# Small Business Investment Companies; Leverage; Participating Securities; Conditions Affecting Good Standing of Licensees

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URL: https://www.frixlaw.com/law-library/documents/fr%3A94-7843

## Record

- **Collection:** Federal Register
- **Document type:** Uncategorized Document
- **Published:** April 8, 1994

## Text

SUMMARY: This final rule implements certain of the changes to the Small
Business Investment Act of 1958, as amended, made by the ``Small
Business Equity Enhancement Act of 1992 (September 4, 1992).'' The
changes implemented by this rule relate to Leverage provided to SBICs
by SBA, and include increasing from $35 million to $90 million the
amount of Leverage that may be outstanding to any one Licensee or group
of Licensees under common control, incrementally reducing the maximum
ratio of Leverage to capital as capital is increased, establishing a
new form of Leverage (Participating Securities) which will be available
to Licensees that make Equity Capital Investments in small concerns,
permitting Specialized SBICs that are organized as limited partnerships
to obtain Leverage from SBA in the form of a preferred limited
partnership interest, and making other technical changes necessary to
implement the legislation.

DATES: This final rule is effective April 25, 1994.

FOR FURTHER INFORMATION CONTACT: Marvin D. Klapp, Acting Director,
Office of Program Development; telephone (202) 205-6515.

SUPPLEMENTARY INFORMATION: On August 5, 1993, SBA published two
proposed rules to implement certain changes to the Small Business
Investment Act of 1958, as amended (Act), made by title IV of Public
Law 102-366 (September 4, 1992). See 58 FR 41852 and 58 FR 41882. The
first of the two rules proposed changes in the way financial assistance
(Leverage) is provided to small business investment companies (SBICs or
Licensees), including the creation of a new form of Leverage called
Participating Securities, which would be available to Licensees making
equity-type investments in small concerns. The second of the two rules
proposed changes affecting the licensing and operations of SBICs.
The public was afforded a sixty-day period in which to submit
comments on the two proposed rules to the Agency. In recognition of the
complexity of the subject matter involved, SBA reopened and extended
the comment period on both proposed rules until November 18, 1993. See
58 FR 57568 (October 26, 1993).
After receiving and giving careful consideration to approximately
109 comment letters, SBA is today finalizing both proposed rules. This
final rule finalizes the proposed rule concerning Leverage,
Participating Securities and other miscellaneous matters. The final
rule immediately following this rule in the Federal Register
(Operations Rule) finalizes the proposed rule concerning licensing and
operations of SBICs.
In addition, SBA is simultaneously finalizing in this separate part
of the Federal Register the proposed rule published on July 29, 1993
(58 FR 40603), which revises one of the size standards for the SBIC
Program (Size Rule).

1. General Leverage Provisions

a. Introduction

SBA is finalizing the renumbering and reorganization of the
``Leverage'' sections of the SBIC Program regulations (Sec. 107.210
through Sec. 107.263) as proposed. SBA intends, at a later date, to
conform the remainder of the SBIC Program regulations (part 107 of
title 13 of the Code of Federal Regulations) to the new numbering
system used in the Leverage sections.
As in the proposed rule, the term ``Licensee'' used in this final
rule always includes SBICs licensed under the authority of section
301(c) of the Act (section 301(c) Licensees) and SBICs licensed under
the authority of section 301(d) of the Act (section 301(d) Licensees).
A section 301(c) Licensee is sometimes referred to as a Regular SBIC
because there is no restriction on the type of Small Concern that it
may assist. A section 301(d) Licensee is sometimes referred to as a
Specialized SBIC or SSBIC because it is only authorized to assist Small
Concerns owned by persons whose participation in the free enterprise
system is hampered because of social or economic disadvantages.

b. Application Procedures

In proposed Sec. 107.210, SBA set forth the application procedures
and basic eligibility requirements for obtaining Leverage from SBA. SBA
received fifty-eight (58) comment letters on this section, many of
which addressed the requirement in Sec. 107.210(c)(2) that applicants
for Leverage demonstrate a need for the Leverage funds.
The requirement for a demonstration of need is not a new concept
for the SBIC Program. Historically, a Licensee was considered to
``need'' Leverage if sixty-five percent (65%) of its private capital
had been invested or committed to investments in Small Concerns.
However, if a Licensee had significant available resources of its own
(e.g., unfunded commitments from investors), it was generally
considered not to be in need of Leverage.
SBA proposed an exception to this general rule for applicants for
Participating Securities Leverage: SBA would disregard the applicant's
temporary excess liquidity resulting from unfunded commitments or
drawdowns of commitments if the Licensee had invested at least fifty
percent (50%) of its Leverageable Capital\1\ and Leverage in Equity
Capital Investments (the required investment category for issuers of
Participating Securities). Under this exception, though, Licensees with
unfunded commitments would probably find themselves ineligible for
their first issuance of Participating Securities Leverage unless fifty
percent (50%) of their Leverageable Capital had already been invested
in Equity Capital Investments.
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\1\This term and the related term ``Regulatory Capital'' are
defined in the Operations Rule.
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The comments received by SBA questioned the appropriateness of
requiring Licensees to make Equity Capital Investments in order to be
eligible for Participating Securities Leverage. They argued that such a
requirement was inconsistent with the intent of the legislation, which
required that Equity Capital Investments be made with the proceeds of
Participating Securities.
The comments also argued in favor of extending to Debenture and
Preferred Securities issuers the same ability to demonstrate a need for
Leverage while commitments from investors remain unfunded.
SBA agrees with the comments. If any Licensee has invested fifty
percent (50%) of its Leverageable Capital plus outstanding Leverage and
is in compliance with SBA regulations, it should be eligible for SBA
Leverage. This should be true for all Licensees, not just those that
issue Participating Securities, and should be true regardless of the
type of investments that have been made by the Licensee (assuming, of
course, that the Licensee's past investments have been in eligible
Small Concerns). The proposed rule has been revised and finalized
accordingly.
It should be noted here that eligibility for Leverage does not mean
that Leverage necessarily will be available and forthcoming. In the
event that the demand for Leverage exceeds the available supply, SBA
will allocate Leverage among the eligible applicants unless and until
additional funds or guarantee authority is made available to meet such
demand.

c. Fees

As proposed, Sec. 107.210(d) increased the user fee charged in
connection with obtaining Leverage to two percent (2%) of the face
amount of Debentures, and instituted the same two percent (2%) fee for
Participating Securities. SBA received twenty-two (22) comments on this
subject, some objecting to an increased fee for Debenture Leverage
unless there were a corresponding increase in the cost of administering
such Leverage, and others objecting to increased fees in general unless
the fees could be used to offset the costs of managing the SBIC
Program.
SBA believes the increased fees are necessary to maintain the
current Debenture program and implement the new Participating
Securities program. SBA currently is able to use such fees to pay the
costs associated with the Leverage fundings, including the fees of
parties with which it contracts to perform services attendant to these
fundings. Any excess fees are deposited in the U.S. Treasury and are
counted when determining the ``subsidy rate'' of the particular SBIC
program that generated the fees. The subsidy rate for a program is a
measurement that determines the multiple of SBA guarantee authority
that can be made available for each dollar appropriated to that program
by Congress. Fees in excess of actual costs associated with the
Leverage fundings have the effect of reducing the particular SBIC
program's subsidy rate, thereby resulting in more ``guarantee dollars''
being available for the program participants. This is a benefit to all
Licensees seeking Leverage, especially when appropriated funds are
being curtailed due to budgetary constraints. SBA is therefore
finalizing the provision as proposed: the new user fee will be two
percent (2%) for all Debenture and Participating Securities issuers.

d. Subordination of Debentures

Proposed Sec. 107.210(f)(5) clarified that when SBA agrees to
subordination with respect to Debentures guaranteed after July 1, 1991,
the amount of indebtedness to which such subordination applies is fixed
at the time SBA subordinates, and is limited then and later to the
lesser of two hundred percent (200%) of the Licensee's Leverageable
Capital, or $10 million. Any indebtedness of the Licensee in excess of
that amount, whether in existence at the time SBA subordinates or
acquired subsequently, will not benefit from SBA's subordination.
The comments received on this provision were supportive of the
change. The provision is adopted as proposed.

e. Restrictions on Third Party Debt

As explained under the proposed rule, Licensees have been permitted
to apply for and obtain financing from third parties without obtaining
SBA's prior approval or even notifying the Agency, except upon the
filing of annual financial statements. Third party lenders have viewed
SBA Leverage, which is unsecured and generally subordinate, as part of
the capital base of the Licensee. In some cases, third party financing,
when aggregated with Leverage, has exceeded a prudent level of
indebtedness, and SBA has been forced to suffer large losses upon the
distribution of a Licensee's assets in liquidation, receivership or
bankruptcy proceedings.
Concern over SBA's creditor position prompted the Agency to tighten
its terms of subordination in July 1991. See 56 FR 31777. The
subordination limits then adopted, however, have not discouraged some
Licensees from incurring large amounts of secured third party debt.
Recognizing its obligation to further protect its exposure as the
largest creditor of most debtor Licensees, SBA proposed that it have
the right to approve all new third party debt of a Licensee.
As proposed, Sec. 107.210(f)(6) required that, after September 30,
1993, Licensees would need to obtain the written approval of SBA before
incurring or refinancing any third party debt or obtaining any line of
credit. In addition to conventional third party debt, this restriction
covered guarantees by Licensees and other voluntarily assumed
contingent liabilities. Licensees with existing lines of credit were
required to have such lines approved by SBA before increasing the
amounts outstanding above the balance owed on September 30, 1993.
SBA received 45 comments on this provision; all were opposed to the
proposal as written. The comments expressed concern that the need for
prior approval from SBA could be very damaging to SBIC business
operations. They suggested elimination of the requirement of prior
approval for a Licensee's normal business credit arrangements, for its
short-term bridge debt and, up to a certain safe-harbor level, for any
third-party debt.
After considering these comments, SBA has concluded that it can
eliminate entirely the requirement for prior approval of a Licensee's
unsecured third-party debt and still protect the Agency's interest in
the Licensee. This change, reflected in the final rule, should allow
Licensees to engage in their ordinary business credit arrangements
without interference from SBA.
SBA is not convinced, however, that secured third-party debt, of
any amount, should be incurred by a Licensee without SBA's prior
approval. SBA understands the SBIC industry's concern regarding the
prior approval process; in the past, SBA may not have been able to
respond to SBIC requests for approval in other matters as expeditiously
as both the SBICs and SBA might have liked. While SBA expects to deal
with all requests for prior approval on a timely basis, SBA is prepared
to commit itself to a thirty-day turn-around on certain requests. Thus,
the final rule provides that if a Licensee is in regulatory compliance
and has SBA Leverage not in excess of 1.5 times its Leverageable
Capital, and if the Licensee's request is for approval of a secured
line of credit which would not cause its aggregate third-party debt to
exceed fifty percent (50%) of Leverageable Capital, then the Licensee's
request for prior approval will be considered approved unless SBA
notifies it otherwise within thirty (30) days of receiving the request.
It should be noted that all debt, whether secured or unsecured, will be
aggregated to determine whether the Licensee may avail itself of the
thirty-day turn-around.
When making its determination as to whether a Licensee's request
for secured third-party debt should be approved, SBA will take into
consideration various factors including, but not limited to, the amount
of secured indebtedness relative to other debt of the Licensee and the
amount of secured indebtedness relative to the value of the Licensee's
collateral proposed to be granted as security.
Licensees are reminded that once a line of credit is approved by
SBA, subsequent draw-downs under the line of credit do not require SBA
approval.
The final rule extends the date after which SBA approval will be
required from September 30, 1993, to the date of publication of this
final rule. Licensees with existing secured lines of credit are
reminded to obtain SBA approval of such lines before increasing the
amounts outstanding above the balance owed on the date of publication.
The final rule also clarifies that if a Licensee has no Leverage,
it is not required to have its third-party debt approved by SBA.

f. Maintenance of Unimpaired Capital

(i) General
Former Sec. 107.203(d) required Leveraged Licensees to maintain
Private Capital in an amount sufficient to avoid a condition of Capital
Impairment. Under that regulation, a section 301(c) Licensee was
Capitally Impaired and was in violation of Sec. 107.203(d) if its
Undistributed Net Realized Earnings deficit, together with any
Unrealized Depreciation in excess of Unrealized Appreciation, exceeded
fifty percent (50%) of Private Capital. For a section 301(d) Licensee,
the applicable percentage was seventy-five percent (75%).
The proposed regulation on Capital Impairment (Sec. 107.210(h))
allowed, for the first time, varying degrees of impairment depending
upon differences in the composition of the portfolios of Licensees. The
proposal took the form of two grid structures, each consisting of nine
(9) categories for section 301(c) and section 301(d) Licensees,
respectively. The proposed rule continued to permit a higher percentage
of impairment for a section 301(d) Licensee than for a section 301(c)
Licensee whose situation was otherwise identical. However, the
differential was reduced to five (5) percentage points from the former
twenty-five (25) percentage points. In addition, the proposed rule
recognized the delay in profitability that is expected to occur in
venture investing.
The rationale for moving to a grid structure that would allow an
equity investor SBIC a higher permissible level of capital impairment
than a lender SBIC was set forth in the proposed rule. Essentially, the
proposed structure recognized that in a venture portfolio, especially
during the early years, there are likely to be considerable losses
before profits are realized, and a Capital Impairment Percentage of
fifty percent (50%) or more may exist even when the portfolio has
genuine long-term value. However, for a Licensee which only provides
loan financing, a Capital Impairment Percentage of fifty percent (50%)
generally indicates a significant operating deficit that cannot be
offset by appreciation in the portfolio.
Also new in the proposed regulation on Capital Impairment was the
treatment of net Unrealized Appreciation. Under the old Capital
Impairment concept, Licensees have been required to treat net
Unrealized Depreciation as if it represented realized losses, but they
received no corresponding credit for net Unrealized Appreciation. The
proposed regulation acknowledged the existence of net Unrealized
Appreciation in a Licensee's portfolio, yet attempted to avoid
providing incentives for Licensees to inflate their portfolio values
artificially. Thus, SBA proposed to allow partial recognition of net
Unrealized Appreciation in the computation of Capital Impairment, to an
extent which would vary depending on whether or not the portfolio
securities were Publicly Traded and Marketable.
The proposed rule also provided that a violation of the Capital
Impairment regulation would constitute an event of default with respect
to Debentures and Preferred Securities (Sec. 107.261(d)), and that such
a violation also would affect the good standing of a Licensee issuing
Participating Securities (Sec. 107.262(d)). In all cases, Licensees
were afforded an opportunity to cure a violation before SBA could
impose any of the remedies available to it under the proposed
regulations.
The thirty-nine (39) comments received on the Capital Impairment
proposal generally were unfavorable. While there was little objection
to the grid structure per se, there was strong objection to the
permissible Capital Impairment percentages located within the grid. The
respondents happily accepted the relatively high percentages available
to the equity-investor SBICs, but felt that the proposed percentages
for lender SBICs were excessively low. Specialized SBICs also argued
that the percentages for section 301(d) Licensees were unfair, and that
SBA should return to a single percentage (75%) for all Specialized
SBICS, regardless of portfolio composition or amount of Leverage.
SBA has decided to retain the grid structure for the section 301(c)
Licensees, and to increase their permissible levels of Capital
Impairment by five (5) percentage points across the board. Thus, a
section 301(c) Licensee would be permitted to have impaired Regulatory
Capital of anywhere from thirty-five percent (35%) to seventy percent
(70%), depending on the Licensee's portfolio mix and its Leverage
ratio. SBA believes this is an appropriate resolution as it balances
its own concerns with those of SBICs, as expressed in the comments.
For section 301(d) Licensees, SBA intends to return to the current
permissible level of Capital Impairment. All Specialized SBICs will be
permitted a Capital Impairment level of seventy-five percent (75%),
regardless of portfolio mix or Leverage ratio. The differential between
the Regular and Specialized SBICs will be from five (5) percentage
points for an equity investor Licensee to forty (40) points for a
lender Licensee. This differential is a recognition of the more
limited, and often riskier, pool of small business concerns in which a
Specialized SBIC may make investments.
There were also a number of comments on the subject of net
Unrealized Appreciation, arguing, for the most part, in favor of full
recognition of all net Unrealized Appreciation as an offset to realized
losses, or for looser standards for recognizing net Unrealized
Appreciation on private securities.
SBA continues to believe that full recognition of all net
Unrealized Appreciation is inappropriate and that the proposed
standards for recognizing net Unrealized Appreciation on private
securities are sufficiently liberal. Licensees will now, for the first
time, be permitted some credit for net Unrealized Appreciation.
Accordingly, SBA is not prepared to loosen these criteria further.
The final Capital Impairment issue addressed in the comment letters
was the length of the forbearance periods for issuers of Participating
Securities. SBA understands the industry's desire for a longer period
of forbearance, but believes that the four and five year allowances
that were proposed, together with the increased permissible percentages
agreed to in this final rule, should be adequate for a Licensee with a
minimally successful portfolio.
SBA also reminds the SBIC industry that Capital Impairment is a
curable violation. See Secs. 107.261(d)(5) and 107.262(d)(3). In fact,
special cure methods are available to Participating Securities issuers.
See Sec. 107.210(h)(7).
One final change has been made to the proposed Capital Impairment
provision; it concerns the inclusion of non-cash gains in the
computation of Capital Impairment. Under the former definition of
Capital Impairment, all amounts required by SBA accounting rules to be
classified as Non-cash Gains/Income (as reported on SBA Form 468) were
excluded from the Capital Impairment formula. SBA believes this
provision was too stringent, and that Licensees should be able to
receive credit in the impairment computation for non-cash gains under
certain circumstances. However, when the Agency rewrote the Capital
Impairment test in the proposed rule, full credit was mistakenly
permitted for all Non-cash Gains/Income of a Licensee, regardless of
the source. This error was the consequence of using the term
``Undistributed Realized Earnings,'' which includes all Non-cash Gains/
Income, in the computation. The unintended result of this change was
that delinquent accrued interest converted into a note, interest income
accrued on deferred-interest notes and other components of Non-cash
Gains/Income which may be uncertain as to collectibility would be
counted as realized earnings in determining Capital Impairment.
It was SBA's intent when drafting the proposed Capital Impairment
provision to give capital gains credit only for certain Non-cash Gains/
Income: Specifically, those that the Agency felt had the greatest
certainty of measurement and collectibility. In this final rule, SBA
has clarified that the only Non-cash Gains/Income that may be counted
when computing Capital Impairment are those Non-cash Gains/Income that
are realized in the form of Publicly Traded and Marketable securities
or investment grade debt instruments.
A debt instrument would not be considered investment grade for
purposes of this rule unless it had actually been rated ``BBB'' or
``Baa'', or better, by Standard & Poor's Corporation or Moody's
Investment Service, respectively. A non-rated debt instrument issued by
a company with outstanding investment grade debt also could be
considered investment grade if the Licensee were to obtain a written
opinion from an investment banking firm acceptable to SBA stating that
the non-rated debt instrument is equivalent in risk to the issuer's
investment grade debt.
The following is an example of how this rule operates: If a
Licensee sells a portfolio investment with a basis of $200,000 and
receives, exchange, General Electric stock worth $300,000 plus a below
investment grade promissory note for $150,000, the Licensee should
include in the Capital Impairment computation $100,000 of the $250,000
of Non-cash Gains/Income it received.
In order to implement this change, the final rule adds a new
defined term, ``Includible Non-cash Gains/Income'', to Sec. 107.3 to
represent those non-cash gains for which SBA will give credit for
purposes of Capital Impairment. In the final version of
Sec. 107.210(h), the Licensee computes Capital Impairment by starting
with Undistributed Net Realized Earnings, which is net of all Non-cash
Gains/Income, and adds back Includible Non-cash Gains/Income.
Undistributed Net Realized Earnings has been added to the definitions
section of the regulation. This should be a familiar term to all
Licensees because of its appearance on SBA Form 468. See Sec. 107.3.
The final rule also clarifies that a Licensee's Unrealized Gain
(Loss) on Securities Held must reflect the estimated tax effects
associated with the future realization of gains or losses. See the
definition of Unrealized Gain (Loss) on Securities Held (Sec. 107.3).
In summary, the Capital Impairment proposal is finalized as
proposed except for a five (5) percentage point increase for Regular
SBICs, a return to the seventy-five percent (75%) test for Specialized
SBICS, and the inclusion of only a limited class of non-cash gains.
This final rule repeats the summary of the computation of Capital
Impairment as it appeared in the summary of the proposed rule. The only
change is the use of ``Undistributed Net Realized Earnings plus
Includible Non-cash Gains/Income'' instead of ``Undistributed Realized
Earnings'', as discussed above.
(ii) Computation of Capital Impairment Percentage
If Unrealized Gain (Loss) on Securities Held is zero or positive,
and the sum of Undistributed Net Realized Earnings plus Includible Non-
cash Gains/Income is also zero or positive, no Capital Impairment
exists and no further calculations are necessary. If either or both
amounts are less than zero, the Licensee must make the calculations
described in Secs. 107.210(h) (3) and (4). Depending upon the results
of interim calculations in these paragraphs, the Licensee may be
required to compute a Capital Impairment Percentage.
(iii) Determination of Capital Impairment Violation
As with the proposed rule, a Licensee will not be in violation of
Sec. 107.210(h) simply by having a Capital Impairment Percentage
greater than zero. Violations of Sec. 107.210(h) arise out of an
excessive Capital Impairment Percentage. For section 301(d) Licensees,
Capital Impairment of more than seventy-five percent (75%) is
considered excessive; for section 301(c) Licensees, maximum permissible
Capital Impairment percentages are set forth in a table in the
regulation.
(iv) Special Rules for Licensees With Outstanding Participating
Securities
(A) General. All Leveraged Licensees, including Licensees with
outstanding Participating Securities, are required to compute their
Capital Impairment Percentages in the same manner. A Licensee with
outstanding Participating Securities may, for as long as five years
following its initial issuance of Participating Securities, have a
Capital Impairment Percentage higher than the applicable table permits
(but not as high as eighty-five percent (85%)) without thereby being in
violation of Sec. 107.210(h) if it meets the other requirements set
forth in Sec. 107.210(h)(7). In addition, a Licensee that meets the
requirements set forth in Sec. 107.210(h)(7) (i) or (ii) will be
afforded an opportunity to cure on terms that may be more favorable
than those available to other Licensees.
(B) Curable Capital Impairment Percentage during first 48 months
following initial issuance of Participating Securities. During the
first forty-eight (48) months after initially issuing Participating
Securities, a Licensee with outstanding Participating Securities will
not be impaired if: (1) Its Capital Impairment Percentage is less than
eighty-five percent (85%); (2) at least two-thirds of its outstanding
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Equity Capital
Investments.
(C) Curable Capital Impairment Percentage during first 60 months
following initial issuance of Participating Securities. During the
first sixty (60) months after initially issuing Participating
Securities, a Licensee with outstanding Participating Securities will
not be impaired if: (1) Its Capital Impairment Percentage is less than
eighty-five percent (85%); (2) at least two-thirds of its outstanding
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Start-up
Financings. For the purposes of this regulation, a Start-up Financing
is an Equity Capital Investment in a growth-oriented Small Concern
that, at the time of the investment, (1) has not been in existence, in
any form, for more than three fiscal years, (2) has not had positive
cash flow or sales exceeding $5 million in any fiscal year, and (3) is
not formed for the purpose of acquiring any existing business.
(D) Cure of Capital Impairment. During the fifth year following its
initial issuance of Participating Securities, a Licensee that meets the
requirements described in paragraph (B) above may cure its Capital
Impairment by taking one or more of the following actions within thirty
(30) days after it determines that it has a condition of Capital
Impairment. The Licensee may increase its Regulatory Capital\2\ by
depositing in an escrow account satisfactory to SBA a cash contribution
equal to fifteen percent (15%) of outstanding Leverage; or it may
provide SBA with a guarantee satisfactory to SBA, for the benefit of
SBA, equal to fifteen percent (15%) of its outstanding Leverage. In
addition to the normal credit considerations that would determine
whether a guarantee is satisfactory to SBA, the terms of the guarantee
must provide that any guarantee fee that otherwise would be due the
guarantor from the Licensee, and any other sums that would be due the
guarantor by virtue of the guarantor's right of subrogation, must be
deferred and subordinated to the full repayment of all outstanding
Leverage plus any unpaid Earned Prioritized Payments (as defined in
Sec. 107.3) and earned Adjustments (discussed below under
Sec. 107.243(d)).
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\2\This increase in Regulatory Capital operates only to cure
what would otherwise be a Capital Impairment. It does not increase
the Licensee's eligibility for Leverage.
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During the sixth year following its initial issuance of
Participating Securities, a Licensee that meets the above requirements
may cure its Capital Impairment by taking one of the actions described
in the preceding paragraph, except that the amount of the cash deposit
or guarantee shall be equal to thirty percent (30%) of outstanding
Leverage. Any amount deposited previously may be used as a credit
against the thirty percent (30%) requirement.

2. Leverage for Section 301(c) Licensees

No comments were received on proposed Sec. 107.220; accordingly, it
is finalized as proposed. This section provides Leverage requirements
for section 301(c) Licensees, and reflects amendments to the Act
contained in Section 402 of Public Law 102-366. Section 107.220 permits
SBA to provide Leverage to section 301(c) Licensees through the
purchase or guarantee of Debentures and/or Participating Securities.
After March 31, 1993, a section 301(c) Licensee's amount of Leverage
outstanding at any time shall not exceed three hundred percent (300%)
of its Leverageable Capital up to $15 million; two hundred percent
(200%) of its Leverageable Capital of more than $15 million, but not
more than $30 million; and an amount, not exceeding $15 million, which
is equal to one-hundred percent (100%) of its Leverageable Capital over
$30 million. The aggregate amount of outstanding Leverage by any
Licensee or group of two or more Licensees under Common Control\3\
shall not exceed $90 million. On a case-by-case basis, SBA may grant an
exception to this ceiling to a group of Licensees under Common Control
and permit a higher amount, subject to such terms and conditions as SBA
considers appropriate to minimize risk of loss in the event of default.
In no event, however, shall the aggregate amount of a Licensee's
Participating Securities exceed two hundred percent (200%) of
Leverageable Capital.
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\3\This term is defined in the Operations Rule.
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A ``grandfather clause'' is provided for Licensees that, on March
31, 1993, have outstanding Debentures in excess of three hundred
percent (300%) of Leverageable Capital, so that such Licensees are not
required to prepay such excess. Such Licensees also may apply to issue
additional Debentures or Participating Securities solely to pay the
amount due on such maturing Debentures. The maturity date of any new
Debenture or Participating Securities issued for this purpose may not
be later than September 30, 2002.

3. Leverage for Section 301(d) Licensees

In proposed Sec. 107.230, SBA described some of the terms and
conditions of Leverage for section 301(d) Licensees. SBA may provide
Leverage to section 301(d) Licensees through the purchase or guarantee
of Debentures and/or Participating Securities, and/or through the
purchase of Preferred Securities. As further described below, the
proposed rule provided that section 301(d) Licensees would be eligible
for subsidized Debenture Leverage and for Preferred Securities Leverage
up to a maximum of four hundred percent (400%) of Leverageable Capital
or $35 million, whichever is less. Leverage in excess of that amount
would be nonsubsidized.
Six (6) comments were received on proposed Sec. 107.230. The
comments were supportive of the proposal, except for the ceiling of $35
million for subsidized Leverage. As the comments recognized, however,
the $35 million ceiling on subsidized Leverage is statutory in origin.
Section 402 of Public Law 102-366, which increased the general Leverage
ceiling for the SBIC program above its prior level of $35 million,
established the subsidized Leverage ceiling for section 301(d)
Licensees. The regulation cannot permit a higher amount of subsidized
Leverage than is permitted by the Act.
SBA therefore is finalizing Sec. 107.230 as proposed, with the
exception of one minor change, designed to correct an error: The four
percent (4%) dividend on preferred stock and the four percent (4%)
return on the preferred limited partnership interest accrue on an
annual basis (rather than on a daily basis, as stated in the proposed
rule).
The Articles of section 301(d) Licensees are required to be
conformed to the requirements discussed in paragraphs a. or b. below,
as appropriate, in order to issue Preferred Securities after the date
hereof.

a. Preferred Stock

In the case of corporate Licensees, the preferred stock purchased
by SBA prior to November 21, 1989, shall be non-voting stock with a
three percent (3%) cumulative preferred dividend paid out of Retained
Earnings Available for Distribution. Preferred stock issued after
November 21, 1989, shall provide for four percent (4%) preferred
cumulative dividends payable out of Retained Earnings Available for
Distribution. Four percent (4%) preferred stock shall be redeemed not
later than fifteen (15) years after issuance at a price not less than
par value plus unpaid dividends accrued to the redemption date. SBA may
guarantee non-subsidized Debentures offered for sale by a Licensee
immediately prior to the redemption of its four percent (4%) preferred
stock in such amounts as will permit simultaneous redemption of such
stock.

b. Preferred Limited Partnership Interest

Section 412 of Public Law 102-366 authorizes unincorporated section
301(d) Licensees to issue preferred limited partnership interests to
SBA which would have the same terms and conditions as the four percent
(4%) preferred stock described immediately above (that is, a preferred
and cumulative return at an annual rate of four percent (4%), payable
from Retained Earnings Available for Distribution). Such preferred
limited partnership interests shall be redeemed not later than fifteen
(15) years from the date of issuance at a price not less than SBA's
contributed capital plus accumulated and unpaid distributions through
the redemption date. SBA may guarantee non-subsidized Debentures issued
by a section 301(d) Licensee immediately preceding such redemption in
such amounts as will permit simultaneous redemption of such preferred
limited partnership interests.

C. Leverage Ceiling

As in the proposed rule, Sec. 107.230(c) establishes maximum
Leverage eligibility for section 301(d) Licensees. All types of
Leverage issued by such Licensees shall be aggregated for purposes of
determining Leverage eligibility, including aggregation of Leverage
issued by Licensees under Common Control. As stated earlier, section
301(d) Licensees are eligible for maximum subsidized Leverage
(consisting of Preferred Securities and Debentures issued with a rate
reduction) of four hundred percent (400%) of Leverageable Capital or
$35 million, whichever is less. Section 301(d) Licensees also are
eligible for nonsubsidized Leverage in excess of $35 million, subject
to the amounts and conditions specified for section 301(c) Licensees.
In order to qualify for Leverage exceeding three hundred percent
(300%) of Leverageable Capital, at least thirty percent (30%) of the
Licensee's Total Funds Available for Investment must be invested in or
committed to Venture Capital Financing of Disadvantaged Concerns, and a
Licensee must maintain thirty percent (30%) of its Total Funds
Available for Investment in such investments while Leverage in excess
of three hundred percent (300%) of Leverageable Capital is outstanding.
For the purpose of meeting the thirty percent (30%) test, the Venture
Capital Financings shall be valued at cost. The present definition of
Venture Capital Financing remains unchanged and is set forth in
Sec. 107.230(c)(3)(iii).

d. Second Tier of Preferred Securities

As in the proposed rule, SBA is authorized to purchase Preferred
Securities in amounts in excess of one hundred percent (100%) of
Leverageable Capital, but not in excess of two hundred percent (200%)
of Leverageable Capital, from certain Licensees. These are section
301(d) Licensees with Leverageable Capital of $500,000 or more, or
section 301(d) Licensee licensed on or before October 13, 1971,
regardless of the amount of Leverageable Capital. In either case, a
Licensee must have Qualified Investments (as defined in
Sec. 107.230(c)(4)(iv)) equal, at cost, to the amount of Preferred
Securities in excess of one hundred percent (100%) of Leverageable
Capital. Commitments to make Qualified Investments may be counted to
satisfy this requirement.
It should be noted that the definition of Qualified Investments is
similar, but not identical to, the definition of Venture Capital
Financing as set forth in Sec. 107.230(c)(3)(iii). The most important
difference is that a secured debt instrument may qualify as a Venture
Capital Financing but would not qualify as a Qualified Investment.

e. Participating Securities

Section 107.230(c)(6) authorizes section 301(d) Licensees to issue
Participating Securities in an amount not exceeding two hundred percent
(200%) of Leverageable Capital, less an amount equal to Licensee's
outstanding Preferred Securities. Prioritized Payments and Profit
Participation on Participating Securities issued by section 301(d)
Licensees shall not be subsidized.

f. Other Provisions

Section 107.230(d) describes the types of Debentures which section
301(d) Licensees may issue, and Sec. 107.230(e) permits section 301(d)
Licensees, in SBA's discretion, to retire Debentures through the
issuance of Preferred or Participating Securities.
Section 107.230(f) is a recodification of former
Sec. 107.201(a)(2)(iii).

4. Participating Securities

As proposed, Secs. 107.240 through 107.247 described special rules
which would apply to Licensees issuing Participating Securities.
SBA received many comments on these proposed rules. Most were very
supportive, although many suggestions for improving the proposal were
received. Comments related to specific provisions of the Participating
Securities are addressed in the discussion of those respective sections
of the rule.
The Small Business Equity Enhancement Act of 1992 (title IV of Pub.
L. 102-366) was a mandate for a new relationship between SBA and the
venture capital community. The salient feature of this new relationship
is the creation of Participating Securities. These are equity-type
securities with the characteristics of preferred stock or a preferred
limited partnership interest.
SBA recognizes that venture capital companies usually make initial
equity capital investments, manage their portfolios (making follow-on
investments as necessary), and finally sell their investments as they
mature, with the objective of realizing capital gains. As investments
are sold, funds customarily are distributed to investors rather than
reinvested.
Under this rule, as a means of financing Licensees that issue
Participating Securities, SBA will guarantee the payment of Prioritized
Payments on, and the Redemption Price of, the Participating Securities
to an authorized Trust or pool which purchases the Participating
Securities. Prioritized Payments are the equivalent of dividend
payments of the Participating Securities. As an inducement for its
guarantee, SBA will be entitled to a share in the profits that are
generated from investments made while the Participating Securities are
outstanding (Profit Participation).
Pass-through Trust Certificates evidencing rights in the Trust or
pools of guaranteed Participating Securities will be sold to investors.
The rights and obligations evidenced in the Trust Certificates also
will be guaranteed by SBA. The proceeds of the sale of the Trust
Certificates will be used to fund the Participating Securities.
SBA anticipates that the Prioritized Payments made by Licensees
that issue Participating Securities normally will not be adequate to
fund debt service obligations of the guaranteed Trust Certificates in
the early years of the Participating Securities' existence.
Accordingly, SBA will be called upon to make such payments. Over the
duration of a Participating Security's life, SBA expects to be repaid
most of such guarantee payments through a combination of Earned
Prioritized Payments and Profit Participation. Since Prioritized
Payments on Participating Securities are payable only to the extent of
earnings, SBA realizes that the repayment of its guarantee payments
will depend upon the ability of its Licensees to operate profitably as
equity investors.
SBA understands that venture capital equity investments in Small
Concerns are risky on an individual basis, and that losses on such
investments frequently occur earlier than profits. It anticipates that
Licensees issuing Participating Securities will incur losses in the
early years of their investment cycle as investments in a limited
number of portfolio concerns prove unprofitable and are written off.
SBA recognizes that it must be patient in expecting profitable
operations from Licensees with Participating Securities. At the same
time, SBA has the responsibility to assure that publicly-guaranteed
funds are administered prudently by capable managers. Accordingly, SBA
has sought to formulate an economic and regulatory structure which will
enhance the likelihood that Licensees participating in the program will
be successful.
In issuing this final rule, SBA believes that it can fulfill the
objectives of the Small Business Equity Enhancement Act of 1992 to
foster a venture capital industry that is able to serve the needs of
eligible Small Concerns, create or retain jobs, expand the tax base,
and achieve other objectives such as commercialization of technology,
supporting manufacturing firms, fostering urban and rural business
development, and stimulating exports.
SBA recognizes that its guarantee of Participating Securities will
be an essential factor in the decision of investors to fund Licensees,
and that such investors will need to have confidence in SBA's long-term
investment philosophy. While SBA intends that Participating Securities
serve as patient capital, investors must recognize SBA's special
responsibilities to protect public funds and assure compliance with
program objectives and regulations.
It should be noted that section 410 of Public Law 102-366
authorized inclusion in a Licensee's private capital of investments by
public and private pension funds as well as limited investments by
state and local governments. The form of Participating Securities has
been structured with the intention of avoiding the imposition of
Unrelated Business Taxable Income (UBTI) on certain tax-exempt
investors. SBA believes that pension funds and other tax-exempt
investors will find it advantageous to invest in SBICs using
Participating Securities. Since such institutional investors
historically have provided investment capital to the private venture
capital industry and have acquired expertise in selecting managers and
monitoring investments, SBA anticipates that SBICs will benefit from
this investor expertise. SBA also hopes to benefit from the expertise
of institutional investors to help assure the profitability of the
Licensees that issue Participating Securities.

a. General Provisions

Proposed Sec. 107.241 set forth general provisions for Licensees
issuing Participating Securities. This section reflects SBA's effort to
use marketplace dynamics to assure a successful program.
(i) Minimum Regulatory Capital
Proposed Sec. 107.241(a) set forth minimum capital requirements for
eligibility to issue Participating Securities. In general, a Licensee
would be required to have Regulatory Capital of at least $10 million in
order to be considered eligible to issue Participating Securities. A
Licensee with less than $10 million, but not less than $5 million, in
Regulatory Capital also could be eligible if it were able to
demonstrate to SBA's satisfaction that if could be financially viable
over the long term.
SBA received nineteen (19) comments on this provision, with some
comments favoring the minimum capital requirements and others opposing
them. Many of those opposed to the requirements argued in favor of a $5
million threshold, and voiced the concern that larger SBICs may not
serve the needs of smaller businesses and early-stage companies.
SBA shares the concern that SBICs capitalized at over $10 million
may not be oriented toward investing in smaller concerns. SBA is
addressing that concern by requiring all Licensees to make a certain
percentage of their investments in companies that are smaller than the
maximum size permitted under the Size Rule. This requirement appears in
Sec. 107.101(i) and is more fully discussed in the Operations Rule.
In view of this requirement, SBA is comfortable with the $10
million minimum capital requirement, and feels it is warranted for the
following reasons:
(1) A Licensee making venture capital type investments with
Regulatory Capital of less than $10 million normally will be incurring
excessively high fixed and marginal costs relative to the amount of its
capital; and
(2) Successfully raising $10 million for venture capital
investments constitutes a significant affirmation by the investment
community of the management capabilities of a Licensee. A more detailed
discussion of SBA's rationale for adopting the $10 million threshold
may be found in the proposed rule at 58 FR 41856.
As stated above, SBA will consider authorizing the issuance of
Participating Securities by a Licensee with Regulatory Capital of less
than $10 million, but not less than $5 million, if the Licensee can
show that it has a reasonable prospect of being profitable over the
long term. Thus, a Licensee with Regulatory Capital of less than $10
million might qualify to issue Participating Securities if it is a
subsidiary of a bank, bank holding company, or other large organization
which undertakes to subsidize management expenses of the Licensee and
to provide management personnel and operation support.
A Licensee with Regulatory Capital of less than $10 million also
may be acceptable to SBA if it operates in a rural area or within a
specific geographic area, such as a reasonably compact and focused
urban area. Any such Licensee must have management with proven
expertise in the types of investments proposed and must show, through
its plan of operations, how it can be operated soundly and profitably
over the long term without depleting its capital base through excessive
overhead.
It should be noted that some readers may have misunderstood the
significance of the $10 million threshold. Raising $10 million will not
automatically qualify an applicant for licensing as an SBIC that will
issue Participating Securities. As has always been the case, applicants
for licensing must demonstrate financial viability and qualified
management, regardless of the amount of their Regulatory Capital. It is
possible that a license applicant with $10 million in Regulatory
Capital will have such high overhead expenses or such inexperienced
management that its likelihood of profitability is put into question.
SBA would not issue a license under such circumstances. Under ordinary
circumstances, however, it can be expected that $10 million should
serve as adequate capital for licensing as an SBIC in the Participating
Securities program.
(ii) Equity Capital Investments
Since no comments were received on proposed Sec. 107.241(b), SBA is
finalizing it as proposed. This section requires Licensees issuing
Participating Securities to invest an amount equal to the Original
Issue Price of such securities solely in Equity Capital Investments.
Equity Capital Investments must be maintained at such level and may be
reduced only by the amount of repayments of such Participating
Securities. ``Equity Capital Investments'' means common or preferred
stock, limited partnership interests, options, and warrants or similar
equity instruments, including subordinated debt with equity features if
such debt provides only for interest payments contingent upon and
limited to the extent of earnings. Equity Capital Investments in the
form of debt may not be amortized.
(iii) Management and Ownership Diversity
Proposed Sec. 107.241(c) required that there be some diversity
between the ownership and the management of a Licensee that issues
Participating Securities. The eight comments on this provision were
mixed, with some supporting the proposal as an appropriate means of
preventing self-dealing, and others opposing the proposal as unduly
restrictive.
SBA believes that the benefits of this proposal far outweigh any
inconvenience to Licensees. It is important that Licensees issuing
Participating Securities have investors who are independent of
management and who have a substantial stake in the Licensee's financial
performance. SBA believes that the presence of such investors will help
to assure that Licensees are operated with the objective of optimizing
returns and protecting the interests of all investors, including SBA.
The proposal is therefore finalized without change.
Under paragraph (1) of Sec. 107.241(c), SBA will consider the
diversity requirement satisfied if at least three (3) unaffiliated
shareholders or limited partners (only one is required in the case of
Institutional Investors) own, in the aggregate, at least thirty percent
(30%) of a Licensee or Licensee's ultimate parent entity. Such
diversity also will be deemed to be achieved if a Licensee or its
ultimate parent entity is publicly traded under U.S. securities laws.
The independence and ability of investors to exercise oversight is
maintained by the prohibition against the delegation of voting rights
contained in paragraph (2) of Sec. 107.241(c). An exception is made for
certain proxies and the use of unaffiliated advisors so as not to
interfere with the routine operations of a Licensee.
(iv) Management Fees
Under proposed Sec. 107.241(d), a Licensee issuing Participating
Securities would be subject to a ceiling on its Management Expenses of
2.5% of Combined Capital (Regulatory Capital plus outstanding
Leverage), plus $125,000 in the case of Licensees with Combined Capital
of less than $20 million. SBA could permit a higher amount or, in the
case of larger funds, require a lower amount.
SBA received sixteen (16) comments on this proposal. A frequently-
appearing objection was that the regulatory provision was more
restrictive than the underlying statutory provision. Another objection
concerned SBA's ability to unilaterally reduce allowable Management
Expenses for larger funds.
It is true that the proposal was more restrictive than the
underlying statutory provision. Section 403 of Public Law 102-366
provided a ceiling on Management Expenses only for purposes of
computing SBA's Profit Participation. In the proposed rule, SBA
extended the ceiling to a Participating Securities issuer's actual
expenditures for Management Expenses, but allowed for an amount in
excess of the ceiling if there were a clearly demonstrable need. SBA
felt that the Management Expenses allowed under the proposal were
adequate for most Licensees and were consistent with current venture
capital industry practices.
Based on the comments, SBA has reconsidered its position. Under
this final rule, a Licensee issuing Participating Securities will be
subject to the limits discussed above only for purposes of computing
Earmarked Profits, which (as further discussed below) determine the
amounts that may be allocated to Earned Prioritized Payments and to
Profit Participation. See Sec. 107.242(d). Accordingly,
Sec. 107.241(d), as finalized, no longer provides that a Licensee's
actual Management Expenses are subject to percentage limits; however,
the section still provides that actual Management Expenses must be
approved by SBA.
It should be understood by readers new to the SBIC Program that SBA
presently approves, and will continue to approve, the management
compensation for all Licensees, not just issuers of Participating
Securities.\4\ Management compensation is but one component of
Management Expenses, which includes such additional items as office
expenses and office and equipment rentals. See the definition of
Management Expenses in Sec. 107.3. Depending on the particular
circumstances of the Licensee, approved management compensation and
Management Expenses for a larger fund may be lower, on a percentage
basis, than approved amounts for a smaller fund.
---------------------------------------------------------------------------

\4\Licensees with outstanding Leverage must have increases in
their management compensation approved before such increases are
adopted. Licensees with no outstanding Leverage may have increases
in their management compensation approved after the fact.
---------------------------------------------------------------------------

This final rule also now provides that Licensees placed under
``restricted operations'' under Sec. 107.262(d) are required to re-
obtain SBA's approval of their Management Expenses (or, for issuers of
Preferred Securities, their management compensation) at the time
restricted operations are imposed.
(v) Third-Party Debt (Temporary Debt)
Proposed Sec. 107.241(e) limited the type and amount of third-party
debt that a Licensee issuing Participating Securities could incur, and
required that the Licensee obtain the written approval of SBA before
incurring any such debt. Under the proposal, the only third-party debt
that Licensees issuing Participating Securities would be permitted to
have would be ``Temporary Debt'' in an amount not to exceed fifty
percent (50%) of Leverageable Capital. Licensees would have to pay off
and remain free of all Temporary Debt for at least thirty (30)
consecutive days during each fiscal year.
The fifteen (15) comments received on this provision objected to
the requirement that a Licensee obtain prior SBA approval in order to
incur Temporary Debt. The requirement was characterized as unduly
restrictive and unnecessary. As with the comments discussed above under
''Third-party Debt'' (subsection 1.(e) above), concern was expressed
over possible delays in SBA's response time.
SBA continues to believe that prior SBA approval of third-party
debt is an important component of its administration of the SBIC
Program. This is true for all Licensees, including those that issue
Participating Securities. In order to unify its approach to third-party
debt, SBA is finalizing Sec. 107.241(e) so that it conforms to the
general Third-party Debt provision discussed above. In other words, if
an issuers of Participating Securities is in regulatory compliance and
has Leverage not in excess of 1.5 times its Leverageable Capital, and
if the Licensee's request is for approval of a secured line of credit
which would not cause its aggregate third-party debt to exceed the
Temporary Debt limitation of fifty percent (50%) of Leverageable
Capital, then the Licensee's request shall be considered approved
unless SBA notifies it otherwise within thirty (30) days of receiving
the request. Unsecured Temporary Debt up to the permissible level of
Temporary Debt shall not require prior approval.
(vi) Liquidity Requirement
Proposed Sec. 107.241(f) established a liquidity requirement for
Licensees issuing Participating Securities in order to assure that such
Licensees have sufficient cash to cover their operating overhead during
the ensuing year. A Licensee would have a condition of Liquidity
Impairment if the Liquidity Ratio (as defined in Sec. 107.241(f)(2))
obtained by dividing Total Current Funds Available\5\ by Total Current
Funds Required is less than 1.20. No Distributions could be made if
they would cause a condition of Liquidity Impairment.
---------------------------------------------------------------------------

\5\Section 107.241(f)(2) includes a self-explanatory chart that
shows how the respective values for Total Current Funds Available
and Total Current Funds Required are to be determined.
---------------------------------------------------------------------------

Few comments were received on this provision. Some opposed the
concept as an unnecessary administrative burden; others recommended
different weightings to some of the calculation inputs.
SBA considers this provision important and does not agree that it
is burdensome to the Licensee. SBA considers it essential that
Licensees maintain a level of liquid assets sufficient to meet
operating expenses, make necessary follow-on investments, and allow
investments to be held until they mature and can be sold in the normal
course of business. Accordingly, SBA is finalizing the provision
without change.
(vii) Mandatory Redemption
No comments were received on proposed Sec. 107.241(g), which
required that Participating Securities be redeemed not later than
fifteen (15) years after their issue date. The provision is finalized
without change. As stated in the proposed rule, the redemption date
generally will be ten (10) years after the date of issue and always
will be the same as the maturity date of the Trust Certificates.
(viii) Priority in Liquidation
No comments were received on proposed Sec. 107.241(h), which
provided that upon liquidation of a Licensee, the Redemption Price of
any Participating Securities, plus any Prioritized Payments, Profit
Participation and other amounts that may be due SBA, shall be senior in
priority to all other equity interests of the Licensee. The provision
is finalized without change.
As explained in the proposed rule, SBA recognizes that Prioritized
Payments and Profit Participation are distributable only to the extent
of profits on Earmarked Assets, notwithstanding the cumulative feature
of Prioritized Payments. When a Licensee is liquidated, however, there
can be no Distributions to investors before amounts due SBA, its agent,
or Trustee are paid.

b. Computation of Earmarked Profits (Losses)

SBA received no comments on the computation of Earmarked Profits
(Losses), proposed Sec. 107.242. The provision is finalized as it was
proposed, except for minor wording changes in the paragraph on
Earmarked Investment Expenses. Since it should prove useful to have a
complete summary of the Participating Securities regulations in one
document, SBA is reprinting here the discussion on the computation of
Earmarked Profits (Losses) that appeared in the proposed rule.
There are seven steps in the computation of Earmarked Profits
(Losses) as set forth in Sec. 107.242. (Please note that SBA will
provide the spreadsheet templates and/or other software necessary for
making the ensuing calculations.)
(i) Step 1: Determination of Earmarked Assets
Earmarked Assets are a Licensee's Loans and Investments\6\ that are
outstanding at the time a Licensee issues Participating Securities\7\
or acquired while Participating Securities are outstanding, plus any
non-cash assets given in consideration for the disposition or exchange
of any such asset. Even after all Participating Securities have been
redeemed, Earmarked Assets maintain such status. See Sec. 107.242(b).
---------------------------------------------------------------------------

\6\``Loans and Investments'' is a term that is defined in this
rule as ``Portfolio Securities, Assets Acquired in Liquidation,
Operating Concerns Acquired, and Other Securities Received as set
forth in the Statement of Financial Position (SBA Form 468)''.
\7\A company licensed on or before March 31, 1993 may elect to
exclude its entire portfolio as it existed on that date (but not
less than its entire portfolio) from the category of ``Earmarked
Assets.'' In addition, if a company licensed on or before such date
is refinancing outstanding Debentures by the issuance of
Participating Securities, the company's entire portfolio must be
included in Earmarked Assets. Special rules for such Licensees are
located in Sec. 107.247.
---------------------------------------------------------------------------

(ii) Step 2: Calculating the Earmarked Asset Ratio
This step establishes the percentage of a portfolio that is
earmarked. Since a Licensee may have non-Earmarked Assets deriving from
assets acquired after all Participating Securities have been redeemed,
or determined under the special rules governing SBICs licensed on or
before March 31, 1993 (see Sec. 107.247), it is necessary that all
Licensees calculate an Earmarked Asset Ratio (EAR) as delineated in
Sec. 107.242(c). The ratio is calculated on a weighted average basis
(that is, on a month-by-month basis, which is then averaged) for the
year or fraction of the year in question. For companies licensed after
March 31, 1993 that have not yet redeemed any Participating Securities,
EAR will equal one hundred percent (100%). The formula is:

EAR=[(EA+UPPS)/(L&I+UPPS)] x 100

where:

EA=Earmarked Assets valued at cost
UPPS=Uninvested proceeds of Participating Securities
L&I=Total Loans and Investments (valued at cost).

The example that follows would apply only to companies licensed on
or before March 31, 1993. Assume that such a Licensee had $15 million
in Loans and Investments, issued $10 million of Participating
Securities two months prior to the close of its fiscal year, and had
elected to exclude its pre-existing portfolio from being Earmarked
Assets (as permitted in Sec. 107.247). The following calculations would
apply:

Values at Close of Month 1
------------------------------------------------------------------------
Uninvested
Earmarked assets proceeds Loans and investments
------------------------------------------------------------------------
Zero....................... $10,000,000 $15,000,000 (acquired on or
before 3/31/93).
------------------------------------------------------------------------

If the Licensee invested $2 million from the proceeds of
Participating Securities during the next month, and sold $1 million of
assets for cash, the following would occur:

Values at Close of Month 2
------------------------------------------------------------------------
Uninvested Loans and
Earmarked assets proceeds investments
------------------------------------------------------------------------
$2,000,000.............................. $8,000,000 $16,000,000
------------------------------------------------------------------------

As of the close of Month 1, the Licensee's (interim) EAR was 40
percent [(0=10,000,000)/(15,000,000=10,000,000)].
As of the close of Month 2, for Month 2, (interim) EAR was 41.666
percent [(2,000,000+8,000,000)/(16,000,000+8,000,000)].
As of the close of the Licensee's fiscal year, the Licensee's EAR
was 40.833 percent [(40+41.666)/2] or [(2,000,000+18,000,000)/
(31,000,000+18,000,000)]. For the purposes of the calculations
hereafter discussed, this Licensee's EAR is 40.833 percent.
(iii) Step 3: Ascertaining Earmarked Investment Income
Earmarked Investment Income (EII) is defined in Sec. 107.242(d)(1)
by the formula:

EII=IDA+([IIF+OI] x EAR)

where

IDA=All income directly attributable to Earmarked Assets
IIF=Interest on idle funds
OI=Other income not attributable to specific assets
EAR=Earmarked Asset Ratio

Thus, if IDA were $1,000,000 and other income not attributable to
specific assets were $500,000, EII would be:

($1,000,000+($500,000 x 40.833%)) or $1,204,165.
(iv) Step 4: Calculating Earmarked Investment Expenses
As defined in Sec. 107.242(d)(2), Earmarked Investment Expenses has
two components--Management Expenses and non-Management Expenses.
For the purposes of the calculations in Sec. 107.242(d)(2),
Management Expenses means the lesser of (1) Licensee's approved
Management Expenses multiplied by its EAR; or (2) 2.5 percent of the
product of the Licensee's Combined Capital, multiplied by its EAR
(plus, in the case of a Licensee whose Combined Capital is less than
$20 million, an additional sum equal to the product of $125,000 and the
Licensee's EAR). Expressed in formula terms, this would be:

Management Expense (ME)=0.025 x (CC x EAR) for a Licensee with Combined
Capital (CC) of $20 million or more.
ME = [(0.025 x {CC x EAR}) + ($125,000 x EAR)] for a Licensee with
Combined Capital of less than $20 million.

The second component of Earmarked Investment Expense is non-
Management Expense. Some non-Management Expenses can be attributed
directly to Earmarked Assets and, of course, are to be allocated to
Earmarked Investment Expenses. In addition, Licensee must allocate to
Earmarked Investment Expense a sum equal to the product of non-
Management Expense not attributable to specific assets (specifically
including interest on SBA-guaranteed Debentures) times Licensee's
Earmarked Asset Ratio. See Sec. 107.242(d)(2)(ii).
The sum of the above-described Management and non-Management
Expenses constitutes Earmarked Investment Expenses.
(v) Step 5: Determining Earmarked Net Investment Income (Loss)
Subtract Earmarked Investment Expenses (step 4) from Earmarked
Investment Income to determine Earmarked Net Investment Income (Loss)
(step 3).
(vi) Step 6: Determining Earmarked Realized Gain (Loss) on Securities
Section 107.242(e) sets forth rules for determining gain or loss on
securities that constitute Earmarked Assets (Earmarked Realized Gain
(Loss) on Securities). For the purpose of determining whether a gain or
a loss has been realized\8\ on the sale of an Earmarked Asset, the
asset's cost basis and net sales price shall be used. The asset's cost
basis shall not be increased, even by capitalization of unpaid
interest, except that if the basis of an investment in an
unincorporated Small Concern is appropriately determined by using the
equity method of accounting, the Licensee's basis may be increased by
the Licensee's share of the Small Concern's income. See
Sec. 107.242(e)(3).
---------------------------------------------------------------------------

\8\Unrealized Appreciation or Unrealized Depreciation, as the
case may be, on Earmarked Assets that are Distributed shall be
recognized as if the appreciation or depreciation were realized at
the time of the In-Kind Distribution. See Sec. 107.242(3)(4), and
see also Sec. 107.245(e)(3), which relates to In-Kind Distributions.
---------------------------------------------------------------------------

(vii) Step 7: Computing Earmarked Profits (Losses)
Earmarked Profits (Losses) must be computed no less frequently than
annually as of the close of a Licensee's fiscal year, and at such other
times as Licensee elects to make a Distribution. See Sec. 107.242(a).
The computation is simple enough: Earmarked Profits (Losses) is the
sum, positive or negative, of Earmarked Net Investment Income (Loss)
and Earmarked Realized Gain (Loss) on Securities. See Sec. 107.242(f).

c. Computation, Allocation, and Distribution of Prioritized Payments

(i) Introduction
Proposed Sec. 107.243 provided for the computation, allocation, and
payment of Prioritized Payments. These payments are preferred and
cumulative at the Trust Certificate Rate, which is the rate SBA
guarantees to pay annually to the Trust Certificate holders.
Prioritized Payments resemble dividends on preferred stock or
equivalent distribution on preferred or senior limited partnership
interests.
The few comments received on this portion of the proposed rule
objected only to the Adjustments to the Prioritized Payments. In
general, the Adjustments are additional amounts that become payable to
SBA in the event the Licensee has sufficient profits. They are the
result of the compounding that must be performed by a Licensee if it
does not pay, at the end of its fiscal year, an amount equal to its
annual Prioritized Payments. During the course of that year, SBA will
have been making the interest payments as they come due under Trust
Certificates issued against a pool containing the Licensee's
Participating Securities. SBA's payment will be an amount equal to the
Prioritized Payments on all the Participating Securities in the pool.
The Licensees are not expected to be able to reimburse SBA immediately
for those payments; SBA may wait years for reimbursement, and may never
be reimbursed fully. The Adjustments are intended as partial
compensation to SBA for the time-value of the payments the Agency makes
in the interim. The Adjustments also help to lower the subsidy rate for
the Participating Securities program. For these reasons, SBA feels it
is important to retain the proposed concept of compounding of
Prioritized Payments in this final rule. It should be emphasized that
the Adjustments, like the Prioritized Payments themselves, are not due
and payable unless the Licensee has sufficient Earmarked Profits to pay
them.
As a reminder to the reader, the calculation of Prioritized
Payments is to be performed at least annually within ninety (90) days
after the end of the Licensee's fiscal year, and also at the end of any
fiscal quarter for which a Distribution is contemplated. If the
Licensee has cumulative Earmarked Profits, Prioritized Payments up to
the amount of such profits are characterized as Earned Prioritized
Payments and are to be distributed automatically within (90) days after
the end of the Licensee's fiscal year, except to the extent that such
Distribution would create a condition of Liquidity Impairment.
A Licensee with Participating Securities or Earmarked Assets in its
portfolio is prohibited from making any Distributions that are
considered to be a return on capital until all Prioritized Payments
have been distributed. Before returns of capital can be made, all
Earned Prioritized Payments must have been distributed. See
Sec. 107.245. We repeat in paragraphs (ii) through (vii) below, for the
reader's benefit, the detailed discussion of the computation of Earned
Prioritized Payments and Earned Adjustments that appeared in the
proposed rule. There are no changes to the related regulatory
provisions in this final rule.
(ii) Establishment of Prioritized Payment Accounts
To assist in the process of determining whether, or when, a
Licensee is responsible for making payments, two Prioritized Payment
accounts must be established: A Prioritized Payment Accumulation
Account (AA) which is a memorandum account, and a Prioritized Payment
Distribution Account (DA) which is a liability account. For the sake of
simplicity, the hypothetical examples set forth in paragraphs (iii) and
(iv) below illustrate the computations at the fiscal year end following
the first issuance of Participating Securities.
(iii) Initial allocations to Prioritized Payment Accumulation Account
The Prioritized Payment Accumulation Account initially reflects the
``accrual'' (as a memorandum entry only) of Prioritized Payments.
Computations involving this account always begin with the entry of a
sum equal to all Prioritized Payments for the fiscal period in
question. For example, if a Licensee had issued $10 million of eight
percent (8%) Participating Securities at the beginning of its fiscal
year, the initial amount to be added to the AA at the close of the
fiscal year would be $800,000. See Sec. 107.243(b)(1). As subsequently
explained, the Adjustments referred to above may also be added to this
account.
(iv) Initial Allocations to Prioritized Payment Distribution Account
(DA)
The first step in determining what should be added to the DA is to
ascertain cumulative Earmarked Profits (Losses). If, at the fiscal year
end following the first issuance of Participating Securities, the
Licensee has cumulative Earmarked Profits, that sum constitutes
Distributable Earmarked Profits.
The second step is to compare Distributable Earmarked Profits with
the balance in the AA. The lesser of the two is subtracted from the AA
and is added to the DA. This amount now constitutes Earned Prioritized
Payments. See Sec. 107.243(c).
For example, suppose that Earmarked Profits were $20,000. Since
$20,000 is less than the $800,000 of Prioritized Payments, $20,000 is
subtracted from the AA and is added to the DA. At this point there
would be $780,000 in the AA and $20,000 in the DA. The latter sum
represents Earned Prioritized Payments and is the amount the Licensee
will distribute to SBA or the Trust, unless such Distribution would
cause a Liquidity Impairment. See Sec. 107.243(c).
(v) Subsequent Allocations to Prioritized Payment Accumulation Account
and to Prioritized Payment Distribution Account
Subsequent allocations to these accounts will be made similarly,
except that Distributable Earmarked Profits for subsequent years are
calculated by subtracting from cumulative Earmarked Profits all
previous Earned Prioritized Payments and all earned Adjustments (as
described below) for prior fiscal periods.
In our example, at the end of the second year following issuance of
$10 million of eight percent (8%) Participating Securities, an
additional $800,000 would be allocable preliminarily to the AA,
bringing that account (temporarily) up to $1,580,000. If Earmarked
Profits for the second year were $40,000, cumulative Earmarked Profits
would be $60,000. Ignoring for the moment ``earned Adjustments'',
Distributable Earmarked Profits for Year 2 would be $40,000. Since
$40,000 is less than 41,580,000, the sum of $40,000 would be added to
the DA and subtracted from the AA. Thus, at the close of Year 2, the
balance in the AA would be $1,540,000 (exclusive of any Adjustments)
and, assuming no Distribution of Earned Prioritized Payments had been
made to SBA, the balance in the DA would be $60,000.
In making these calculations, Earmarked Losses are disregarded.
Thus, if the Licensee had Earmarked Profits of $20,000 for the first
year and Earmarked Losses of $100,000 during the second year, the
$20,000 ``obligation'' already reflected in the DA would have been
unaffected. See Sec. 107.243(d).
(vi) Distributions of Prioritized Payments
With one exception, a Licensee is required to remit the balance in
its DA to SBA, its agent or Trustee within 90 days after the end of the
Licensee's fiscal year, or before any Distribution is made to its own
investors, as appropriate. Any amount remitted to SBA is subtracted
from the DA. If a Licensee has issued Participating Securities on more
than one occasion, Prioritized Payments are made in order of maturity
of the underlying Participating Security.
As an exception, a Licensee is excused from remitting the balance
in the DA to the extent that such remittance would cause the Licensee
to violate the liquidity requirement set forth in Sec. 107.241(f).
Thus, if a Licensee has Earned Prioritized Payments of $1,400,000, and
a cash balance of $1,800,000, but needs to retain $1,000,000 in cash to
attain the required liquidity ratio, the Licensee must remit only
$800,000 to SBA. See Sec. 107.243(c)(3)(iii). Failure to make
Distributions because of insufficient liquidity does not trigger a
regulatory violation.
(vii) Adjustments to Prioritized Payments
A Licensee's failure to make timely distributions of Earned
Prioritized Payments in an amount equal to Prioritized Payments results
in the accumulation of additional amounts which may become payable to
SBA, subject to the existence of sufficient Earmarked Profits. If, at
the end of any fiscal year, there is an unpaid balance in the AA, an
amount equal to the average monthly balance in that account is
multiplied by a rate equal to the average of the rates on new Trust
Certificates (TCs) sold to the public\9\ during the Licensee's fiscal
year, and the product is added to the balance in the AA as a supplement
to Prioritized Payments. See Sec. 107.243(d)(1).
---------------------------------------------------------------------------

\9\SBA will publish a notice of the TC rate from time to time in
the Federal Register.
---------------------------------------------------------------------------

Similarly, if there is an unpaid balance in the DA account at the
end of the Licensee's fiscal year, an amount equal to the average
monthly balance in that account is multiplied by a rate equal to the
average of the rates on new TCs sold to the public during the
Licensee's fiscal year, and the product is added to the balance in the
AA, not to the balance in the DA. See Sec. 107.243(d)(2).
These additional amounts added to the AA are referred to as
``Adjustments''. Once added to the AA, the Adjustments are
indistinguishable from Prioritized Payments; they are characterized as
``earned'' and transferred to the DA in the same manner as Prioritized
Payments are characterized as ``earned.''
As long as unpaid Earned Prioritized Payments, including earned
Adjustments, are outstanding, the Licensee must make the calculations
described in this paragraph ``c'' as of the end of each subsequent
fiscal quarter until all such amounts are paid in full. See
Sec. 107.243(c)(3).

d. Calculation and Allocation of Profit Participation

(i) Introduction
In proposed Sec. 107.244, SBA described its right to a percentage
of the profits of a Licensee issuing Participating Securities. In
consideration for its guarantee of a Licensee's Participating
Securities, SBA\10\ has a contractual right to Profit Participation
consisting of a specified percentage of the Licensee's Earmarked
Profits. The percentage is determined, in part, by the ratio of
outstanding Participating Securities Leverage to Leverageable Capital.
---------------------------------------------------------------------------

\10\Neither the holders of TCs, nor the Trust itself has any
interest in the Profit Participation to which SBA may be entitled.
---------------------------------------------------------------------------

SBA received eighteen (18) comments on the subject of the Profit
Participation. Most complained that the regulations should provide a
mechanism for offsetting prior distributions of profits to SBA against
subsequent losses of the Licensee. This so-called ``levelling up'' is a
component of many venture capital funds, and is designed to ensure that
partners ultimately receive only their agreed-upon profit shares.
SBA was aware of this issue when it drafted the proposed rule.
Under the Distributions section of the preamble to the proposed rule
(section 4.e.(vi)), SBA discussed the reasons for not including a
level-up in the proposed rule. See 58 FR 41862. SBA believed then, and
continues to believe, that Section 403 of Public Law 102-366 prohibits
a recharacterization of amounts already distributed to SBA. There is no
discretion on SBA's part to include a ``levelling-up'' provision in
this final rule.
Even if a recharacterization of distributed amounts were legally
permissible, SBA believes that it would be extremely difficult to
calculate because of the complexity produced by changes in SBA's profit
share (the Profit Participation) and its share of Distributions under
Secs. 107.245 (c) and (d). SBA's profit share in a Licensee is
increased when new Participating Securities are issued by the Licensee
and/or the Licensee's Leverageable Capital is decreased. SBA's profit
share is decreased when approved increases in Leverageable Capital
occur. At the same time, SBA's share of Distributions (in the form of
returns on capital or returns of capital) is changed as increases or
decreases occur in either the Licensee's Leverageable Capital or its
Leverage outstanding. See discussion of Secs. 107.245 (c) and (d)
below. SBA currently does not have a mechanism that can account
accurately for all these changes in order to identify what SBA's share
of Distributions would have been if ``losses after profits'' were taken
into account.
SBA also believes that there should be less need for a
recharacterization of distributed amounts if the Licensee has been
valuing its portfolio investments fairly, especially the determination
of Unrealized Depreciation on Loans and Investments. SBA regulations
require Licensees to reduce their Undistributed Net Realized Earnings
by their Unrealized Depreciation on Loans and Investments in order to
determine Retained Earnings Available for Distribution (READ). See
Sec. 107.3. Distributions of SBA's Profit Participation, which the
commenters would like to be able to recharacterize as a return of
capital, can only be made out of the Licensee's READ. Therefore, if the
Licensee has not grossly underestimated its Unrealized Depreciation,
the Licensee's READ and consequently its Distributions of Profit
Participation to SBA should already reflect, to some degree, future
realized losses. There should be reduced need for a major
recharacterization of earlier distributed amounts when the later losses
are actually realized.
In conclusion, in the absence of a statutory amendment allowing for
a recharacterization, a satisfactory mechanism to implement the change,
and a compelling justification of the need for it, SBA is finalizing
the proposed rule without incorporating a level-up or
recharacterization of prior distributions. SBA expects that discussions
on the subject will continue between it and interested industry members
and that it might at some time in the future propose a different
resolution.
The method for computing, allocating and distributing the Profit
Participation is described below. Although the method has been
simplified from that set forth in the proposed rule, the result is
identical.
In summary, Sec. 107.244 mandates the establishment of a Profit
Participation Account to reflect the allocation and distribution of the
Profit Participation due SBA. The sum to be allocated is determined by
multiplying the Base for Profit Participation, if positive, by the
applicable Profit Participation Rate.
(ii) Computing the Profit Participation Base
The computation of the Profit Participation Base is to be made at
the end of the Licensee's fiscal year and at the end of any fiscal
quarter for which a Distribution is contemplated. Briefly, the Base for
Profit Participation (Base) is a number equal to year-to-date Earmarked
Profits (Losses) minus year-to-date Prioritized Payments and
Adjustments, minus any unused loss carryforward, as determined in the
manner hereafter discussed.
(iii) Determination of Unused Loss Carryforward
To determine its unused loss carryforward, a Licensee must look
back to the Base computed at the end of its previous fiscal year (the
``Previous Base''). If the Previous Base was zero or greater, then the
Licensee's unused loss carryforward is zero. However, if the Previous
Base was less than zero, then the unused loss carryfoward is equal to
the Previous Base. During or at the end of its first year of operation,
a Licensee has no Previous Base and, therefore, no loss carryforward.
In effect, a Previous Base which is negative reflects all prior
losses and Accumulated Prioritized Payments of the Licensee, which are
carried forward to offset future earnings. Conversely, a Previous Base
which is positive is not carried forward because once Earmarked Profits
are used as the basis for an allocation to the Profit Participation
Account, they are disregarded in any subsequent allocation or
computation. See Sec. 107.244(b)(2).
Some illustrations may help clarify this concept. Assume that a
Licensee had issued $10 million of 8 percent Participating Securities
on July 1, 1994, the first day of its fiscal year, and had Earmarked
Profits of $20,000 as of the close of the fiscal year, June 30, 1995.
The Licensee's Base would be ($780,000), computed by subtracting
Prioritized Payments of $800,000 for Earmarked Profits of $20,000 (the
unused loss carryfoward would be zero because the Licensee had not
previously computed a Base). Now assume that fiscal year 1995-96 was
extremely successful and that the Licensee's Earmarked Profits for that
year were $2 million. Since the Previous Base was negative, it would be
the Licensee's unused loss carryforward. The new Base, therefore, would
be $420,000: ([$2,000,000 current period Earmarked Profits--$800,000
current period Prioritized Payments]-$780,000 unused loss
carryforward).
As a second example, assume that the Licensee had instead posted an
Earmarked Loss of $20,000 during the first year that Participating
Securities were outstanding. The unused loss carryforward would be
$820,000. At the end of the second year, the Base for Profit
Participation would be only $380,000 ([$2,000,000-$800,000]-$820,000).
(iv) Computing Profit Participation Rates
(A) When computation is required; general rules. Computation of a
Profit Participation Rate for the relevant fiscal period must be made
at least annually or prior to any Distribution. A Licensee should use
one of the two formulas, as appropriate, which are set forth in
paragraphs (B) and (C), below. Except as described in paragraph (E)
below, the Profit Participation Rate that any particular Licensee must
use depends on the highest ratio of Leverageable Capital to
Participating Securities outstanding which has ever been computed for
such Licensee. This is the Participating Securities to Leverageable
Capital (PLC) ratio.
(B) Participating Securities not at any time in excess of
Leverageable Capital. Subject to the indexing described in paragraph
(D) below, for a Licensee whose outstanding Participating Securities
have never exceeded its Leverageable Capital, the Profit Participation
Rate is equal to the PLC ratio multiplied by nine percent (9%). Thus,
the Profit Participation Rate=PLC ratio x 0.09. For a Licensee that has
a PLC ratio equal to exactly one hundred percent (100%) of Leverageable
Capital, the Profit Participation Rate is nine percent (9%); for every
other Licensee described in this paragraph (B), the Profit
Participation Rate is less than nine percent (9%).
(C) Participating Securities in excess of Leverageable Capital at
any time. Subject to the indexing described in paragraph (D), for a
Licensee whose outstanding Participating Securities have exceeded its
Leverageable Capital, the Profit Participation Rate is equal to nine
percent (9%) plus an additional percentage equal to the product of .03
multiplied by an amount obtained by subtracting one (1) from the PLC
ratio. In other words, Profit Participation Rate=.09+(.03 x [PLC
ratio-1]). If a Licensee has $10 million in Leverageable Capital and
$15 million in Participating Securities, the PLC ratio =1.5 and Profit
Participation Rate equals 10.5 percent, .09+(.03 x [1.5-1]).
(D) Indexing. No indexing of the Profit Participation Rate is
required if, on the date the Participating Securities were issued, the
yield-to-maturity rate on Treasury bonds with a remaining term of ten
years (the ``Treasury Rate'') is exactly eight percent (8%). Otherwise,
the Profit Participation Rate calculated in accordance with
Sec. 107.244(c) (2) or (3) shall be adjusted upward or downward
proportionately to such Treasury Rate (that is, by the percentage,
rather than the same number of percentage points or basis points, by
which the Treasury Rate may be above or below eight percent (8%)).
For example, if the Treasury Rate were ten percent (10%) and the
unindexed Profit Participation Rate were nine percent (9%), the
appropriate indexed Rate would be 11.25 percent. Ten (10) is twenty-
five percent (25%) more than eight (8); 125 percent of nine percent
(9%) is 11.25 percent.
If a Licensee has issued Participating Securities on two or more
occasions, any indexing of the Profit Participation Rate will be based
on the average Treasury Rate for all such issuances, weighted to
reflect the dollar amount of each issue and the portion of the fiscal
period during which each issue was outstanding. See
Sec. 107.244(c)(4)(ii).
(E) Approved increases in Leverageable Capital. Computation of the
Profit Participation Rate is not to be affected by any subsequent
increase in Leverageable Capital, except to the extent that (1) the
increase in Leverageable Capital is the result of the funding of
unfunded commitments or the conversion to cash of assets previously
recognized by SBA as a part of Private Capital, but not of Leverageable
Capital, or (2) such increase is expressly provided for in a plan of
operations previously approved by SBA. See Sec. 107.244(c)(5).
(v) Computing Profit Participation
The amount of SBA's Profit Participation for a fiscal year or
fiscal year-to-date is computed by multiplying the Base as of the end
of such period by the Profit Participation Rate for such period, and
subtracting from the result any amounts of Profit Participation that
were paid or reserved for payment to SBA for any prior interim period
during the same fiscal year.
Any computation of Profit Participation made as of the close of an
interim fiscal quarter is subject to adjustment whenever any subsequent
interim distributions are contemplated, and at the end of the fiscal
year, in order to account for any increase in the Profit Participation
Rate. If the Profit Participation Rate decreases as a result of an
approved increase in Leverageable Capital, Profit Participations
already computed for any interim periods shall not be adjusted. See
Sec. 107.244(d)(3).
(vi) Allocation of Profit Participation
Prior to any Distributions, and in any event within 90 days
following the end of the Licensee's fiscal year, the amount of any
Profit Participation calculated in accordance with Sec. 107.244(d)
shall be allocated to a Profit Participation Account. Funds equal to
the amount allocated to this account shall be reserved for SBA and
shall not be available for reinvestment in Small Concerns or for any
other use by the Licensee; these funds shall be distributed only to
SBA.
(vii) Distribution of Profit Participation
Distribution of allocated Profit Participation shall be made at the
same time that profits are distributed to the Licensee's investors,
either as a tax Distribution or as a return on capital.

e. Distributions

(i) General
Proposed Sec. 107.245 set forth restrictions and other conditions
on a Licensee's Distributions other than Prioritized Payments. All
Prioritized Payments must be paid before any Distributions are made
that are classified as a tax Distribution or a return on capital.
Earned Prioritized Payments and earned Adjustments, as recorded in the
DA, must be paid before any Distributions are made that are classified
as returns of capital. Distributions pursuant to Sec. 107.245 may be
made only to the extent that they do not cause a condition of Liquidity
Impairment. See Sec. 107.241(f).
Comments received on proposed Sec. 107.245 are addressed in the
particular subsection (Tax Distributions, Returns on Capital, or
Returns of Capital) to which such comments relate.
(ii) Tax Distributions
(A) General. Pursuant to proposed Sec. 107.245(b), a Licensee that
is organized as a limited partnership, S Corporation, or similar pass-
through entity, could elect to make an annual Distribution from
Retained Earnings Available for Distribution (READ) to each of its
investors (specifically including SBA) in amounts not greater than the
``Maximum Tax Liability'' (as computed in paragraph (B) below) for
Federal and State income taxes on the Federal taxable income imputed to
each investor for that fiscal year. Since SBA is not a tax-paying
entity, the amount of SBA's share of any such Distribution would be
determined by multiplying the tax Distribution to all partners by SBA's
``Profit Participation Rate'', determined in accordance with
Sec. 107.244. Anything that SBA received as its share of a tax
Distribution would be credited first against Profit Participation as
described below.
Some comments warned that the Agency's interest would not be
protected adequately if Licensees were permitted to make tax
Distributions based on annual profits, without regard to the tax
benefit that had been conferred on investors by prior years' losses. A
cumulative measure of income comparable to that used for Prioritized
Payments or returns on capital was recommended.
While not disagreeing with the need for protection, SBA believes
that the final rule offers adequate safeguards against an unfair
result. A Licensee's ability to make a tax Distribution is always
dependent upon the existence of sufficient Retained Earnings Available
for Distribution. Tax Distributions can only be made from a Licensee's
READ, which is a cumulative measure of income. Although a Licensee may
compute a Maximum Tax Liability (which is based on annual income) in
excess of its Retained Earnings Available for Distribution, its tax
Distribution can never exceed its READ. Thus, prior years' losses do
affect a Licensee's ability to make a tax Distribution.
Furthermore, SBA has revised the proposed tax Distribution
provision to clarify that to the extent a Licensee is unable or elects
not to make a tax Distribution for any fiscal year within ninety (90)
days following the end of such fiscal year, it shall have no right to
make such Distribution at any later date. With this clarification, SBA
has decided to finalize the proposal on tax Distributions.
There are two other important limitations on the right of a
Licensee to make tax Distributions. There can be no unpaid Prioritized
Payments and the Distribution can not cause the Licensee to have a
``Liquidity Impairment''.
Although Sec. 107.245(b) refers to ``tax Distributions'', the
amounts distributed may exceed any true tax liability (particularly for
those investors that are exempt from Federal or State taxation). Other
than SBA, every investor in a Licensee that is a pass-through entity is
presumed conclusively (1) to be a resident, for tax purposes, of the
State in which the Licensee's principal office is located; and (2) to
be liable to pay Federal and State income taxes at the highest marginal
tax rates applicable to each category of income (such as ordinary
income as opposed to capital gains). If individuals are taxed at a
higher rate than corporations, every investor will be presumed
conclusively to be an individual even if actually a corporation or a
pension fund. See Sec. 107.245(b).
(B) Computation of tax Distribution to Investors. The maximum
amount potentially distributable to all investors (including SBA) is
determined by multiplying the aggregate amounts of ordinary income and
capital gains imputed to investors by the highest combined marginal
Federal and State tax rates applicable to each category, taking into
account the deductibility of State taxes when computing Federal taxes.
Local taxes (for example, county and city taxes) are disregarded for
this purpose.
By way of illustration, assume that at the end of the Licensee's
first fiscal year, $1,000 in ordinary income had been imputed to all
investors (including tax-exempt organizations). If the highest rate of
Federal tax on ordinary income is thirty-five percent (35%) and the
highest rate of State tax on ordinary income is five percent (5%), it
is conclusively presumed that investors will have to pay $50 in State
income taxes on the $1,000 in the Licensee's hands. But since the $50
payable to the State is deductible from the investors' Federal taxable
income, their Federal income tax liability is based on only $950, and
is therefore equal to $332.50. The maximum amount that may be
distributed to investors (including SBA) pursuant to Sec. 107.245(b)
would be $332.50 plus $50.00 or $382.50 (not $400, which would be forty
percent (40%) of $1,000).
The proposed rule incorrectly suggested that SBA's share of the tax
Distribution was in addition to the tax Distribution to investors as
computed above. SBA is here clarifying that, in accordance with section
403 of Public Law 102-366, the tax Distribution to investors as
computed above includes SBA's tax Distribution. In other words, the
amount calculated as the tax Distribution for all investors is not
available for distribution to all non-SBA investors; SBA's portion must
be deducted for distribution to SBA.
(C) Computation of tax Distributions to SBA. The amount to be
remitted to SBA is computed by multiplying the total tax Distribution
as computed above by the Profit Participation Rate computed in
accordance with Sec. 107.244(c). The amount of such tax Distribution to
SBA shall be subtracted from the Profit Participation Account referred
to above.
(iii) Returns on Capital
(A) General. Proposed Sec. 107.245(c) established requirements for
all Distributions in the form of returns on capital and some
Distributions in the form of returns of capital. The proposal provided
that after making all Prioritized Payments and any tax Distributions, a
Licensee with READ would be required, within 90 days following the
close of its fiscal year (or in its discretion, a fiscal quarter), to
make Distributions under this section to its investors and SBA to the
extent that they would not cause a Liquidity Impairment. In appropriate
circumstances, SBA could waive this requirement. All such Distributions
to investors must be made from READ (and would be returns on capital);
Distributions to SBA may or may not be from READ (and may be returns on
capital or returns of capital).
A number of comments indicated dissatisfaction with the requirement
that Distributions be made within 90 days of the Licensee's fiscal year
end. They argued that it can often be imprudent for a Licensee to
distribute all of its profits, and expressed concern over potential
delays in obtaining waivers from SBA.
SBA is particularly sympathetic to issues affecting the prudent
management of Licensees. The Liquidity Impairment test itself is
imposed on all Distributions to ensure that Licensees are prudent
managers of their cash flows. Still, SBA recognizes that prudent
management of cash flow and investments means more than merely
satisfying the Liquidity Impairment test, and that there will be times
when a Licensee should refrain from distributing all profits. While SBA
believes that the waiver provision will help to prevent the imprudent
distribution of a Licensee's profits, it agrees with the need for
prompt consideration of waiver requests.
In order to assure Licensees that requests for prior approval will
be processed on a timely basis, the final rule provides that the
Licensee's request for prior approval will be considered approved
unless SBA notifies it otherwise within thirty (30) days of receiving
the request. All requests for prior approval should be accompanied by
sufficient information for SBA to make an informed decision.
SBA has concluded that Licensees may need more than ninety (90)
days after their respective fiscal year-ends to calculate and make
Distributions under Sec. 107.245(c). Accordingly, this final rule
provides that a Licensee is required to make such Distributions within
120 days of the end of its fiscal year.
Each Licensee that expects to need prior approval under
Sec. 107.245(c) should make sure its request is received by SBA before
the ninetieth day after its fiscal year end so that SBA is able to
respond before the arrival of the 120th day, when Distributions must be
made. SBA believes that with the addition of a definitive thirty-day
response time, Licensees should be able to plan for their needs and yet
meet the requirements of the regulation.
The balance of Sec. 107.245(c) is finalized as it was proposed. It
provides that while the dollar amount of Profit Participation is
determined by formula according to the ratio of Participating
Securities to Leverageable Capital, the actual amount to be distributed
to SBA when there is a return on capital to private investors is a
function of the ratio of total Leverage (Debentures, and Preferred
Securities, and Participating Securities) to Leverageable Capital. See
Sec. 107.245(c).
As with the proposed rule, if SBA determines that the value of the
Licensee's assets are materially overstated and if SBA provides the
Licensee with timely notice of such determination in advance of a
proposed Distribution, SBA reserves the right to restrict
Distributions.
Distributions paid to SBA under Sec. 107.245(c) are applied in the
following sequence:
(i) Profit Participation;
(ii) Dividends or equivalent distributions on Preferred Securities;
(iii) Redemption or prepayment of outstanding Participating
Securities;
(iv) Redemption or prepayment of outstanding Preferred Securities;
and
(v) Repayment of principal of outstanding Debentures. If there are
restrictions on prepayment of outstanding Debentures, that part of
SBA's share of a Distribution that is to be applied toward such
prepayment shall be deposited in an escrow account on such terms and
conditions as SBA may prescribe.
It is noted that Distributions to SBA will be made from READ only
to the extent of Profit Participation and dividends or equivalent
distributions, if any, on Preferred Securities. To the extent that a
Distribution is applied as a repayment or redemption of Leverage, it
shall not reduce READ.
(B) Computation of SBA's share. As in the proposed rule, if
outstanding Leverage is more than two hundred percent (200%) of
Leverageable Capital, SBA's share of any Distribution under
Sec. 107.245(c) shall be in the ratio of Leverage to Leverageable
Capital. In other words, if a Licensee has outstanding Leverage equal
to three hundred percent (300%) of Leverageable Capital, SBA's share
shall be \3/4\ or seventy-five percent (75%) of any such Distribution
and SBA would be entitled to $3 for every $1 distributed to other
investors. If outstanding Leverage were two hundred fifty percent
(250%) of Leverageable Capital, SBA would be entitled to $2.50 for
every $1 distributed to other investors.
If outstanding Leverage is more than one hundred percent (100%) of
Leverageable Capital, but not more than two hundred percent (200%),
SBA's share of any such Distribution shall be equal to the aggregate
shares of all other investors. For every $1 distributed to other
investors, SBA shall receive $1.
If outstanding Leverage is not more than one hundred percent (100%)
of Leverageable Capital, SBA's share of any such Distribution shall be
a percentage equal to the Profit Participation Rate.
(iv) Returns of Capital
Under this heading, it is appropriate to discuss comments received
regarding the definition of ``Retained Earnings Available for
Distribution'' (READ). Any changes in that definition would affect the
allocation of Distributions between returns on capital and returns of
capital for companies with Participating Securities. It should be
noted, however, that READ is a defined term which applies to all
Licensees. Any change in the definition would actually have a more
significant effect on Licensees without Participating Securities
because they are subject to much stricter limitations on their ability
to return capital to investors.
In general, the comments expressed the opinion that READ should
include Unrealized Appreciation as an offset to Unrealized
Depreciation. In other words, READ would be defined to mean
Undistributed Net Realized Earnings less net Unrealized Depreciation.
SBA understands the arguments of the industry, including issues of
fairness and good faith, but remains unconvinced. As a general rule,
the portfolio valuation process is not sufficiently reliable to allow
Unrealized Appreciation to be a component of READ without introducing
an undue risk of premature distributions. While the calculation of
Capital Impairment allows for an offset of Unrealized Appreciation
against Unrealized Depreciation, and even gives credit against realized
losses for some net Unrealized Appreciation, Capital Impairment and
READ serve different purposes in the SBIC Program. The former is a
regulatory measure of financial health; the latter is the basis for
distributing cash out of the company. Accordingly, SBA intends to
retain the conservative measure of READ in its final rule, defining
READ to mean Undistributed Net Realized Earnings less Unrealized
Depreciation.
SBA recognizes that there may be occasions when otherwise
unauthorized distributions should be approved. A Licensee may request
SBA's prior approval to make a distribution in excess of READ in
accordance with the provisions of Sec. 107.1201. In considering such
requests, SBA will consider all relevant factors, including the
existence of Unrealized Appreciation.
Since there were no other comments on Sec. 107.245(d), SBA is
finalizing it without any other change. It provides that after paying
all Earned Prioritized Payments including earned Adjustments in the DA,
and all allocated Profit Participation, and provided the Licensee does
not have a condition of Capital Impairment, a Licensee that has either
outstanding Participating Securities or Earmarked Assets in its
portfolio may return capital to its investors and SBA, pursuant to the
terms set forth in Sec. 107.245(d). This provision allows an exception
to Sec. 107.802, which prohibits Licensees from distributing capital in
excess of two percent (2%) per year without the prior written approval
of SBA, subject to certain restrictions. However, unless SBA decides
otherwise on a case-by-case basis, any such Distribution shall be
subject to the liquidity requirement in Sec. 107.241(f).
Generally, Distributions in the form of returns of capital shall be
made to SBA and private investors in the ratio of Leverage to
Leverageable Capital as of the date of the proposed Distribution. For
example, if outstanding Leverage is equal to three hundred percent
(300%) of Leverageable Capital, SBA's share will be $3 for every $1
distributed to the private investors.
If, however, a Licensee has a Capital Impairment Percentage greater
than zero, the relative shares of SBA and the private investors must be
computed differently. In such a case, Leverageable Capital for the
purposes of Sec. 107.245(d) is deemed to be Leverageable Capital
multiplied by a percentage equal to the difference between one hundred
percent (100%) and the Licensee's Capital Impairment Percentage.
Assuming a Licensee had $10,000,000 of Leverageable Capital and a
Capital Impairment Percentage of forty-two percent (42%), the
Licensee's Leverageable Capital for purposes of this computation will
be deemed to be $5,800,000 ([100%-42%] x [$10,000,000]).
The proceeds of SBA's share of any capital Distribution shall be
credited in the manner prescribed for returns on capital under
Sec. 107.245(c), as set forth in Sec. 107.245(c)(5).
(v) In-Kind Distributions
No comments were received on the subject of In-kind Distributions,
proposed Sec. 107.245(e). The provision is therefore finalized in the
form in which it was proposed. Under Sec. 107.245(e), Distributions of
READ or of capital need not be in cash, but may be in the form of
portfolio securities, subject to certain restrictions. The securities
to be distributed must be Publicly Traded and Marketable, as defined in
Sec. 107.3, at the time of Distribution.
At the time a corporate Licensee declares an In-kind Distribution,
or an Unincorporated Licensee actually makes one, the Licensee must
impute a gain or loss to the securities in question, determined as of
the date of the declaration or distribution, as the case may be. Such
imputed gain or loss shall be used to calculate Earmarked Profits
pursuant to Sec. 107.242(e) as if it were a realized gain or loss.
All Distributions of securities that constitute part of an In-kind
Distribution must be made on a pro-rata basis to each investor,
including SBA, as if the securities previously had been converted to
cash and the proceeds constituted the entire Distribution. A Licensee
may not distribute a disproportionate percentage of the stock of
company A to investor X and a disproportionate share of the stock of
company B to investor Y, even if the values of the shares of A and B
are equal.
SBA's share of an In-kind Distribution shall be deposited with the
Central Registration Agent (CRA) unless SBA and the Licensee agree that
the Licensee will dispose of SBA's share of such securities. If the
Licensee disposes of SBA's share of securities, it shall remit the
proceeds promptly to SBA or to SBA's designated agent or Trustee.

f. Post-Redemption Obligations

No comments were received on proposed Sec. 107.246, which described
the continuing obligations of Participating Securities issuers after
their Participating Securities have been redeemed. The section is
finalized without change, except to clarify that post-redemption
Distributions of Accumulated Prioritized Payments are to be computed
and paid on a quarterly basis, but otherwise in the same manner as
before redemption.
If, after redeeming all of its outstanding Participating
Securities, a Licensee has both Earmarked Assets in its portfolio and
an unpaid outstanding balance in the Prioritized Payment Accumulation
Account (AA), the Licensee remains ``obligated'' to determine, at the
end of each fiscal quarter, whether any Prioritized Payments have
become Earned Prioritized Payments and to distribute such amounts to
SBA in accordance with Sec. 107.243. See Sec. 107.246(a). After the
last Earmarked Asset has been disposed of, and any resulting Earned
Prioritized Payments paid to SBA, the Licensee is under no further
obligation to pay the remaining balance, if any, in the AA. See
Sec. 107.246(b).
Section 107.246(c) overrides the language of Sec. 107.245(e) (In-
kind Distributions) in cases involving In-kind Distributions to be made
after redemption of all Participating Securities if there are also
unpaid Prioritized Payments. Under Sec. 107.246(c), no In-kind
Distributions of Earmarked Assets may be made unless SBA is paid a sum
equal to the full amount of the unpaid Prioritized Payments or the full
amount of Unrealized Appreciation on the Earmarked Assets in question,
whichever is less. Subject to this rule, a Licensee that has fully
redeemed its Participating Securities may distribute Earmarked Assets
that are not Publicly Traded and Marketable if it has SBA's prior
written consent to such Distribution and to the valuation assigned by
the Licensee.

g. Special Rules for Companies Licensed On or Before March 31, 1993

(i) General
SBA did not receive any comments on proposed Sec. 107.247, the
special rules for companies licensed on or before March 31, 1993. The
section is therefore finalized without change. It provides that a
company licensed on or before March 31, 1993 that thereafter applies
for SBA's guarantee of its Participating Securities must meet certain
procedural requirements not applicable to other Licensees. These
companies are also afforded certain exemptions or options not available
to companies licensed after March 31, 1993. See Sec. 107.247. The
details are set forth below.
(ii) Special Requirements
When applying for SBA's guarantee of a first issuance of
Participating Securities, any company licensed on or before March 31,
1993 must submit:
(a) A valuation report for each portfolio asset as of the date of
the financial statements that accompany the application, and as of the
end of each of the preceding three years, and
(b) A copy of each portfolio concern's last annual report and/or
fiscal year-end financial statements, and most recent interim financial
statements. See Sec. 107.247(d). This information is required in
addition to the financial information that all Licensees, including
companies licensed after March 31, 1993, are required to submit in
connection with an application for SBA's guarantee of their
Participating Securities.
If the Licensee has negative Undistributed Realized Earnings and/or
a net Unrealized Loss on Securities Held, SBA may make its approval of
the Licensee's request for a guarantee of Participating Securities
contingent upon a quasi-reorganization in accordance with generally
accepted accounting principles. See Sec. 107.247(d)(2).
If the financial statements of the Licensee submitted with the
application are interim financial statements, the Licensee shall have a
limited scope audit performed by its SBA-approved independent
accountants. These accountants shall use whatever auditing procedures
are necessary to enable them to express an opinion on the Licensee's
Statement of Financial Position and the accompanying Schedule of
Investments.
(iii) Refinancing of Debentures
Subject to the two following conditions, a company licensed on or
before March 31, 1993 may use part or all of the proceeds of
Participating Securities to repay or prepay Debentures outstanding on
that date. The Licensee must demonstrate to SBA that it has outstanding
Equity Capital Investments, valued at cost, in an amount equal to the
amount of Participating Securities that would be used to refinance the
outstanding Debentures that are to be repaid or prepaid. The Licensee
also may not elect to exclude any of its pre-existing portfolio from
the category of Earmarked Assets.
A Licensee that pays or prepays an outstanding Debenture after it
has issued Participating Securities is presumed to have used the
proceeds of the Participating Securities for this purpose unless it can
demonstrate the availability of other funds to pay the principal amount
of the Debenture in question. See Sec. 107.247(a).
(iv) Exclusion of Pre-Existing Portfolio Assets
Unless a Licensee intends to use part or all of the proceeds from
the issuance of Participating Securities to repay or prepay a Debenture
outstanding on March 31, 1993, it may elect, when its first application
for SBA's guarantee is submitted, to exclude all, but not less than
all, portfolio assets outstanding on March 31, 1993 from the category
of Earmarked Assets. In such event, SBA is not obligated to extend its
guarantee if it concludes that exclusion of the Licensee's March 31,
1993 portfolio would significantly decrease SBA's chances of obtaining
a satisfactory return on its guarantee.

5. Financing by Use of SBA Guaranteed Trust Certificates

Proposed Sec. 107.250 was a recodification of existing
Sec. 107.201(c), revised to include the new Participating Securities.
No comments were received on the proposal, which is therefore finalized
without substantive change.

6. Conditions Affecting Good Standing of Leveraged Licensees

a. Introduction

SBA received forty-three (43) comment letters concerning SBA's
proposed remedies for regulatory violations by Leveraged Licensees
(Sec. Sec. 107.261 and 107.262). SBA had proposed to separate the
remedies for violations by issuers of Debentures and Preferred
Securities (Sec. 107.261) from the remedies for violations by issuers
of Participating Securities (Sec. 107.262). The comments supported the
distinction made between Debentures and Participating Securities. The
suggestion that remedies be different for Preferred Securities and
Participating Securities, however, was opposed by Specialized SBICs.
These Licensees objected to the characterization of Preferred
Securities as more akin to Debentures than Participating Securities.
They argued that the Preferred Security, which has attributes of both
debt and equity securities, should be treated as an equity security for
purposes of the remedies section. They expressed concern that if
Preferred Securities continue to carry the same remedies as Debentures,
tax-exempt entities such as pension funds will refrain from investing
in Specialized SBICs in order to avoid incurring Unrelated Business
Taxable Income (UBTI).
SBA expresses no opinion as to whether tax-exempt entities
investing in Specialized SBICs that issue Preferred Securities would
incur UBTI as a result of SBA's former remedies (former Sec. 107.203)
or its proposed remedies (proposed Sec. 107.261). Nevertheless, SBA
believes that there is sufficient justification for treating Preferred
Securities as if they were an equity-type security and relocating them
into the Participating Securities remedies section (Sec. 107.262). The
rule is finalized with this change.
The overall structure of the remedies sections remains otherwise
intact. In order to maintain the separation between the two sections on
remedies, no cross-default provisions are provided between Debentures,
on the one hand, and Preferred Securities and Participating Securities,
on the other. If a Licensee has both Debentures and Participating
Securities, a default under the former will not automatically trigger a
``default'' under the latter, and vice versa.

b. General Conditions and Remedies

Many comments on the proposed remedies sections objected to the
requirement that all Licensees issuing Leverage after publication of
this final rule amend their articles of incorporation or partnership
agreements to indicate consent, in advance, to SBA's right to require
the removal of officers, directors, or general partners and to the
appointment of SBA or its designee as receiver of the Licensee for the
purpose of continuing to operate the company. See Sec. Sec. 107.261(f)
and 107.262 (b) and (c). Such remedies would only take effect upon the
occurrence of certain specified violations involving, for the most
part, fraudulent activities or willful actions.
The principal effect of the consent to a receivership would be that
SBA would be entitled to the receivership promptly, as a matter of
right. Except upon the occurrence of an automatic event of default
under a Debenture (see Sec. 107.261(b)), Licensee's consent would not
include consent to a receivership for the purpose of liquidating the
company.
The comments objected strongly to the consent provision,
particularly as it relates to Debenture issuers (Sec. 107.261(f)). They
recommended that SBA rely upon its current statutory authority for
removal of management and/or the appointment of a receiver, which
allows a Licensee the opportunity to challenge, in advance, SBA's
intended action. Unfortunately, SBA has found that SBICs have used that
opportunity to delay the availability of SBA's remedy while they file
for protection under Federal bankruptcy laws.
SBA looked carefully at the specific violations that could trigger
the advance consent remedies. The Agency is convinced that, with one
small exception, the advance consent is appropriate for the very
serious nature of the defaults in question.
The one exception is the payment default by issuers of Debentures
(Sec. 107.261(c)(7)). SBA intends to continue its customary practice of
affording Licensees an opportunity to cure payment defaults. The
proposed rule would have permitted SBA to use its remedial powers
before

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A94-7843. Public record. Not legal advice.