[Federal Register Volume 59, Number 68 (Friday, April 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-7843]
[[Page Unknown]]
[Federal Register: April 8, 1994]
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Part II
Small Business Administration
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13 CFR Parts 107 and 121
Small Business Investment Companies and Small Business Size Standards;
Rules
SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
Small Business Investment Companies; Leverage; Participating
Securities; Conditions Affecting Good Standing of Licensees
AGENCY: Small Business Administration.
ACTION: Final rule.
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SUMMARY: This final rule implements certain of the changes to the Small
Business Investment Act of 1958, as amended, made by the ``Small
Business Equity Enhancement Act of 1992 (September 4, 1992).'' The
changes implemented by this rule relate to Leverage provided to SBICs
by SBA, and include increasing from $35 million to $90 million the
amount of Leverage that may be outstanding to any one Licensee or group
of Licensees under common control, incrementally reducing the maximum
ratio of Leverage to capital as capital is increased, establishing a
new form of Leverage (Participating Securities) which will be available
to Licensees that make Equity Capital Investments in small concerns,
permitting Specialized SBICs that are organized as limited partnerships
to obtain Leverage from SBA in the form of a preferred limited
partnership interest, and making other technical changes necessary to
implement the legislation.
DATES: This final rule is effective April 25, 1994.
FOR FURTHER INFORMATION CONTACT: Marvin D. Klapp, Acting Director,
Office of Program Development; telephone (202) 205-6515.
SUPPLEMENTARY INFORMATION: On August 5, 1993, SBA published two
proposed rules to implement certain changes to the Small Business
Investment Act of 1958, as amended (Act), made by title IV of Public
Law 102-366 (September 4, 1992). See 58 FR 41852 and 58 FR 41882. The
first of the two rules proposed changes in the way financial assistance
(Leverage) is provided to small business investment companies (SBICs or
Licensees), including the creation of a new form of Leverage called
Participating Securities, which would be available to Licensees making
equity-type investments in small concerns. The second of the two rules
proposed changes affecting the licensing and operations of SBICs.
The public was afforded a sixty-day period in which to submit
comments on the two proposed rules to the Agency. In recognition of the
complexity of the subject matter involved, SBA reopened and extended
the comment period on both proposed rules until November 18, 1993. See
58 FR 57568 (October 26, 1993).
After receiving and giving careful consideration to approximately
109 comment letters, SBA is today finalizing both proposed rules. This
final rule finalizes the proposed rule concerning Leverage,
Participating Securities and other miscellaneous matters. The final
rule immediately following this rule in the Federal Register
(Operations Rule) finalizes the proposed rule concerning licensing and
operations of SBICs.
In addition, SBA is simultaneously finalizing in this separate part
of the Federal Register the proposed rule published on July 29, 1993
(58 FR 40603), which revises one of the size standards for the SBIC
Program (Size Rule).
1. General Leverage Provisions
a. Introduction
SBA is finalizing the renumbering and reorganization of the
``Leverage'' sections of the SBIC Program regulations (Sec. 107.210
through Sec. 107.263) as proposed. SBA intends, at a later date, to
conform the remainder of the SBIC Program regulations (part 107 of
title 13 of the Code of Federal Regulations) to the new numbering
system used in the Leverage sections.
As in the proposed rule, the term ``Licensee'' used in this final
rule always includes SBICs licensed under the authority of section
301(c) of the Act (section 301(c) Licensees) and SBICs licensed under
the authority of section 301(d) of the Act (section 301(d) Licensees).
A section 301(c) Licensee is sometimes referred to as a Regular SBIC
because there is no restriction on the type of Small Concern that it
may assist. A section 301(d) Licensee is sometimes referred to as a
Specialized SBIC or SSBIC because it is only authorized to assist Small
Concerns owned by persons whose participation in the free enterprise
system is hampered because of social or economic disadvantages.
b. Application Procedures
In proposed Sec. 107.210, SBA set forth the application procedures
and basic eligibility requirements for obtaining Leverage from SBA. SBA
received fifty-eight (58) comment letters on this section, many of
which addressed the requirement in Sec. 107.210(c)(2) that applicants
for Leverage demonstrate a need for the Leverage funds.
The requirement for a demonstration of need is not a new concept
for the SBIC Program. Historically, a Licensee was considered to
``need'' Leverage if sixty-five percent (65%) of its private capital
had been invested or committed to investments in Small Concerns.
However, if a Licensee had significant available resources of its own
(e.g., unfunded commitments from investors), it was generally
considered not to be in need of Leverage.
SBA proposed an exception to this general rule for applicants for
Participating Securities Leverage: SBA would disregard the applicant's
temporary excess liquidity resulting from unfunded commitments or
drawdowns of commitments if the Licensee had invested at least fifty
percent (50%) of its Leverageable Capital\1\ and Leverage in Equity
Capital Investments (the required investment category for issuers of
Participating Securities). Under this exception, though, Licensees with
unfunded commitments would probably find themselves ineligible for
their first issuance of Participating Securities Leverage unless fifty
percent (50%) of their Leverageable Capital had already been invested
in Equity Capital Investments.
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\1\This term and the related term ``Regulatory Capital'' are
defined in the Operations Rule.
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The comments received by SBA questioned the appropriateness of
requiring Licensees to make Equity Capital Investments in order to be
eligible for Participating Securities Leverage. They argued that such a
requirement was inconsistent with the intent of the legislation, which
required that Equity Capital Investments be made with the proceeds of
Participating Securities.
The comments also argued in favor of extending to Debenture and
Preferred Securities issuers the same ability to demonstrate a need for
Leverage while commitments from investors remain unfunded.
SBA agrees with the comments. If any Licensee has invested fifty
percent (50%) of its Leverageable Capital plus outstanding Leverage and
is in compliance with SBA regulations, it should be eligible for SBA
Leverage. This should be true for all Licensees, not just those that
issue Participating Securities, and should be true regardless of the
type of investments that have been made by the Licensee (assuming, of
course, that the Licensee's past investments have been in eligible
Small Concerns). The proposed rule has been revised and finalized
accordingly.
It should be noted here that eligibility for Leverage does not mean
that Leverage necessarily will be available and forthcoming. In the
event that the demand for Leverage exceeds the available supply, SBA
will allocate Leverage among the eligible applicants unless and until
additional funds or guarantee authority is made available to meet such
demand.
c. Fees
As proposed, Sec. 107.210(d) increased the user fee charged in
connection with obtaining Leverage to two percent (2%) of the face
amount of Debentures, and instituted the same two percent (2%) fee for
Participating Securities. SBA received twenty-two (22) comments on this
subject, some objecting to an increased fee for Debenture Leverage
unless there were a corresponding increase in the cost of administering
such Leverage, and others objecting to increased fees in general unless
the fees could be used to offset the costs of managing the SBIC
Program.
SBA believes the increased fees are necessary to maintain the
current Debenture program and implement the new Participating
Securities program. SBA currently is able to use such fees to pay the
costs associated with the Leverage fundings, including the fees of
parties with which it contracts to perform services attendant to these
fundings. Any excess fees are deposited in the U.S. Treasury and are
counted when determining the ``subsidy rate'' of the particular SBIC
program that generated the fees. The subsidy rate for a program is a
measurement that determines the multiple of SBA guarantee authority
that can be made available for each dollar appropriated to that program
by Congress. Fees in excess of actual costs associated with the
Leverage fundings have the effect of reducing the particular SBIC
program's subsidy rate, thereby resulting in more ``guarantee dollars''
being available for the program participants. This is a benefit to all
Licensees seeking Leverage, especially when appropriated funds are
being curtailed due to budgetary constraints. SBA is therefore
finalizing the provision as proposed: the new user fee will be two
percent (2%) for all Debenture and Participating Securities issuers.
d. Subordination of Debentures
Proposed Sec. 107.210(f)(5) clarified that when SBA agrees to
subordination with respect to Debentures guaranteed after July 1, 1991,
the amount of indebtedness to which such subordination applies is fixed
at the time SBA subordinates, and is limited then and later to the
lesser of two hundred percent (200%) of the Licensee's Leverageable
Capital, or $10 million. Any indebtedness of the Licensee in excess of
that amount, whether in existence at the time SBA subordinates or
acquired subsequently, will not benefit from SBA's subordination.
The comments received on this provision were supportive of the
change. The provision is adopted as proposed.
e. Restrictions on Third Party Debt
As explained under the proposed rule, Licensees have been permitted
to apply for and obtain financing from third parties without obtaining
SBA's prior approval or even notifying the Agency, except upon the
filing of annual financial statements. Third party lenders have viewed
SBA Leverage, which is unsecured and generally subordinate, as part of
the capital base of the Licensee. In some cases, third party financing,
when aggregated with Leverage, has exceeded a prudent level of
indebtedness, and SBA has been forced to suffer large losses upon the
distribution of a Licensee's assets in liquidation, receivership or
bankruptcy proceedings.
Concern over SBA's creditor position prompted the Agency to tighten
its terms of subordination in July 1991. See 56 FR 31777. The
subordination limits then adopted, however, have not discouraged some
Licensees from incurring large amounts of secured third party debt.
Recognizing its obligation to further protect its exposure as the
largest creditor of most debtor Licensees, SBA proposed that it have
the right to approve all new third party debt of a Licensee.
As proposed, Sec. 107.210(f)(6) required that, after September 30,
1993, Licensees would need to obtain the written approval of SBA before
incurring or refinancing any third party debt or obtaining any line of
credit. In addition to conventional third party debt, this restriction
covered guarantees by Licensees and other voluntarily assumed
contingent liabilities. Licensees with existing lines of credit were
required to have such lines approved by SBA before increasing the
amounts outstanding above the balance owed on September 30, 1993.
SBA received 45 comments on this provision; all were opposed to the
proposal as written. The comments expressed concern that the need for
prior approval from SBA could be very damaging to SBIC business
operations. They suggested elimination of the requirement of prior
approval for a Licensee's normal business credit arrangements, for its
short-term bridge debt and, up to a certain safe-harbor level, for any
third-party debt.
After considering these comments, SBA has concluded that it can
eliminate entirely the requirement for prior approval of a Licensee's
unsecured third-party debt and still protect the Agency's interest in
the Licensee. This change, reflected in the final rule, should allow
Licensees to engage in their ordinary business credit arrangements
without interference from SBA.
SBA is not convinced, however, that secured third-party debt, of
any amount, should be incurred by a Licensee without SBA's prior
approval. SBA understands the SBIC industry's concern regarding the
prior approval process; in the past, SBA may not have been able to
respond to SBIC requests for approval in other matters as expeditiously
as both the SBICs and SBA might have liked. While SBA expects to deal
with all requests for prior approval on a timely basis, SBA is prepared
to commit itself to a thirty-day turn-around on certain requests. Thus,
the final rule provides that if a Licensee is in regulatory compliance
and has SBA Leverage not in excess of 1.5 times its Leverageable
Capital, and if the Licensee's request is for approval of a secured
line of credit which would not cause its aggregate third-party debt to
exceed fifty percent (50%) of Leverageable Capital, then the Licensee's
request for prior approval will be considered approved unless SBA
notifies it otherwise within thirty (30) days of receiving the request.
It should be noted that all debt, whether secured or unsecured, will be
aggregated to determine whether the Licensee may avail itself of the
thirty-day turn-around.
When making its determination as to whether a Licensee's request
for secured third-party debt should be approved, SBA will take into
consideration various factors including, but not limited to, the amount
of secured indebtedness relative to other debt of the Licensee and the
amount of secured indebtedness relative to the value of the Licensee's
collateral proposed to be granted as security.
Licensees are reminded that once a line of credit is approved by
SBA, subsequent draw-downs under the line of credit do not require SBA
approval.
The final rule extends the date after which SBA approval will be
required from September 30, 1993, to the date of publication of this
final rule. Licensees with existing secured lines of credit are
reminded to obtain SBA approval of such lines before increasing the
amounts outstanding above the balance owed on the date of publication.
The final rule also clarifies that if a Licensee has no Leverage,
it is not required to have its third-party debt approved by SBA.
f. Maintenance of Unimpaired Capital
(i) General
Former Sec. 107.203(d) required Leveraged Licensees to maintain
Private Capital in an amount sufficient to avoid a condition of Capital
Impairment. Under that regulation, a section 301(c) Licensee was
Capitally Impaired and was in violation of Sec. 107.203(d) if its
Undistributed Net Realized Earnings deficit, together with any
Unrealized Depreciation in excess of Unrealized Appreciation, exceeded
fifty percent (50%) of Private Capital. For a section 301(d) Licensee,
the applicable percentage was seventy-five percent (75%).
The proposed regulation on Capital Impairment (Sec. 107.210(h))
allowed, for the first time, varying degrees of impairment depending
upon differences in the composition of the portfolios of Licensees. The
proposal took the form of two grid structures, each consisting of nine
(9) categories for section 301(c) and section 301(d) Licensees,
respectively. The proposed rule continued to permit a higher percentage
of impairment for a section 301(d) Licensee than for a section 301(c)
Licensee whose situation was otherwise identical. However, the
differential was reduced to five (5) percentage points from the former
twenty-five (25) percentage points. In addition, the proposed rule
recognized the delay in profitability that is expected to occur in
venture investing.
The rationale for moving to a grid structure that would allow an
equity investor SBIC a higher permissible level of capital impairment
than a lender SBIC was set forth in the proposed rule. Essentially, the
proposed structure recognized that in a venture portfolio, especially
during the early years, there are likely to be considerable losses
before profits are realized, and a Capital Impairment Percentage of
fifty percent (50%) or more may exist even when the portfolio has
genuine long-term value. However, for a Licensee which only provides
loan financing, a Capital Impairment Percentage of fifty percent (50%)
generally indicates a significant operating deficit that cannot be
offset by appreciation in the portfolio.
Also new in the proposed regulation on Capital Impairment was the
treatment of net Unrealized Appreciation. Under the old Capital
Impairment concept, Licensees have been required to treat net
Unrealized Depreciation as if it represented realized losses, but they
received no corresponding credit for net Unrealized Appreciation. The
proposed regulation acknowledged the existence of net Unrealized
Appreciation in a Licensee's portfolio, yet attempted to avoid
providing incentives for Licensees to inflate their portfolio values
artificially. Thus, SBA proposed to allow partial recognition of net
Unrealized Appreciation in the computation of Capital Impairment, to an
extent which would vary depending on whether or not the portfolio
securities were Publicly Traded and Marketable.
The proposed rule also provided that a violation of the Capital
Impairment regulation would constitute an event of default with respect
to Debentures and Preferred Securities (Sec. 107.261(d)), and that such
a violation also would affect the good standing of a Licensee issuing
Participating Securities (Sec. 107.262(d)). In all cases, Licensees
were afforded an opportunity to cure a violation before SBA could
impose any of the remedies available to it under the proposed
regulations.
The thirty-nine (39) comments received on the Capital Impairment
proposal generally were unfavorable. While there was little objection
to the grid structure per se, there was strong objection to the
permissible Capital Impairment percentages located within the grid. The
respondents happily accepted the relatively high percentages available
to the equity-investor SBICs, but felt that the proposed percentages
for lender SBICs were excessively low. Specialized SBICs also argued
that the percentages for section 301(d) Licensees were unfair, and that
SBA should return to a single percentage (75%) for all Specialized
SBICS, regardless of portfolio composition or amount of Leverage.
SBA has decided to retain the grid structure for the section 301(c)
Licensees, and to increase their permissible levels of Capital
Impairment by five (5) percentage points across the board. Thus, a
section 301(c) Licensee would be permitted to have impaired Regulatory
Capital of anywhere from thirty-five percent (35%) to seventy percent
(70%), depending on the Licensee's portfolio mix and its Leverage
ratio. SBA believes this is an appropriate resolution as it balances
its own concerns with those of SBICs, as expressed in the comments.
For section 301(d) Licensees, SBA intends to return to the current
permissible level of Capital Impairment. All Specialized SBICs will be
permitted a Capital Impairment level of seventy-five percent (75%),
regardless of portfolio mix or Leverage ratio. The differential between
the Regular and Specialized SBICs will be from five (5) percentage
points for an equity investor Licensee to forty (40) points for a
lender Licensee. This differential is a recognition of the more
limited, and often riskier, pool of small business concerns in which a
Specialized SBIC may make investments.
There were also a number of comments on the subject of net
Unrealized Appreciation, arguing, for the most part, in favor of full
recognition of all net Unrealized Appreciation as an offset to realized
losses, or for looser standards for recognizing net Unrealized
Appreciation on private securities.
SBA continues to believe that full recognition of all net
Unrealized Appreciation is inappropriate and that the proposed
standards for recognizing net Unrealized Appreciation on private
securities are sufficiently liberal. Licensees will now, for the first
time, be permitted some credit for net Unrealized Appreciation.
Accordingly, SBA is not prepared to loosen these criteria further.
The final Capital Impairment issue addressed in the comment letters
was the length of the forbearance periods for issuers of Participating
Securities. SBA understands the industry's desire for a longer period
of forbearance, but believes that the four and five year allowances
that were proposed, together with the increased permissible percentages
agreed to in this final rule, should be adequate for a Licensee with a
minimally successful portfolio.
SBA also reminds the SBIC industry that Capital Impairment is a
curable violation. See Secs. 107.261(d)(5) and 107.262(d)(3). In fact,
special cure methods are available to Participating Securities issuers.
See Sec. 107.210(h)(7).
One final change has been made to the proposed Capital Impairment
provision; it concerns the inclusion of non-cash gains in the
computation of Capital Impairment. Under the former definition of
Capital Impairment, all amounts required by SBA accounting rules to be
classified as Non-cash Gains/Income (as reported on SBA Form 468) were
excluded from the Capital Impairment formula. SBA believes this
provision was too stringent, and that Licensees should be able to
receive credit in the impairment computation for non-cash gains under
certain circumstances. However, when the Agency rewrote the Capital
Impairment test in the proposed rule, full credit was mistakenly
permitted for all Non-cash Gains/Income of a Licensee, regardless of
the source. This error was the consequence of using the term
``Undistributed Realized Earnings,'' which includes all Non-cash Gains/
Income, in the computation. The unintended result of this change was
that delinquent accrued interest converted into a note, interest income
accrued on deferred-interest notes and other components of Non-cash
Gains/Income which may be uncertain as to collectibility would be
counted as realized earnings in determining Capital Impairment.
It was SBA's intent when drafting the proposed Capital Impairment
provision to give capital gains credit only for certain Non-cash Gains/
Income: Specifically, those that the Agency felt had the greatest
certainty of measurement and collectibility. In this final rule, SBA
has clarified that the only Non-cash Gains/Income that may be counted
when computing Capital Impairment are those Non-cash Gains/Income that
are realized in the form of Publicly Traded and Marketable securities
or investment grade debt instruments.
A debt instrument would not be considered investment grade for
purposes of this rule unless it had actually been rated ``BBB'' or
``Baa'', or better, by Standard & Poor's Corporation or Moody's
Investment Service, respectively. A non-rated debt instrument issued by
a company with outstanding investment grade debt also could be
considered investment grade if the Licensee were to obtain a written
opinion from an investment banking firm acceptable to SBA stating that
the non-rated debt instrument is equivalent in risk to the issuer's
investment grade debt.
The following is an example of how this rule operates: If a
Licensee sells a portfolio investment with a basis of $200,000 and
receives, exchange, General Electric stock worth $300,000 plus a below
investment grade promissory note for $150,000, the Licensee should
include in the Capital Impairment computation $100,000 of the $250,000
of Non-cash Gains/Income it received.
In order to implement this change, the final rule adds a new
defined term, ``Includible Non-cash Gains/Income'', to Sec. 107.3 to
represent those non-cash gains for which SBA will give credit for
purposes of Capital Impairment. In the final version of
Sec. 107.210(h), the Licensee computes Capital Impairment by starting
with Undistributed Net Realized Earnings, which is net of all Non-cash
Gains/Income, and adds back Includible Non-cash Gains/Income.
Undistributed Net Realized Earnings has been added to the definitions
section of the regulation. This should be a familiar term to all
Licensees because of its appearance on SBA Form 468. See Sec. 107.3.
The final rule also clarifies that a Licensee's Unrealized Gain
(Loss) on Securities Held must reflect the estimated tax effects
associated with the future realization of gains or losses. See the
definition of Unrealized Gain (Loss) on Securities Held (Sec. 107.3).
In summary, the Capital Impairment proposal is finalized as
proposed except for a five (5) percentage point increase for Regular
SBICs, a return to the seventy-five percent (75%) test for Specialized
SBICS, and the inclusion of only a limited class of non-cash gains.
This final rule repeats the summary of the computation of Capital
Impairment as it appeared in the summary of the proposed rule. The only
change is the use of ``Undistributed Net Realized Earnings plus
Includible Non-cash Gains/Income'' instead of ``Undistributed Realized
Earnings'', as discussed above.
(ii) Computation of Capital Impairment Percentage
If Unrealized Gain (Loss) on Securities Held is zero or positive,
and the sum of Undistributed Net Realized Earnings plus Includible Non-
cash Gains/Income is also zero or positive, no Capital Impairment
exists and no further calculations are necessary. If either or both
amounts are less than zero, the Licensee must make the calculations
described in Secs. 107.210(h) (3) and (4). Depending upon the results
of interim calculations in these paragraphs, the Licensee may be
required to compute a Capital Impairment Percentage.
(iii) Determination of Capital Impairment Violation
As with the proposed rule, a Licensee will not be in violation of
Sec. 107.210(h) simply by having a Capital Impairment Percentage
greater than zero. Violations of Sec. 107.210(h) arise out of an
excessive Capital Impairment Percentage. For section 301(d) Licensees,
Capital Impairment of more than seventy-five percent (75%) is
considered excessive; for section 301(c) Licensees, maximum permissible
Capital Impairment percentages are set forth in a table in the
regulation.
(iv) Special Rules for Licensees With Outstanding Participating
Securities
(A) General. All Leveraged Licensees, including Licensees with
outstanding Participating Securities, are required to compute their
Capital Impairment Percentages in the same manner. A Licensee with
outstanding Participating Securities may, for as long as five years
following its initial issuance of Participating Securities, have a
Capital Impairment Percentage higher than the applicable table permits
(but not as high as eighty-five percent (85%)) without thereby being in
violation of Sec. 107.210(h) if it meets the other requirements set
forth in Sec. 107.210(h)(7). In addition, a Licensee that meets the
requirements set forth in Sec. 107.210(h)(7) (i) or (ii) will be
afforded an opportunity to cure on terms that may be more favorable
than those available to other Licensees.
(B) Curable Capital Impairment Percentage during first 48 months
following initial issuance of Participating Securities. During the
first forty-eight (48) months after initially issuing Participating
Securities, a Licensee with outstanding Participating Securities will
not be impaired if: (1) Its Capital Impairment Percentage is less than
eighty-five percent (85%); (2) at least two-thirds of its outstanding
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Equity Capital
Investments.
(C) Curable Capital Impairment Percentage during first 60 months
following initial issuance of Participating Securities. During the
first sixty (60) months after initially issuing Participating
Securities, a Licensee with outstanding Participating Securities will
not be impaired if: (1) Its Capital Impairment Percentage is less than
eighty-five percent (85%); (2) at least two-thirds of its outstanding
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Start-up
Financings. For the purposes of this regulation, a Start-up Financing
is an Equity Capital Investment in a growth-oriented Small Concern
that, at the time of the investment, (1) has not been in existence, in
any form, for more than three fiscal years, (2) has not had positive
cash flow or sales exceeding $5 million in any fiscal year, and (3) is
not formed for the purpose of acquiring any existing business.
(D) Cure of Capital Impairment. During the fifth year following its
initial issuance of Participating Securities, a Licensee that meets the
requirements described in paragraph (B) above may cure its Capital
Impairment by taking one or more of the following actions within thirty
(30) days after it determines that it has a condition of Capital
Impairment. The Licensee may increase its Regulatory Capital\2\ by
depositing in an escrow account satisfactory to SBA a cash contribution
equal to fifteen percent (15%) of outstanding Leverage; or it may
provide SBA with a guarantee satisfactory to SBA, for the benefit of
SBA, equal to fifteen percent (15%) of its outstanding Leverage. In
addition to the normal credit considerations that would determine
whether a guarantee is satisfactory to SBA, the terms of the guarantee
must provide that any guarantee fee that otherwise would be due the
guarantor from the Licensee, and any other sums that would be due the
guarantor by virtue of the guarantor's right of subrogation, must be
deferred and subordinated to the full repayment of all outstanding
Leverage plus any unpaid Earned Prioritized Payments (as defined in
Sec. 107.3) and earned Adjustments (discussed below under
Sec. 107.243(d)).
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\2\This increase in Regulatory Capital operates only to cure
what would otherwise be a Capital Impairment. It does not increase
the Licensee's eligibility for Leverage.
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During the sixth year following its initial issuance of
Participating Securities, a Licensee that meets the above requirements
may cure its Capital Impairment by taking one of the actions described
in the preceding paragraph, except that the amount of the cash deposit
or guarantee shall be equal to thirty percent (30%) of outstanding
Leverage. Any amount deposited previously may be used as a credit
against the thirty percent (30%) requirement.
2. Leverage for Section 301(c) Licensees
No comments were received on proposed Sec. 107.220; accordingly, it
is finalized as proposed. This section provides Leverage requirements
for section 301(c) Licensees, and reflects amendments to the Act
contained in Section 402 of Public Law 102-366. Section 107.220 permits
SBA to provide Leverage to section 301(c) Licensees through the
purchase or guarantee of Debentures and/or Participating Securities.
After March 31, 1993, a section 301(c) Licensee's amount of Leverage
outstanding at any time shall not exceed three hundred percent (300%)
of its Leverageable Capital up to $15 million; two hundred percent
(200%) of its Leverageable Capital of more than $15 million, but not
more than $30 million; and an amount, not exceeding $15 million, which
is equal to one-hundred percent (100%) of its Leverageable Capital over
$30 million. The aggregate amount of outstanding Leverage by any
Licensee or group of two or more Licensees under Common Control\3\
shall not exceed $90 million. On a case-by-case basis, SBA may grant an
exception to this ceiling to a group of Licensees under Common Control
and permit a higher amount, subject to such terms and conditions as SBA
considers appropriate to minimize risk of loss in the event of default.
In no event, however, shall the aggregate amount of a Licensee's
Participating Securities exceed two hundred percent (200%) of
Leverageable Capital.
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\3\This term is defined in the Operations Rule.
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A ``grandfather clause'' is provided for Licensees that, on March
31, 1993, have outstanding Debentures in excess of three hundred
percent (300%) of Leverageable Capital, so that such Licensees are not
required to prepay such excess. Such Licensees also may apply to issue
additional Debentures or Participating Securities solely to pay the
amount due on such maturing Debentures. The maturity date of any new
Debenture or Participating Securities issued for this purpose may not
be later than September 30, 2002.
3. Leverage for Section 301(d) Licensees
In proposed Sec. 107.230, SBA described some of the terms and
conditions of Leverage for section 301(d) Licensees. SBA may provide
Leverage to section 301(d) Licensees through the purchase or guarantee
of Debentures and/or Participating Securities, and/or through the
purchase of Preferred Securities. As further described below, the
proposed rule provided that section 301(d) Licensees would be eligible
for subsidized Debenture Leverage and for Preferred Securities Leverage
up to a maximum of four hundred percent (400%) of Leverageable Capital
or $35 million, whichever is less. Leverage in excess of that amount
would be nonsubsidized.
Six (6) comments were received on proposed Sec. 107.230. The
comments were supportive of the proposal, except for the ceiling of $35
million for subsidized Leverage. As the comments recognized, however,
the $35 million ceiling on subsidized Leverage is statutory in origin.
Section 402 of Public Law 102-366, which increased the general Leverage
ceiling for the SBIC program above its prior level of $35 million,
established the subsidized Leverage ceiling for section 301(d)
Licensees. The regulation cannot permit a higher amount of subsidized
Leverage than is permitted by the Act.
SBA therefore is finalizing Sec. 107.230 as proposed, with the
exception of one minor change, designed to correct an error: The four
percent (4%) dividend on preferred stock and the four percent (4%)
return on the preferred limited partnership interest accrue on an
annual basis (rather than on a daily basis, as stated in the proposed
rule).
The Articles of section 301(d) Licensees are required to be
conformed to the requirements discussed in paragraphs a. or b. below,
as appropriate, in order to issue Preferred Securities after the date
hereof.
a. Preferred Stock
In the case of corporate Licensees, the preferred stock purchased
by SBA prior to November 21, 1989, shall be non-voting stock with a
three percent (3%) cumulative preferred dividend paid out of Retained
Earnings Available for Distribution. Preferred stock issued after
November 21, 1989, shall provide for four percent (4%) preferred
cumulative dividends payable out of Retained Earnings Available for
Distribution. Four percent (4%) preferred stock shall be redeemed not
later than fifteen (15) years after issuance at a price not less than
par value plus unpaid dividends accrued to the redemption date. SBA may
guarantee non-subsidized Debentures offered for sale by a Licensee
immediately prior to the redemption of its four percent (4%) preferred
stock in such amounts as will permit simultaneous redemption of such
stock.
b. Preferred Limited Partnership Interest
Section 412 of Public Law 102-366 authorizes unincorporated section
301(d) Licensees to issue preferred limited partnership interests to
SBA which would have the same terms and conditions as the four percent
(4%) preferred stock described immediately above (that is, a preferred
and cumulative return at an annual rate of four percent (4%), payable
from Retained Earnings Available for Distribution). Such preferred
limited partnership interests shall be redeemed not later than fifteen
(15) years from the date of issuance at a price not less than SBA's
contributed capital plus accumulated and unpaid distributions through
the redemption date. SBA may guarantee non-subsidized Debentures issued
by a section 301(d) Licensee immediately preceding such redemption in
such amounts as will permit simultaneous redemption of such preferred
limited partnership interests.
C. Leverage Ceiling
As in the proposed rule, Sec. 107.230(c) establishes maximum
Leverage eligibility for section 301(d) Licensees. All types of
Leverage issued by such Licensees shall be aggregated for purposes of
determining Leverage eligibility, including aggregation of Leverage
issued by Licensees under Common Control. As stated earlier, section
301(d) Licensees are eligible for maximum subsidized Leverage
(consisting of Preferred Securities and Debentures issued with a rate
reduction) of four hundred percent (400%) of Leverageable Capital or
$35 million, whichever is less. Section 301(d) Licensees also are
eligible for nonsubsidized Leverage in excess of $35 million, subject
to the amounts and conditions specified for section 301(c) Licensees.
In order to qualify for Leverage exceeding three hundred percent
(300%) of Leverageable Capital, at least thirty percent (30%) of the
Licensee's Total Funds Available for Investment must be invested in or
committed to Venture Capital Financing of Disadvantaged Concerns, and a
Licensee must maintain thirty percent (30%) of its Total Funds
Available for Investment in such investments while Leverage in excess
of three hundred percent (300%) of Leverageable Capital is outstanding.
For the purpose of meeting the thirty percent (30%) test, the Venture
Capital Financings shall be valued at cost. The present definition of
Venture Capital Financing remains unchanged and is set forth in
Sec. 107.230(c)(3)(iii).
d. Second Tier of Preferred Securities
As in the proposed rule, SBA is authorized to purchase Preferred
Securities in amounts in excess of one hundred percent (100%) of
Leverageable Capital, but not in excess of two hundred percent (200%)
of Leverageable Capital, from certain Licensees. These are section
301(d) Licensees with Leverageable Capital of $500,000 or more, or
section 301(d) Licensee licensed on or before October 13, 1971,
regardless of the amount of Leverageable Capital. In either case, a
Licensee must have Qualified Investments (as defined in
Sec. 107.230(c)(4)(iv)) equal, at cost, to the amount of Preferred
Securities in excess of one hundred percent (100%) of Leverageable
Capital. Commitments to make Qualified Investments may be counted to
satisfy this requirement.
It should be noted that the definition of Qualified Investments is
similar, but not identical to, the definition of Venture Capital
Financing as set forth in Sec. 107.230(c)(3)(iii). The most important
difference is that a secured debt instrument may qualify as a Venture
Capital Financing but would not qualify as a Qualified Investment.
e. Participating Securities
Section 107.230(c)(6) authorizes section 301(d) Licensees to issue
Participating Securities in an amount not exceeding two hundred percent
(200%) of Leverageable Capital, less an amount equal to Licensee's
outstanding Preferred Securities. Prioritized Payments and Profit
Participation on Participating Securities issued by section 301(d)
Licensees shall not be subsidized.
f. Other Provisions
Section 107.230(d) describes the types of Debentures which section
301(d) Licensees may issue, and Sec. 107.230(e) permits section 301(d)
Licensees, in SBA's discretion, to retire Debentures through the
issuance of Preferred or Participating Securities.
Section 107.230(f) is a recodification of former
Sec. 107.201(a)(2)(iii).
4. Participating Securities
As proposed, Secs. 107.240 through 107.247 described special rules
which would apply to Licensees issuing Participating Securities.
SBA received many comments on these proposed rules. Most were very
supportive, although many suggestions for improving the proposal were
received. Comments related to specific provisions of the Participating
Securities are addressed in the discussion of those respective sections
of the rule.
The Small Business Equity Enhancement Act of 1992 (title IV of Pub.
L. 102-366) was a mandate for a new relationship between SBA and the
venture capital community. The salient feature of this new relationship
is the creation of Participating Securities. These are equity-type
securities with the characteristics of preferred stock or a preferred
limited partnership interest.
SBA recognizes that venture capital companies usually make initial
equity capital investments, manage their portfolios (making follow-on
investments as necessary), and finally sell their investments as they
mature, with the objective of realizing capital gains. As investments
are sold, funds customarily are distributed to investors rather than
reinvested.
Under this rule, as a means of financing Licensees that issue
Participating Securities, SBA will guarantee the payment of Prioritized
Payments on, and the Redemption Price of, the Participating Securities
to an authorized Trust or pool which purchases the Participating
Securities. Prioritized Payments are the equivalent of dividend
payments of the Participating Securities. As an inducement for its
guarantee, SBA will be entitled to a share in the profits that are
generated from investments made while the Participating Securities are
outstanding (Profit Participation).
Pass-through Trust Certificates evidencing rights in the Trust or
pools of guaranteed Participating Securities will be sold to investors.
The rights and obligations evidenced in the Trust Certificates also
will be guaranteed by SBA. The proceeds of the sale of the Trust
Certificates will be used to fund the Participating Securities.
SBA anticipates that the Prioritized Payments made by Licensees
that issue Participating Securities normally will not be adequate to
fund debt service obligations of the guaranteed Trust Certificates in
the early years of the Participating Securities' existence.
Accordingly, SBA will be called upon to make such payments. Over the
duration of a Participating Security's life, SBA expects to be repaid
most of such guarantee payments through a combination of Earned
Prioritized Payments and Profit Participation. Since Prioritized
Payments on Participating Securities are payable only to the extent of
earnings, SBA realizes that the repayment of its guarantee payments
will depend upon the ability of its Licensees to operate profitably as
equity investors.
SBA understands that venture capital equity investments in Small
Concerns are risky on an individual basis, and that losses on such
investments frequently occur earlier than profits. It anticipates that
Licensees issuing Participating Securities will incur losses in the
early years of their investment cycle as investments in a limited
number of portfolio concerns prove unprofitable and are written off.
SBA recognizes that it must be patient in expecting profitable
operations from Licensees with Participating Securities. At the same
time, SBA has the responsibility to assure that publicly-guaranteed
funds are administered prudently by capable managers. Accordingly, SBA
has sought to formulate an economic and regulatory structure which will
enhance the likelihood that Licensees participating in the program will
be successful.
In issuing this final rule, SBA believes that it can fulfill the
objectives of the Small Business Equity Enhancement Act of 1992 to
foster a venture capital industry that is able to serve the needs of
eligible Small Concerns, create or retain jobs, expand the tax base,
and achieve other objectives such as commercialization of technology,
supporting manufacturing firms, fostering urban and rural business
development, and stimulating exports.
SBA recognizes that its guarantee of Participating Securities will
be an essential factor in the decision of investors to fund Licensees,
and that such investors will need to have confidence in SBA's long-term
investment philosophy. While SBA intends that Participating Securities
serve as patient capital, investors must recognize SBA's special
responsibilities to protect public funds and assure compliance with
program objectives and regulations.
It should be noted that section 410 of Public Law 102-366
authorized inclusion in a Licensee's private capital of investments by
public and private pension funds as well as limited investments by
state and local governments. The form of Participating Securities has
been structured with the intention of avoiding the imposition of
Unrelated Business Taxable Income (UBTI) on certain tax-exempt
investors. SBA believes that pension funds and other tax-exempt
investors will find it advantageous to invest in SBICs using
Participating Securities. Since such institutional investors
historically have provided investment capital to the private venture
capital industry and have acquired expertise in selecting managers and
monitoring investments, SBA anticipates that SBICs will benefit from
this investor expertise. SBA also hopes to benefit from the expertise
of institutional investors to help assure the profitability of the
Licensees that issue Participating Securities.
a. General Provisions
Proposed Sec. 107.241 set forth general provisions for Licensees
issuing Participating Securities. This section reflects SBA's effort to
use marketplace dynamics to assure a successful program.
(i) Minimum Regulatory Capital
Proposed Sec. 107.241(a) set forth minimum capital requirements for
eligibility to issue Participating Securities. In general, a Licensee
would be required to have Regulatory Capital of at least $10 million in
order to be considered eligible to issue Participating Securities. A
Licensee with less than $10 million, but not less than $5 million, in
Regulatory Capital also could be eligible if it were able to
demonstrate to SBA's satisfaction that if could be financially viable
over the long term.
SBA received nineteen (19) comments on this provision, with some
comments favoring the minimum capital requirements and others opposing
them. Many of those opposed to the requirements argued in favor of a $5
million threshold, and voiced the concern that larger SBICs may not
serve the needs of smaller businesses and early-stage companies.
SBA shares the concern that SBICs capitalized at over $10 million
may not be oriented toward investing in smaller concerns. SBA is
addressing that concern by requiring all Licensees to make a certain
percentage of their investments in companies that are smaller than the
maximum size permitted under the Size Rule. This requirement appears in
Sec. 107.101(i) and is more fully discussed in the Operations Rule.
In view of this requirement, SBA is comfortable with the $10
million minimum capital requirement, and feels it is warranted for the
following reasons:
(1) A Licensee making venture capital type investments with
Regulatory Capital of less than $10 million normally will be incurring
excessively high fixed and marginal costs relative to the amount of its
capital; and
(2) Successfully raising $10 million for venture capital
investments constitutes a significant affirmation by the investment
community of the management capabilities of a Licensee. A more detailed
discussion of SBA's rationale for adopting the $10 million threshold
may be found in the proposed rule at 58 FR 41856.
As stated above, SBA will consider authorizing the issuance of
Participating Securities by a Licensee with Regulatory Capital of less
than $10 million, but not less than $5 million, if the Licensee can
show that it has a reasonable prospect of being profitable over the
long term. Thus, a Licensee with Regulatory Capital of less than $10
million might qualify to issue Participating Securities if it is a
subsidiary of a bank, bank holding company, or other large organization
which undertakes to subsidize management expenses of the Licensee and
to provide management personnel and operation support.
A Licensee with Regulatory Capital of less than $10 million also
may be acceptable to SBA if it operates in a rural area or within a
specific geographic area, such as a reasonably compact and focused
urban area. Any such Licensee must have management with proven
expertise in the types of investments proposed and must show, through
its plan of operations, how it can be operated soundly and profitably
over the long term without depleting its capital base through excessive
overhead.
It should be noted that some readers may have misunderstood the
significance of the $10 million threshold. Raising $10 million will not
automatically qualify an applicant for licensing as an SBIC that will
issue Participating Securities. As has always been the case, applicants
for licensing must demonstrate financial viability and qualified
management, regardless of the amount of their Regulatory Capital. It is
possible that a license applicant with $10 million in Regulatory
Capital will have such high overhead expenses or such inexperienced
management that its likelihood of profitability is put into question.
SBA would not issue a license under such circumstances. Under ordinary
circumstances, however, it can be expected that $10 million should
serve as adequate capital for licensing as an SBIC in the Participating
Securities program.
(ii) Equity Capital Investments
Since no comments were received on proposed Sec. 107.241(b), SBA is
finalizing it as proposed. This section requires Licensees issuing
Participating Securities to invest an amount equal to the Original
Issue Price of such securities solely in Equity Capital Investments.
Equity Capital Investments must be maintained at such level and may be
reduced only by the amount of repayments of such Participating
Securities. ``Equity Capital Investments'' means common or preferred
stock, limited partnership interests, options, and warrants or similar
equity instruments, including subordinated debt with equity features if
such debt provides only for interest payments contingent upon and
limited to the extent of earnings. Equity Capital Investments in the
form of debt may not be amortized.
(iii) Management and Ownership Diversity
Proposed Sec. 107.241(c) required that there be some diversity
between the ownership and the management of a Licensee that issues
Participating Securities. The eight comments on this provision were
mixed, with some supporting the proposal as an appropriate means of
preventing self-dealing, and others opposing the proposal as unduly
restrictive.
SBA believes that the benefits of this proposal far outweigh any
inconvenience to Licensees. It is important that Licensees issuing
Participating Securities have investors who are independent of
management and who have a substantial stake in the Licensee's financial
performance. SBA believes that the presence of such investors will help
to assure that Licensees are operated with the objective of optimizing
returns and protecting the interests of all investors, including SBA.
The proposal is therefore finalized without change.
Under paragraph (1) of Sec. 107.241(c), SBA will consider the
diversity requirement satisfied if at least three (3) unaffiliated
shareholders or limited partners (only one is required in the case of
Institutional Investors) own, in the aggregate, at least thirty percent
(30%) of a Licensee or Licensee's ultimate parent entity. Such
diversity also will be deemed to be achieved if a Licensee or its
ultimate parent entity is publicly traded under U.S. securities laws.
The independence and ability of investors to exercise oversight is
maintained by the prohibition against the delegation of voting rights
contained in paragraph (2) of Sec. 107.241(c). An exception is made for
certain proxies and the use of unaffiliated advisors so as not to
interfere with the routine operations of a Licensee.
(iv) Management Fees
Under proposed Sec. 107.241(d), a Licensee issuing Participating
Securities would be subject to a ceiling on its Management Expenses of
2.5% of Combined Capital (Regulatory Capital plus outstanding
Leverage), plus $125,000 in the case of Licensees with Combined Capital
of less than $20 million. SBA could permit a higher amount or, in the
case of larger funds, require a lower amount.
SBA received sixteen (16) comments on this proposal. A frequently-
appearing objection was that the regulatory provision was more
restrictive than the underlying statutory provision. Another objection
concerned SBA's ability to unilaterally reduce allowable Management
Expenses for larger funds.
It is true that the proposal was more restrictive than the
underlying statutory provision. Section 403 of Public Law 102-366
provided a ceiling on Management Expenses only for purposes of
computing SBA's Profit Participation. In the proposed rule, SBA
extended the ceiling to a Participating Securities issuer's actual
expenditures for Management Expenses, but allowed for an amount in
excess of the ceiling if there were a clearly demonstrable need. SBA
felt that the Management Expenses allowed under the proposal were
adequate for most Licensees and were consistent with current venture
capital industry practices.
Based on the comments, SBA has reconsidered its position. Under
this final rule, a Licensee issuing Participating Securities will be
subject to the limits discussed above only for purposes of computing
Earmarked Profits, which (as further discussed below) determine the
amounts that may be allocated to Earned Prioritized Payments and to
Profit Participation. See Sec. 107.242(d). Accordingly,
Sec. 107.241(d), as finalized, no longer provides that a Licensee's
actual Management Expenses are subject to percentage limits; however,
the section still provides that actual Management Expenses must be
approved by SBA.
It should be understood by readers new to the SBIC Program that SBA
presently approves, and will continue to approve, the management
compensation for all Licensees, not just issuers of Participating
Securities.\4\ Management compensation is but one component of
Management Expenses, which includes such additional items as office
expenses and office and equipment rentals. See the definition of
Management Expenses in Sec. 107.3. Depending on the particular
circumstances of the Licensee, approved management compensation and
Management Expenses for a larger fund may be lower, on a percentage
basis, than approved amounts for a smaller fund.
---------------------------------------------------------------------------
\4\Licensees with outstanding Leverage must have increases in
their management compensation approved before such increases are
adopted. Licensees with no outstanding Leverage may have increases
in their management compensation approved after the fact.
---------------------------------------------------------------------------
This final rule also now provides that Licensees placed under
``restricted operations'' under Sec. 107.262(d) are required to re-
obtain SBA's approval of their Management Expenses (or, for issuers of
Preferred Securities, their management compensation) at the time
restricted operations are imposed.
(v) Third-Party Debt (Temporary Debt)
Proposed Sec. 107.241(e) limited the type and amount of third-party
debt that a Licensee issuing Participating Securities could incur, and
required that the Licensee obtain the written approval of SBA before
incurring any such debt. Under the proposal, the only third-party debt
that Licensees issuing Participating Securities would be permitted to
have would be ``Temporary Debt'' in an amount not to exceed fifty
percent (50%) of Leverageable Capital. Licensees would have to pay off
and remain free of all Temporary Debt for at least thirty (30)
consecutive days during each fiscal year.
The fifteen (15) comments received on this provision objected to
the requirement that a Licensee obtain prior SBA approval in order to
incur Temporary Debt. The requirement was characterized as unduly
restrictive and unnecessary. As with the comments discussed above under
''Third-party Debt'' (subsection 1.(e) above), concern was expressed
over possible delays in SBA's response time.
SBA continues to believe that prior SBA approval of third-party
debt is an important component of its administration of the SBIC
Program. This is true for all Licensees, including those that issue
Participating Securities. In order to unify its approach to third-party
debt, SBA is finalizing Sec. 107.241(e) so that it conforms to the
general Third-party Debt provision discussed above. In other words, if
an issuers of Participating Securities is in regulatory compliance and
has Leverage not in excess of 1.5 times its Leverageable Capital, and
if the Licensee's request is for approval of a secured line of credit
which would not cause its aggregate third-party debt to exceed the
Temporary Debt limitation of fifty percent (50%) of Leverageable
Capital, then the Licensee's request shall be considered approved
unless SBA notifies it otherwise within thirty (30) days of receiving
the request. Unsecured Temporary Debt up to the permissible level of
Temporary Debt shall not require prior approval.
(vi) Liquidity Requirement
Proposed Sec. 107.241(f) established a liquidity requirement for
Licensees issuing Participating Securities in order to assure that such
Licensees have sufficient cash to cover their operating overhead during
the ensuing year. A Licensee would have a condition of Liquidity
Impairment if the Liquidity Ratio (as defined in Sec. 107.241(f)(2))
obtained by dividing Total Current Funds Available\5\ by Total Current
Funds Required is less than 1.20. No Distributions could be made if
they would cause a condition of Liquidity Impairment.
---------------------------------------------------------------------------
\5\Section 107.241(f)(2) includes a self-explanatory chart that
shows how the respective values for Total Current Funds Available
and Total Current Funds Required are to be determined.
---------------------------------------------------------------------------
Few comments were received on this provision. Some opposed the
concept as an unnecessary administrative burden; others recommended
different weightings to some of the calculation inputs.
SBA considers this provision important and does not agree that it
is burdensome to the Licensee. SBA considers it essential that
Licensees maintain a level of liquid assets sufficient to meet
operating expenses, make necessary follow-on investments, and allow
investments to be held until they mature and can be sold in the normal
course of business. Accordingly, SBA is finalizing the provision
without change.
(vii) Mandatory Redemption
No comments were received on proposed Sec. 107.241(g), which
required that Participating Securities be redeemed not later than
fifteen (15) years after their issue date. The provision is finalized
without change. As stated in the proposed rule, the redemption date
generally will be ten (10) years after the date of issue and always
will be the same as the maturity date of the Trust Certificates.
(viii) Priority in Liquidation
No comments were received on proposed Sec. 107.241(h), which
provided that upon liquidation of a Licensee, the Redemption Price of
any Participating Securities, plus any Prioritized Payments, Profit
Participation and other amounts that may be due SBA, shall be senior in
priority to all other equity interests of the Licensee. The provision
is finalized without change.
As explained in the proposed rule, SBA recognizes that Prioritized
Payments and Profit Participation are distributable only to the extent
of profits on Earmarked Assets, notwithstanding the cumulative feature
of Prioritized Payments. When a Licensee is liquidated, however, there
can be no Distributions to investors before amounts due SBA, its agent,
or Trustee are paid.
b. Computation of Earmarked Profits (Losses)
SBA received no comments on the computation of Earmarked Profits
(Losses), proposed Sec. 107.242. The provision is finalized as it was
proposed, except for minor wording changes in the paragraph on
Earmarked Investment Expenses. Since it should prove useful to have a
complete summary of the Participating Securities regulations in one
document, SBA is reprinting here the discussion on the computation of
Earmarked Profits (Losses) that appeared in the proposed rule.
There are seven steps in the computation of Earmarked Profits
(Losses) as set forth in Sec. 107.242. (Please note that SBA will
provide the spreadsheet templates and/or other software necessary for
making the ensuing calculations.)
(i) Step 1: Determination of Earmarked Assets
Earmarked Assets are a Licensee's Loans and Investments\6\ that are
outstanding at the time a Licensee issues Participating Securities\7\
or acquired while Participating Securities are outstanding, plus any
non-cash assets given in consideration for the disposition or exchange
of any such asset. Even after all Participating Securities have been
redeemed, Earmarked Assets maintain such status. See Sec. 107.242(b).
---------------------------------------------------------------------------
\6\``Loans and Investments'' is a term that is defined in this
rule as ``Portfolio Securities, Assets Acquired in Liquidation,
Operating Concerns Acquired, and Other Securities Received as set
forth in the Statement of Financial Position (SBA Form 468)''.
\7\A company licensed on or before March 31, 1993 may elect to
exclude its entire portfolio as it existed on that date (but not
less than its entire portfolio) from the category of ``Earmarked
Assets.'' In addition, if a company licensed on or before such date
is refinancing outstanding Debentures by the issuance of
Participating Securities, the company's entire portfolio must be
included in Earmarked Assets. Special rules for such Licensees are
located in Sec. 107.247.
---------------------------------------------------------------------------
(ii) Step 2: Calculating the Earmarked Asset Ratio
This step establishes the percentage of a portfolio that is
earmarked. Since a Licensee may have non-Earmarked Assets deriving from
assets acquired after all Participating Securities have been redeemed,
or determined under the special rules governing SBICs licensed on or
before March 31, 1993 (see Sec. 107.247), it is necessary that all
Licensees calculate an Earmarked Asset Ratio (EAR) as delineated in
Sec. 107.242(c). The ratio is calculated on a weighted average basis
(that is, on a month-by-month basis, which is then averaged) for the
year or fraction of the year in question. For companies licensed after
March 31, 1993 that have not yet redeemed any Participating Securities,
EAR will equal one hundred percent (100%). The formula is:
EAR=[(EA+UPPS)/(L&I+UPPS)] x 100
where:
EA=Earmarked Assets valued at cost
UPPS=Uninvested proceeds of Participating Securities
L&I=Total Loans and Investments (valued at cost).
The example that follows would apply only to companies licensed on
or before March 31, 1993. Assume that such a Licensee had $15 million
in Loans and Investments, issued $10 million of Participating
Securities two months prior to the close of its fiscal year, and had
elected to exclude its pre-existing portfolio from being Earmarked
Assets (as permitted in Sec. 107.247). The following calculations would
apply:
Values at Close of Month 1
------------------------------------------------------------------------
Uninvested
Earmarked assets proceeds Loans and investments
------------------------------------------------------------------------
Zero....................... $10,000,000 $15,000,000 (acquired on or
before 3/31/93).
------------------------------------------------------------------------
If the Licensee invested $2 million from the proceeds of
Participating Securities during the next month, and sold $1 million of
assets for cash, the following would occur:
Values at Close of Month 2
------------------------------------------------------------------------
Uninvested Loans and
Earmarked assets proceeds investments
------------------------------------------------------------------------
$2,000,000.............................. $8,000,000 $16,000,000
------------------------------------------------------------------------
As of the close of Month 1, the Licensee's (interim) EAR was 40
percent [(0=10,000,000)/(15,000,000=10,000,000)].
As of the close of Month 2, for Month 2, (interim) EAR was 41.666
percent [(2,000,000+8,000,000)/(16,000,000+8,000,000)].
As of the close of the Licensee's fiscal year, the Licensee's EAR
was 40.833 percent [(40+41.666)/2] or [(2,000,000+18,000,000)/
(31,000,000+18,000,000)]. For the purposes of the calculations
hereafter discussed, this Licensee's EAR is 40.833 percent.
(iii) Step 3: Ascertaining Earmarked Investment Income
Earmarked Investment Income (EII) is defined in Sec. 107.242(d)(1)
by the formula:
EII=IDA+([IIF+OI] x EAR)
where
IDA=All income directly attributable to Earmarked Assets
IIF=Interest on idle funds
OI=Other income not attributable to specific assets
EAR=Earmarked Asset Ratio
Thus, if IDA were $1,000,000 and other income not attributable to
specific assets were $500,000, EII would be:
($1,000,000+($500,000 x 40.833%)) or $1,204,165.
(iv) Step 4: Calculating Earmarked Investment Expenses
As defined in Sec. 107.242(d)(2), Earmarked Investment Expenses has
two components--Management Expenses and non-Management Expenses.
For the purposes of the calculations in Sec. 107.242(d)(2),
Management Expenses means the lesser of (1) Licensee's approved
Management Expenses multiplied by its EAR; or (2) 2.5 percent of the
product of the Licensee's Combined Capital, multiplied by its EAR
(plus, in the case of a Licensee whose Combined Capital is less than
$20 million, an additional sum equal to the product of $125,000 and the
Licensee's EAR). Expressed in formula terms, this would be:
Management Expense (ME)=0.025 x (CC x EAR) for a Licensee with Combined
Capital (CC) of $20 million or more.
ME = [(0.025 x {CC x EAR}) + ($125,000 x EAR)] for a Licensee with
Combined Capital of less than $20 million.
The second component of Earmarked Investment Expense is non-
Management Expense. Some non-Management Expenses can be attributed
directly to Earmarked Assets and, of course, are to be allocated to
Earmarked Investment Expenses. In addition, Licensee must allocate to
Earmarked Investment Expense a sum equal to the product of non-
Management Expense not attributable to specific assets (specifically
including interest on SBA-guaranteed Debentures) times Licensee's
Earmarked Asset Ratio. See Sec. 107.242(d)(2)(ii).
The sum of the above-described Management and non-Management
Expenses constitutes Earmarked Investment Expenses.
(v) Step 5: Determining Earmarked Net Investment Income (Loss)
Subtract Earmarked Investment Expenses (step 4) from Earmarked
Investment Income to determine Earmarked Net Investment Income (Loss)
(step 3).
(vi) Step 6: Determining Earmarked Realized Gain (Loss) on Securities
Section 107.242(e) sets forth rules for determining gain or loss on
securities that constitute Earmarked Assets (Earmarked Realized Gain
(Loss) on Securities). For the purpose of determining whether a gain or
a loss has been realized\8\ on the sale of an Earmarked Asset, the
asset's cost basis and net sales price shall be used. The asset's cost
basis shall not be increased, even by capitalization of unpaid
interest, except that if the basis of an investment in an
unincorporated Small Concern is appropriately determined by using the
equity method of accounting, the Licensee's basis may be increased by
the Licensee's share of the Small Concern's income. See
Sec. 107.242(e)(3).
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\8\Unrealized Appreciation or Unrealized Depreciation, as the
case may be, on Earmarked Assets that are Distributed shall be
recognized as if the appreciation or depreciation were realized at
the time of the In-Kind Distribution. See Sec. 107.242(3)(4), and
see also Sec. 107.245(e)(3), which relates to In-Kind Distributions.
---------------------------------------------------------------------------
(vii) Step 7: Computing Earmarked Profits (Losses)
Earmarked Profits (Losses) must be computed no less frequently than
annually as of the close of a Licensee's fiscal year, and at such other
times as Licensee elects to make a Distribution. See Sec. 107.242(a).
The computation is simple enough: Earmarked Profits (Losses) is the
sum, positive or negative, of Earmarked Net Investment Income (Loss)
and Earmarked Realized Gain (Loss) on Securities. See Sec. 107.242(f).
c. Computation, Allocation, and Distribution of Prioritized Payments
(i) Introduction
Proposed Sec. 107.243 provided for the computation, allocation, and
payment of Prioritized Payments. These payments are preferred and
cumulative at the Trust Certificate Rate, which is the rate SBA
guarantees to pay annually to the Trust Certificate holders.
Prioritized Payments resemble dividends on preferred stock or
equivalent distribution on preferred or senior limited partnership
interests.
The few comments received on this portion of the proposed rule
objected only to the Adjustments to the Prioritized Payments. In
general, the Adjustments are additional amounts that become payable to
SBA in the event the Licensee has sufficient profits. They are the
result of the compounding that must be performed by a Licensee if it
does not pay, at the end of its fiscal year, an amount equal to its
annual Prioritized Payments. During the course of that year, SBA will
have been making the interest payments as they come due under Trust
Certificates issued against a pool containing the Licensee's
Participating Securities. SBA's payment will be an amount equal to the
Prioritized Payments on all the Participating Securities in the pool.
The Licensees are not expected to be able to reimburse SBA immediately
for those payments; SBA may wait years for reimbursement, and may never
be reimbursed fully. The Adjustments are intended as partial
compensation to SBA for the time-value of the payments the Agency makes
in the interim. The Adjustments also help to lower the subsidy rate for
the Participating Securities program. For these reasons, SBA feels it
is important to retain the proposed concept of compounding of
Prioritized Payments in this final rule. It should be emphasized that
the Adjustments, like the Prioritized Payments themselves, are not due
and payable unless the Licensee has sufficient Earmarked Profits to pay
them.
As a reminder to the reader, the calculation of Prioritized
Payments is to be performed at least annually within ninety (90) days
after the end of the Licensee's fiscal year, and also at the end of any
fiscal quarter for which a Distribution is contemplated. If the
Licensee has cumulative Earmarked Profits, Prioritized Payments up to
the amount of such profits are characterized as Earned Prioritized
Payments and are to be distributed automatically within (90) days after
the end of the Licensee's fiscal year, except to the extent that such
Distribution would create a condition of Liquidity Impairment.
A Licensee with Participating Securities or Earmarked Assets in its
portfolio is prohibited from making any Distributions that are
considered to be a return on capital until all Prioritized Payments
have been distributed. Before returns of capital can be made, all
Earned Prioritized Payments must have been distributed. See
Sec. 107.245. We repeat in paragraphs (ii) through (vii) below, for the
reader's benefit, the detailed discussion of the computation of Earned
Prioritized Payments and Earned Adjustments that appeared in the
proposed rule. There are no changes to the related regulatory
provisions in this final rule.
(ii) Establishment of Prioritized Payment Accounts
To assist in the process of determining whether, or when, a
Licensee is responsible for making payments, two Prioritized Payment
accounts must be established: A Prioritized Payment Accumulation
Account (AA) which is a memorandum account, and a Prioritized Payment
Distribution Account (DA) which is a liability account. For the sake of
simplicity, the hypothetical examples set forth in paragraphs (iii) and
(iv) below illustrate the computations at the fiscal year end following
the first issuance of Participating Securities.
(iii) Initial allocations to Prioritized Payment Accumulation Account
The Prioritized Payment Accumulation Account initially reflects the
``accrual'' (as a memorandum entry only) of Prioritized Payments.
Computations involving this account always begin with the entry of a
sum equal to all Prioritized Payments for the fiscal period in
question. For example, if a Licensee had issued $10 million of eight
percent (8%) Participating Securities at the beginning of its fiscal
year, the initial amount to be added to the AA at the close of the
fiscal year would be $800,000. See Sec. 107.243(b)(1). As subsequently
explained, the Adjustments referred to above may also be added to this
account.
(iv) Initial Allocations to Prioritized Payment Distribution Account
(DA)
The first step in determining what should be added to the DA is to
ascertain cumulative Earmarked Profits (Losses). If, at the fiscal year
end following the first issuance of Participating Securities, the
Licensee has cumulative Earmarked Profits, that sum constitutes
Distributable Earmarked Profits.
The second step is to compare Distributable Earmarked Profits with
the balance in the AA. The lesser of the two is subtracted from the AA
and is added to the DA. This amount now constitutes Earned Prioritized
Payments. See Sec. 107.243(c).
For example, suppose that Earmarked Profits were $20,000. Since
$20,000 is less than the $800,000 of Prioritized Payments, $20,000 is
subtracted from the AA and is added to the DA. At this point there
would be $780,000 in the AA and $20,000 in the DA. The latter sum
represents Earned Prioritized Payments and is the amount the Licensee
will distribute to SBA or the Trust, unless such Distribution would
cause a Liquidity Impairment. See Sec. 107.243(c).
(v) Subsequent Allocations to Prioritized Payment Accumulation Account
and to Prioritized Payment Distribution Account
Subsequent allocations to these accounts will be made similarly,
except that Distributable Earmarked Profits for subsequent years are
calculated by subtracting from cumulative Earmarked Profits all
previous Earned Prioritized Payments and all earned Adjustments (as
described below) for prior fiscal periods.
In our example, at the end of the second year following issuance of
$10 million of eight percent (8%) Participating Securities, an
additional $800,000 would be allocable preliminarily to the AA,
bringing that account (temporarily) up to $1,580,000. If Earmarked
Profits for the second year were $40,000, cumulative Earmarked Profits
would be $60,000. Ignoring for the moment ``earned Adjustments'',
Distributable Earmarked Profits for Year 2 would be $40,000. Since
$40,000 is less than 41,580,000, the sum of $40,000 would be added to
the DA and subtracted from the AA. Thus, at the close of Year 2, the
balance in the AA would be $1,540,000 (exclusive of any Adjustments)
and, assuming no Distribution of Earned Prioritized Payments had been
made to SBA, the balance in the DA would be $60,000.
In making these calculations, Earmarked Losses are disregarded.
Thus, if the Licensee had Earmarked Profits of $20,000 for the first
year and Earmarked Losses of $100,000 during the second year, the
$20,000 ``obligation'' already reflected in the DA would have been
unaffected. See Sec. 107.243(d).
(vi) Distributions of Prioritized Payments
With one exception, a Licensee is required to remit the balance in
its DA to SBA, its agent or Trustee within 90 days after the end of the
Licensee's fiscal year, or before any Distribution is made to its own
investors, as appropriate. Any amount remitted to SBA is subtracted
from the DA. If a Licensee has issued Participating Securities on more
than one occasion, Prioritized Payments are made in order of maturity
of the underlying Participating Security.
As an exception, a Licensee is excused from remitting the balance
in the DA to the extent that such remittance would cause the Licensee
to violate the liquidity requirement set forth in Sec. 107.241(f).
Thus, if a Licensee has Earned Prioritized Payments of $1,400,000, and
a cash balance of $1,800,000, but needs to retain $1,000,000 in cash to
attain the required liquidity ratio, the Licensee must remit only
$800,000 to SBA. See Sec. 107.243(c)(3)(iii). Failure to make
Distributions because of insufficient liquidity does not trigger a
regulatory violation.
(vii) Adjustments to Prioritized Payments
A Licensee's failure to make timely distributions of Earned
Prioritized Payments in an amount equal to Prioritized Payments results
in the accumulation of additional amounts which may become payable to
SBA, subject to the existence of sufficient Earmarked Profits. If, at
the end of any fiscal year, there is an unpaid balance in the AA, an
amount equal to the average monthly balance in that account is
multiplied by a rate equal to the average of the rates on new Trust
Certificates (TCs) sold to the public\9\ during the Licensee's fiscal
year, and the product is added to the balance in the AA as a supplement
to Prioritized Payments. See Sec. 107.243(d)(1).
---------------------------------------------------------------------------
\9\SBA will publish a notice of the TC rate from time to time in
the Federal Register.
---------------------------------------------------------------------------
Similarly, if there is an unpaid balance in the DA account at the
end of the Licensee's fiscal year, an amount equal to the average
monthly balance in that account is multiplied by a rate equal to the
average of the rates on new TCs sold to the public during the
Licensee's fiscal year, and the product is added to the balance in the
AA, not to the balance in the DA. See Sec. 107.243(d)(2).
These additional amounts added to the AA are referred to as
``Adjustments''. Once added to the AA, the Adjustments are
indistinguishable from Prioritized Payments; they are characterized as
``earned'' and transferred to the DA in the same manner as Prioritized
Payments are characterized as ``earned.''
As long as unpaid Earned Prioritized Payments, including earned
Adjustments, are outstanding, the Licensee must make the calculations
described in this paragraph ``c'' as of the end of each subsequent
fiscal quarter until all such amounts are paid in full. See
Sec. 107.243(c)(3).
d. Calculation and Allocation of Profit Participation
(i) Introduction
In proposed Sec. 107.244, SBA described its right to a percentage
of the profits of a Licensee issuing Participating Securities. In
consideration for its guarantee of a Licensee's Participating
Securities, SBA\10\ has a contractual right to Profit Participation
consisting of a specified percentage of the Licensee's Earmarked
Profits. The percentage is determined, in part, by the ratio of
outstanding Participating Securities Leverage to Leverageable Capital.
---------------------------------------------------------------------------
\10\Neither the holders of TCs, nor the Trust itself has any
interest in the Profit Participation to which SBA may be entitled.
---------------------------------------------------------------------------
SBA received eighteen (18) comments on the subject of the Profit
Participation. Most complained that the regulations should provide a
mechanism for offsetting prior distributions of profits to SBA against
subsequent losses of the Licensee. This so-called ``levelling up'' is a
component of many venture capital funds, and is designed to ensure that
partners ultimately receive only their agreed-upon profit shares.
SBA was aware of this issue when it drafted the proposed rule.
Under the Distributions section of the preamble to the proposed rule
(section 4.e.(vi)), SBA discussed the reasons for not including a
level-up in the proposed rule. See 58 FR 41862. SBA believed then, and
continues to believe, that Section 403 of Public Law 102-366 prohibits
a recharacterization of amounts already distributed to SBA. There is no
discretion on SBA's part to include a ``levelling-up'' provision in
this final rule.
Even if a recharacterization of distributed amounts were legally
permissible, SBA believes that it would be extremely difficult to
calculate because of the complexity produced by changes in SBA's profit
share (the Profit Participation) and its share of Distributions under
Secs. 107.245 (c) and (d). SBA's profit share in a Licensee is
increased when new Participating Securities are issued by the Licensee
and/or the Licensee's Leverageable Capital is decreased. SBA's profit
share is decreased when approved increases in Leverageable Capital
occur. At the same time, SBA's share of Distributions (in the form of
returns on capital or returns of capital) is changed as increases or
decreases occur in either the Licensee's Leverageable Capital or its
Leverage outstanding. See discussion of Secs. 107.245 (c) and (d)
below. SBA currently does not have a mechanism that can account
accurately for all these changes in order to identify what SBA's share
of Distributions would have been if ``losses after profits'' were taken
into account.
SBA also believes that there should be less need for a
recharacterization of distributed amounts if the Licensee has been
valuing its portfolio investments fairly, especially the determination
of Unrealized Depreciation on Loans and Investments. SBA regulations
require Licensees to reduce their Undistributed Net Realized Earnings
by their Unrealized Depreciation on Loans and Investments in order to
determine Retained Earnings Available for Distribution (READ). See
Sec. 107.3. Distributions of SBA's Profit Participation, which the
commenters would like to be able to recharacterize as a return of
capital, can only be made out of the Licensee's READ. Therefore, if the
Licensee has not grossly underestimated its Unrealized Depreciation,
the Licensee's READ and consequently its Distributions of Profit
Participation to SBA should already reflect, to some degree, future
realized losses. There should be reduced need for a major
recharacterization of earlier distributed amounts when the later losses
are actually realized.
In conclusion, in the absence of a statutory amendment allowing for
a recharacterization, a satisfactory mechanism to implement the change,
and a compelling justification of the need for it, SBA is finalizing
the proposed rule without incorporating a level-up or
recharacterization of prior distributions. SBA expects that discussions
on the subject will continue between it and interested industry members
and that it might at some time in the future propose a different
resolution.
The method for computing, allocating and distributing the Profit
Participation is described below. Although the method has been
simplified from that set forth in the proposed rule, the result is
identical.
In summary, Sec. 107.244 mandates the establishment of a Profit
Participation Account to reflect the allocation and distribution of the
Profit Participation due SBA. The sum to be allocated is determined by
multiplying the Base for Profit Participation, if positive, by the
applicable Profit Participation Rate.
(ii) Computing the Profit Participation Base
The computation of the Profit Participation Base is to be made at
the end of the Licensee's fiscal year and at the end of any fiscal
quarter for which a Distribution is contemplated. Briefly, the Base for
Profit Participation (Base) is a number equal to year-to-date Earmarked
Profits (Losses) minus year-to-date Prioritized Payments and
Adjustments, minus any unused loss carryforward, as determined in the
manner hereafter discussed.
(iii) Determination of Unused Loss Carryforward
To determine its unused loss carryforward, a Licensee must look
back to the Base computed at the end of its previous fiscal year (the
``Previous Base''). If the Previous Base was zero or greater, then the
Licensee's unused loss carryforward is zero. However, if the Previous
Base was less than zero, then the unused loss carryfoward is equal to
the Previous Base. During or at the end of its first year of operation,
a Licensee has no Previous Base and, therefore, no loss carryforward.
In effect, a Previous Base which is negative reflects all prior
losses and Accumulated Prioritized Payments of the Licensee, which are
carried forward to offset future earnings. Conversely, a Previous Base
which is positive is not carried forward because once Earmarked Profits
are used as the basis for an allocation to the Profit Participation
Account, they are disregarded in any subsequent allocation or
computation. See Sec. 107.244(b)(2).
Some illustrations may help clarify this concept. Assume that a
Licensee had issued $10 million of 8 percent Participating Securities
on July 1, 1994, the first day of its fiscal year, and had Earmarked
Profits of $20,000 as of the close of the fiscal year, June 30, 1995.
The Licensee's Base would be ($780,000), computed by subtracting
Prioritized Payments of $800,000 for Earmarked Profits of $20,000 (the
unused loss carryfoward would be zero because the Licensee had not
previously computed a Base). Now assume that fiscal year 1995-96 was
extremely successful and that the Licensee's Earmarked Profits for that
year were $2 million. Since the Previous Base was negative, it would be
the Licensee's unused loss carryforward. The new Base, therefore, would
be $420,000: ([$2,000,000 current period Earmarked Profits--$800,000
current period Prioritized Payments]-$780,000 unused loss
carryforward).
As a second example, assume that the Licensee had instead posted an
Earmarked Loss of $20,000 during the first year that Participating
Securities were outstanding. The unused loss carryforward would be
$820,000. At the end of the second year, the Base for Profit
Participation would be only $380,000 ([$2,000,000-$800,000]-$820,000).
(iv) Computing Profit Participation Rates
(A) When computation is required; general rules. Computation of a
Profit Participation Rate for the relevant fiscal period must be made
at least annually or prior to any Distribution. A Licensee should use
one of the two formulas, as appropriate, which are set forth in
paragraphs (B) and (C), below. Except as described in paragraph (E)
below, the Profit Participation Rate that any particular Licensee must
use depends on the highest ratio of Leverageable Capital to
Participating Securities outstanding which has ever been computed for
such Licensee. This is the Participating Securities to Leverageable
Capital (PLC) ratio.
(B) Participating Securities not at any time in excess of
Leverageable Capital. Subject to the indexing described in paragraph
(D) below, for a Licensee whose outstanding Participating Securities
have never exceeded its Leverageable Capital, the Profit Participation
Rate is equal to the PLC ratio multiplied by nine percent (9%). Thus,
the Profit Participation Rate=PLC ratio x 0.09. For a Licensee that has
a PLC ratio equal to exactly one hundred percent (100%) of Leverageable
Capital, the Profit Participation Rate is nine percent (9%); for every
other Licensee described in this paragraph (B), the Profit
Participation Rate is less than nine percent (9%).
(C) Participating Securities in excess of Leverageable Capital at
any time. Subject to the indexing described in paragraph (D), for a
Licensee whose outstanding Participating Securities have exceeded its
Leverageable Capital, the Profit Participation Rate is equal to nine
percent (9%) plus an additional percentage equal to the product of .03
multiplied by an amount obtained by subtracting one (1) from the PLC
ratio. In other words, Profit Participation Rate=.09+(.03 x [PLC
ratio-1]). If a Licensee has $10 million in Leverageable Capital and
$15 million in Participating Securities, the PLC ratio =1.5 and Profit
Participation Rate equals 10.5 percent, .09+(.03 x [1.5-1]).
(D) Indexing. No indexing of the Profit Participation Rate is
required if, on the date the Participating Securities were issued, the
yield-to-maturity rate on Treasury bonds with a remaining term of ten
years (the ``Treasury Rate'') is exactly eight percent (8%). Otherwise,
the Profit Participation Rate calculated in accordance with
Sec. 107.244(c) (2) or (3) shall be adjusted upward or downward
proportionately to such Treasury Rate (that is, by the percentage,
rather than the same number of percentage points or basis points, by
which the Treasury Rate may be above or below eight percent (8%)).
For example, if the Treasury Rate were ten percent (10%) and the
unindexed Profit Participation Rate were nine percent (9%), the
appropriate indexed Rate would be 11.25 percent. Ten (10) is twenty-
five percent (25%) more than eight (8); 125 percent of nine percent
(9%) is 11.25 percent.
If a Licensee has issued Participating Securities on two or more
occasions, any indexing of the Profit Participation Rate will be based
on the average Treasury Rate for all such issuances, weighted to
reflect the dollar amount of each issue and the portion of the fiscal
period during which each issue was outstanding. See
Sec. 107.244(c)(4)(ii).
(E) Approved increases in Leverageable Capital. Computation of the
Profit Participation Rate is not to be affected by any subsequent
increase in Leverageable Capital, except to the extent that (1) the
increase in Leverageable Capital is the result of the funding of
unfunded commitments or the conversion to cash of assets previously
recognized by SBA as a part of Private Capital, but not of Leverageable
Capital, or (2) such increase is expressly provided for in a plan of
operations previously approved by SBA. See Sec. 107.244(c)(5).
(v) Computing Profit Participation
The amount of SBA's Profit Participation for a fiscal year or
fiscal year-to-date is computed by multiplying the Base as of the end
of such period by the Profit Participation Rate for such period, and
subtracting from the result any amounts of Profit Participation that
were paid or reserved for payment to SBA for any prior interim period
during the same fiscal year.
Any computation of Profit Participation made as of the close of an
interim fiscal quarter is subject to adjustment whenever any subsequent
interim distributions are contemplated, and at the end of the fiscal
year, in order to account for any increase in the Profit Participation
Rate. If the Profit Participation Rate decreases as a result of an
approved increase in Leverageable Capital, Profit Participations
already computed for any interim periods shall not be adjusted. See
Sec. 107.244(d)(3).
(vi) Allocation of Profit Participation
Prior to any Distributions, and in any event within 90 days
following the end of the Licensee's fiscal year, the amount of any
Profit Participation calculated in accordance with Sec. 107.244(d)
shall be allocated to a Profit Participation Account. Funds equal to
the amount allocated to this account shall be reserved for SBA and
shall not be available for reinvestment in Small Concerns or for any
other use by the Licensee; these funds shall be distributed only to
SBA.
(vii) Distribution of Profit Participation
Distribution of allocated Profit Participation shall be made at the
same time that profits are distributed to the Licensee's investors,
either as a tax Distribution or as a return on capital.
e. Distributions
(i) General
Proposed Sec. 107.245 set forth restrictions and other conditions
on a Licensee's Distributions other than Prioritized Payments. All
Prioritized Payments must be paid before any Distributions are made
that are classified as a tax Distribution or a return on capital.
Earned Prioritized Payments and earned Adjustments, as recorded in the
DA, must be paid before any Distributions are made that are classified
as returns of capital. Distributions pursuant to Sec. 107.245 may be
made only to the extent that they do not cause a condition of Liquidity
Impairment. See Sec. 107.241(f).
Comments received on proposed Sec. 107.245 are addressed in the
particular subsection (Tax Distributions, Returns on Capital, or
Returns of Capital) to which such comments relate.
(ii) Tax Distributions
(A) General. Pursuant to proposed Sec. 107.245(b), a Licensee that
is organized as a limited partnership, S Corporation, or similar pass-
through entity, could elect to make an annual Distribution from
Retained Earnings Available for Distribution (READ) to each of its
investors (specifically including SBA) in amounts not greater than the
``Maximum Tax Liability'' (as computed in paragraph (B) below) for
Federal and State income taxes on the Federal taxable income imputed to
each investor for that fiscal year. Since SBA is not a tax-paying
entity, the amount of SBA's share of any such Distribution would be
determined by multiplying the tax Distribution to all partners by SBA's
``Profit Participation Rate'', determined in accordance with
Sec. 107.244. Anything that SBA received as its share of a tax
Distribution would be credited first against Profit Participation as
described below.
Some comments warned that the Agency's interest would not be
protected adequately if Licensees were permitted to make tax
Distributions based on annual profits, without regard to the tax
benefit that had been conferred on investors by prior years' losses. A
cumulative measure of income comparable to that used for Prioritized
Payments or returns on capital was recommended.
While not disagreeing with the need for protection, SBA believes
that the final rule offers adequate safeguards against an unfair
result. A Licensee's ability to make a tax Distribution is always
dependent upon the existence of sufficient Retained Earnings Available
for Distribution. Tax Distributions can only be made from a Licensee's
READ, which is a cumulative measure of income. Although a Licensee may
compute a Maximum Tax Liability (which is based on annual income) in
excess of its Retained Earnings Available for Distribution, its tax
Distribution can never exceed its READ. Thus, prior years' losses do
affect a Licensee's ability to make a tax Distribution.
Furthermore, SBA has revised the proposed tax Distribution
provision to clarify that to the extent a Licensee is unable or elects
not to make a tax Distribution for any fiscal year within ninety (90)
days following the end of such fiscal year, it shall have no right to
make such Distribution at any later date. With this clarification, SBA
has decided to finalize the proposal on tax Distributions.
There are two other important limitations on the right of a
Licensee to make tax Distributions. There can be no unpaid Prioritized
Payments and the Distribution can not cause the Licensee to have a
``Liquidity Impairment''.
Although Sec. 107.245(b) refers to ``tax Distributions'', the
amounts distributed may exceed any true tax liability (particularly for
those investors that are exempt from Federal or State taxation). Other
than SBA, every investor in a Licensee that is a pass-through entity is
presumed conclusively (1) to be a resident, for tax purposes, of the
State in which the Licensee's principal office is located; and (2) to
be liable to pay Federal and State income taxes at the highest marginal
tax rates applicable to each category of income (such as ordinary
income as opposed to capital gains). If individuals are taxed at a
higher rate than corporations, every investor will be presumed
conclusively to be an individual even if actually a corporation or a
pension fund. See Sec. 107.245(b).
(B) Computation of tax Distribution to Investors. The maximum
amount potentially distributable to all investors (including SBA) is
determined by multiplying the aggregate amounts of ordinary income and
capital gains imputed to investors by the highest combined marginal
Federal and State tax rates applicable to each category, taking into
account the deductibility of State taxes when computing Federal taxes.
Local taxes (for example, county and city taxes) are disregarded for
this purpose.
By way of illustration, assume that at the end of the Licensee's
first fiscal year, $1,000 in ordinary income had been imputed to all
investors (including tax-exempt organizations). If the highest rate of
Federal tax on ordinary income is thirty-five percent (35%) and the
highest rate of State tax on ordinary income is five percent (5%), it
is conclusively presumed that investors will have to pay $50 in State
income taxes on the $1,000 in the Licensee's hands. But since the $50
payable to the State is deductible from the investors' Federal taxable
income, their Federal income tax liability is based on only $950, and
is therefore equal to $332.50. The maximum amount that may be
distributed to investors (including SBA) pursuant to Sec. 107.245(b)
would be $332.50 plus $50.00 or $382.50 (not $400, which would be forty
percent (40%) of $1,000).
The proposed rule incorrectly suggested that SBA's share of the tax
Distribution was in addition to the tax Distribution to investors as
computed above. SBA is here clarifying that, in accordance with section
403 of Public Law 102-366, the tax Distribution to investors as
computed above includes SBA's tax Distribution. In other words, the
amount calculated as the tax Distribution for all investors is not
available for distribution to all non-SBA investors; SBA's portion must
be deducted for distribution to SBA.
(C) Computation of tax Distributions to SBA. The amount to be
remitted to SBA is computed by multiplying the total tax Distribution
as computed above by the Profit Participation Rate computed in
accordance with Sec. 107.244(c). The amount of such tax Distribution to
SBA shall be subtracted from the Profit Participation Account referred
to above.
(iii) Returns on Capital
(A) General. Proposed Sec. 107.245(c) established requirements for
all Distributions in the form of returns on capital and some
Distributions in the form of returns of capital. The proposal provided
that after making all Prioritized Payments and any tax Distributions, a
Licensee with READ would be required, within 90 days following the
close of its fiscal year (or in its discretion, a fiscal quarter), to
make Distributions under this section to its investors and SBA to the
extent that they would not cause a Liquidity Impairment. In appropriate
circumstances, SBA could waive this requirement. All such Distributions
to investors must be made from READ (and would be returns on capital);
Distributions to SBA may or may not be from READ (and may be returns on
capital or returns of capital).
A number of comments indicated dissatisfaction with the requirement
that Distributions be made within 90 days of the Licensee's fiscal year
end. They argued that it can often be imprudent for a Licensee to
distribute all of its profits, and expressed concern over potential
delays in obtaining waivers from SBA.
SBA is particularly sympathetic to issues affecting the prudent
management of Licensees. The Liquidity Impairment test itself is
imposed on all Distributions to ensure that Licensees are prudent
managers of their cash flows. Still, SBA recognizes that prudent
management of cash flow and investments means more than merely
satisfying the Liquidity Impairment test, and that there will be times
when a Licensee should refrain from distributing all profits. While SBA
believes that the waiver provision will help to prevent the imprudent
distribution of a Licensee's profits, it agrees with the need for
prompt consideration of waiver requests.
In order to assure Licensees that requests for prior approval will
be processed on a timely basis, the final rule provides that the
Licensee's request for prior approval will be considered approved
unless SBA notifies it otherwise within thirty (30) days of receiving
the request. All requests for prior approval should be accompanied by
sufficient information for SBA to make an informed decision.
SBA has concluded that Licensees may need more than ninety (90)
days after their respective fiscal year-ends to calculate and make
Distributions under Sec. 107.245(c). Accordingly, this final rule
provides that a Licensee is required to make such Distributions within
120 days of the end of its fiscal year.
Each Licensee that expects to need prior approval under
Sec. 107.245(c) should make sure its request is received by SBA before
the ninetieth day after its fiscal year end so that SBA is able to
respond before the arrival of the 120th day, when Distributions must be
made. SBA believes that with the addition of a definitive thirty-day
response time, Licensees should be able to plan for their needs and yet
meet the requirements of the regulation.
The balance of Sec. 107.245(c) is finalized as it was proposed. It
provides that while the dollar amount of Profit Participation is
determined by formula according to the ratio of Participating
Securities to Leverageable Capital, the actual amount to be distributed
to SBA when there is a return on capital to private investors is a
function of the ratio of total Leverage (Debentures, and Preferred
Securities, and Participating Securities) to Leverageable Capital. See
Sec. 107.245(c).
As with the proposed rule, if SBA determines that the value of the
Licensee's assets are materially overstated and if SBA provides the
Licensee with timely notice of such determination in advance of a
proposed Distribution, SBA reserves the right to restrict
Distributions.
Distributions paid to SBA under Sec. 107.245(c) are applied in the
following sequence:
(i) Profit Participation;
(ii) Dividends or equivalent distributions on Preferred Securities;
(iii) Redemption or prepayment of outstanding Participating
Securities;
(iv) Redemption or prepayment of outstanding Preferred Securities;
and
(v) Repayment of principal of outstanding Debentures. If there are
restrictions on prepayment of outstanding Debentures, that part of
SBA's share of a Distribution that is to be applied toward such
prepayment shall be deposited in an escrow account on such terms and
conditions as SBA may prescribe.
It is noted that Distributions to SBA will be made from READ only
to the extent of Profit Participation and dividends or equivalent
distributions, if any, on Preferred Securities. To the extent that a
Distribution is applied as a repayment or redemption of Leverage, it
shall not reduce READ.
(B) Computation of SBA's share. As in the proposed rule, if
outstanding Leverage is more than two hundred percent (200%) of
Leverageable Capital, SBA's share of any Distribution under
Sec. 107.245(c) shall be in the ratio of Leverage to Leverageable
Capital. In other words, if a Licensee has outstanding Leverage equal
to three hundred percent (300%) of Leverageable Capital, SBA's share
shall be \3/4\ or seventy-five percent (75%) of any such Distribution
and SBA would be entitled to $3 for every $1 distributed to other
investors. If outstanding Leverage were two hundred fifty percent
(250%) of Leverageable Capital, SBA would be entitled to $2.50 for
every $1 distributed to other investors.
If outstanding Leverage is more than one hundred percent (100%) of
Leverageable Capital, but not more than two hundred percent (200%),
SBA's share of any such Distribution shall be equal to the aggregate
shares of all other investors. For every $1 distributed to other
investors, SBA shall receive $1.
If outstanding Leverage is not more than one hundred percent (100%)
of Leverageable Capital, SBA's share of any such Distribution shall be
a percentage equal to the Profit Participation Rate.
(iv) Returns of Capital
Under this heading, it is appropriate to discuss comments received
regarding the definition of ``Retained Earnings Available for
Distribution'' (READ). Any changes in that definition would affect the
allocation of Distributions between returns on capital and returns of
capital for companies with Participating Securities. It should be
noted, however, that READ is a defined term which applies to all
Licensees. Any change in the definition would actually have a more
significant effect on Licensees without Participating Securities
because they are subject to much stricter limitations on their ability
to return capital to investors.
In general, the comments expressed the opinion that READ should
include Unrealized Appreciation as an offset to Unrealized
Depreciation. In other words, READ would be defined to mean
Undistributed Net Realized Earnings less net Unrealized Depreciation.
SBA understands the arguments of the industry, including issues of
fairness and good faith, but remains unconvinced. As a general rule,
the portfolio valuation process is not sufficiently reliable to allow
Unrealized Appreciation to be a component of READ without introducing
an undue risk of premature distributions. While the calculation of
Capital Impairment allows for an offset of Unrealized Appreciation
against Unrealized Depreciation, and even gives credit against realized
losses for some net Unrealized Appreciation, Capital Impairment and
READ serve different purposes in the SBIC Program. The former is a
regulatory measure of financial health; the latter is the basis for
distributing cash out of the company. Accordingly, SBA intends to
retain the conservative measure of READ in its final rule, defining
READ to mean Undistributed Net Realized Earnings less Unrealized
Depreciation.
SBA recognizes that there may be occasions when otherwise
unauthorized distributions should be approved. A Licensee may request
SBA's prior approval to make a distribution in excess of READ in
accordance with the provisions of Sec. 107.1201. In considering such
requests, SBA will consider all relevant factors, including the
existence of Unrealized Appreciation.
Since there were no other comments on Sec. 107.245(d), SBA is
finalizing it without any other change. It provides that after paying
all Earned Prioritized Payments including earned Adjustments in the DA,
and all allocated Profit Participation, and provided the Licensee does
not have a condition of Capital Impairment, a Licensee that has either
outstanding Participating Securities or Earmarked Assets in its
portfolio may return capital to its investors and SBA, pursuant to the
terms set forth in Sec. 107.245(d). This provision allows an exception
to Sec. 107.802, which prohibits Licensees from distributing capital in
excess of two percent (2%) per year without the prior written approval
of SBA, subject to certain restrictions. However, unless SBA decides
otherwise on a case-by-case basis, any such Distribution shall be
subject to the liquidity requirement in Sec. 107.241(f).
Generally, Distributions in the form of returns of capital shall be
made to SBA and private investors in the ratio of Leverage to
Leverageable Capital as of the date of the proposed Distribution. For
example, if outstanding Leverage is equal to three hundred percent
(300%) of Leverageable Capital, SBA's share will be $3 for every $1
distributed to the private investors.
If, however, a Licensee has a Capital Impairment Percentage greater
than zero, the relative shares of SBA and the private investors must be
computed differently. In such a case, Leverageable Capital for the
purposes of Sec. 107.245(d) is deemed to be Leverageable Capital
multiplied by a percentage equal to the difference between one hundred
percent (100%) and the Licensee's Capital Impairment Percentage.
Assuming a Licensee had $10,000,000 of Leverageable Capital and a
Capital Impairment Percentage of forty-two percent (42%), the
Licensee's Leverageable Capital for purposes of this computation will
be deemed to be $5,800,000 ([100%-42%] x [$10,000,000]).
The proceeds of SBA's share of any capital Distribution shall be
credited in the manner prescribed for returns on capital under
Sec. 107.245(c), as set forth in Sec. 107.245(c)(5).
(v) In-Kind Distributions
No comments were received on the subject of In-kind Distributions,
proposed Sec. 107.245(e). The provision is therefore finalized in the
form in which it was proposed. Under Sec. 107.245(e), Distributions of
READ or of capital need not be in cash, but may be in the form of
portfolio securities, subject to certain restrictions. The securities
to be distributed must be Publicly Traded and Marketable, as defined in
Sec. 107.3, at the time of Distribution.
At the time a corporate Licensee declares an In-kind Distribution,
or an Unincorporated Licensee actually makes one, the Licensee must
impute a gain or loss to the securities in question, determined as of
the date of the declaration or distribution, as the case may be. Such
imputed gain or loss shall be used to calculate Earmarked Profits
pursuant to Sec. 107.242(e) as if it were a realized gain or loss.
All Distributions of securities that constitute part of an In-kind
Distribution must be made on a pro-rata basis to each investor,
including SBA, as if the securities previously had been converted to
cash and the proceeds constituted the entire Distribution. A Licensee
may not distribute a disproportionate percentage of the stock of
company A to investor X and a disproportionate share of the stock of
company B to investor Y, even if the values of the shares of A and B
are equal.
SBA's share of an In-kind Distribution shall be deposited with the
Central Registration Agent (CRA) unless SBA and the Licensee agree that
the Licensee will dispose of SBA's share of such securities. If the
Licensee disposes of SBA's share of securities, it shall remit the
proceeds promptly to SBA or to SBA's designated agent or Trustee.
f. Post-Redemption Obligations
No comments were received on proposed Sec. 107.246, which described
the continuing obligations of Participating Securities issuers after
their Participating Securities have been redeemed. The section is
finalized without change, except to clarify that post-redemption
Distributions of Accumulated Prioritized Payments are to be computed
and paid on a quarterly basis, but otherwise in the same manner as
before redemption.
If, after redeeming all of its outstanding Participating
Securities, a Licensee has both Earmarked Assets in its portfolio and
an unpaid outstanding balance in the Prioritized Payment Accumulation
Account (AA), the Licensee remains ``obligated'' to determine, at the
end of each fiscal quarter, whether any Prioritized Payments have
become Earned Prioritized Payments and to distribute such amounts to
SBA in accordance with Sec. 107.243. See Sec. 107.246(a). After the
last Earmarked Asset has been disposed of, and any resulting Earned
Prioritized Payments paid to SBA, the Licensee is under no further
obligation to pay the remaining balance, if any, in the AA. See
Sec. 107.246(b).
Section 107.246(c) overrides the language of Sec. 107.245(e) (In-
kind Distributions) in cases involving In-kind Distributions to be made
after redemption of all Participating Securities if there are also
unpaid Prioritized Payments. Under Sec. 107.246(c), no In-kind
Distributions of Earmarked Assets may be made unless SBA is paid a sum
equal to the full amount of the unpaid Prioritized Payments or the full
amount of Unrealized Appreciation on the Earmarked Assets in question,
whichever is less. Subject to this rule, a Licensee that has fully
redeemed its Participating Securities may distribute Earmarked Assets
that are not Publicly Traded and Marketable if it has SBA's prior
written consent to such Distribution and to the valuation assigned by
the Licensee.
g. Special Rules for Companies Licensed On or Before March 31, 1993
(i) General
SBA did not receive any comments on proposed Sec. 107.247, the
special rules for companies licensed on or before March 31, 1993. The
section is therefore finalized without change. It provides that a
company licensed on or before March 31, 1993 that thereafter applies
for SBA's guarantee of its Participating Securities must meet certain
procedural requirements not applicable to other Licensees. These
companies are also afforded certain exemptions or options not available
to companies licensed after March 31, 1993. See Sec. 107.247. The
details are set forth below.
(ii) Special Requirements
When applying for SBA's guarantee of a first issuance of
Participating Securities, any company licensed on or before March 31,
1993 must submit:
(a) A valuation report for each portfolio asset as of the date of
the financial statements that accompany the application, and as of the
end of each of the preceding three years, and
(b) A copy of each portfolio concern's last annual report and/or
fiscal year-end financial statements, and most recent interim financial
statements. See Sec. 107.247(d). This information is required in
addition to the financial information that all Licensees, including
companies licensed after March 31, 1993, are required to submit in
connection with an application for SBA's guarantee of their
Participating Securities.
If the Licensee has negative Undistributed Realized Earnings and/or
a net Unrealized Loss on Securities Held, SBA may make its approval of
the Licensee's request for a guarantee of Participating Securities
contingent upon a quasi-reorganization in accordance with generally
accepted accounting principles. See Sec. 107.247(d)(2).
If the financial statements of the Licensee submitted with the
application are interim financial statements, the Licensee shall have a
limited scope audit performed by its SBA-approved independent
accountants. These accountants shall use whatever auditing procedures
are necessary to enable them to express an opinion on the Licensee's
Statement of Financial Position and the accompanying Schedule of
Investments.
(iii) Refinancing of Debentures
Subject to the two following conditions, a company licensed on or
before March 31, 1993 may use part or all of the proceeds of
Participating Securities to repay or prepay Debentures outstanding on
that date. The Licensee must demonstrate to SBA that it has outstanding
Equity Capital Investments, valued at cost, in an amount equal to the
amount of Participating Securities that would be used to refinance the
outstanding Debentures that are to be repaid or prepaid. The Licensee
also may not elect to exclude any of its pre-existing portfolio from
the category of Earmarked Assets.
A Licensee that pays or prepays an outstanding Debenture after it
has issued Participating Securities is presumed to have used the
proceeds of the Participating Securities for this purpose unless it can
demonstrate the availability of other funds to pay the principal amount
of the Debenture in question. See Sec. 107.247(a).
(iv) Exclusion of Pre-Existing Portfolio Assets
Unless a Licensee intends to use part or all of the proceeds from
the issuance of Participating Securities to repay or prepay a Debenture
outstanding on March 31, 1993, it may elect, when its first application
for SBA's guarantee is submitted, to exclude all, but not less than
all, portfolio assets outstanding on March 31, 1993 from the category
of Earmarked Assets. In such event, SBA is not obligated to extend its
guarantee if it concludes that exclusion of the Licensee's March 31,
1993 portfolio would significantly decrease SBA's chances of obtaining
a satisfactory return on its guarantee.
5. Financing by Use of SBA Guaranteed Trust Certificates
Proposed Sec. 107.250 was a recodification of existing
Sec. 107.201(c), revised to include the new Participating Securities.
No comments were received on the proposal, which is therefore finalized
without substantive change.
6. Conditions Affecting Good Standing of Leveraged Licensees
a. Introduction
SBA received forty-three (43) comment letters concerning SBA's
proposed remedies for regulatory violations by Leveraged Licensees
(Sec. Sec. 107.261 and 107.262). SBA had proposed to separate the
remedies for violations by issuers of Debentures and Preferred
Securities (Sec. 107.261) from the remedies for violations by issuers
of Participating Securities (Sec. 107.262). The comments supported the
distinction made between Debentures and Participating Securities. The
suggestion that remedies be different for Preferred Securities and
Participating Securities, however, was opposed by Specialized SBICs.
These Licensees objected to the characterization of Preferred
Securities as more akin to Debentures than Participating Securities.
They argued that the Preferred Security, which has attributes of both
debt and equity securities, should be treated as an equity security for
purposes of the remedies section. They expressed concern that if
Preferred Securities continue to carry the same remedies as Debentures,
tax-exempt entities such as pension funds will refrain from investing
in Specialized SBICs in order to avoid incurring Unrelated Business
Taxable Income (UBTI).
SBA expresses no opinion as to whether tax-exempt entities
investing in Specialized SBICs that issue Preferred Securities would
incur UBTI as a result of SBA's former remedies (former Sec. 107.203)
or its proposed remedies (proposed Sec. 107.261). Nevertheless, SBA
believes that there is sufficient justification for treating Preferred
Securities as if they were an equity-type security and relocating them
into the Participating Securities remedies section (Sec. 107.262). The
rule is finalized with this change.
The overall structure of the remedies sections remains otherwise
intact. In order to maintain the separation between the two sections on
remedies, no cross-default provisions are provided between Debentures,
on the one hand, and Preferred Securities and Participating Securities,
on the other. If a Licensee has both Debentures and Participating
Securities, a default under the former will not automatically trigger a
``default'' under the latter, and vice versa.
b. General Conditions and Remedies
Many comments on the proposed remedies sections objected to the
requirement that all Licensees issuing Leverage after publication of
this final rule amend their articles of incorporation or partnership
agreements to indicate consent, in advance, to SBA's right to require
the removal of officers, directors, or general partners and to the
appointment of SBA or its designee as receiver of the Licensee for the
purpose of continuing to operate the company. See Sec. Sec. 107.261(f)
and 107.262 (b) and (c). Such remedies would only take effect upon the
occurrence of certain specified violations involving, for the most
part, fraudulent activities or willful actions.
The principal effect of the consent to a receivership would be that
SBA would be entitled to the receivership promptly, as a matter of
right. Except upon the occurrence of an automatic event of default
under a Debenture (see Sec. 107.261(b)), Licensee's consent would not
include consent to a receivership for the purpose of liquidating the
company.
The comments objected strongly to the consent provision,
particularly as it relates to Debenture issuers (Sec. 107.261(f)). They
recommended that SBA rely upon its current statutory authority for
removal of management and/or the appointment of a receiver, which
allows a Licensee the opportunity to challenge, in advance, SBA's
intended action. Unfortunately, SBA has found that SBICs have used that
opportunity to delay the availability of SBA's remedy while they file
for protection under Federal bankruptcy laws.
SBA looked carefully at the specific violations that could trigger
the advance consent remedies. The Agency is convinced that, with one
small exception, the advance consent is appropriate for the very
serious nature of the defaults in question.
The one exception is the payment default by issuers of Debentures
(Sec. 107.261(c)(7)). SBA intends to continue its customary practice of
affording Licensees an opportunity to cure payment defaults. The
proposed rule would have permitted SBA to use its remedial powers
before allowing the Licensee an opportunity to cure its payment
default. Accordingly, SBA is moving the default referred to as
``Failure to make payment'' from the category of non-curable defaults
(Sec. 107.261(c)) to the category of curable defaults
(Sec. 107.261(d)).
With this change, a Licensee issuing Debentures after the effective
date of this rule will be required to consent in advance to the forced
removal of management and the appointment of an operating receivership
for the following events: fraud, fraudulent transfers, willful
conflicts of interest, willful noncompliance, repeated events of
default, transfer of control of the Licensee, uncured excessive fees,
uncured improper Distributions and uncured payment defaults.
These consent provisions will not apply to any Licensee which only
has Leverage issued prior to the effective date of this final rule.
Prospectively, however, the consent will be incorporated in all newly-
issued Debentures, Preferred Securities, and Participating Securities.
As a result, for Licensees with Leverage issued both before and after
the effective date of this rule, the Licensee will be deemed to have
consented to a receivership upon the occurrence of a default under
Leverage issued after such date, but not if the default is only under
Leverage issued before such date.
SBA also is making clear in this final rule that while the Agency
determines appropriate cure periods for curable violations on a case-
by-case basis, the cure period under Sec. 107.261 or Sec. 107.262 will
never be less than fifteen (15) days. As with the proposed rule, an
opportunity to cure is made available in the final rule under
Secs. 107.261(d) and 107.262(c). In response to comments from
Licensees, this final rule also affords an issuer of Participating
Securities or Preferred Securities an opportunity to cure before being
placed under ``restricted operations.'' See Sec. 107.262(d).
SBA does not agree with the recommendation in some comment letters
that, in the case of bankruptcy, voluntary assignment for the benefit
of creditors, and transfers of control, Licensees issuing Participating
or Preferred Securities still should have the opportunity to remove the
responsible party and/or otherwise effect a cure before SBA can use its
remedial powers. SBA believes strongly that if one of these violations
occurs, the Agency must be free to exercise its remedies as rapidly as
possible, since time may be of the essence in preserving any value left
in the company.
SBA is concerned that it may have risked ceding too much of its
regulatory responsibility in formulating the proposed remedy for
Capital Impairment for Participating Securities issuers (and now
Preferred Securities issuers) under Sec. 107.262(d)(3), which remedy
may not be adequate in the case of ``extreme'' Capital Impairment. The
remedy proposed for Capital Impairment was to place the Licensee under
restricted operations, a status which allows SBA to control the flow of
money in and out of the Licensee until the violation is cured. This is
appropriate for Capital Impairment levels of under one hundred percent
(100%), when a Licensee's Regulatory Capital (but not SBA's investment)
has essentially been lost. When Capital Impairment equals or exceeds
one hundred percent (100%), SBA believes it must have the ability to
take necessary action to protect its investment.
Since SBA considers Capital Impairment of at least one hundred
percent (100%) as equivalent in risk to actual insolvency because it
means that the Licensee has lost one hundred percent (100%) of its
Regulatory Capital, the remedies available for a Licensee's insolvency
will now be available for extreme Capital Impairment. These remedies
include Licensee's consent to the forced removal of management and/or
the appointment of a receiver for the purpose of continuing to operate
the company. Accordingly, in this final rule, a provision for extreme
Capital Impairment is added to the insolvency default. Since issuers of
Participating Securities can be expected to have high Capital
Impairment during the earlier years of the security's life, with the
impairment level declining as later profits are taken, such Licensees
will be exempted from the extreme Capital Impairment provision until
the end of the eighth (8th) year following the Licensee's initial
issuance of Participating Securities.
A Licensee with extreme Capital Impairment will be afforded an
opportunity to cure such impairment only if it has not already been
afforded an opportunity to cure a lesser degree of Capital Impairment
under Sec. 107.262(d)(3). In other words, SBA does not intend to permit
a second cure period if a Licensee has failed to cure during its prior
opportunity.
The remaining provisions in the remedies sections are finalized as
proposed. A more detailed discussion of the violations and associated
remedies for the different types of Leverage securities is provided in
paragraphs c. and d. below.
c. Licensees With Outstanding Debentures; Events of Default
As finalized, Sec. 107.261 will apply to all Licensees issuing
Debentures after the effective date of this rule. As with the former
regulation (Sec. 107.203), all such Licensees will be deemed to have
consented to the remedies provision in effect on the date of issuance
of Debentures as if such remedies were fully set forth in the
Debentures. Such remedies include, but are not limited to, a right to
acceleration or redemption of the Debentures and the establishment of a
receivership with SBA or its designee as receiver.
As with the proposed rule, Sec. 107.261 sets forth three (3)
categories of defaults or violations that could result in the
acceleration of a Licensee's outstanding Leverage and the appointment
of SBA as receiver of the Licensee. The first such category, set forth
in Sec. 107.261(b), consists of three (3) events that automatically
accelerate all outstanding Leverage without notice or demand to the
Licensee, and allow SBA to apply for receivership of the Licensee
without Licensee's objection.
The events in question are insolvency, a voluntary assignment for
the benefit of creditors, and the filing of a voluntary or involuntary
petition for relief under the Bankruptcy Code. A Licensee is insolvent
for purposes of this regulation and Sec. 107.262(b) if its liabilities
exceed its assets or if it is unable to pay its debts as they come due,
even if its assets exceed its liabilities at the time.
Under the second category of defaults, upon written notice, SBA may
demand immediate repayment or redemption of all outstanding Debentures,
or take any other action permitted under the Act. See Sec. 107.261(c).
As finalized, nine (9) defaults are included in this category, all of
which include an element of either willfulness or actual fraud. No
opportunity to cure the default will be afforded the Licensee.
Moreover, for six (6) of the defaults in this category the Licensee
already will have consented to SBA's right to require the Licensee to
replace officers, directors, or general partners with persons approved
by SBA, and to SBA's appointment as receiver for the purpose of
continuing Licensee's operations. See Sec. 107.261(f). It should be
noted that the written notice contemplated under Sec. 107.261(c) is
notification by SBA that the Licensee's Leverage must be immediately
repaid or redeemed, not a notice that SBA will make such a demand in
the future.
With respect to the third category of nine (9) violations or
defaults, SBA will afford the Licensee the opportunity to cure its
violations. See Sec. 107.261(d). ``Failure to make payment'' has been
moved to this section of the regulations, and is now a curable default.
As discussed above, SBA will never require that a default be cured in
less than fifteen (15) days. If the Licensee fails to cure to SBA's
satisfaction, SBA may accelerate and/or, in the case of three (3) of
the violations, pursue the other remedies discussed in the previous
paragraph. See Sec. 107.261(f).
Section 107.261(e) authorizes SBA to impose a limited sanction on
Licensees that repeatedly fail to comply with one or more ``non-
substantive'' provisions of the Act or the regulations. Such Licensees
will be denied additional Leverage, and also may be required to take
actions necessary to come into full compliance. If, under such
circumstances, a Licensee were to fail to take the steps necessary to
accomplish the remedial actions required by SBA, such Licensee's
Debentures could be accelerated, or other remedies, including a
receivership, could be instituted. See Sec. 107.261(c)(7).
SBA is repeating here the guidance it provided in the proposed rule
regarding the distinction between ``substantive'' and ``non-
substantive'' provisions of the Act and the regulations promulgated
under it. SBA considers each of the provisions of the Act and the
regulations to have an important purpose. Even a regulation as
seemingly minor as the one that requires all Licensees to maintain a
listed telephone number and regular business hours serves a significant
purpose: Licensees should be accessible to their communities, not just
their friends. An unlisted telephone number or irregular business
hours, in the absence of other violations, should not be equated with
more serious violations, however. Thus such violations are not as
significant or ``substantive'' as are violations due to unacceptably
high levels of capital impairment or financings that are tainted by
conflicts of interest. Accordingly, phone listing and business hour
requirements will be characterized as ``non-substantive'', as will
other housekeeping-type requirements. All other requirements under the
Act and the regulations, specifically including the filing of required
financial and disclosure forms with SBA, will be considered
``substantive''.
d. Licensees With Outstanding Participating Securities and/or Preferred
Securities; Conditions Affecting Licensee's Good Standing
As discussed above, SBA is extending the reach of Sec. 107.262 to
cover violations under Preferred Securities in addition to those under
Participating Securities. As finalized, Sec. 107.262 will apply to any
Licensee that issues Participating Securities or, after the date
hereof, Preferred Securities. It will continue to apply until the
Licensee repays or redeems its Preferred Securities, or repays or
redeems its Participating Securities and sells or otherwise liquidates
its Earmarked Assets.
Section Sec. 107.262 sets forth four (4) categories of events that
would affect prejudicially a Licensee's good standing. The remedies
available to SBA under this section, and the Licensee's consent to such
remedies, are required to be set forth in the articles of incorporation
or partnership agreement of the Licensee prior to its issuance of
Participating Securities or, after the effective date of this rule,
Preferred Securities.
The first category of events set forth in Sec. 107.262(b) consists
of six (6) events, the occurrence of any of which will permit SBA to
take certain action. If the offending Licensee is a corporation, SBA
can, upon notice to the Licensee, require the Licensee to replace, with
individuals approved by SBA, one or more of its officers and/or a
sufficient number of its directors to constitute a majority of the
board. If the offending Licensee is a partnership, SBA can, upon notice
to the Licensee, require the removal of the responsible party and/or
require replacement of the general partner by a new general partner
selected by the Licensee but approved by SBA. Alternatively, or in
addition to the remedies just described, SBA can apply for the
institution of an operating receivership, with SBA or its designee as
receiver. As in the case of Debenture Leverage, Licensees with
Participating Securities or Preferred Securities will be deemed to have
consented to such receivership.
Section 107.262(c) lists three (3) events with remedies identical
to those provided under Sec. 107.262(b). SBA would have the right to
avail itself of such remedies only if the Licensee failed to remove the
person(s) identified by SBA as responsible for the violation and/or to
cure the violation within a time period of not less than fifteen (15)
days, as determined by SBA. One of the three (3) events in this
category is the willful or repeated noncompliance by the Licensee with
the substantive provisions of the Act or regulations. Repeated
noncompliance should be understood to mean an additional violation of a
statutory or regulatory provision after the Licensee has been notified
of the initial violation. If a Licensee willfully distributes amounts
in excess of Distributions permitted by SBA, such action will
constitute willful noncompliance under Sec. 107.262(c), not merely an
``improper distribution'' under Sec. 107.262(d).
Section 107.262(d) lists eleven (11) events, the occurrence of any
of which will allow SBA, on written notice to the Licensee, to take
certain action aimed at controlling the flow of money in and out of the
Licensee until such time as the Licensee were to cure the event(s) to
SBA's satisfaction. SBA may prohibit Distributions to parties other
than SBA, its agent or Trustee. SBA also may prohibit the Licensee from
investing in any Small Concern which it is not currently financing
unless it were legally bound to make such investment. SBA may require
that any unfunded commitments to invest in the Licensee be funded as
soon as possible. If the Licensee fails to comply with the restrictions
imposed by SBA (as described above), SBA can apply for the institution
of an operating receivership with SBA or its designee as receiver,
again without any objection from the Licensee. As mentioned above under
the discussion of Management Expenses, Licensees placed under
restricted operations will be required to re-obtain SBA's approval of
their Management Expenses or, in the case of Preferred Securities
issuers, their management compensation.
Section 107.262(e), regarding repeated non-substantive violations,
corresponds to Sec. 107.261(e), previously discussed. If a Licensee
fails to take the steps necessary to accomplish the remedial actions
required by SBA under Sec. 107.262(e), SBA may take the actions
described in the preceding paragraph to control the flow of money in
and out of the Licensee.
e. Non-Waiver
No comments were received on proposed Sec. 107.263, which is a
recodification and amplification of the non-waiver provision formerly
found in Sec. 107.203(b)(5). It has been and will continue to be SBA's
policy to attempt to resolve all problems with a Licensee before taking
formal remedial action. Section 107.263 clarifies that if SBA does not
resort to the full measure of the remedies available under
Secs. 107.261 and 107.262, or does so only after a delay, SBA will not
be deemed to have waived its right to pursue such remedies in
connection with either the original default or any subsequent default.
Compliance With Executive Orders 12866, 12612 and 12778 and the
Regulatory Flexibility and Paperwork Reduction Acts
Executive Order 12866 and Regulatory Flexibility Act
This final rule will be a significant regulatory action for
purposes of E.O. 12866 because it will have an annual effect on the
economy of more than $100 million. For purposes of the Regulatory
Flexibility Act, 5 U.S.C. 601 et seq., it also will have a significant
economic impact on a substantial number of small entities.
This final rule is being adopted pursuant to a statutory mandate
(Section 415 of Pub. L. 102-366) which requires SBA to promulgate
regulations implementing The Small Business Equity Enhancement Act of
1992.
Prominent among the statutory provisions implemented by this final
rule is the creation of a new class of SBA-guaranteed securities
(Participating Securities), as further described in this rule. The
potential benefits of this final rule, and in particular the
Participating Securities provisions, include attracting new capital
into the SBIC Program from a variety of sources. This new capital,
together with SBA Leverage, will substantially exceed $100 million per
year and ultimately will be invested by SBICs in eligible small
business concerns.
Financing small concerns is consistent with the Administration's
goal to encourage the formation of new businesses and the growth of
existing businesses. While it is not possible to quantify the
anticipated benefits of this regulatory action, it is expected that the
availability of new capital to small businesses will result in a
substantial number of new jobs and associated increases in payroll,
corporate and capital gains tax revenues.
The potential costs of this regulation cannot be quantified or
estimated. A portion of the cost to the government of administering the
Participating Securities program is expected to be offset by the two
percent (2%) user fee imposed on Licensees issuing such securities.
Potential costs of this regulation to Licensees can not be quantified;
however, no Licensee is ever require to issue Participating Securities
or any other form of Leverage.
There are no reasonably feasible alternatives to this final rule
that would accomplish the intent and direction of Title IV of Public
Law 102-366.
Executive Order 12612
SBA certifies that this final rule will have no Federalism
implications warranting the preparation of a Federalism Assessment in
accordance with Executive Order 12612.
Executive Order 12778
SBA certifies that this final rule is drafted, to the extent
practicable, in accordance with the standards set forth in Section 2 of
E.O. 12778.
Paperwork Reduction Act
For purposes of the Paperwork Reduction Act, 44 U.S.C., ch. 35, SBA
certifies that this final rule will impose no additional reporting or
recordkeeping requirements.
[Catalog of Federal Domestic Assistance Program No. 59.011, Small
Business Investment Companies]
List of Subjects in 13 CFR Part 107
Investment companies, Loan programs-business, Reporting and record-
keeping requirements, Small businesses.
For the reasons set forth above, part 107 of title 13, Code of
Federal Regulations is amended as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for part 107 is revised to read as
follows:
Authority: Title III of the Small Business Investment Act, 15
U.S.C. 681 et seq.; 15 U.S.C. 687(c); 15 U.S.C. 683; 15 U.S.C. 687d;
15 U.S.C. 687g; 15 U.S.C. 687b; 15 U.S.C. 687m, as amended by Pub.
L. 102-366.
2. Section 107.1 is amended by adding at the end the following two
sentences, to read as follows:
Sec. 107.1 Scope of Part 107.
* * * Provisions of this part which are not mandated by the Act
shall not supersede existing State law. A party claiming that a
conflict exists shall submit an opinion of independent counsel, citing
authorities, for SBA's resolution of the issues involved.
3. Section 107.3 is amended by revising the definitions for
``Leverage'' and ``SBA'' and by adding additional definitions, in
alphabetical order, to read as follows:
Sec. 107.3 Definition of terms.\2\
---------------------------------------------------------------------------
\2\Terms defined in this section are capitalized hereafter.
---------------------------------------------------------------------------
Accumulated Prioritized Payments means Prioritized Payments which
are not payable as of any given date because the Licensee has
insufficient cumulative Earmarked Profits. It is the aggregate of
cumulative Prioritized Payments less Earned Prioritized Payments.
* * * * *
Affiliate or Affiliates has the meaning set forth in Sec. 121.401.
* * * * *
Central Registration Agent or CRA means one or more agents
appointed by SBA for the purpose of issuing TCs and performing the
functions enumerated in Sec. 107.250(b) and performing similar
functions for Debentures and Participating Securities funded outside
the pooling process.
* * * * *
Combined Capital means the sum of Regulatory Capital and
outstanding Leverage.
* * * * *
Debentures means debt obligations issued by Licensees pursuant to
section 303(a) of the Act and held or guaranteed by SBA.
* * * * *
Distributable Earmarked Profits shall have the meaning set forth in
Sec. 107.243(c)(2) and shall be the source for allocation of
Prioritized Payments pursuant to Section 303(g)(2) of the Act.
Distribution means any transfer of cash or non-cash assets to SBA,
its agent or Trustee, or to partners in an Unincorporated Licensee, or
to shareholders in a Corporate Licensee. Distributions shall include
interest on Debentures, returns on Preferred Securities, Prioritized
Payments and adjustments thereto pursuant to Sec. 107.243(d), Profit
Participation, returns on capital to private investors, repayment of
Leverage and returns of Private Capital. Capitalization of Retained
Earnings Available for Distribution shall constitute a Distribution.
Earmarked Assets shall have the meaning set forth in
Sec. 107.242(b) (See also Sec. 107.247).
Earmarked Profits (Losses) mean the aggregate amount of Earmarked
Net Investment Income (Loss) and Earmarked Realized Gain (Loss) on
Securities which becomes the basis for Prioritized Payments and Profit
Participation (See Sec. 107.242).
Earned Prioritized Payments means Prioritized Payments which have
been distributed, or are distributable or deferred in accordance with
Sec. 107.243(c).
Equity Capital Investments means investments in a Small Concern in
the form of common or preferred stock, limited partnership interests,
options, warrants, or similar equity instruments, including
subordinated debt with equity features if such debt provides only for
interest payments contingent upon and limited to the extent of
earnings. Equity Capital Investments shall not require amortization.
Equity Capital Investments may be guaranteed; however, neither Equity
Capital Investments nor such guarantee shall be collateralized or
otherwise secured.
* * * * *
Guaranty Agreement means the contract entered into by SBA which is
a guarantee of the full faith and credit of the United States
Government as to timely payment of principal and interest on Debentures
or the redemption price of and Prioritized Payments on Participating
Securities and SBA's rights in connection with such guarantee.
Includible Non-Cash Gains means those non-cash gains (as reported
on SBA Form 468) that are realized in the form of Publicly Traded and
Marketable Securities or investment grade debt instruments. For
purposes of this definition, investment grade debt instruments means
those instruments that are rated ``BBB'' or ``Baa'', or better, by
Standard & Poor's Corporation or Moody's Investors Service,
respectively. Non-rated debt may be considered to be investment grade
if Licensee obtains a written opinion from an investment banking firm
acceptable to SBA stating that the non-rated debt instrument is
equivalent in risk to the issuer's investment grade debt.
* * * * *
Leverage means the aggregate outstanding amount of the Original
Issue Price of a Licensee's Debentures, Participating Securities, and
Preferred Securities.
* * * * *
Loans and Investments means Portfolio Securities, Assets Acquired
in Liquidation of Portfolio Securities, Operating Concerns Acquired,
and Notes and Other Securities Received, as set forth in the Statement
of Financial Position (SBA Form 468).
Management Expenses means, for Licensees which have Participating
Securities or have Earmarked Assets in their portfolios, those expenses
that include salaries, office expenses, travel, business development,
office and equipment rental, bookkeeping and the development,
investigation and monitoring of investments, but shall not include the
cost of services provided by specialized outside consultants, outside
lawyers and independent public accountants, if they perform services
not generally expected of a venture capital company, nor shall such
term include the cost of services provided by any Associate of the
Licensee which are not part of the normal process of making and
monitoring venture capital financings. See also Sec. 107.903.
* * * * *
Original Issue Price means the price paid by the purchaser for
securities at the time of issuance.
Participating Securities means preferred stock, preferred limited
partnership interests, or similar instruments, including debentures
having interest payable only to the extent of earnings, all of which
are subject to the terms set forth in Secs. 107.240 through 107.247 and
section 303(g) of the Act.
* * * * *
Pool means an aggregation of SBA guaranteed Debentures or SBA
guaranteed Participating Securities approved by SBA.
* * * * *
Preferred Securities means nonvoting preferred stock issued to SBA
by a for-profit section 301(d) Corporate Licensee, or securities having
similar characteristics issued by a section 301(d) Licensee organized
as a nonprofit corporation, or nonvoting preferred limited partnership
interests issued by a section 301(d) Unincorporated Licensee. (See also
Sec. 107.230)
Prioritized Payments means amounts which are preferred and
cumulative and are distributable to the holder of Participating
Securities provided the issuing Licensee has sufficient cumulative
Earmarked Profits, and may be represented by dividends on preferred
stock or interest on qualifying Debentures issued by a corporate
Licensee, or priority returns on preferred limited partnership
interests issued by limited partnership Licensees. For a given fiscal
period, Prioritized Payments shall be the amount resulting from
multiplying the Redemption Price of Participating Securities by the
Trust Certificate Rate, weighted to reflect the number of days such
securities were outstanding.
* * * * *
Profit Participation means a specified percentage of a Licensee's
Earmarked Profits which is computed in accordance with Sec. 107.244 and
to which SBA is entitled, by agreement, in consideration for its
guarantee of such Licensee's Participating Securities.
Publicly Traded and Marketable means securities that are salable
without restriction or that are salable within 12 months pursuant to
Rule 144 of the Securities Act of 1933, as amended, by the holder
thereof (or in the case of an In-kind Distribution by the distributee
thereof), and are of a class which (a) is traded on a regulated stock
exchange, or (b) is listed in the Automated Quotation System of the
National Association of Securities Dealers (NASDAQ), or (c) has, at a
minimum, at least two market makers as defined in the relevant sections
of the Securities Exchange Act of 1934, as amended, and in all cases
the quantity of which can be sold over a reasonable period of time
without having an adverse impact upon the price of the stock.
Qualified Investments shall have the meaning set forth in
Sec. 107.230(c)(4)(iv).
* * * * *
Realized Gain (Loss) on Securities means the amount by which
proceeds from the disposition of Loans and Investments are greater than
(less than) the cost or other basis permitted by SBA. Disposition of
Loans and Investments shall include sale, exchange, write-off,
recoveries from prior disposition, or any other such transaction
resulting in recognition of a gain or loss.
Redemption Price means the amount required to be paid by the
issuer, or successor to the issuer, of Preferred or Participating
Securities to repurchase such securities from the holder. The
Redemption Price shall be the Original Issue Price less any prepayments
or prior redemptions.
Retained Earnings Available for Distribution means Undistributed
Net Realized Earnings less any Unrealized Depreciation on Loans and
Investments (as reported on SBA Form 468), and represents the amount
that may be distributed to investors (including SBA) or transferred to
Private Capital.
SBA means the Small Business Administration, 409 Third Street, SW.,
Washington, DC 20416.
* * * * *
Trust means the legal entity created for the purpose of holding
guaranteed Debentures or Participating Securities and the guaranty
agreement related thereto, receiving, holding and making any related
payments, and accounting for such payments.
Trust Certificate Rate means a fixed rate determined at the time
Participating Securities are issued by the Secretary of the Treasury
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.
Trust Certificates (TCs) means certificates issued by SBA, its
agent or Trustee and representing ownership of all or a fractional part
of a Trust or Pool of Debentures or Participating Securities.
Trustee means the trustees or trustees of a Trust.
Undistributed Net Realized Earnings means Undistributed Realized
Earnings less Non-cash Gains/Income as reported on SBA Form 468.
Undistributed Realized Earnings means the cumulative sum of Net
Investment Income plus Realized Gain (Loss) on Sale of Securities, less
the cumulative sum of Distributions of Earned Prioritized Payments and
Other Distributions made from Retained Earnings Available for
Distribution.
* * * * *
Unrealized Appreciation means the amount by which a Licensee's
valuation of Loans and Investments, as determined by its Board of
Directors or General Partner(s) in accordance with Licensee's valuation
policies, exceeds the cost basis thereof.
Unrealized Depreciation means the amount by which a Licensee's
valuation of Loans and Investments, as determined by its Board of
Directors or General Partner(s) in accordance with Licensee's valuation
policies, is below the cost basis thereof.
Unrealized Gain (Loss) on Securities Held means the amount by which
a Licensee's aggregate valuation of its Loans and Investments is above
(below) their aggregate cost basis, and is equal to the sum of the
Unrealized Appreciation and Unrealized Depreciation on all Loans and
Investments, net of estimated future income tax expense or estimated
realizable future income tax benefit, as appropriate.
Venture Capital Financing shall have the meaning set forth in
Sec. 107.230(c)(3).
4. Part 107, title 13, of the Code of Federal Regulations is
amended by removing the undesignated center heading ``Borrowing by
Licensee'' and Secs. 107.201 through Sec. 107.205 and by adding after
Sec. 107.105 the undesignated center heading ``Leverage'' and
Secs. 107.210 through 107.263 to read as follows:
Leverage
Sec. 107.210 Leverage--General.
(a) General. (1) SBA may purchase or guarantee three types of
Licensee securities:
(i) Debentures,
(ii) Preferred Securities, and
(iii) Participating Securities.
(2) All Licensees issuing Preferred Securities after August 16,
1982, or Debentures or Participating Securities shall be deemed to have
agreed to the terms and conditions set forth in Secs. 107.260 through
107.263 as in effect at the time of such issuance and as if fully set
forth in such Preferred Securities, Debenture or Participating
Securities.
(b) Application procedures. All Leverage applications shall be
filed with SBA's Investment Division located at 409 Third Street SW.,
Washington, DC 20416.
(1) A section 301(c) Licensee may apply for Debentures pursuant to
section 303(b) of the Act on SBA Form 1022, and for Participating
Securities pursuant to section 303(g) of the Act on SBA Form 1022B, in
accordance with accompanying instructions.
(2) A section 301(d) Licensee may apply for Debentures pursuant to
section 303(b) of the Act on SBA Form 1022, for Preferred Securities
pursuant to section 303(c) of the Act on SBA Form 1022A, and for
Participating Securities pursuant to section 303(g) of the Act on SBA
Form 1022B, in accordance with accompanying instructions.
(c) Basic requirements. Leverage applicants shall demonstrate to
SBA's satisfaction that they meet the following requirements:
(1) Eligibility for the amount of Leverage requested in accordance
with Sec. 107.220 for section 301(c) Licensees and Sec. 107.230 for
section 301(d) Licensees.
(2) A need for Leverage as evidenced by Licensee's investment
activity and its lack of sufficient funds available for investment;
Provided, however, that a Leverage applicant that has invested at least
fifty percent (50%) of its aggregate Leverageable Capital and
outstanding Leverage shall be presumed to lack sufficient funds
available for investment.
(3) Adequacy of Private Capital and an ability to meet its
obligations.
(4) Applicants for Participating Securities shall meet the
requirements of Sec. 107.241 in addition to all other Leverage
requirements.
(5) Compliance with the regulations as set forth in this part.
(d) Fees and charges. (1) Licensees offering Debentures or
Participating Securities for sale to, or for guarantee by, SBA are
required to pay a one-time fee equal to two percent (2%) of the face
amount of the Participating Securities or of the Debentures.
(2) The fee on Debentures or Participating Securities which are
issued for the purpose of refunding maturing obligations shall be paid
before such Debentures or Participating Securities are purchased or
guaranteed. If the Licensee's Debentures or Participating Securities
evidence a new indebtedness, as distinguished from the refinancing of a
pre-existing indebtedness, the fee shall be deducted from the proceeds
remitted to the Licensee.
(3) No portion of the fee shall be refundable upon prepayment of
any Debenture or early redemption of any Participating Security by the
Licensee.
(4) SBA may establish a fee structure for the performance of
services by the CRA; however, SBA shall not collect any fee for the
guarantee of TCs.
(e) Employment of SBA officials. Without the prior written consent
of SBA, for a period of two years after the date of the most recent
Leverage issued by Licensee (or the receipt of any SBA Assistance as
defined in part 105 of this chapter), Licensee shall not employ, or
tender any offer of employment to, or retain for professional services,
any person who on or within one year prior to such date:
(1) Served as an officer, attorney, agent, or employee of SBA; and
(2) As such, occupied a position or engaged in activities which SBA
shall have determined involved discretion with respect to the granting
of Assistance under the Act.
(f) SBA guarantee. (1) SBA may in its discretion agree to guarantee
a Licensee's Debentures or Participating Securities unconditionally,
irrespective of the validity, regularity or enforceability of such
Debentures or Participating Securities or any other circumstances which
might constitute a legal or equitable discharge or defense of a
guarantor and, pursuant to its guarantee, make timely payments of
principal and interest on such Debentures or the Redemption Price of
and Prioritized Payments on such Participating Securities, irrespective
of any default by the issuing Licensee or acceleration of the maturity
of such Debentures by SBA, or the inability of the Licensee to pay the
Redemption Price of or to make the Prioritized Payments on such
Participating Securities, or any early redemption of the Participating
Securities by SBA pursuant to Sec. 107.245.
(2) SBA in its discretion may arrange for public or private
financing under its guarantee authority. Such financing arranged by SBA
may be accomplished by the sale of individual Debentures or
Participating Securities, aggregations of Debentures or Participating
Securities, or Pools or Trusts of Debentures or Participating
Securities issued or sold pursuant to Sec. 107.250. Persons interested
in providing funds to Licensees with SBA's guarantee shall notify SBA
by letter, certifying any direct or indirect beneficial interest, or
actual or potential voting rights, in any Licensee, or in any person
directly or indirectly controlling, controlled by or under common
control with, any Licensee. These reporting requirements are approved
under OMB No. 3245-0081.
(3) No SBA guarantee shall be extended to any entity:
(i) Having a direct or indirect beneficial interest of ten or more
percent in the Regulatory Capital of the Licensee whose securities are
to be guaranteed, or in any Person directly or indirectly controlling,
controlled by, or under Common Control with, such Licensee; or
(ii) Having such interest in another Licensee which has received or
is about to receive, pursuant to any understanding, arrangement, cross-
dealing, reciprocal or circular arrangement, any direct or indirect
financing (or commitment for financing) from another lender with SBA's
guarantee.
(iii) SBA may void any guarantee obtained in violation of this
paragraph (f)(3), but the foregoing shall not apply to lenders whose
borrowers are selected or approved by SBA or its agents.
(4) In the event SBA pays a claim under its guarantee, it shall be
subrogated fully to the rights satisfied by such payment; and no state
law, and no Federal law, shall preclude or limit SBA's exercise of its
ownership rights acquired by subrogation upon payment under its
guarantee.
(5) With respect to Debentures guaranteed after July 1, 1991, SBA's
claim against any Licensee shall be subordinated, as of the effective
date of SBA's guarantee, in the event of the insolvency of such
Licensee, only in favor of existing and future indebtedness outstanding
to lenders, not including Associates of a Licensee, and only to the
extent that the aggregate amount of such indebtedness does not exceed
the lesser of two hundred percent (200%) of such Licensee's Regulatory
Capital, or $10 million; Provided, however,
(i) That in its sole discretion SBA may agree in advance and in
writing to a subordination in favor of an Associate or in favor of one
or more loans from Lending Institutions or other lenders that would
cause the aggregate amount of outstanding senior debt to exceed the
foregoing limitation;
(ii) That nothing contained in these regulations shall limit the
authority of SBA to refuse to subordinate its claims against any
Licensee if SBA determines at the time of issuing its guarantee, that
the exercise of reasonable investment prudence and the financial
soundness of the Licensee warrant such a refusal; and
(iii) That nothing contained in these regulations shall affect the
seniority of any indebtedness created prior to July 11, 1991, over the
claims of SBA derived from any debenture(s) and/or guarantee(s)
outstanding as of that date.
(6) After April 8, 1994, no Licensee with outstanding Leverage may
incur secured debt or refinance existing indebtedness with secured debt
without the prior written approval of SBA. If a Licensee is in
regulatory compliance and has Leverage not in excess of one hundred
fifty percent (150%) of its Leverageable Capital, and the request is
for approval of a secured line of credit which would not cause its
aggregate indebtedness (other than Leverage) to exceed fifty percent
(50%) of its Leverageable Capital, then the Licensee may consider its
request approved unless notified otherwise by SBA within thirty (30)
days of SBA's receipt of such request. This paragraph (f)(6) applies to
secured debt, secured guarantees and other contingent obligations
voluntarily assumed, and the establishment of secured lines of credit.
Unless otherwise agreed to by SBA in writing, Licensees with existing
secured lines of credit shall have such lines approved before
increasing the amounts outstanding thereunder. SBA's approval under
this paragraph may be conditioned upon such restrictions and
limitations as it may determine.
(g) SBA sale of Leverage securities. Upon such conditions and for
such consideration as it deems reasonable, SBA may sell, assign,
transfer, or otherwise dispose of any Preferred Security, Debenture,
Participating Security, or other security held by or on behalf of SBA
in connection with Leverage. Upon notice by SBA, Licensee will make all
payments of principal, dividends, interest, Prioritized Payments, and
redemptions as shall be directed by SBA. Licensee shall be liable for
all damage or loss which SBA may sustain by reason of such disposal, up
to the amount of Licensee's liability under such security, plus court
costs and reasonable attorney's fees incurred by SBA.
(h) Maintenance of unimpaired capital. Each Licensee with Leverage
shall maintain its Regulatory Capital in sufficient amounts to avoid a
condition of Capitol Impairment. A condition of Capital Impairment
shall be a condition affecting Licensee's good standing pursuant to
Secs. 107.261(d) and 107.262(d).
(1) Definition of Capital Impairment. A condition of Capital
Impairment shall exist when a Licensee's Capital Impairment Percentage
exceeds the maximum permissible level set forth in paragraph (h)(5) of
this section.
(2) Preliminary Impairment Test. If Unrealized Gain (Loss) on
Securities Held is zero or greater, and the sum of Undistributed Net
Realized Earnings plus Includible Non-Cash Gains is also zero or
greater, no Capital Impairment exists and no further procedures shall
be performed pursuant to this paragraph (h). Otherwise, a Licensee
shall compute its ``Adjusted Unrealized Gain (Loss) on Securities
Held'' in accordance with paragraph (3) below.
(3) Adjusted Unrealized Gain (Loss) on Securities Held. (i) When a
Licensee has Unrealized Depreciation in excess of Unrealized
Appreciation on securities held, the Licensee's Adjusted Unrealized
Gain (Loss) on Securities Held shall be equal to its Unrealized Gain
(Loss) on Securities Held.
(ii) When a Licensee has Unrealized Appreciation in excess of
Unrealized Depreciation on securities held, the Licensee's Adjusted
Unrealized Gain (Loss) on Securities Held shall be the sum, net of
estimated future income tax expense, of eighty percent (80%) of the
portion of such excess which consists of Unrealized Appreciation on
Publicly Traded and Marketable securities and fifty percent (50%) of
the portion of such excess which consists of Unrealized Appreciation on
securities which meet the following criteria:
(A) The Small Concern which issued the security received a
significant subsequent equity financing by an investor whose objectives
were not primarily strategic and at a price that, in SBA's judgment,
would conclusively support the Unrealized Appreciation;
(B) Such financing represents a substantial investment in the form
of an arm's length transaction by a sophisticated new investor in the
issuer's securities; and
(C) Such financing occurred within twenty-four (24) months of the
date of the calculation of the Impairment Percentage or, if the
financing did not occur within such twenty-four (24) month period, the
Small Concern's pre-tax cash flow from operations for the most recent
fiscal year was at least ten percent (10%) of the Small Concern's
average contributed capital for such fiscal year.
(4) Computing the Capital Impairment Percentage. Licensee shall add
Adjusted Unrealized Gain (Loss) on Securities Held to the sum of
Undistributed Net Realized Earnings plus Includible Non-Cash Gains. If
the result is zero or greater, no Capital Impairment exits and no
further computations shall be performed pursuant to this paragraph (h).
If the result is less than zero, Licensee shall drop the negative sign,
divide by Regulatory Capital (excluding Treasury Stock), and multiply
by one hundred (100). The result shall be Licensee's Capital Impairment
Percentage.
(5) Determination of maximum permissible Capital Impairment
Percentage. (i) A section 301(c) Licensee shall determine its maximum
permissible Capital Impairment Percentage at the intersection of its
Leverage Percentage and its Equity Investment Percentage in the table
in paragraph (h)(6) of this section. As used in such table, ``Equity
Investments'' includes those Debt Securities which, after consideration
of all of the terms, conditions and documentation of such financing,
are determined by Licensee's Board of Directors or General Partner(s)
to have in excess of fifty percent (50%) of the anticipated return on
such financing represented by the potential for equity appreciation.
(ii) A section 301(d) Licensee's maximum permissible Capital
Impairment Percentage is seventy-five percent (75%).
(6) Capital Impairment condition. If Licensee's Capital Impairment
Percentage is greater than its maximum permissible Capital Impairment
Percentage, Licensee has a condition of Capital Impairment; Provided,
however, that until the close of Licensee's fiscal year next
succeeding April 25, 1995, a section 301(c) Licensee shall not have a
condition of Capital Impairment if its Capital Impairment Percentage is
less than or equal to fifty percent (50%).
Note: The symbols used below have the following meanings: >
means ``greater than''; means ``greater than or equal
to''; < means="" ``less="" than'';="" and=""> means ``not greater
than''.
Maximum Permissible Capital Impairment Percentages For Section 301(c)
Licensees
------------------------------------------------------------------------
Percentage of portfolio in equity
investments (at cost)
Leverage percentage ----------------------------------------
67% 40% <40% equity="" equity="" equity="" ------------------------------------------------------------------------="">200........................... 50 40 35
200................ 60 50 40
100................ 70 55 45
------------------------------------------------------------------------
(7) Forbearance for Licensees with outstanding Participating
Securities. (i) At any time during the first forty-eight (48) months
following its initial issuance of Participating Securities, any
Licensee which has Leverage consisting of a minimum of two-thirds
Participating Securities and has at least two-thirds of its Loans and
Investments, at cost, in Equity Capital Investments, shall not be
considered to have a condition of Capital Impairment unless such
Licensee's Capital Impairment Percentage equals or exceeds eighty-five
percent (85%).
(ii) At any time during the first sixty (60) months following its
initial issuance of Participating Securities, a Licensee which has
Leverage consisting of a minimum of two-thirds Participating Securities
and has at least two-thirds of its Loans and Investment, at cost, in
Start-up Financings shall not be considered to have a condition of
Capital Impairment unless such Licensee's Capital Impairment Percentage
equals or exceeds eighty-five percent (85%). ``Start-up Financing''
shall mean an Equity Capital Investment in a growth-oriented Small
Concern which:
(A) Is engaged in activities including, but not limited to,
technology development or commercialization, manufacturing, and/or
exporting;
(B) At the time of the investment has not been in existence, in any
form, for more than three fiscal years;
(C) Has not had sales exceeding $5 million or positive cash flow in
any fiscal year; and
(D) Is not formed for the purpose of acquiring any existing
business.
(iii) At any time during the fifth year following its initial
issuance of Participating Securities, any Licensee which meets the
Leverage and investment ratios set forth in paragraph (h)(7)(i) of this
section, and does not have a Capital Impairment Percentage which equals
or exceeds eighty-five percent (85%), shall not be considered to have a
condition of Capital Impairment if, within thirty (30) days of
Licensee's determination that it has a condition of Capital Impairment,
such Licensee either:
(A) Increases its Regulatory Capital by a cash contribution equal
to fifteen percent (15%) of its outstanding Leverage and places such
funds in an escrow account, or other account satisfactory to SBA, for
the benefit of SBA, or
(B) Provides SBA with a guarantee satisfactory to SBA, for the
benefit of SBA, equal to fifteen percent (15%) of its outstanding
Leverage.
(iv) At any time during the sixth year following its initial
issuance of Participating Securities, any Licensee which meets the
Leverage and investment ratios set forth in paragraph (h)(7)(i) of this
section, and does not have a Capital Impairment Percentage which equals
or exceeds eighty-five percent (85%), shall not be considered to have a
condition of Capital Impairment if, within thirty (30) days of
Licensee's determination that it has a condition of Capital Impairment,
such Licensee either:
(A) Increases its Regulatory Capital by a cash contribution equal
to thirty percent (30%) of its outstanding Leverage and places such
funds in an escrow account, or other account satisfactory to SBA, for
the benefit of SBA, or
(B) Provides SBA with a guarantee satisfactory to SBA, for the
benefit of SBA, equal to thirty percent (30%) of its outstanding
Leverage; Provided, however, that any escrowed funds or guarantee
received pursuant to paragraphs (h)(7)(iii) of this section shall be
credited toward the requirements of this paragraph (h)(7)(iv).
(v) Any funds placed in an escrow or other account pursuant to
paragraph (h)(7) (iii) or (iv) of this section shall not be eligible
for Leverage purposes.
(vi) Any fee and/or any claim to repayment by the party making the
capital contribution or by the guarantor must be deferred and
subordinate to all outstanding Leverage plus any unpaid Earned
Prioritized Payments and other earned amounts.
(vii) Any funds in the escrow account and/or any guarantee received
by SBA under this paragraph (h)(7) of this section shall be utilized to
pay or repay any amounts due SBA in the event of an acceleration or
mandatory redemption under Sec. 107.261, or shall be released and
returned to Licensee at such time as the sum of Licensee's Adjusted
Unrealized Gain (Loss) on Securities Held and Undistributed Net
Realized Earnings plus Includible Non-Cash Gains is determined by SBA
to be zero or greater.
(8) Quarterly Requirement and Procedure. Each Licensee is
responsible, on a quarterly basis, for determining whether it has a
condition of Capital Impairment and for promptly notifying SBA if it
has such condition; Provided, however, that SBA is not precluded from
making it with determination.
(i) Collection or compromise of SBA claims. SBA may, upon such
conditions and for such consideration as it deems reasonable, collect
or compromise all claims relating to Preferred or Participating
Securities or obligations held or guaranteed by SBA, and all legal or
equitable rights accruing to SBA.
Sec. 107.220 Leverage for 301(c) Licensees.
(a) General. SBA may provide Leverage to any Section 301(c)
Licensee through the purchase or guarantee of Debentures and/or
Participating Securities.
(b) Leverage formula. After March 31, 1993, the amount of Leverage
a section 301(c) Licensee may have outstanding at any time shall not
exceed the following amounts:
(1) If Leverageable Capital is not more than $15,000,000, Leverage
shall not exceed three hundred percent (300%) of Leverageable Capital;
(2) If Leverageable Capital is more than $15,000,000 but not more
than $30,000,000, Leverage shall not exceed $45,000,000 plus two
hundred percent (200%) of the mount of Leverageable Capital over
$15,000,000;
(3) If Leverageable Capital is more than $30,000,000, Leverage
shall not exceed $75,000,000 plus one hundred percent (100%) of the
amount of Leverageable Capital over $30,000,000, but not to exceed an
additional $15,000,000.
(c) Maximum limits and exceptions. Notwithstanding paragraph (b) of
this section, in no event shall the aggregate amount of outstanding
Leverage of any Licensee or group of two or more Licensees (including
both section 301(c) and section 301(d) Licensees) under Common Control
exceed $90,000,000 unless SBA determines, on a case-by-case basis, to
permit a higher aggregate amount for companies under Common Control and
SBA imposes such additional terms and conditions as it determines
appropriate to minimize the risk of loss to SBA in the event of
default.
(d) Grandfather clause. Nothing in these provisions shall require
any section 301(c) Licensee that on March 31, 1993, has outstanding
Debentures in excess of three hundred percent (300%) of Leverageable
Capital to prepay such excess. Any such Licensee may apply for an
additional Debenture guarantee or Participating Security guarantee,
provided that the proceeds are used solely to pay the amount due on any
such maturing Debenture. The maturity of such new Debenture or
Participating Security shall not be later than September 30, 2002.
(e) Limits on Participating Securities. The aggregate amount of
Participating Securities outstanding from a Licensee shall not exceed
two hundred percent (200%) of Leverageable Capital.
Sec. 107.230 Leverage for 301(d) Licensees.
(a) General. SBA may provide Leverage to any Section 301(d)
Licensee through the purchase or guarantee of Debentures and/or
Participating Securities, and/or through the purchase of Preferred
Securities.
(b) Articles requirements for Preferred Securities Leverage. In
addition to the requirements specified in Sec. 107.101, no Preferred
Securities will be acquired by SBA from any Section 301(d) Licensee
unless the following provisions are contained in such Licensee's
Articles:
(1) Corporate Section 301(d) Licensees. (i) Payment of dividends to
SBA. Preferred stock issued by a corporate Section 301(d) Licensee to
SBA after November 21, 1989, shall provide for the preferred payment of
cumulative dividends at a rate of four percent (4%) per annum on the
par value of such stock, accruing from the date of issuance to the date
of payment, both inclusive. Such dividends shall be declared and
payable from Retained Earnings Available for Distribution before any
amount shall be set aside for or paid to any other class of stock. In
the event SBA has received less than four percent (4%) in any fiscal
year, the deficiency shall be payable on a preferred basis from
subsequent Retained Earnings Available for Distribution without
interest thereon. Before any declaration of dividends or any
Distribution (other than to SBA), all dividends accumulated and unpaid
on Preferred Securities issued to SBA shall be paid. The dividend rate
on nonvoting Preferred Securities purchased by SBA prior to November
21, 1989, shall remain three percent (3%) of their par value and
otherwise be subject to the provisions of this paragraph.
(ii) Mandatory redemption of Preferred Securities. Preferred
Securities purchased by SBA on or after November 21, 1989, shall be
redeemed by the issuer not later than fifteen (15) years from the date
of issuance, at a price not less than the par value, plus any unpaid
dividends accrued to the redemption date. SBA may, in its discretion,
guarantee Debentures offered for sale by such Licensee at the Debenture
sale immediately preceding such fifteenth anniversary date, pursuant to
section 321 of the Act, in such amounts as will permit the simultaneous
redemption of such Preferred Securities, including all or any part of
accrued and unpaid dividends, for immediate payment to SBA. SBA shall
not pay any part of the interest on such Debentures except pursuant to
its guarantee. See also Sec. 107.230(f).
(2) Unincorporated Section 301(d) Licensees. (i) Payment of
Distributions to SBA. Preferred limited partnership interests issued to
SBA by a limited partnership section 301(d) Licensee shall provide for
Distributions to SBA on a preferred and cumulative basis at an annual
rate of four percent (4%) on the entire amount of SBA's capital
contribution (with no adjustments other than those reflecting prior
returns of capital), accruing from the date of issuance to the date of
Distribution, both inclusive. SBA shall be paid from Retained Earnings
Available for Distribution. In the event SBA has received less than
four percent (4%) in any fiscal year, the deficiency shall be payable
on a preferred basis from subsequent Retained Earnings Available for
Distribution without interest thereon. Before any allocation or
Distribution (other than to SBA), all accumulated and unpaid
Distributions on preferred limited partnership interests issued to SBA
shall be paid.
(ii) Mandatory redemption of preferred limited partnership
interest. Preferred limited partnership interests shall be redeemed by
the issuer not later than fifteen (15) years from the date of issuance,
at a price not less than the amount of SBA's contributed capital, with
no adjustments other than those reflecting prior returns of capital,
plus any accumulated and unpaid Distribution to and including the
redemption date. SBA may, in its discretion, guarantee Debentures
offered for sale by such Licensee at the Debenture sale immediately
preceding such fifteenth anniversary date, pursuant to section 321 of
the Act, in such amounts as will permit the simultaneous redemption of
such preferred limited partnership interests, including all or any part
of accumulated and unpaid Distributions, for immediate payment to SBA.
SBA shall not pay any part of the interest on such Debentures except
pursuant to its guarantee. See also Sec. 107.230(f).
(c) Maximum Leverage--General. All Leverage issued by Section
301(d) Licensees shall be aggregated for purposes of determining
Leverage eligibility. Subject to the limitations on Leverage issued by
Licensees under Common Control set forth in Sec. 107.220(c), the total
amount of Leverage permissible to a section 301(d) Licensee shall be
determined as follows:
(1) Maximum Subsidized Leverage. A section 301(d) Licensee or group
of such Licensees under Common Control shall be eligible for maximum
subsidized Leverage of four hundred percent (400%) of Leverageable
Capital or $35,000,000, whichever is less, subject to the exceptions
and limitations set forth in paragraphs (c) (3) through (6) of this
section. For purposes of this paragraph, ``subsidized Leverage'' means
Preferred Securities and Debentures issued with a rate reduction or
subsidy.
(2) Leverage above $35,000,000. A section 301(d) Licensee is
eligible for Leverage in excess of $35,000,000, in the amounts and
subject to the conditions set forth in Sec. 107.220 (b) and (c);
Provided, however, that the aggregate amount of subsidized Leverage
issued by such Licensee or group of such Licensees under Common Control
shall not exceed $35,000,000.
(3) Conditions for Leverage exceeding 300 percent. (i) To qualify
for Leverage exceeding three hundred percent (300%) of Leverageable
Capital, at least thirty percent (30%) of a section 301(d) Licensee's
Total Funds Available for Investment must be invested in (or committeed
to) Venture Capital Financings. Licensee must maintain thirty percent
(30%) of its Total Funds Available for Investment in such investments,
at their cost basis, subsequent to issuing Leverage in excess of three
hundred percent (300%) of Leverageable Capital. See also
Secs. 107.261(d)(9) and 107.262(d)(9).
(ii) ``Total Funds Available for Investment'' means ninety percent
of the sum of total current assets plus Loans and Investments on a cost
basis and net of current maturities.
(iii) ``Venture Capital Financing'' means an investment in a
Disadvantaged Concern represented by Equity Securities as defined in
Sec. 107.3 with no repurchase requirement for at least five (5) years,
except as may be approved specifically by SBA under Sec. 107.801 for
purposes of relinquishing Control over a Small Concern; any right to
purchase Equity Securities in conjunction with the purchase of Equity
or Debt Securities which, after consideration of all of the terms,
conditions and documentation of such financing, are determined by
Licensee's Board of Directors or General Partner(s) to have in excess
of fifty percent (50%) of the anticipated return on such financing
represented by the potential for equity appreciation; or Debt
Securities or Loans which are subordinated by their terms to all
borrowings of the issuer, except borrowings from officers, directors,
and owners of the Small Concern, or Close Relatives thereof, and which
are not amortized during the first three (3) years. A Financing which
originally qualified as a Venture Capital Financing but which is
currently carried as ``assets acquired in liquidation of portfolio
securities'' or ``operating concerns acquired'' shall continue to
qualify as a Venture Capital Financing, at original cost.
(4) Second Tier Preferred Securities Leverage. SBA is authorized to
purchase Preferred Securities from a section 301(d) Licensee in amounts
in excess of one hundred percent (100%) of Leverageable Capital, but
not in excess of two hundred percent (200%) of Leverageable Capital,
Provided:
(i) Its license was issued on or before October 13, 1971; or
(ii) Its license was issued after October 13, 1971, and Licensee
has Leverageable Capital of $500,000 or more; and
(iii) In either case, it has Qualified Investments (or commitments
to make such investments), at cost, equal to the amount of Preferred
Securities in excess of one hundred percent (100%) of Leverageable
Capital--See also Sec. 107.262(d)(9).
(iv) For this purpose, ``Qualified Investments'' means, subject to
Secs. 107.320 and 107.801, an investment in a Disadvantaged Concern
represented by stock of any class (including preferred stock) or
limited partnership interests, or shares of any eligible syndicate,
business trust, joint stock company or association, mutual corporation,
cooperative or other joint venture for profit; or unsecured debt
instruments which are subordinated by their terms to all other
borrowings (as distinguished from all other debts and obligations) of
the issuer and which, after consideration of all of the terms,
conditions and documentation of such instruments, are determined by
Licensee's Board of Directors or General Partner(s) to have in excess
of fifty percent (50%) of the anticipated return on such financing
represented by the potential for equity appreciation. ``Qualified
Investments'' shall not include a debt secured by any agreement with a
third party, whether or not a security interest has been created in any
asset of such third party, with or without recourse against such third
party.
(5) Non-Cumulative. If a Financing qualifies as both a Venture
Capital Financing and a Qualified Investment, such Financing may be
construed as both a Venture Capital Financing and a Qualified
Investment.
(6) Participating Securities Leverage. The aggregate of a section
301(d) Licensee's outstanding Participating Securities and Preferred
Securities shall not exceed two hundred percent (200%) of Leverageable
Capital. The Prioritized Payments and the Profit Participation on
Participating Securities issued by section 301(d) Licensees shall not
be adjusted by any subsidy or rate reduction.
(d) Debentures issued by section 301(d) Licensees. Subject to the
limitations of paragraph (c) of this section, section 301(d) Licensees
may issue three types of Debentures:
(1) Debentures guaranteed by SBA pursuant to section 303(c) of the
Act. During the first five (5) years of the term of such Debentures,
the rate of interest payable by the issuer shall be three hundred (300)
basis points below the interest rate stated on the face of the
Debenture.
(2) Debentures guaranteed by SBA pursuant to section 303(b) of the
Act. Such Debentures are not entitled to a reduced interest rate.
(3) Debentures purchased by SBA pursuant to section 303(c) of the
Act. Such Debentures shall be entitled to a reduced interest rate
determined according to section 317 of the Act. They shall specify both
the subsidized interest rate and the non-subsidized interest rate (as
prescribed by sections 317 and 303(b) of the Act), together with the
dates between which each applies.
(e) Exchange of outstanding Debentures for Preferred or
Participating Securities. (1) Subject to the conditions applicable to
the issuance of Preferred or Participating Securities, a section 301(d)
Licensee may, in SBA's discretion, retire Debentures through the
issuance of such securities. A section 301(d) Licensee proposing to
exchange its outstanding Debentures shall be required to pay all unpaid
accrued interest plus any applicable prepayment penalties, fees, and
other charges as a condition of such exchange.
(2) Notwithstanding the provisions of paragraph (e)(1) of this
section paragraph, Debentures purchased or guaranteed by SBA on the
basis of funds not included in Leverageable Capital may not be retired
through issuance of Preferred or Participating Securities. Such
Debentures, to the extent purchased or guaranteed by SBA on the basis
of ineligible funds, shall be paid at maturity, unless such maturity is
extended by SBA. In this regard, SBA shall have discretion to extend
such maturity to a date not more than fifteen (15) years from the date
of issuance if it believes such extension is necessary to achieve an
orderly liquidation of the indebtedness.
(f) Preferred Securities--voluntary redemption rights. A section
301(d) Licensee may redeem Preferred Securities purchased by SBA, in
whole or in part, on any dividend payment date or distribution of
capital date (provided that it gives SBA at least thirty days prior
written notice). It shall do so by paying SBA the Original Issue Price
of such securities, but not less than $50,000 in any one transaction,
plus any dividends or distributions accumulated and unpaid to the date
of redemption. SBA is authorized to sell Preferred Securities purchased
on or before November 20, 1989 to the issuer at a price less than the
sum of the Original Issue Price and any unpaid dividends or
distributions. SBA shall determine the sale price of such Preferred
Securities in its sole discretion after considering such factors as it
deems appropriate. These factors shall include, but not be limited to,
the market value of such securities, the value of benefits previously
provided and anticipated to accrue to the issuer, the amount of
dividends previously paid, accrued, and anticipated, and SBA's estimate
of any anticipated redemption. In such event, SBA may guarantee
Debentures issued by the Licensee in order to accomplish the repurchase
of such Preferred Securities; Provided, however, that SBA shall not pay
any part of the interest on such Debentures, except pursuant to its
guarantee. See also Secs. 107.230(b)(1)(ii) and 107.230(b)(2)(ii).
Sec. 107.240 Participating Securities.
The provisions of Secs. 107.241 through 107.247 shall apply to
Participating Securities and all Licensees issuing such securities.
Sec. 107.241 Participating Securities--General.
(a) Minimum capital. Subject to Sec. 107.101(d), a Licensee with
Regulatory Capital of $10 million or more shall be eligible to issue
Participating Securities. A Licensee with Regulatory Capital of less
than $10 million shall be eligible to issue Participating Securities if
it demonstrates to SBA's satisfaction that it can be financially viable
over the long term with such lesser amount; Provided, however, that no
application to issue Participating Securities shall be considered if
the Licensee's Regulatory Capital is less than $5 million.
(b) Investment requirements. Any Licensee issuing Participating
Securities shall invest an amount equal to the Original Issue Price of
such securities solely in Equity Capital Investments. After the initial
investment of such funds, unless SBA permits otherwise, such Licensee
shall maintain Equity Capital Investments as of the end of each fiscal
year with an original cost of not less than the outstanding balance of
Participating Securities.
(c) Management and ownership diversity. Unless otherwise approved
by SBA, Licensee applying for Participating Securities shall have
diversity between management and ownership. As long as any Earmarked
Assets remain in its portfolio, the Licensee shall maintain such
diversity. This diversity may be established only by satisfying both of
the following requirements:
(1) The Licensee shall meet at least one of the following three
conditions:
(i) The Licensee or its ultimate parent shall have three or more
shareholders or limited partners who, in the aggregate, have not less
than a thirty percent (30%) interest in such Licensee's Regulatory
Capital and who (except for such status as a shareholder or limited
partner) are not Associates of, or Affiliates of any Associate of, such
Licensee; or
(ii) The Licensee or its ultimate parent shall have one or more
Institutional Investors that are:
(A) Regulated by state or Federal authorities satisfactory to SBA,
(B) Public or private employee pension funds,
(C) Trusts, foundations, or endowments which are exempt from
Federal income taxation, or
(D) Other Institutional Investors satisfactory to SBA, who directly
or indirectly have in the aggregate not less than a thirty percent
(30%) interest in such Licensee's Regulatory Capital and who (except
for such status as a shareholder or limited partner) are not Associates
of, or Affiliates of any Associate of, such Licensee; or
(iii) The common stock or limited partnership interests of
Licensee, or at least one class of voting common stock or the limited
partnership interests of the ultimate parent (if any) of Licensee, is
publicly traded. For purposes of this paragraph (c)(1), ``ultimate
parent'' shall mean an entity that directly or indirectly has an
interest of more than fifty percent (50%) of the Regulatory Capital of
a Licensee.
(2) Shareholders or limited partners of a Licensee shall not have
delegated their voting rights to any other person or entity without
prior SBA approval. Publicly traded Licensees are exempt from this
provision. This restriction also shall not apply to proxies given to
vote at single specified meetings, or to delegation of such rights to
investment advisors that are not Affiliates of the Licensee except for
their shareholder or partner status.
(d) Approved Management Expense. Every Licensee that has
Participating Securities outstanding or has Earmarked Assets in its
portfolio shall have its Management Expenses approved by SBA at the
time of licensing and prior to any proposed increases in such Expenses.
(e) Temporary Debt. (1) The only debt other than Leverage that any
Licensee with outstanding Participating Securities may incur shall be
Temporary Debt. Each such Licensee must obtain the prior written
approval of SBA before incurring any secured Temporary Debt. If a
Licensee which is in regulatory compliance and which has Leverage not
in excess of one hundred fifty percent (150%) of its Leverageable
Capital shall request approval for a secured line of credit which would
not cause its aggregate indebtedness (other than Leverage) to exceed
fifty percent (50%) of Leverageable Capital, then the Licensee may
consider its request approved unless notified otherwise within thirty
(30) days of SBA's receipt of such request.
(2) For this purpose, the term ``Temporary Debt'' means qualified
short-term borrowings of a Licensee for the purposes of providing funds
for a particular Financing of a Small Concern or funds to maintain a
Licensee's operating liquidity, which are borrowed from regulated
financial institutions or regulated credit companies or, if approved by
SBA on a case-by-case basis, from non-regulated lenders, including
shareholders or partners.
For a borrowing to qualify as Temporary Debt, total borrowings
outstanding may not exceed fifty percent (50%) of Licensee's
Leverageable Capital, and all such borrowings must be paid off for at
least thirty (30) consecutive days during the Licensee's fiscal year so
that Licensee has no Temporary Debt during such thirty-day period. A
Licensee with indebtedness which does not meet the requirements of
Temporary Debt must eliminate such indebtedness to qualify for issuance
of Participating Securities.
(f) Liquidity requirements. A Licensee with outstanding
Participating Securities shall maintain adequate liquidity so as to
avoid a condition of Liquidity Impairment (as defined in paragraph
(f)(1) of this section). Such a condition shall affect the Licensee's
good standing pursuant to Sec. 107.262(c).
(1) Definition of Liquidity Impairment. A condition of Liquidity
Impairment shall exist when a Licensee's Liquidity Ratio, as determined
in paragraph (f)(2) of this section is less than 1.20. Each Licensee is
responsible for calculating whether it has a condition of Liquidity
Impairment as of the close of its fiscal year, at the time of
application for Leverage, or at such time as Licensee contemplates
making any Distribution. SBA shall have the right to make the final
determination in this regard.
(2) Computation of Liquidity Ratio. Licensee's Liquidity Ratio
shall be equal to its Total Current Funds Available divided by its
Total Current Funds Required, as determined in accordance with the
following table:
Calculation of SBIC Liquidity Ratio
------------------------------------------------------------------------
As
reported
Financial account on SBA Wt. Weighted
form 468 amount
------------------------------------------------------------------------
Cash and Invested Idle Funds............. ........ 1.00
Commitments From Investors............... ........ 1.00
Other Current Assets..................... ........ 1.00
Current Portion of Maturities............ ........ .50
Publicly Traded & Marketable Securities.. ........ .65
Anticipated Operating Revenue for next 12
months.................................. (\1\) 1.00
------------------------------
Total Ccurrent Funds Available....... ........ ........ A
==============================
Current Liabilities...................... ........ 1.00
Commitments Outstanding.................. ........ .75
Anticipated Operating Revenue for next 12
months.................................. (\1\) 1.00
Anticipated Interest Expense for next 12
months.................................. (\1\) 1.00
Contingent Liabilities (Guarantees)...... ........ .25
------------------------------
Total Current Funds Required......... ........ ........ B
------------------------------
Liquidity Ratio: (A/B)............... ........ ........
------------------------------------------------------------------------
\1\As determined by Licensee's management, pursuant to a plan of
operations.
(g) Redemption. The redemption date of Participating Securities
shall be the same as the maturity date of the Trust Certificates for
the Trust containing such securities. In no event shall such date be
later than fifteen (15) years after the issue date. Participating
Securities shall be redeemed at the Redemption Price plus any unpaid
Earned Prioritized Payments and any additional earned amounts due
pursuant to Sec. 107.243 (c) and (d).
(h) Priority in Liquidation. In the event of liquidation of a
Licensee, the Redemption Price of Participating Securities, together
with any Prioritized Payments, any additional amounts due pursuant to
Sec. 107.243 (c) and (d), and any Profit Participation allocated
pursuant to Sec. 107.244(e), shall be senior in priority for all
purposes to all other equity interests in the issuing Licensee,
whenever created.
Sec. 107.242 Computation of Earmarked Profits (Losses).
(a) Frequency of Calculation. A Licensee that has Participating
Securities outstanding or has Earmarked Assets in its portfolio shall
compute Earmarked Profits (Losses) no less frequently than at the end
of its fiscal year and at such other times as Licensee elects to make a
Distribution.
(b) Earmarked Assets. ``Earmarked Assets'' means Loans and
Investments that exist at the time Participating Securities are issued
or that are acquired by Licensee while Participating Securities are
outstanding and non-cash assets received in exchange for any such
assets. Notwithstanding Licensee's redemption of all or part of its
Participating Securities, Licensee's Earmarked Assets shall retain such
status until their disposition. Investments made subsequent to the
complete repayment or redemption of all Participating Securities are
not considered Earmarked Assets unless Licensee issues additional
Participating Securities, at which time all of Licensee's Loans and
Investments again become Earmarked Assets. For special rules providing
exclusions applicable to companies licensed prior to March 31, 1993,
see Sec. 107.247.
(c) Earmarked Asset Ratio. To compute Earmarked Profits (Losses),
Licensee first shall compute an Earmarked Asset Ratio for the fiscal
year or portion thereof, as appropriate. Earmarked Asset Ratio means,
at cost basis, the ratio of Earmarked Assets plus the proceeds of
Participating Securities not yet invested to Licensee's total Loans and
Investments plus the proceeds of Participating Securities not yet
invested, stated as a percentage. The Earmarked Asset Ratio shall be
computed on the respective weighted average amounts of Earmarked
Assets, total Loans and Investments, and uninvested proceeds of
Participating Securities outstanding during such fiscal year or portion
thereof.
(d) Determining Earmarked Net Investment Income (Loss).
(1) Determining Earmarked Investment Income. (i) Licensee shall
allocate to Earmarked Investment Income all income which is directly
attributable to such Earmarked Assets.
(ii) Licensee shall multiply interest on idle funds and other
income not attributable to specific assets by the Earmarked Asset
Ratio.
(iii) The aggregate of (d)(1) (i) and (ii) of this section shall be
Earmarked Investment Income.
(2) Determining Earmarked Investment Expenses. (i) Earmarked
Investment Expenses. Earmarked Investment Expenses shall be equal to
the sum of:
(A) Management Expenses as computed pursuant to paragraph
(d)(1)(ii) of this section and
(B) Non-Management Expenses as computed pursuant to paragraph
(d)(1)(iii) of this section.
(ii) Management Expenses. For the purpose of determining Earmarked
Investment Expenses, Management Expenses shall be the lesser of:
(A) Licensee's approved Management Expenses times its Earmarked
Asset Ratio, or
(B) An amount determined by multiplying Licensee's Combined Capital
times its Earmarked Asset Ratio times 2.5 percent, and adding $125,000
times the Earmarked Asset Ratio to the product if Licensee's Combined
Capital is less than $20,000,000.
(iii) Non-Management Expenses. Licensee shall allocate to Earmarked
Assets those non-Management Expenses which are directly attributable to
such assets. Licensee shall add to this amount the product obtained by
multiplying the Earmarked Asset Ratio by those non-Management Expenses
not attributable to specific assets. Interest on Debentures shall be
considered a non-Management Expense.
(3) Earmarked Net Investment Income (Loss). Earmarked Investment
Income in paragraph (d)(1) of this section shall be reduced by
Earmarked Investment Expenses in paragraph (d)(2) of this section to
determine Earmarked Net Investment Income (Loss).
(e) Determining Earmarked Realized Gain (Loss) on Securities.
Licensee shall compute its Earmarked Realized Gain (Loss) on Securities
by subtracting the basis of such assets from their net sales price, in
accordance with the following:
(1) The cost of an asset shall be the basis used for computing
Realized Gain (Loss), unless another basis is permitted by SBA.
(2) If an exchange of assets occurs, the basis of the acquired
asset(s) shall be the cost of the original asset being exchanged.
(3) The basis of Earmarked Assets shall be increased only by
additional financings to the Small Concern, or by Licensee's share of
the income of an unincorporated Small Concern in which Licensee's basis
is appropriately determined using the equity method of accounting. The
basis of Earmarked Assets shall not be increased by capitalization of
interest.
(4) Unrealized Appreciation or (Unrealized Depreciation) on
Earmarked Assets that are being distributed as an In-Kind Distribution
shall be recognized as Realized Gain (Loss) on Securities. (See
Sec. 107.245(e)(3))
(f) Determining Earmarked Profits (Losses). The aggregate of
Earmarked Net Investment Income (Loss) and Earmarked Realized Gain
(Loss) on Securities (paragraphs (d) and (e) of this section shall be
Earmarked Profits (Losses) for the relevant period.
Sec. 107.243 Computation, Allocation, and Distribution of Prioritized
Payments.
(a) General. Prioritized Payments shall be classified as either
Accumulated Prioritized Payments or Earned Prioritized Payments. Earned
Prioritized Payments (and additional ``earned'' amounts determined
under this section) shall be allocated from Distributable Earmarked
Profits and distributed from the Prioritized Payment Distribution
Account. Such Distributions shall occur before any other Distribution
and accordingly shall not be included in Distributions to SBA as set
forth in Sec. 107.245.
(b) Accounts. Licensee shall establish the following two accounts
in its books and records:
(1) Prioritized Payment Accumulation Account. The Prioritized
Payment Accumulation Account shall be a memorandum account to which
Licensee shall add all Prioritized Payments on its Participating
Securities and any additional amounts (``Adjustments'') required under
paragraphs (d)(1) and (d)(2) of this section. Licensee shall deduct
from the Prioritized Payment Accumulation Account all Earned
Prioritized Payments and those Adjustments which are considered
``earned'' according to the same criteria applied to Prioritized
Payments in paragraph (c) of this section. The balance in this account
shall represent Licensee's Accumulated Prioritized Payments and
unearned Adjustments.
(2) Prioritized Payment Distribution Account. The Prioritized
Payment Distribution Account shall be a liability account to which
Licensee shall add all Earned Prioritized Payments and earned
Adjustments and from which Licensee shall deduct all Distributions of
Earned Prioritized Payments and earned Adjustments. The balance in this
account shall represent Licensee's undistributed Earned Prioritized
Payments and earned Adjustments.
(c) Allocation and Distribution of Prioritized Payments. At the end
of each fiscal year, and at the end of any fiscal quarter for which a
Distribution is contemplated, Licensee shall perform the following
procedures:
(1) Add to the Prioritized Payment Accumulation Account all
Prioritized Payments for the relevant fiscal period.
(2) Determine the cumulative sum of Earmarked Profits (Losses) and
subtract from such sum all Earned Prioritized Payments and earned
Adjustments previously allocated to the Prioritized Payment
Distribution Account. The result, if greater than zero, shall be
Licensee's Distributable Earmarked Profits.
(3) If Licensee has Distributable Earmarked Profits:
(i) Licensee shall allocate to the Prioritized Payment Distribution
Account an amount equal to the lesser of Distributable Earmarked
Profits or the balance in the Prioritized Payment Accumulation Account.
(ii) Licensee shall reduce the Prioritized Payment Accumulation
Account by the amount allocated to the Prioritized Payment Distribution
Account in paragraph (c)(3)(i) of this section.
(iii) Subjects to the liquidity requirement set forth in
Sec. 107.241(f) Licensee shall distribute an amount equal to the
balance in its Prioritized Payment Distribution Account to SBA, or its
designated agent or Trustee, within ninety (90) days after the end of
Licensee's fiscal year or before any other Distribution is made, as
appropriate. The Prioritized Payment Distribution Account balance shall
be reduced by such Distribution.
(iv) If Licensee has issued Participating Securities on more than
one occasion, Prioritized Payments shall be made on such Participating
Securities in order of issue date.
(4) If a Licensee has no Distributable Earmarked Profits, no
allocation shall be made to the Prioritized Payment Distribution
Account.
(d) Adjustments to Prioritized Payment Accumulation Account. The
Prioritized Payment Accumulation Account shall be subject to the
following adjustments:
(1) If, at the end of any fiscal year, there exists any balance in
the Prioritized Payment Accumulation Account, Licensee shall add to
such account an amount equal to the product of the average balance in
such account during such fiscal year, multiplied by the average Trust
Certificate Rate in effect during such fiscal year.
(2) If, at the end of any fiscal year, there remains any
undistributed balance in the Prioritized Payment Distribution Account,
Licensee shall compute an additional amount equal to the product of the
average outstanding balance in such account during such fiscal year,
multiplied by the average Trust Certificate Rate in effect during such
fiscal year. Such amount shall be added to the Prioritized Payment
Accumulation Account.
(3) If, after Licensee has performed the procedures required in
paragraphs (c), (d)(1) and (d)(2) of this section, there remains any
undistributed balance in the Prioritized Payment Distribution Account,
Licensee shall continue to perform the procedures in this Sec. 107.243
as of the end of each subsequent fiscal quarter until such amounts are
paid in full.
Sec. 107.244 Computation and Allocation of Profit Participation.
(a) Profit Participation Account. Licensee shall establish a Profit
Participation Account in its books and records which shall reflect the
allocation and distribution of Profit Participation. This account shall
be reduced by any tax Distribution made to SBA, or its designated agent
or Trustee, pursuant to 107.245(b) or other Distributions pursuant to
107.245(c).
(b) Computing the Base for Profit Participation. At the end of each
fiscal year, and at the end of any fiscal quarter for which a
Distribution is contemplated, Licensee shall compute and maintain a
record of its Base for Profit Participation (``Base'') according to the
following procedure:
(1) Base. The Base shall be equal to Earmarked Profits (Losses)
minus Prioritized Payments and any Adjustments for the fiscal year or
fiscal year-to-date, as appropriate, minus any unused loss carryforward
from prior fiscal years.
(2) Unused loss carryforward. If Licensee has not previously
computed a Base for Profit Participation at the end of a fiscal year,
or if the Base computed at the end of Licensee's previous fiscal year
(the ``Previous Base'') was zero or greater, Licensee's unused loss
carryforward shall be zero. If the Previous Base was less than zero,
Licensee's unused loss carryforward shall be equal to Previous Base.
(c) Profit Participation Rates. A Licensee which issues
Participating Securities shall compute a Profit Participation Rate for
the relevant fiscal year or fiscal year-to-date in accordance with the
following procedure:
(1) Subject to paragraph (c)(5) of this section, the applicable
Profit Participation Rate shall be based upon the highest ratio of
Participating Securities Leverage to Leverageable Capital which has
ever been outstanding for such Licensee, regardless of any repayment or
redemption (the ``PLC ratio'').
(2) Subject to any indexing required in paragraph (c)(4) of this
section if the PLC Ratio is one or less, the Profit Participation Rate
shall be equal to the PLC ratio times nine percent (9%).
(3) Subject to any indexing required in paragraph (4) of this
section, if the PLC Ratio is more than one but not greater than two,
the Profit Participation Rate shall be computed as follows:
(i) Nine percent (9%), plus
(ii) The PLC Ratio minus one, times three percent (3%).
(4) The Profit Participation Rate shall be indexed to the yield-to-
maturity on Treasury bonds with a remaining term of ten (10) years (the
``Treasury Rate''), according to the following procedures:
(i) Licensees that have issued Participating Securities on only one
occasion. If, on the date Participating Securities are issued, the
Treasury Rate is other than eight percent (8%), the Profit
Participation Rates specified in paragraphs (c) (2) and (3) of this
section shall be adjusted proportionately, that is, by the percentage
difference between such Treasury Rate and eight percent (8%). For
example, if the Treasury Rate were eight percent (8%) when a Licensee
issued Participating Securities equal to one hundred percent (100%) of
Leverageable Capital, the Profit Participation Rate would be nine
percent (9%) pursuant to paragraph (c)(2) of this section. If the
Treasury Rate were ten percent (10%) at the time of issuance, however,
the Licensee's Profit Participation Rate would be 11.25 percent
[{<.10-.08} 08)+1}="" x="" .09="" x="" 100="11.25%]" (ii)="" licensees="" that="" have="" issued="" participating="" securities="" on="" more="" than="" one="" occasion.="" if,="" on="" any="" of="" the="" dates="" participating="" securities="" are="" issued,="" the="" treasury="" rate="" is="" other="" than="" eight="" percent="" (8%):="" (a)="" licensee="" shall="" compute="" an="" average="" of="" such="" treasury="" rates="" for="" all="" issuances="" of="" participating="" securities,="" weighted="" to="" reflect="" the="" dollar="" amount="" of="" each="" issuance="" and="" the="" portion="" of="" the="" fiscal="" period="" during="" which="" each="" issuance="" was="" outstanding.="" for="" example,="" if="" a="" licensee="" issued="" $10="" million="" of="" participating="" securities="" on="" the="" first="" day="" of="" its="" fiscal="" year="" when="" the="" treasury="" rate="" was="" eight="" percent="" (8%),="" and="" another="" $15="" million="" on="" the="" 300th="" day="" of="" its="" fiscal="" year="" when="" the="" treasury="" rate="" was="" ten="" percent="" (10%),="" then="" the="" weighted="" average="" treasury="" rate="" computed="" as="" of="" the="" end="" of="" the="" fiscal="" year="" would="" be="" 8.42%.="" [15,000,000="" x="" (365-300)/365="2,671,233;" 10,000,000+2,671,233="12,671,233" weighted="" average="" participating="" securities;="" {(10,000,000="" x="" .08)+(2,671,233="" x="" .10)}/12,671,233="8.42%" weighted="" average="" treasury="" rate]="" (b)="" the="" profit="" participation="" rates="" specified="" in="" paragraphs="" (c)="" (2)="" and="" (3)="" of="" this="" section="" then="" shall="" be="" adjusted="" by="" the="" percentage="" difference="" between="" the="" weighted="" average="" treasury="" rate="" and="" eight="" percent="" (8%).="" in="" the="" example="" given="" in="" paragraph="" (c)(4)(ii)(a)="" of="" this="" section,="" if="" the="" $25="" million="" of="" participating="" securities="" issued="" were="" equal="" to="" two="" hundred="" percent="" (200%)="" of="" leverageable="" capital,="" the="" profit="" participation="" rate="" for="" the="" fiscal="" year="" would="" be="" 12.63%.=""><.0842-.08>/.08)+1} x .12 x 100=12.63%]
(5) The computation of the Profit Participation Rate shall not be
modified due to an increase in the Leverageable Capital of Licensee
unless the increase:
(i) Is the result of the takedown of commitments or the conversion
of non-cash assets, provided such commitments or assets were included
in the Licensee's Private Capital; or
(ii) Is expressly provided for in a plan of operations submitted to
and approved by SBA in writing.
(d) Computing the Profit Participation. If the Base for the
relevant fiscal period, as determined in paragraph (b) of this section,
is greater than zero, Licensee shall compute the Profit Participation
in accordance with the following procedure:
(1) The Profit Participation for the fiscal year or fiscal year-to-
date shall be the result obtained by multiplying the Base by the Profit
Participation Rate determined in paragraph (c) of this section.
(2) Such Profit Participation shall be reduced by any amounts of
Profit Participation that were distributed or reserved for distribution
to SBA, or its designated agent or Trustee, for any interim period(s)
during such fiscal year.
(3) Any computation of Profit Participation made on the basis of an
interim fiscal quarter shall be adjusted, both at fiscal year-end and
whenever any additional interim Distributions are made, to account for
any increase in the Profit Participation Rate.
(e) Allocation of Profit Participation. Prior to any Distribution
and in any event within ninety (90) days following the end of the
Licensee's fiscal year, the Licensee shall allocate to its Profit
Participation Account the amount of Profit Participation calculated
pursuant to paragraph (d) of this section. Funds equal to amounts
allocated to the Licensee's Profit Participation Account shall be
reserved for distribution to SBA, its designated agent or Trustee; such
amounts shall not be available for reinvestment in Small Concerns or
for any other use by the Licensee.
(f) Distribution of Allocated Profit Participation. Distribution of
allocated Profit Participation shall be made at the same time that
profits are distributed to private capital investors either as tax
Distributions or as other returns on capital (see Sec. 107.245).
Sec. 107.245 Distributions.
(a) General. Distributions shall only be made based on computations
and allocations as of the end of a Licensee's fiscal year or fiscal
quarter (reflecting results for the fiscal year-to-date). For purposes
of this Sec. 107.245, Prioritized payments shall not be considered a
Distribution, but Profit Participation shall be considered a
Distribution and shall be included in Distributions made to SBA, or its
designated agent or Trustee, under paragraphs (b) and/or (c) of this
section.
(b) Distributions for tax purposes. After all Prioritized Payments
have been paid, and subject to the liquidity requirements set forth in
Sec. 107.241(f), a Licensee that is operating as a limited partnership,
an ``S Corporation'', or an equivalent pass-through entity for tax
purposes, may make an annual distribution from Retained Earnings
Available for Distribution to its investors (including SBA) in an
amount not greater than the Licensee's Maximum Tax Liability. SBA, or
its designated agent or Trustee, shall receive a ``tax Distribution''
equal to its Profit Participation Rate specified in Sec. 107.244(c)
times the Maximum Tax Liability. For purposes of this paragraph, the
term ``Maximum Tax Liability'' means the aggregate amount of income
allocated to partners or shareholders for Federal income tax purposes
with respect to the fiscal year of the Licensee immediately preceding
such Distribution, multiplied by the highest combined marginal Federal
and State income tax rates for corporations or individuals, whichever
is higher, on each type of income included in such return. For purposes
of this paragraph, the term ``State income tax'' means the state income
tax of the State where the Licensee's principal place of business is
located.
(c) Returns on Capital. After all Prioritized Payments and tax
Distributions permitted under paragraph (b) of this section have been
made, and the liquidity requirement set forth in Sec. 107.241(f) has
been satisfied, a Licensee which has Participating Securities
outstanding or has Earmarked Assets shall make Distributions to its
investors, specifically including SBA, or its designated agent or
Trustee, as if it were an investor, in the ratios/percentages specified
below within one hundred twenty (120) days after Licensee's fiscal year
end. Subject to prior written approval from SBA, a Licensee may
withhold from such Distributions reasonable reserves necessary to
protect Licensee's investments or relative position in Loans and
Investments and to meet contingent liabilities, without giving rise to
a payment failure in violation of Sec. 107.262(d)(6). Under no
circumstances shall such reserves be used to make investments in
additional portfolio companies. A Licensee requesting prior approval
under this paragraph may consider its request approved if SBA has not
notified the Licensee otherwise within thirty (30) days of receipt of
such request. A Licensee may make Distributions pursuant to this
paragraph (c) as of the end of any fiscal quarter, subject to the same
restrictions as provided in this section. All Distributions under this
paragraph (c) to private investors shall be from Retained Earnings
Available for Distribution and shall be a return on capital.
Distributions of Profit Participation to SBA, its designated agent or
Trustee, also shall be from Retained Earnings Available for
Distribution. Distributions under this paragraph to SBA, its designated
agent or Trustee, which are in excess of the Profit Participation shall
be from Retained Earnings Available for Distribution if they are
applied to dividends or equivalent distributions on Preferred
Securities (as provided in paragraph (c)(5) of this section, but shall
be from other than Retained Earnings Available for Distribution if they
are applied as a repayment or redemption of Leverage (see paragraph
(c)(5) of this section). All Distributions pursuant to this paragraph
shall be calculated as follows:
(1) When the amount of Leverage outstanding as of the date of the
proposed Distribution is more than two hundred percent (200%) of
Leverageable Capital, Distribution to the private investors and to SBA,
its designated agent or Trustee, shall be made in the ratio of
Leverageable Capital to Leverage.
(2) When the amount of Leverage outstanding as of the date of the
proposed Distribution is more than one hundred percent (100%) but not
more than two hundred percent (200%) of the amount of Leverageable
Capital, Distributions to private investors and to SBA, its designated
agent or Trustee, shall be made in a one-to-one (1:1) ratio.
(3) When the amount of Leverage outstanding as of the date of the
proposed Distribution is one hundred percent (100%), or less, of the
amount of Leverageable Capital, SBA's percentage share of such
Distribution shall be at the Profit Participation Rate.
(4) SBA may restrict Distributions under this paragraph (c) if SBA
determines that the value of Licensee's assets are materially
overstated, provided that SBA gives the Licensee notice of such
determination in advance of the proposed Distribution.
(5) Distributions to SBA, its designated agent or Trustee, under
this paragraph (c) shall be applied first to Profit Participation;
second, to the extent there remain any Retained Earnings Available for
Distribution, to dividends or equivalent distributions on Preferred
Securities; third, as a redemption of Participating Securities; fourth,
as a redemption of Preferred Securities; and fifth, as the repayment of
principal of any outstanding Debentures, such repayment to be made into
escrow on terms and conditions determined by SBA.
(d) Returns of capital. Notwithstanding Sec. 107.802, after all
Earned Prioritized Payments and any additional earned amounts computed
pursuant to Sec. 107.243 (c) and (d) and all Profit Participation
computed pursuant to Sec. 107.244(e) have been distributed, and
provided Licensee does not have a condition of Capital Impairment, a
Licensee which has Participating Securities outstanding or has
Earmarked Assets may return capital to its investors, specifically
including SBA, its designated agent or Trustee, as if it were an
investor. It may do so, however, only if the amount of such
Distribution does not reduce Licensee's Regulatory Capital below the
minimum required, or cause Licensee to have excess Leverage contrary to
Section 303 of the Act. Any return of capital under this paragraph
shall be made to private investors and to SBA in the ratio of
Leverageable Capital to Leverage as of the date of the proposed
Distribution; Provided, however, that if a Licensee is required to
compute a Capital Impairment Percentage under Sec. 107.210(h), such
ratio shall be modified by replacing Leverageable Capital with the
product of Leverageable Capital multiplied by the complement of the
Capital Impairment Percentage. For this purpose, ``complement'' means a
percentage equal to one hundred percent (100%) minus the Capital
Impairment Percentage, but not less than zero. Notwithstanding the
above, returns of capital shall be subject to the liquidity requirement
set forth in Sec. 107.241(f) unless SBA's prior written approval is
obtained. Any amounts received by SBA, its designated agent or Trustee,
under this paragraph (d) shall be applied to Leverage in the order set
forth in paragraph (c)(5) of this section.
(e) In-Kind Distributions. A Licensee making a Distribution
pursuant to paragraph (c) or (d) of this section may elect to make such
Distribution in the form of securities (an In-Kind Distribution),
subject to the following conditions:
(1) An In-Kind Distribution may be made only if the specific
securities to be distributed are Publicly Traded and Marketable at the
time of Distribution.
(2) An In-Kind Distribution may be made only if the Distribution of
each security is made to all investors and to SBA, its designated agent
or Trustee, pro-rata based on the amounts that would have been
distributed to each if such Distributions were in cash.
(3) A Licensee making an In-Kind Distribution shall impute a gain
(loss) on the securities being distributed as if such securities were
being sold, using the value of such securities as of the declaration
date of the planned Distribution in the case of a corporate Licensee,
and on the distribution date in the case of an Unincorporated Licensee.
Such gain (loss) shall be included in the calculation of Earmarked
Profits (Losses) pursuant to Sec. 107.242(e) as if it were realized.
(4) A Licensee making an In-Kind Distribution shall deposit SBA's
share of such securities for disposition with the CRA which will select
a Disposition Agent. Alternatively, if Licensee agrees, SBA may direct
that the Licensee dispose of SBA's share. If Licensee disposes of SBA's
share, it shall remit the proceeds promptly to SBA, its designated
agent or Trustee. As used in this paragraph, the term ``Disposition
Agent'' means a Person who is knowledgeable about and proficient in the
marketing of thinly traded securities.
Sec. 107.246 Post-redemption obligations.
After all Participating Securities have been redeemed, a Licensee
shall have the following obligations:
(a) When a Licensee has Accumulated Prioritized Payments as
specified in Sec. 107.243 and has not disposed of all Earmarked Assets
as specified in Sec. 107.242(b), Licensee's obligation to distribute
such Accumulated Prioritized Payments shall continue and Distributions
shall be made, at the end of each fiscal quarter, from Distributable
Earmarked Profits, if any, computed as set forth in Sec. 107.243.
(b) After the disposition of all Earmarked Assets, if there remain
any Accumulated Prioritized Payments, the obligation to make such
payments shall be extinguished.
(c) Notwithstanding Sec. 107.245, from the time of redemption of
all Participating Securities and until all Earmarked Assets have been
disposed of, Licensee shall not make any In-Kind Distributions of such
assets unless it pays to SBA such sums, up to the amount of the
Unrealized Appreciation on such assets, as may be necessary to pay in
full any Accumulated Prioritized Payments. Prior to making any such
distribution of assets which are not Publicly Traded and Marketable,
Licensee shall obtain the written approval of SBA, specifically
including approval of the valuation of such asset(s).
Sec. 107.247 Special Rules for Companies Licensed on or Before March
31, 1993.
Companies licensed on or before March 31, 1993 that apply for
Participating Securities are subject to the following special rules:
(a) Election to exclude pre-existing portfolio. If the proceeds of
the Participating Security are not used to refinance outstanding
Debentures at the time of its first application for Participating
Securities, such Licensee may elect to have its entire portfolio in
existence as of March 31, 1993 excluded from classification as
Earmarked Assets. Payment or prepayment of any outstanding Debenture
shall be presumed to be a refinancing of such Debenture unless Licensee
can demonstrate to the satisfaction of SBA that it had financial
resources to pay the principal amount due on the Debenture independent
of the proceeds of the Participating Securities.
(b) Non-Election. If such Licensee does not elect to exclude such
assets, they shall be considered Earmarked Assets, and SBA shall
receive a Profit Participation on such Earmarked Assets in accordance
with the conditions specified in Sec. 107.244.
(c) Refinancing Debentures with Participating Securities. SBA may
permit the proceeds of a Participating Security to be used to pay the
principal amount due on outstanding Debentures of such Licensee,
provided Licensee has outstanding Equity Capital Investments in an
amount, at cost, equal to the amount of the Debentures being
refinanced, and Licensee has not elected to exclude assets from
Earmarked Assets.
(d) Requirements for first issuance of Participating Securities.
Whether or not a company licensed prior to March 31, 1993 elects to
exclude its portfolio under paragraph (a) of this section, such
Licensee's application for a guarantee of its first issuance of
Participating Securities shall be subject to the following
requirements:
(1) Licensee shall submit a valuation report for each of its Loans
and Investments as of the date of the financial statements submitted
with its application and as of the end of each of the prior three
fiscal years, together with the last annual report (and/or fiscal year-
end financial statements) and most recent interim financial statements
of each Small Concern.
(2) If Licensee has negative Undistributed Realized Earnings and/or
a net Unrealized Loss on Securities Held, SBA may require Licensee to
undergo a quasi-reorganization in accordance with generally accepted
accounting principles.
(3) If Licensee's financial statements submitted with its
application are interim financial statements, Licensee shall have a
limited scope audit performed by its SBA-approved independent public
accountant. For purposes of this paragraph, ``limited scope audit''
means auditing procedures sufficient to enable the independent public
accountant to express an opinion on the Statement of Financial Position
and the accompanying Schedule of Investments.
Sec. 107.250 Financing by use of SBA Guaranteed Trust Certificates
(``TCs'').
(a) Authority. (1) Full Faith and Credit. Sections 321 (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. Any guarantee
by SBA of such TC shall be limited to the principal and interest due on
the Debentures or the Redemption Price of and Prioritized Payments on
Participating Securities in any Trust or Pool backing such TC. The full
faith and credit of the United States is pledged to the payment of all
amounts due under the guarantee of any TC.
(2) Periodic Exercise of Authority. SBA shall issue guarantees of
Debentures and Participating Securities under section 303 and of TCs
under section 321 of the Act at three month intervals, or at shorter
intervals, taking into account the amount and number of such guarantees
or TCs.
(3) Terms and Conditions of the TCs. TCs shall provide for a pass-
through to their holders of all amounts of principal and interest paid
on the Debentures, or the Redemption Price of and Prioritized Payments
on the Participating Securities, in the Pool or Trust against which
they are issued. SBA shall determine the legal and other terms and
conditions of TCs in conjunction with the Secretary of the Treasury and
its own statutory authority and such other requirements as may be
mandated by law. The interest rate on Debentures or the Prioritized
Payment rate on the Participating Securities in a Trust or Pool shall
be determined pursuant to section 303 (b) or (g), respectively, of the
Act.
(4) Section 301(d) Subsidy. Subject to the limits of
Sec. 107.203(c), if SBA guarantees Debentures of a section 301(d)
Licensee, section 303(d) of the Act requires SBA to make payments to
the CRA, or to the holder of any such Debenture, sufficient to reduce
the effective rate of interest to such Licensee during the first five
years of the term of such Debenture by three percentage points.
(5) Rights of Prepayment of Debentures or Early Redemption of
Participating Securities on a TC.
(i) The rights, if any, of a Licensee to prepay any Debenture or
make early redemption of any Participating Security are established by
the terms of such securities, and no such right is created or denied by
the regulations in this part.
(ii) SBA's rights to purchase or prepay and Debenture without
premium are established by the terms of the Guaranty Agreement relating
to the Debenture. SBA's rights to redeem, at any time, any
Participating Security without premium are established by the terms of
the Guaranty Agreement relating to the Participating Security.
(iii) Any prepayment of a Debenture or early redemption of a
Participating Security pursuant to the terms of the Guaranty Agreement
relating to such securities, shall reduce the SBA guarantee of timely
payment of principal and interest on a TC in proportion to the amount
of principal or Redemption Price that such prepaid Debenture or
redeemed Participating Security represents in the Trust or Pool backing
such TC.
(iv) SBA shall be discharged from its guarantee obligation to the
holder or holders of any TC, or any successor or transferee of such
holder, to the extent of any such prepayment, whether or not such
successor or transferee shall have notice of any such prepayment.
(v) Interest on prepaid Debentures and Prioritized Payments on
Participating Securities shall accrue only through the date of such
voluntary prepayment or SBA payment, as the case may be.
(vi) In the event that all Debentures or Participating Securities
constituting a Trust or Pool are prepaid, the TCs backed by such Trust
or Pool shall be redeemed by payment of the unpaid principal and
interest on the TCs; Provided, however, that in the case of the
prepayment of a Debenture pursuant to the provisions of the Guaranty
Agreement relating to the Debenture, the CRA shall pass through pro
rata to the holders of the TCs any such prepayments including any
prepayment penalty paid by the obligor Licensee pursuant to the terms
of the Debenture.
(6) SBA ownership rights. In the event SBA pays a claim under the
guarantee of a TC, it shall be subrogated fully to the rights satisfied
by such payment; no state or Federal law shall preclude or limit SBA's
exercise of its ownership rights acquired by subrogation upon payment
under its guarantee.
(7) Pool or Trust approval. SBA shall approve the formation of each
Pool or Trust.
(8) Pool or Trust attributes. SBA may, in its discretion, establish
the size of the Pools and their composition, the interest rate on the
TCs issued against Trusts or Pools, fees, discounts, premiums and other
charges made in connection with the Pools, Trusts, and TCs, and any
other characteristics of a Pool or Trust it deems appropriate.
(b) Functions of the CRA. Pursuant to a contract entered into with
SBA, the CRA shall do the following as agent of SBA:
(1) Issuance of the TCs. Upon the formation of any Pool or Trust
approved by SBA, CRA shall issue TCs, in the form prescribed by SBA,
upon the primary sale of Debentures or Participating Securities, and
shall issue or effect the transfer of TCs upon the sale of original
issue TCs in any secondary market transaction.
(2) Receipt of amounts due on Debentures and Participating
Securities. CRA shall receive payments from Licensees of amounts due on
Debentures and Participating Securities, and amounts paid under
voluntary prepayments or prepayments by SBA pursuant to the terms of
the relevant Guaranty Agreements.
(3) Payments of amounts due on TCs. CRA shall make periodic
payments as scheduled or required by the terms of the TCs, and pay all
amounts required to be paid upon prepayment of Debentures or redemption
of Participating Securities.
(4) Custody of Debentures and Participating Securities and
Documentation. CRA shall hold and safeguard all Debentures and
Participating Securities constituting Trusts or Pools and shall
release, upon instructions of SBA, the Dentures and Participating
Securities paid in full at maturity or prepaid in full prior to
maturity. CRA also shall be custodian of such other documentation as
SBA shall direct by written instructions.
(5) Registration of Debentures and Participating Securities and
TCs. CRA shall provide for the registration of all pooled Debentures
and Participating Securities, all Pools and Trusts, and all TCs. With
respect to each sale of Debentures or Participating Securities, such
registration shall include:
(i) The identification of the selling License;
(ii)The interest rate to be paid on the Debentures;
(iii) The Prioritized Payment rate to be paid on the Participating
Securities;
(iv) All commissions, fees, and/or discounts paid to brokers and
dealers in TCs or others;
(v) Identification of each purchaser and any subsequent purchaser
of any TC;
(vi) The interest rate on any TC;
(vii) The price paid by any purchaser for a TC;
(viii) The fee of the CRA; and
(ix) Such other information as SBA may deem appropriate or that may
be customary in the markets for transactions of similar type.
(6) Fidelity bond or insurance. CRA shall provide a fidelity bond
or insurance in such amount as SBA may require to fully protect the
interest of the government.
(7) Other necessary functions. CRA shall perform such other
functions as SBA may deem necessary to implement the provisions of this
section.
(c) SBA regulation of disclosure and Brokers and Dealers. (1)
Disclosure to purchasers. Prior to any sale of a Debenture,
Participating Security, or TC, SBA shall require the seller, or the
broker or dealer as agent for the seller, to disclose to the purchaser,
in a form prescribed or approved by SBA, specified information on the
terms, conditions, and yield of such instrument.
(2) Brokers and Dealers. Each broker, dealer, and Pool or Trust
assembler approved by SBA pursuant to these regulations shall either be
regulated by a Federal financial regulatory agency, or be a member of
the National Association of Securities Dealers (NASD), and shall be in
good standing in respect to compliance with the financial, ethical, and
reporting requirements of such body. They also shall be in good
standing with SBA as determined by the SBA Associate Administrator for
Investment (see paragraph (c)(3)(v) of this section) and shall provide
a fidelity bond or insurance in such amount as SBA may require. Nothing
in these provisions shall affect the applicability of the securities
laws, as that term is defined in section 3(a)(47) of the Securities
Exchange Act of 1934, or any of the rules and regulations thereunder,
or otherwise supersede or limit the jurisdiction of the Securities and
Exchange Commission or any authority at any time conferred under the
securities laws.
(3) Suspension and/or termination of Broker or Dealer. SBA shall
exclude from the sale and all other dealings in Debentures,
Participating Securities or TCs any broker or dealer:
(i) If such broker's or dealer's authority to engage in the
securities business has been revoked or suspended by a supervisory
agency. When such authority has been suspended, such broker or dealer
will be suspended by SBA for the duration of such suspension by the
supervisory agency.
(ii) If such broker or dealer has been indicted or otherwise
formally charged with a misdemeanor or felony bearing on its fitness to
participate in the market for Debentures, Participating Securities or
TCs, such broker or dealer may be suspended while the charge is
pending. Upon conviction, participation may be terminated.
(iii) When such broker or dealer has suffered an adverse final
civil judgment, holding that such broker or dealer has committed a
breach of trust or violation of law or regulation protecting the
integrity of business transactions or relationships, participation in
the market for Debentures, Participating Securities or TCs may be
terminated.
(iv) When such broker or dealer has failed to make full disclosure
of the information required by Sec. 107.250(c)(1) of this part, such
broker's or dealer's participation in the market for Debentures,
Participating Securities or TCs may be terminated.
(v) Proceedings to terminate such broker's or dealer's
participation in the market for Debentures, Participating Securities or
TCs shall be conducted in accordance with Part 134 of this Title. SBA
may, for any of the reasons stated above, suspend the privilege of any
broker or dealer to participate in this market. SBA shall give written
notice at least ten (10) business days prior to the effective date of
such suspension. Such notice shall inform the broker or dealer of the
opportunity for a hearing pursuant to part 134 of this Title. The
Assistant Administrator of the Office of Hearings and Appeals or an
Administrative Law Judge of such office shall be the reviewing official
for purposes of Secs. 134.32(b)(7) and 134.34.
(d) Access to records. The CRA and any broker, dealer and Pool or
Trust assembler operating under the regulations in this part shall make
all books, records and related materials associated with Debentures,
Participating Securities and TCs available to SBA for review and
copying purposes. Such access shall be at such party's primary place of
business during normal business hours.
(e) Selling Debentures, Participating Securities and TCs. The
function of locating purchasers, and negotiating and closing the sale
of Debentures, Participating Securities and TCs, may be performed
either by SBA or an agent appointed by SBA. Nothing in the regulations
in this part shall be interpreted to prevent the CRA from acting as
SBA's agent for this purpose.
(f) Agents. SBA will appoint or cause to be appointed agent(s) to
perform functions necessary to market and service Debentures,
Participating Securities, or TCs pursuant to this part.
(1) Selling Agent. As a condition of guaranteeing a Debenture or
Participating Security, SBA shall cause each Licensee to appoint a
Selling Agent to perform functions which include, but are not limited
to:
(i) Selecting qualified entities to become pool or Trust assemblers
(``Poolers''). Such actions shall be subject to SBA prior written
approval and to the provisions of paragraph (c)(2) of this section.
(ii) Receiving guaranteed Debentures and Participating Securities
as well as negotiating the terms and conditions of periodic offerings
of Debentures and/or TCs with Poolers on behalf of Licensees.
(iii) Directing and coordinating periodic sales of Debentures and
Participating Securities and/or TCs.
(iv) Arranging for the production of the Offering Circular,
certificates, and such other documents as may be required from time to
time.
(2) Fiscal Agent. SBA shall appoint a Fiscal Agent to:
(i) Establish performance criteria for Poolers.
(ii) Monitor and evaluate the financial markets to determine those
factors that will minimize or reduce the cost of funding Debentures or
Participating Securities.
(iii) Monitor the performance of the Selling Agent, Poolers, CRA,
and the Trustee.
(iv) Perform such other functions as SBA, from time to time, may
prescribe.
Sec. 107.260 Conditions affecting good standing of Licensees with
Leverage.
Licensees with outstanding Debentures issued after April 25, 1994
are subject to the provisions of Sec. 107.261. Licensees with
outstanding Preferred Securities issued after April 25, 1994 and/or
with outstanding Participating Securities or with Earmarked Assets in
their portfolios are subject to the provisions of Sec. 107.262.
Sec. 107.261 Conditions affecting issuers of Debentures.
(a) Applicability. The provisions of this section apply to
Licensees issuing Debentures after April 25, 1994. All such Licensees
shall be deemed to have agreed to the terms, conditions and remedies
set forth in this section, as in effect at the time of such issuance
and as if fully set forth in such Debentures. Debentures issued prior
to April 25, 1994 shall continue to be governed by the remedies in
effect at the time of their issuance.
(b) Automatic Events of Default. Without notice, presentation or
demand, the entire indebtedness evidenced by Debentures, including
accrued interest, and any other amounts owed SBA with respect thereto,
shall be immediately due and payable, and Licensee shall be deemed to
have consented to the appointment of SBA or its designee as receiver of
Licensee pursuant to Section 311(c) of the Act, upon the occurrence of
any one or more of the following events:
(1) Insolvency. Licensee becomes equitably or legally insolvent.
(2) Voluntary assignment. Licensee makes a voluntary assignment for
the benefit of creditors without SBA's prior written approval.
(3) Bankruptcy. A petition is filed by Licensee in commencement of
any bankruptcy or reorganization proceeding, receivership, dissolution
or other similar creditors' rights proceeding, or such action is
initiated against Licensee and is not dismissed within 60 days.
(c) Events of Default with notice. Upon written notice, SBA may
declare the entire indebtedness evidenced by Debentures, including
accrued interest, and/or any other amounts owed SBA with respect
thereto, immediately due and payable, and SBA may avail itself of any
remedy available under the Act, specifically including institution of
proceedings for the appointment of SBA or its designee as receiver of
Licensee pursuant to Section 311(c) thereof, upon the occurrence of any
one or more of the following events as determined by SBA:
(1) Fraud. Licensee commits a fraudulent act which causes detriment
to SBA's position as a creditor or guarantor.
(2) Fraudulent transfers. Licensee makes any transfer or incurs any
obligation that is fraudulent under the terms of 11 U.S.C. 548.
(3) Willful conflicts of interest. Licensee willfully violates
Sec. 107.903.
(4) Willful non-compliance. Licensee willfully violates one or more
of the substantive provisions of the Act, specifically including but
not limited to the provisions summarized in Section 310(c) of the Act,
or any substantive regulation promulgated under the Act.
(5) Repeated Events of Default. At any time after being notified by
SBA of the occurrence of an Event of Default under paragraph (d) of
this section, Licensee engages in similar behavior which results in
another occurrence of the same Event of Default.
(6) Transfer of Control. Licensee violates Sec. 107.104 and/or
willfully violates Sec. 107.601, and such violation results in a
transfer of Control of Licensee.
(7) Non-cooperation under Sec. 107.261(e). Licensee fails to take
appropriate steps, satisfactory to SBA, to accomplish such action as
SBA may have required pursuant to paragraph (e) of this section.
(8) Non-notification of Events of Default. Licensee fails to notify
SBA as soon as it knows or reasonably should have known that any Event
of Default exists as set forth in this section.
(9) Non-notification of defaults to others. Licensee fails to
notify SBA in writing within ten days from the date of a declaration of
an event of default or nonperformance by Licensee under any note,
debenture or indebtedness of Licensee issued to, or held by, anyone
other than SBA.
(d) Events of Default with opportunity to cure. Upon written notice
by SBA to a Licensee of the existence of one or more of the following
Events of Default as determined by SBA, and the provision by SBA of an
opportunity to cure such default(s) within a time period of not less
than fifteen (15) days, and only if Licensee fails to cure such
default(s) to SBA's satisfaction within such time period, SBA may
declare the entire indebtedness evidenced by Debentures, including
accrued interest, and/or any other amounts owed SBA with respect
thereto, to be immediately due and payable, and SBA may avail itself of
any remedy available under the Act, specifically including institution
of proceedings for the appointment of SBA or its designee as receiver
of Licensee pursuant to Section 311(c) thereof:
(1) Excessive fees. (i) If SBA has previously approved an aggregate
amount to be paid for salaries or other compensation of officers,
directors, employees, or fees paid to Investment Advisers/Managers, and
such amount has increased without SBA's prior written approval, or (ii)
if SBA has previously approved a formula for the aggregate amount to be
paid for salaries or other compensation of officers, directors, or
employees, or fees paid to Investment Advisers/Managers, and the
aggregate amount paid exceeds the formula amount or the formula has
changed without SBA's prior written approval.
(2) Improper Distributions. Licensee makes any Distribution to its
shareholders or partners, except with the prior written consent of SBA,
other than:
(i) As permitted under Sec. 107.802;
(ii) Payments out of Retained Earnings Available for Distribution
based on either the shareholders' pro-rata interests or the provisions
for profit distributions in Licensee's partnership agreement, as
appropriate; and
(iii) Distributions by Licensees issuing Participating Securities
as permitted under Secs. 107.243 and 107.245.
(3) Failure to make payment. Unless otherwise approved by SBA,
failure by Licensee to make timely payment of any amount due under any
security or obligation of Licensee, issued to, held or guaranteed by
SBA.
(4) Failure to maintain Regulatory Capital. Licensee fails to
maintain its minimum Regulatory Capital as required under these
regulations or, without the prior written consent of SBA, reduces its
Regulatory Capital, except as permitted by Secs. 107.245 and 107.802.
(5) Capital Impairment. Licensee has a condition of Capital
Impairment as determined under Sec. 107.210(h).
(6) Cross-default. Failure of Licensee to pay any amount when due
on any obligation greater than $100,000 or the occurrence of any event
or the existence of any condition, the effect of which default or event
or condition is to cause or to permit such obligation to become due or
to become payable (with or without notice) prior to its stated
maturity, unless Licensee pays such amount within any applicable grace
period or contests the payment of such obligation in good faith by
appropriate proceedings.
(7) Nonperformance. Nonperformance or violation by Licensee of one
or more of the terms and conditions of any note, Debenture, or other
obligation of Licensee issued to, held or guaranteed by SBA, or of any
agreement with or conditions imposed by SBA in its administration of
the Act and the regulations promulgated thereunder.
(8) Noncompliance. Except as otherwise provided in paragraph (c)(5)
of this section, failure of Licensee, as determined by SBA, to comply
with one or more of the substantive provisions of the Act, specifically
including but not limited to the provisions summarized in section
310(c) of the Act, or any substantive regulation promulgated under the
Act.
(9) Failure to maintain investment ratios. Failure of Licensee to
maintain the investment ratio for Leverage in excess of three hundred
percent (300%) of Leverageable Capital (Sec. 107.230(c)(3)), if
applicable to such Licensee, as of the end of each fiscal year. For
this purpose, any prepayment, sale, or disposition of Venture Capital
Financing, increase in Leverageable Capital, and receipt of additional
Leverage, within 120 days prior to the end of the fiscal year shall be
disregarded in determining whether Licensee meets the foregoing
requirement as of the close of its fiscal year.
(e) Repeated non-substantive violations. If a Licensee repeatedly
fails to comply with any one or more of the non-substantive provisions
of the Act or any non-substantive regulation promulgated thereunder,
SBA, after written notification to the Licensee and until such
condition is cured to SBA's satisfaction, shall deny additional
Leverage to such Licensee and/or require such Licensee to take such
actions as SBA may determine to be appropriate under the circumstances.
(f) Consent to removal of officers, directors, or general partners
and/or appointment of receiver. The Articles of any Licensee issuing
Debentures after April 25, 1994, shall include the following provisions
as a condition to the purchase or guarantee by SBA of such Leverage.
Upon the occurrence of any of the events specified in 13 CFR 107.261(c)
(1) through (6) or 107.261(d) (1) through (3) as determined by SBA, SBA
shall have the right, and Licensee consents to SBA's exercise of such
right:
(1) With respect to a Corporate Licensee, upon written notice, to
require Licensee to replace, with individuals approved by SBA, one or
more of Licensee's officers and/or such number of directors of
Licensee's board of directors as is sufficient to constitute a majority
of such board; or
(2) With respect to an Unincorporated Licensee, upon written
notice, to require Licensee to remove the person(s) responsible for
such occurrence and/or to remove the general partner of Licensee, which
general partner shall then be replaced in accordance with Licensee's
Articles by a new general partner approved by SBA; and/or
(3) With respect to either a Corporate or Unincorporated Licensee,
to obtain the appointment of SBA or its designee as receiver of
Licensee pursuant to section 311(c) of the Act for the purpose of
continuing to operate Licensee. The appointment of a receiver to
liquidate a Licensee shall not be within such consent, but shall
instead be governed by the relevant provisions of the Act.
Sec. 107.262 Conditions affecting issuers of Preferred Securities and/
or Participating Securities.
(a) Applicability. The conditions of this section apply to
Licensees issuing Preferred Securities after April 25, 1994, and to
Licensees with outstanding Participating Securities or with Earmarked
Assets in their portfolios. The Articles of any such Licensee shall
include the provisions of this Sec. 107.262 as a condition to the
purchase by SBA of Preferred Securities, or as a condition to the
guarantee by SBA of Participating Securities and for so long as the
Licensee owns Earmarked Assets. Preferred Securities issued prior to
April 25, 1994 shall continue to be governed by the remedies in effect
at the time of their issuance.
(b) Consent to removal of officers, directors, or general partners,
and/or appointment of receiver. Upon the occurrence of any of the
conditions set forth below, as determined by SBA, SBA shall have the
following rights, and Licensee consents to SBA's exercise of any or all
of such rights: With respect to a Corporate Licensee, upon written
notice, to require Licensee to replace, with individuals approved by
SBA, one or more of Licensee's officers and/or such number of directors
of Licensee's board of directors as is sufficient to constitute a
majority of such board; or with respect to an Unincorporated Licensee,
upon written notice, to require Licensee to remove the person(s)
responsible for such occurrence and/or to remove the general partner of
Licensee, which general partner shall then be replaced in accordance
with Licensee's Articles by a new general partner approved by SBA; and/
or with respect to either a Corporate or Unincorporated Licensee, to
the appointment of SBA or its designee as receiver of Licensee pursuant
to section 311(c) of the Act for the purpose of continuing to operate
Licensee. The appointment of a receiver to liquidate a Licensee shall
not be within such consent, but shall instead be governed by the
relevant provisions of the Act. The conditions shall be as follows:
(1) Insolvency or extreme Capital Impairment. Licensee becomes
equitably or legally insolvent, or has a Capital Impairment Percentage
of one hundred percent (100%) or more (``extreme Capital Impairment'')
and has not cured such Capital Impairment within the time limits set by
SBA in writing. In this regard, no issuer of Participating Securities
shall be deemed to have a condition of extreme Capital Impairment
during the first eight (8) years following its initial issuance of
Participating Securities, and no Licensee shall be afforded an
opportunity to cure under this paragraph if it has already been
afforded an opportunity to cure its Capital Impairment under paragraph
(d)(3) of this section.
(2) Voluntary assignment. Licensee makes a voluntary assignment for
the benefit of creditors.
(3) Bankruptcy. Licensee commences any bankruptcy or reorganization
proceeding, receivership, dissolution or other similar creditors'
rights proceeding, or such action is initiated against Licensee and is
not dismissed within sixty (60) days.
(4) Transfer of Control. Licensee violates Sec. 107.104 and/or
willfully violates Sec. 107.601, and such violation results in a
transfer of Control of Licensee.
(5) Fraud. Licensee commits a fraudulent act which causes serious
detriment to SBA's position as a guarantor.
(6) Fraudulent transfers. Licensee makes any transfer or incurs any
obligation that is fraudulent under the terms of 11 U.S.C. 548.
(c) Failure to remove. Upon the occurrence of any of the conditions
set forth below, as determined by SBA, and only if Licensee fails to
remove the person(s) SBA identifies as responsible for such occurrence
and/or cure such occurrence to SBA's satisfaction within a time period
determined by SBA (but not less than fifteen (15) days), SBA shall have
the following rights, and Licensee consents to SBA's exercise of any or
all of such rights: With respect to a Corporate Licensee, upon written
notice, to replace one or more of Licensee's officers and/or such
number of directors of Licensee's board of directors as is sufficient
to constitute a majority of such board; or with respect to an
Unincorporated Licensee, upon written notice, to require Licensee to
remove the person(s) responsible for such occurrence and/or to remove
the general partner of Licensee, which general partner shall then be
replaced in accordance with Licensee's Articles by a new general
partner approved by SBA; and/or with respect to either a Corporate or
Unincorporated Licensee, to obtain the appointment of SBA or its
designee as receiver of Licensee pursuant to section 311(c) of the Act
for the purpose of continuing to operate Licensee. The appointment of a
receiver to liquidate a Licensee shall not be within such consent, but
shall instead be governed by the relevant provisions of the Act. The
conditions shall be as follows:
(1) Willful conflicts of interest. Licensee willfully violates
Sec. 107.903.
(2) Willful or repeated noncompliance. Licensee willfully or
repeatedly violates one or more of the substantive provisions of the
Act, specifically including but not limited to the provisions
summarized in section 310(c) of the Act, or any substantive regulation
promulgated under the Act.
(3) Failure to comply with restrictions under Section 107.262(d).
Licensee fails to comply with the restrictions imposed by SBA under
paragraph (d) of this section.
(d) Consent to restricted operations. Upon the occurrence of any of
the conditions set forth in this paragraph (d), as determined by SBA,
and until such condition(s) are cured to SBA's satisfaction within a
time period determined by SBA (but not less than fifteen (15) days),
upon written notice SBA shall have the following rights, and Licensee
consents to SBA's exercise of any or all of such rights: To prohibit
Licensee from making any additional investments except for investments
pursuant to legally binding commitments entered into by Licensee prior
to such notice and, subject to SBA's prior written approval,
investments that are necessary to protect Licensee's investment; until
all Leverage is redeemed and amounts due are paid, to prohibit
Distributions by the Licensee to any party other than SBA, its agent or
Trustee; to require all commitments to Licensee to be funded at the
earliest time(s) permitted in accordance with Licensee's Articles; and
to review and re-determine Licensee's approved Management Expenses or,
for Preferred Securities issuers, Licensee's approved management
compensation. The conditions shall be as follows:
(1) Removal Conditions. Any condition occurs which is listed in
paragraph (b) or (c) of this section.
(2) Failure to maintain Regulatory Capital. Licensee fails to
maintain its minimum Regulatory Capital as required by these
regulations.
(3) Capital or Liquidity Impairment. Licensee has a condition of
Capital Impairment as determined under Sec. 107.210(h) or, if
applicable to such Licensee, a condition of Liquidity Impairment as
determined under Sec. 107.241(f), and fails to cure the impairment
within time limits set by SBA in writing.
(4) Improper Distributions. A Licensee makes any Distribution to
its shareholders or partners other than those permitted by
Secs. 107.245 and 107.802.
(5) Excessive Management Expenses or fees. Without the prior
written consent of SBA:
(i) Licensee incurs Management Expenses in excess of those
permitted under Sec. 107.241(d), if applicable to such Licensee; or
(ii) If SBA has previously approved an aggregate amount to be paid
for salaries or other compensation of officers, directors, employees,
or fees paid to Investment Advisers/Managers, Licensee increases such
amount; or
(iii) If SBA has previously approved a formula for the aggregate
amount to be paid for salaries or other compensation of officers,
directors, or employees, or fees paid to Investment Advisers/Managers,
Licensee pays an aggregate amount in excess of the formula amount or
changes the formula.
(6) Failure to make payment. Licensee fails to pay any amounts due
under Preferred Securities or required by Secs. 107.240 through
107.247, unless otherwise permitted by SBA.
(7) Noncompliance. Except as otherwise provided for in paragraphs
(c)(1) and (c)(2) of this section, SBA determines that Licensee has
failed to comply with one or more of the substantive provisions of the
Act, specifically including but not limited to the provisions
summarized in section 310(c) of the Act, or any substantive regulation
promulgated under the Act.
(8) Failure to maintain diversity. Licensee fails to maintain
diversity between management and ownership as required by
Sec. 107.241(c), if applicable to such Licensee.
(9) Failure to maintain investment ratios. Licensee fails to
maintain the investment ratios or amounts required for Participating
Securities (Sec. 107.241(b)) or Leverage in excess of three hundred
percent (300%) of Leverageable Capital (Sec. 107.230(c)(3)) or
Preferred Securities in excess of one hundred percent (100%) of
Leverageable Capital (Sec. 107.230(c)(4)), if applicable to such
Licensee, as of the end of each fiscal year. In this regard, any
(i) Prepayment, sale, or disposition of Equity Capital Investments
or Venture Capital Financing or Qualified Investments, as appropriate,
(ii) Increase in Leverageable Capital, or
(iii) Receipt of additional Leverage, occurring within one hundred
twenty (120) days prior to the end of the fiscal year shall be
disregarded in determining whether Licensee meets the foregoing
requirements as of the close of its fiscal year.
(10) Nonperformance. Licensee violates or fails to perform one or
more of the terms and conditions of any Participating Security or
Preferred Security or of any agreement with or conditions imposed by
SBA in its administration of the Act and the regulations promulgated
thereunder.
(11) Noncooperation under Section 107.262(e). Licensee fails to
take appropriate steps, satisfactory to SBA, to accomplish such action
as SBA may have required pursuant to paragraph (e) of this section.
(e) Repeated non-substantive violations. If a Licensee repeatedly
fails to comply with any one or more of the non-substantive provisions
of the Act or any non-substantive regulation promulgated thereunder,
SBA, after written notification to the Licensee and until such
condition is cured to SBA's satisfaction, shall deny additional
Leverage to such Licensee and/or require such Licensee to take such
actions as SBA may determine to be appropriate under the circumstances.
Sec. 107.263 Non-waiver.
No failure to exercise or delay in exercising any right or remedy
under the Act or the regulations in this part shall operate as a waiver
of any such right or remedy by SBA. No failure(s) by SBA to require the
performance by Licensee of any one or more of the terms or provisions
of any debt instrument, Preferred Security or Participating Security of
Licensee issued to, held, or guaranteed by SBA shall in any way affect
SBA's right to enforce the same. Similarly, SBA's waiver of, or failure
to enforce, any term or provision of any debt instrument, Preferred
Security or Participating Security of Licensee issued to, held, or
guaranteed by SBA or of any event or condition set forth in
Secs. 107.261 or 107.262 shall not be taken or held to be a waiver of
any succeeding breach of any such term or provision or condition.
5. Section 107.901 is amended by revising the first sentence of
paragraph (a) to read as follows:
Sec. 107.901 Prohibited use of funds.
* * * * *
(a) Relending, reinvesting, etc. For relending or reinvesting, if
its primary business activity involves, directly or indirectly,
providing funds to others, the purchase of debt obligations, factoring,
or long-term leasing of equipment with no provision for maintenance or
repair; Provided, however, that Venture Capital Financings (as defined
in Sec. 107.230(c)(3)) of a Disadvantaged Concern engaged primarily in
relending or reinvesting activities shall be permitted, except for
banks and savings and loan associations not insured by agencies of the
Federal Government, and agricultural credit companies.* * *
* * * * *
6. Section 107.906 is amended by revising paragraph (a) to read as
follows:
Sec. 107.906 Violations based on false filings and nonperformance of
agreements with SBA.
* * * * *
(a) Nonperformance. Nonperformance of any of the requirements of
any Debenture, Participating Security or Preferred Security issued to,
held or guaranteed by SBA, or of any written agreement with SBA.
* * * * *
7. Section 107.1004 is amended by revising the first sentence of
paragraph (a) to read as follows:
Sec. 107.1004 Reporting changes not subject to prior SBA approval.
(a) Changes to be reported. Any change of Licensee's name, address,
telephone number, officers, directors, or other participants in the
management of Licensee, articles, operating area, investment policy, or
increase in capitalization not otherwise required to be submitted for
prior approval (see, for example, Sec. 107.601) shall be reported to
SBA not later than thirty days after these events. * * *
* * * * *
Dated: February 25, 1994.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-7843 Filed 4-7-94; 8:45 am]
BILLING CODE 8025-01-M
