# Small Business Investment Company Investment Diversification and Growth

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2023-13981

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** July 18, 2023
- **Citation:** 88 FR 45982

## Text

SMALL BUSINESS ADMINISTRATION
13 CFR Parts 107 and 121
RIN 3245-AH90
Small Business Investment Company Investment Diversification and Growth

AGENCY:

U.S. Small Business Administration.

ACTION:

Final rule.

SUMMARY:

On October 19, 2022, the U.S. Small Business Administration (“SBA” or “Agency”) published a notice of proposed rulemaking (“NPRM” or “proposed rule”) to revise the regulations for the Small Business Investment Company (“SBIC”) program to significantly reduce barriers to program participation for new SBIC fund managers and funds investing in underserved communities and geographies, capital intensive investments, and technologies critical to national security and economic development. The proposed rule introduced an additional type of SBIC (“Accrual SBICs”) to increase program investment diversification and patient capital financing for Small Businesses, modernize rules to lower financial barriers to program participation, and incorporate the statutory requirements of the Spurring Business in Communities Act of 2017, which was enacted on December 19, 2018. This final rule implements proposed regulatory changes as modified to address comments SBA received.

DATES:

This rule is effective August 17, 2023.

FOR FURTHER INFORMATION CONTACT:

Policy:
Bailey G. DeVries, Associate Administrator of the Office of Investment and Innovation, Small Business Administration,
oii.frontoffice@sba.gov,
202-941-6064. This phone number can also be reached by individuals who are deaf or hard of hearing, or who have speech disabilities, through the Federal Communications Commission's TTY-Based Telecommunications Relay Service teletype service at 711.

Regulatory Comments/
Federal Register
Docket:
Nathan Putnam, Office of Investment and Innovation, Small Business Administration,
oii.frontoffice@sba.gov,
202-699-1746. This phone number can also be reached by individuals who are deaf or hard of hearing, or who have speech disabilities, through the Federal Communications Commission's TTY-Based Telecommunications Relay Service teletype service at 711.

SUPPLEMENTARY INFORMATION:

I. Background Information

A. Small Business Investment Company Program

The mission of the SBIC program is to enhance small business access to capital by stimulating and supplementing “the flow of private equity capital and long-term loan funds which small-business concerns need for the sound financing of their business operations and for their growth, expansion, and modernization, and which are not available in adequate supply.” SBA carries out this mission by licensing and monitoring privately owned and managed investment funds that raise capital from private investors (“Private Capital”) and issue SBA-guaranteed Debentures (“Debentures”) to make private long-term equity and debt investments into qualifying Small Businesses.

SBA currently has two types of Debentures available for private funds that have received an SBIC license: a current pay (or “Standard”) Debenture and a “Discount” Debenture. The vast majority of licensed SBICs applying for SBA Leverage use the Standard Debenture with a ten-year maturity and interest due and payable on a semi-annual basis. This structure aligns with the cash flows of a subset of private fund strategies, including funds with mezzanine, private credit, and leveraged buyout strategies because private funds utilizing such mezzanine, private credit, or leveraged buyout strategies typically generate fund-level cash liquidity within the time period required to meet semi-annual interest payments. The Discount Debenture is issued at a steep discount to face value and accrues to face value over five years, at which time SBICs must pay current interest; this Debenture is only available for low and moderate income (LMI) investments and Energy Saving Qualified Investments (as defined in 13 CFR 107.50). Although SBICs have invested almost 20% of their investments in LMI areas, as of December 31, 2021, less than 0.5% of Debentures committed and issued since Fiscal Year (“FY”) 2000 used the Discount Debenture to make such investments. No SBIC has used the Discount Debenture for Energy Saving Qualified Investments. Market feedback suggests that the reason SBICs do not utilize the Discount Debenture is due to the steep discount at issue and the misalignment of the required interest payments commencing at year five to the typical cash flow patterns of patient capital investors, such as long-duration private equity funds. Between FYs 1994 through 2004, SBA was authorized to issue Participating Securities, which were an SBIC Program instrument designed to support equity investors. The program ceased due to losses in that program.

Based on SBA's analysis of SBICs licensed for the legacy Participating Securities instrument, SBA found widespread evidence that participating security SBIC losses were largely due to the instrument's statutorily mandated structural flaws and regulations which enabled high risk portfolio construction decisions. These issues were further exacerbated by macro-economic conditions, concentration in early-stage venture (which, at the time, was an emerging alternative investment strategy), and pervasive information asymmetry in the venture market in the early 2000s. One of the major flaws in the participating security was that SBA advanced interest payments (known as “prioritized payments”) on behalf of the Licensee and was only repaid out of the Licensee's profits. Since over half of these SBICs were not profitable, less than half of the $2.8 billion in prioritized payments advanced by SBA were reimbursed by SBICs licensed in the Participating Securities program. Due to the complexities associated with the statutory Participating Securities distribution waterfall, computing a single distribution required a significant amount of time and effort on the part of the Licensee and SBA. For example, Licensees were required to file hard copies of the computation documents with SBA for regulatory monitoring and examination purposes. These complications increased the workload on SBA to calculate each distribution, increased fund administration expenses for the Licensee, and created loopholes whereby Licensees could sequence profits distributions such that SBA would receive only its capped share of profits (typically less than 10%). In several cases, private investors received substantial returns based on early profit distributions and the SBIC would subsequently incur losses, resulting in SBA being the only party not fully repaid. Further, Licensees in the Participating Securities program typically did not have diverse portfolios and SBA did not consider portfolio diversification at the fund-of-fund level as a means to mitigate risk, an important consideration in modern portfolio theory. As a result, about half of the participating securities financings prior to 2001 were in computers, information technology, and related professional technical services. Additionally, almost half of the participating securities financings prior to 2001 were in companies under two years of age at first financing. As a result, when the

“dot com” bubble financial downturn arrived in 2000, the SBIC portfolio was not appropriately diversified for sustained portfolio financial performance.

Between October 1, 2016, and September 30, 2021, SBICs provided over $29 billion in financings to Small Businesses. However, only 18 percent of Debenture SBIC financings were in the form of patient capital equity investments, and less than a quarter of SBICs licensed were focused on equity. Over 75 percent of all financings of Small Businesses by Debenture SBICs included a debt component. During this same timeframe, SBA licensed 116 SBICs with almost $7.8 billion in initial Private Capital, and two-thirds of licenses were approved for subsequent funds from asset management firms that had previously received an SBIC license. As of December 31, 2021, SBA had 298 operating SBICs across 207 asset management firms with almost $35 billion in Regulatory Capital and Debentures, including undrawn commitments.

B. Notice of Proposed Rulemaking

The Small Business Investment Act of 1958, as amended (the “Act”) declares to be the policy of the Congress and the purpose of the Act to improve and stimulate the national economy in general and the small-business segment thereof. The Act states as the intention of Congress “financial assistance under this Act, when practicable, priority be accorded to small business concerns which lease or purchase equipment and supplies which are produced in the United States” and “financial assistance provided hereunder shall not result in a substantial increase of unemployment in any area of the country.” The Act further authorizes the SBA Administrator “to prescribe regulations governing the operations of small business investment companies.”

On October 19, 2022, SBA proposed changes to 13 CFR part 107 (87 FR 63436) to reduce barriers to program participation for new SBIC fund managers and funds investing in (i) underserved communities and geographies, (ii) capital intensive investments, and (iii) technologies critical to national security and economic development. This rule also was intended to implement Executive Order (“E.O.”) 13985, Advancing Racial Equity and Support for Underserved Communities Through the Federal Government, by reducing financial and administrative barriers to participation in the SBIC program and modernizing the program's license offerings to align with a more diversified set of new funds investing in underserved small businesses. Changes included (1) implementing a new type of Debenture (“Accrual Debenture”) designed to align with the cash flows of long-term, equity-oriented funds (“Accrual SBICs”); (2) revising the existing prohibited investment requirements under 13 CFR 107.720 that permit SBICs to invest in relenders or reinvestors under specific circumstances; (3) modernizing the licensing, operations, and examinations rules to lower costs and administrative barriers faced by new funds applying to the SBIC program; (4) implementing a formal licensee “Watchlist” process; (5) implementing a consistent approach to investor and SBA distributions; (6) implementing some of the modernization improvements it received through a
Federal Register
notification (82 FR 38617) and round tables in 2017; and (7) formally implementing the Spurring Business in Communities Act, Public Law 115-333.

C. Comments

SBA received 15 comment letters related to the proposed rule or the SBIC program and two comments that were not related to the proposed rule or the SBIC program. Those comments that addressed the content of the proposed rule or were pertinent to the rule are discussed in the Section-by-Section Analysis below. Some of the comments related to the SBIC program were not directly within the scope of the rule but are briefly addressed below.

Comments Related to the SBIC Program But Not Directly Within Scope of the Proposed Rulemaking

Three comments focused on the timeline of the SBIC licensing process, a matter addressed in the context of applicants from Underlicensed States within proposed changes to 13 CFR 107.300. One comment focused on whether anticipated approval timeframes for applicants who have successfully raised Private Capital could be shortened. Two comments focused on how an expedited licensing process would be valuable and how a clear, defined, expedited timeline could be critical to increasing underserved fund manager applications. In response to these comments, SBA intends to move forward with two courses of action: (1) introduce an expedited subsequent fund licensing process for eligible applicants while maintaining current risk management standards and practices (see discussion of Expedited Subsequent Fund licensing in section II.D. and revisions to 13 CFR 107.305, below), and (2) modify standard operating procedures to increase transparency in the licensing process and decrease potential tail-end delays.

One commenter recommended an amendment to 13 CFR 107.501 requiring SBA to publish in the
Federal Register
the names of SBICs that were licensed and the dates on which SBICs were licensed. SBA appreciates this recommendation and will publish license approvals in the
Federal Register
within 30 business days of the end of the month in which the license was approved by the SBA Administrator.

One commenter encouraged SBA to underscore the importance of operational capability to the SBIC program by adopting an exclusion from the management fee offset requirement for fees paid by portfolio companies to operations teams aligned formally with an SBIC licensee. SBA agrees that operating partners, venture partners, portfolio services teams and venture studio models provide valuable technical assistance and networking for SBIC portfolio concerns. SBA recognizes the management fee offset (including fees for services provided to portfolio concerns) is often negotiated between private funds and their limited partners and will approve the scope and type of services included or excluded from management fee offsets during the licensing process. Upon licensure, an SBIC Licensee must adhere to the scope of the approved management fee plan.

One commenter suggested, in pursuit of increased fund manager diversity, that SBA create new programs that help Licensees, particularly new Licensees, increase their chances of success while gaining valuable experience. SBA agrees with the posture of “field-building” and seeks to do so in this final rule through (a) reducing regulatory restrictions on investments in reinvestors and (b) the introduction of the Accrual Debenture, both of which will enable access to capital to more first-time and emerging fund managers through SBIC fund-of-funds strategies.

One commenter suggested putting processes in place for SBICs to collect and share data of entrepreneurs obtaining capital disaggregated by gender, race, and ethnicity. SBA agrees that transparency into the demographics, as well as more detailed geographic data, of portfolio concerns and licensees will enable greater public understanding of the SBIC program impact. As such, SBA is making modifications to existing data collections that enable voluntarily reporting of this information from licensees and their portfolio concerns.

One commenter suggested SBA work more closely with limited partners

(investors in SBICs) and share SBIC program financial returns information, as it could help first-time and emerging managers raise more Private Capital. SBA agrees with this comment. As such, SBA is considering modifications to the existing Form 468 to consistently collect industry standard investment performance metrics including Total Value to Paid-in Capital, Distributed to Paid-in Capital, Residual Value to Paid-in Capital, and Gross and Net Internal Rate of Return on a quarterly and annual basis. This will enable SBA to publicly report on the investment performance of the overall SBIC portfolio, by vintage year, investment strategy and emerging vs. established SBIC funds. SBA will not publicly disclose the investment returns of individual Licensees.

One commenter suggested SBA create a diversity working group which would include SBA staff, principals of SBIC Licensees, and industry participants. This working group would support the stated efforts of SBA to recruit a more diverse set of managers to the SBIC program. SBA agrees with the substance of this comment and believe that this can be addressed through the Agency's recently announced Federal Advisory Committee (the SBA Investment Capital Advisory Committee) established under the Federal Advisory Committee Act.

One commenter requested SBA consider rule changes now and in the future that would further encourage the SBIC program to focus on technology and tech-driven companies which address critical national priorities, including addressing climate change, strengthening supply chains, improving health outcomes, and bolstering national security. SBA agrees with the substance of this comment. The program-wide diversification rules support prioritization of undercapitalized industries and technologies, particularly those aligned to seeding, scaling and transitioning technologies critical to U.S. national security.

One commenter expressed support for SBA's proposed rule extending the affiliation exceptions under 13 CFR 121.103(b)(5) to private equity partnerships organized as a 3(c)(7) funds. The commentator also referenced a 2015 comment letter concerning 13 CFR 107.720(b) and suggested further modification to SBA's passive business investment rule. SBA does not intend to change the passive investment rules.

One commenter supports a rule that lowers barriers and advances racial equity and asks that the rule consider opportunities to support emerging managers. SBA agrees with the substance of this comment and is implementing several program modernizations to support this objective including removal of “reinvestment” restrictions which prohibit Section 301(c) Licensees from investing in a fund-of-funds capacity in emerging managers, scaled licensing fees, and reductions in administrative burdens.

One commenter suggested SBICs licensed under the proposed rule should be allowed to participate to a limited degree (10-15 percent of the total invested into a company) in secondary sales—
i.e.,
supplementary funding provided at financing for purposes other than funding the operations of a Small Business. SBA agrees this has become a standard industry practice. Current regulations do not restrict partial secondary sales from current investors in future financing rounds.

One commenter proposed an additional change to the definition of Leverageable Capital by suggesting a definition change to the sum of Regulatory Capital, excluding unfunded commitments, and the greater of $0 or 50 percent times the total of the financed investments made by the Licensee less the Leverage provided by SBA and Regulatory Capital, excluding unfunded commitments. SBA appreciates this suggestion and notes that SBA is revising the definition of Regulatory Capital to be more explicit regarding how to interpret the exclusion clause. As such, SBA is revising the
exclusion of questionable commitments
to clarify that an unfunded commitment may be questionable due to lack of enforceable legal agreements under United States law or an issue of collectability for financial or any other reason, or both. SBA notes that the unfunded commitment of an investor that has satisfied the applicable net worth test set forth in the definition of Institutional Investor will not be of questionable collectability (for financial reasons) if the Licensee's Limited Partnership Agreement (or other governing agreement) contains sufficient remedies against defaulting investor to ensure collection. Furthermore, SBA is revising the definition of
Regulatory Capital
to highlight the distinction between Regulatory Capital and Leverageable Capital—
i.e.,
that Regulatory Capital which is not in the form of unfunded commitments is Leverageable Capital.

General Comments About the Rulemaking

One commenter asked why the proposed rule refers to October 1, 2023, several times. SBA is removing the reference to October 1, 2023, except with respect to implementation of the minimum Annual Charge. One commenter suggested that SBA follow this comment period with an “Interim Final Rule” instead of a final rule. SBA has followed the Federal rulemaking and comment process. During the 60-day public comment period, SBA raised awareness for the proposed rule through events noted on the
Federal Register
. (
See, e.g.,
87 FR 68109) The comments received by SBA are robust and significant relative to historical rulemaking feedback received on regulations governing the SBIC program. SBA is confident that the robust engagement from the public enables the agency to publish and implement a final rule.

One commenter stated that they are supportive of increased “underserved” focus. SBA appreciates support for the increased focus on underserved communities and industries.

II. Section by Section Analysis

A. Section 107.50 Definition of Terms

In the proposed rulemaking, SBA proposed adding two terms associated with the new Accrual Debenture discussed in section I.B. of this rule: “Accrual Debenture” and “Accrual Small Business Investment Company (“Accrual SBIC”).” The Accrual Debenture means a Debenture issued at face value that accrues interest over its ten-year term, where SBA guarantees all principal and unpaid accrued interest. As discussed in the preamble, SBA believes that the Standard Debenture does not align with the cash flows needed for patient capital strategies primarily investing in the equity of or providing revenue-based financing to Small Businesses.

One commenter supported the introduction of Accrual Debenture SBICs and administrative changes to facilitate access for first-time fund managers. SBA appreciates this support for the Accrual Debenture financial instrument and administrative changes to facilitate access.

Two commenters supported expansion of the asset classes and strategies of private funds participating in the SBIC program, yet had concerns about incorporating “highly risky, very long-term, early investments which may span 10-15 years before failure or success are determined.” There were additional comments regarding the management and oversight of taxpayer exposure to potential defaults and losses in the SBIC Program. One commenter urged SBA to publicly produce the distribution models displaying how the SBIC program will maintain a zero-subsidy rate with the addition of an

alternative debenture instrument to the existing semi-annual interest payment debenture instrument. SBA appreciates the public's concern for portfolio risk management and credit risk management processes in a Federal credit program. Among others, risks in private investing come in many forms. including illiquidity risk, duration risk, volatility risk, concentration risk, credit risk, and tail-event risk. Over several decades, SBA has found that illiquidity risk, duration risk, and strategy concentration risk correlate with the highest risk of overall program losses. The Accrual Debenture instrument combined with the portfolio diversification rules address these three primary risk considerations through cash flow matching, duration and repayment management, and guardrails to prevent the overall program from over-concentrating in more volatile `risk-on' strategies. As with all private fund investments, proper investment and operational due diligence and ongoing portfolio monitoring is essential to safeguarding capital.

Three comments remarked on the control provisions related to Accrual SBICs. One comment was concerned that by excluding control equity funds from securing licenses for the Accrual Debenture, SBA will hamper its ability to achieve the goals of the SBIC program noting that allowing control equity strategies will reduce the overall risk of the new Accrual class. Another comment encouraged SBA to include buyout funds in Accrual SBICs by removing the restriction that they are required to own less than 50 percent at the time of initial financing. SBA also received a comment noting that strict requirements may limit the universe of investible companies and interest from investors and suggested that SBA further study the potential impact of these requirements. Finally, two comments raised general concerns around the provision that Accrual SBIC licensees will generally own no more than 50 percent of the Small Business at initial Financing. SBA agrees with the recommendation to encourage more private markets flexibility and dynamism with the adoption of the Accrual Debenture instrument. As such, SBA is removing both the language in the proposed rule which restricted ownership of a portfolio concern at the time of initial Financing to less than 50% and the guidance that at least 75% of financing by an Accrual SBIC be classified as equity. SBA's objective with the introduction of the Accrual Debenture is to offer a financial product aligned to investment strategies with longer duration and strategies with more episodic distributions to investors. The introduction of the Accrual Debenture instrument is intended to ensure that SBA can support the full spectrum and the dynamic nature of private market investments in Small Businesses. Between the existing Standard Debenture and the Accrual Debenture instrument, SBA will increase program flexibility for greater private market participation resulting in increased benefits to small businesses. One comment stated that the increase in the oversight that the rule implements would result in costs to the taxpayer or increased fees. That commenter further noted that fee changes should consider rising interest rates and that when capital is drawn incrementally, taxpayer losses associated with rising inflation and interest rates are reduced. SBA has taken such factors into account in the program subsidy model which includes the President's Economic Assumptions. The model forecasts interest rates based on macro-economic conditions. Interest rates are set at the time of funding draws which mitigates risk of future taxpayer losses.

One commenter expressed concerns that the nature of the repayment terms of the Accrual Debenture could pose the same type of issues that resulted from the Participating Securities program. SBA performed extensive analysis and modeling of the historical defaults, repayments, recoveries and losses across Debenture instruments and the Participating Securities instrument when preparing the proposed rulemaking.

The following table summarizes preliminary modeling outputs for anticipated fiscal year cohort 2024 Accrual SBIC commitments.

SBIC type

Fiscal year
cohort

Lifetime
defaults (% of
disbursements)

Lifetime
recoveries (%
of defaults)

Net loss
rate (% of
disbursements)

Accrual
2024
35.78
67.77
11.53

SBA assumes a higher default risk profile and net loss rate for anticipated Accrual Debenture Leverage compared to Standard Debenture leverage. This assumption is supported by an analysis of third-party private equity industry data and historical SBIC debenture performance data. Because accrued interest and leverage is repaid as profit distributions become available, SBA considered how fund performance will impact the expected loss rate on Accrual Debentures. SBA therefore estimated distribution to paid-in capital (DPI) and total value to paid-in capital (TVPI) assumptions for the Accrual SBIC population using custom venture capital and private equity benchmarks relevant to anticipated Accrual SBIC funds. These distributional assumptions are fed into a cash flow engine to estimate leverage repayments and defaults for anticipated Accrual SBIC Leverage commitments. SBA estimates the terminal DPI distribution for Accrual SBIC funds in the table shown below. The median terminal DPI assumption is just above the forecasted breakeven point to repay all accrued interest and leverage (approximately 1.20). SBA forecasts defaults on funds assumed to have a DPI at debenture maturity below the forecasted breakeven point.

Metric

10th
percentile

25th
percentile

50th
percentile

75th
percentile

90th
percentile

DPI
0.26
0.68
1.26
1.98
3.62

After blending forecasted cash flows for anticipated Accrual and Standard SBIC leverage and factoring in the estimated composition of debenture leverage by fund type (Accrual vs. Standard), SBA forecasts a 0.00 percent subsidy rate in the debenture program. To maintain a 0.00 percent subsidy rate in the debenture program, SBA estimates an annual fee charge landing between the annual charge implemented for fiscal years 2022 and 2023.

Further, SBA has taken several steps to mitigate risk to the program, such as limiting the leverage available to

individual Accrual SBICs to one and one quarter tiers of leverage in relation to their Leverageable Capital and modifying the distribution waterfall for Accrual Debenture SBICs to ensure that SBA receives distributions on accrued interest and pro rata on principal with distributions to the private investors. SBA retains the ability to take action for regulatory defaults including uncured capital impairment, which remains vital to protecting U.S. taxpayer dollars.

The Accrual Debenture instrument is based on the successful features of the existing Debenture instrument with modifications to the distribution waterfall and timing of interest payments to reduce the risk of default and losses. The requirement for pro rata distributions to SBA is specifically designed to avoid the repayment issues that occurred in the Participating Securities program which included a flawed time-based return metric that enabled Participating Securities Licensees to pay a minimum amount to SBA and then forego future distributions if the SBIC subsequently performed poorly.

After consideration of all public comments, SBA has modified the final rule to state that the Accrual Debenture will only be available to Accrual SBICs and Reinvestor SBICs, defined in § 107.720, to align with the types of long-duration growth investing they primarily perform. Standard SBICs may only issue Standard Debentures and Discount Debentures. Approval to operate as an Accrual SBIC or Reinvestor SBIC is subject to SBA's investment due diligence, credit procedures, and statutory limitations. The final rule defines an Accrual SBIC as a Section 301(c) Licensee that elects at the time of licensing to issue Accrual Debentures. SBA expects that Accrual SBICs will most commonly be formed as limited partnerships that are subject to 13 CFR 107.160. These regulations will limit the Accrual Debenture to SBICs that focus on stimulating and supporting the creation and growth of Small Businesses.

A limitation of the Accrual Debenture is the amount of SBA leverage available to Accrual SBICs and Reinvestor SBICs. In order to determine the maximum amount of leverage that Accrual SBICs and Reinvestor SBICs may have outstanding, SBA will aggregate the total principal leverage plus ten years of accrued interest on such principal to determine the total Accrual Debentures that the Accrual SBIC may issue based on the statutory limitation. For example, if an Accrual SBIC has $100 million in Regulatory Capital, the total Accrual Debenture principal it may be approved for may be only $118 million if the forecast interest would accrue to approximately $57 million over a ten-year timeframe at a four percent interest rate, since higher amounts would result in SBA guaranteeing outstanding leverage amounts in excess of $175 million, the current statutory maximum for Leverage available to a single Licensee. SBIC applicants will be required to identify whether they intend to use Standard or Discount Debentures or if they intend to use the Accrual Debenture as an Accrual SBIC or Reinvestor SBIC.

SBA proposed modifying the definition of “Associate” regarding the status of an entity Institutional Investor based on its ownership interest in a Licensee. Currently an entity Institutional Investor whose ownership represents over 33 percent of the Licensee's Private Capital is considered an “Associate”. SBA is revising regulations to change this to 50 percent or more to align with the financing practices of Community Development Corporations and other institutional investors seeking patient capital investment funds and first-time funds. Under the proposal, an entity Institutional Investor, as a limited partner in a partnership Licensee, will not be considered an Associate solely because that entity's investment in the Partnership, including commitments, represents 10 percent or more but less than 50 percent of the Licensee's Private Capital, provided that such investment also represents no more than five percent of the entity's net worth.

One commenter asked whether the definition of Associate is applicable to all types of SBICs and expressed reservations around financing practices misalignment between taxpayer-guaranteed Federal programs and not-for-profit community development corporations, which often focus heavily on real estate and affordable housing. SBA clarifies that the definition of Associate is applicable to all SBICs. Notwithstanding the focus of any type of potential Licensee, SBA regulations already restrict financings to certain real estate businesses. (See 13 CFR 107.720(c)) Moreover, SBA carefully evaluates the proposed investment strategy of each license applicant to ensure conformance with SBA regulations.

One commenter raised the potential unintended consequences of increasing, within the definition of Associate, the threshold percentage under which an entity Institutional Investor will be considered an Associate (from 33 percent to 50 percent) including the risk of giving a single investor nearly full control over governance matters including future amendments to a licensee's limited partnership agreement (LPA). The commenter recommended SBA withdraw the amendment and retain the current 33 percent threshold or, if it is raised, not increase beyond 35 percent. SBA seeks to increase regulatory flexibility through this final rule. The increased ownership threshold is a reflection of this principle. SBA appreciates that investors hold different governance and investment policy expectations which often must be agreed to by fund managers in order to receive a funding commitment. To protect the interests of limited partners in SBICs licensed prior to a final rule, SBA asserts this rule change
only
applies to funds licensed after the rule is implemented. Limited partners can align with the principals of SBICs on investor concentration and rights through their limited partnership agreement.

The proposed rule defined the term “Annual Charge” that is currently defined as “Charge” under current 13 CFR 107.50. SBA is implementing this change because this is typically the term used to refer to the annual fee associated with SBA-guaranteed Leverage in both SBA's website and much of its documentation, and more appropriately refers to the recurring payment associated with this Leverage fee. SBA will maintain the term “Charge” in its regulations for backwards compatibility, but indicate it has the same meaning as “Annual Charge”. Currently, the term “Charge” is defined as the annual fee on Leverage issued on or after October 1, 1996. Since there is no outstanding Leverage issued prior to October 1, 1996, this language will be removed from the definition. The current definition also states that the Leverage is subject to the terms and conditions set forth in § 107.1130(d). This final rule adds a reference to § 107.585. Although current § 107.585 identifies restrictions regarding reductions in Regulatory Capital (which are typically performed in conjunction with a distribution to its private investors), this final rule expands § 107.585 to define new distribution requirements for Accrual SBICs issuing Leverage. (See § 107.585 later in this final rule.) The final rule adopts the definition substantially as proposed.

SBA proposed amending the definition of “Control Person” under § 107.50 to clarify what constitutes a controlling relationship over a Limited Partnership Licensee with a government sponsored non-profit management company relationship. Section 107.50 is amended to state that when over 30

percent of the Private Capital managed by the Licensee comes from unaffiliated and unassociated entities (outside of their association as an investor in the Licensee), the management company of the Licensee is a government sponsored non-profit entity and the general partner(s) of the Licensee are bound by a fiduciary duty to the investors in the Licensee, the management of the Licensee can be determined to be free from outside control.

One commenter noted it would be helpful to the public if SBA would (i) provide an example or examples of situations that meet the proposed definition of “Control Person”, and (ii) provide additional information in the rule that explains how changing the definition of “Control Person” does not further lessen SBA's control of Licensees, which exists with the current definition of “Control Person”. SBA respectfully notes that it does not exert control over Licensees. SBA further notes that as set forth in 13 CFR 107.305, appropriate evaluation and risk mitigation measures including but not limited to: due diligence, background checks, review of governance documents, transferee's liability contract and applicant certifications etc. are in place to ensure that SBA has properly evaluated any persons exerting control over Licensees.

Another commenter noted licensees or anchor funds that seek intentional or known future ownership of small businesses appears to be outside the intention or Statement of Policy by Congress in the Small Business Investment Act of 1958 for capital supplementation to small businesses versus control and ownership of small businesses. The SBA could not substantiate the commenters interpretation based on the Small Business Investment Act of 1958 and adds that permissive SBIC control of portfolio concerns for up to seven years is a longstanding principle of the program. The final rule adopts the definition substantially as proposed. In the proposed rulemaking, SBA sought public input for any suggested changes to “Equity Capital Investments” that SBA should consider. One commenter suggested that SBA adopt the definition of “qualifying investment[s]” for a venture capital fund from 17 CFR 275.203(l)-1 (Rule 203(l)-1 under the Investment Advisers Act of 1940) (or a substantially similarly definition). SBA will continue to maintain its definition of “equity capital investments.” The proposed rule included under § 107.50 the terms “Final Licensing Fee” and “Initial Licensing Fee,” as these terms have been defined in § 107.300 and used in § 107.410. The final rule adopts the definition substantially as proposed.

The proposed rule defined the term “GAAP” as “Generally Accepted Accounting Principles” as established by the Financial Accounting Standards Board (FASB), which refer to financial accounting and reporting standards for public and private companies and not for profit organizations in the United States. The U.S. Securities and Exchange Commission has recognized the financial accounting and reporting standards of the FASB as “generally accepted” under section 108 of the Sarbanes-Oxley Act. SBA is defining this term as the final rule refers to GAAP in various locations in the regulations.

SBA proposed amending the term “Leverage” to remove the inclusion of “Participating Securities” and “Preferred Securities” which are no longer available in the SBIC program and no longer outstanding in operating SBICs. While SBICs with outstanding Participating Securities Leverage remain in the Office of SBIC Liquidation, those Licensees are subject to the regulations at the time that Leverage was issued. SBA also is amending the term Leverage to clarify that Leverage and SBA's guarantee would apply to both the principal and unpaid accrued interest associated with the Accrual Debenture. This definition will clarify SBA's guarantee in relation to the new security and the Leverage maximum restrictions regarding Accrual Leverage. For example, SBA will not approve Accrual Debentures for an amount in which the principal balance and ten years of accrued interest are projected to exceed the statutory maximum for leverage available to any single licensee (currently $175 million). This definition also clarifies the total capital that SBA is guaranteeing at any time. For example, if an Accrual SBIC had $20 million principal in Accrual Debentures that accrued $4 million in interest, SBA's guarantee would be $24 million, as SBA's guarantee extends to the accrued interest. SBA is required under statute to guarantee both principal and interest on outstanding leverage. This final rule requires SBA to estimate the interest rate associated with any Accrual Debenture commitment in a conservative manner to ensure that the total capital that SBA guarantees does not exceed its overall authority set forth in the Act or other applicable Federal laws.

SBA proposed the terms “Leveraged Licensee” and “Non-leveraged Licensee” in § 107.50. Current regulations provide greater flexibility to Licensees that do not have outstanding Leverage and do not intend to issue leverage since SBA has no credit risk. This final rule will provide further benefits and flexibility to such Licensees. In order to simplify the regulations, Leveraged Licensees would include any Licensee with outstanding Leverage, Leverage commitments, Earmarked Assets (which are only associated with Licensees that issued Participating Securities), and any Licensee that intends to issue Leverage in the future. The intent of the certification is to ensure that SBA applies the appropriate scrutiny to any Licensee that intends to seek Leverage in the future. This regulation is not intended to prohibit subsequent SBIC funds from seeking Leverage. This final rule also defines Non-leveraged Licensee as a Licensee that has no outstanding Leverage or Leverage commitment, certifies (in writing) that such Licensee will not seek Leverage throughout the life of the fund, and has no Earmarked Assets. For example, if ABC, LP has outstanding Leverage of $10 million and subsequently (a) fully repays its outstanding Leverage, (b) has no further Leverage commitments, (c) has no Earmarked Assets, and (d) certifies that it will not seek any Leverage in the future, ABC, LP would be considered a Non-leveraged Licensee, even if the management company of ABC, LP also has a Leveraged Licensee (ABC II, LP) with outstanding Leverage of $20 million. As another example, if DEF, LP is granted an SBIC License and certifies to SBA (in writing) that it does not intend to issue Leverage, SBA would consider DEF, LP to be a Non-leveraged Licensee. This final rule adds the proposed terms substantially as proposed.

In the proposed rule, SBA proposed to define the term “Qualified Line of Credit” to describe a form of secured borrowing which would be available to leveraged licensees under § 107.550(c). Considering the matter further, SBA decided to use the more descriptive term “Capital Call Line” to align with industry terminology and to better describe what is essentially the same type of borrowing to be permitted under § 107.550(e). (See section II.I. of this rule.)

SBA proposed changing regulations to modify the term “Retained Earnings Available for Distribution” to include the acronym “READ” and to clarify that READ distributions must be performed in accordance with the proposed § 107.585. This final rule adopts the modification and clarifies that READ distributions must be performed in accordance with the revised § 107.585.

SBA proposed changing regulations to add the terms “SBIC” or “Small Business Investment Company” to have the same meaning as Licensee. SBA uses the terms “SBIC” and “Licensee” interchangeably throughout the regulations and in its policies and documents. SBA also proposed changing regulations to add the term “SBIC website” as
www.sba.gov/sbics,
which is the public website that SBA maintains all information on the SBIC program, including all standard operating procedures, policies, SBIC forms, and any reports that SBA publishes from time to time. Regulations refer to this site throughout the regulations. This final rule adopts the changes as proposed.

The proposed rule added the terms “State” and “Underlicensed State” in § 107.50 to support implementation of Public Law 115-333 which gives priority in Licensing to applicants headquartered in Underlicensed States with below median SBIC financing. The term “State” will be defined to include all fifty States, the Commonwealth of Puerto Rico, the District of Columbia, and all U.S. territories with permanent populations (Guam, U.S. Virgin Islands, Northern Mariana Islands, and American Samoa). The term “Underlicensed State” means a State in which the number of operating licensees per capita is fewer than the median number for all States. To determine the per capita per State, SBA will use the most recent resident population from the U.S. Census as of the date of the calculation. SBA will publish the list of Underlicensed States periodically on the SBIC website.

One commenter expressed support of the “under-licensed state” concept and suggested expanding the concept to “under-licensed region.” Another commenter requested as an extension of the proposed change to include Underlicensed States where there are little to no licenses for minority and women-led SBIC funds. In this final rule, SBA is implementing regulations in support of the “Spurring Business Act of 2017.” Additionally, SBA has outlined an increased focus on “underserved” broadly in this final rule which includes geographies as well as communities. The final rule adds the terms substantially as proposed.

SBA proposed to add the term “Total Leverage Commitment” to have the meaning as defined in proposed § 107.300. This final rule adds the term “Total Intended Leverage Commitment” to have the meaning as defined in revised § 107.300. As discussed under that section, SBA is changing regulations to approve the Total Intended Leverage Commitment at the time of licensing.

SBA proposed changing regulations to add the term “Enhanced Monitoring” as defined in the proposed § 107.1850. As discussed under that section, SBA has replaced “Enhanced Monitoring” with “Watchlist” and is implementing the Watchlist process in this final rule (previously outlined under Standard Operating Procedures) to better monitor SBICs.

SBA proposed changing regulations to change the term “Wind-up” Plan to “Wind-down” Plan throughout part 107 because SBA believes that it better reflects the wind-down of a fund at the end of its life cycle. This final rule adopts the change as proposed.

B.
Section 107.150 Management Ownership Diversification Requirements

This regulation identifies the SBIC ownership diversification requirement under section 302(c) of the Act (also referenced in part 107 as the “diversification requirement”). That section requires SBIC ownership be “sufficiently diversified from and unaffiliated with the ownership of the licensee in a manner that ensures independence and objectivity in the financial management and oversight of the investments and operations of the licensee.” To ensure independence per statute, current § 107.150(b) requires that “no Person or group of Persons who are Affiliates of one another may own or control, directly or indirectly, more than 70 percent of your Regulatory Capital or your Leverageable Capital.” In the proposed rulemaking, SBA proposed changing regulations to remove the “indirectly” requirement to provide greater clarification as to sources of Regulatory Capital available to an SBIC.

As an exception to the diversification ownership requirement under § 107.150(b)(1), SBA allows an investor that is a Traditional Investment Company (a term defined in 13 CFR 107.150(b)(2)) to own and control more than 70 percent of the Licensee's Regulatory Capital. Such SBICs are essentially drop-down funds for that Traditional Investment Company and are structured exclusively to pool capital from more than one source for the purpose of investing and generate profits. SBA proposed changing regulations also to include non-profit entities to also own more than 70 percent of the Licensee's Regulatory Capital to facilitate capital raising efforts, particularly for first-time funds and funds targeting investments in underserved geographies and critical technologies.

By meeting the requirements of § 107.150(c)(2), such non-profit entities would be exempt from requirements under § 107.150(c)(1) which state that the management of the Licensee must be unaffiliated from the sources of Regulatory Capital. It should be noted that SBA will continue to review and monitor such entities to ensure that the SBIC is a for-profit vehicle for the non-profit, the management of the Licensee is bound by a fiduciary duty to investors, and to ensure such entities do not pose undue investment or operational risk to SBA.

Two commenters supported the regulation as proposed. One commenter suggested allowances for non-profit entities to control more than 70 percent of the Licensee's Regulatory Capital. SBA appreciates the comment. In terms of extending the allowance beyond that of “traditional investment companies”, SBA believes, at this time, consistency with existing practices and regulations is most prudent and will not extend beyond the 70 percent threshold.

One commenter opposed the proposed modification to the definition of “traditional investment company” to include non-profit entities. SBA appreciates the comment and seeks to clarify that this modification to the existing regulations does not permit SBA to license a non-profit entity as an SBIC. By statute, SBICs must be for-profit entities. The modification to the regulation permits up to 70 percent of the regulatory capital contributed to the for-profit SBIC to come from non-profit management company of a limited partnership SBIC. Non-profit entities are already permitted as the management company of limited partnership SBICs. The final rule provides guidance as to the extent of Regulatory Capital that can be provided by a management company with non-profit status. After consideration of all public comments, the final rule adopts the proposed § 107.150 without change.

C.
Section 107.210 Minimum Capital Requirements for Licensees

This section identifies minimum Private Capital requirements for SBICs. In the proposed reulemaking, SBA proposed amending the term “Wind-up” to “Wind-down” as previously discussed in section II.A. of this rule discussing § 107.50. SBA also proposed removing all references to “Participating Securities” since SBA no longer issues such leverage and any SBICs in SBA's portfolio that issued such leverage are either in Wind-down or are monitored by the Office of SBIC Liquidations.

Paragraph (a)(1) requires SBICs (with the exception of Early Stage SBICs) to

have Regulatory Capital of at least $5 million, but provides an exception for SBA, in its sole discretion and based on a showing special circumstances and good cause, to license an applicant with only $3 million if the applicant: (i) meets its licensing standards with the exception of minimum capital; (ii) has a viable business plan reasonably projecting profitable operations; and (iii) has a reasonable timetable for achieving Regulatory Capital of at least $5 million. Public Law 115-333 specifically allows an applicant licensed under this exception and located in an Underlicensed State to receive up to 1 tier of Leverage until the Licensee meets the $5 million minimum Regulatory Capital requirement. SBA proposed changing regulations to specify that one example of “good cause” would be the applicant is headquartered in an Underlicensed State. If licensed, Leveraged Licensees from Underlicensed States would be eligible for up to 1 tier of Leverage until they raise the $5 million minimum Regulatory Capital requirement.

One commenter supports the regulations and encourages clarification and expansion of “good cause” to ensure the exception is applied fairly and not solely based on geography. SBA appreciates the comment and notes that the “good cause” exception is not solely based on geography. Consistent with existing regulations, “good cause” factors may be applied in a non-exclusive manner based on criteria already specified in § 107.210. Further, SBA notes that any SBIC licensee that receives a license under the “good cause” exception must satisfy the requirements of 13 CFR 107.210, including satisfaction of all licensing standards and requirements except the minimum capital requirement, as determined solely by SBA, a viable business plan reasonably projecting profitable operations, and a reasonable timetable for achieving Regulatory Capital of at least $5,000,000.

One commenter asserted hesitation with the low thresholds established by statute under the regulation because of the potential risk to the program from licensing under-capitalized licensees. The commenter also suggested SBA publish objective, quantifiable standards for fund sizes, ask Congress for higher “low limit”, and warned SBA that using the “good cause” exception other than in rare instances involving a licensee's narrowly tailored circumstances would inject higher risk into the SBIC program that could trigger unintended consequences. Finally, the commenter suggested that Licensees should be allowed to accept “indirect” government funds, but this capital should not be leverageable. Further, it should not be used for satisfying the private market validation expectations for a license. SBA seeks to implement the statute as established by Congress. SBICs can accept government funds to the extent permitted by the Act. During the licensing process, SBA will continue to employ the concepts such as external validation and fund size viability when assessing applicants.

One commenter encouraged SBA to allow first-time managers to lower the Private Capital commitment threshold to between $10 to 15 million, in an effort to reduce barriers to program participation for first time and diverse fund managers. SBA shares the value of reducing barriers to participation for emerging and diverse managers. The expansion of reinvestor provisions coupled with the introduction of the Accrual Debenture seeks to enable access to capital to more first-time and emerging fund managers through targeted fund-of-funds SBIC relationships. SBA notes that SBICs with at least $5 million (or $3 million for “good cause”) satisfies minimum capital requirements set forth in 13 CFR 107.210—however, SBICs must also meet the minimum adequacy requirements set forth in section 302(a)(3) of the Act. The final rule adopts the proposed § 107.210 without change.

D.
Section 107.300 License Application Form and Fee

This regulation identifies the process and rules regarding applying for a License and the associated Licensing Fees. SBA proposed amending the introductory paragraph to give priority to applicants headquartered in Underlicensed States with below median SBIC financing dollars, in accordance with Public Law 115-333. Applicants may have branch offices in other locations, but the headquarters for the applicant must be in an Underlicensed State with below median SBIC financing dollars to receive priority. The proposed regulation provides that SBA will publish the list of States in a notice on the SBIC website, which was previously discussed under section II.A. of this rule. SBA also proposed changing regulations to ensure that once priority is established, such applicants will continue to receive priority throughout the licensing process. For example, if Iowa is identified as an Underlicensed State with below median financing and an applicant headquartered in Iowa applies to receive an SBIC license, SBA would give them priority in licensing. If SBA then published a new list of States qualifying for licensing priority after the applicant was given priority, the applicant would continue to have priority in both phases of the licensing process (initial review and final licensing) even if Iowa is no longer identified as an Underlicensed State with below median SBIC financing dollars.

SBA proposed amending paragraph (b) to identify that SBA will approve the total leverage commitments for the life of the Licensee at licensing. SBA believes that similar to private investors, SBA should approve the entire leverage commitment at licensing, based on the evaluation criteria set forth in § 107.305 and the maximum leverage commitment limits set forth in § 107.1150. This change is intended to (1) reduce the burden associated with separate commitment requests performed after the fund has been licensed and (2) reduce the uncertainty with regard to SBA's leverage commitment and consequently reduce the Private Capital raise timeframe for a prospective Licensee. SBA recognizes that Licensees often raise capital after licensing. However, SBA notes that it is important for Licensees to raise their capital prior to submitting their Licensing application for Final Review, as this practice will help SBA better evaluate applicants, monitor for potential risks, and process applications faster. SBA will continue to maintain its right to deny any new issuance of Leverage at the time of a debenture commitment funding draw request and to exercise other rights and remedies as discussed in part 107, subpart J, in the event of regulatory violations, including capital impairment. SBA is also seeking to better diversify its leverage portfolio for maximum impact across underserved sectors as finalized under § 107.320.

SBA proposed modifying its Licensing fees to lower financial barriers for new funds. Effective October 1, 2022, the Initial Licensing Fee is $11,500 and the Final Licensing Fee is $40,200 for a combined Licensing Fee of $51,700. Each year, SBA adjusts these fees based on the Consumer Price Index. Although larger more established funds can easily afford these fees, smaller funds and new fund managers view the fees as prohibitive to SBIC program participation given their smaller size. Additionally, SBA charges the same fee for applicants seeking to issue Debentures as those who do not intend to issue Debentures. SBA proposed to revise the Initial Licensing Fees based on its fund sequence (meaning the order of succession of the fund) as follows:

Fund sequence
Initial licensing fee

Fund I
$5,000

Fund II
10,000

Fund III
15,000

Fund IV+
20,000

SBA will determine the applicant's Fund Sequence based on the applicant's management team composition and experience as a team, including the business plan (also known as the strategy) of the fund provided in Phase I of the application process. For example, if the management team of applicant DEF I consists primarily of the same team members of funds ABC I and ABC II, SBA will consider the fund sequence of DEF I as a Fund III, regardless of the number in the applicant's name.

SBA proposed changing the Final Licensing Fee as the Final Licensing Base Fee plus 1.25 basis points multiplied by the Leverage dollar amount requested by the applicant, where the Final Licensing Base Fee would be as follows:

Fund sequence
Final licensing base fee

Fund I
$10,000

Fund II
15,000

Fund III
25,000

Fund IV+
30,000

For example, a fourth time fund seeking $175 million in Leverage would pay a Final Licensing Base Fee of $51,875, computed as $30,000 plus 1.25 basis points (or .0125 percent) times $175 million.

SBA believes that its Non-leveraged Licensees present less credit risk to SBA, while accomplishing the SBIC mission of providing equity and long-term loans to Small Businesses. SBA's final changes would effectively lower the combined Licensing Fee for all Non-leveraged applicants and lower the fees for applicants with less SBA leverage at risk and new funds. Fund managers seeking a fourth or later fund and seeking leverage would pay a higher fee, and the fee would scale with the dollar amount of SBA leverage sought by the Applicant. SBA notes that SBA's licensing costs are substantially higher than even the highest final combined Licensing Fee. SBA believes this modernized licensing fee model, which is designed to make fees commensurate with years of participation in the SBIC program and the dollar amount of SBA leverage at risk, will reduce cost barriers for small funds and new funds applying to the SBIC program.

SBA also proposed an application resubmission penalty fee of $10,000 for any applicant that has previously withdrawn or otherwise is not approved for a license that must be paid in addition to the Initial and Final Licensing Fees. SBA's final licensing fees remain below SBA's expenses required to process such applications. The intent of the resubmission fee is to impose a penalty for each time an applicant resubmits its application to offset the outlay of additional SBA time and resources. Applicants can request SBA approval to waive the resubmission penalty fee that SBA may consider on a case-by-case basis.

One commenter agreed with the proposed $10,000 application resubmission fee and encouraged SBA to have written, clear, consistent, objective, licensing criteria that are published and applied evenly and consistently across all applicants. Another comment suggested: (1) lower license fees should be exclusive to “small” applicants, (2) clarifying licensing metrics, (3) expanding the definition of qualifying experience to include relevant operating or investment experience. A third comment noted that the proposed regulatory changes are intended to expand the program and make it easier for applicants in certain geographical areas, but that this may take place at the expense of applicants that are otherwise equally qualified. A fourth comment agrees with the resubmission fee and suggested increased transparency to the applicant surrounding the application review process and timely communication from the licensing committee through the process. The commenter further suggested that if an exam finding during the application review process is the cause of denial, the applicant should be given a reasonable amount of time to resolve the finding. SBA agrees with the concept of reduced fees for first-time SBIC applicants. Consistent with the items raised by these commenters, SBA will implement an expedited licensing process for eligible subsequent license applicants (discussed below) and modernize standard operating procedures and policies to further reduce administrative, cost and time burdens on applicants.

Regarding Licensees with multiple SBIC licenses, one commenter noted opposition to proposed higher fees for licensing and examinations, noting the relative ease of processing those licenses. The commenter recommended that SBA include an optional accelerated license for qualified repeat SBIC managers, which option would be worth the increased fee. The commenter also recommends that SBA establish an accelerated licensing process for non-leveraged bank-owned SBICs, as it would improve the licensing process and justify the proposed fee increase. Another commenter believes increased fees for subsequent licenses penalizes funds with an established track record and may deter SBIC managers from continuing to obtain new licenses. In response to these comments, SBA will not implement changes to examination fees which were included in the proposed rule. Furthermore, SBA is introducing regulatory reforms which will reduce time and cost burdens associated with licensing for qualifying subsequent funds as a result of an expedited licensing process. Regulatory reforms to support an expedited and streamlined licensing process for qualifying subsequent fund applications are as follows:

Expedited Subsequent Fund Licensing:
Management teams that are already operating one or more licensed SBICs must be in good operational and regulatory compliance standing with SBA in order to submit a license application for a subsequent fund. Subsequent fund license applicants must have at least two full years of operations from date of licensing of the most recently licensed SBIC (a longer or shorter operating history may be merited based on track record and prior performance). The financial performance and portfolio valuations of the current licensee(s) must demonstrate adequate coverage for any outstanding SBA Leverage. The current licensee(s) must also be able to present a clean audit opinion from the SBIC's independent public accountant, covering the most recent, full year of operations, and no unresolved regulatory violations for the most recent SBA exam covering a period ended within 12 months of the request being filed.

SBA will consider a series of factors when determining whether a subsequent fund applicant has demonstrated a commitment to best practices within the SBIC program.

Streamlined Application Requirements for Subsequent Fund License Applicants:
Applicants operating an active Licensee, can apply under a “Short-Form Subsequent Fund MAQ” application by meeting the following eligibility criteria:

•
Consistent strategy and fund size
—targeted Regulatory Capital to be raised is ≤133% the size of their most recent SBIC fund (inflation adjustments will be considered). Same asset class and

investment strategy as most recent license.

•
Clean Regulatory History
—no major findings, significant “other matters” or unresolved “other matters” related to licensees managed by the principals of applicant in the previous ten years.

•
Consistent LP-general partnership (GP) Dynamics
—no new limited partner will represent ≥33% of the Private Capital of the licensee upon reaching final close at target fund size or hard cap. The two largest investors in terms of committed capital have verbally committed to invest in the new fund pending receipt of license. The most recent Limited Partnership Agreement of the active Licensee and all Side Letters will have no substantive changes for the applicant fund.

•
Investment Performance Stability
—the most recent licensee net distributions to paid-in capital (DPI) and net total value to paid-in capital (TVPI) are at or above median vintage year and strategy performance benchmarks for the prior three quarters. The principals of the applicant are not managing a licensee in default or with high Capital Impairment (CIP).

•
Consistent or Reduced Leverage Management
—the applicant is requesting a leverage to Private Capital ratio ≤ the current or most recent SBIC licensee at target fund size or hard cap.

•
Firm stability
—subject to SBA's determination, no material changes to the broader firm, to include resignations, terminations, or retirements by members of the General Partnership, investment committee, broader investment team, or key finance and operations personnel that have a material adverse impact on the stability of the SBIC.

•
Promotions from within
—demonstration of a commercially reasonable effort of promoting internal investment team talent from within the firm/organization sponsoring the license.

•
Inclusive equity
—demonstration of a commercially reasonable effort of the appropriate/increased sharing of carry and/or management company economics with promoted talent or distribution of equitable or increasingly equitable economics among the partnership.

•
Federal Bureau of Investigation (FBI) Criminal and Internal Revenue Service (IRS) Background Check No Findings
—the sponsoring entity and all principals of the Licensee do not have an FBI criminal record and do not have IRS violations from the date of their most recent SBIC fund licensure.

•
No Outstanding or Unresolved Material Litigation Matters
—no outstanding or unresolved litigation matters involving allegations of dishonesty, fraud, or breach of fiduciary duty or otherwise requiring a report under § 107.660(c) or (d) as to a prior Licensee, the prospective Applicant's general partner, or any other person who was required by SBA to complete a personal history statement in connection with the license application.

•
No Outstanding Tax Liens
—on the principals applying to manage the licensee, on the most recent or active licensee, and on the sponsoring entity of the licensee.

Should an applicant fulfill and formally attest to meeting
all
of the above eligibility criteria, the applicant can submit a streamlined “Short-Form Subsequent Fund MAQ”.

All named principals of the applicant will be subject to FBI criminal and IRS background checks as well as reference checks. Applicants with minimal and non-material changes to the active or most recent licensee LPA and any Side Letters, will be designated for expedited processing.

Regarding capital at licensure, one commenter welcomes the change to the licensing application fee but requested further clarity on the fee structure. One commenter had concerns regarding fund-raising challenges faced by first-time applicants fundraising at time of application. The commenter suggested SBA approve a specific maximum ratio of Leverage to Regulatory capital for the Licensee. Further, the commenter suggested that SBA implement a specific upper limit of Regulatory Capital that would be leverageable at the approved ratio. Another commenter expressed concern that the revised regulations could limit sources of capital and leverage, noting that SBICs could potentially be subject to upfront fees on unutilized leverage within the investment period. A third commenter noted capital flow into the program could be negatively impacted by licensing revisions, effectively eliminating post-license capital raise campaigns and requiring greater commitments up front from capital investors/limited partners. And finally, a fourth commenter recommended amending the proposal to continue to allow leverage commitments on capital raised post-licensing. The commenter noted concerns that the current proposal may negatively impact capital flow, limiting fund size, capacity to finance small businesses, and negatively impacting investors. In response, SBA clarifies that SBA Leverage commitments, up to the dollar amount indicated in the letter of intent to commit, must equal the ratio of SBA-to-private capital commitments indicated in that letter. Such SBA commitments be extended following Closings occurring within 12 months of licensing. These requests will be filled automatically, contingent upon the licensee certifying no material adverse changes (MACs) have occurred since licensing. This is intended to streamline and expedite the commitment request process. SBA further seeks to clarify language to distinguish between a `Total Intended Leverage Commitment' letter of intent indicating a specific intended commitment dollar amount at Green Light and ratio of SBA leverage to Private Capital from SBA available upon licensing. Additionally, SBA seeks to further clarify the difference between the `Total Intended Leverage Commitment' and `commitment requests' made toward the amount indicated in the letter of intent to commit.

SBA seeks to clarify that SBA's commitment dollar amount will be limited such that leverage principal and projected interest must be less than or equal to the statutory cap on individual Licensee leverage, currently $175 million, for a Licensee issuing Accrual Debentures or leverage principal less than or equal to the statutory leverage cap for a Licensee issuing Standard Debentures. For both debenture instruments, Total Intended Leverage Commitment dollar amounts made to the applicant represents leverage principal. SBA defines the term “Total Intended Leverage Commitment” to mean the dollar amount or ratio of SBA Leverage Commitments to Private Capital that SBA will approve conditional upon closing the applicant's stated Private Capital target and conditional upon maintaining acceptable capital impairment (CIP) levels and regulatory compliance during the life of the license. SBA will provide the `Total Intended Leverage Commitment' to the applicant in the Green Light Letter. The Total Intended Leverage Commitment dollar amount will be made final within 12 months of licensure or upon the Licensee's final closing, whichever occurs first. Licensees issuing Accrual Debentures shall not be permitted to make distributions within 12 months of Licensure.

Finally, it should be noted that SBA is amenable to and expects that most applicants will have multiple fund closings. It is acceptable to SBA for an applicant to have a fund closing and begin making investments prior to Licensing. However, the applicant bears the burden of assuming any risk should a license not be approved. One

commenter identified that SBIC program administrative and operating costs are not covered by subsidy, noting that in 2017, less than 40 percent of SBA's administrative costs were offset by fees, leaving the taxpayer to bear the costs. The commenter stated that SBA should seek ways to reduce taxpayer costs associated with SBIC program expenses.

The table below displays the cost to administer the SBIC program. It includes direct costs from the operating budget, including contracts; compensation and benefits; Agency-wide costs, such as rent and telecommunications; and indirect costs.

FY 2020
actual

FY 2021
actual

FY 2022
actual

$24,254,000
$21,492,000
$28,211,000

In FY2022, the return-on-investment (ROI) of taxpayer dollars as measured by the ratio of FY2022 financings to U.S. small businesses relative to program cost was 28,003 percent or $7.9 billion divided by $28,211,000. The same $28,211,000 resulted in 129,098 U.S. small business jobs created and sustained and enabled the program to operate with the necessary risk management and oversight practices and procedures to provide Federal funding to SBICs at zero subsidy to U.S. taxpayers. The final rule includes an expedited and streamlined licensing process for qualifying subsequent fund applications and SBA is finalizing § 107.300 substantially as proposed.

E. Section 107.305 Evaluation of License Applicants

Current § 107.305 discusses how SBA evaluates an applicant to the program. Paragraph (a) describes management qualifications. SBA is proposing to amend paragraph (a) to include two additional management qualifications. The first is relevant industry operational experience, which may be combined with investment skill to demonstrate managerial capacity. The second, if applicable, is the applicant's experience in managing a regulated business, including but not limited to an SBIC. Paragraph (b) describes how SBA evaluates an applicant's track record. SBA is amending paragraph (b) to include two additional performance qualifications. The first is the inclusion of an applicant's operating experience, which when combined with an investment team's prior relevant industry investing experience, is relevant in assessing an applicant's investment performance. The second addition, when applicable, is the applicant's past adherence to statutory and regulatory SBIC program requirements. This addition will be considered for applicants with past SBIC program experience.

Paragraph (c) describes how SBA evaluates the applicant's investment strategy. SBA is amending paragraph (c) to clarify that the applicant's investment strategy is to be contained in its business plan, as well as to underscore the importance of section 102 “Statement of Policy” of the Act which describes the public purpose of the SBIC program.

Two commenters encouraged SBA to continue making the licensing process more transparent and inclusive, noting current criteria limiting the potential pool of qualified managers. SBA is updating standard operating procedures and policies to reduce the burden of the licensing process on applicants and to improve transparency in the licensing process.

One commenter requested, in addition to relevant industry operational experience, inclusion of financial portfolio management experience in adjacent areas such as relevant experience in lending and early-stage equity investments. SBA agrees that relevant investment experience in adjacent areas is a valid consideration in the licensing process. SBA considers the totality of experience of the principals of the applicant during the licensing process. As the proposed rule is consistent with these principles, SBA is finalizing § 107.305 substantially as proposed.

F. Section 107.320 Leverage Portfolio Diversification

Current § 107.320 discusses how SBA evaluates Early Stage SBICs and reserves the right for SBA to maintain diversification among Early Stage SBICs with respect to the year they commence operations and their geographic location. In light of the fact that SBA used its entire Leverage authorization in FY 2021, SBA proposed modifying this regulation to reserve SBA's right to maintain Leverage portfolio diversification in approving Leverage commitments with respect to the year in which they commenced, the SBIC's geographic location, giving first priority to Licensees from Underlicensed States with below median SBIC financing dollars, their asset class and investment strategy. SBA's intent is to maximize the SBIC program's economic impact to underserved Small Businesses while managing risk through portfolio diversification. SBA notes that SBA will continue to license all qualified applicants based on its evaluation criteria and will not take into consideration any projected shortage or unavailability of leverage when reviewing and processing SBIC license applications.

One commenter believes 13 CFR 107.320 should remain unchanged, noting the SBIC Debenture program doesn't currently exhibit outsized losses due to a lack of portfolio diversification. The same commentor also expressed concern that the proposed rule could result in SBA having too great discretion in selecting program participants. The purpose of portfolio diversification is to ensure that SBA successfully meets the mission and intent of the SBIC program (as established by Congress) while mitigating overall SBIC program concentration risk in strategies which could present higher repayment risk and volatility risk and thus compromise the program's zero subsidy status. Ensuring SBA has discretion to mitigate program concentration in risk assets to mitigate against the potential for taxpayer losses is in line with best practice portfolio risk management approaches of public and private institutional investment programs.

One commenter stated that by prioritizing the approval of leverage commitments based on geographical characteristics, it may prolong the process for Licensees that are not headquartered in these areas. The final rule balances shifting licensing timelines with mitigating program risk. Through the introduction of expedited licensing for eligible subsequent funds and updates to standard operating procedures, SBA will improve licensing and leverage commitment timelines across the program, thus mitigating any risk of prolonged leverage commitment processes for Licensees. SBA is finalizing § 107.320 substantially as proposed.

G. Section 107.501 Identification

This regulation identifies requirements related acknowledgment of a Licensee as “a Federal licensee under the Small Business Investment Act of 1958, as amended.”

One commenter recommended an amendment to 13 CFR 107.501 requiring SBA to publish in the
Federal Register
the names of SBICs that were licensed and the dates on which SBICs were licensed. Based on this comment, SBA is finalizing § 107.501 to include a requirement for SBA to publish license approvals in the
Federal Register
within 30 business days of the end of the month in which the license was approved by the SBA Administrator.

H. Section 107.503 Licensee's Adoption of an Approved Valuation Policy

This regulation requires Licensees to prepare and maintain a valuation policy that must be approved by SBA for use in determining the value of its investments. Current regulations require that Licensees adopt without change the model valuation policy set forth in SBA's Valuation Guidelines for SBICs or obtain SBA's prior approval of an alternative valuation policy. SBA established this requirement to ensure it could adequately monitor the SBIC portfolio, that valuations were performed in a reasonable and standard fashion, and to minimize Leverage losses in order to maintain zero subsidy cost. SBA recognizes that private equity typically uses valuations performed in accordance with GAAP and that many SBIC private investors require GAAP. This causes many SBICs to maintain two sets of valuations. SBA is currently working to re-evaluate this requirement for Leveraged Licensees. SBA is requiring both valuations based on SBA Valuation guidelines and those reported to their private investors in accordance with GAAP to assess the potential impact. SBA is also working with its valuation contractor to evaluate what changes to SBA's Valuation Guidelines would be necessary to make them GAAP compliant and the impact to SBA's monitoring and risk should SBA adopt GAAP compliant guidelines. SBA sought input from the public on this issue as part of this rulemaking. However, SBA recognizes that Non-leveraged Licensees pose no credit risk to SBA. In the proposed rule, SBA proposed that Non-leveraged Licensees (which include both those licensed as Non-leveraged Licensees and Licensees that fully repay Leverage and seek no further Leverage) may adopt a Valuation Policy in accordance with GAAP. SBA believes this will lower the burden associated with current regulations.

Current paragraph (d) requires licensees with outstanding Leverage or Earmarked assets to value their portfolio twice a year (at the end of the second quarter and the end of the fiscal year). SBA proposed to clarify that this requirement applies to all Leveraged Licensees and increase reporting from semi-annually to quarterly, commensurate with the required quarterly reporting of the Form 468.

One commenter agreed with the revision as written.

One commenter gave feedback including (1) the Form 468 is not accommodating of GAAP reporting, (2) that SBICWeb requires a redesign, (3) new reporting requirements can put undue burden on analysts, (4) reporting is cumbersome, (5) by changing accounting principles, it would be difficult to compare year over year results, (6) unlevered SBICs could be at a disadvantage with respect to determining when to make READ. With respect to the first five items, SBA is updating its technology, data collection, and filing processes to accommodate new reporting requirements and reduce the reporting burden on managers and SBA analysts. Further, SBA notes that if the valuations are not changing significantly, the level of effort to update the reporting is limited. If valuations do change significantly, this does increase the level of effort required in updating the reporting, however SBA believes that sufficient program oversight of this federally regulated financial institution necessitates this level of effort and unlevered SBICs are not positioned to be disadvantaged. After consideration of all comments, SBA is finalizing § 107.503 substantially as proposed.

I. Section 107.504 Equipment and Office Requirements

This regulation identifies the equipment and office requirements needed by SBICs to operate within the program. The current regulation requires a personal computer with a modem and internet access under paragraph (a) and the need for a facsimile capability under paragraph (b). SBA received industry comments that this regulation was outdated. Some SBICs indicated that they bought facsimile machines to ensure they complied with the requirement. The intent of this regulation is to ensure that SBICs can properly communicate with SBA, receive official correspondence, prepare and provide electronic reporting, and apply for Leverage. The proposed changes would eliminate the modem requirement under paragraph (a); eliminate the facsimile requirement under paragraph (b); and modify paragraph (a) to more broadly require that SBICs must have technology to securely send and receive emails, scan documents, and prepare and submit electronic information and reports required by SBA. This language would allow for reasonable changes in technology without the need to modify regulations. All SBICs already utilize this technology in their day-to-day operations. This change should reduce costs by eliminating unnecessary equipment.

One commenter concurred with the changes as written. SBA is finalizing § 107.504 substantially as proposed.

J. Section 107.550 Prior Approval of Secured Third-Party Debt of Leveraged Licensees

This regulation requires SBICs to obtain prior SBA approval for secured third-party debt for Leveraged Licensees.

Section 107.550(a) defines secured third-party debt to include Temporary Debt, a defined term in § 107.570 that applies only to SBICs with outstanding Participating Securities. Since there are no operating SBICs with outstanding Participating Securities, except in the Office of SBIC Liquidation, SBA proposed removing § 107.570 and references to Temporary Debt and Participating Securities in § 107.550.

Section 107.550(c) identifies rules associated with secured lines of credit in existence on April 8, 1994. SBA proposed to remove that requirement since it is obsolete.

SBA proposed replacing § 107.550(c) with a secured “Qualified Line of Credit” which SBICs could utilize without SBA prior approval. One commenter recommended clarifying the language in this section, and one commenter stated that the proposed terms will increase the administrative burden on Licensees as they would need to call capital more often. SBA agrees that the language required clarification and the terms should be more aligned to industry standard practices. Consequently, SBA is rescinding the proposed changes to § 107.550(c) and replacing it with this simplified update to the existing regulations by defining a “Capital Call Line”.

Since the final rule provides an exemption from SBA approval for Capital Call Lines that SBA would likely have otherwise approved, the final rule eliminates paragraph (e) which discusses automatic 30-day approval for secured third-party debt. With the replacement of “Qualified Line of Credit” with “Capital Call Line”, SBA is finalizing § 107.550 substantially as proposed.

K. Section 107.570 Restrictions on Third-Party Debt of Issuers of Participating Securities

This regulation identifies restrictions on third-party debt for SBICs that issued Participating Securities. As discussed under section II.L. of this rule, no operating SBICs have outstanding Participating Securities and SBA is no longer authorized to provides such Leverage. SBA proposed to remove this regulation.

SBA received no comments on this section. This final rule adopts the proposed removal of § 107.570.

L. Section 107.585 Distributions and reductions in Regulatory Capital

This section is currently titled “Voluntary decrease in Licensee's Regulatory Capital” and requires Licensees to obtain SBA's prior written approval to reduce Regulatory Capital by more than two percent in any fiscal year. Current § 107.1000(b)(2) exempts Non-leveraged Licensees from § 107.585 if the decrease does not result in Regulatory Capital below what is required by the Act and the regulations and is reported to SBA within 30 days. Typically, reductions in capital are performed in conjunction with a distribution that represents a return of capital, to its private investors. SBA allows profit distributions, also known as “Retained Earnings Available for Distribution” or “READ” without SBA prior approval, unless the Licensee was licensed as an Early Stage SBIC or if the SBIC issued Participating Securities.

SBA received comments from private investors that the existing regulations (prior to the proposed rule) were unclear as to when a Licensee could distribute to its investors. SBA has also had instances in which Leveraged Licensees made “READ” distributions, and subsequently wrote down assets that would have reduced or removed “READ”. Leveraged Licensees must consider such write-downs before making such distributions to avoid “improper” distributions. SBA is also concerned that Accrual Licensees may distribute profits without repaying Leverage. In particular, equity investors often have returns that are less consistent than private creditor or mezzanine funds. SBA has incurred losses in several Licensees that returned profits to its private investors through early profit distributions and then wrote down assets later in the fund's life.

In the proposed rulemaking, SBA proposed to retitle this regulation to “Distributions and Reductions in Regulatory Capital” and modify the requirements to address these concerns. Three commenters raised that a change to the distribution waterfall of the Traditional Debenture. The SBA has considered this feedback and intends to apply the new pro rata distribution waterfall exclusively to the Accrual Debenture instrument and to institute a more flexible repayment timeframe to align with existing debenture pre-payment processes. Based on public comment, in issuing the final rule, SBA will not apply the modified distribution waterfall to Standard Debenture Licensees. This final rule thus separates distribution requirements based on three categories of SBICs: (1) Non-leveraged Licensees; (2) Standard Debenture SBICs; and (3) Accrual SBICs and Reinvestor SBICs. The rationale for these categories and the specific requirements follows.

(1)
Non-leveraged Licensees.
SBA is setting a separate set of requirements for Non-leveraged Licensees because they pose no credit risk to SBA. Final rules would allow Non-leveraged Licensees to distribute to their private investors without SBA prior approval as long as they retain sufficient Regulatory Capital to meet minimum capital requirements under § 107.210, unless such amounts are in accordance with their SBA approved Wind-up Plan. If a Non-leveraged Licensee does not have an SBA approved Wind-up Plan, they may make distributions, as long as such Non-leveraged Licensees retain sufficient Regulatory Capital to meet minimum capital requirements under § 107.210. If a Non-leveraged Licensee has an SBA-approved Wind-down Plan, their Regulatory Capital can drop below the minimum capital requirements if such amounts are in accordance with that plan. This requirement should provide even greater flexibility to Non-leveraged Licensees. In accordance with current policies, the final rule would clarify that Non-leveraged Licensees must report any reductions in Regulatory Capital to SBA within 30 days on an updated Capital Certificate, which is Exhibit K in SBA form 2181.

(2)
Standard Debenture SBICs.
SBA recognizes that existing licensees and current applicants to the program expect to be able to distribute READ based on current regulations. Standard Debenture SBICs will remain under the current rules.

(3)
Accrual SBICs and Reinvestor SBICs.
SBA is requiring, in the regulations for these SBICs, a distribution waterfall that repays SBA the principal balance on outstanding Leverage on at least a pro rata basis with private investors. Accrual SBICs and Reinvestor SBICs must repay Leverage at its ten-year maturity and may prepay Leverage at any time. SBA is requiring the following waterfall:

a. Payment of Annual Charges and accrued interest associated with Leverage. (Interest will be paid to the bond holders based on the Leverage terms.)

b. Calculate SBA's share based on the ratio of SBA Total Intended Leverage Commitment and Total Private Capital Commitments, inclusive of Qualified Non-Private Funds, determined within 12 months of Licensure established as follows: SBA Share = Total Distributions × [Total Intended Leverage Commitment/(Total Intended Leverage Commitment + Total Private Capital Commitments)].

c. Repay SBA Leverage to bond holders in an amount no less than SBA's Share to the extent of outstanding Leverage. If SBA's share is more than the Outstanding Leverage held by the Licensee and the Licensee has unfunded Leverage Commitments, the Licensee must submit a Leverage Commitment cancellation equal to SBA's share minus SBA Leverage redemptions. The rationale for this cancellation requirement is to minimize the risk that the SBIC will distribute significant profits to its private investors, then issue additional SBA leverage that results in losses, leaving SBA with losses after the private investors made significant profits.

d. Distribute to private investors the remaining amount.

e. Report the distribution to SBA. You must report the distribution and calculations to SBA on your Form 468 submission(s).

If permitted under a Licensee's partnership agreement, a Licensee may choose to reserve capital or reinvest all or a portion of it instead of distributing to SBA and investors. In this circumstance, a Licensee would decrease the amount distributed to its investors so that the private investors receive no more on a pro rata basis as the repayment of SBA Leverage and interest due. SBA is only concerned that private investors bear at least the same risk for loss as SBA.

One commenter provided the following feedback: (a) tax distributions due to ordinary income must flow to limited partners for tax liabilities; (b) Debenture securities must be paid in full, which could limit SBIC ability to repay Debentures in full and provide sufficient distributions to limited partners to pay taxes; (c) potential unintended consequence of outcome of “trapping” cash in SBIC. SBA clarifies that Accrual SBICs are not prohibited from tax distributions in this final rule and encourages SBICs to consider

smaller distributions that can be repaid in full. SBA underscores that the intent of the changes is to reduce the risk to the taxpayer by ensuring that debentures backed by an SBA guarantee are repaid.

One commenter concurred with SBICs being allowed to make distributions without prior SBA approval and with SBA proposing that future material adverse changes be taken into consideration for leveraged funds licensed before October 1, 2023. The same commenter raised that the proposed waterfall also does not differentiate between READ and return of capital proceeds, which would result in the repayment of leverage being misaligned with what may be laid out in a Licensee's wind down plan. As stated above, SBA has not included changes to the waterfall or READ requirements for Standard Debentures and is finalizing § 107.585 with the modified distribution requirements based on three categories of SBICs: (1) Non-leveraged Licensees; (2) Standard Debenture SBICs; and (3) Accrual SBICs and Reinvestor SBICs.

M. Section 107.590 Licensee's Requirement To Maintain Active Operations

This regulation identifies requirements for Licensees to maintain active operations and submit a Wind-up Plan when they decide they are no longer making any new investments. SBA proposed implementing regulations to change the name to “Wind-down Plan” as discussed under section II.A. of this rule.

SBA received no comments on this section. This final rule adopts the proposed § 107.590 without change.

N. Section 107.620 Requirements To Obtain Information From Portfolio Concerns

This regulation specifies the threshold of information requested by SBICs from Portfolio Concerns. In the proposed rulemaking, SBA proposed implementing regulations to amend specified information collections for Financings after the effective date of the rule to provide certain optional demographic information on Portfolio Concerns. The SBA is amending information collections to enhance reporting accuracy and consistency around the small business demographic impact of the SBIC program.

One commenter expressed concern that including voluntary reporting of demographic data could be viewed as mandatory by licensees and their portfolio companies and could be costly, while another commenter expressed concern that making this voluntary may discourage Licensees from providing it. SBA notes that voluntary reporting of demographic information balances flexibility for program participants with providing SBA and taxpayers with adequate transparency into the community impact of the SBIC program overall, in accordance with the President's Executive Order (“E.O.”) 13985, Advancing Racial Equity and Support for Underserved Communities Through the Federal Government. Additionally, SBA notes that such information is collected post-licensing and is not a component of the SBIC licensing process. This final rule adopts the proposed § 107.620 without change.

O. Section 107.630 Requirement for Licensees To File Financial Statements With SBA (Form 468)

This regulation identifies requirements associated with Licensee's financial statements on Form 468. Paragraph (a) requires the annual Form 468 to be submitted on or before the last day of the third month following the end of the fiscal year, except for information in paragraph (e). This is not consistent with § 107.650 which requires that portfolio valuations be submitted on the Form 468 within 90 days following the end of the fiscal year. Current § 107.630 also does not have a paragraph (e). SBA believes the entire Form 468 should be due at the same time. Therefore, in the proposed rulemaking, SBA proposed implementing regulations to make the annual Form 468 due date consistent with § 107.650.

Paragraph (d) requires certain economic information regarding each Licensee's portfolio companies, so that SBA can assess the program's economic impact. SBA proposed implementing regulations adding information to help SBA determine net jobs created and total jobs created or retained, including identifying the number of jobs added due to a business acquisition versus growth in the business.

SBA also proposed to add fund management contact information and optional demographic information. SBA is seeking to collect management contact information in order to improve its customer relationship management and to better assess relationships between its Licensees. Demographic information regarding fund management is requested for reporting purposes only and on a voluntary basis.

Two commenters agreed with the proposal as written. One commentor asked whether the Form 468 could be filed on a Monday if the deadline falls on a weekend. Form 468 instructions will now provide the following procedural accommodation: when a deadline falls on a weekend the form can be filed on the next day which is not a Saturday, a Sunday, or a Federal holiday.

One commentor agreed that SBA can improve its oversight of SBICs through timely reporting requirements. SBA appreciates the support for timely reporting. This final rule adopts the proposed § 107.630 substantially without change.

P. Section 107.640 Requirement To File Portfolio Financing Reports (SBA Form 1031)

This regulation currently requires Licensees to submit a Portfolio Financing Report on SBA Form 1031 within 30 days of the closing date of the Financing. To reduce the burden on Licensees, SBA proposed to make this a quarterly submission in which the Licensee must report the financing within 30 calendar days of the calendar year quarter following the closing date of the Financing. For example, if a Licensee closes a financing on February 10, 2023, the Licensee will need to submit the related Form 1031 no later than April 30, 2023. If the Licensee is identified as meeting the Watchlist criteria, as finalized under § 107.1850, SBA may require more frequent reporting.

One commenter noted that new deadlines might have a negative impact on Bank limited partners with regard to federally required reporting and examination obligations and might elongate the time it takes SBIC licensees to report to SBA. Another commenter opposed quarterly submissions within 30 calendar days of quarter following closing or financing, noting generating a quarter's worth of Form 1031s would be burdensome. In response, SBA will allow for Form 1031s within 30 days of quarter end. To mitigate concerns around the burden of the reporting requirement when SBICs have a large number of 1031 filings due at one time, SBA permits Form 1031s for portfolio company financings to be disaggregated and submitted on a more frequent basis. The option to submit a single Form 1031 within 30 days of quarter end rather than within 30 days of financing is intended to reduce the administrative filing burden on SBICs. Bank limited partners are encouraged to establish reporting expectations with SBICs through their limited partnership agreements. SBA's intent is to provide additional regulatory flexibility, when and where possible, with respect to 1031 filings. SBA agrees with

commenters who were supportive of changes that allow more time for SBICs to make timely submissions, and therefore SBA is issuing the final rule as set forth in 13 CFR 107.740.

Q. Section 107.650 Requirement To Report Portfolio Valuations to SBA

This regulation currently requires Licensees to report portfolio valuations within 90 days of the end of the Licensee's fiscal year and quarterly valuations 30 days following the close of each quarter. SBA proposed implementing regulations to clarify that only Leveraged Licensees are required to report for quarterly reporting periods. All Licensees must report at least annually. SBA proposed implementing regulations to expand the timeframe for quarterly valuations, including material adverse changes, to 45 calendar days following the close of each quarter. This is intended to give Licensees additional time to prepare reports.

One commenter stated they do not believe the benefits of reporting changes outweigh the costs unless SBA reports and publicly releases in a timely manner aggregate program data and analysis. As part of the final rule, SBA is modernizing data collection and reporting processes which will enable the timely reporting of existing program economic and operational performance measures and the introduction of new metrics related to the investment performance of the program. Quarterly reporting will be limited to a “short form” version of the Form 468 to reduce the reporting burden while enabling transparency into program investment performance and improved monitoring.

One commenter asked for clarification as to whether SBA will continue to allow data collections and metrics regarding net jobs created and total jobs created and retained to be provided on a quarter lag after year end, as the data may not be readily available within 90 days of an SBICs fiscal year end. SBA confirms that the 90-day lag is intended to represent a one quarter lag after fiscal year end. This final rule adopts the proposed § 107.650 without change.

R. Section 107.660 Other Items Required To Be Filed by Licensee With SBA

This regulation identifies other items required by the Licensee. Paragraph (a) requires the Licensee to provide to SBA a copy of any report it gives to its private investors. Although the Licensee is required under current regulations to provide to SBA report they provide to their private investors, SBA proposed implementing regulations to specify valuation data items to improve clarity. SBA also proposed implementing regulations to specify that Licensees should submit to SBA any report it gives to its private investors no later than 30 days after the date on which such SBIC sent any report to its private investors. This requirement is intended to keep SBA aware of any important communications regarding the licensee in a timely fashion.

Regarding submission of the reports provided to the private investors, one commenter noted it would be helpful for SBA to specify the types of reports they are looking for and their purpose. SBA specifies that quarterly and annual financial reports and fund investment performance reports are examples of reports frequently delivered to private investors with the intended purpose of providing transparency into portfolio holdings and investment returns. This final rule adopts the proposed § 107.660 without change.

S. Section 107.692 Examination Fees

This regulation identifies how SBA calculates examination fees. Currently under paragraph (b), SBA charges a Minimum Base Fee + .024% of assets at cost up, not to exceed a Maximum Base Fee. SBA adjusts the Minimum Base Fee and the Maximum Base Fee annually. Although current regulations give Non-leveraged Licensees a lower Maximum Base Fee, this formula does not fully address the risk and additional monitoring required for Leveraged Licensees. SBA proposed to change and streamline this formula to $10,000 + .035% of their Total Leverage Commitment established at Licensing (see section II.D. of this rule). By establishing the examination fee up front, SBA believes this will reduce uncertainty in cashflows. Because SBICs licensed prior to the proposed rule may not have a Total Leverage Commitment, SBA proposed that the formula for existing licensees be $10,000 + .035% of their outstanding Leverage plus SBA's undrawn commitment amount. Since the proposed formula would give all Non-leveraged licensees a flat rate of $10,000 and SBA incurs more costs based on the assets of the Licensee, SBA proposed that any Non-leveraged Licensee with over $50 million in assets at cost pay an additional $20,000. Although SBA recognizes that a Leveraged Licensee with over $50 million in assets at cost and $30 million in leverage commitments would only pay $20,500 in exam fees versus $30,000 for a Non-leveraged Licensee, SBA nevertheless proposed this additional fee for larger Non-leveraged Licensees with over $50 million in assets based on the infrequency of requests for less than one tier of leverage. Two commenters opposed the proposed fee changes. Regarding Licensees with multiple SBIC licensed funds or “repeat licensees”, one commenter noted opposition to proposed higher fees for examinations for repeat licensees. One commenter requested that SBA annually publish the top-ten most common exam findings so SBICs can proactively remedy their own practices. SBA appreciates these comments and will not be moving forward with modifications to Examination fees.

One commentor encouraged SBA to consider enhancing its credit standard to require examinations within an 18-month time period for all SBICs with SBA-guaranteed leverage. SBA appreciates the comment and, as stated prior in response to broader comments regarding licensing and examination fees, SBA withdraws the proposed changes to § 107.692 and will not be moving forward with modifications to Examination frequency because it believes that the incremental risk mitigation would be minimal and would not warrant the additional resources required.

T. Section 107.720 Small Businesses That May Be Ineligible for Financing

This regulation identifies small businesses in which Licensees may not invest. Paragraph (a) restricts Licensees from making investments into relenders or reinvestors as defined under paragraph (a)(1). In the existing regulation, paragraph (a)(2) currently gives an exception for Venture Capital Financings to relenders or reinvestors that qualify as Disadvantaged Businesses unless the Disadvantaged Business is a bank or savings and loan not insured by agencies of the Federal Government or agricultural credit companies. In the proposed rule, SBA proposed modifying the exception to permit Licensees to make equity investments in certain underserved relenders or reinvestors that make financings solely to Small Business Concerns that a Licensee may directly finance under part 107. Based on the comments discussed below, SBA is now modifying this exception to permit reinvestors which are Accrual SBICs (
i.e.,
“Reinvestor SBICs”) to make equity investments in certain underserved reinvestors that, in turn, make financings solely to Small Businesses which meet the Act size standards (set forth in 13 CFR 107.700 and 121.301(c)(2)) or the Small Business Act alternative size standards (set forth in 13 CFR 121.301(c)(1)) with at least 50 percent of employees in the United States, at the time of investment. SBA

believes expanding this provision will significantly help expand the SBIC program's footprint in underserved communities. By more broadly defining “underserved,” SBA can maintain flexibility and agility to align with evolving market conditions by clarifying what constitutes “underserved” through policy notices in order to increase its economic impact to underserved communities. While Disadvantaged Business will continue to be considered underserved, rural and low-and-moderate-income areas may also be applicable to this group. To ensure that capital continues to be directed to SBA's mission, SBA also is implementing regulations to limit reinvestor financing to those that existing SBICs could generally finance. This limitation is designed to help SBA grow a national emerging fund manager pipeline focused on supporting the financing needs of U.S. small businesses.

Two commenters noted that the definition of “underserved” could be further clarified. However, another commenter was supportive of leaving “underserved” not fully defined and proposed including clear safe harbors for SBICs serving rural, low-income areas, and veteran-owned businesses. SBA notes that a broad interpretation of underserved, consistent with the text of Executive Order 13985, “Advancing Racial Equity and Support for Underserved Communities,” and a requirement to provide a justification in the applicant's business plan as to how a particular geographic, industry or market segment is underserved and how the investment strategy and approach addresses this underserved part of the market. A safe harbor will not be required as SBA will approve the business plan prior to the licensee making investments. Investments are to be made in accordance with the approved business plan.

Two commenters recommended that SBA revise the language to ensure that SBICs are not precluded from making investments in Minority Depository Institutions (MDIs). SBA appreciates the suggested comment. SBA notes that Licensees are permitted to make investments in certain types of
relenders
and
reinvestors
which, for Section 301(d) Licensees, which may include Minority Depository Institutions that qualify as Disadvantaged Businesses. Section 301(c) Licensees are permitted to make investments in reinvestors under the Act.

One commenter suggested SBA define Fund-of-Funds as
Reinvestor SBICs
in regulations and standard operating procedures. SBA appreciates and agrees with the comment and will define
Reinvestor SBIC.
SBA will also clarify that there is no restriction on the type of capital that can be invested by a
Reinvestor SBIC.

Two commenters suggested that the requirements limiting investments in re-investors to only those who have complied with SBA cost of money and conflict of interest regulations could mean that not many qualified fund-of-funds managers will be able to access the program. One commenter suggested SBA clarify which specific rules it intended to capture and that all restrictions on existing SBICs be applied to the ultimate recipients of the capital. One commenter believes it would be necessary to permit potential reinvestor SBIC funds-of-funds to invest all of their capital into underserved underlying funds. In addition, the underlying funds in which an SBIC is investing pursuant to the exception should not be controlled by the SBICs or the SBIC's management. They should also be allowed to provide capital to non-levered SBICs but not to SBICs with any type of leverage. Another commenter expressed concern around permitting Fund-of-Funds to invest only their Regulatory Capital into underlying re-lenders and re-investors.

SBA appreciates suggested revisions to permitted investments by the underlying funds of the
Reinvestor SBICs
and has revised this final rule to define and clarify that
Reinvestor SBICs
can make Equity Capital Investments in underserved non-SBA leveraged limited partnerships, SBIC or non-SBIC licensed, that finance businesses that meet SBA's small business size standards, are owned and controlled by U.S. citizens and/or entities headquartered in the United States, and have at least 50 percent of employees based in the United States at the time of investment.

In terms of “cost of money”, SBA notes that § 107.855 defines “Cost of Money” to mean “the interest and other consideration that you receive from a Small Business.” Subject to lower ceilings prescribed by local law, the Cost of Money to the Small Business must not exceed the ceiling determined under § 107.855 introductory text and (a). In connection with this requirement, SBA notes that this section applies to all Loans and Debt Securities.

Regarding conflicts of interest, given the nature of private markets, SBA anticipates
Reinvestor SBICs
are likely to invest in the portfolio concerns of underlying funds. Consistent with the safe harbors to conflicts of interest being implemented in this rule, SBA's prior written approval is not required in connection with such co-investments if a third-party investor unaffiliated and unassociated with the
Reinvestor SBIC
and the underlying fund investor is contributing Equity Capital Investments to the portfolio concern alongside the
Reinvestor SBIC
investing directly into the portfolio concern held by the underlying fund. At least one substantial third-party investor unaffiliated and unassociated with the
Reinvestor SBIC
must be investing on the same terms as the
Reinvestor SBIC.

One commenter noted a lack of clarity around monitoring and reporting of reinvestors. SBA clarifies that
Reinvestor SBICs
will be expected to submit reporting of all underlying portfolio concern holdings including information regarding the limited partnership investor in the portfolio concern, name of the concern, industry, size and type of investment, most recent valuation, tax identification number, industry, location and number of employees at time of initial investment. Such reporting will be provided as an exhibit to the Form 468 for
Reinvestor SBICs
.

One commenter expressed concern that expanding opportunities for reinvestors will confuse investors who consider the SBIC program. SBA appreciates the concern. With more diversification of asset classes and alternative investments strategies included in the SBIC Program, investors should consider each prospective SBIC fund investment's risks and benefits on a case-by-case basis before investing.

Finally, one commenter encouraged SBA to consult with Congressional Committees to clarify whether these changes require new authorities granted by Congress. SBA notes that section 310(c) states that each small business investment company shall be examined at least every two years in such detail so as to determine whether or not it has engaged in relending. Permitting
Reinvestor SBICs
as Section 301(c) Licensees is consistent with the Act and aligns with the stated policy set forth in the SBIC Act of stimulating and supplementing the flow or private equity capital and long-term loan funds which small-business concerns need for the sound financing of their business operations and for their growth, expansion, and modernization, and which are not available in adequate supply.

SBA has included clarification around Reinvestor SBICs and is finalizing § 107.720 substantially as proposed.

U. Section 107.730 Financings Which Constitute Conflicts of Interest

Current § 107.730 prohibits Licensees from transactions that constitute

conflicts of interest, as required by the Act. Paragraph (a) provides a general rule that Licensees may not self-deal to the prejudice of a Small Business, the Licensee, its shareholders or partners, or SBA, and must obtain prior written exemptions for transactions that may constitute a conflict of interest and specifies certain transactions in paragraphs (a)(1) through (5) that would constitute a conflict of interest. Paragraph (a)(1) identifies (as one specific prohibition) a Financing to a Licensee's Associate, as defined in § 107.50, unless the Small Business being financed is only an Associate because another the Licensee's Associate investment fund holds a ten percent or greater interest in the Small Business, the Associate investment fund previously invested in the Small Business at the same time and on the same terms and conditions, and the Associate investment fund is providing a follow-on financing to the Small Business at the same time and on the same terms and conditions as the Licensee.

Based on market feedback and an analysis of conflict-of-interest approval requests from Licensees, the current safe harbor provisions for follow-on financings to small business portfolio companies are resulting in delays providing capital to small businesses. This potentially hurts the small businesses and increases the burden on Licensees and SBA. SBA proposed implementing regulations to include a safe harbor for financing a portfolio concern by an Associate when an outside third-party participates in the equity financing of the Licensee's portfolio concern.

Paragraph (d) identifies Financings with Associates that also constitute conflicts of interest requiring SBA prior approval but provides exceptions under paragraph (d)(3). Paragraph (d)(3)(iii) identifies exceptions for SBICs with outstanding Participating Securities. Since no operating Licensees remain in SBA's portfolio, SBA is implementing regulations to remove this exception. Paragraph (d)(3)(iv) identifies exceptions involving Non-leveraged Licensees. SBA is implementing regulations to revise this exception to incorporate the new Non-leveraged Licensee term and simplify this regulation.

One commenter agreed with the regulation as proposed. This final rule adopts the proposed § 107.730 substantially as set forth in the proposed rule.

V. Section 107.830 Minimum Duration/Term of Financing

Paragraph (c)(2) discusses “prepayments” and states: “You [Licensee] must permit voluntary prepayment of Loans and Debt Securities by the Small Business. You must obtain SBA's prior written approval of any restrictions on the ability of the Small Business to prepay other than the imposition of a reasonable prepayment penalty under paragraph (c)(3) of this section.”

SBA considered in the proposed rulemaking process whether it should make changes to § 107.830(c)(2) regarding prepayment restrictions for Loans and Debt Securities to remove the requirement for SBA's prior written approval regarding any restriction on the ability of a small business to prepay (other than the imposition of a reasonable prepayment penalty). SBA had become concerned that certain terms in unitranche or multi-lender transactions that require voluntary prepayments to be distributed on a pro rata basis to all lenders in a transaction could be considered a prepayment restriction. Generally, SBA does not view a financing term that requires a portfolio concern to make prepayment distributions on a pro rata basis to all lenders in a transaction to be a prepayment restriction.

One commenter supported the regulation as proposed with two suggestions: a) support a clarifying statement within § 107.830(c)(2) that “[r]equirements to apply prepayments pro rata among a group of lenders that is pari passu in rights to payment will not be deemed to constitute a restriction on prepayments hereunder” and b) adding to 13 CFR 107.830(c) a safe harbor for a reasonable restriction on the minimum increments in which partial prepayments can be made by small businesses. SBA supports the proposed suggestions and, in response, added in the final rule a clarifying statement within § 107.830(c)(2) that “[r]equirements to apply prepayments pro rata among a group of lenders that is pari passu in rights to payment will not be deemed to constitute a restriction on prepayments hereunder” and added to 13 CFR 107.830(c) a safe harbor for a reasonable restriction on the minimum increments in which partial prepayments can be made by small businesses.

One commenter indicated that small businesses should not be discouraged from making prepayments. SBA agrees that the small business must be the first consideration and does not seek to discourage prepayment for small businesses. However, in order to encourage funds to participate in the SBIC program and provide such capital, SBA must consi

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2023-13981. Public record. Not legal advice.