On March 11, 2021, President Biden signed the American Rescue Plan Act, which reauthorized and funded the State Small Business Credit Initiative (SSBCI). This updated version of the SSBCI program provides an additional $10 billion to states, the District of Columbia, territories and tribal governments to provide access to capital for small business to spur job creation and technological advancement across the nation. The goal of the program is to democratize access to capital for startups across the country, with a focus on funding traditionally underrepresented founders, fund managers (specifically emerging fund managers) and communities. The reboot of the SSBCI program has $8.5 billion more allocated to it than its 2010 predecessor, and for all intents and purposes, is designed from a policy perspective to put dollars in the hands of companies led by socially and economically disadvantaged individuals (SEDI) in traditionally underserved markets (outside California, New York City and Boston).
The SSBCI program, which is governed by the Department of the Treasury, set forth the amounts of capital that each state, territory, the District of Columbia and tribal government (collectively as used herein, governing authorities) would be allocated, but left it to each of the respective governing authorities to determine how the dollars would be deployed in each jurisdiction. And for applicants seeking to apply to a governing authority once a governing authority’s plan has been approved by the Treasury, the process has created questions and confusion for funds seeking to receive capital for deployment.
Different States, Different Applications, Burdensome Costs
While each governing authority’s SSBCI program must comply with the overarching rule set laid out by the Treasury, each governing authority has also structured its respective program based on its own specific needs and overall economic goals. In New York, for example, the state has tasked Empire State Development to determine what the application process will be, how the funds will be dispersed and how the capital may be used. The state has created a litany of thoughtful programs to support investors and companies at various stages through a suite of offerings. As part of its Emerging and Regional Fund Partner Program, for example, New York has sought to focus a bucket of its capital for deployment on new and emerging fund managers. The NYS SSBCI capital may not constitute more than 25% of the capital of the fund and, as currently written, should not violate a venture fund’s “qualifying venture capital exemption,” the exemption which permits banks and bank holding companies to invest in qualifying venture capital funds as an amendment to the Volcker Rule, which previously limited those entities from doing so absent a Small Business Investment Company (SBIC) license or other limited exemption. The state’s application is 26 questions (not including subparts) with a litany of exhibits, including legal documentation drafts and due diligence materials.
That is then juxtaposed against states like Ohio, whose SSBCI program as currently written would permit OH SSBCI capital to comprise up to 50% of a fund or constitute a dollar-for-dollar match of private capital. Ohio’s program, though, is presently structured such that the monies from the state come in initially as long-term debt which must first be repaid in full, and then the state requests distributions as if its investment was a limited partner position in any fund receiving the capital. As currently penned (and which the Ohio Department of Development notes is subject to modification in whole or part), the Ohio program violates the qualifying venture capital fund exemption, which means funds either need to find a different private fund exemption or face registering as an investment adviser with the SEC. Ohio’s application process consists of an initial letter of intent, followed by a full application, and requires proof of matching capital by April 2023.
For the governing authorities whose SSBCI programs have been approved, each and every one differs from the program of the other governing authorities, meaning every fund applicant will need to expend money, time and resources creating application materials for each respective request.
While much of that may seem reasonable given that taxpayer dollars are being used to make the governing authorities’ investments into funds, many of the governing authorities’ programs are focused on deploying capital into emerging or traditionally underrepresented fund managers, many of whom to do not have vast track records or deep pocketbooks to finance creating the necessary documentation for every state in which they intend to apply. And, worse yet, in states that currently have their program disbursements structured as long-term debt to the funds which cannot satisfy another private venture fund exemption under Volcker, fund managers will have to become registered investment advisers to be legally compliant with the SEC. This means that traditionally undercapitalized and emerging funds managed by socially and economically disadvantaged individuals in traditionally underserved markets will be expected to come up with additional money to register with the SEC and manage the related compliance requirements which, simply stated, is unrealistic at best.
Compliance Chaos
And speaking of compliance, even if fund managers who apply and receive capital from the various governing authorities do not have to register with the SEC as RIAs, they will have different compliance requirements for each governing authority from which they have received capital. While there are common best practices to maintain strong compliance policies and procedures, when every single governing authority has a different set of required information to be provided in a unique format, different due dates, and the ability to alter the required information necessary to remain compliant with each program, fund managers will likely have to add a compliance-focused team member, hire a third-party consultant to collect and report the information, or increase their workload in an already difficult and time-stretched space to get each governing authority the sui generis information that they require.
And if that is not enough, each state mandates how and where the capital can be deployed differently. In Kentucky, for example, only 50% of the capital needs to be deployed within the commonwealth, where Pennsylvania and Michigan, respectively, require that at least 90% of the capital be deployed within their corresponding borders. This means that capital flows need to be mapped and tracked in order to adhere to compliance requirements or fund managers run the risk on defaulting on the program or incurring a penalty, which at its maximum, could result in being required to return the funds received (plus interest, where applicable).
Further, while each governing authority follows the overarching policy of requiring that funds invest in SEDI businesses, the pre-money valuations of those SEDI businesses, whether they have received or are receiving SSBCI capital from other investors as part of an investment round, and what other types of public capital they may have received are all relevant as to whether funds may invest in the SEDI businesses, which need the capital and are the target constituency of the federal program in the first place. And with each governing authority’s respective regulatory schema of what constitutes a valid SEDI investment being in constant flux and about as clear as mud, the current end result, particularly for emerging fund managers, is a system that makes it nearly impossible to keep it all straight while also running their own organizations.
A Brighter Future?
As governing authorities finalize their respective programs and start to deploy capital, it is likely, though not guaranteed, that a set of best practices for state-by-state compliance will emerge. If it does, the emerging fund manager in receipt of SSBCI capital can expect brighter, more manageable days ahead. However, until those best practices emerge from the shambolic application and compliance systems currently contemplated, emerging fund managers will continue to have at least 53 problems (states, territories, tribal authorities and the District of Columbia) to contend with as they seek to invest in traditionally underrepresented founders.
Please contact Lindsay Karas Stencel or Jacob Denham with any questions.
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