00-15421. Small Business Investment Companies

AGENCY:

Small Business Administration.

ACTION:

Proposed rule.

SUMMARY:

This proposed rule would implement a provision of Public Law 106-9, enacted April 5, 1999, under which certain types of consideration paid to a small business investment company (SBIC) by a small business are excluded from “cost of money” limitations.

DATES:

Submit comments on or before July 20, 2000.

ADDRESSES:

Address comments to Don A. Christensen, Associate Administrator for Investment, U.S. Small Business Administration, 409 3rd Street, SW, Suite 6300, Washington, DC 20416.

FOR FURTHER INFORMATION CONTACT:

Leonard W. Fagan, Investment Division, at [phone].

SUPPLEMENTARY INFORMATION:

This proposed rule would implement a provision of Public Law 106-9, enacted April 5, 1999, that amended section 308(i)(2) of the Small Business Investment Act of 1958. The amendment provided that certain types of consideration paid to an SBIC by a small business are excluded from the regulatory limitations on “Cost of Money” established by the Small Business Administration (SBA). The amendment excluded from these Cost of Money limits any consideration consisting of “contingent obligations” granting the SBIC an interest in the “equity or increased future revenue” of the small business.

To implement this change, SBA is proposing to broaden one of the exclusions from Cost of Money in § 107.855(g) and to add another. First, § 107.855(g)(12) would be revised to allow the exclusion of royalty payments for all SBIC financings. Currently, this exclusion applies only to “LMI Investments” as defined in § 107.50. To qualify for the exclusion, the royalty must be based on improvement in the performance of the small business after the date of the financing. The royalty could be expressed, for example, as a percentage of any increase in an underlying unit of measurement (e.g., revenues or sales) after the date of the financing. As discussed in the preamble to the final rule establishing the original provision for LMI Investments (64 FR 52641), the royalty can be based on an increase in more than one unit of measurement. For example, a royalty could provide for payment to the SBIC if either the revenue or the profits of the small business increased.

If an SBIC makes an investment through a holding company or an investment vehicle, as permitted under § 107.720(b), performance improvements will be evaluated in the same manner already established for LMI Investments. In determining whether a business's performance has improved, SBA will look through any holding company or investment vehicle to the performance of the operating business itself.

SBA is proposing one additional change with respect to royalty payments. In § 107.815(a), the definition of a Debt Security would be revised to include a loan with a right to receive royalties that are excluded from the Cost of Money. The effect of this change is that a financing of this type will be subject to the lower Cost of Money ceiling applicable to Debt Securities, rather than the higher ceiling applicable to Loans with no upside potential.

SBA also proposes to add § 107.855(g)(13), which would exclude from Cost of Money any gains realized by an SBIC from the disposition of Equity Securities issued by a small business. This provision has been added as a clarification, since SBA's longstanding practice has been to exclude such gains from the Cost of Money limits. For example, if an SBIC receives warrants that qualify as Equity Securities, or converts debt to an Equity Security, any gains realized on the disposition of these interests do not count against the Cost of Money ceiling.

Finally, SBA proposes to remove paragraph § 107.855(i). This paragraph allows an SBIC that is lending to a small business to receive a one-time “bonus” at the end of the loan term, contingent upon one or more factors reflecting the performance of the business during the loan period. Such bonus payments are excluded from the Cost of Money. The proposed revision of § 107.855(g)(12), which would provide a broader exclusion of contingent payments from the Cost of Money, renders the bonus provision redundant.

Compliance With Executive Orders, 12866, 12988, and 13132, the Regulatory Flexibility Act (5 U.S.C. 601, et seq., and the Paperwork Reduction Act (44 U.S.C. Ch. 35)

SBA has determined that this proposed rule does not constitute a significant rule within the meaning of section 3(f) of Executive Order 12866.

Under the Regulatory Flexibility Act, 5 U.S.C. 601, et seq., SBA has determined that this proposed rule will not have a significant economic impact on a substantial number of small entities. The purpose of the proposed rule is to implement a provision of Public Law 106-9 allowing small business investment companies (SBICs) to realize contingent payments, such as royalties, from small businesses without being subject to regulatory limits on the amount of consideration received. Interest and other non-contingent payments made to SBICs by small businesses would continue to be subject to the existing Cost of Money regulations. This provision is expected to be attractive primarily to SBICs considering investments in small businesses that are seeking to grow, but whose owners do not want to give substantial equity interests to outside investors. In such cases, the SBIC can participate in the growth of the business by collecting a royalty rather than through an ownership interest.

Based on recent statistics for the SBIC program, the circumstances that this proposed rule would address do not appear to apply to most small businesses currently receiving SBIC financing. In fiscal year 1999, SBICs provided financing to 1,983 different small businesses. In approximately two-thirds of all the financings closed during that year, the SBIC obtained an actual or potential equity interest in the small business; even if the proposed rule had been in place, it is unlikely that these transactions would have included royalty provisions. The remaining one-third of SBIC financings typically consist of loans to very small businesses with low growth potential, which are unlikely to have the ability to make royalty payments under any circumstances. Thus, it is unlikely that this proposed rule would affect a substantial number of small entities. The proposed rule is expected to expand financing opportunities for certain small businesses wishing to grow while remaining closely held, rather than make SBIC financing more expensive for small businesses currently being served by the program.

For purposes of Executive Order 12988, SBA has determined that this proposed rule is drafted, to the extent practicable, in accordance with the standards set forth in Section 3 of that Order.

For purposes of Executive Order 13132, SBA has determined that this proposed rule has no federalism implications.

For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA certifies that this proposed rule contains no new reporting or recordkeeping requirements.

List of Subjects in 13 CFR Part 107

• Investment companies
• Loan programs-business
• Reporting and recordkeeping requirements
• Small businesses

For the reasons set forth in the preamble, SBA proposes to amend 13 CFR part 107 as follows:

PART 107—SMALL BUSINESS INVESTMENT COMPANIES

1. The authority citation for part 107 continues to read as follows:

Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g and 687m.

2. In § 107.815, revise the first sentence of paragraph (a) to read as follows:

§ 107.815

Financings in the form of Debt Securities.

* * * * *

(a) Definitions. Debt Securities are instruments evidencing a loan with an option or any other right to acquire Equity Securities in a Small Business or its Affiliates, or a loan which by its terms is convertible into an equity position, or a loan with a right to receive royalties that are excluded from the Cost of Money pursuant to § 107.855(g)(12).

* * * * *

3. In § 107.855, revise paragraph (g)(12), add paragraph (g)(13), and remove paragraph (i) to read as follows:

§ 107.855

Interest rate ceiling and limitations on fees charged to Small Businesses (“Cost of Money”).

* * * * *

(g) * * *

(12) Royalty payments based on improvement in the performance of the Small Business after the date of the Financing.

(13) Gains realized on the disposition of Equity Securities issued by the Small Business.

* * * * *

Dated: June 8, 2000.

Aida Alvarez,

Administrator.