New SBA tax blocker exception for BDCs with dropdown SBICs

On January 19, 2024, the US Small Business Administration (SBA) created a new exception applicable to business development companies (BDCs) with wholly owned small business investment companies (SBICs) that will allow use of blocker entities.¹ Specifically, when making equity investments in portfolio companies taxed as pass-through entities (e.g., LLCs), a BDC and its wholly owned SBIC may hold its investment through a blocker entity, which is taxed as a corporation for federal income tax purposes. This would allow the BDC parent to continue to meet its source-of-income requirement as a regulated investment company (RIC). Historically, SBICs would have to forego such investment opportunities to avoid its BDC parent jeopardizing its RIC tax treatment. The new exception will become effective by March 2024, unless the SBA receives a significant number of comments by February 19, 2024. 

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_{1 The exception permits SBICs to structure an investment through up to two levels of passive entities. In other words, if the SBIC is holding the investment through a blocker entity, up to one additional holding company can be used in the financing under the SBIC regulations.}