[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: 94-7844]
[[Page Unknown]]
[Federal Register: April 8, 1994]
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SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
Small Business Investment Companies; Definitions of Various
Terms; Miscellaneous Final Rules; Valuation Guidelines
AGENCY: Small Business Administration.
ACTION: Final rule.
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SUMMARY: This final rule adopts proposed rules published by the Small
Business Administration (SBA) on August 5, 1993. The purpose of this
rule is to implement certain provisions of the Small Business Equity
Enhancement Act of 1992, and to clarify and simplify the regulations
governing Small Business Investment Companies (Licensees) in order to
encourage increased private investment in Licensees.
EFFECTIVE DATE: April 25, 1994.
ADDRESSES: Robert D. Stillman, Associate Administrator for Investment;
Small Business Administration; suite 6300; 409 3rd Street, SW.,
Washington, DC 20416.
FOR FURTHER INFORMATION CONTACT:
Marvin D. Klapp, Acting Director, Office of Program Development;
Telephone (202) 205-6515.
SUPPLEMENTARY INFORMATION:
Alter Ego Financing
SBA had proposed to amend its regulations in order to permit
Licensees to extend Financial Assistance to a Small Concern whose sole
business was the leasing of commercial or industrial real estate to an
operating concern under identical ownership. In the Small Business
Investment Company Program there has never been an ``alter ego''
exception to the general rule that forbids Financial Assistance to
Small Concerns engaged in leasing real estate, although other programs
administered by SBA had such exceptions in their rules. See 13 CFR
Secs. 108.8(d) and 120.101-2(e). One reason for the proposal was to
bring the rules of the Small Business Investment Company Program into
greater, though not absolute, conformity with these rules. However, SBA
has since published proposals that would change these other ``alter
ego'' rules. Accordingly, SBA has decided to defer consideration of the
rule proposed on August 5, 1993 until it has completed the rule-making
process with respect to Parts 108 and 120 of its regulations. It should
be clearly understood that the proposed rule is neither withdrawn nor
adopted in final to become effective simultaneously with the adoption
of final amendments to Parts 108 and 120. Licensees also are reminded
that no existing rule forbids the extension of Financial Assistance to
an eligible Small Concern for the acquisition of industrial or
commercial real estate on which their business operations will be
conducted.
Associate of a Licensee
The proposal to amend the definition of Control Person in
connection with the proposal to allow limited partnerships to serve as
a general partner of a Licensee elicited a number of comments raising
issues that SBA deemed best addressed by a change in the definition of
Associate of a Licensee.
Generally speaking, an investor with an equity interest of 10
percent or more in a Licensee will continue to fall within the
definition of Associate of a Licensee, without regard to whether that
equity interest consists of stock or a limited partner's interest. The
rule reflects SBA's assumption that anyone with a 10 percent equity
interest in a Licensee will have a degree of influence with the
Licensee's management, even if such influence can't be openly exercised
by virtue of the investor's status as a limited partner. However, the
statutory changes intended to make the program more attractive to large
institutional investors, and the response received by SBA in connection
with its proposal to amend the definition Control Person, have
persuaded SBA of the necessity to draw a distinction between a limited
partner whose policy in dealing with the Licensee and/or the general
partner is likely to be ``hands off'', and a limited partner that is
likely to seek to influence the general partner. Accordingly, the
distinction is being drawn between the generality of investors with a
stake of 10 percent or more in the Licensee, and an Institutional
Investor whose investment as a limited partner in the Licensee does not
represent more than 33 percent of the Licensee's partnership capital
and does not exceed 5 percent of such investor's net worth.
Commitment
Although the proposed new definition of ``Commitment'' is being
adopted without change, the comments received indicate a need for a
more detailed explanation of SBA's underlying purpose. Since
``Commitment'' is being defined as an undertaking by a Licensee to
Finance a Small Concern, there was some concern as to whether the use
of the word ``commitment'' to describe an Institutional Investor's
undertaking to make future investments in a Licensee might not be
unduly confusing. Upon consideration, the term ``commitment'', which is
the term used in the Act, will continue to be used to describe an
Institutional Investor's undertaking or obligation; the context will
preclude confusion on the reader's part.
SBA intends to apply the new definition primarily to determine
whether a Licensee is inactive within the meaning of Sec. 107.902, and
whether the Licensee is obligated to return part of any processing fee
it may have collected pursuant to Sec. 107.402(d), as adopted this day.
Therefore SBA has no particular concern with the terms of any
Commitment or purported Commitment extended after the adoption of this
regulation that has been fully funded by a Financing to a Small
Concern.
The new definition of ``Commitment'' assigns a meaning to the term
that is narrower than the sense in which many Licensees have used the
term. SBA, in practice, has never considered a general statement of
willingness to extend Financing to constitute a Commitment. Now, SBA's
position is a matter of record. Even though the new definition of
``Commitment'' excludes a number of letters that some Licensees may
have previously considered to be commitments, the effect of such
exclusion will not be as disruptive as some comments have predicted.
In general, the new definition will not be used to test a
Licensee's need for Leverage. However, the definition of Commitment
will be used in the review of any application submitted for Preferred
Securities Leverage in excess of 100 percent of the Licensee's
Leverageable Capital, or Leverage in excess of 300 percent of the
Licensee's Leverageable Capital. This distinction is mandated by the
language of sections 303(c)(1)(E) and 303(c)(4) of the Act,
respectively, both of which speak of ``funds * * * legally committed''.
Some comments had expressed concern that the new definition of
Commitment would impair the right of a Licensee to provide additional
Financing, pursuant to Sec. 107.706, to a portfolio concern that was no
longer a Small Concern. In response to these and other comments, SBA
has revised paragraph (a) of Sec. 107.706 to eliminate existing
restrictions or preconditions with respect to further Financing of
portfolio concerns that have ceased to be eligible solely because they
have ceased to be Small Concerns, but which have not yet made a public
offering of their securities.
Two themes ran through almost all the comments submitted to SBA.
One was that ``reasonable conditions precedent'' should be further
defined or described; the other was that completion of the Licensee's
due diligence process with results satisfactory to the Licensee should
be considered a reasonable condition precedent. Although SBA is
reluctant to provide a list of reasonable conditions precedent in the
regulation for fear that such list might be regarded as an exclusive
one, it is willing to describe ``reasonable conditions precedent'' in
general terms. A ``reasonable condition precedent'' is one that does
not lie within the Licensee's ability to cause or prevent. ``Completion
of due diligence with results satisfactory to the Licensee'' is an
example of a condition precedent that lies within the Licensee's
control. On the other hand, requirements that a disinterested person
verify the value of the Small Concern's assets or its net worth, or
that there be no adverse change in the Small Concern's financial
condition between the date of the commitment and the scheduled
disbursement date, or that the Small Concern do or achieve something
that lies reasonably within its capacity would all be considered a
``reasonable condition precedent.''
Common Control
The proposed definitions of ``Common Control'' and of ``Control''
are adopted with an editorial change. The last two sentences of the
proposed definition of ``Control'', beginning with the words ``Two or
more Licensees * * *'' have been moved, without change, to the
definition of ``Common Control.''
A change in the present definition of ``Control'' and a new
definition, ``Common Control'' both were made necessary because section
402 of Public Law 102-366 (September 4, 1992) imposed a $90 million
ceiling on the aggregate amount of Leverage of all forms that might be
outstanding in any Licensee, or in any group of Licensees under common
control, ``unless the Administration determines on a case by case basis
to permit a higher amount for companies under common control and
imposes such additional terms and conditions as it determines
appropriate to minimize the risk of loss to the Administration in the
event of default.''
SBA believes that Congress did not intend the words ``commonly
controlled'' to mean only ``commonly owned'', since there are many
different methods of control other than mere ownership of record.
Rather, SBA believes that Congress intended to limit the dollar amount
for which SBA would be at risk as a result of the business judgment of
a single management group, even though the managers are not the owners.
Consequently, the intention of this regulation is that two or more
Licensees will be presumed to be ``commonly controlled'' if there is an
affiliate relationship between or among them, which could be based upon
ownership of stock or partnership capital of the Licensees, or upon
management (including arrangements that are characterized as investment
advisory contracts in which the adviser participates in the selection
of the Licensee's investments) by affiliated persons or entities, even
if there is no affiliation between or among the owners of the
Licensees. The presumption that two or more Licensees are ``Commonly
Controlled'' is not precluded solely because of the absence of any
affiliation between or among their respective owners, or any interlock
of their respective officers and/or directors, or general partners or
Control Persons. Subject to the right of any Licensee to present
evidence or arguments in rebuttal, Licensees shall be presumed to be
under ``Common Control'' under the terms of the proposed rule if day-
to-day management is contracted out to a single entity, or to two or
more affiliated entities.
The fact of common ownership need not compel the conclusion of
Common Control if it can be satisfactorily demonstrated to SBA that,
for example, two or more Licensees under common ownership operate under
entirely different management teams, are located in different regions,
and pursue different investment plans. On the other hand, the
presumption of Common Control would not be rebutted by a showing that
two or more Licensees are separately owned and that each has a separate
board of directors or general partner, if it also appeared that each
board or general partner had effectively delegated operational control
to a common adviser/manager.
Although public comment was generally favorable, one comment
considered the $90 million Leverage ceiling for a single Licensee to be
excessive. It is apparent from other provisions of Public Law 102-366
that Congress intended to make as much as $90 million available to
qualifying Licensees.
Another comment urged that two or more Licensees with different
ownership and different directors and/or general partners not be
considered under Common Control solely because the day-to-day
management has been delegated to a common manager.
SBA believes that any definition of ``Common Control'' that did not
cover the case of a common manager would be too narrow, especially with
regard to a company whose investors were led to believe that their
company would be run by a particular management team.
Yet another comment objected to the use of the words ``or
otherwise'' in the first sentences of the respective definitions of
``Control'' and ``Common Control.'' In each case, ``or otherwise''
appears at the end of a list of the means by which one might obtain or
exercise control over a business. Concern was expressed that an
institutional investor intending ultimately to form its own wholly
owned Licensee might be reluctant to become a 10 percent limited
partner in another Licensee lest SBA consider both Licensees to be
under common control, thus limiting the amount of Leverage available to
the wholly owned Licensee.
SBA understands these concerns, which are believed to arise not so
much from the definitions of Common Control and Control as from the
definition of Control Person, which has also been revised.
With regard to Common Control and Control, the point of both
definitions is to address the factual issue of whether A controls
Licensee X, without distinction as to how A came to control X. SBA does
not wish to leave open the possibility that someone might control a
Licensee and yet not be covered by these definitions; and it is not
confident that an enumeration consisting only of ``ownership,
management, [or] contract'' represents all the ways by which A might
control X. For example, if A were a 10 percent limited partner in
Licensee X, and the general partner received no salary or management
fee from X, but was instead an at-will employee of A, A's control of
the general partner's salary might justify a conclusion that A actually
controls X, even though A is only a 10 percent limited partner.
Control Person
The proposed amendment is adopted with changes to meet some of the
concerns touched upon in the discussion of Common Control and Control.
Some of these concerns have already been touched upon in discussing the
change in the definition of ``Associate of a Licensee''.
The term ``Control Person'' is concededly a misnomer as applied to
some of the persons described in the definition. For many years SBA's
regulations have defined the term ``Associate of a Licensee'' to
include any person with an equity interest of 10 percent or more in a
Licensee; it was thought that a person with a 10 percent interest or
more would have a significant, even if sometimes informal, influence
over the Licensee's operations. When SBA decided to allow Licensees
organized as limited partnerships to have a corporate general partner,
it was necessary to coin a term to cover those persons that might
control, or at least influence, the Licensee's corporate general
partner and thus the Licensee itself even though they themselves might
have no direct relationship to the Licensee. The term chosen to
describe such persons was ``Control Person'', even though it is defined
in language that includes persons that could only be described as
potentially having an influential, but not controlling, voice in the
Licensee's affairs. On the one hand, SBA's intention was to bring such
persons within the definition of ``Associate of a Licensee'' in order
to prevent self-dealing by or in favor of such persons. On the other
hand, it was never SBA's intention to create a presumption that an
ownership interest of 10 percent or more in an entity that serves as a
general partner of the Licensee would, by itself, constitute control
over the Licensee, even though the language of the proposal may have
given that impression. Accordingly, the final regulation draws a
distinction between a Person that has an interest in a corporation or
partnership, including a limited partnership interest, that serves
directly or indirectly as a general partner of a Licensee, and also
participates in that entity's operations and thus ultimately in the
Licensee's investment decisions; and, in contrast, a passive investor
in the same kind of entity. In the case of a participant in the
entity's affairs, an interest of 10 percent or more will bring such
Person within the definition of Control Person. A passive investor with
an interest of less than 33 percent in an entity that serves directly
or indirectly as a general partner of a Licensee is now excluded from
the definition of Control Person.
Cost of Money (COM)
SBA proposed three regulatory changes intended to increase the
income a Licensee might derive from Loans and Debt Security Financings.
The first proposal, amending the definition of COM to allow
Licensees to impose upon Small Concerns certain additional fees and
charges that would be excluded from the computation of COM, is adopted
as final without change. The other two regulatory proposals intended to
allow a Licensee to charge more for Financial Assistance will be
discussed hereafter.
All comments were favorable, though some expressed the view that
SBA had not gone far enough. One comment urged that the definition of
COM explicitly exclude, in addition to any other excluded fees, charges
and fees paid to non-Associate consultants, accountants, and lawyers.
SBA does not believe that any further amendment to the definition
is needed to accomplish the objective sought by this comment. COM is
defined in terms of payments to a Licensee and its Associates. Thus,
payments to non-Associates for technical and professional services are
already excluded from the definition.
Another comment had urged that a Licensee be allowed to charge a
fee, excluded from COM calculation, for arranging financing from an
Associate of that Licensee regularly engaged in investment banking.
While SBA considers this proposal to be worthy of serious
consideration, SBA declines to adopt it at this time.
The amended definition of COM no longer excludes commitment fees.
Instead, the definition permits Licensees to charge a processing fee of
up to 3 percent of the requested amount of Financing, without including
it in COM; and to collect this fee, in full or in part, before
processing the Small Concern's application. In other words, a Licensee
may charge interest at the maximum permissible rate, and collect an
additional processing fee, not to exceed 3 percent of the amount of the
Financing. If the Financing closes, the Licensee may collect or retain
the full amount of the processing fee, even if no commitment was
extended, and no part of this fee will be included in the computation
of COM. On the other hand, if the Licensee has collected a processing
fee equal to 3 percent of the requested Financing, any additional fee,
whether based on the extension of a commitment, or otherwise, will be
included in computation of COM.
Although the regulatory changes will permit a Licensee to require a
processing fee before processing an application for Financing,
Sec. 107.402 makes it clear that it is not intended that any Licensee
will derive a profit from a rejected application. In such a case, the
Licensee must return the entire amount of any processing fee collected
in excess of certain specified out-of-pocket costs. See Sec. 107.402,
as adopted. If the application is rejected, the Small Concern will have
no obligation to reimburse the Licensee for any additional expenses the
Licensee may have incurred, even if the Licensee has previously charged
a smaller advance processing fee than it might have charged, or no
processing fee at all.
If the Licensee does provide Financing, the Small Concern also may
be required to reimburse the Licensee for out-of-pocket conveyance and/
or recordation fees, taxes, and reasonable closing costs. Such
reimbursement, which may be required in addition to the processing fee,
is not to be included in the computation of COM.
The definition of COM also would allow Licensees to impose upon
Small Concerns three other charges, in addition to presently-excluded
charges, that would be excluded from the computation of COM.
By agreement with a Small Concern, a Licensee may receive a
reasonable fee for its efforts in arranging financing from non-SBIC
non-Associate sources, and the amount of such fee, whether or not the
Licensee itself participates in the financing, is excluded from the
computation of COM.
A Licensee may require the Small Concern to reimburse it for the
reasonable and necessary costs incurred by the Licensee in monitoring
the Financing, and the amount of such reimbursement is excluded from
computation of COM.
A Licensee that has a ``watchdog'' director serving on the board of
a Small Concern pursuant to Sec. 107.903(f) may receive reasonable
director's fees, not in excess of those paid to outside directors; and
such fees are not to be included in computing COM.
Finally, the language presently found in the definition of COM that
requires a Licensee, in the event of prepayment under certain
circumstances, to refund unearned front-end charges has been moved to
Sec. 107.402(f), and will be discussed later.
Disadvantaged Concern
The definition is revised to reflect SBA's current position, but
SBA expects to undertake a separate rule-making in the near future on
this subject.
Institutional Investor
Section 410 of Public Law 102-366 added a definition of ``private
capital'' to the Act that, among other things, requires SBA to
recognize ``unfunded commitments from Institutional Investors that meet
criteria established by the Administration'' as part of a Licensee's
Private Capital for certain purposes. Accordingly, SBA proposed a
definition of ``Institutional Investor'' which is now adopted with a
number of changes.
The most important change entails the imposition, with one
exception, of a minimum net worth requirement on all entities or
persons that which to be considered Institutional Investors, so that
their unfunded commitments may be recognized by SBA as a part of a
Licensee's Private Capital for regulatory purposes. The net worth
requirement does not affect any Person that actually makes an equity
investment in a Licensee, but only SBA's recognition of an unfunded
commitment for regulatory purposes.
Even though SBA does not extend Leverage against unfunded
commitments, the inability of an investor to fund a commitment may
adversely affect SBA's risks with respect to Leverage previously
extended. Although it was SBA's intention to define ``Institutional
Investor'' broadly and inclusively it is also important that there be a
substantial probability that the commitment recognized by SBA will be
fully funded when the time comes. This probability does not necessarily
exist with respect to every institution that falls within the proposed
definition of Institutional Investor. Accordingly, SBA has determined
to impose a $1 million minimum net worth test upon all entities that
seek to qualify as Institutional Investors, and a $2 million minimum
net worth standard upon all persons that seek to qualify. However,
while the final rule exempts individuals who are Accredited Investors
from the $2 million net worth test, such individuals will be considered
Institutional Investors only if such person's commitment is backed by a
letter of credit from another Institutional Investor.
At this point it is appropriate to note that while an Accredited
Investor with a net worth of less than $2 million is the only kind of
individual who will be required to provide a letter of credit in order
to be considered an Institutional Investor, it does not follow that SBA
will automatically recognize as a part of a Licensee's Private Capital
the full amount of the commitment made by every individual
Institutional Investor with a net worth of $2 million or more.
Unless an individual Institutional Investor has a net worth of $10
million or more, a letter of credit from another Institutional Investor
will be required to back up that part of the commitment that exceeds 10
percent of the Institutional Investor's net worth. See the definition
of Private Capital.
Another change relates to the requirement of a letter of credit. A
number of comments had pointed out that compliance with the proposed
requirement that an individual investor's (unfunded) commitment be
backed by a letter of credit from a qualified Institutional Investor
was not feasible in the case of a commitment that was not to be fully
funded within one year; banks and similar Institutional Investors
normally do not issue letters of credit with terms in excess of one
year.
Upon reflection, SBA will recognize a commitment backed by a one-
year letter of credit as long as the letter of credit is renewed or
replaced at its expiration with another letter equal to the unfunded
amount of the commitment, expiring on the anniversary of its issuance
or on the date the commitment is to be fully funded, whichever shall
first occur. An unfunded commitment not backed by a current letter of
credit shall cease to be recognized as a part of Regulatory Capital as
of the date the letter of credit expires, which may cause the Licensee
to be in violation of any regulatory restrictions or requirements that
are expressed in terms of the Licensee's Regulatory Capital.
Another change represents a response to certain inquiries
concerning foreign investors. SBA never intended that an individual
investor who meets the standards set forth in the definition of
``Institutional Investor'' should be excluded from the definition
solely because he or she was not a permanent resident of the United
States, as long as he or she irrevocably designates an agent in the
United States for service of process. The definition is amended to
reflect this intention.
Private Capital
With one significant change, and with three changes of an editorial
nature, the definition of Private Capital is adopted as proposed.
The proposed definition had allowed ``funds invested which are
income derived from the investment of grants that have been made by a
state or local government agency or instrumentality into a nonprofit
corporation or institution exercising discretionary authority with
respect to such funds; and funds invested by a State financing agency,
or similar agency or instrumentality, to the extent such funds are
derived from such agency's income and not from appropriated State or
local funds'' to be included in the Regulatory Capital of a Section
301(d) Licensee, subject to the limitation that the aggregate amount of
such funds and funds invested in the Licensee directly by any State or
local government or instrumentality might not exceed 40 percent of that
Licensee's Regulatory Capital. This 40 percent limit is not in the
final version. Thus, a Section 301(d) Licensee may be capitalized
entirely with such indirect funds.
However, it does not follow that a State or local governmental
entity supplying such funds to a section 301(d) Licensee can control
the Licensee. Section 301(b) of the Act requires SBA to make a positive
determination as to the probability of successful operation by any
applicant before it may issue a license, specifically considering the
applicant's prospects of ``adequate profitability''. In making this
determination, SBA considers it essential that control of a Licensee be
in hands other than the representatives of public sector investors.
One editorial change has been made to reflect the fact that, while
the law requires unfunded binding commitments to invest in a Licensee
to be treated as a part of the Licensee's Regulatory Capital for some
purposes, fundamental accounting principles forbid the inclusion of
unfunded commitments in ``paid-in capital and paid-in surplus.''
The proposed definition of Private Capital included a paragraph (4)
providing in relevant part that for the purpose of determining whether
a Licensee was in compliance with certain cited regulations, the term
Private Capital used in each such regulation should be considered to
mean ``Regulatory Capital''. For ease of reference, the term Regulatory
Capital has been substituted in each cited regulation and the
corresponding language of paragraph ((4) is deleted.
To encourage license applicants to assist Small Concerns as soon as
they are able, even before they receive a license, language has been
added to make it clear that securities of eligible Small Concerns
Financed by an applicant or by the applicant's investors after the date
its license application has been physically received by the Office of
Investment, but before the license is issued, will be regarded as a
part of Regulatory Capital for Licensing and other purposes, subject to
SBA approval. The added language reflects SBA's present practice.
Section 301(d) Licensee
The proposed definition is adopted with editorial changes that
conform to the changes in the definition of Disadvantaged Concern.
Limited Partnerships
The proposed rule is adopted with one significant change. The
requirement that the funds of a corporate or limited partnership
general partner not invested in the Licensee be either co-invested with
those of the Licensee or invested in ``idle funds'' investments is
eliminated. SBA has never Leveraged such funds, and SBA does not hold
general partners as such personally liable for the repayment of
Leverage obligations. No purpose is served by treating such general
partners differently from unleveraged Licensees.
Operational Requirements
Except as hereafter noted, SBA adopts as final its proposal to
amend Sec. 107.101 regarding operational requirements in order both to
increase the chances of successful operation on the part of Licensees,
and to minimize SBA's exposure to loss.
A company that applies for a license, or a Licensee that applies
for leverage, must demonstrate to SBA that its management has something
more than general business experience. Such applicant or Licensee must
show that management has experience making the sizes and types of loans
or investments in Small Concerns of the sizes and types contemplated in
the Licensee's Plan of Operations.
SBA's experience has shown that companies entering the SBIC program
with only the statutory minimum amount of capital have little chance of
carrying on the ``successful operations'' and achieving the ``adequate
profitability'' required by section 301(c) of the Act. Accordingly,
every applicant will be required to have sufficient capital in excess
of the minimum to operate soundly and profitably within the context of
its plan of operations as approved by SBA. Each prospective Licensee
must have sufficient capital so that it will be able to pay its
expenses without dissipating its Regulatory Capital. Based on SBA's
experience, given Licensees' fixed expenses for management and rent,
and their costs of due diligence, even in the case of straight loans,
SBA believes that a stand-alone company bearing the full expense of
rent, management, accounting services, etc. has only a limited prospect
of profitability if its Regulatory Capital is less than $5 million.
Accordingly, SBA would prefer that applicants have minimum capital of
$5 million before admission to the program. It does not follow, though,
that SBA will never hereafter license a company with Regulatory Capital
of less than $5 million. In appropriate cases, consideration will be
given to the possibility that the applicant's overhead expenses may be
substantially less than customary because they will be shared with
other companies having similar investment policies, or underwritten by
the applicant's investors.
SBA's experience also has shown that the portfolio valuation
process is a weakness of some Licensees. Accordingly, SBA has taken
steps to improve the process and the valuation standards. Each Licensee
is required to adopt a policy for the valuation of its portfolio
investments, to evaluate portfolio investments in accordance with such
policy, and to report such evaluations to SBA. For their guidance, SBA
adds an Appendix III to Part 107 setting forth the basis upon which
valuation guidelines should be framed. Appendix III as adopted differs
somewhat from its proposed form because of SBA's response to comments
it has received.
With the widespread use of computers in virtually all businesses,
SBA is in the process of developing systems to enable SBICs to perform
their reporting requirements through electronic transmission from the
most commonly used types of personal computers. SBA will provide SBICs
with custom software that will enable SBICs to perform their reporting
tasks more easily, more accurately, and more quickly. To this end, SBA
is requiring all SBICs to have personal computers, to run SBA-provided
software, and to report electronically as directed by SBA by June 30,
1994.
The final version of Sec. 107.101 adopted today includes a new
paragraph (i) that was not a part of the original proposal. The
combination of the tendency within the Small Business Investment
Company industry toward the formation of larger companies and increases
in the size standards applicable to the industry (see 58 FR 40603,
proposed July 29, 1993 and adopted as final simultaneously herewith)
raises the possibility that the flow of investment capital into smaller
concerns may be substantially reduced. Accordingly, SBA will require
Licensees to ensure that a percentage of the Financings they extend in
the future go to Smaller Concerns--concerns that qualify as Small
either under the standard set forth in 13 CFR Sec. 121.802(a)(2)(i) as
in effect on January 1, 1993, or under the industry size standard in
effect at the time of the Financing--as defined in Sec. 107.3. A
Licensee that fails to meet the goal set forth in this regulation may
make no Financings of concerns that do not qualify as Smaller Concerns
until it has brought itself into compliance.
At the end of each Licensee's first full fiscal year following the
adoption of this rule, at least 10 percent of the dollar amount of all
Financings made by the Licensee between those dates shall have been
extended to such Smaller Concerns. At the end of each subsequent fiscal
year following the adoption of this rule, the cumulative dollar amount
of Financings extended to such Smaller Concerns by each Licensee since
the adoption of this rule must equal at least 20 percent of the
cumulative total of Financings over the same period. For the purpose of
determining whether a Licensee has achieved these objectives, a change
of ownership Financing pursuant to Sec. 107.711 in which the resulting
concern qualifies as a Smaller Concern will be counted as a Financing
of such Smaller Concern.
The purpose of this rule is to insure a continued flow of Financial
Assistance to Smaller Concerns despite the adoption of a new size
standard. Therefore the rule does not mean that a certain percentage of
the Licensee's portfolio as of the end of any (full) fiscal year
following the adoption of this rule must consist of investments in
Smaller Concerns. In the case of any present Licensee, 100 percent of
its portfolio on the date of this final rule would consist of
investments in Smaller Concerns. Thus, such Licensee would be free to
operate for a number of years without Financing any Smaller Concerns if
the rule were addressed to a specific percentage of portfolio as of the
close of a fiscal year. Such a result would be inconsistent with the
previously-declared purpose of the rule, which is aimed at future
investments. Given the purpose of the rule, events such as prepayments,
the sale or exchange of portfolio securities, or the write-down or
write-off of portfolio securities will not affect the Licensee's
compliance.
Nor does the rule necessarily require a specific percentage of
Financings to Smaller Concerns within any given fiscal year; the object
of the rule is a cumulative percentage as of the end of a period. The
wording of the rule is intended to imply a carry-forward from one
fiscal year to the next, of Financings to Smaller Concerns made after
the effective date of the rule.
Calculation of Cost of Money Ceiling
The proposal to allow Licensees to calculate an alternative Cost of
Money Ceiling based on their own weighted average cost of money is
adopted with a number of significant changes.
Until now, the maximum permissible rate of interest that any
Licensee might impose upon any Small Concern was calculated with
reference to the rate of interest on the SBA-guaranteed debentures
underlying the most recent offering of trust certificates to the
public. While the existing rule facilitated the determination of a
uniform ceiling throughout the industry, it ignored the actual interest
expense on the debenture leverage drawn down by any individual
Licensee.
SBA had originally proposed to amend Sec. 107.302 to allow
Licensees that have been leveraged through the sale of debentures to
use their own weighted average cost of funds borrowed from SBA, or with
SBA's guarantee, as the case may be, as an alternative basis for
calculating their respective interest rate ceilings. Although companies
licensed under section 301(d) of the Act that sell debentures to SBA
(or to the public with SBA's guarantee) may enjoy the benefits of a
subsidized interest rate for the first five years of the debenture's
term, this subsidy is to be disregarded in the calculation of the
alternative interest rate ceiling. On the other hand, Licensees that
have sold Preferred Securities (stock or limited partnership interests)
or Participating Securities may not include dividends or distributions
on such securities in the calculation of their alternative interest
rate ceilings.
The entire focus of the proposal was on Leveraged Licensees, partly
because section 305 of the Act, as amended by section 411 of Public Law
102-366, spoke only of ``companies which have issued debentures
pursuant to this Act'', and partly because it was assumed that non-
Leveraged Licensees did not utilize borrowed funds. The final
regulation reflects the numerous comments that informed SBA that non-
Leveraged Licensees do indeed have borrowings, albeit from other
sources. Accordingly, the final rule will allow a Licensee to utilize
Weighted Average Cost of Qualified Borrowings (including SBA-guaranteed
Debentures) rather than Weighted Average Cost of Leverage as an
alternative basis for the calculation of its Cost of Money limit.
The use of the term ``Qualified Borrowings'', defined in
Sec. 107.3, is intended to discourage a Licensee's acceptance of
extremely high (above-market) interest loans, presumably from
Associates, for the purpose of maximizing the COM that the Licensee may
then impose upon a Small Concern.
It should be understood that under the terms of the regulation as
proposed and adopted, the Weighted Average Cost of Qualified Borrowings
that is to be used by a Licensee is its cost over the Licensee's
preceding fiscal year, certified to SBA when the Licensee's Annual
Report (Form 468) is transmitted. However, it is also SBA's intention
to make this alternative method available as soon as possible to any
Licensee that may wish to use it without waiting until the end of its
fiscal year.
Following the publication of this final rule, any Licensee may
promptly certify its Weighted Average Cost of Qualified Borrowings to
SBA as if this regulation had been in effect prior to the close of the
Licensee's preceding fiscal year. Solely for the purposes of
determining whether the notification is timely within the meaning of
Sec. 107.302(f), SBA will regard the effective date of this rule as the
closing date of the Licensee's fiscal year. In other words, if the
Licensee's fiscal year ends on December 31, and this rule is adopted as
final on the following May 1, a Licensee may certify a Weighted Average
Cost of Borrowed Funds based on the fiscal year that closed on the
preceding December 31, and the required notification to SBA will be
considered timely if made within 30 days after May 1.
If a Licensee does not make a timely certification of its Weighted
Average Cost of Qualified Borrowings, it will be presumed that its
Weighted Average Cost of Borrowed Funds for the preceding fiscal year
is zero, so that the COM ceiling applicable to its Financings will be
that based on the current Debenture Rate. It should be understood
clearly that the interest rate ceiling based on the Debenture Rate
remains the only permissible ceiling applicable to Loans or Debt
Security Financings committed or disbursed prior to the certification
of the Licensee's Weighted Average Cost of Qualified Borrowings.
Since each Licensee may have its own individual COM ceiling, SBA
proposed a solution to the question of the applicable ceiling when two
or more Licensees participate in a joint financing. See Sec. 107.302(g)
as proposed. In response to comments, SBA has determined to adopt a
simpler final rule. The applicable COM limit for a joint financing is
the highest of any of the three following ceilings:
(1) A ceiling based on the current Debenture Rate, which is the
same for all Licensees at any given time;
(2) A ceiling determined with reference to the lead lender's
Weighted Average Cost of Qualified Borrowings; or
(3) A ceiling equal to the weighted average of the highest ceiling
available to each participating Licensee. If a Licensee has not
certified a Weighted Average Cost of Qualified Borrowings to SBA at the
time it participates in a joint financing, or has no Qualified
Borrowings, the ``highest ceiling available'' to such Licensee is, of
course, a ceiling based on the current Debenture Rate. SBA acknowledges
that on occasion some participating Licensees may be able to collect
interest and/or other charges for the use of money in excess of the
limit that would apply if they had done the Financing separately; but
SBA considers that such situations will arise only rarely, and the
excess cost to the Small Concern will be minimal.
SBA had proposed to adopt a new rule that would limit both the
amount of default penalty that a Licensee may impose, and the
circumstances under which a penalty might be imposed. Based upon the
comments received, SBA now believes that a rule limiting post-default
interest to the maximum rate permitted by the Cost of Money ceiling in
effect at the time of default may be insufficient to deter deliberate
default. Accordingly, the final rule will permit a Licensee to impose
and collect a default penalty not to exceed 7 percentage points over
the rate specified in the Note or Loan Agreement, for as long as the
default shall continue.
As proposed, the rule would have allowed a default penalty to be
imposed only if the Small Concern failed to make payment in accordance
with the terms of its obligation. The final rule will also allow a
default penalty to be imposed for failure to furnish required reports
or other information. Inasmuch as SBA will require Licensees to furnish
information concerning the economic impact of the loans and investments
they make, and to verify the use of Financing proceeds by Small
Concerns; and to obtain the necessary documentation pertaining to such
use and to economic impact generally, SBA considers the Licensee's
ability to impose a monetary sanction on the Small Concern both an
inducement to the Licensee to force compliance by the Small Concern and
an indispensable tool for that purpose.
Regulatory Relief for Unleveraged Licensees
As directed by section 408 of Public Law 102-366, SBA reviewed and
proposed to revise those regulations ``intended to provide for the
safety and soundness of'' leveraged Licensees with a view toward
exempting unleveraged Licensees from compliance with such regulations,
or promulgating different rules for unleveraged Licensees. SBA's
proposal to exempt unleveraged Licensees from compliance with
Sec. 107.303 (overline limitation) is adopted as proposed.
SBA's proposal to relieve unleveraged Licensees from compliance
with Sec. 107.708 (idle funds) is also adopted without change. SBA's
proposal to amend Sec. 107.708 as it applies to Leveraged Licensees
will be discussed later.
The language of Sec. 107.708 now reflects SBA's position with
respect to a Licensee's deposit of idle funds in an Associate bank,
which has always been that such a deposit does not constitute the
Financing of an Associate unless the Licensee is receiving a lower
interest rate than the Associate gives the public. In the case of an
unleveraged Licensee, SBA will not consider the deposit of funds with
an Associate bank to constitute self-dealing, even if the Licensee
accepts a lower interest rate than the Associate gives the public.
SBA does not intend that any Licensee shall simultaneously be
leveraged and exempted from compliance with Secs. 107.303 and 107.708,
or with any other regulations that may later be made inapplicable to
unleveraged Licensees. Accordingly, no Leverage is to be made available
to any unleveraged Licensee that is not, at the time of the request for
Leverage, in compliance with regulations applicable to Licensees with
outstanding Leverage.
Economic Impact
SBA had proposed to add a paragraph (c) to Sec. 107.304 to require
that each Portfolio Financing Report (Form 1031) set forth the economic
impact expected to result from the financing in terms of job creation
or retention, expanded business activity, or other identified
indicators of economic impact. In response to comments, SBA has
determined that it would be more appropriate to require the Licensee to
include in its own annual reports to SBA additional information
reflecting the actual economic impact of its Financing on each
Portfolio Concern, instead of requiring the Licensee to submit its
predictions of economic impact.
Verification of Use of Proceeds
SBA's proposal to require Licensees to take reasonable steps to
verify the use of Financing proceeds by portfolio concerns is adopted
with certain changes intended to clarify what is expected of Licensees.
The purpose of this regulation is to reduce the possibility that
Licensee funds may be used for purposes beyond the contemplation of the
Act or for purposes forbidden by the regulations; it is intended to
make existing prohibitions more effective.
For example, Sec. 107.901(c) has long forbidden the extension of
Financing to concerns engaged in the operation of rental real estate,
but the scope of the prohibition is not limited to concerns that openly
hold themselves out (to the Licensee, at least) as being engaged in the
operation of rental real estate. Also prohibited is the use of Licensee
funds to acquire or improve rental real estate even if the Small
Concern's primary business (at least immediately before the Financing)
is classifiable other than as a prohibited Major Group 65 activity. SBA
seeks to make it as difficult as possible for a Small Concern to divert
funds from the legitimate purpose represented to the Licensee and
reported to SBA on the Form 1031. As the preceding sentence suggests,
SBA considers the diversion-of-proceeds problem to be one primarily
involving innocent Licensees that have been wrongfully induced by a
Small Concern to make a Financing.
Certainly a Small Concern's representations pertaining to the
eligibility of the end use of its funds are as material as those
pertaining to the value of its assets or its revenues. Nor should a
Small Concern be able to deceive Licensees with impunity as to the
ultimate intended use of Financing proceeds. While the cooperation of
Licensees is necessary to prevent such deceit, the real obligation
should fall upon the Small Concerns themselves. Accordingly, the
regulation adopted today clarifies the Licensee's duty to verify that
the use of funds was in accordance with the representations made to the
Licensee. To assist the Licensee in obtaining such information, SBA has
adopted other regulations that will permit a Licensee to impose a
substantial default penalty on a Small Concern that fails to furnish
required post-financing information (see Sec. 107.302(h)) and that
allow a Licensee to recover from the Small Concern the reasonable and
necessary out-of-pocket expenses incurred in monitoring the Financing
(see paragraph (7) of the definition of Cost of Money).
Accordingly, Licensees will be required to enter in their own
files, and to maintain therein, the expected date of a post-closing
review for the purpose of monitoring use of proceeds, which shall be
not later than 90 days after the scheduled use of the funds.
In conducting a post-closing review or monitoring the subsequent
activities of a portfolio concern, Licensees should be alert to the
possibility of diversion of proceeds. If post-Financing financial
statements from the Small Concern, or visits to the Small Concern,
disclose substantial amounts of newly-created non-trade receivables or
investment assets, suspicion is warranted.
Similarly, since ``working capital'' is always understood to mean
money for use in the portfolio concern's business, as represented to
the Licensee and reported on the Form 1031, a request for a ``working
capital'' loan that seems wholly out of proportion for an enterprise of
the Small Concern's size in the same line of business should be a
warning signal.
Prepayment Penalties
Most of the substance of the proposed Sec. 107.402 has already been
discussed in connection with the proposed definition of Cost of Money.
However, the proposed Sec. 107.402 reflected a new approach to the
treatment of prepayment penalties by a Licensee that has also charged
front-end fees. Under the rule adopted today, which is substantially as
proposed, every Licensee may charge a reasonable prepayment penalty for
voluntary prepayment without regard to front-end charges, but a
Licensee that charges an excessive prepayment penalty shall be required
to refund the entire amount of the penalty to the Small Concern.
A number of comments had sought some guidance as to what SBA would
consider a reasonable prepayment penalty. Accordingly, the regulation
clarifies that SBA will presume that a prepayment penalty equal to 5
percent of the outstanding balance in the first year of the Financing's
term, and declining by one percentage point per year until the fifth
year, is a reasonable prepayment penalty. The formula is that employed
in the case of prepayment of SBA-guaranteed Debentures. SBA considers
this a more precise and useful standard than one referring to a penalty
``customary for financial institutions in the geographic area in which
the financing is being made.''
If a Licensee has imposed front-end charges that are not
specifically excluded from computation of COM (such as points,
discounts, or processing fees in excess of 3 percent) such charges
shall be prorated over the stated term of the Financing and if the sum
of interest and unearned front-end charges exceeds the applicable COM
limit, the excess shall be repaid to the Small Concern.
Special Situations for Short-Term Financing
The proposal to amend Sec. 107.403(b)(1) by adding a narrow
exception to the general requirement that all Financings have a term of
at least five years is adopted without change. The new exception is
created in favor of Small Concerns that have received government
contracts under Federal, State, or local set-aside programs for
``minority'' or ``disadvantaged'' concerns, so that Licensees may
provide the short-term contract financing that the Small Concern needs
to perform the contract.
Although such Financing would only go to firms receiving contracts
under set-aside programs wherein eligibility had been established by
the contracting agency, Licensees extending short-term contract
Financing would have a responsibility to assure that the Small Concern
in question is a ``Disadvantaged Concern'', as defined in Sec. 107.3.
Consideration for Issuance of Licensee's Securities
The proposal to amend Sec. 107.705 to allow a Licensee to issue its
securities in exchange for non-cash assets approved by SBA is adopted
with an editorial change.
Paragraph (4) of the definition of ``Private Capital'', as
originally proposed, had included a warning concerning future
Financings of, and/or assumptions of Control over, concerns whose
securities were exchanged with the Licensee for stock or partnership
interests therein. The intended gist of the warning was that if the
legality of a certain action or Financing depends upon the need to
protect a Licensee's investment, a Licensee that has only issued its
stock or partnership interests in exchange for securities of a Small
Concern is not considered to have any investment to protect. This
warning language, adopted without change, will now be a part of
Sec. 107.705 as adopted; it is transferred from paragraph (4) of the
definition of Private Capital. However, this restriction will not apply
to securities of eligible Small Concerns that SBA has approved for
inclusion in Regulatory Capital.
Retention of Investments
The final version of Sec. 107.706 differs substantially from the
proposed version. Section 107.706 originally had addressed the right of
a Licensee to retain its investment in, and to provide additional
Financing to, a concern that had ceased to be a Small Concern. SBA had
proposed to broaden the scope of the regulation to cover the case in
which a concern's eligibility is lost, either because it ceases to be
an alter ego of another eligible concern, or because it has shifted its
activity into an ineligible line of business. The policy decision,
previously discussed, to defer adoption of an alter ego rule required
the elimination of all such references in the proposed rule. The other
changes, discussed below, respond to comments received from the public.
The proposed rule would have left untouched the present rule
restricting the right of Licensees to provide additional Financing to
concerns whose growth and expansion was such as to take them out of the
definition of Small Concern. After further consideration, SBA is
persuaded that growth and expansion are desirable processes that should
neither restrict the access of the successful portfolio concern to
additional Financing from the Licensees that Financed it when it was
small, or the right of the Licensees to take additional advantage of an
unusually promising investment opportunity. Accordingly, paragraph (a)
has been revised to allow a Licensee with a pre-existing investment in
a concern that is no longer small to make additional investments until
the portfolio concern makes a public offering of its securities; and,
even after that, to exercise options, warrants or other rights to
acquire Equity Securities of the portfolio concern.
The regulation adopted this day with respect to additional
Financing of concerns that have become ineligible by reason of a change
in business operations represents the reconciliation of two conflicting
policy considerations. On the one hand, if SBA regulations declare
Small Concerns engaged in certain lines of business to be ineligible,
it makes no sense to allow Licensees to Finance an initially-eligible
concern so that it can shift its business activities into an ineligible
area. On the other hand, SBA recognizes that subsequent and unforeseen
occurrences may require a Small Concern to shift its activities into an
ineligible area.
Accordingly, the final regulation distinguishes between the case of
a concern that becomes ineligible by reason of a change in its business
activities within one year after the Licensee's Financing and that of a
concern that changes its business activities more than a year after the
Licensee's Financing. The regulation provides that if the concern moves
into an ineligible line of business within one year from the date of
the Licensee's Financing, a rebuttable presumption will arise that the
change in business activity was contemplated by the Small Concern at
the time of the Licensee's Financing. Accordingly, the Licensee shall
have the right to treat such change as a default or other breach of
covenant on the Small Concern's part, and to sue for any resulting
damages. See Sec. 107.305. The Licensee may also divest itself of the
investment if it considers such action to be in its best interests.
However, the Licensee's retention of such an investment in its
portfolio is a matter of balancing of program integrity against
possible loss to the Licensee, which is something that can only be done
on a case-by-case basis. Accordingly, requests for retention of the
investment should be accompanied by evidence tending to rebut the
presumption of bad faith on the part of the Small Concern by a showing
that the change in the Small Concern's business was prompted by a
change in circumstances subsequent to the date of the Licensee's
Financing and not reasonably foreseeable by the Small Concern.
If the change in business activity takes place more than one year
or more after the Licensee's Financing, of if the presumption of
regulatory violation has been rebutted, the Licensee may provide
additional Financing, but only to the extent necessary to prevent loss
of its original investment. SBA intends to allow only the most narrow
exception to its policy forbidding the Financing of concerns engaged in
ineligible business activities.
A change that takes place within one year gives the Licensee the
option to treat the event as a default and to accelerate the maturity
of all obligations. If the Licensee wishes to retain its investment in
the portfolio concern, it must obtain SBA's approval; and to obtain
such approval, it must rebut the presumption that the change was within
the contemplation of the parties, and, hence, in violation of the
applicable regulation, at the time of the Licensee's Financing. The
Licensee may rebut this presumption with evidence that the change was
the result of changed circumstances, unforeseen at the time of the
Licensee's Financing.
A change that takes place more than a year after the Licensee's
Financing may be treated by the Licensee as a default, but there is
neither a presumption that the change was within the contemplation of
the parties at the time of the Licensee's Financing, nor a requirement
of SBA approval should the Licensee decide to retain its investment.
Purchase of Portfolio Securities From SBA or From Licensees in
Liquidation
SBA's proposal to amend Sec. 107.707 to clarify the authority of
Licensees to purchase securities of Small Concerns from SBA, as either
the receiver or the assignee of another Licensee, is adopted without
change.
Licensees are reminded that Sec. 107.403(b)(3) presently allows
them to purchase securities of a Small Concern, including its
promissory notes, from any (non-Associate) non-issuer (including the
receiver of a failed financial institution), provided such acquisition
``constitutes a reasonably necessary part of the overall sound
financing of such concern.'' In contrast, Sec. 107.707 contains no such
restriction and is therefore narrowly drawn. SBA has determined that no
benefit to the Program or to small business would result from
broadening the scope of Sec. 107.707 to allow the purchase of a Small
Concern's Notes from the liquidators of a failed lending institution
when such purchase is made for its own sake, and not as a ``reasonably
necessary part of the overall sound financing of such concern.''
Idle Funds Investments
So far as this proposal deals with unleveraged Licensees, its
effects have already been discussed. That part of the proposal dealing
with investments of idle funds by Leveraged Licensees is adopted with
certain changes.
The final regulation clarifies in two ways the authority of
Leveraged Licensees to invest in repurchase agreements (repos).
The subject matter of the repo may only be obligations of, or
obligations guaranteed as to principal and interest by, the United
States; it is not enough that such Federal or Federally-guaranteed
obligations serve as collateral security for the performance of a repo
whose subject is some other kind of security.
The securities underlying the repo must be maintained in a
custodial account at a Federally-insured institution. They may not
remain in the hands of a party that is not itself Federally-insured;
and they may not be held as commingled assets of the custodial
institution.
The proposed regulation would not have allowed Licensees to
maintain idle funds deposits in excess of the insurance limit. The
final regulation permits Licensees to maintain idle funds in a
Federally-insured institution in excess of the insurance limit, but
only if that institution is ``well capitalized'' in accordance with the
standard set forth in 12 CFR 325.103(b)(1), as amended from time to
time.
Financing Changes of Ownership
The proposed rule is adopted with three changes.
The effect of the only significant substantive change is to allow
non-Leveraged Licensees to Finance changes of ownership if the debt-to-
equity ratio of the resulting concern is no higher than 8 to 1. As
proposed, the ratio had been 7 to 1.
The focus of Sec. 107.711 as proposed and adopted is the concern
that would emerge from the transfer of ownership, giving effect to all
financings, mergers and reorganizations contemplated by the parties. In
fact, the term ``contemplated'' has been substituted for ``agreed to''
to cover the case in which two or more parties agree in principle on a
general course of conduct, but have not reached definitive agreement on
all points.
If the concern resulting from the consummated acquisition will have
no more than 500 full-time equivalent employees, the Licensee may
finance the acquisition. If the concern resulting from the consummated
acquisition will have more than 500 full-time equivalent employees, the
Licensee may still finance the acquisition if, and only if, the
resulting concern also meets either one of two alternative debt/equity
ratio tests. If the Licensee in question has outstanding Leverage, the
resulting concern's debt/equity ratio may not exceed 5:1; in the case
of an unleveraged Licensee, the applicable debt/equity ratio may not
exceed 8:1.
The regulation contains a paragraph (b)(2)(iii) that excludes
certain classes of debt and other obligations from the category of
``debt'' for the purpose of determining the resulting concern's debt/
equity ratio. To preclude confusion, the paragraph has been slightly
modified to include contingent liabilities within the definition of
``debt''.
It should be understood that Sec. 107.711 does not constitute an
amendment of the size standards. The standards to be set forth in
Sec. 107.711 are applicable only in the context of financing a change
of ownership.
Minimum Capital Requirements
The proposal to amend Sec. 107.712(c) is adopted without change;
the amendment is a clerical one, mandated by statute.
Compliance With Executive Orders 12866 and 12612, 12778, and With
the Regulatory Flexibility and Paperwork Reduction Acts
This final rule will be a significant regulatory action for
purposes of Executive Order 12866 because it will have an annual effect
on the economy of more than $100 million, and, for purposes of the
Regulatory Flexibility Act, 5 U.S.C. 601, et seq., it is likely to have
a substantial impact upon a number of small entities.
Much of this final rule is adopted pursuant to a statutory mandate
(section 415 of Pub. L. 102-366) that requires SBA to promulgate
regulations implementing The Small Business Equity Enhancement Act of
1992.
Among the statutory provisions to be implemented by regulation is a
definition of ``Private Capital'' that includes funds invested by State
and local governments and their instrumentalities, and by pension funds
managed by State or local government officials. Another provision
mandates the recognition of unfunded commitments of institutional
investors as a part of ``Private Capital'' for certain purposes. The
effect of these provisions is to encourage the investment of additional
capital in the Small Business Investment Company program; and the
amount of such new capital, together with SBA Leverage, is expected to
be substantially in excess of $100 million per year.
The potential benefits of this regulation have been set forth under
Supplementary Information. The potential cost of this regulation cannot
be quantified or estimated.
Executive Order 12612
SBA certifies that this regulation will not have federalism
implications warranting the preparation of a Federalism Assessment in
accordance with Executive Order 12612.
Executive Order 12278
For the purposes of Executive Order 12278, SBA certifies that this
rule is drafted, to the extent practicable, in accordance with the
standards set forth in section 2 of that Order.
Paperwork Reduction Act
This final rule will impose only minimal additional recordkeeping
and reporting requirements on Licensees and on the Small Concerns
Financed by them. SBA believes that much of the information needed to
ensure that funds advanced by Licensees are used by Small Concerns in
accordance with the Act and regulations, or to verify the effect of the
program in terms of job creation and additional tax purposes, or to
verify that Licensee Financing of changes of ownership serves a public
purpose by encouraging the preservation or creation of jobs, is
customarily provided by Small Concerns as part of their business plan
projections, or developed by Licensees as part of its due diligence.
(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, Small businesses.
For the reasons set forth above, part 107 of title 13, Code of
Federal Regulations is hereby 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., as amended; 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 of
``Control'', ``Control Person'', ``Cost of Money'', ``Disadvantaged
Concern'' ``Private Capital'', and ``Section 301(d) Licensee'' and by
adding definitions of ``Commitment'', ``Common Control'',
``Institutional Investor'', ``Leverageable Capital'', ``Qualified
Borrowing'', ``Regulatory Capital'', ``Section 301(c) Licensee'', and
``Smaller Concern'' in the appropriate alphabetical order and by
revising paragraph (b) of the definition of ``Associate of a
Licensee'', to read as follows:
Sec. 107.3 Definition of terms.\2\
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\2\Terms defined in this section are capitalized hereafter.
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* * * * *
Associate of a Licensee means:
* * * * *
(b)(1) Any Person owning or controlling, directly or indirectly,
ten percent or more of any class of stock of a Corporate Licensee; or
(2) any Person owning or controlling, directly or indirectly, a limited
partner's interest representing ten percent or more of the partnership
capital of an Unincorporated Licensee; Provided, however, That if a
Person described in the preceding paragraph (b)(2) of this definition
is an Institutional Investor and the amount of such Person's investment
in a Licensee, including commitments, does not exceed 5 percent of that
Person's net worth, then such Person shall not be considered an
Associate unless the amount of such Person's limited partnership
interest represents 33 percent or more of partnership capital.
* * * * *
Commitment means a written agreement between a Licensee and a Small
Concern that obligates the Licensee to provide Financing (except a
guarantee) to a Small Concern (whose eligibility has already been
determined by the Licensee) in a fixed or determinable sum, by a fixed
or determinable future date. In this context the term ``agreement''
means that there has been agreement on the principal economic terms of
the Financing; Provided, however, that the terms of the Commitment may
include reasonable conditions precedent not within the control of the
Licensee to the Licensee's obligation to fund the Commitment.
* * * * *
Common Control means a condition where two or more Licensees either
through ownership, management, contract, or otherwise, are under the
Control of one group or Person. Two or more Licensees are presumed to
be under Common Control if they are affiliates of each other by reason
of common ownership or common officers, directors, or general partners;
or if they are managed or their investments are significantly directed
either by a common independent investment advisor or managerial
contractor, or by two or more such contractors that are affiliates of
each other. This presumption may be rebutted by evidence satisfactory
to SBA. The term ``affiliate'' is defined in Sec. 121.401 of this
title.
Control means the possession, direct or indirect, of the power to
direct or cause the direction of the management and policies of a
Licensee or a Small Concern, whether through the ownership of voting
securities, by contract, or otherwise.
Control Person means (a) A general partner of an Unincorporated
Licensee, including all general partners of a partnership serving
either as a general partner of an Unincorporated Licensee or as a
general partner of any other (intervening) partnership, limited or
general, that serves directly or indirectly as a general partner of an
Unincorporated Licensee;
(b) Any officer, director, agent or employee of a corporate general
partner of an Unincorporated Licensee, or of any corporation that is a
general partner in a partnership serving as a general partner of an
Unincorporated Licensee, or as a general partner of any other
(intervening) partnership, limited or general, that serves directly or
indirectly as a general partner of an Unincorporated Licensee;
(c) Any Person that participates in the investment decisions of the
general partner of an Unincorporated Licensee and owns or controls,
directly or indirectly, an interest of 10 percent or more as a
stockholder in, or limited partner of, any corporation or limited
partnership that serves directly or indirectly as a general partner of
such Unincorporated Licensee;
(d) Any Person that does not participate in the investment
decisions of the general partner of an Unincorporated Licensee and owns
or controls, directly or indirectly, an interest of 40 percent or more
as a stockholder in, or limited partner of, any corporation or limited
partnership that serves directly or indirectly as a general partner of
such Unincorporated Licensee.
* * * * *
Cost of Money generally includes all consideration that a Small
Concern and/or its affiliates is (are) contractually obligated to pay
to a Licensee and/or the Associates of such Licensee in connection with
Financial Assistance from such Licensee, such as interest, discounts,
points, fees, commissions, and any other thing of value, except as
hereinafter set forth.
(a) The following fees and charges are not to be included in
calculating Cost of Money:
(1) Processing fees determined in accordance with Sec. 107.402;
(2) Out-of-pocket conveyance and/or recordation fees and taxes;
(3) Reasonable closing costs;
(4) A reasonable fee for arranging financing from non-SBIC non-
Associate sources of capital, whether or not the Licensee participates
in such financing, if there is a written agreement in advance with the
Small Concern to pay such fee;
(5) Fees for management consulting services, but only if calculated
on a per hour, commercially reasonable basis for services actually
rendered,
(6) Prepayment penalties pursuant to Sec. 107.402;
(7) Reasonable and necessary out-of-pocket expenses incurred in
monitoring the financing; and
(8) Board of Director fees not to exceed those paid to other
outside directors and pursuant to Sec. 107.903(f).
(b) All other fees and charges shall be included in calculating
Cost of Money.
* * * * *
Disadvantaged Concern means a Small Concern that is at least 50
percent owned, and controlled and managed, by a person or persons whose
participation in the free enterprise system is hampered because of
social or economic disadvantages.
* * * * *
Institutional Investor means any of the following classes of
entities having a net worth of not less than $1 million; or of persons
having a net worth of not less than $2 million, exclusive of the value
of the equity in his or her most valuable residence, unless otherwise
specified:
(a) Entities. (1) Any State or National bank, trust company,
savings bank, or savings and loan association, including any such
institution investing the funds of others in a fiduciary capacity;
(2) Any insurance company
(3) Any 1940 Act Investment Company or Business Development
Company, as defined in the Investment Company Act of 1940, as amended;
(4) Any holding company of the foregoing;
(5) Any employee benefit or pension plan established for the
benefit of employees of the Federal government or any State, their
political subdivisions, or any agency or instrumentality thereof;
(6) Any employee benefit or pension plan, as defined in the
Employee Retirement Income Security Act of 1974, as amended;
(7) Any trust, foundation or endowment exempt from Federal income
taxation under the Internal Revenue Code, as amended;
(8) Any corporation, partnership, or other entity with a net worth
in excess of $10,000,000;
(9) Any State, its respective political subdivisions, or any agency
or instrumentality thereof;
(10) Any entity whose primary purpose is to manage and invest non-
Federal funds on behalf of any of the foregoing Institutional
Investors; or
(11) Any other entity that SBA shall determine to be an
Institutional Investor.
(b) Persons. (1)(i) Any individual with a personal net worth of
less than $2 million who is an Accredited Investor as defined by the
Securities Act of 1933, as amended, and whose commitment to the
Licensee is backed by a letter of credit from a qualified Institutional
Investor;
(ii) Any individual whose personal net worth (exclusive of the
value of his or her most valuable residence) is equal to not less than
ten times the amount of his or her commitment; or
(iii) Any individual whose personal net worth (exclusive of the
value of any equity in his or her most valuable residence) equals or
exceeds $10 million: Provided, however, That the commitment of any
individual who is not a permanent resident of the United States shall
also be backed by an irrevocable appointment of an agent within the
United States for the service of process.
(2) See paragraph (b) of the definition of Private Capital for
restrictions on the amount of an Institutional Investor's commitment
that will be recognized by SBA as a part of a Licensee's Private
Capital. See also the definition of Regulatory Capital in Sec. 107.3,
and Sec. 107.241(c).
* * * * *
Leverageable Capital means Regulatory Capital, excluding unfunded
commitments and qualified non-private funds whose source is Federal
funds.
* * * * *
Private Capital--(a) General. Private Capital means the combined
private (non-governmental) paid-in capital and paid-in surplus of a
Corporate Licensee, or the private (non-governmental) partnership
capital of an Unincorporated Licensee, plus unfunded binding
commitments by an Institutional Investor (including commitments
evidenced by a promissory note) to purchase stock or limited
partnership interests in, or to make capital contributions to a
Licensee. The private paid-in capital and paid-in surplus of a
Corporate Licensee, or the private partnership capital of an
Unincorporated Licensee, may include funds invested by a public or
private pension fund; and qualified nonprivate funds as described in
paragraph (c) of this definition. Notwithstanding the foregoing, non-
cash assets purchased by a license applicant and non-cash assets
contributed to a Licensee or a license applicant will not be considered
part of Private Capital, except as permitted by Sec. 107.705(a) (1)
through (6), or unless approved by SBA.
(b) Exclusions. Private Capital shall not include:
(1) Funds borrowed by a Licensee from any source,
(2) Leverage funds obtained as a result of SBA's purchase or
guarantee of securities,
(3) Funds obtained directly or indirectly from any Federal, State,
or local government, or agency or instrumentality thereof, unless such
funds are qualified nonprivate funds, or
(4) That part of a commitment from an Institutional Investor with a
net worth of less than $10 million that exceeds 10 percent of such
Institutional Investor's net worth, except to the extent that such
excess is backed by a letter of credit from another Institutional
Investor.
(c) Qualified nonprivate funds. ``Qualified nonprivate funds''
means:
(1) Funds directly or indirectly invested in any Licensee on or
before August 16, 1982 by any Federal agency except SBA, pursuant to a
statute explicitly mandating the inclusion of such funds in ``Private
Capital'';
(2) Funds directly or indirectly invested in any Licensee by any
Federal agency pursuant to a statute that is enacted after September 4,
1992, explicitly mandating the inclusion of such funds in ``Private
Capital'';
(3) Funds invested in any Licensee by any State or local government
entity, including the amount of any guarantee extended by such entity;
and
(4) In any section 301(d) Licensee or such applicant, funds
invested which are income derived from the investment of grants that
have been made by a state or local government agency or instrumentality
into a nonprofit corporation or institution exercising discretionary
authority with respect to such funds; and funds invested by a State
financing agency, or similar agency or instrumentality, to the extent
such funds are derived from such agency's income and not from
appropriated State or local funds; Provided, however, that for any
Licensee or applicant, the funds described in paragraph (c)(3) of this
definition shall not exceed 33% of Regulatory Capital.
* * * * *
Qualified Borrowing means a loan to a Licensee bearing interest at
a rate not in excess of the usual rate charged on the date of the loan
by banks in the locality in which the Licensee's principal office is
located; and/or a Debenture purchased or guaranteed by SBA. See
Sec. 107.302.
* * * * *
Regulatory Capital.--(a) General. Regulatory Capital means Private
Capital, excluding non-cash assets contributed to a Licensee or a
license applicant and non-cash assets purchased by a license applicant
unless such assets have been converted to cash or have been approved by
SBA for inclusion in Regulatory Capital. For purposes of this
definition, sales of contributed non-cash assets with recourse or
borrowing against such assets shall not constitute a conversion to
cash.
(b) Exclusions. The amount of a commitment, the collectibility of
which SBA determines to be questionable, shall also be excluded from
Regulatory Capital.
* * * * *
Section 301(c) Licensee means an SBIC organized as a for-profit
corporation, a limited liability company or a limited partnership
organized in accordance with Sec. 107.4, and licensed pursuant to
section 301(c) of the Act.
Section 301(d) Licensee means an SBIC organized as a for-profit
corporation, a non-profit corporation, a limited liability company or a
limited partnership organized in accordance with section 107.4, and
licensed pursuant to section 301(d) of the Act. Such Licensees are
permitted to provide assistance only to Disadvantaged Concerns.
* * * * *
Smaller Concern means a concern that together with its affiliates
does not have net worth in excess of $6.0 million, and does not have
average net income after Federal income taxes (excluding any carry-over
losses) for the preceding two years in excess of $2.0 million; or a
concern that together with its affiliates, meets the size standard in
effect at the time of the Financing for the industry in which it is
then primarily engaged, and excluding its affiliates meets the size
standard in effect at the time of the Financing for the industry in
which it is then primarily engaged.
* * * * *
4. Section 107.4 is amended by revising paragraphs (b) (1), (2) and
(3)(i), by revising the fourth sentence in paragraph (c), and by adding
a new paragraph (f), to read as follows:
Sec. 107.4 Limited Partnership SBIC.
* * * * *
(b) Application. * * *
(1) Number of General Partners. A Licensee shall have as its
general partners at least two individuals; or one or more corporations
(including limited liability corporations), or one or more partnerships
(including limited partnerships), or any combination of individuals,
and/or corporations, and/or partnerships. General partners of a general
partner of an Unincorporated Licensee shall be considered for all
purposes to be general partners of such Licensee. For the status of
limited partners of a limited partnership that serves as a general
partner of a Licensee, see the definition of Control Person in
Sec. 107.3.
(2) General Partner. A general partner which is a corporation,
limited liability company or limited partnership (an ``Entity General
Partner'') shall be organized under state law solely for service as
such and its Articles or Certificate of Incorporation or Limited
Partnership Agreement or other similar governing instrument (which, in
each case, shall accompany the license application) shall specify that
no person shall serve as an officer, director or general partner
without SBA's approval. No Entity General Partner may serve as such for
any other Licensee and where an Entity General Partner is a limited
partnership, such partnership shall be subject to the number of general
partners defined in paragraph (b)(1) of this section. An Entity General
Partner is subject to the same examination and reporting requirements
as a Licensee under Sec. 310(b) of the Act. The restrictions and
obligations imposed upon a Licensee by Secs. 107.210 through 107.263,
and 107.601, 107.603, 107.701, 107.702, 107.703, 107.709, 107.801,
107.802, 107.803, 107.1001, 107.1002, and 107.1004 apply also to an
Entity general partner of a Licensee.
(3) Articles of Partnership. * * *
(i) The partnership shall have a minimum duration of not less than
the longer of ten years or two years following the maturity of the
last-maturing security issued by the partnership evidencing Leverage
from SBA. After 10 years and provided all Leverage has been repaid or
redeemed and provided that all amounts due SBA, its agency, or trustee
have been paid, the partnership may be terminated by a vote of the
Licensee's partners. (For purposes of this provision SBA shall not be
considered a partner.)
* * * * *
(c) Obligations of a Control Person. * * * The conditions specified
in Secs. 107.210 through 107.263 shall apply to all general partners;
the conditions specified in Sec. 107.210(e) shall apply to all Control
Persons. * * *
* * * * *
(f) Special Leverage requirement. Prior to the extension of any
Leverage, an Unincorporated Licensee shall furnish SBA with evidence
that it qualifies as a partnership for tax purposes, either by a ruling
from the Internal Revenue Service, or by any opinion of counsel.
5. Section 107.101 is amended by revising paragraph (a), by
redesignating paragraphs (d) and (e) as paragraphs (e) and (f), by
adding a new paragraph (d), by revising the introductory text of newly
designated paragraph (e), and by adding new paragraphs (g), (h) and
(i), to read as follows:
Sec. 107.101 Operational requirements.
* * * * *
(a) Management. Each Licensee shall have and maintain qualified
management (or an Investment Adviser/Manager pursuant to Sec. 107.709)
in charge of its operations who will be available during normal
business hours to the public. Any manager of a Licensee shall be deemed
an officer thereof. When applying for a license or for Leverage, a
Licensee must demonstrate, to the satisfaction of SBA, that its
management has the knowledge, experience and capability necessary for
investing in the types of businesses contemplated by the Act, these
regulations, and Licensee's Plan of Operations. Neither management, nor
any board of directors, nor any general partner shall be controlled
either directly or indirectly by investors of qualified non-private
funds.
* * * * *
(d) General capital requirements. Each company shall have at
licensing, and thereafter shall maintain Regulatory Capital adequate to
assure a reasonable prospect that the company will be operated soundly
and profitably over the long term, and managed actively and prudently
in accordance with its articles or partnership agreement and within the
context of its Plan of Operations, as approved by SBA. In this regard,
SBA shall determine the ability of the company to be economically
viable, both prior to licensing and prior to approving any request for
financing, taking into consideration the income and losses which the
company anticipates on its Loans and Investments, and the experience
and qualifications of the company's owner's and managers. Compliance
with these requirements shall be determined within the context of
capital impairment and other regulations that relate to safety and
soundness.
(e) Minimum Capital. Any company licensed after April 8, 1994 shall
have Regulatory Capital in U.S. dollars sufficient to meet the
requirements of paragraph (d) of this section, but in no case shall a
Licensee have Regulatory Capital (not including commitments to invest
in a Licensee) less than the following minimum levels:
* * * * *
(g) Valuation guidelines and responsibility. (1) Each Licensee
shall adopt a written Valuation Policy for its use in determining the
value of its Loans and Investments, and each applicant for a License
shall submit such Policy as part of its application. Such Policy shall
adhere to the provisions of Appendix III. The boards of directors of
corporations and the general partners of partnerships shall have sole
responsibility for adopting the Licensee's valuation policy and,
pursuant thereto, for valuing Loans and Investments of such Licensee.
Loans and Investments shall be valued individually and in the aggregate
by the Board of Directors or General Partners at least semiannually--as
of the end of the second quarter of Licensee's fiscal year and as of
the end of Licensee's fiscal year, Provided however, That Licensees
without Leverage need only perform valuations as of the end of the
fiscal year. On a case-by-case basis, SBA may require valuations to be
made more frequently.
(2) Licensee shall forward valuation reports to SBA within 90 days
of the end of the fiscal year in the case of annual valuations, and
within thirty days following the close of other reporting periods.
Material changes in valuations shall be reported not less often than
quarterly within thirty days following the close of the quarter.
(3) Only valuations performed as of the fiscal year-end are
required to be reviewed by the Licensee's independent public
accountant. Such accountant shall have responsibility to review the
Licensee's valuation procedures and the implementation of such
procedures, including adequacy of documentation. Such accountant also
shall have reporting responsibilities regarding the results of this
review (see Appendix I, section III and section V, paragraphs I and J).
(4) Any Licensee that adopts the exact wording of those parts of
section III of Appendix III, entitled ``Valuation Policy'', that are
set in bold type, without any additions or changes will be presumed to
have an acceptable Valuation Policy. A Licensee may write a policy
which differs from the bold type, but must have such policy approved by
SBA, in writing. Applicants for either a 301(c) or 301(d) license must
submit their Valuation Policies for approval as part of the licensing
application process.
(h) Computer requirements. By June 30, 1994 all Licensees shall
have a personal computer facility with modem capable of running
software provided by SBA and person(s) trained in the use of SBA-
provided software and shall electronically transmit information and
reports as required by SBA. Such Licensees shall use such software for
the purpose of reporting specific financial information required by
SBA.
(i) Financing of Smaller Concerns. As of the close of the
Licensee's first full fiscal year commencing on or after April 8, 1994,
at least 10 percent of the cumulative dollar amount of Financing
extended during the period between April 8, 1994 and the close of such
fiscal year shall consist of Financings of Smaller Concerns. As of the
close of each subsequent fiscal year, the cumulative dollar amount of
Financing extended to Smaller Concerns shall be no less than 20 percent
of the total dollar amount of Financing extended since April 8, 1994.
Unless a Licensee is in compliance with the requirements of this
paragraph, Financing may be extended only to a Smaller Concern. A
Financing extended pursuant to Sec. 107.711 in which the resulting
concern qualifies as a Smaller Concern will be considered a Financing
of a Smaller Concern.
6. Section 107.103 is revised to read as follows:
Sec. 107.103 Public notice.
SBA shall publish notice of the license application in the Federal
Register. It shall include such appropriate information as the name and
location of the proposed Corporate Licensee, its area of operation, the
names and addresses of its officers, directors, and owners of, or
persons controlling 10 or more percent of its voting stock; and in the
case of an Unincorporated Licensee, its name, location, and area of
operation, and the names and addresses of its Control Persons. If any
Control Person is a corporation, the notice shall set forth the names
and addresses of any officers, directors, and owners of, or persons
controlling 10 percent or more of the stock of such corporation. In the
case of an Unincorporated Licensee, the notice shall also include the
name and address of each owner of 10 percent or more of the Licensee's
Regulatory Capital. The public shall be afforded reasonable opportunity
for the submission of written comments. The proposed Licensee shall
publish a similar notice in a newspaper of general circulation in the
city or proposed area of operation, and shall furnish a certified copy
to SBA within 10 days of the date of publication.
7. Section 107.302 is revised to read as follows:
Sec. 107.302 Cost of money; loans and debt securities.
Subject to lower ceilings prescribed by local law, Cost of Money on
Loans and Debt Securities shall not exceed the higher of the following:
(a) Loans. The higher of either the Licensee's certified Weighted
Average Cost of Qualified Borrowings, computed in accordance with
paragraph (e) of this section, or the current Debenture Rate, plus, in
either case, 7 percentage points, rounded off to the next lower eighth
of one percent; Provided, however; That if the current Debenture Rate
is 8 percent per annum or lower, a Licensee is permitted to charge up
to 15 percent.
(b) Debt securities. The higher of either the Licensee's certified
Weighted Average Cost of Qualified Borrowings, computed in accordance
with paragraph (e) of this section, or the current Debenture Rate,
plus, in either case, 6 percentage points, rounded off to the next
lower eighth of one percent; Provided, however; That if the current
Debenture Rate is 8 percent per annum or lower, a Licensee is permitted
to charge up to 14 percent.
(c) Maximum Cost of Money. The maximum Cost of Money on any
specific Financing shall be determined with reference to either the
Licensee's certified Weighted Average Cost of Qualified Borrowings or
the Debenture Rate in effect as of the day the Licensee collects a
processing fee or enters into a Commitment, or makes the first
disbursement, whichever shall first occur.
(d) Effective date. The Cost of Money limitation in effect on April
24, 1994 shall remain applicable to all Financings committed or
disbursed on or before that date.
(e) Computation of Weighted Average Cost of Qualified Borrowings.
Licensee's Weighted Average Cost of Qualified Borrowings (as a percent)
shall be computed as follows:
TR08AP94.000
where:
W=Weighted Average Cost of Qualified Borrowings
A=Dollar amount of Interest on Qualified Borrowings still outstanding
at the end of the prior fiscal year, as found on Form 468. (SSBICs are
presumed to have paid interest at the coupon rate, without regard to
any subsidy payments by SBA)
P=Outstanding principal amount of Qualified Borrowings at the end of
the prior fiscal year, net of related fees
D=Days outstanding for prior fiscal year
i=Individual Note, Debenture, or other debt instrument
n=Number of Notes, Debentures, or other debt instruments outstanding at
end of fiscal year
=sum of
This equation is read as: Multiply the principal balance (net of
Leverage fees) of each Note, Debenture, or other debt instrument still
outstanding at the end of the preceding fiscal year by the number of
days that the instrument was outstanding in that fiscal year and divide
this product by 365; take the sum of these amounts and divide that sum
into total interest expense for those Qualified Borrowings still
outstanding at the end of the fiscal year; finally multiply the
resulting number by 100.
(f) Notification of Weighted Average Cost of Qualified Borrowings.
A Licensee that wishes to utilize its Weighted Average Cost of
Qualified Borrowings as the basis of an alternative COM ceiling for its
next succeeding fiscal year shall transmit a written certification of
its Weighted Average Cost of Qualified Borrowings to SBA as a part of
its Annual Financial Report (SBA Form 468) for the prior fiscal year;
provided however, that where such licensee provides Financing using the
Weighted Average Cost of Qualified Borrowings before submitting its
Annual Financial Report, such Licensee shall submit its certified
Weighted Average Cost of Qualified Borrowings as an attachment to the
SBA Form 1031 for each such financing. Such Weighted Average Cost of
Qualified Borrowings shall be reviewed by the Licensee's independent
public accountant, who shall provide a certification that the Weighted
Average Cost of Qualified Borrowings was calculated in accordance with
SBA's regulations. Failure to submit timely a certified Weighted
Average Cost of Qualified Borrowings in such manner shall constitute a
binding waiver of Licensee's right to use its Weighted Average Cost of
Qualified Borrowings as the basis for an alternative Cost of Money
limitation for the remainder of the Licensee's fiscal year, unless for
good cause shown, SBA grants written approval for its use.
(g) Application of Weighted Average Cost of Qualified Borrowings to
Financings Involving Multiple Licensees. (1) If two or more Licensees
participate in the same Financing of a Small Concern, the basis for
determining the applicable COM ceiling shall be the highest of any of
the following:
(i) The current Debenture Rate; or
(ii) The certified Weighted Average Cost of Qualified Borrowings of
the lead Licensee in the Financing; or
(iii) The weighted average of the Weighted Average Cost of
Qualified Borrowings of all Licensees participating in the Financing.
(2) For the purposes of the calculation in paragraph (q)(1)(iii) of
this section, the Weighted Average Cost of Qualified Borrowings of a
Licensee that has not certified such cost to SBA or that has no
outstanding Qualified Borrowings shall be the Debenture Rate in effect
at the time of the Financing.
(h) Default Penalties. In the event of a monetary default by a
Small Concern or a failure to provide any post-Financing report or
other document required by the terms of the Loan Agreement or SBA
regulations, Licensees may, by way of default penalty and without
regard to any Cost of Money limit that may otherwise be applicable,
raise the interest rate by as much as seven percentage points over the
rate specified in the Financing, until such time as the default shall
be cured.
8. Section 107.303 is amended by revising paragraph (a), by
redesignating paragraph (b) as paragraph (c), by adding a new paragraph
(b), and by revising the newly designated paragraph (c) introductory
text, (c)(6) and the example that follows newly designated paragraph
(c)(7), to read as follows:
Sec. 107.303 Overline limitation.
(a) Leveraged Licensees. Without written SBA approval, the
aggregate amount of funds disbursed for securities acquired (exclusive
of write-down), and of Commitments and guaranties issued for a Small
Concern (including affiliated concerns as defined in Sec. 121.401 of
this chapter) shall not exceed twenty percent of a Licensee's
Regulatory Capital: Provided, however, That for section 301(d)
Licensees the limitation shall be thirty percent.
(b) Non-Leveraged Licensees. Any Licensee that does not have
outstanding Leverage shall be exempt from this section; Provided,
however, that no Leverage will be extended to any Licensee until such
Licensee is in compliance with paragraph (a) of this section.
(c) Increased Limit. For purposes of this section only, Regulatory
Capital may include the net unrealized gains of a Licensee represented
by marketable securities and support an additional overline limitation
(increased limit) subject to the following conditions:
* * * * *
(6) By availing itself of this increased limit, Licensee agrees
that, in the event the net unrealized gains show a reduction on the
first business day of any calendar quarter and for at least thirty days
thereafter, below seventy percent of the net unrealized gains, Licensee
will (not later than ninety (90) days from such date) cause to be
injected sufficient Regulatory Capital to restore support for the
increased limit or reduce the increased limit of its investments to a
point at which no investment exceeds 20 percent of the sum of its
Regulatory Capital plus the remaining net unrealized appreciation
represented by marketable securities.
* * * * *
Example: On January 15, 1995 the Licensee documents net
unrealized gains of $100,000. Licensee adds $100,000 to its
Regulatory Capital and increases its overline limitation
accordingly. Licensee now makes one or more investments in reliance
on this increased limit. Hereafter, on each subsequent first
business day of April, July, October, and January, Licensee must
document net unrealized gains of a least $100,000. On April 15, 1996
Licensee can document further net unrealized gains for an aggregate
of $150,000 and invest pursuant to an increased limit of $30,000
(20% of $150,000). Following the first business day of April, 1997,
Licensee documents net unrealized gains of only $120,000. All
investments within the increased limit remain undiminished in the
portfolio. Licensee is now required to cause to be injected
sufficient cash into Regulatory Capital before July 1, 1997, so that
the sum of the remaining net unrealized gains and the added cash
equals at least five times the increased limit of its largest
investment. In the alternative, Licensee must reduce before July 1,
1997, its overline investments made in reliance on this subsection
so that none will exceed 20 percent of Regulatory Capital plus
$24,000. Any further reduction of net unrealized gains will require
additional proportionate injection of cash or reduction of
investments.
* * * * *
9. Section 107.304 is amended by revising the heading and
paragraphs (a)(1) and (b) and by adding paragraph (c) to read as
follows:
Sec. 107.304 Size status, financial report, and non-discrimination.
(a) * * *
(1) The Licensee has determined that the concern being assisted is
a Small Concern based on the financial size standards set forth in
Sec. 121.802(a)(3)(i) or the single industry standard covering the
industry in which the applicant Small Concern is, or will be, primarily
engaged as set forth in Sec. 121.802(a)(3)(ii); or SBA has determined
at the request of the Licensee or of such concern that the latter is a
Small Concern. The Licensee and the Small Concern shall execute SBA
Form 480, Size Status Declaration, including Licensee's representation
that applicable size standards have been met, unless the size
determination has been made by SBA.
* * * * *
(b) Financial reports.--(1) Initial Financing decision. In
considering any Financing for a Small Concern the Licensee shall
require the concern to submit such financial statements, plans of
operation (including intended use of financing proceeds), cash flow
analyses and projections as are necessary to support the Licensee's
investment decisions, considering the size and type of the business and
the amount of the Financing being considered. Such materials shall be
in English and shall be retained by, and become a part of the permanent
record of, the Licensee.
(2) Subsequent reports. The terms of the Financing shall require
each assisted Small Concern to forward to the Licensee, at least
annually, such financial statements (including verification of the use
of financing proceeds) as are necessary to verify not only the
financial condition of the Small Concern for the purpose of valuing the
Licensee's investment therein, but also the continued eligibility of
such Small Concern. Such statements shall be in English and be
certified by the chief financial officer, general partner, or
proprietor of such Small Concern and shall be retained by, and become a
part of the permanent records of, the Licensee. If the Licensee shall
deem it appropriate, considering the size and type of the business
involved, the Licensee may accept, for financial and valuation purposes
only, a complete copy of the Federal income tax return, including all
appropriate schedules thereto, filed by the business or by the
proprietor, as the case may be. The foregoing requirements shall not
apply, however, when the Licensee acquires the securities from an
underwriter in a public offering (see 107.404), in which event the
Licensee shall keep copies of all reports furnished by such Small
Concern to the holders of its securities.
(c) Economic impact. When a Licensee's Form 468 is forwarded to SBA
it shall be accompanied by an assessment of the economic impact of each
Financing, specifying the full-time equivalent jobs created or
retained, the impact of the financing on the business in terms of
expanded revenue and taxes, and other appropriate economic benefits
including, but not limited to, technology development or
commercialization, minority business development, urban or rural
business development, expansion of exports and assistance to
manufacturing firms (SIC Major Groups 20-39)
.10. Part 107 is amended by adding a new Sec. 107.305 before the
heading ``Equity Capital'' to read as follows:
Sec. 107.305 Use of proceeds.
Proceeds of financings by a Licensee shall be used by the Small
Concern for its sound financing and for its growth, modernization, or
expansion and such use shall be reported on SBA Form 1031. Accordingly,
Licensees shall obtain sufficient information to give reasonable
assurance that the proposed financing will be used for purposes
intended by the Act and this Part of the regulations. Financing
documents shall contain provisions which require the Small Concern to
provide information specified in Sec. 107.304(b), and which give the
Licensee and/or SBA access to the Small Concern's records to confirm
such use of proceeds. The Licensee shall conduct a reasonable post
closing review within 90 days after disbursement of the proceeds to
assure that proceeds were used for the intended purposes. The financing
documents shall also provide that any diversion by a Small Concern of
financing proceeds from their reported use without the Licensee's prior
written consent shall constitute an event of default when the Licensee
has made a loan or a violation of a covenant with the Licensee when the
Licensee has made an investment. The financing documents also shall
specify that such event of default or covenant violation shall give the
Licensee the right to demand immediate repayment of the financing.
Nothing in this paragraph shall be construed to restrict the Licensee's
right to sue the Small Concern for any additional damages it may
sustain as a result of the improper diversion of funds or to bring suit
against the individuals responsible for such diversion of funds. Any
unauthorized diversion that comes to the attention of a Licensee shall
be reported promptly to SBA for such action against the Small Concern
as SBA may consider proper. See also Sec. 107.906(b).
11. Section 107.401(a)(5) is revised to read as follows:
Sec. 107.401 SBIC guaranty of loans.
(a) * * *
(5) The total guaranties issued and outstanding for all Small
Concerns shall not exceed one hundred percent of Regulatory Capital.
* * * * *
12. Section 107.402 is amended by revising paragraphs (a) and (d)
and adding paragraphs (e), (f), and (g) to read as follows:
Sec. 107.402 Commitments.
(a) General. A Licensee is authorized to enter into a written
Commitment to furnish Financing to a Small Concern.
* * * * *
(d) Processing fees. A Licensee is authorized to charge a
processing fee, in no event to exceed three percent of the amount of
Financing requested: Provided, however, That if the amount of Financing
offered in response by the Licensee and agreed to by the Small Concern
is a lesser amount, the maximum processing fee may not exceed three
percent of such lesser amount. A processing fee that does not exceed
the foregoing limits shall not be considered part of the Small
Concern's Cost of Money. A processing fee that exceeds the foregoing
limits shall, to the extent of such excess, be considered part of the
Small Concern's Cost of Money.
(1) Collection of processing fee. (i) The processing fee may be
collected, in full or in part, when the Licensee accepts the Small
Concern's application for financing, or such fee may be deducted from
Financing proceeds. When the application is accepted for processing,
however, the Licensee shall furnish the applicant Small Concern with a
written statement setting forth:
(A) The maximum Cost of Money determined with reference to
Licensee's certified Weighted Average Cost of Qualified Borrowings, if
any, or the present Debenture Rate, as appropriate;
(B) A date by which Licensee will notify the applicant of its
decision; and
(C) The specific processing services to be performed by the
Licensee.
(ii) Failure to furnish such statement shall cause the amount of
any processing fee to be included in Cost of Money if the requested
Financing closes, or shall obligate Licensee to refund the entire
amount of the processing fee if the request for Financing is denied.
(2) Partial refund of processing fee when Financing does not close.
(i) No Commitment extended. If the Licensee has not provided a
Commitment and the Small Concern and the Licensee do not close the
Financing, that part of the processing fee in excess of Eligible Costs,
hereafter enumerated, that were incurred by the Licensee shall be
refunded within thirty days to the Small Concern, together with a
detailed accounting of the Eligible Costs incurred by the Licensee.
(ii) Commitment extended. If the Licensee has provided a Commitment
and the Small Concern and the Licensee do not close the Financing, any
refund of the processing fee, in whole or in part, is dependent upon
which party caused the Financing not to close, as follows:
(A) Failure to close attributable to Small Concern. If the
Financing does not close due to actions of the Small Concern, the
Licensee is entitled to retain the processing fee, not to exceed three
percent of the amount of the Licensee's Commitment. If Eligible Costs
exceed the processing fee, Licensee may obtain reimbursement for such
excess Eligible Costs only if the Small Concern has entered into a
contractual agreement providing for such reimbursement. If no such
contractual agreement exists, a Small Concern shall not be required to
pay an additional processing fee, even if the amount of the Licensee's
Eligible Costs exceed the amount of the processing fee advanced by the
Small Concern.
(B) Failure to close attributable to Licensee. If the failure to
close is attributable to actions of the Licensee, that part of the
processing fee in excess of Eligible Costs incurred by the Licensee
shall be refunded to the Small Concern within thirty days, together
with a detailed accounting of the Eligible Costs incurred by the
Licensee.
(3) Eligible costs. As used in this Section, Eligible Costs means:
(i) Actual computed costs incurred in the segregation of money to fund
a Commitment, if one was extended;
(ii) Ordinary and reasonable out-of-pocket expenses necessary to
process the application and perform due diligence, and
(iii) Actual costs paid to non-Associates of the Licensee for
specialized application processing services which are not ordinarily
performed by the Licensee.
(e) Additional fees. If the Small Concern and the Licensee close
the Financing, Licensee is authorized to deduct from the proceeds the
unpaid remainder of any processing fee previously agreed upon, not to
exceed 3 percent of the total Financing provided at the closing, and,
in addition, to charge the Small Concern for Eligible Costs incurred by
the Licensee and reasonable closing costs. Such fees and charges shall
not be included in the calculation of Cost of Money.
(f) Prepayment penalties. A Licensee may charge a reasonable
penalty for prepayment of a Financing which shall be excluded from the
Cost of Money calculation. If such prepayment penalty is considered by
SBA to be unreasonable, however, Licensee shall not be entitled to such
prepayment penalty, and if the penalty has been collected, shall refund
the entire prepayment penalty to the Small Concern. A prepayment
penalty equal to 5 percent of the outstanding balance during the first
year of any Financing, declining by one percentage point per year
through the fifth year, will be considered a reasonable penalty.
(g) Front-end charges. If a Licensee has imposed front end charges
such as points, discount, loan origination fee, a processing fee to the
extent it exceeds three percent, or other such charges, regardless of
the label the Licensee may apply, that are not specifically excluded
from Cost of Money, such charges shall be prorated over the stated term
of the Financing. In that case, the sum of interest and unearned front-
end charges shall not exceed the Cost of Money limit in effect at the
time of the Financing; and in the event of prepayment, any resulting
excess Cost of Money shall be returned to the Small Concern.
13. Section 107.403 is amended by revising paragraph (b)(1), to
read as follows:
Sec. 107.403 Other Permissible Financing.
* * * * *
(b) * * *
(1) Short-term Financing. Financing with a term of less than five
years when it constitutes:
(i) Interim financing in contemplation of long-term Financing of a
Small Concern by the Licensee or a group including the Licensee and
others in an amount at least equal to such total interim financing:
Provided, however, That the maximum aggregate period for short-term
Financing in contemplation of long-term Financing shall not exceed one
year; or
(ii) Protection of prior investments; or
(iii) Financing ownership change pursuant to Sec. 107.711; or
(iv) Financing required by a Small Concern to perform a contract
that it has been awarded under any Federal, State, or local government
set-aside program for ``minority'' or ``disadvantaged'' contractors.
This paragraph (b)(1) supplements the authority to make short term
investments in Disadvantaged Concerns under Sec. 107.301(a).
* * * * *
15. Section 107.501(c) is amended by revising the last sentence
thereof, to read as follows:
Sec. 107.501 Management services.
* * * * *
(c) Management Services Corporation. * * * Licensee's investments
in and receivables from such corporation shall not exceed 3 percent of
the Licensee's Regulatory Capital.
15. Section 107.601 is amended by revising the first sentence of
paragraph (g) and by revising paragraph (h)(1), to read as follows:
Sec. 107.601 Changes in ownership or control of Licensee.
* * * * *
(g) Public notice. SBA shall publish notice in the Federal Register
concerning the application for approval of a proposed transfer of
Control over a Licensee, including such appropriate information as the
name and location of the Licensee and of the proposed transferees who
will own ten or more percent of any class of its Regulatory Capital. *
* *
(h) Standards governing SBA approval. (1) SBA may, as a condition
of approving a proposed transfer of Control, require an increase in
Licensee's Regulatory Capital.
* * * * *
16. Section 107.705 is amended by adding a new paragraph (a)(8) to
read as follows:
Sec. 107.705 Consideration for issuance of Licensee securities.
(a) * * *
(8) With SBA's prior written approval, contributed non-cash assets:
Provided, however, That for the purposes of Secs. 107.403(b),
107.706(b), and 107.710, under which the legality of certain Financings
is conditional upon a need to protect the Licensee's investment, and
for the purpose of Sec. 107.801, under which assumption of control over
a Small Concern is permitted only to protect the Licensee's investment,
Licensees are not considered to have any investment to protect in such
contributed assets unless such assets are included in Regulatory
Capital.
* * * * *
17. Section 107.706 is revised to read as follows:
Sec. 107.706 Retention of investments.
(a) Change in size. A Licensee may retain its investment in a
concern which qualified as small at the time of initial financing, but
which subsequently became large. Subject to Sec. 107.303, additional
Financing may be provided at any time before such concern makes a
public offering of its securities. In addition, stock options,
warrants, or other rights to purchase Equity Securities of such
concern, if acquired while the concern qualified as a Small Concern,
may be exercised even after a public offering has been made.
(b) Change in business activity or ownership--(1) Change within one
year of Licensee Financing. Without SBA's written approval, a Licensee
may not retain its investment in a Portfolio Concern, small or
otherwise, that has become ineligible by reason of a subsequent change
in such concern's business activity within one year from the date of
the Licensee's initial Financing. Any such change shall be presumed to
have been within the contemplation of the Small Concern at the time of
the Licensee's Financing, and shall constitute a default or breach of
the terms of the Licensee's Financing by the Small Concern, thereby
giving the Licensee the right to demand immediate repayment of all
indebtedness and redemption of all equity investments in such concern.
See Sec. 107.305. A Licensee's request to SBA for approval to retain
its investment shall be accompanied by evidence sufficient to rebut
this presumption that the Small Concern's change to an ineligible
business activity within one year of the Licensee's Financing was
within the contemplation of the Small Concern at the time the Licensee
provided Financing and, hence, in violation of applicable regulations.
Such presumption may be rebutted by a showing that the change in
business activity was prompted by an unforeseen change in
circumstances.
(2) Change more than one year after Financing; additional
Financing. If SBA has granted approval for the retention of an
investment as provided in paragraph (b)(1) of this section, or if the
change to an ineligible business has taken place more than one year
after the Licensee's initial Financing, additional Financing may be
provided to the extent necessary to protect the Licensee against the
loss of the amount of its original investment.
18. Section 107.707 is revised to read as follows:
Sec. 107.707 Purchases of securities from another Licensee or from
SBA.
A Licensee may exchange with or purchase for cash from another
Licensee, or from SBA as the receiver or assignee of another Licensee
or former Licensee, Portfolio securities (or any interest therein), but
only on a non-recourse basis, and only if:
(a) The Licensee shall not have at any time more than one-third of
its total assets (valued at cost) invested in such securities; and
(b) The Licensee, if it has previously sold Portfolio securities
(or any interest therein) on a recourse basis, shall include the amount
for which it may be contingently liable in its overline limit under
Sec. 107.303.
19. Section 107.708 is revised to read as follows:
Sec. 107.708 Deposits and investments of idle funds.
(a) General. Except as set forth in paragraphs (b) and (c) of this
section, all funds of a Licensee (other than a petty cash fund of up to
$2,000) shall be deposited without delay in an account in a federally
insured financial institution.
(b) Leveraged Licensees. (1) Funds of a Licensee with outstanding
Leverage, or that has applied for Leverage, that are not invested in
Small Concerns and not reasonably needed for its day-to-day operations
shall be invested in:
(i) Direct obligations of, or obligations guaranteed as to
principal and interest by the United States, the remaining maturities
of which do not exceed fifteen months; or
(ii) In repurchase agreements with federally insured institutions,
the maturity of which does not exceed seven days, in which the
securities being sold and repurchased shall only be direct obligations
of, or obligations guaranteed as to principal and interest by the
United States, such securities to be maintained in a custodial account
at a federally insured institution; or
(iii) In certificates of deposit maturing within one year or less
issued by a federally insured institution, up to the amount of
insurance; or
(iv) In a deposit account in a federally insured institution, up to
the amount of the insurance, subject to a withdrawal restriction not to
exceed one year;
(2) Provided, however, That funds in excess of the insured amount
may be maintained in certificates of deposit or a deposit account in a
federally insured institution which is deemed to be ``well
capitalized'' in accordance with the definition set forth in
regulations of the Federal Deposit Insurance Corporation, as amended
(12 CFR 325.103); and Provided, further, That nothing in this paragraph
shall be interpreted to forbid the temporary deposit, not to exceed 30
days, of Licensee's funds in excess of the insured amount in a
federally insured institution in a transfer account established to
facilitate the receipt and disbursement of funds or to hold funds
necessary to honor Commitments issued by the Licensee. For the purposes
of this paragraph (b) a deposit in, or repurchase agreement with, a
federally insured institution that is an Associate of the Licensee
shall not be considered a Financing of such Associate if the terms of
such deposit or repurchase agreement are the same, or more favorable,
than those available to the general public.
(c) Non-Leveraged Licensees. Funds of an unleveraged Licensee that
are not invested in Small Concerns and not reasonably needed for its
day-to-day operations and exempt from the provisions of paragraph (b)
of this section, but nothing contained in this paragraph shall be
deemed to authorize any Licensee to Finance an Associate in violation
of Sec. 107.903, or to engage in any other activity prohibited by this
part. No Leverage will be extended to any Licensee until such Licensee
is in compliance with paragraph (b) of this section. For purpose of
this paragraph, a Licensee's deposit of funds in a federally insured
institution that is an Associate of the Licensee is not considered a
Financing of an Associate under Sec. 107.903.
20. Section 107.710 is amended by revising paragraph (b)(3), to
read as follows:
Sec. 107.710 Assets in liquidation.
* * * * *
(b) Preservation of assets. * * *
(3) In addition to the amounts authorized by paragraphs (a) and (b)
of this section, a Licensee may make the following required
expenditures allocable to such assets in an aggregate amount which,
together with its total investment attributable thereto, and its
expenditures pursuant to paragraphs (a) and (b) of this section do not
exceed 35 percent of its Regulatory Capital, except as specifically
approved in writing by SBA: Prior mortgage interest; principal
payments; taxes and necessary insurance coverage.
* * * * *
21. Section 107.711 is revised to read as follows:
Sec. 107.711 Financing changes of ownership.
(a) General. A Licensee may finance a change of ownership in a
Small Concern when it will promote the sound development or preserve
the existence of the Small Concern; or will assist in creation of a
Small Concern as a result of a corporate divestiture, or facilitate
ownership in a Disadvantaged Concern.
(b) Special size standard; debt/equity ratios. In determining
whether the existence of a Small Concern has been preserved, or whether
a Small Concern has been created as a result of a divestiture, the
Licensee must make an assessment of the concern as though the change of
control had been accomplished, giving effect to all contemplated
financings, mergers, and acquisitions.
(1) Concerns with not more than 500 employees. Such Financings
shall be permitted where the resulting concern has been determined to
be small (see Sec. 107.304(a)(1)) and its full-time equivalent
employment does not exceed 500 employees.
(2) Concerns with more than 500 employees. If the full-time
equivalent employment exceeds 500 employees, the Financing will only be
permitted when the concern meets one of the following debt/equity ratio
tests:
(i) If the Financing is provided by a Licensee with outstanding
Leverage, the Concern's ratio of debt to equity is no more than 5 to 1;
(ii) If the Financing is provided by a Licensee with no outstanding
Leverage, the Concern's ratio of debt to equity is no more than 8 to 1.
(iii) As used herein, ``debt'' means long-term debt, including
contingent liabilities, but exclusive of accounts payable, short-term
working capital loans which require that the Concern have no
outstanding balance for at least 30 consecutive days during its fiscal
year, operating leases, letters of credit and subordinated notes
payable to the seller, and any other liabilities approved by SBA on a
case-by-case basis; and ``equity'' means common and preferred stock in
the case of a corporation, or contributed capital in the case of a
partnership.
22. Section 107.712 is amended by revising the first sentence of
paragraph (c) to read as follows:
Sec. 107.712 Section 301(d) Licensee wholly or partly owned by
Licensee companies.
* * * * *
(c) Capital contribution. The capital contribution of a participant
Licensee in excess of the minimum capital ($1,500,000, which shall be
in cash or cash equivalents, in U.S. dollars) of the section 301(d)
Licensee, may (notwithstanding Sec. 107.705(a)) be represented by
securities of Small Concerns eligible for investment by a section
301(d) Licensee, at cost or value, whichever is lower. * * *
* * * * *
23. Section 107.901(a) is amended by revising the last sentence
thereof to read as follows:
Sec. 107.901 Prohibited uses of funds.
No funds may be provided to a Small Concern:
(a) Relending, reinvesting, etc. * * * Without SBA's prior written
approval, all Financings pursuant to this proviso shall not exceed the
Licensee's Regulatory Capital as of the close of any full fiscal
year.\8\
---------------------------------------------------------------------------
\8\1940 Act Companies are reminded that sections 12(d) (2) and
(3) of that Act impose additional restrictions on certain
investments otherwise permitted by this Sec. 107.901(a).
---------------------------------------------------------------------------
* * * * *
24. Part 107 is amended by adding, at the end thereof, a new
Appendix III, to read as follows:
Appendix III to Part 107--Valuation Guidelines for SBICs
I. Introduction
This appendix describes the policies and procedures to which
Licensees (SBICs and SSBICs) must conform in valuing their Loans and
Investments and provides guidance as to the techniques and standards
which are generally applicable to such valuations.
The need for clearly defined valuation policies and procedures
and understandable techniques arises in connection with the
requirement that Licensees report the worth of their portfolios to
investors and SBA. This information assists SBA in its assessment of
the overall operational performance and financial condition of
individual Licensees and of the industry.
II. Overall Guidelines
A. Definitions
1. Asset Value means the amount that the general partners or
board of directors of an SBIC have established as a current value in
accordance with its Valuation Policy.
2. Marketable Securities means securities for which market
quotations are readily available and the market is not ``thin'',
either in absolute terms, or relative to the potentially saleable
holdings of the Licensee and other investors with saleable blocks of
such securities. These securities are valued as follows:
(a) For over-the-counter stocks, taking the average of the bid
price at the close for the valuation date and the preceding two
days, and
(b) For listed stocks, taking the average of the close for the
valuation date and the preceding two days. This classification does
not include securities which are subject to resale restrictions,
either under securities laws or contractual agreements, although
other securities of the same class may be freely marketable.
3. Other Securities means all Loans and Investments not defined
in paragraph A.(2) of this section. Such securities shall be valued
at Asset Value. Most SBIC and SSBIC investments will fall in this
classification.
4. Valuation Policy means the official document of a Licensee
that definitively sets forth the Licensee's methods of valuing Loans
and Investments in accordance with the requirements of Sec. 101(g)
and this appendix.
B. Objective
The goal of a Licensee's valuation process is to value its Loans
and Investments. However, the very nature of Licensees' investments
sometimes makes the determination of fair market value
problematical. In most cases there is no market for the investment
at the time of valuation. Therefore, except where market quotations
are readily available and the markets are not ``thin'', the Boards
of Directors or General Partners are necessarily responsible for
determining in good faith the value of Loans and Investments.
Determination of value will depend upon the circumstances in
each case. No exact formula can be devised that will be generally
applicable to the multitude of different valuation issues that will
arise. This is especially true for semiannual valuation updates of
relatively new investments for which current results either exceed
or do not meet the Small Concern's forecasts. A sound valuation
should be based upon all of the relevant facts, with common sense
and informed judgment influencing the process of weighing those
facts and determining their significance in the aggregate.
C. General Considerations
The Asset Value of Loans and Investments will depend upon the
circumstances of each individual case and will be based upon the
nature of the asset and the stage of a company's existence.
In negotiating the terms and conditions of an investment with a
Small Concern, the Licensee, in effect, establishes an initial
valuation for the investment, which is cost. Cost shall be the Asset
Value until there is a basis to increase or decrease the valuation.
Unrealized appreciation should be recognized when warranted, but
should be limited to those investments that have a sustained
economic basis for an increase in value. Temporary market
fluctuations or a temporary increase in earnings should not be the
cause or sole reason for appreciation.
Unrealized depreciation should be recorded when portfolio
companies show sustained unfavorable financial performance.
Continuous close scrutiny of Loans and Investments will provide
insight into the business cycles and problems encountered by small
business concerns. This insight will allow the Licensee to
differentiate between a temporary downturn or setback and a long-
term problem indicating a measurable decline in Asset Value.
When a decline in Asset Value appears permanent, a complete or
partial write-off of the asset (i.e., recording a realized loss
rather than unrealized depreciation) should occur. Some of the more
obvious indications of permanent impairment of an investment include
the termination of business operations, a petition for bankruptcy
protection or liquidation, or the absence of a verifiable forwarding
address of the business or its proprietor(s). Less obvious
situations may include the loss of major revenue accounts, the shut
down of a critical distribution channel, an adverse legal or
regulatory ruling, or the expiration of a priority claim on
collateral in a distressed Small Concern. These and other possible
circumstances should be assessed on a case-by-case basis, with
supporting documentation on file.
D. Valuation Responsibility
As specified in 13 CFR 107.101(g), the Licensee's Board of
Directors or General Partners have the sole responsibility for
determining Asset Value. In determining Asset Value, the Board of
Directors or General Partners must satisfy themselves that all
appropriate factors relevant to a good faith valuation have been
considered and that the methods used are reasonable and prudent and
are consistently applied. Although the Board of Directors or General
Partners have the ultimate responsibility for determining Asset
Value, they may appoint management or other persons to assist them
in such determinations and to provide supporting data and make the
necessary calculations pursuant to the Board's or General Partner's
direction. It is essential that a careful, conservative, yet
realistic approach be taken by Licensees in determining the Asset
Value of each Loan and Investment.
As part of the annual audit of the Licensee's financial
statements, the Licensee's independent public accountant has
responsibility to review the Licensee's valuation procedures and
implementation of such procedures including adequacy of
documentation. The independent public accountant also has reporting
responsibility regarding the results of this review. (See appendix I
to this part, section III and section V, paragraphs I and J).
E. Frequency of Valuation
Loans and Investments shall be valued individually and in the
aggregate by the Board of Directors or General Partners at least
semiannually--as of the end of the second quarter of Licensee's
fiscal year and as of the end of Licensee's fiscal year, Provided
however, That Licensees without Leverage need only perform
valuations once a year. On a case-by-case basis, SBA may require
valuations to be made more frequently. Only valuations performed as
of the fiscal year-end are required to be reviewed by the Licensee's
independent public accountant, as discussed in paragraph D. of this
section. Each Licensee shall forward a valuation report to SBA
within 90 days of the end of its fiscal year in the case of annual
valuations, and within thirty days following the close of other
reporting periods. Material changes in valuations shall be reported
not less often than quarterly within thirty days following the close
of the quarter. Since the valuations will only be as sound as the
timeliness of the financial information upon which they are based,
Licensees shall require frequent financial statements from Small
Concerns. Monthly financial statements are normally appropriate.
F. Written Valuation Policy
Each Licensee shall establish a written Valuation Policy
approved by its Board of Directors or General Partners that includes
a statement of policies and procedures that are consistent with
section III of this appendix.
G. Documentation
Each Licensee shall prepare and retain in its permanent files a
valuation report as of each valuation date documenting, for each
portfolio security, the cost, the current Fair Value and the
previous Fair Value, plus the methodology and supporting data used
to determine the value of each such portfolio security. The minutes
of meetings of Boards of Directors or General Partners at which
valuations are determined will contain a resolution confirming that
the valuations of each portfolio security were determined in
accordance with Licensee's duly adopted valuation procedures and
will incorporate by reference the valuation report signed by each
Director or General Partner along with any dissenting valuation
opinions.
H. Instructions
In section III below, certain sentences are in bold type and
others are in regular type. Those sentences that are in bold type
generally should be included in the Valuation Policy of each
Licensee. However, this exact wording is not mandatory and may be
modified, substituted, added to, or omitted. Sentences in regular
type are commentary provided by SBA that need not be included in a
Licensee's Valuation Policy, but may be adapted, if desired.
I. Approval
1. Any Licensee that utilizes the exact wording of Section III
that is set in bold type, without any additions, deletions, or
changes will be presumed to have an acceptable Valuation Policy.
However, it is acknowledged that this wording may not be directly
applicable to all Licensees, and if a Valuation Policy by an
existing Licensee is written which differs from the bold type,
approval by SBA, in writing, of the Valuation Policy must be
obtained. If changes from the bold type are minor, it is suggested
that the Licensee indicate deletions with a caret (caret) and
underline additions.
2. Applicants for either a 301(c) or 301(d) License must submit
their Valuation Policies for approval as part of the licensing
application process.
III. Valuation Policy
A. General
1. The Board of Directors [General Partners] have sole
responsibility for determining the Asset Value of each of the Loans
and Investments and of the portfolio in the aggregate.
2. Loans and Investments shall be valued individually and in the
aggregate at least semi-annually--as of the end of the second
quarter of the fiscal year-end and as of the end of the fiscal year.
[* * * at least annually--as of the end of the fiscal year.] Fiscal
year-end valuations are audited as set forth in 13 CFR part 107
appendix III, section II, paragraph D.
3. This Valuation Policy is intended to provide a consistent,
conservative basis for establishing the Asset Value of the
portfolio. The Policy presumes that Loans and Investments are
acquired with the intent that they are to be held until maturity or
disposed of in the ordinary course of business.
B. Interest-Bearing Securities
1. Loans shall be valued in an amount not greater than cost with
Unrealized Depreciation being recognized when value is impaired. The
valuation of loans and associated interest receivables on interest-
bearing securities should reflect the portfolio concern's current
and projected financial condition and operating results, its payment
history and its ability to generate sufficient cash flow to make
payments when due.
2. When a valuation relies more heavily on asset versus earnings
approaches, additional criteria should include the seniority of the
debt, the nature of any pledged collateral, the extent to which the
security interest is perfected, the net liquidation value of
tangible business assets, and the personal integrity and overall
financial standing of the owners of the business. In those instances
where a loan valuation is based on an analysis of certain
collateralized assets of a business or assets outside the business,
the valuation should, at a minimum, consider the net liquidation
value of the collateral after reasonable selling expenses. Under no
circumstances, however, shall a valuation based on the underlying
collateral, be considered as justification for any type of loan
appreciation.
3. Appropriate unrealized depreciation on past due interest
which is converted into a security (or added to an existing
security) should be recognized when collection is doubtful.
Collection is presumed to be in doubt when one or both of the
following conditions occur:
(i) Interest payments are more than 120 days past due; or
(ii) The small concern is in bankruptcy, insolvent, or there is
substantial doubt about its ability to continue as a going concern.
a. Licensees may rebut this presumption by providing evidence of
collectibility satisfactory to SBA. Such evidence may include the
existence of collateral, the value of which has been verified
through an appraisal by an independent professional appraiser
acceptable to SBA. Such an appraisal shall be at liquidation value
(net of liquidation costs) and shall have been performed within the
12 months immediately preceding the valuation date. In considering
whether collateral provides an appropriate basis for valuations, SBA
will review the Licensee's operating history for evidence concerning
its willingness and ability to pursue available remedies (including
foreclosure) in default situations.
b. For those Licensees primarily involved in making loans, the
use of a loan classification system is strongly encouraged to help
manage portfolios and determine Asset Values, with loans that
warrant extra attention being flagged by SBIC management. Such a
``watch list'' can also be used to report to the Board of Directors
or General Partner(s). For each loan placed on the watch list, a
reason or statement should describe the particular situation. Danger
signals that should alert the SBIC to potential problems include
delinquency, a lack of profitability, weak or decreasing equity,
increasing debt load, a deteriorating cash position, an abnormal
increase in accounts payable, inaccurate financial information,
insurance cancellation, judgments and tax liens, family problems,
loss of employees, collateral problems, slowdown in inventory
turnover, poor maintenance of plant and equipment, and heavy
reliance on short term debt.
c. Upon careful consideration of all the relevant factors, the
Board of Directors or General Partners shall determine which loans
require recognition of Unrealized Depreciation. It is a good rule of
operation for an SBIC to perform downward valuations earlier rather
than later. When the quality of a loan recovers, a higher Asset
Value may subsequently be assigned.
4. The carrying value of interest bearing securities shall not
be adjusted for changes in interest rates.
5. Valuation of convertible debt may be adjusted to reflect the
value of the underlying equity security net of the conversion price.
a. Accepted methods for valuing convertible debentures generally
involve one of two approaches. The first approach views the
debenture as a debt obligation. Under this approach, the SBIC or
SSBIC should utilize the loan valuation techniques described in this
section above. The second approach considers the conversion of all
convertible securities of the same class into their common stock
equivalent, taking into account dilution, and a subsequent valuation
of the SBIC's or SSBIC's proportionate equity interest. Valuation of
this equity interest should follow the equity valuation techniques
described in Paragraph C. of this section.
b. Normally, the reported value is the higher of these two
alternatives. However, Licensees should disregard higher equity
values and retain lower debt-based valuations if there are
circumstances which make conversion undesirable. When equity
considerations govern the Asset Value assigned, all underlying
factors should be disclosed.
C. Equity Securities--Private Companies
1. Investment cost is presumed to represent value except as
indicated elsewhere in these guidelines.
2. Valuation should be reduced if a company's performance and
potential have significantly deteriorated. If the factors which led
to the reduction in valuation are overcome, the valuation may be
restored.
3. The anticipated pricing of a Small Concern's future equity
financing should be considered as a basis for recognizing Unrealized
Depreciation, but not for Unrealized Appreciation. If it appears
likely that equity will be sold in the foreseeable future at a price
below the Licensee's current valuation, then that prospective
offering price should be weighed in the valuation process.
4. Valuation should be adjusted to a subsequent significant
equity financing that includes a meaningful portion of the financing
by a sophisticated, unrelated new investor. A subsequent significant
equity financing that includes substantially the same group of
investors as the prior financing should generally not be the basis
for an adjustment in valuation. A financing at a lower price by a
sophisticated new investor should cause a reduction in value of
prior securities.
5. If substantially all of a significant equity financing is
invested by an investor whose objectives are in large part
strategic, or if the financing is led by such an investor, it is
generally presumed that no more than 50% of the increase in
investment price compared to the prior significant equity financing
is attributable to an increased valuation of the company.
6. Where a company has been self-financing and has had positive
cash flow from operations for at least the past two fiscal years,
Asset Value may be increased based on a very conservative financial
measure regarding P/E ratios or cash flow multiples, or other
appropriate financial measures of similar publicly-traded companies,
discounted for illiquidity. Should the chosen valuation cease to be
meaningful, the valuation may be restored to a cost basis, or in the
event of significant deterioration in performance or potential, to a
valuation below cost to reflect impairment.
a. Under these conditions, valuation factors that may be
considered, include:
(1) The utilization of a multiple of earnings, cash flow, or
revenues, which are commensurate with the multiples which the market
currently accords to comparable companies in similar businesses and
industries, with an appropriate discount for conditions such as
illiquidity or a minority position. Care should be taken to use only
comparable companies, including not only business similarities but
also similarities as to size, financial condition, and earnings
outlook. However, in order for comparative market prices to be
meaningful, data for a representative sample or similar companies
must be available.
(2) Among the more important factors to be considered in a
particular case are (i) The nature of the business, (ii) the risk
involved, and (iii) the growth, stability or irregularity of
earnings and cash flows. A company with a positive earnings trend
and a favorable outlook may command a capitalization factor
(multiplier) in the marketplace that will result in a stock
valuation well above book value. When the gross value of a small
concern is computed by applying a capitalization rate to pre-
interest, pre-tax earnings, the value of equity securities is
derived by subtracting the outstanding debt of the concern from the
gross value. While capitalization rates do vary, an appropriate rate
can be determined by analyzing rates for comparable companies in the
same industry. Investigating similar companies in the same industry
or geographic area can be done directly or through published
material from sources such as the Value Line, Standard and Poor's,
Robert Morris and Associates, or any other of the numerous sources
available for comparative industry data.
(3) Another method discounts the present value of estimated
future proceeds to a Licensee including dividend income and sales of
securities, using a discount rate that reflects the degree of risk
of the equity interest.
(4) One may also utilize the recent sale prices of comparable
blocks of the issuer's securities in arm's length transactions.
b. Equity interests or limited partnership interests without the
benefit of stock certificates and which generally define a certain
percentage of the profits to be allocated to each of the investors
based on its relative contributions should be valued in a manner
similar to the valuation methods described in this section.
7. With respect to portfolio companies that are likely to face
bankruptcy or discontinue operations for some other reason,
liquidating value may be employed. This value may be determined by
estimating the realizable value (often through professional
appraisals or firm offers to purchase) of all assets and then
subtracting all liabilities and all associated liquidation costs.
a. Liquidation value will depend on the decreasing value of
wasting assets, the costs experienced by the business being
liquidated, the expenses borne by the Licensee in order to be able
to realize any liquidating value, the elapsed time until such net
proceeds can be realized, the ranking of the Licensee's claims
relative to other security interests and subordination agreements,
and the probability of any ultimate realization of value.
b. Incorporating this approach as a normal step in valuation can
provide improved understanding of the downside of an investment.
c. Licensees should recognize unrealized appreciation or
depreciation, as appropriate, on Assets Acquired in liquidation of
Loans and Investments. In order to recognize Unrealized
Appreciation, asset values must be verified by an appraisal which
meets all the conditions specified in the preceding paragraph;
provided, however, that if the assets acquired constitute a going
concern, such assets may be appraised as a going concern rather than
at liquidation value. Unrealized Appreciation may not be recognized
if the Licensee does not benefit from such appreciation. For
example, an asset acquired through foreclosure should not be carried
at a value greater than the defaulted loan balance plus any expenses
and penalties to which the Licensee is entitled.
8. Warrants should be valued at the excess of the value of the
underlying security over the exercise price.
a. Valuation of debt with detachable warrants can be done
similarly to convertible debt by treating the debt and warrants as a
unit, or, alternatively, the debt can be valued on its own basis as
a debt instrument, and the warrants separately. If the warrants are
valued separately, the following factors must be taken into account:
(1) Current value of issued shares.
(2) The differential between the exercise price and the
underlying share values if the current share values are higher than
the exercise price.
(3) Time until expiration dates are reached or dates of changes
in terms of exercise prices.
(4) Number of shares into which the warrants are exercisable on
various dates.
(5) Restrictions on sale of the underlying stock.
(6) Restrictions on the transferability of the warrants.
(7) Registration rights for the warrants or the underlying
shares.
(8) Financial ability of the Licensee to perform the exercise of
its rights or to sell it warrants.
(9) The ultimate desirability, if any, of exercising the rights
given by the warrants.
D. Equity Securities--Public Companies
1. Public securities should be valued as follows:
(a) For over-the-counter stocks, take the average of the bid
price at the close for the valuation date and the preceding two
days, and
(b) For listed stocks, take the average of the close for the
valuation date and the preceding two days.
a. However, securities are not deemed to be freely marketable in
those situations wherein such securities are very thinly or
infrequently traded, or may be lacking in truly representative
market quotations, or where the market for such securities cannot
absorb the quantity of shares which the Licensee and similar
investors may want to sell.
b. In such cases, Asset Value must be determined by the Board of
Directors or General Partners.
2. The valuation of public securities that are restricted should
be discounted appropriately until the securities may be freely
traded. Such discounts typically range from 10% to 40%, but the
discounts can be more or less, depending upon the resale
restrictions under securities laws or contractual agreements.
3. When the number of shares held is substantial in relation to
the average daily trading volume, the valuation should be discounted
by at least 10%, and generally by more.
Dated: March 1, 1994.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-7844 Filed 04-07-94; 8:45 am]
BILLING CODE 8025-01-M
