[Federal Register Volume 62, Number 198 (Tuesday, October 14, 1997)]
[Proposed Rules]
[Pages 53253-53269]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-26720]
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SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
Small Business Investment Companies
AGENCY: Small Business Administration.
ACTION: Proposed rule.
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SUMMARY: Title II of Public Law 104-208 (September 30, 1996), entitled
the ``Small Business Programs Improvement Act of 1996'', made a number
of changes to the Small Business Investment Act of 1958, as amended.
For the Small Business Investment Company program, these changes
include provisions affecting capital requirements, Leverage eligibility
and fees, and the status of Section 301(d) Licensees. This proposed
rule would implement the statutory provisions; in addition, it would
make various technical corrections and clarifications, as well as
changes intended to improve the fairness and flexibility of the
regulations.
DATES: Comments must be submitted on or before November 13, 1997.
ADDRESSES: Written comments should be addressed to Don A. Christensen,
Associate Administrator for Investment, U.S. Small Business
Administration, 409 3rd Street, S.W., Suite 6300, Washington, D.C.
20416.
FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division,
at (202) 205-7583.
SUPPLEMENTARY INFORMATION: This proposed rule would implement the
provisions of Title II of Public Law 104-208 (September 30, 1996) which
relate to small businesses investment companies (SBICs). This rule
would also make certain other substantive changes, clarifications and
technical corrections to the regulations governing SBICs, including
those concerning portfolio diversification, Cost of Money, and the
computation of distributions to be made by SBICs that have issued
Participating Securities.
Section 301(d) Licensees
Prior to October 1, 1996, an SBIC program applicant could be
licensed under either section 301(c) or section 301(d) of the Small
Business Investment Act of 1958, as amended (Act). A Section 301(d)
Licensee, also known as a ``specialized SBIC'' or ``SSBIC'', agreed to
invest only in businesses owned and controlled by socially or
economically disadvantaged individuals. In return, a Section 301(d)
Licensee received certain benefits not available to other SBICs, such
as eligibility for certain types of subsidized Leverage (as defined in
Sec. 107.50).
Effective October 1, 1996, section 208(b)(3) of Public Law 104-208
repealed section 301(d) of the Act. However, the repeal provision was
accompanied by the following language: ``The repeal * * * shall not be
construed to require the Administrator to cancel, revoke, withdraw, or
modify any license issued under section 301(d) of the Small Business
Investment Act of 1958 before the date of enactment of this Act.''
This proposed rule would revise several sections in part 107 to
implement this statutory change. The revisions would eliminate
provisions relating to the licensing of new SSBICs while retaining
rules governing the operations of existing SSBICs.
Thus, in Sec. 107.50, a ``Section 301(d) Licensee'' would be
defined as ``a company licensed prior to October 1, 1996 under section
301(d) of the Act as in effect on the date of licensing, that may
provide Assistance only to Disadvantaged Businesses.'' Current
Sec. 107.110, which deals with organization of a section 301(d) license
applicant, would be removed. Similarly, Sec. 107.120 would be revised
by
[[Page 53254]]
eliminating references to the licensing of an SSBIC to operate as the
subsidiary of another Licensee or group of Licensees. Any existing
SSBIC which was licensed as a subsidiary would be permitted to continue
its operations under the same conditions as before; however, the
proposed rule would not allow an existing SSBIC that is not already a
subsidiary of another Licensee to become one. SBA has noted no demand
on the part of existing Licensees to reorganize in this fashion.
The proposed revision of Sec. 107.230(d)(4) would eliminate future
use of the provision which allowed Section 301(d) Licensees to include
in their Private Capital, without limitation, funds indirectly obtained
from State or local government sources. Under the proposed rule, such
funds would be included in Private Capital only if they were invested
in or committed in writing to the Licensee prior to October 1, 1996.
Otherwise, Section 301(d) Licensees would be limited to State and local
government funds equal to 33 percent of their Regulatory Capital under
current Sec. 107.230(d)(3), which applies to all Licensees. This change
is necessary to bring the regulations into conformity with the Act as
amended by Public Law 104-208.
Other proposed changes reflect amendments to the Act which
eliminated subsidized SBA Leverage. Such Leverage was previously
available to SSBICs in the form of Debentures with an interest rate
subsidy or Preferred Securities with a 4 percent dividend. Although
subsidized Leverage can no longer be issued, the Act does not require
SSBICs to prepay or redeem such Leverage prior to its scheduled
maturity. In addition, an SSBIC may apply for any type of non-
subsidized Leverage (Debentures or Participating Securities) for which
it is eligible.
To implement these changes, current Secs. 107.1100 and 107.1110
would be condensed into proposed Sec. 107.1100. The proposed section
would eliminate the separate descriptions of the types of Leverage
available to Section 301(c) and Section 301(d) Licensees and would
eliminate all references to subsidized Leverage.
SBA is also proposing revisions to Sec. 107.1160 in order to
conform with the Act. The entire section, which sets forth conditions
governing the issuance of Leverage by a Section 301(d) Licensee, would
apply only to Leverage issued on or before September 30, 1996. After
that date, a Section 301(d) Licensee would be eligible to apply for
Leverage under Sec. 107.1150, subject to the same terms and conditions
as other Licensees.
Similarly, the proposed revisions to the definition of ``Preferred
Securities'' in Sec. 107.50 and to Secs. 107.1400, 107.1420 and
107.1430 reflect the fact that SBA's authority under the Act to
purchase Preferred Securities ceased as of October 1, 1996. The
appropriation of funds for such securities actually ended as of October
1, 1995, but some Preferred Securities were issued in fiscal year 1996
by Licensees drawing against SBA's commitments of fiscal year 1995
funds.
Finally, the provisions of current Sec. 107.1350 which allow a
Section 301(d) Licensee to retire certain Debentures by issuing
Preferred Securities would be eliminated. The remainder of the section,
dealing with the retirement of Debentures through the issuance of
Participating Securities, would be redesignated as Sec. 107.1585 and
would apply to both SBICs and SSBICs.
Common Control
``Common Control'' as defined in Sec. 107.50 currently means ``a
condition where two or more Licensees, either through ownership,
management, contract, or otherwise, are under the Control of one group
or Person.'' However, the defined term as used in paragraphs (4) and
(5) of the definition of ``Associate'' is clearly intended to refer to
Persons other than Licensees. To accommodate this usage, the proposed
rule would revise the Common Control definition to refer to ``two or
more Persons'' rather than ``two or more Licensees''. The portion of
the definition under which certain circumstances establish a
presumption of Common Control would continue to apply only to two or
more Licensees.
Management and Ownership Diversity
Section 208(c)(3) of Public Law 104-208 amended the Act to require
that new SBICs have diversity between management and ownership. For any
SBIC licensed on or after September 30, 1996, SBA must ensure that the
management ``is sufficiently diversified from and unaffiliated with the
ownership of the licensee in a manner that ensures independence and
objectivity in the financial management and oversight of the
investments and operations of the licensee.'' SBA has required
diversity between management and ownership since 1994 for Participating
Securities issuers and since 1996 for other new leveraged Licensees.
Therefore, in response to the new statutory requirement, SBA is
proposing only minor changes to improve the effectiveness of
Sec. 107.150.
Under current Sec. 107.150(a), a Licensee or license applicant can
demonstrate diversity if at least 30 percent of its Regulatory Capital
is held by at least three shareholders or limited partners (or one
acceptable Institutional Investor) unrelated to management.
Specifically, these investors cannot be Associates of the Licensee or
applicant, or Affiliates of any of its Associates. The proposed rule
would retain these concepts, but would eliminate the phrase ``Affiliate
of an Associate''. Instead, proposed Sec. 107.150(a) would specify that
to qualify for diversity purposes, an investor must not be an Associate
of the Licensee or applicant and must not ``Control, be Controlled by,
or be under Common Control with'' an Associate. SBA does not intend for
this language to be substantively different from the current language,
but believes that readers may find it easier to understand. In
addition, the proposed rule would address certain other characteristics
of ``diversity investors'' which are not covered in the current
regulation, but which SBA considers important.
Proposed Sec. 107.150(a) would specify that the investors relied
upon to satisfy the diversity requirement cannot be Affiliates of one
another. SBA believes that if such investors are related parties, the
requirement that there be at least three of them is rendered
essentially meaningless. The proposed rule also would give SBA
discretion to reject for diversity purposes an investor whose ownership
interest is not significant, either in terms of absolute dollars or
percentage of ownership. This provision underscores the purpose of the
diversity rules, which is to encourage the presence of investors who
are likely to have a serious interest, similar to SBA's, in the fair
and prudent management of the SBIC.
The proposed changes reflect policies which SBA has been developing
in its review of license applications. In particular, SBA has used
informal internal guidelines to evaluate whether a proposed investor's
interest is substantial enough to qualify for diversity purposes. SBA
is continuing to refine these guidelines and expects to incorporate
them into its standard operating procedures.
Capital Requirements
Under the Act as amended by section 208(c) of Public Law 104-208,
SBICs licensed on or after October 1, 1996 must meet increased minimum
capital requirements. Previously, the statutory minimum capital
requirement was $2.5 million. The new requirements would be implemented
in proposed Sec. 107.210, which combines and revises elements of
current Secs. 107.210 and 107.220. Proposed Sec. 107.210(a)(1) would
require
[[Page 53255]]
a company that does not wish to be eligible to issue Participating
Securities to have Regulatory Capital of at least $5,000,000. As an
exception to this general rule, SBA would be able to license an
applicant with Regulatory Capital of at least $3,000,000, but only if
the applicant meets certain conditions set forth in the proposed
regulation. As mandated by the Act, this exception is limited to those
instances where ``special circumstances and good cause'' can be shown.
Proposed Sec. 107.210(a)(2) contains essentially the same language
as the current Sec. 107.220(a). It would require a company licensed on
or after October 1, 1996, that wishes to be eligible to apply for
Participating Securities to have Regulatory Capital of at least
$10,000,000, with a permitted exception for an applicant which
demonstrates to SBA's satisfaction that it can be financially viable
over the long term with a lower amount (but under no circumstances less
than $5,000,000). SBA regulations have required this level of
Regulatory Capital for Participating Securities issuers since 1994.
The proposed rule would not permit prospective Participating
Securities issuers to be licensed pursuant to the exception available
to other applicants, under which a license may be granted with
Regulatory Capital as low as $3,000,000. For applicants planning to
issue Participating Securities, SBA believes that the ability to meet
the standard minimum capital requirement is an important indicator of
the credibility of management. SBA also doubts that any such applicant
can demonstrate financial viability with Regulatory Capital of only
$3,000,000, even on a temporary basis.
In addition to the Regulatory Capital requirements described above,
proposed Sec. 107.210(a) would also require any company licensed on or
after October 1, 1996, to have Leverageable Capital of at least
$2,500,000. Leverageable Capital is a subset of Regulatory Capital;
while both include capital actually contributed to a Licensee by its
private investors, the major difference between them is that Regulatory
Capital also includes the Licensee's unfunded binding commitments from
Institutional Investors. The proposed rule, which is consistent with
SBA's current licensing policy, reflects the Agency's belief that the
presence of a certain minimum level of Leverageable Capital
demonstrates an applicant's seriousness and readiness to operate
actively as an SBIC.
The proposed rule would not require SBICs licensed before October
1, 1996 to increase their capital. Under proposed Sec. 107.210(b), such
companies would have to meet the applicable minimum capital
requirements under the regulations in effect on September 30, 1996 (see
Secs. 107.210 and 107.220 as in effect on that date). These
requirements vary depending upon the date a company was licensed and
the type of SBA Leverage it has issued or wants to issue.
See also the section of this preamble entitled ``Eligibility for
Leverage and Leverage Commitments''.
Valuations
Section 208(f)(2) of Public Law 104-208 included one provision
related to the valuation of portfolio securities held by Licensees
which was not already reflected in the regulations. Under this
provision, as part of the annual audit of a Licensee's financial
statements, the independent auditor must provide to SBA a statement
that the Licensee's valuations were performed in accordance with its
SBA-approved valuation policy, as required by section 310(d)(2) of the
Act. SBA has included this requirement in proposed Sec. 107.503(e). SBA
is also proposing various non-substantive wording changes in
Sec. 107.503 to improve the clarity of the section.
Reports To Be Filed With SBA
Current Sec. 107.660 requires an SBIC to provide SBA with copies of
reports given to its investors or filed with the Securities and
Exchange Commission, and to notify SBA when it becomes a party to
litigation or other proceedings. Proposed Sec. 107.660(d) would add a
requirement for a Licensee to notify SBA if an officer, director,
general partner or other Control Person is charged with or convicted of
any criminal offense other than a misdemeanor involving a minor motor
vehicle violation. Key personnel associated with a license applicant
currently must provide this type of information as part of the personal
history statement included in the SBIC license application. The purpose
of the proposed rule is to give SBA a mechanism for updating such
information as needed to ensure the integrity of the SBIC program.
Financing of Smaller Enterprises
Since April 1994, SBICs have been required to direct a certain
percentage of their investment activity to businesses which fall
significantly below the maximum size permitted for a Small Business.
These businesses were originally referred to as ``Smaller Businesses'',
a term which was changed to ``Smaller Enterprises'' in a final rule
published in the Federal Register on March 13, 1997 (62 FR 11759).
Under proposed Sec. 107.710, the basic requirement for a Licensee
to invest at least 20 percent of the total dollar amount of its
Financings in Smaller Enterprises would remain unchanged. However,
proposed Sec. 107.710(c) would add a new requirement to implement
section 208(c)(2) of Public Law 104-208. This provision applies to
SBICs licensed on or before September 30, 1996, which issue Leverage
after that date and which do not meet the current minimum capital
requirement (Regulatory Capital of at least $5,000,000 for Debentures
or at least $10,000,000 for Participating Securities). For such
Licensees, at least 50 percent of the aggregate dollar amount of their
Financings extended after September 30, 1996 must be invested in
Smaller Enterprises. As a practical matter, SBA has found that
Licensees to which this requirement applies typically invest almost
exclusively in Smaller Enterprises.
Like the current regulation, the proposed rule would measure
compliance with the requirements to finance Smaller Enterprises as of
the end of a Licensee's fiscal year. Under current Sec. 107.710(e), a
Licensee which has not achieved the required percentage of investments
in Smaller Enterprises is allowed one additional year to bring its
portfolio into compliance. The proposed rule would retain this
provision. However, such a Licensee would not be eligible for
additional Leverage until it reaches the required percentage. See also
the section of this preamble entitled ``Eligibility for Leverage and
Leverage Commitments''.
Passive Businesses
SBICs are generally prohibited from investing in passive
businesses. However, an exception is provided for holding companies
which pass through the financing proceeds to an active subsidiary. The
precise nature of this exception has changed over time. Prior to 1996,
the general prohibition did not apply ``to any Small Concern wholly
owning another eligible Small Concern engaged in a regular and
continuous business operation.'' Under current Sec. 107.720(b)(2),
which became effective January 31, 1996, an SBIC may finance a passive
business ``if, for all Financings extended, it passes substantially all
the proceeds through to the same eligible Small Business that is not
passive.''
The goal of the 1996 revision was to eliminate the requirement for
the passive business to be the 100 percent owner of the operating
business, while still ensuring some substantial relationship between
the two by
[[Page 53256]]
allowing funds to be passed through to only one active entity. SBA now
believes that the latter provision may unnecessarily restrict some
Small Businesses. For example, a holding company may be established
with two operating subsidiaries, one engaged in manufacturing and the
other in distribution of the manufactured product. Under the current
regulation, if the holding company received financing from an SBIC, it
could pass through the proceeds to only one subsidiary, even though
both subsidiaries are essentially components of the same business.
At the same time, SBA continues to believe that there must be a
significant relationship between a financed passive business and the
active business which ultimately receives the proceeds. To satisfy this
goal, proposed Sec. 107.720(b)(2) would permit financing of a passive
Small Business if it passes substantially all the proceeds through to
one or more ``subsidiary companies'', defined as companies in which the
financed passive business owns at least 50 percent of the voting
securities. The current provision limiting the pass-through of proceeds
to only one Small Business would be eliminated.
Co-Investment With Associates
Licensees may co-invest with Associates, subject to the conditions
in Sec. 107.730(d). This section sets forth certain circumstances under
which the terms of a co-investment are presumed to be fair and
equitable to the SBIC, so that no specific demonstration of equity is
required. Under current Sec. 107.730(d)(3)(iv), this presumption
applies to co-investments by two non-leveraged SBICs. The proposed rule
would apply the same presumption to co-investments by a non-leveraged
SBIC and its non-SBIC Associate. The rationale behind the presumption
is the same in both cases: SBA has no financial exposure, and is
therefore unconcerned that a Licensee may be disadvantaged relative to
its Associate.
Portfolio Diversification Requirements
Under current Sec. 107.740, a leveraged SBIC may not have more than
20 percent of its Regulatory Capital invested in or committed to a
single Small Business or group of related businesses, unless SBA gives
its prior written approval (for SSBICs, the limit is 30 percent of
Regulatory Capital). The purpose of this ``overline'' limit is to avoid
excessive risk by ensuring a certain degree of portfolio
diversification.
Since the beginning of the Participating Securities program, SBA
has been aware that the current regulation may have an unintended
effect. Participating Securities issuers operate under detailed rules
governing distributions to SBA as well as to their private investors.
These regulations permit a Licensee to return capital to its non-SBA
partners under certain conditions, thereby reducing its Regulatory
Capital and overline limit. SBA is concerned that a Licensee in these
circumstances may suddenly have multiple violations of the overline
regulation, even though its portfolio was sufficiently diversified
based on its original Regulatory Capital.
To address this problem, proposed Sec. 107.740(a) would base a
Licensee's maximum permitted investment in or commitment to a Small
Business on its Regulatory Capital at the time the investment or
commitment is made. The limit would apply to the total amount of
Financings and Commitments extended to the Small Business by the
Licensee. For example, if a Licensee had invested $1,000,000 in a Small
Business and wanted to provide follow-on financing at a time when its
Regulatory Capital was $8,000,000, the amount of the follow-on
financing could not exceed $600,000 (20 percent of $8,000,000, minus
the $1,000,000 already invested).
It should be noted that the proposed rule would require a Licensee
to be in compliance at the date of a Commitment and at the date of a
Financing. Thus, a Licensee preparing to fund a Commitment it had made
to a Small Business must ensure that it has sufficient Regulatory
Capital as of the closing date to support the completed Financing.
Proposed Sec. 107.740(a) would continue to permit overline
investments with the prior written approval of SBA.
Cost of Money
Current Sec. 107.855 sets forth limits on interest rates and other
charges that SBICs may impose on Small Businesses. SBA is proposing
three changes to these ``Cost of Money'' rules. The first change
reflects section 208(d)(6) of Public Law 104-208, under which SBICs
must pay to SBA an additional charge of 1 percent per year on any
Leverage issued after September 30, 1996 (except for draws against
commitments made by SBA in fiscal year 1996). The proposed rule would
allow a Licensee to include this charge in its base rate when computing
its Cost of Money ceiling. The base rate would be equal to either the
current Debenture Rate plus the 1 percent charge (see Sec. 107.855(c)),
or the Licensee's own Cost of Capital with the 1 percent charge treated
as additional interest expense in the computation (see
Sec. 107.855(d)). Although this change may increase the cost of
borrowing for some Small Businesses, SBA believes that it is warranted
because it reflects the increase in Licensees' cost of funds. There
would be no change in the basic Cost of Money limitations of 19 percent
for Loans and 14 percent for Debt Securities which Licensees may use
regardless of the level of prevailing interest rates.
For Section 301(d) Licensees which elect to compute a Cost of Money
ceiling based on their own Cost of Capital, proposed Sec. 107.855(d)(4)
would clarify that interest expense on a subsidized SBA-guaranteed
debenture may be computed using the debenture's face (unsubsidized)
interest rate. This provision was inadvertently deleted when the
regulations were revised in January 1996, but has since remained in
effect as a matter of SBA policy.
Finally, SBA is proposing to clarify the treatment of warrants with
respect to Cost of Money. The regulations governing Cost of Money apply
to Loans (which have no provision for obtaining equity in a Small
Business) and Debt Securities (which involve some type of equity
feature). SBA generally interprets these rules to exclude from Cost of
Money any returns realized on the equity portion of a Debt Security
because such returns normally are neither assured nor predictable.
However, SBA has become aware of certain situations under which the
current regulations may effectively require inclusion of the value of
warrants in Cost of Money.
This may occur when a Licensee lends cash to a Small Business, and
receives in return not only a note for the amount lent, but also
detachable warrants to acquire equity in the Small Business. Generally
accepted accounting principles require the Licensee to determine the
fair value, if any, of the warrants received and to record the warrants
at that value, while discounting the note by the same amount. The
discount is then amortized to interest income over the life of the
note. Under current Sec. 107.855(f), the income created through
amortization of the discount is included in Cost of Money.
SBA believes that this provision unduly disadvantages SBICs which
allocate substantial value to the warrants acquired, relative to SBICs
which assign zero or nominal value. Typically, SBICs invest in private
companies which have no readily ascertainable market value. Thus, the
value allocated to such companies' warrants is often determined through
negotiation rather than the application of precise methods. Given the
level of
[[Page 53257]]
uncertainty associated with such valuations, SBA prefers to create a
level playing field in which all returns realized on detachable
warrants are excluded from Cost of Money.
Proposed Sec. 107.855(g)(1) would address this concern by allowing
a specific exclusion from Cost of Money for a discount on the loan
portion of a Debt Security, if the discount results solely from the
allocation of fair value to detachable stock purchase warrants as
required by generally acceptable accounting principles. Discounts in
general would still be included in Cost of Money. For example, if a
Licensee provided $1,000,000 to a Small Business and received a note
for $1,100,000, the amortization of the $100,000 discount over the life
of the note would be treated as additional interest income for Cost of
Money purposes.
Control
Proposed Sec. 107.865 contains two clarifications to the existing
regulation concerning Control of a Small Business by an SBIC. Under
current Sec. 107.865(c), a Licensee can rebut a presumption of Control
if certain criteria concerning the ownership of the Small Business and
the composition of its board of directors are satisfied. The proposed
rule would eliminate references to the rounding of percentages in
determining whether the board of directors meets the established
criteria. The current language is confusing because it is unclear how
the rounding is to be applied; SBA believes that removing it would
permit a plain reading of the regulation.
The second proposed clarification involves current Sec. 107.865(d),
which sets forth the conditions under which a Licensee may take
temporary Control of a portfolio company. The proposed rule would
permit such Control where reasonably necessary for the protection of a
Licensee's existing investment; the only revision is the addition of
the word ``existing''. The proposed language is not a substantive
change; it is intended simply to make explicit SBA's long-standing
interpretation of this provision.
Eligibility for Leverage and Leverage Commitments
Section 208 of Public Law 104-208 established certain requirements
which an SBIC must satisfy in order to obtain SBA Leverage. Proposed
Sec. 107.1120 (c) and (d) would implement these requirements. An SBIC
licensed after September 30, 1996, with Regulatory Capital of less than
$5,000,000 would be ineligible for Leverage until it reached the
$5,000,000 level. An SBIC licensed on or before September 30, 1996,
would not be required to increase its capital in order to obtain
additional Leverage; however, if its Regulatory Capital was less than
$5,000,000 ($10,000,000 for a company seeking to issue Participating
Securities), it would have to certify in writing that at least 50
percent of the aggregate dollar amount of its Financings extended after
September 30, 1996 would be provided to Smaller Enterprises (see also
proposed Sec. 107.710(c)). Finally, any Licensee seeking Leverage would
be required to certify in writing that it is in compliance with the
general requirement to provide 20 percent of its total Financings to
Smaller Enterprises under Sec. 107.710(b).
SBICs can obtain Leverage by applying directly for funding when it
is needed or by obtaining a Leverage commitment from SBA which it can
draw down over a period of time. SBA is proposing minor changes to the
current rules governing the commitment process. The proposed rule would
eliminate the minimum and maximum amounts for a Leverage commitment in
current Sec. 107.1200(c). SBA believes that these limits are
unnecessary. Under the proposed rule, commitment amounts would have to
be in multiples of $5,000 to accommodate requirements of the Leverage
funding process; in all other respects, the amount of a commitment
would be at SBA's discretion. Similarly, the current limitations in
Sec. 107.1230(b) on the amount that a Licensee can draw against its
commitment would be eliminated. The proposed rule would require draws,
like commitments, to be in multiples of $5,000; in addition, SBA would
have discretion to determine a minimum draw amount, and would publish
notice of any such determination in the Federal Register from time to
time.
Leverage Fees
SBA is proposing changes in Secs. 107.1130 and 107.1210 to
implement provisions of section 208(d)(6) of Public Law 104-208 which
affect the fees SBICs must pay in order to obtain SBA Leverage. These
fee changes were effective October 1, 1996, and were implemented on an
interim basis by SBA Policy Notice 1000-6.
Under proposed Sec. 107.1130, a Licensee would pay a nonrefundable
``leverage fee'' to SBA when Debentures or Participating Securities are
issued. The fee is 3 percent of the face amount of the Leverage issued,
replacing the 2 percent user fee and the 1 percent commitment fee
previously in effect. If a Licensee receives a Leverage commitment from
SBA, it must prepay the 3 percent fee at the time it receives the
commitment (see proposed Sec. 107.1210(a)); otherwise, the fee is
payable when the Leverage is issued.
Proposed Sec. 107.1130(d) would require a Licensee to pay to SBA an
additional ``Charge'' on Debentures and Participating Securities (see
also Sec. 107.50 for the definition of this proposed new term). For
both types of Leverage, the Charge is 1 percent per annum. The Charge
is payable under the same terms and conditions as the interest on
Debentures or the Prioritized Payments on Participating Securities, as
applicable. Thus, a Debenture issuer would pay the Charge in two semi-
annual installments together with its interest payments. In contrast, a
Participating Securities issuer would pay the Charge only when it had
profits and was distributing Prioritized Payments under Sec. 107.1540.
The Charge would not apply to Leverage drawn down against a commitment
obtained from SBA on or before September 30, 1996.
Participating Securities--General
SBICs began to issue Participating Securities in 1995. As Licensees
and SBA have gained experience with the program, there have been a
number of regulatory changes intended to correct errors and to
eliminate inconsistencies and confusing language. The proposed rule
continues this process of correction and clarification, and also
includes certain substantive changes.
Current Sec. 107.1500 sets forth general terms and conditions of
the Participating Security. One of these conditions, set forth in
Sec. 107.1500(b)(4), is that a Licensee must make Equity Capital
Investments equal to the amount of Participating Securities it issues,
and must maintain such investments in an amount equal to its
outstanding balance of Participating Securities. The proposed rule
would implement a provision of Public Law 104-208 by eliminating the
maintenance requirement. Thus, a Licensee would be responsible only for
investing the appropriate dollar amount in Equity Capital Investments,
and would not have to be concerned with the timing of the liquidation
of those investments. The same change would also be reflected in
proposed Sec. 107.1820, which sets forth conditions that an SBIC must
comply with in connection with its issuance of Participating
Securities. In this section, under paragraph (e)(9), the failure to
maintain a specified amount of Equity Capital Investments would be
eliminated from the list of Restricted Operations Conditions.
Proposed Sec. 107.1500(e), concerning amounts to be paid upon
redemption of Participating Securities, includes the
[[Page 53258]]
new 1 percent annual Charge on Leverage issued on or after October 1,
1996 (see the section entitled ``Leverage Fees'' in this preamble).
Proposed Sec. 107.1500(f), concerning the priority of Participating
Securities when a Licensee liquidates, reflects the same change. In
addition, this paragraph would clarify that only Earned Prioritized
Payments (that is, those Prioritized Payments which the Licensee has
sufficient profits to pay) have priority in liquidation; the Licensee
has no obligation to pay Accumulated Prioritized Payments (those not
covered by available profits).
Liquidity Requirements for Participating Securities
The proposed rule includes two minor changes to the liquidity
requirements in Sec. 107.1505. Currently, a Licensee must perform the
liquidity impairment computation at the end of its fiscal year, when it
applies for Leverage, and when it intends to make a Distribution. Under
proposed Sec. 107.1505(a)(2), SBA would be able to exempt a Licensee
applying for Leverage from the computation requirement. SBA has found
that many SBICs in the early stages of their existence are extremely
liquid; in these cases, the Agency believes that the formal liquidity
computation provides no additional useful information and need not be
performed.
The second proposed change involves the computation of the
liquidity ratio in Sec. 107.1505(b). Various components of the ratio
are assigned weights which reflect the ease and/or probability of their
conversion to cash. One of the components of ``Total Current Funds
Available'' (the numerator of the liquidity ratio) is Publicly Traded
and Marketable Securities, as reported on SBA Form 468. Under the
current regulation, a Licensee is given credit for 65 percent of the
reported value of these securities in the liquidity computation. In
contrast, the proposed rule would allow the Licensee to count 100
percent of the reported value as a source of liquidity. SBA is
proposing this change because Licensees are expected to take
appropriate discounts (for restrictions, large holdings relative to
trading volume, etc.) when valuing their securities, as required by
SBA's valuation guidelines for SBICs. Since these discounts are already
reflected in the portfolio valuations reported on Form 468, SBA
considers it unnecessary to discount these values further in the
liquidity computation.
Earmarked Profit (Loss)
Under Sec. 107.1510, Participating Securities issuers are required
to compute Earmarked Profit (Loss) as a preliminary step in determining
the amounts of various Distributions. SBA is proposing two changes to
this section. The first would affect only a Licensee holding assets not
subject to SBA Profit Participation (``non-Earmarked Assets''). For a
hypothetical SBIC in this situation (none are currently licensed), the
proposed rule would simplify the computation of the ``Earmarked Asset
Ratio''. This ratio is intended to measure the proportion of the total
portfolio which consists of Earmarked Assets, but is currently
complicated by the inclusion of a factor described as ``weighted
average uninvested proceeds of Participating Securities''. SBA believes
that this amount would be extremely difficult, if not impossible, to
compute in practice; even if it could be determined, it would have
little effect on the resulting ratio because it is included in both the
numerator and denominator. Therefore, SBA is proposing to eliminate
this factor entirely from the Earmarked Asset Ratio computation in
Sec. 107.1510(c). The proposed rule would also simplify the Earmarked
Asset Ratio formula by replacing ``weighted average'' Earmarked Assets
and ``weighted average'' Loans and Investments with simple averages.
The intent of this change is that the ``average'' amounts specified
would represent average monthly balances, as computed by the
Participating Securities software developed by SBA. The Agency believes
this method provides reasonable precision without requiring detailed
tracking of the number of days outstanding for each portfolio
investment, as the weighted average method requires.
The other proposed change affecting the Earmarked Profit (Loss)
computation is in Sec. 107.1510(d)(1)(ii), which deals with the
amortization of leverage fees paid to SBA and partnership syndication
costs incurred by an SBIC. Currently, for the purpose of computing
Earmarked Profit (Loss), such costs must be amortized over five years.
The proposed rule would require amortization over not less than five
years. This change would accommodate companies which amortize the fees
over a longer period for financial statement purposes and would prefer
not to make an additional adjustment when performing the required
profit computations.
Prioritized Payments
Section 107.1520 tells a Licensee how to compute Prioritized
Payments and how to determine whether it has profits which will cause
Prioritized Payments to become ``earned'' and therefore payable to SBA.
Three changes to this section are proposed. First, the proposed rule
would implement a provision of Public Law 104-208 by including
``Charges'' (the 1 percent annual fee discussed in this preamble under
the heading ``Leverage Fees'') on outstanding Participating Securities
in the required computations. Although Charges are not part of
Prioritized Payments, they are payable under the same terms and
conditions, as set forth in the proposed section.
Second, the computation of profit for the purposes of Sec. 107.1520
would be revised under proposed Sec. 107.1520(d). Under the current
regulations, a Licensee's ``profit'' equals its cumulative Earmarked
Profit minus its cumulative Earned Prioritized Payments from prior
periods. This computation ignores the fact that some or all of the
profit computed in this manner may have already been distributed under
other sections of the regulations, either to SBA as Profit
Participation or to the Licensee's private investors. SBA received no
comments addressing this concern when the regulations governing
Participating Securities were originally proposed in April 1994 or
revised in January 1996; nevertheless, the Agency is concerned that the
current regulation may, in effect, place duplicate claims on the same
income. The proposed rule would take prior profit distributions into
account in determining whether a Licensee has profits which can be used
to pay Prioritized Payments.
Third, proposed Sec. 107.1520(f) would provide additional detail
concerning the computation of Adjustments, a type of compounding of
unpaid Prioritized Payments. The current regulation is written in
general terms which do not explain exactly how certain amounts should
be calculated. The proposed rule follows the method which is currently
used in the software developed by SBA to perform the allocation and
distribution computations required for Participating Securities.
Profit Participation
An SBIC which has issued Participating Securities must allocate
Profit Participation to SBA when it has earned profits over and above
the amount necessary to pay its Prioritized Payments in full. Under
current Sec. 107.1530, Profit Participation is determined by computing
a ``Base'' and a ``Profit Participation Rate'', and multiplying the
Base by the Rate. The proposed rule would modify both the Base and the
Rate under certain circumstances.
[[Page 53259]]
The Base for Profit Participation represents a cumulative measure
of a Licensee's Earmarked Profit after Prioritized Payments,
Adjustments and Charges. A Participating Securities issuer must compute
its Base as of the end of each fiscal year, but may also compute the
Base for a period of less than one year in order to make an interim
distribution of profits. If an SBIC elects to make such a distribution,
it faces the possibility that the Profit Participation it pays to SBA
for the interim period will be greater than the Profit Participation it
would have been obligated to pay had it waited until the end of the
fiscal year. This can happen because the SBIC suffers losses during the
remainder of the year, or simply because additional Prioritized
Payments accumulate during that time; either or both of these factors
would reduce the SBIC's year-end Base. Under current Sec. 107.1530(c),
an SBIC which has paid ``excess'' Profit Participation under these
conditions can treat the excess as ``Unused Loss'' at year end, thereby
reducing the Base which it will use the next time it computes Profit
Participation. However, this approach captures only a part of the
SBIC's loss; the actual loss incurred between the interim distribution
date and the fiscal year end is equal to the difference between the
interim and year-end Bases, not just the Profit Participation computed
on that difference. For this reason, SBA is concerned that the current
regulation may impose a significant penalty on a Licensee which chooses
to make an interim distribution, and may unduly distort an SBIC's
decisions concerning the timing of distributions. Proposed
Sec. 107.1530(c) would allow a Licensee in the circumstances described
to treat the full amount of the difference between its interim and
year-end Bases as Unused Loss.
Most SBICs operate for a period of time before issuing
Participating Securities; in some cases, companies are already
investing actively even before they are licensed. In the computation of
the Base, the current regulations do not address the question of
whether net income or loss from fiscal years prior to the issuance of
Participating Securities may be included. Under proposed
Sec. 107.1530(c)(3), a Licensee would be permitted to include prior
losses in its Base with SBA approval, which would be required only once
when the Licensee computes the Base for the first time. SBA expects to
approve inclusion of prior losses in most cases, but is proposing the
approval requirement to cover unusual circumstances, such as a company
with non-Earmarked Assets or one which has operated for an extended
period of time before issuing Participating Securities. The proposed
rule does not discuss net income realized in prior fiscal years because
SBA has not seen this situation in practice; the Agency considers this
an unlikely occurrence which would be handled on a case by case basis.
The Profit Participation Rate is computed using a formula in which
the key variable is the ratio of Participating Securities to
Leverageable Capital (the ``PLC ratio''). Proposed Sec. 107.1530(e)
would retain the basic definition of the PLC ratio as the highest ratio
of outstanding Participating Securities to Leverageable Capital that an
SBIC has ever attained, as well as the exception which allows the ratio
to be reduced if Leverageable Capital increases above its highest
previous level, subject to certain conditions. Proposed
Sec. 107.1530(e)(2) (i) and (ii) would simplify the method for
recomputing the PLC ratio following an increase in Leverageable
Capital. The new PLC ratio would equal the highest dollar amount of
Participating Securities the SBIC has ever had outstanding, divided by
the SBIC's current Leverageable Capital. This computation would replace
the present three-step method which is not only quite complex, but also
can produce anomalous results when a Licensee's highest dollar amount
of Participating Securities outstanding does not coincide with its
highest ratio. SBA does not believe that any Licensee would be
disadvantaged by this change.
After computing the Base and the Profit Participation Rate, an SBIC
computes Profit Participation under Sec. 107.1530(h). In the proposed
rule, this paragraph has been reworded to improve its clarity. No
substantive changes are proposed.
Tax Distributions
Limited partnership SBICs which have paid their Prioritized
Payments in full and still have remaining Retained Earnings Available
for Distribution are permitted to make an annual ``tax distribution''
to their investors, with SBA also receiving a share. Both the Act and
Sec. 107.1550 of the regulations use the term ``tax distribution'',
based on the concept of allowing partnerships (or other flow-through
entities) to distribute cash that investors can use to pay their taxes
on the income allocated to them by the partnership. In practice, the
permitted tax distribution may or may not correspond to a particular
investor's actual tax liability, since the computation uses assumed
rather than actual tax rates and does not distinguish between taxable
and tax-exempt investors.
SBA is proposing one substantive change in Sec. 107.1550(a)(1),
which would be revised to include the 1 percent per annum Charge on
Participating Securities issued on or after October 1, 1996 (except for
those issued pursuant to a commitment obtained from SBA before that
date). Under Public Law 104-208, Charges are payable as a preferred
return to SBA under the same terms and conditions as Prioritized
Payments; therefore, a Licensee must pay all its Prioritized Payments,
Adjustments and Charges before it can make a distribution under
Sec. 107.1550.
The other proposed revisions in Sec. 107.1550 are clarifications
rather than substantive changes. In the formula used to compute a
Licensee's Maximum Tax Liability, proposed Sec. 107.1550(b)(1) would
specify that Prioritized Payments allocated to SBA are to be excluded
from the net ordinary income and capital gains allocated to partners.
Proposed Sec. 107.1550(b)(2) would clarify that while a Licensee may
use either individual or corporate tax rates to compute Maximum Tax
Liability, it must apply the same type of rate, either individual or
corporate, to both ordinary income and capital gains. Finally, proposed
Sec. 107.1550(b)(3) would specify that in computing combined Federal
and State tax rates to be used in the Maximum Tax Liability formula, a
Licensee must assume that State income taxes are deductible for Federal
income tax purposes. All of these changes are consistent with SBA's
interpretation of the current regulations.
Distributions Based on ``Retained Earnings Available for
Distribution''
As of the end of each fiscal year, if a Participating Securities
issuer has Retained Earnings Available for Distribution (``READ'')
remaining after paying all of its Prioritized Payments and making a tax
distribution (if applicable), it must distribute the balance of READ in
accordance with Sec. 107.1560. SBA is proposing two clarifications to
this section, as well as one minor substantive change.
Proposed Sec. 107.1560 (a)(4) and (b)(1) would both be revised to
clarify that the amount of READ to be distributed is determined after
giving effect to any preceding distributions of Prioritized Payments
under Sec. 107.1540 and tax distributions under Sec. 107.1550. The
current regulation may not be clear on this point, although SBA has
always interpreted it in a manner consistent with the proposed rule.
Current Sec. 107.1560(e) contains a table which gives SBA's
percentage share of
[[Page 53260]]
any distributions made under Secs. 107.1560 or 107.1570(a). The heading
of the first column refers to the Licensee's ``ratio of Leverage to
Leverageable Capital as of the fiscal year end''. This heading is
appropriate for distributions under Sec. 107.1560, which are always
computed as of the end of a fiscal year, but may be confusing for
interim distributions under Sec. 107.1570(a). If a Licensee makes an
interim distribution, the intent of the regulations is to measure the
ratio of Leverage to Leverageable Capital as of the end of the interim
period for which the distribution is made. The proposed rule would
clarify this point by replacing ``fiscal year'' with ``fiscal period''
in the column heading.
Proposed Sec. 107.1560(a)(1) would be revised to include the 1
percent per annum Charge on Participating Securities issued on or after
October 1, 1996. Under Public Law 104-208, Charges are payable as a
preferred return to SBA under the same terms and conditions as
Prioritized Payments; therefore, a Licensee must pay all its
Prioritized Payments, Adjustments and Charges before it can make any
other distribution under Sec. 107.1560.
Optional Distributions Not Based on READ
A Licensee which has no READ may be able to make distributions to
its private investors and SBA in accordance with Sec. 107.1570(b).
Distributions under this section are at the option of the SBIC and
essentially constitute returns of capital. The current regulation sets
forth conditions for making a distribution of this type. Under the
proposed rule, two of these conditions would be revised. First,
Sec. 107.1570(b)(1)(i) would require an SBIC to pay any earned Charges,
along with its Earned Prioritized Payments and earned Adjustments,
before distributing under Sec. 107.1570(b). This change is in
accordance with section 208(d)(6) of Public Law 104-208; similar
changes proposed in Secs. 107.1550 and 107.1560 are discussed earlier
in this preamble.
Second, under current Sec. 107.1570(b)(1)(ii), a Licensee must have
``distributed all Profit Participation computed under Sec. 107.1530''
before distributing under Sec. 107.1570(b). This language may present a
problem for an SBIC because of the following circumstances: Profit
Participation is computed only on the basis of realized income or loss;
however, the ability to distribute Profit Participation depends on the
availability of READ, which also takes into account unrealized losses
in a Licensee's portfolio. Thus, it is possible that a Licensee may
compute Profit Participation to be allocated to SBA, but may be unable
to pay it until some later date. Under these conditions, the Licensee
would be blocked from distributing under Sec. 107.1570(b). To remedy
this situation, the proposed rule would require a Licensee to
distribute Profit Participation only to the extent permitted based on
its READ. SBA believes that the language in section 303(g)(10) of the
Act, which requires payment of all Profit Participation ``due'' to SBA
before a Licensee can return capital, provides sufficient flexibility
to support this interpretation.
Notice of Participating Securities Distributions
The current regulations do not require SBICs with Participating
Securities to notify SBA before making distributions. In practice,
Licensees generally have sought SBA's assistance with the distribution
calculations and have given SBA sufficient opportunity to review the
results. Because of the complexity of some of the required
computations, and the difficulty of correcting errors after a
distribution takes place, SBA is proposing to formalize this practice.
The proposed rule would require an SBIC to notify SBA 10 business days
before a planned distribution under Secs. 107.1540 through 107.1570,
unless SBA permits otherwise. This language would give SBA the
flexibility to allow distributions on shorter notice, if the
circumstances warrant, without requiring Licensees to submit a formal
request for a written exemption. SBA believes that this provision would
not unreasonably constrain a Licensee's freedom of action and would
provide important protection for Licensees as well as the Agency.
Timing of Participating Securities Distributions
The current regulations permit Participating Securities issuers to
make distributions only on quarterly ``Payment Dates'' (February 1, May
1, August 1 and November 1 of each year). This structure was adopted to
coincide with the terms of the public fundings of Participating
Securities, under which investors receive interest payments and any
returns of principal to which they are entitled on these dates. In the
preamble to the final rule published on January 31, 1996 (61 FR 3177),
SBA stated that it intended to seek a solution that would provide
Licensees with greater flexibility in making distributions,
particularly distributions in the form of securities.
Proposed Sec. 107.1575 would allow an SBIC to make distributions
(either in cash or in kind) on dates other than Payment Dates with
SBA's prior written approval. SBA wishes to provide SBICs with as much
flexibility as possible; however, for administrative and oversight
purposes, the Agency feels strongly that it must have an opportunity to
review planned distributions in advance.
Distributions based on fiscal year end results, such as required
annual distributions of Prioritized Payments, would have to be made no
later than the second Payment Date following the Licensee's fiscal year
end. This requirement is consistent with the current regulation, which
requires such distributions to be made on either the first or second
Payment Date.
For any distribution made on other than a Payment Date, the
distribution date would be used as the cutoff date for all the required
computations (Earmarked Profits, Prioritized Payments, etc.). This
approach may require a Licensee to perform a mid-month closing of its
financial statements, which may not be as clean or convenient as a
month-end closing. However, SBA believes it is the only approach which
will accommodate all potential distributions, particularly
distributions of securities on which realized gain cannot be recognized
before the distribution date.
If a distribution to SBA includes a redemption of Participating
Securities, the proposed rule specifies that the effective date of the
redemption will be the next Payment Date following the distribution
date. This provision is necessary because Participating Securities are
funded through the purchase by investors of Trust Certificates, under
which principal can be returned only on Payment Dates. Because of this
structure, a Licensee will also be responsible for Prioritized Payments
through the next Payment Date on the amount of Participating Securities
to be redeemed.
In-Kind Distributions by Licensees
Participating Securities issuers are permitted to make
distributions to SBA in the form of securities under the conditions set
forth in Sec. 107.1580. The current regulation limits in-kind
distributions to those distributions required or permitted by
Secs. 107.1560 and 107.1570. Distributions of Prioritized Payments,
which are governed by Sec. 107.1540, must be made in cash. Because
Prioritized Payments precede any other distributions, this limitation
can have a potentially significant effect on the timing and value of
distributions in general. To alleviate this concern, proposed
Sec. 107.1580(a) would allow distributions
[[Page 53261]]
under Secs. 107.1540, 107.1560 and 107.1570 to be made in the form of
securities. Distributions under Sec. 107.1550 would continue to be
permitted on a cash-only basis, since the stated purpose of such
distributions is to provide investors in flow-through entities with
sufficient cash to pay their anticipated tax liabilities.
Characteristics of SBA's Leverage Guarantee
Section 303(b) of the Act authorizes SBA to guarantee the timely
payment of all principal and interest as scheduled on Debentures or
Participating Securities, pursuant to regulations issued by the Agency.
In the final rule published January 31, 1996 (61 FR 3177), the section
of the regulations which implemented this provision of the Act was
dropped inadvertently. Proposed Sec. 107.1720 would restore the
previous language setting forth the unconditional nature and other
characteristics of SBA's guarantee.
Capital Impairment
SBA is not proposing any substantive changes in the Capital
Impairment computations set forth in Secs. 107.1830 through 107.1850,
but is proposing one clarification. Current Sec. 107.1830(a) has caused
some confusion by stating that the current Capital Impairment
regulations apply to a Licensee if it has outstanding Leverage issued
on or after April 25, 1994. While this statement is true, it is
incomplete. This is because SBA Leverage is subject to the Capital
Impairment regulations in effect on the date the Leverage is issued.
Thus, a Licensee must comply with the current impairment rules if it
has Leverage issued on or after April 25, 1994; however, if it has
Leverage issued before that date as well, it must also comply with the
impairment rules in effect when such Leverage was issued. Proposed
Sec. 107.1830(a) would clarify this point by specifically linking the
applicability of the Capital Impairment regulations to the Leverage
issued. In the same paragraph, the proposed rule would also state that
a Licensee must comply with any specific conditions to which it has
agreed by contract with SBA. This is not a substantive change, but
simply makes explicit a Licensee's obligation to abide by the terms of
any agreement it has made with the Agency.
Miscellaneous Corrections and Editorial Changes
The definition of ``Commitment'' in Sec. 107.50 would be reworded
in the third person (i.e., to refer to ``a Licensee'' instead of
``you'') to conform to the style in which the other definitions are
written.
In current Sec. 107.720(c), the SIC code for Operative Builders is
incorrect. The proposed rule contains the correct 4-digit code (1531).
Proposed Sec. 107.1590 sets forth special rules applicable to
Participating Securities issuers licensed on or before March 31, 1993.
The proposed rule would eliminate the current paragraph (c), which
allows Licensees to repay outstanding Debentures with the proceeds of
newly issued Participating Securities, subject to certain conditions.
Since this paragraph properly applies to all Licensees, regardless of
licensing date, its content would be transferred to the new proposed
Sec. 107.1585. The substance of Sec. 107.1590 would remain unchanged.
In Sec. 107.1600, references to section 321 of the Act would be
changed to section 319, reflecting the amendment of the Act by Public
Law 104-208.
In the definition of Trust Certificate Rate and in Secs. 107.1240
and 107.1520(a)(1), certain technical changes have been proposed to
facilitate the interim Leverage funding mechanism currently under
consideration by SBA.
Limited Liability Companies
Section 208(b)(1) of Public Law 104-208 amended the Act to permit
SBICs to organize as limited liability companies (LLCs). SBA is
studying the legal and administrative issues which may arise in
connection with LLCs, and will publish a proposed rule to implement
this form of organization by SBICs at a later date.
Although SBA regulations do not yet provide for LLC Licensees, SBA
has the statutory authority to license such companies. SBA's current
policy is to accept a license application from an LLC only if the LLC
is organized under Delaware's Limited Liability Company Act and does
not intend to issue Participating Securities, which SBA has not yet
developed in a form suitable for use by an LLC. SBA may reconsider
these limitations as SBA acquires greater familiarity with the LLC form
of organization and as a body of case law is created under the various
state LLC laws. The adoption of a Uniform LLC Act by a significant
number of states also would induce SBA to reexamine its current
preference for Delaware law.
Until SBA regulations are revised to accommodate LLC Licensees,
such Licensees should understand that SBA regards the members of the
LLC to be equivalent to the general partners in a partnership Licensee
unless the LLC's operating agreement clearly indicates otherwise. Thus,
all members of an LLC Licensee will automatically be considered Control
Persons and Associates of the Licensee unless the LLC's operating
agreement vests management authority only in certain members of the
company.
Compliance With Executive Orders, 12612, 12778, and 12866, the
Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork
Reduction Act (44 U.S.C. Ch. 35)
SBA certifies that this proposed rule would not be a significant
regulatory action for purposes of Executive Order 12866 because it
would not have an annual effect on the economy of more than $100
million, and that it would not have a significant economic impact on a
substantial number of small entities within the meaning of the
Regulatory Flexibility Act, 5 U.S.C. 601, et seq. The purpose of the
proposed rule is to implement provisions of Public Law 104-208 which
relate to small business investment companies, and to make certain
other changes, primarily technical corrections and clarifications, to
the regulations governing SBICs.
For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA
certifies that this proposed rule, if adopted in final form, would
contain no new reporting or recordkeeping requirements that have not
already been approved by the Office of Management and Budget.
For purposes of Executive Order 12612, SBA certifies that this rule
would not have any federalism implications warranting the preparation
of a Federalism Assessment.
For purposes of Executive Order 12778, SBA certifies that this rule
is drafted, to the extent practicable, in accordance with the standards
set forth in Section 2 of that Order.
List of Subjects in 13 CFR Part 107
Investment companies, Loan programs-business, Reporting and
recordkeeping requirements, Small businesses.
For the reasons set forth above, SBA hereby proposes to amend Part
107 of Title 13 of the Code of Federal Regulations as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for part 107 continues to read as
follows:
Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g
and 687m, Pub. L. 104-208.
2. Section 107.50 is proposed to be amended by revising the
definitions for
[[Page 53262]]
Commitment, Common Control, Preferred Securities, Section 301(d)
Licensee, and Trust Certificate Rate, and adding a definition of
Charge, to read as follows:
Sec. 107.50 Definitions of terms.
* * * * *
Charge means an annual fee on Leverage issued on or after October
1, 1996 (except for Leverage issued pursuant to a commitment made by
SBA before October 1, 1996), which is payable to SBA by Licensees,
subject to the terms and conditions set forth in 107.1130(d).
* * * * *
Commitment means a written agreement between a Licensee and an
eligible Small Business that obligates the Licensee to provide
Financing (except a guarantee) to that Small Business in a fixed or
determinable sum, by a fixed or determinable future date. In this
context the term ``agreement'' means that there has been agreement on
the principal economic terms of the Financing. The agreement may
include reasonable conditions precedent to the Licensee's obligation to
fund the commitment, but these conditions must be outside the
Licensee's control.
Common Control means a condition where two or more Persons, either
through ownership, management, contract, or otherwise, are under the
Control of one group or Person. Two or more Licensees are presumed to
be under Common Control if they are Affiliates of each other by reason
of common ownership or common officers, directors, or general partners;
or if they are managed or their investments are significantly directed
either by a common independent investment advisor or managerial
contractor, or by two or more such advisors or contractors that are
Affiliates of each other. This presumption may be rebutted by evidence
satisfactory to SBA.
* * * * *
Preferred Securities means nonvoting preferred stock or nonvoting
limited partnership interests issued to SBA prior to October 1, 1996,
by a Section 301(d) Licensee. Such securities were issued at par value
in the case of preferred stock, or at face value in the case of
preferred limited partnership interests.
* * * * *
Section 301(d) Licensee means a company licensed prior to October
1, 1996 under section 301(d) of the Act as in effect on the date of
licensing, that may provide Assistance only to Disadvantaged
Businesses. A Section 301(d) Licensee may be organized as a for-profit
corporation, as a non-profit corporation, or as a limited partnership.
* * * * *
Trust Certificate Rate means a fixed rate determined by the
Secretary of the Treasury at the time Participating Securities or
Debentures are pooled, taking into consideration the current average
market yield on outstanding marketable obligations of the United States
with maturities comparable to the maturities of the Trust Certificates
being guaranteed by SBA, adjusted to the nearest one-eighth of one
percent.
* * * * *
Sec. 107.110 [Removed]
3. Section 107.110 is proposed to be removed.
4. Section 107.120 is proposed to be revised to read as follows:
Sec. 107.120 Special rules for a Section 301(d) Licensee owned by
another Licensee.
A Section 301(d) Licensee which was licensed to operate as the
subsidiary of one or more Licensees (participant Licensees) may
continue to do so, subject to the following:
(a) Each participant Licensee must continue to own at least 20
percent of the voting securities of the Section 301(d) Licensee.
(b) A participant Licensee must continue to treat its entire
capital contribution to the subsidiary as a reduction of its
Leverageable Capital. The participant Licensee's remaining Leverageable
Capital must be sufficient to support its outstanding Leverage.
(c) A participant Licensee may not transfer its Leverage to a
subsidiary Section 301(d) Licensee.
5. In Sec. 107.150, the introductory text of paragraph (a)(1) is
proposed to be revised to read as follows:
Sec. 107.150 Management and ownership diversity requirement.
* * * * *
(a) Requirement one. * * *
(1) At least 30 percent of your Regulatory Capital and Leverageable
Capital must be owned by Persons unrelated to management. To satisfy
this requirement, such Persons must not be your Associates (except for
their status as your shareholders or limited partners) and must not
Control, be Controlled by, or be under Common Control with any of your
Associates. You must have as investors at least three such Persons who
are not Affiliates of one another and whose investments are significant
in both dollar and percentage terms, as determined by SBA. As an
alternative, you may substitute one investor who is an acceptable
Institutional Investor for the three investors who are otherwise
required. For purposes of this paragraph (a)(1), the following
Institutional Investors are acceptable:
* * * * *
6. Section 107.210 is proposed to be revised to read as follows:
Sec. 107.210 Minimum capital requirements for Licensees.
(a) Companies licensed on or after October 1, 1996. A company
licensed on or after October 1, 1996 must have Leverageable Capital of
at least $2,500,000 and must meet the applicable minimum Regulatory
Capital requirement:
(1) Licensees other than Participating Securities issuers. A
Licensee that does not wish to be eligible to apply for Participating
Securities must have Regulatory Capital of at least $5,000,000. As an
exception to this general rule, SBA in its sole discretion and based on
a showing of special circumstances and good cause may license an
applicant with Regulatory Capital of at least $3,000,000, but only if
the applicant:
(i) Has satisfied all licensing standards and requirements except
the minimum capital requirement, as determined solely by SBA;
(ii) Has a viable business plan reasonably projecting profitable
operations; and
(iii) Has a reasonable timetable for achieving Regulatory Capital
of at least $5,000,000.
(2) Participating Securities issuers. A Licensee that wishes to be
eligible to apply for Participating Securities must have Regulatory
Capital of at least $10,000,000, unless it demonstrates to SBA's
satisfaction that it can be financially viable over the long term with
a lower amount. Under no circumstances can the Licensee have Regulatory
Capital of less than $5,000,000.
(b) Companies licensed before October 1, 1996. A company licensed
before October 1, 1996 must meet the minimum capital requirements
applicable to such company, as required by the regulations in effect on
September 30, 1996. See Sec. 107.1120(c)(2) for Leverage eligibility
requirements.
Sec. 107.220 [Removed]
7. Section 107.220 is proposed to be removed.
8. Section 107.230 is proposed to be amended by revising the
introductory
[[Page 53263]]
text of paragraph (d)(4) to read as follows:
Sec. 107.230 Permitted sources of Private Capital for Licensees.
* * * * *
(d) Qualified Non-private Funds. * * *
(4) Funds invested in or committed in writing to any Section 301(d)
Licensee prior to October 1, 1996, from the following sources: * * *
* * * * *
9. In Sec. 107.503, paragraphs (a), (b) and (e), and the heading
and first sentence of paragraph (c), are proposed to be revised to read
as follows:
Sec. 107.503 Licensee's adoption of an approved valuation policy.
(a) Valuation guidelines. You must prepare, document and report the
valuations of your Loans and Investments in accordance with the
Valuation Guidelines for SBICs issued by SBA. These guidelines may be
obtained from SBA's Investment Division.
(b) SBA approval of valuation policy. You must have a written
valuation policy approved by SBA for use in determining the value of
your Loans and Investments. You must either:
(1) Adopt without change the model valuation policy set forth in
section III of the Valuation Guidelines for SBICs; or
(2) Obtain SBA's prior written approval of an alternative valuation
policy.
(c) Responsibility for valuations. Your board of directors or
general partner(s) will be solely responsible for adopting your
valuation policy and for using it to prepare valuations of your Loans
and Investments for submission to SBA. * * *
* * * * *
(e) Review of valuations by independent public accountant. (1) For
valuations performed as of the end of your fiscal year, your
independent public accountant must review your valuation procedures and
the implementation of such procedures, including adequacy of
documentation.
(2) The independent public accountant's report on your audited
annual financial statements (SBA Form 468) must include a statement
that your valuations were prepared in accordance with your approved
valuation policy established in accordance with section 310(d)(2) of
the Act.
10. Section 107.660 is proposed to be amended by redesignating
paragraph (d) as paragraph (e) and by adding a new paragraph (d) to
read as follows:
Sec. 107.660 Other items required to be filed by Licensee with SBA.
* * * * *
(d) Notification of criminal charges. If any officer, director,
general partner or other Control Person is charged with or convicted of
any criminal offense other than a misdemeanor involving a minor motor
vehicle violation, you must report the incident to SBA within 5
calendar days. Such report must fully describe the facts which pertain
to the incident.
* * * * *
11. Section 107.710 is proposed to be amended by adding a sentence
at the end of paragraph (e) and by revising paragraphs (b) and (c) to
read as follows:
Sec. 107.710 Requirement to finance Smaller Enterprises.
* * * * *
(b) Smaller Enterprise Financings. (1) General rule. At the close
of each of your fiscal years, at least 20 percent of the total dollar
amount of the Financings you extended since April 25, 1994 must have
been invested in Smaller Enterprises. If you were licensed after April
25, 1994, the 20 percent requirement applies to the total dollar amount
of the Financings you extended since you were licensed plus any pre-
licensing investments approved by SBA for inclusion in your Regulatory
Capital.
(2) Phase-in for new Licensees. At the close of your first full
fiscal year after licensing, at least 10 percent of the total dollar
amount of the Financings you extended, including any pre-licensing
investments approved by SBA for inclusion in your Regulatory Capital,
must have been invested in Smaller Enterprises. At the close of each
fiscal year thereafter, you must meet the requirement in paragraph
(b)(1) of this section.
(c) Special requirement for certain leveraged Licensees. (1) This
paragraph (c) applies if you were licensed on or before September 30,
1996, and you issued Leverage after that date, and you have Regulatory
Capital of:
(i) Less than $10,000,000 if such Leverage was Participating
Securities; or
(ii) Less than $5,000,000 if such Leverage was Debentures.
(2) At the close of each of your fiscal years, at least 50 percent
of the total dollar amount of the Financings you extended after
September 30, 1996 must have been invested in Smaller Enterprises.
* * * * *
(e) Non-compliance with this section. * * * However, you will not
be eligible for additional Leverage until you reach the required
percentage (see Sec. 107.1120 (c) and (d)).
12. In Sec. 107.720, paragraph (b)(2) and the introductory text of
paragraph (c)(1) are proposed to be revised to read as follows:
Sec. 107.720 Small Businesses that may be ineligible for Financing.
* * * * *
(b) Passive businesses. * * *
(2) Exception for pass-through of proceeds to subsidiary. You may
finance a passive business if it is a Small Business and it passes
substantially all the proceeds through to one or more subsidiary
companies, each of which is an eligible Small Business that is not
passive. For the purpose of this paragraph (b)(2), ``subsidiary
company'' means a company in which at least 50 percent of the
outstanding voting securities are owned by the Financed passive
business.
(c) Real estate businesses. (1) You are not permitted to finance
any business classified under Major Group 65 (Real Estate) or Industry
No. 1531 (Operative Builders) of the SIC Manual, with the following
exceptions: * * *
* * * * *
13. In Sec. 107.730, paragraph (d)(3)(iv) is proposed to be revised
to read as follows:
Sec. 107.730 Financings which constitute conflicts of interest.
* * * * *
(d) Financings with Associates. * * *
(3) Exceptions to paragraphs (d)(1) and (d)(2) of this section. * *
*
(iv) Both you and your Associate are non-leveraged Licensees, or
you are a non-leveraged Licensee and your Associate is not a Licensee.
* * * * *
14. In Sec. 107.740, paragraph (a) is proposed to be revised to
read as follows:
Sec. 107.740 Portfolio diversification (``overline'' limitation).
(a) General rule. This Sec. 107.740 applies if you have outstanding
Leverage or want to be eligible for Leverage. Without SBA's prior
written approval, you may provide Financing or a Commitment to a Small
Business only if the resulting amount of your aggregate outstanding
Financings and Commitments to such Small Business and its Affiliates
does not exceed:
(1) 20 percent of your Regulatory Capital as of the date of the
Financing or Commitment if you are a Section 301(c) Licensee; or
(2) 30 percent of your Regulatory Capital as of the date of the
Financing or Commitment if you are a Section 301(d) Licensee.
* * * * *
[[Page 53264]]
15. Section 107.855 is proposed to be amended by revising
paragraphs (c)(1), (c)(4)(i) and (d)(4), redesignating paragraphs
(g)(1) through (g)(10) as paragraphs (g)(2) through (g)(11), and adding
a new paragraph (g)(1) to read as follows:
Sec. 107.855 Interest rate ceiling and limitations on fees charged to
Small Businesses (``Cost of Money'')
* * * * *
(c) How to determine the Cost of Money ceiling for a Financing. * *
*
(1) Choose a base rate for your Cost of Money computation. The base
rate may be either the Debenture Rate currently in effect plus the
applicable Charge determined under Sec. 107.1130(d)(1), or your own
``Cost of Capital'' as determined under paragraph (d) of this section.
* * * * *
(4) * * *
(i) The current Debenture Rate plus the applicable Charge
determined under Sec. 107.1130(d)(1);
* * * * *
(d) How to determine your Cost of Capital. * * *
(4) For all qualified borrowings outstanding at your last fiscal
year or fiscal quarter end, determine the aggregate interest expense
for the past four fiscal quarters, excluding amortization of loan fees.
For the purposes of this paragraph (d)(4):
(i) Interest expense on Debentures includes the 1 percent Charge
paid by a Licensee under Sec. 107.1130(d)(1); and
(ii) Section 301(d) Licensees with outstanding subsidized
Debentures are presumed to have paid interest at the rate stated on the
face of such Debentures, without regard to any subsidy paid by SBA.
* * * * *
(g) Charges excluded from the Cost of Money. * * *
(1) Discount on the loan portion of a Debt Security, if such
discount exists solely as the result of the allocation of value to
detachable stock purchase warrants in accordance with generally
accepted accounting principles.
* * * * *
16. In Sec. 107.865, the first sentence of paragraph (c)(2) and
paragraph (d)(1) are proposed to be revised to read as follows:
Sec. 107.865 Restrictions on Control of a Small Business by a
Licensee.
* * * * *
(c) Rebuttals to presumption of Control. * * *
(2) The management of the Small Business can elect at least 40
percent of the board members of a corporation, general partners of a
limited partnership, or managers of a limited liability company, as
appropriate, and the Investor Group can elect no more than 40 percent.
* * *
* * * * *
(d) Temporary Control permitted. * * *
(1) Where reasonably necessary for the protection of your existing
investment;
* * * * *
17. Section 107.1100 is proposed to be revised to read as follows:
Sec. 107.1100 Types of Leverage and application forms.
(a) Types of Leverageable available. You may apply for Leverage
from SBA in one or both of the following forms:
(1) The purchase or guarantee of your Debentures.
(2) The purchase or guarantee of your Participating Securities.
(b) Application forms. Use SBA Form 1022 to apply for Debentures
and SBA Form 1022B to apply for Participating Securities.
(c) Where to send your application. Send all Leverage applications
to SBA, Investment Division, 409 Third Street, S.W., Washington, DC
20416.
Sec. 107.1110 [Removed]
18. Section 107.1110 is proposed to be removed.
19. Section 107.1120 is proposed to be amended by revising
paragraph (c), redesignating paragraphs (d) through (f) as paragraphs
(e) through (g), and adding a new paragraph (d) to read as follows:
Sec. 107.1120 General eligibility requirements for Leverage.
* * * * *
(c) Meet the minimum capital requirements of Sec. 107.210, subject
to the following additional conditions:
(1) If you were licensed after September 30, 1996 under the
exception in Sec. 107.210(a)(1), you will not be eligible for Leverage
until you have Regulatory Capital of at least $5,000,000.
(2) If you were licensed on or before September 30, 1996, and have
Regulatory Capital of less than $5,000,000 (less than $10,000,000 if
you wish to issue Participating Securities):
(i) You must certify in writing that at least 50 percent of the
aggregate dollar amount of your Financings extended after September 30,
1996 will be provided to Smaller Enterprises (as defined in
Sec. 107.710(a)); and
(ii) You must demonstrate to SBA's satisfaction that the approval
of Leverage will not create or contribute to an unreasonable risk of
default or loss to the United States government, based on such
measurements of profitability and financial viability as SBA deems
appropriate.
(d) Certify in writing that you are in compliance with the
requirement to finance Smaller Enterprises in Sec. 107.710(b).
* * * * *
20. Section 107.1130 is proposed to be amended by revising the
heading and paragraphs (a) through (c), redesignating paragraph (d) as
paragraph (e), and adding a new paragraph (d) to read as follows:
Sec. 107.1130 Leverage fees and additional charges payable by
Licensee.
(a) Leverage fee. You must pay a leverage fee to SBA for each
issuance of a Debenture or Participating Security. The fee is 3 percent
of the face amount of the Leverage issued.
(b) Payment of leverage fee. (1) If you issue a Debenture or
Participating Security to repay or redeem existing Leverage, you must
pay the leverage fee before SBA will guarantee or purchase the new
Leverage security.
(2) If you issue a Debenture or Participating Security that is not
used to repay or redeem existing Leverage, SBA will deduct the leverage
fee from the proceeds remitted to you, unless you prepaid the fee under
Sec. 107.1210.
(c) Refundability. The leverage fee is not refundable under any
circumstances.
(d) Additional charge for Leverage.--(1) Debentures. You must pay
to SBA a Charge of 1 percent per annum on the outstanding amount of
your Debentures issued on or after October 1, 1996, payable under the
same terms and conditions as the interest on the Debentures. This
Charge does not apply to Debentures issued pursuant to a Leverage
commitment obtained from SBA on or before September 30, 1996.
(2) Participating Securities. You must pay to SBA a Charge of 1
percent per annum on the outstanding amount of your Participating
Securities issued on or after October 1, 1996, payable under the same
terms and conditions as the Prioritized Payments on the Participating
Securities. This Charge does not apply to Participating Securities
issued pursuant to a Leverage commitment obtained from SBA on or before
September 30, 1996.
* * * * *
21. Section 107.1160 is proposed to be amended by adding
introductory text to read as follows:
[[Page 53265]]
Sec. 107.1160 Maximum amount of Leverage for a Section 301(d)
Licensee.
This section applies to Leverage issued by a Section 301(d)
Licensee on or before September 30, 1996. Effective October 1, 1996, a
Section 301(d) Licensee may apply to issue new Leverage, or refinance
existing Leverage, only on the same terms permitted under
Sec. 107.1150.
* * * * *
22. Section 107.1200 is proposed to be amended by revising
paragraphs (c) and (d) to read as follows:
Sec. 107.1200 SBA's Leverage commitment to a Licensee--application
procedure, amount, and term.
* * * * *
(c) Limitations on the amount of a Leverage commitment. The amount
of a Leverage commitment must be a multiple of $5,000.
(d) Term of Leverage commitment. SBA's Leverage commitment will
automatically lapse on the expiration date stated in the commitment
letter issued to you by SBA.
23. Section 107.1210 is proposed to be revised to read as follows:
Sec. 107.1210 Payment of leverage fee upon receipt of commitment.
(a) Prepayment of leverage fee. As a condition of SBA's Leverage
commitment, and before you draw any Leverage, you must prepay the
leverage fee established under Sec. 107.1130(a). The fee is equal to 3
percent of the face amount of the Debentures or Participating
Securities reserved under the commitment.
(b) Automatic cancellation of commitment. Unless you pay the full
amount of the leverage fee by 5 P.M. Eastern Time on the 30th calendar
day following the issuance of SBA's Leverage commitment, the commitment
will be automatically canceled.
24. In Sec. 107.1230, paragraphs (a) and (b) are proposed to be
revised to read as follows:
Sec. 107.1230 Draw-downs by Licensee under SBA's Leverage commitment.
(a) Licensee's authorization of SBA to purchase or guarantee
securities. By submitting a request for a draw against SBA's Leverage
commitment, you authorize SBA, or any agent or trustee SBA designates,
to guarantee your Debenture or Participating Security and to sell it
with SBA's guarantee.
(b) Limitations on amount of draw. The amount of a draw must be a
multiple of $5,000. SBA, in its discretion, may determine a minimum
dollar amount for draws against SBA's Leverage commitments. Any such
minimum amounts will be published in Notices in the Federal Register
from time to time.
* * * * *
25. Section 107.1240 is proposed to be amended by revising
paragraphs (a)(1), (b), (c) and (d) to read as follows:
Sec. 107.1240 Funding of Licensee's draw request through sale to
short-term investor.
(a) Licensee's authorization of SBA to arrange sale of securities
to short-term investor. * * *
(1) The sale of your Debenture or Participating Security to a
short-term investor at a rate that may be different from the Trust
Certificate Rate which will be established at the time of the pooling
of your security;
* * * * *
(b) Sale of Debentures to a short-term investor. If SBA sells your
Debenture to a short-term investor:
(1) The sale price will be the face amount.
(2) At the next scheduled date for the sale of Debenture Trust
Certificates, whether or not the sale actually occurs, you must pay
interest to the short-term investor for the short-term period. If the
actual sale of Trust Certificates takes place after the scheduled date,
you must pay the short-term investor interest from the scheduled sale
date to the actual sale date. This additional interest is due on the
actual sale date.
(3) Failure to pay the interest constitutes noncompliance with the
terms of your Leverage (see Sec. 107.1810).
(c) Sale of Participating Securities to a short-term investor. If
SBA sells your Participating Security to a short-term investor, the
sale price will be the face amount.
(d) Licensee's right to repurchase its Debentures before pooling.
You may repurchase your Debentures from the short-term investor before
they are pooled. To do so, you must:
(1) Give SBA written notice at least 10 days before the cut-off
date for the pool in which your Debenture is to be included; and
(2) Pay the face amount of the Debenture, plus interest, to the
short-term investor.
26. Subpart I of Part 107 is proposed to be amended by removing the
undesignated center heading ``Exchange of Outstanding Debentures for
Participating or Preferred Securities--Section 301(d) Licensees'', by
redesignating Sec. 107.1350 as Sec. 107.1585, and by revising
redesignated Sec. 107.1585 to read as follows:
Sec. 107.1585 Exchange of Debentures for Participating Securities.
You may, in SBA's discretion, retire a Debenture through the
issuance of Participating Securities. To do so, you must:
(a) Obtain SBA's approval to issue Participating Securities;
(b) Pay all unpaid accrued interest on the Debenture, plus any
applicable prepayment penalties, fees, and other charges;
(c) Have outstanding Equity Capital Investments (at cost) equal to
the amount of the Debenture being refinanced; and
(d) Classify all your existing Loans and Investments as Earmarked
Assets.
27. In Sec. 107.1400, the heading and introductory text are
proposed to be revised to read as follows:
Sec. 107.1400 Dividends or partnership distributions on 4 percent
Preferred Securities.
If you issued Preferred Securities to SBA on or after November 21,
1989, you must pay SBA a dividend or partnership distribution of 4
percent per year, from the date you issued Preferred Securities to the
date you repay them, both inclusive. The dividend or partnership
distribution is:
* * * * *
28. Section 107.1420 is proposed to be revised to read as follows:
Sec. 107.1420 Articles requirements for 4 percent Preferred
Securities.
If you have outstanding 4 percent Preferred Securities, your
Articles must contain all the provisions in Secs. 107.1400 and
107.1410.
Sec. 107.1430 [Amended]
29. Section 107.1430 is proposed to be revised by removing the last
sentence.
30. In Sec. 107.1500, paragraphs (b)(1) and (b)(4), the last
sentence of paragraph (e), and paragraph (f)(2) are proposed to be
revised to read as follows:
Sec. 107.1500 General description of Participating Securities.
* * * * *
(b) Special eligibility requirements for Participating Securities.
* * *
(1) Minimum capital (see Sec. 107.210).
* * * * *
(4) Equity investing, as set forth in this paragraph (b)(4). If you
issue Participating Securities, you must invest an amount equal to the
Original Issue Price of such securities solely in Equity Capital
Investments, as defined in Sec. 107.50.
* * * * *
(e) Mandatory redemption of Participating Securities. * * * You
must pay the Redemption Price plus any unpaid Earned Prioritized
Payments and any earned Adjustments and earned Charges (see
Sec. 107.1520).
[[Page 53266]]
(f) Priority of Participating Securities in liquidation of
Licensee. * * *
(2) Any Earned Prioritized Payments and any earned Adjustments and
earned Charges (see Sec. 107.1520); and
* * * * *
31. In Sec. 107.1505, the last sentence of paragraph (a) and
paragraph (b) are proposed to be revised to read as follows:
Sec. 107.1505 Liquidity requirements for licensees issuing
Participating Securities.
(a) Definition of Liquidity Impairment. * * * You are responsible
for calculating whether you have a condition of Liquidity Impairment:
(1) As of the close of your fiscal year;
(2) At the time you apply for Leverage, unless SBA permits
otherwise; and
(3) At such time as you contemplate making any Distribution.
(b) Computation of Liquidity Ratio. Your Liquidity Ratio equals
your Total Current Funds Available (A) divided by your Total Current
Funds Required (B), as determined in the following table:
Calculation of Liquidity Ratio
----------------------------------------------------------------------------------------------------------------
Amount reported
Financial account on SBA Form 468 Weight Weighted amount
----------------------------------------------------------------------------------------------------------------
(1) Cash and invested idle funds............ ............... x 100 .................
(2) Commitments from investors.............. ............... x 1.00 .................
(3) Current maturities...................... ............... x 0.50 .................
(4) Other current assets.................... ............... x 1.00 .................
(5) Publicly Traded and Marketable ............... x 1.00 .................
Securities.
(6) Anticipated operating revenue for next ............... x 1.00 .................
12 months (\1\).
(7) Total Current Funds Available........... ............... .............................. A
----------------------------------------------------------------------------------------------------------------
(8) Current liabilities..................... ............... x 1.00 .................
(9) Commitments to Small Businesses......... ............... x 0.75 .................
(10) Anticipated operating expense for next (\1\) x 1.00 .................
12 months.
(11) Anticipated interest expense for next (\1\) x 1.00 .................
12 months.
(12) Contingent liabilities (guarantees).... ............... x 0.25 .................
(13) Total Current Funds Required........... ............... .............................. B
----------------------------------------------------------------------------------------------------------------
\1\ As determined by Licensee's management under its business plan.
* * * * *
32. In Sec. 107.1510, the introductory text, the last sentence of
paragraph (c) and paragraph (d)(1)(ii) are proposed to be revised to
read as follows:
Sec. 107.1510 How a Licensee computes Earmarked Profit (Loss).
Computing your Earmarked Profit (Loss) is the first step in
determining your obligations to pay Prioritized Payments, Adjustments
and Charges under Sec. 107.1520 and Profit Participation under
Sec. 107.1530.
* * * * *
(c) How to compute your Earmarked Asset Ratio. * * * Otherwise,
compute your Earmarked Asset Ratio using the following formula:
EAR = (EA)(LI) x 100
where:
EAR=Earmarked Asset Ratio
EA=Average Earmarked Assets (at cost) for the fiscal year or
interim period
LI=Average Loans and Investments (at cost) for the fiscal year or
interim period
(d) How to compute your Earmarked Profit (Loss) if Earmarked Asset
Ratio is 100 percent. * * *
(1) * * *
(ii) For the purpose of determining Net Income (Loss), leverage
fees paid to SBA and partnership syndication costs that you incur must
be capitalized and amortized on a straight-line basis over not less
than five years.
* * * * *
33. Section 107.1520 is proposed to be revised to read as follows:
Sec. 107.1520 How a Licensee computes and allocates Prioritized
Payments to SBA.
This section tells you how to compute Prioritized Payments,
Adjustments and Charges on Participating Securities and determine the
amounts you must pay. To distribute these amounts, see Sec. 107.1540.
(a) How to compute Prioritized Payments and Adjustments--(1)
Prioritized Payments. For a full fiscal year, the Prioritized Payment
on an outstanding Participating Security equals the Redemption Price
times the related Trust Certificate Rate. For an interim period, you
must prorate the annual Prioritized Payment. If your Participating
Security was sold to a short-term investor in accordance with
Sec. 107.1240, the Prioritized Payment for the short-term period equals
the Redemption Price times the short-term rate.
(2) Adjustments. Compute Adjustments using paragraph (f) of this
section.
(3) Charges. Compute Charges in accordance with
Sec. 107.1130(d)(2).
(b) Licensee's obligation to pay Prioritized Payments, Adjustments
and Charges. You are obligated to pay Prioritized Payments, Adjustments
and Charges only if you have profit as determined in paragraph (d) of
this section.
(1) Prioritized Payments that you must pay (or have already paid)
because you have sufficient profit are ``Earned Prioritized Payments''.
(2) Prioritized Payments that have not become payable because you
lack sufficient profit are ``Accumulated Prioritized Payments''. Treat
all Prioritized Payments as ``Accumulated'' until they become
``Earned'' under this section.
(3) Adjustments (computed under paragraph (f) of this section) and
Charges (computed under Sec. 107.1130(d)(2)) are ``earned'' according
to the same criteria applied to Prioritized Payments.
(c) How to keep track of Prioritized Payments. You must establish
three accounts to record your Accumulated and Earned Prioritized
Payments:
(1) Accumulation Account. The Accumulation Account is a memorandum
account. Its balance represents your Accumulated Prioritized Payments,
unearned Adjustments and unearned Charges.
(2) Distribution Account. The Distribution Account is a liability
account. Its balance represents your unpaid Earned Prioritized
Payments, earned Adjustments and earned Charges.
[[Page 53267]]
(3) Earned Payments Account. The Earned Payments Account is a
memorandum account. Each time you add to the Distribution Account
balance, add the same amount to the Earned Payments Account. Its
balance represents your total (paid and unpaid) Earned Prioritized
Payments, earned Adjustments and earned Charges.
(d) How to determine your profit for Prioritized Payment purposes.
As of the end of each fiscal year and any interim period for which you
want to make a Distribution:
(1) Bring the Accumulation Account up to date by adding to it all
Prioritized Payments and Charges through the end of the appropriate
fiscal period.
(2) Determine whether you have profit for the purposes of this
section by doing the following computation:
(i) Cumulative Earmarked Profit (Loss) under Sec. 107.1510(f);
minus
(ii) The Earned Payments Account balance; minus
(iii) All Distributions previously made under Secs. 107.1550,
107.1560 and 107.1570(a); minus
(iv) Any Profit Participation previously allocated to SBA under
Sec. 107.1530, but not yet distributed.
(3) The amount computed in paragraph (d)(2) of this section, if
greater than zero, is your profit. If the amount is zero or less, you
have no profit.
(4) If you have a profit, continue with paragraph (e) of this
section. Otherwise, continue with paragraph (f) of this section.
(e) Allocating Prioritized Payments to the Distribution Account.
(1) If you have a profit under paragraph (d) of this section, determine
the lesser of:
(i) Your profit; or
(ii) The balance in your Accumulation Account.
(2) Subtract the result in paragraph (e)(1) of this section from
the Accumulation Account and add it to the Distribution Account and the
Earned Payments Account.
(f) How to compute Adjustments. You must compute Adjustments as of
the end of each fiscal year if you have a balance greater than zero in
either your Accumulation Account or your Distribution Account, after
giving effect to any Distribution that will be made no later than the
second Payment Date following the fiscal year end.
(1) Determine the combined average Accumulation Account and
Distribution Account balances for the fiscal year, assuming that
Prioritized Payments accumulate on a daily basis without compounding.
(2) Multiply the average balance computed in paragraph (f)(1) of
this section by the average of the Trust Certificate Rates for all the
Participating Securities poolings during the fiscal year.
(3) Add the amounts computed in this paragraph (f) to your
Accumulation Account.
(g) Licensee's obligation to pay Prioritized Payments after
redeeming Participating Securities. This paragraph (g) applies if you
have redeemed all your Participating Securities, but you still hold
Earmarked Assets and still have a balance in your Accumulation Account.
(1) You must continue to perform all the procedures in this
Sec. 107.1520 as of the end of each fiscal quarter and prior to making
any Distribution. You must distribute any Earned Prioritized Payments,
earned Adjustments and earned Charges in accordance with Sec. 107.1540.
(2) After you dispose of all your Earmarked Assets and make any
required Distributions in accordance with Sec. 107.1540, your
obligation to pay any remaining Accumulated Prioritized Payments,
unearned Adjustments and unearned Charges will be extinguished.
34. Section 107.1530 is proposed to be amended by removing
paragraphs (e)(3) and (e)(4) and revising paragraphs (c), (e)(2) and
(h) to read as follows:
Sec. 107.1530 How a Licensee computes SBA's Profit Participation.
* * * * *
(c) How to compute the Base. As of the end of each fiscal year and
any year-to-date interim period for which you want to make a
Distribution, compute your Base using the following formula:
B = EP-PPA-UL
where:
B=Base
EP=Earmarked Profit (Loss) for the period from Sec. 107.1510
PPA=Prioritized Payments for the period from Sec. 107.1520(a)(1),
Adjustments (if applicable) from Sec. 107.1520(f), and Charges (if
applicable) from Sec. 107.1130(d)(2)
UL=``Unused Loss'' from prior periods as determined in this
paragraph (c).
(1) If the Base computed as of the end of your previous fiscal year
(your ``Previous Base'') was less than zero, your Unused Loss equals
your Previous Base.
(2) If your Previous Base was zero or greater, your Unused Loss
equals zero, with the following exception: If you made an interim
Distribution of Profit Participation during your previous fiscal year,
and your Previous Base was lower than the interim Base on which your
Distribution was computed, then your Unused Loss equals the difference
between the interim Base and the Previous Base. For example, assume you
are computing your Base as of December 31, 1997, your fiscal year end.
Your Previous Base, computed as of December 31, 1996, was $3,000,000.
During 1996, you made an interim Distribution which was computed on a
Base of $3,500,000 as of June 30, 1996. The $500,000 difference between
the 1996 interim and year-end Bases would be carried forward as Unused
Loss in the computation of your Base as of December 31, 1997.
(3) If you had no Participating Securities outstanding as of the
end of your last fiscal year, you may request SBA's approval to treat
your Undistributed Net Realized Loss, as reported on SBA Form 468 for
that year, as Unused Loss. If you did not file SBA Form 468 because you
were not yet licensed as of the end of your last fiscal year, you may
request SBA's approval to treat pre-licensing losses as Unused Loss.
* * * * *
(e) Compute the ``PLC ratio''. * * *
(2) Exception. You may reduce the ratio computed under paragraph
(e)(1) of this section if you have increased your Leverageable Capital
above its highest previous level. The increase must have taken place at
least 120 days before the date as of which your Base is computed. In
addition, the increase must have been expressly provided for in a plan
of operations submitted to and approved by SBA in writing, or must be
the result of the takedown of commitments or the conversion of non-cash
assets that were included in your Private Capital. If these conditions
are satisfied, compute your reduced PLC ratio as follows:
(i) Divide the highest dollar amount of Participating Securities
you have ever had outstanding by your increased Leverageable Capital.
(ii) If the result in paragraph (e)(2)(i) is lower than your PLC
ratio currently in effect, such result will become your new PLC ratio.
* * * * *
(h) Computing SBA's Profit Participation. If the Base from
paragraph (c) of this section is greater than zero, you must compute
SBA's Profit Participation as follows:
(1) Multiply the Base from paragraph (c) by the Profit
Participation Rate from paragraph (g).
(2) If your last Profit Participation computation was for an
interim period during the same fiscal year and used a higher Profit
Participation Rate than the
[[Page 53268]]
Rate you just used in paragraph (h)(1) of this section, you must adjust
the amount computed in paragraph (h)(1) as follows:
(i) Determine the difference between the Profit Participation Rate
you just used in paragraph (h)(1) and the Rate used in your previous
computation;
(ii) Multiply the difference by the Base from your last Profit
Participation computation; and
(iii) Add the result to the amount you computed in paragraph
(h)(1).
(3) Reduce the Profit Participation computed in paragraphs (h)(1)
and (h)(2) by any amounts of Profit Participation that you distributed
or reserved for distribution to SBA, or its designated agent or
Trustee, for any previous interim period(s) during the fiscal year. The
result is SBA's Profit Participation (unless it is less than zero, in
which case SBA's Profit Participation is zero).
* * * * *
35. Section 107.1540 is proposed to be amended by adding a sentence
at the end of the introductory text to read as follows:
Sec. 107.1540 Distributions by Licensee--Prioritized Payment and
Adjustments.
* * * You must notify SBA of any planned distribution under this
section 10 business days before the distribution date, unless SBA
permits otherwise.
* * * * *
36. Section 107.1550 is proposed to be amended by adding a sentence
at the end of the introductory text and by revising paragraphs (a)(1)
and (b) to read as follows:
Sec. 107.1550 Distributions by Licensee--permitted ``tax
Distributions'' to private investors and SBA.
* * * You must notify SBA of any planned distribution under this
section 10 business days before the distribution date, unless SBA
permits otherwise.
(a) Conditions for making a tax Distribution. * * *
(1) You have paid all your Prioritized Payments, Adjustments, and
Charges, so that the balance in both your Distribution Account and your
Accumulation Account is zero (see Sec. 107.1520).
* * * * *
(b) How to compute the Maximum Tax Liability. (1) Compute your
Maximum Tax Liability for a full fiscal year only. Use the following
formula:
M=(TOI x HRO) + (TCG x HRC)
where:
M=Maximum Tax Liability
TOI=Net ordinary income allocated to your partners or other owners
for Federal income tax purposes for the fiscal year immediately
preceding the Distribution, excluding Prioritized Payments allocated to
SBA
HRO=The highest combined marginal Federal and State income tax rate
for corporations or individuals on ordinary income, determined in
accordance with paragraphs (b)(2) through (b)(4) of this section
TCG=Net capital gains allocated to your partners or other owners
for Federal income tax purposes for the fiscal year immediately
preceding the Distribution, excluding Prioritized Payments allocated to
SBA
HRC=The highest combined marginal Federal and State income tax rate
for corporations or individuals on capital gains, determined in
accordance with paragraphs (b)(2) through (b)(4) of this section.
(2) You may compute the highest combined marginal Federal and State
income tax rate on ordinary income and capital gains using either
individual or corporate rates. However, you must apply the same type of
rate, either individual or corporate, to both ordinary income and
capital gains.
(3) In determining the combined Federal and State income tax rate,
you must assume that State income taxes are deductible from Federal
income taxes. For example, if the Federal tax rate was 35 percent and
the State tax rate was 5 percent, the combined tax rate would be [35%
x (1-.05)]+5% = 38.25%.
(4) For purposes of this paragraph (b), the ``State income tax'' is
that of the State where your principal place of business is located,
and does not include any local income taxes.
* * * * *
37. In Sec. 107.1560, in the first column of the table in paragraph
(e), the column heading is proposed to be revised to read ``If your
ratio of Leverage to Leverageable Capital as of the fiscal period end
is:'', a sentence is proposed to be added at the end of the
introductory text, and paragraphs (a)(1), (a)(4) and (b) are proposed
to be revised to read as follows:
Sec. 107.1560 Distributions by Licensee--required Distributions to
private investors and SBA.
* * * You must notify SBA of any planned distribution under this
section 10 business days before the distribution date, unless SBA
permits otherwise.
(a) Conditions for making distributions. * * *
(1) You must have paid all Prioritized Payments, Adjustments and
Charges, so that the balance in both your Distribution Account and your
Accumulation Account is zero (see Secs. 107.1520 and 107.1540).
* * * * *
(4) The amount you distribute under this section must not exceed
your remaining Retained Earnings Available for Distribution.
(b) Total amount you must distribute. Unless SBA permits otherwise,
the total amount you must distribute equals the result (if greater than
zero) of the following computation:
(1) Your Retained Earnings Available for Distribution as of the end
of your fiscal year, after giving effect to any Distribution under
Secs. 107.1540 and 107.1550; minus
(2) All previous Distributions under this Sec. 107.1560 and
Sec. 107.1570(a) that were applied as redemptions or repayments of
Leverage; plus
(3) All previous Distributions under Sec. 107.1570(b) that reduced
your Retained Earnings Available for Distribution.
* * * * *
38. Section 107.1570 is proposed to be amended by adding a sentence
at the end of the introductory text and by revising the heading and
paragraphs (b)(1)(i) and (b)(1)(ii) to read as follows:
Sec. 107.1570 Distributions by Licensee--optional Distributions to
private investors and SBA.
* * * You must notify SBA of any planned distribution under this
section 10 business days before the distribution date, unless SBA
permits otherwise.
* * * * *
(b) Other optional Distributions. * * *
(1) Conditions for making a Distribution. * * *
(i) You have distributed all Earned Prioritized Payments, earned
Adjustments, and earned Charges, so that the balance in your
Distribution Account is zero (see Sec. 107.1520).
(ii) You have distributed all Profit Participation computed under
Sec. 107.1530 which you are required to distribute under Sec. 107.1560
or permitted to distribute under Sec. 107.1570(a), as appropriate, and
you have made all required Distributions under Sec. 107.1560.
* * * * *
39. Section 107.1575 is proposed to be added to subpart I to read
as follows:
Sec. 107.1575 Distributions on other than Payment Dates.
(a) Permitted distributions on other than payment dates.
Notwithstanding any provisions to the contrary in Secs. 107.1540
through 107.1570, you may make Distributions on dates other than
Payment Dates as follows:
[[Page 53269]]
(1) Required annual Distributions under Secs. 107.1540(a)(1), and
any Distributions under Secs. 107.1550 and 107.1560, must be made no
later than the second Payment Date following the end of your fiscal
year;
(2) Required Distributions under Sec. 107.1540(b) must be made no
later than the first Payment Date following the end of the applicable
fiscal quarter;
(3) Optional Distributions under Sec. 107.1540(a)(2) and
Sec. 107.1570 may be made on any date.
(b) Conditions for making distribution. All Distributions under
this Sec. 107.1575 are subject to the following conditions:
(1) You must obtain SBA's written approval before the distribution
date;
(2) You must use the distribution date as the ending date of the
period for which you compute your Earmarked Profits, Prioritized
Payments, Adjustments, Charges, Profit Participation, Retained Earnings
Available for Distributions, liquidity ratio, Capital Impairment, and
any other applicable computations required under Secs. 107.1500 through
107.1570;
(3) If your Distribution includes an amount which SBA will apply as
a redemption of Participating Securities, the effective date of such
redemption, for all purposes including future computations of
Prioritized Payments, will be the next Payment Date following the
distribution date.
40. In Sec. 107.1580, the introductory text of paragraph (a) is
proposed to be revised to read as follows:
Sec. 107.1580 Special rules for In-Kind Distributions by Licensees.
(a) In-Kind distributions. A Distribution under Secs. 107.1540,
107.1560 or 107.1570 may consist of securities (an ``In-Kind
Distribution''). Such a Distribution must satisfy the conditions in
this paragraph (a).
* * * * *
41. Section 107.1590 is proposed to be amended by removing
paragraph (c), redesignating paragraph (d) as paragraph (c), and
revising paragraph (a)(1) to read as follows:
Sec. 107.1590 Special rules for companies licensed on or before March
31, 1993.
* * * * *
(a) Election to exclude pre-existing portfolio. * * *
(1) The proceeds of your first issuance of Participating Securities
are not used to refinance outstanding Debentures (see
Sec. 107.1585(a)). SBA will consider payment or prepayment of any
outstanding Debenture to be a refinancing unless you demonstrate to
SBA's satisfaction that you can pay the Debenture principal without
relying on the proceeds of the Participating Securities.
* * * * *
42. In Sec. 107.1600, the first sentence of paragraph (a) and
paragraph (b) are proposed to be revised to read as follows:
Sec. 107.1600 SBA authority to issue and guarantee Trust Certificates.
(a) Authorization. Sections 319 (a) and (b) of the Act authorize
SBA or its CRA to issue TCs, and SBA to guarantee the timely payment of
the principal and interest thereon. * * *
(b) Periodic exercise of authority. SBA will issue guarantees of
Debentures and Participating Securities under section 303 and of TCs
under section 319 of the Act at three month intervals, or at shorter
intervals, taking into account the amount and number of such guarantees
or TCs.
* * * * *
43. Section 107.1720 is proposed to be added to subpart I to read
as follows:
Sec. 107.1720 Characteristics of SBA's guarantee.
If SBA agrees to guarantee a Licensee's Debentures or Participating
Securities, such guarantee will be unconditional, irrespective of the
validity, regularity or enforceability of the Debentures or
Participating Securities or any other circumstances which might
constitute a legal or equitable discharge or defense of a guarantor.
Pursuant to its guarantee, SBA will make timely payments of principal
and interest on the Debentures or the Redemption Price of and
Prioritized Payments on the Participating Securities.
44. In Sec. 107.1820, paragraph (e)(9) is proposed to be revised to
read as follows:
Sec. 107.1820 Conditions affecting issuers of Preferred Securities
and/or Participating Securities.
* * * * *
(e) Restricted Operations Conditions. * * *
(9) Failure to meet investment requirements. You fail to make the
amount of Equity Capital Investments required for Participating
Securities (Sec. 107.1500(b)(4)), if applicable to you; or you fail to
maintain as of the end of each fiscal year the investment ratios or
amounts required for Leverage in excess of 300 percent of Leverageable
Capital (Sec. 107.1160 (c)) or Preferred Securities in excess of 100
percent of Leverageable Capital (Sec. 107.1160(d)), if applicable to
you. In determining whether you have met the maintenance requirements
in Sec. 107.1160(c) or (d), SBA will disregard any prepayment, sale, or
disposition of Venture Capital Financings, any increase in Leverageable
Capital, and any receipt of additional Leverage, within 120 days prior
to the end of your fiscal year.
* * * * *
45. In Sec. 107.1830, paragraph (a) is revised to read as follows:
Sec. 107.1830 Licensee's Capital Impairment--definition and general
requirements.
(a) Applicability of this section. This Sec. 107.1830 applies to
Leverage issued on or after April 25, 1994. For Leverage issued before
April 25, 1994, you must comply with paragraphs (e) and (f) of this
section and the Capital Impairment regulations in this part in effect
when you issued your Leverage. For all Leverage issued, you must also
comply with any contractual provisions to which you have agreed.
* * * * *
Dated: September 25, 1997.
Aida Alvarez,
Administrator.
[FR Doc. 97-26720 Filed 10-10-97; 8:45 am]
BILLING CODE 8025-01-P
