA generates revenue from SBICs through leverage and fees. SBA charges a fee on outstanding debenture leverages, and there are processing fees for the services SBA provides to SBIC. These fees are how the SBIC program meets Congress’s zero-subsidy requirement. The SBA analyzes the rate of default and then sets the fee level to cover losses for failed SBICs.

Unfortunately, reliable SBIC data is scattered and discontinuous. The SBA’s last detailed SBIC report was in 2014.³⁵ It released a returns report in early 2025, but the data cannot be independently audited.³⁶ Current SBA data focuses mainly on fund types rather than investment details.³⁷ While detailed program data existed in the early 2000s, no equivalent public information is available today.³⁸ This data gap hampers policymakers’ understanding of SBIC investments. The SBA collects detailed investment data through required SBIC forms but keeps this information from both the public and Congress. To analyze the program, I used a mix of public SBA data, data from PitchBook on SBICs, and outside analysis of the SBIC program to verify my analysis.

Most SBICs are mezzanine capital funds, a fact that is confirmed by both the SBA’s fund list and PitchBook classifications. Mezzanine capital is between senior debt (traditional bank loans with first claim on assets) and equity. Firms repay this debt either with cash or in payment-in-kind (deferred interest payments added to the loan’s principal balance). Unlike regular debt, mezzanine debt often includes equity conversion features. Over the past decade, the average SBIC investment was $34.9 million.³⁹

SBA data and academic research prove SBICs deliver excellent returns. From 2013 to 2021, according to the SBA, SBICs averaged an internal rate of return (IRR) of 15.03 percent.⁴⁰ SBICs outperformed average private equity firms for seven of the nine years that the SBA tracked for its fund performance. The Institute for Private Capital, a private capital research group at the University of North Carolina, found that SBICs’ returns averaged 15.46 percent and outperformed comparable funds.⁴¹ It should be noted that IRR is a controversial metric because of the way it is calculated and its built-in assumption that distributions can be reinvested at the same rate of return. Both the SBA and the University of North Carolina, however, provide other metrics that show strong returns for SBICs.

The SBA provides return data, but it offers no contemporary breakdown of SBIC investments by category. To fill this gap, I analyzed SBIC funds using PitchBook data. Though PitchBook includes an SBIC filter, there were many false positives. To create a better dataset, I imported the SBA’s list of SBICs into PitchBook. This curated dataset reveals SBIC investment patterns.⁴²

By deal count, SBICs most frequently invest in businesses classified as “Other Commercial Services,” “Business/Productivity Software,” “Clinic/Outpatient Services,” “Media and Information Services,” and “IT Consulting and Outsourcing.”⁴³ Within “Other Commercial Services,” half of the deals are for industrial businesses ranging from HVAC companies to machine tool shops. The top three states for these deals are California (14.2 percent), Texas (8.9 percent), and New York (6.4 percent).

PitchBook data shows that SBIC firms pursue private equity-type deals over VC investments. It is through these rules that SBICs can engage in behaviors seen across the rest of the private equity industry, the most common being a leveraged buyout.⁴⁴ Like traditional private equity firms, SBICs pursue rollups, in which a portfolio company acquires smaller competitors to drive industry consolidation. SBICs completed 4.25 times more rollup deals in 2024 than in 2014.⁴⁵ Out of all SBIC deals, 24.09 percent were rollups.

These rollups span industries, from forming fast-food restaurant chains, consolidating dental practices, merging machine tool shops, and rolling up veterinarian clinics. Rollups aren’t inherently problematic. If consolidation creates value, investors have made smart decisions. The bigger question concerns the intent of the SBIC program. Is it meant to help companies invest in innovative companies or to provide cheap government loans to subsidize transactions that were going to happen anyway? The sbicct program suggests that policymakers favor the former approach, while current investment patterns indicate that the latter predominates.

Related to rollups are SBICs investing in companies larger than the SBA size limits. SBICs can invest in surprisingly large companies for several reasons. The size of a small business is defined by SBA standards, which can be larger than the $24 million net worth limit, and much larger than what people typically think of as a small business. Manufacturing businesses use employee counts as size standards, allowing companies with over 1,000 employees to count as small businesses.⁴⁶ Second, SBICs can continue financing portfolio companies even after they outgrow small business status.⁴⁷ This enables an SBIC to participate in the financial life cycle of a company, from initial investment to IPO. Third, SBICs are allowed to participate in financing deals involving large businesses as long as the SBICs are creating a small business as part of a corporate divestiture. These regulations allow SBICs to do rollup investment.

Despite regulatory burdens, well-performing SBICs can enjoy a healthy profit. If an SBIC earns more than the principal and interest owed to the SBA, it keeps the rest. This arrangement still benefits the SBA, even if it does not share in the upside. It receives loan repayments, not equity returns. Today, it mostly invests in SBICs in unglamorous industries that VCs ignore: dental chains, small manufacturers, and similar enterprises.

The sbicct program, with its use of Accrual licenses for equity investment, is an experiment in seeing whether the SBIC program can fulfill the original intent of Congress: funding small businesses that want to grow and produce innovative products. Given the current administration’s increased use of equity investment, the government seems a lot less concerned about “threatening free enterprise” than the creators of the SBIC program intended.

Improving SBICs

Main Street companies aren’t Sand Hill Road targets. They generally will not produce returns attractive to a VC fund, but many are still successful companies that need financing. Recent Congresses have introduced proposals to overhaul SBIC investing. For example, Senator Marco Rubio introduced the SBA Reauthorization and Improvement Act of 2019 to make SBA programs more effective at funding small businesses.⁴⁸ His proposed changes included creating new kinds of debentures: one focused on funding start-ups and another focused on manufacturing businesses that need patient capital.

The reauthorization died in committee because of disagreements between Democrats and Republicans on regulatory reform in the bill. While bills such as the American Innovation and Manufacturing Act of 2021 and the Made in America Manufacturing Finance Act of 2025 show continued interest in manufacturing funding, congressional interest in SBIC reform has declined.⁴⁹ The lack of interest is troubling because of the recent changes to the SBIC program with the creation of Accrual licenses. Congress needs strong oversight on the program to ensure that the Accrual program does not collapse like the Participating Securities program did in the 1990s.

Continued monitoring of the sbicct program is important, as well, to see whether sector-specific SBIC investing is useful. If the sbicct program succeeds, other special license programs involving the SBA and a domain-expertise-focused agency could be set up. For example, a focused SBIC program could be created for the energy sector that could collaborate with the Loan Programs Office in the Department of Energy. Unlike that office’s hundred-million-dollar loans, energy SBICs could provide smaller loans and equity to emerging energy companies. This would complement the department’s research and large-scale funding by financing companies that have moved beyond pure research but are not yet ready for hundred-million-dollar commitments.

In contrast, if the Accrual license program fails, Congress will need to rapidly wind down the program to make sure that the SBA does not suffer from unnecessary losses. There is no reason, considering the example of the participating securities program, that the SBA should lose money in the same way.

Smart oversight is required for the continued success of the SBIC program. Current program datasets are fragmented and disconnected. Program overview data doesn’t connect to IRR data, which in turn lacks the detail of the SBA’s previous comprehensive reports.⁵⁰ Why doesn’t the SBA publicly report the most common investment categories? Or compare returns between leveraged and non-leveraged SBICs? Or show how leverage is distributed across different SBICs? Without good data, Congress and outside groups cannot analyze the performance of the program. A harder data request, but important to justifying the program, would be a counterfactual analysis of the investment portfolio. Would the current portfolio of companies that SBICs invested in still receive investment if the program did not exist?

Another way to improve the SBIC program would be to cut regulations in the program for laws that are not in use or known to be in use. A rule of thumb should be that if a particular requirement is not easily verifiable by Congress or the public, it should go. For example, the Energy Saving Qualified Investment is a program to motivate investment into small energy companies. Unfortunately, it is impossible to know through public data how many companies benefited from this program. Even worse, because of the design of the program, few SBICs have even used it.⁵¹

A similar principle applies to the smaller enterprises rule. American lawmakers originally envisioned SBICs investing primarily in innovative technology companies. Historically, this meant companies such as Intel. Today, it would include companies such as Cloudflare and Cava. SBICs do invest in such companies, but they also fund food brands, pet food companies, and yoga studios. If a yoga studio chain is profitable with solid growth prospects, the investment makes financial sense. But funding yoga studios rather than innovative companies may stray from the program’s original intent.

Both Democrats and Republicans want America to build things again: semiconductors, nuclear power, and more. But beneath high-tech industries lie thousands of underappreciated businesses—machine shops, chemical manufacturers, and others—that form the backbone of any industrial economy. Overhauling the SBIC program to fund these unsung industrial companies will help ensure that American manufacturing survives and that American small businesses continue to grow.

This article originally appeared in American Affairs Volume IX, Number 4 (Winter 2025): 11–25.

Notes