Small Business Size Standards: Increase Size Standard of Small Business Concerns Eligible for Assistance by Small Business Investment Companies

SMALL BUSINESS ADMINISTRATION

13 CFR Part 121

Small Business Size Standards: Increase Size Standard of Small

Business Concerns Eligible for Assistance by Small Business Investment

Companies

AGENCY: Small Business Administration.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Small Business Administration (SBA) is revising one of the

two size standards that establish eligibility criteria for small

business concerns applying for assistance from Small Business

Investment Companies (SBICs). This action increases the ceilings on the

primary standard used, the SBIC Standard, from $6 million net worth and

$2 million after-tax net income, to $18 million net worth and $6

million after-tax net income.

This action is consistent with the current program restructuring

resulting from the enactment of recent legislation, and updates the

existing standard for inflation since the last adjustments in 1979.

The increased standard benefits small businesses by restoring

eligibility to many concerns that lost this status solely because of

the effects of inflation. The increased standard also permits the SBICs

with higher levels of private capital, particularly those new licensees

entering the Program as a result of the legislative changes, to provide

follow-on investments and equity-oriented financing to growth-oriented

small business concerns.

EFFECTIVE DATE: April 25, 1994.

FOR FURTHER INFORMATION CONTACT:

Robert D. Stillman, Associate Administrator for Investment, Small

Business Administration, 409 3rd Street, SW., suite 6300, Washington,

DC 20416.

SUPPLEMENTARY INFORMATION:

Background

In the Federal Register of July 29, 1993, (58 FR 40603), SBA

published a Proposed Rule to revise the two-test standard that SBICs

use as the primary size standard determining eligibility for small

business concerns applying for financial and/or management assistance

under the SBIC Program.

Concerns applying for assistance must be eligible for the Program

under one of two standards: The two-test standard for net worth and

after-tax net income (herein called the ``SBIC Standard'' or

``Standard'') [Sec. 121.802 (a)(2)(i)] or, the single-test standard,

stated in number of employees or annual revenues, that is specified for

the applicant's industry [Sec. 121.802(a)(2)(ii)].

SBA proposed to increase only the two tests in the SBIC Standard.

The net worth test would be increased from $6 million to $18 million

and the after-tax net income test would be increased from $2 million to

$6 million. As an alternative, the applicant concern would continue to

have the option of qualifying under the industry size standard.

The current action dates from a September 1990 proposal to

reinstate a third test, an assets test, in the SBIC Standard. The

assets test had been eliminated by a regulatory amendment in 1979. In

1990, a gross assets test of $20 million was proposed to be applied

only to SBIC change of ownership financings. The purpose of this

proposal was to prevent SBICs from participating in highly leveraged

transactions where the concern financed appeared to be other than

small. While SBIC regulations do not preclude change of ownership

transactions, SBA found it necessary to have the ability to monitor and

control these transactions to prevent the violation of Program

integrity. Following Federal Register publication and evaluation of the

public comments received in response, SBA withdrew this proposal, in

July 1991, for further analysis.

SBA's July 29, 1993, proposal for a change in the SBIC Standard was

the result of an extensive review and restructuring of the SBIC Program

which occurred over the intervening two-year period. The proposal

focused on an update of the net worth and net income components of the

Standard to facilitate the Program changes underway, particularly the

legislative changes recently enacted, and to adjust for inflation. SBA

no longer proposed to reinstate an assets test to address the leveraged

buyout issue as the administration of these transactions was determined

to be an eligibility issue suitable for coverage in the SBIC financing

regulations rather than a size issue. Consequently, SBA sought, through

a separate proposed rule (58 FR 41852) which covered a number of

operating regulations, to amend the SBIC regulations applicable to

change of ownership transactions (Sec. 107.711) in order to address

this issue.

The proposed SBIC Standard was a vital part of the structural

changes, along with the revisions in part 107, that were initiated to

strengthen and improve the SBIC Program. Overall, the Program

revitalization efforts underway are designed to enhance the SBIC

Program to be a more effective tool in providing small business

concerns access to risk capital in a way that will result in job

creation, economic growth, and other national objectives being

achieved.

Discussion of Comments

In response to the July 29, 1993, proposal, SBA received 30 letters

from: managers of currently licensed SBICs, investors and venture

capitalists planning to form SBICs, investors who have submitted

license applications for new SBICs, individual members of SBA's

Investment Advisory Council, and trade associations representing SBICs.

Almost all comments, except for one, supported the proposed increase in

the SBIC Standard and contained one or more comments regarding the need

for an increased standard and its benefits.

Typical comments in support of the increase were that the proposal:

Was a long-overdue and appropriate adjustment; would increase capital

available for financing; was more in line with the larger capital

structures of businesses now approaching SBICs for financing,

particularly since new starts have become more capital intensive in the

1990s; would allow for multiple rounds of financing for established

small businesses; and would increase financing for small businesses

having the potential for growth and job creation. One commentator also

recommended that there be periodic, automatic adjustments in the size

standard to offset inflation.

The one exception offered a counter proposal for a small increase

than SBA proposed. The counter proposal maintained that, while the

Proposed Rule met the expectations of the SBIC industry, only an

inflation adjustment should be made to double the present Standard, to

a net worth of $12 million and net income of $4 million.

Response

The Proposed Rule stated that there were two elements contributing

to the increase in the Standard. About half of the increase in the

Standard was attributable to the restructuring of the SBIC Program as a

result of title IV of Public Law 102-366 in order to address the need

for financing growth-oriented and development-stage small businesses.

The remainder of the increase was an inflationary adjustment.

However, the counter proposal would limit the increase in the

Standard to only an inflation adjustment thus eliminating a significant

portion of the SBICs' capability to provide the type of small business

financing envisioned by Public Law 102-366.

In addition, limiting the increase would restrict the formation of

SBICs with higher amounts of private capital, as also envisioned by the

legislation which has key provisions intended to encourage SBICs to

significantly increase their levels of private capital. Under these

provisions, some SBICs will continue to have private capital of less

than $10 million, while some new SBICs will have as much as $50 million

in private capital. The optimum size of SBICs electing to issue the new

security, created by the legislation, is expected to be $15 to $20

million in private capital. These SBICs will typically invest from

$200,000 to $1 million in one small business since each SBIC is able to

invest up to 20% of its private capital in any one small business

concern. The increased SBIC Standard will allow the SBICs with higher

amounts of private capital the flexibility to invest up to 20% of their

private capital in the multiple rounds of financings needed to grow a

small business from its initial founding to its take-off as a

successful venture.

In essence, increasing the SBIC Standard by only an inflation

adjustment would accommodate retroactive, or historical, trends and

restore the purchasing power of the dollar which was eroded from 1979

to 1992. However, such an increase would ignore the current and

prospective goals of the Program restructuring already underway. This

restructuring is designed to strengthen and expand the capabilities of

SBICs to finance small businesses so that they can increase their

contribution to economic growth and job creation.

Therefore, after careful review of the public comments noted above

together with other Program and economic data, SBA is adopting the rule

as proposed, with both a historical inflation adjustment and an

adjustment for current Program needs.

Compliance With Executive Orders 12866, 12612 and 12778, and the

Regulatory Flexibility and Paperwork Reduction Acts

Executive Order 12866 and Regulatory Flexibility Act

Although this final rule is expected to have a significant economic

impact on a substantial number of small entities for purposes of the

Regulatory Flexibility Act (5 U.S.C. 601, et seq), it will not

constitute a significant rule for the purpose of Executive Order 12866,

since its annual economic effect is less than $100 million. An initial

regulatory flexibility analysis of this proposal is as follows.

(1) Description of Entities to Which the Rule Applies

SBA estimates that 99.7% of all firms in the United States could be

eligible for SBIC financing after the adoption of this final rule

(estimate based on Internal Revenue Service Statistics of Income, 1988

for active corporations). By comparison, when the current standard was

adopted in 1979, approximately 99.6% of all firms were eligible for

SBIC assistance. In absolute terms, under the proposed standard,

approximately 7,000 additional firms would gain eligibility as small

businesses. Many of these concerns probably had small business status

under the 1979 standard, but since then have lost eligibility because

of general price increases due to inflation.

However, it should be noted that the Standard sets the ceiling on

how the target population is defined and on the entire population

potentially eligible for SBIC assistance. In practice, the level of

private capital invested in an individual SBIC and the SBIC's

investment plan actually set the limits on each small business

financing.

Actual Program experience shows the enormous gap between the total

population eligible for SBIC financing and the number that actually

participate in the Program. The total number of business concerns that

fit under the current SBIC Standard and, therefore, are potentially

eligible for SBIC assistance, is approximately 3.6 million small

concerns. By contrast, the number of financings annually from both

Regular SBICs and Specialized SBICs averages 2,000 per year, based on

Fiscal 1991 and 1992 data. Overall, from 1960 to 1991, almost 70,000

different small business concerns received financing under the SBIC

Program.

Moreover, a review of the initial capitalization of SBICs indicates

that based on the levels of private capital there are three types of

SBICs each serving a limited segment of potentially eligible concerns

for SBIC financing: the Regular SBICs with a minimum private capital of

$2.5 million and having a balanced portfolio with a primary emphasis on

providing debt financing to small business; the SSBICs with minimum

private capital of $1.5 million and specializing in financing small

businesses that are owned by persons who are socially or economically

disadvantaged; and venture capital SBICs which tend to have higher

levels of private capital in order to provide equity oriented

financings to growth oriented small business concerns.

Since current Program changes are designed to expand the private

capital of all types of SBICs, the proposed Standard will allow SBICs

with higher levels of private capital to provide larger amounts of

financings to small business concerns. However, the optimum size

venture capital SBIC is expected to be $10 to $20 million in private

capital. There will be SBICs with private capital of less than $10

million and some SBICs will have as much as $50 million in private

capital. At the lower levels (e.g., from $1 million to $5 million), an

SBIC will typically invest from $200,000 to $1 million in one small

business since each SBIC is able to invest up to 20% of its private

capital in any one small business concern.

Moreover, the SBIC Standard is a program Standard applicable only

to small business concerns that apply for financing from an SBIC. As

such, the change affects only potential clients of SBICs and does not

alter the definition of a small business for the wide variety of

business development, financial assistance and procurement assistance

programs offered by SBA.

The proposed Standard does not impose a regulatory burden because

it does not regulate or control business behavior.

(2) Description of Reasons Why This Action Is Being Taken and

Objectives of Rule

SBA has provided above in the Supplementary Information a

description of the reasons why this action is being taken and a

statement of the reasons for and objectives of this proposed rule.

(3) Legal Basis for the Proposed Rule

The legal basis for this rule is sections 3(a) and 5(b) of the

Small Business Act, 15 U.S.C. 632(a) and 634(b)(6).

(4) Federal Rules

There are no Federal rules which duplicate, overlap or conflict

with this proposed rule. SBA has statutorily been given exclusive

jurisdiction in establishing size standards for small business

concerns.

(5) Significant Alternatives to Proposed Rule

This rule sets forth changes from the current size standard in

order to establish the most appropriate definition of small business

concerns eligible for assistance under the SBIC Program. There are no

significant alternatives to defining a small business concern other

than developing another alternative size standard. As discussed in the

Supplementary Information above, the SBIC Program already provides two

options for determining the eligibility of applicant concerns, and this

proposal applies to only one of those options. A review of the SBIC

portfolio indicated that almost all applicant concerns were eligible

under the single size standard covering the industry in which the

applicant concern was primarily engaged even though these firms chose

to qualify under the SBIC Standard instead of the industry-based

standards.

Executive Order 12612

SBA certifies that this rule will not have federalism implications

warranting the preparation of a Federalism Assessment in accordance

with Executive Order 12612.

Paperwork Reduction Act

SBA certifies that this rule, promulgated as final, will not add

any new reporting or recordkeeping requirements under the Paperwork

Reduction Act of 1980, 44 U.S.C., Chapter 35.

Executive Order 12778

SBA certifies that this rule is prepared, to the extent

practicable, in accordance with the standards set forth in section 2 of

E.O. 12778.

List of Subjects in 13 CFR Part 121

Financial assistance--small business concerns, Small Business

Investment Companies, Small Business Investment Company Program.

Accordingly, part 121 of 13 CFR is amended as follows:

PART 121--SMALL BUSINESS SIZE REGULATIONS

1. The authority citation for part 121 continues to read as

follows:

Authority: 15 U.S.C. 632(a), 634(b)(6), 637(a) and 644(c).

Sec. 121.802 [Amended]

2. Section 121.802(a)(2) is amended by removing the words ``Small

Business Investment Company,''.

3. Section 121.802 is amended by redesignating paragraph (a)(3) as

paragraph (a)(4) and by adding a new paragraph (a)(3) to read as

follows:

Sec. 121.802 Establishment of the Size Standard.

(a) * * *

(3) SBIC Standard. For financial and/or management/technical

assistance under the Small Business Investment Company Program, an

applicant concern must meet one of the following standards:

(i) Together with its affiliates, it does not have net worth in

excess of $18 million, and does not have average net income after

Federal income taxes (excluding any carry-over losses) for the

preceding 2 completed fiscal years in excess of $6 million; or

(ii) Together with its affiliates, it meets the size standard for

the industry in which it is primarily engaged and, excluding its

affiliates, meets the size standard for the industry in which it is

primarily engaged. These size standards are set forth in Sec. 121.601.

* * * * *

Dated: March 1, 1994.

Erskine B. Bowles,

Administrator.

[FR Doc. 94-7845 Filed 4-7-94; 8:45 am]

BILLING CODE 8025-01-M