# Small Business Investment Companies

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A95-28757

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** November 28, 1995
- **Citation:** 60 FR 58530

## Text

SUMMARY: In response to President Clinton's government-wide regulatory
reform initiative, the Small Business Administration (SBA) is proposing
to restructure its existing regulations. This proposed rule is intended
to streamline the regulations governing the Small Business Investment
Company (SBIC) program. To this end, SBA proposes to eliminate obsolete
regulations and to reorganize the remaining regulations in a more
readable format.
In addition to changes in organization, the proposed regulations
include a number of substantive changes, many of which are intended to
reduce the regulatory burden on Licensees, as well as SBA's
administrative burden. Other proposed changes would provide additional
protection for SBA's position as a creditor of, or investor in,
Licensees with outstanding Leverage. At the same time, certain
requirements would be made inapplicable to non-leveraged Licensees,
which pose no financial risk to the Agency.

DATES: Comments must be submitted on or before December 28, 1995.

ADDRESSES: Written comments should be addressed to David R. Kohler,
Regulatory Reform Initiative Team Leader, Office of General Counsel,
U.S. Small Business Administration, 409 3rd Street, S.W., Suite 13,
Washington, D.C. 20416, Attn. Part 107.

FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division,
at (202) 205-6510.

SUPPLEMENTARY INFORMATION: On March 4, 1995, President Clinton issued a
Memorandum to all federal agencies, directing them to simplify their
regulations. In response to this directive, SBA has completed a page-
by-page, line-by-line review of all of its existing regulations to
determine which might be revised or eliminated. As a result of its
review of the regulations governing the SBIC program, SBA is proposing
to eliminate obsolete or redundant regulations, substantively revise
others, and reorganize all of Part 107 in a more readable format.
In this proposed rule, all sections are renumbered for purposes of
clarity and improved organization, and the regulations are organized
into the following new subparts:
(A) Introduction to Part 107.
(B) Definition of Terms Used in Part 107.
(C) Qualifying for an SBIC License. (D) Changes in Ownership,
Control, or Structure of Licensee; Transfer of License.
(E) Managing the Operations of a Licensee.
(F) Record keeping, Reporting, and Examination Requirements for
Licensees.
(G) Financing of Small Businesses by Licensees.
(H) Non-leveraged Licensees, Exceptions to the Regulations.
(I) SBA Financial Assistance for Licensees (Leverage).
(J) Licensee's Noncompliance with Terms of Leverage.
(K) Ending Operations as a Licensee.
(L) Miscellaneous.
For convenience, this preamble includes a chart listing the current
section numbers in Part 107 and matching them to either a corresponding
proposed regulation or indicating that the current section is deleted
in the proposed regulations. The chart also identifies the character of
any changes to the current regulations.
Following the chart is a two-part analysis of the proposed changes
to the SBIC regulations. Part I details regulations that would be
eliminated. Part II describes proposed modifications of the current
regulations and the policy reasons for them.

Part 107: Current and Proposed Section Numbers
----------------------------------------------------------------------------------------------------------------
Revised (non- Revised
Current section Proposed section substantive) (substantive) Deleted No change
----------------------------------------------------------------------------------------------------------------
107.1............................ 107.20.............. ............ ............. ............ X
107.2............................ 107.40.............. ............ X ............ ............
107.3............................ 107.50.............. ............ X ............ ............
107.4............................ 107.160............. X X ............ ............
107.101(a)....................... 107.130, 107.230(d). X X ............ ............
107.101(b)....................... 107.508............. X ............. ............ ............
107.101(c)....................... .................... ............ ............. X ............
107.101(d)....................... 107.200............. X ............. ............ ............
107.101(e)....................... 107.210............. X ............. ............ ............
107.101(f)....................... 107.230(e).......... X ............. ............ ............
107.101(g)....................... 107.503............. X ............. ............ ............
107.101(h)....................... 107.504............. X ............. ............ ............
107.101(i)....................... 107.710............. X ............. ............ ............
107.102(a)....................... 107.300............. ............ X ............ ............
107.102(b)....................... 107.400(b), X ............. ............ ............
107.680(b).
107.103.......................... .................... ............ ............. X ............
107.104.......................... 107.475............. X ............. ............ ............
107.105.......................... 107.1900............ X ............. ............ ............
107.210(a)-(d)................... 107.1100-107.1140... X ............. ............ ............
107.210(e)....................... 107.509............. X ............. ............ ............

[[Page 58531]]

107.210(f)(1)-(4)................ 107.1700............ ............ ............. ............ X
107.210(f)(5).................... 107.560............. X ............. ............ ............
107.210(f)(6).................... 107.550............. ............ X ............ ............
107.210(g)....................... 107.1710............ ............ ............. ............ X
107.210(h)....................... 107.1830-107.1850... X ............. ............ ............
107.210(i)....................... 107.1720............ ............ ............. ............ X
107.215.......................... 107.1200-107.1240... X ............. ............ ............
107.215(a)....................... 107.1200(c)......... ............ X ............ ............
107.215(f)(1).................... 107.1230(b)......... ............ X ............ ............
107.220(a)-(b)................... 107.1150(a)......... X ............. ............ ............
107.220(c)....................... 107.1150(b)......... X ............. ............ ............
107.220(d)....................... 107.1150(b)(2)...... ............ ............. ............ ............
107.220(e)....................... 107.1170............ X ............. ............ ............
107.230(a)....................... 107.1100(b)......... X ............. ............ ............
107.230(b)....................... 107.1400-107.1430... X ............. ............ ............
107.230(c)(1)-(5)................ 107.1160............ X ............. ............ ............
107.230(c)(3)(iii)............... 107.1160(f)......... ............ X ............ ............
107.230(c)(4)(iv)................ 107.1160(f)......... ............ X ............ ............
107.230(c)(6).................... 107.1170............ X ............. ............ ............
107.230(d)....................... 107.1100(c)......... X ............. ............ ............
107.230(e)....................... 107.1350............ X ............. ............ ............
107.230(f)....................... 107.1450............ X ............. ............ ............
107.241(a)....................... 107.220............. X ............. ............ ............
107.241(b)....................... 107.1500(b)(4)...... X ............. ............ ............
107.241(c)....................... 107.150............. ............ X ............ ............
107.241(d)....................... 107.140, 107.510.... ............ X ............ ............
107.241(e)....................... 107.570............. X ............. ............ ............
107.241(f)....................... 107.1505............ X ............. ............ ............
107.241(g)....................... 107.1500(e)......... X ............. ............ ............
107.241(h)....................... 107.1500(f)......... X ............. ............ ............
107.242.......................... 107.1510............ ............ X ............ ............
107.243.......................... 107.1520, 107.1540.. X ............. ............ ............
107.244.......................... 107.1530............ X ............. ............ ............
107.245(a)....................... 107.1540(a)......... X ............. ............ ............
107.245(b)....................... 107.1550............ X ............. ............ ............
107.245(c)....................... 107.1560............ X ............. ............ ............
107.245(d)....................... 107.1570............ X ............. ............ ............
107.245(e)....................... 107.1580............ X ............. ............ ............
107.246.......................... 107.1520(g)......... X ............. ............ ............
107.247.......................... 107.1590............ X ............. ............ ............
107.250.......................... 107.1600- 107.1680.. ............ ............. ............ X
107.260.......................... 107.1800............ X ............. ............ ............
107.261.......................... 107.1810............ X ............. ............ ............
107.262.......................... 107.1820............ X ............. ............ ............
107.263.......................... 107.1910............ ............ ............. ............ X
107.301(a)....................... 107.830............. ............ X ............ ............
107.301(b)....................... 107.845............. X ............. ............ ............
107.302.......................... 107.855............. ............ X ............ ............
107.303.......................... 107.740............. X ............. ............ ............
107.304(a)....................... 107.610, 107.700.... X ............. ............ ............
107.304(b)....................... 107.620............. X ............. ............ ............
107.304(c)....................... 107.630(e).......... X ............. ............ ............
107.305.......................... .................... ............ ............. X ............
107.320(a)....................... 107.800............. X ............. ............ ............
107.320(b)....................... 107.815(a).......... X ............. ............ ............
107.321.......................... 107.850............. ............ X ............ ............
107.322.......................... .................... ............ ............. X ............
107.401.......................... 107.820............. ............ X ............ ............
107.402(a)....................... 107.825............. X ............. ............ ............
107.402(b)-(c)................... .................... ............ ............. X ............
107.402(d)-(e)................... 107.860............. ............ X ............ ............
107.402(f)....................... 107.830(d)(3)....... X ............. ............ ............
107.402(g)....................... 107.855............. ............ X ............ ............
107.403(a)....................... .................... ............ ............. X ............
107.403(b)(1).................... 107.835............. ............ X ............ ............
107.403(b)(2).................... .................... ............ ............. X ............
107.403(b)(3).................... 107.828............. X ............. ............ ............
107.404.......................... 107.828............. ............ X ............ ............
107.501.......................... 107.900............. ............ X ............ ............
107.601.......................... 107.410-107.440..... X ............. ............ ............

[[Page 58532]]

107.601(e)....................... 107.1120(f)......... X ............. ............ ............
107.601(g)....................... .................... ............ ............. X ............
107.602.......................... 107.460............. ............ X ............ ............
107.603.......................... 107.450............. X ............. ............ ............
107.701.......................... 107.30.............. ............ ............. ............ X
107.702.......................... .................... ............ ............. X ............
107.703.......................... 107.500............. ............ ............. ............ X
107.704.......................... 107.501............. ............ X ............ ............
107.705(a)....................... 107.240............. X ............. ............ ............
107.705(b)....................... 107.250............. X ............. ............ ............
107.706.......................... 107.760............. X ............. ............ ............
107.707(b)....................... 107.828(d).......... X ............. ............ ............
107.708(a)&(b)................... 107.530............. X ............. ............ ............
107.708(c)....................... 107.1000............ X ............. ............ ............
107.709.......................... 107.510............. ............ X ............ ............
107.710.......................... 107.880............. ............ X ............ ............
107.711.......................... 107.750............. X ............. ............ ............
107.712.......................... 107.120............. X ............. ............ ............
107.801.......................... 107.865............. ............ X ............ ............
107.802.......................... 107.585............. X ............. ............ ............
107.803.......................... 107.470............. X ............. ............ ............
107.804.......................... 107.720(e).......... X ............. ............ ............
107.901(a)....................... 107.720(a).......... X ............. ............ ............
107.901(b)....................... 107.720(i).......... X ............. ............ ............
107.901(c)....................... 107.720(c).......... ............ X ............ ............
107.901(d)....................... 107.720(f).......... X ............. ............ ............
107.901(e)....................... 107.720(g).......... ............ X ............ ............
107.901(f)....................... 107.720(b).......... ............ X ............ ............
107.901(g)....................... 107.720(h).......... X ............. ............ ............
107.902.......................... 107.590............. ............ X ............ ............
107.903.......................... 107.730............. X ............. ............ ............
107.904.......................... 107.885............. X ............. ............ ............
107.905.......................... 107.502............. X ............. ............ ............
107.906.......................... 107.507............. X ............. ............ ............
107.1001......................... 107.690-107.692..... ............ X ............ ............
107.1002(a)-(b).................. 107.600............. ............ X ............ ............
107.1002(c)-(d).................. 107.660............. X ............. ............ ............
107.1002(e)...................... 107.630............. ............ X ............ ............
107.1003(a)...................... 107.506............. X ............. ............ ............
107.1003(b)...................... .................... ............ ............. X ............
107.1004......................... 107.680............. X ............. ............ ............
107.1101......................... 107.670............. X ............. ............ ............
107.1201......................... 107.1920............ X ............. ............ ............
107.1202......................... 107.1930............ X ............. ............ ............
----------------------------------------------------------------------------------------------------------------

Part I

Eliminated Sections

SBA proposes deletion of the following sections of the current
regulations. The effect of the proposed deletion and the reason for the
action is provided.
Current Sec. 107.103 would be deleted, eliminating the requirement
for giving public notice of license applications. Similarly,
Sec. 107.601(g) requiring public notice of an application for a change
in a proposed transfer of Control over a Licensee would be deleted. The
Agency has received few comments in the past on either type of
application and believes these requirements unnecessarily lengthen the
application process.
Current Sec. 107.305 would be deleted, eliminating the requirement
for Licensees to conduct a ``post closing review'' of each Financing of
a Small Business in order to assure that the proceeds were used for the
intended purposes. The requirement that Financing documents contain
certain standard provisions restricting the use of proceeds, and the
requirement for Licensees to report any unauthorized diversion of funds
to SBA, would also be eliminated. SBA believes these provisions are
burdensome because of the special documentation requirements imposed,
and essentially redundant because other regulations require an SBIC to
identify and monitor a Small Business's use of financing proceeds. In
particular, under proposed Sec. 107.620 (which would replace current
Sec. 107.304(b)), a Licensee must obtain information about a Small
Business's intended use of proceeds before extending any Financing and
must obtain updated financial information sufficient to verify the
actual use of proceeds.
Current Sec. 107.322, which allows an SBIC making an equity
investment to place restrictions on current and future indebtedness of
the financed Small Business, would be deleted. This deletion would not
restrict the rights of Licensees in any way, since the practices
described are specifically permitted under the Act. See 15 U.S.C.
section 684(b).

[[Page 58533]]

Part II

1. Subpart A--Introduction to Part 107

As part of its effort to make the regulations more readable, SBA
has used ``you'' to refer to a Licensee or a license applicant, as
appropriate, throughout Part 107. Proposed Sec. 107.40(c) explains this
convention.

2. Subpart B--Definition of Terms Used in Part 107

SBA proposes revising the following definitions currently found in
Sec. 107.3 of the regulations.
a. ``Close Relative'' and ``Secondary Relative''
The definition of ``Close Relative'' would be narrowed to cover
only immediate relatives (spouses, along with parents, children,
brothers and sisters, and their spouses). Other relatives, such as
grandparents and grandchildren, aunts, uncles, and first cousins, would
be defined as ``Secondary Relatives.'' The two separate categories have
been proposed so that a distinction between them can be made in the
definition of ``Associate'', which is discussed below. The effect of
the change is to limit the circumstances under which concerns with only
a peripheral relationship to a Licensee, through a Secondary Relative,
become its Associates.
b. ``Associate''
SBA proposes two modifications to the definition of ``Associate'',
a key term that appears extensively in the conflict of interest rules
(proposed Sec. 107.730), and in various other regulations including
proposed Secs. 107.150 (management and ownership diversity
requirement), 107.865 (Control of Small Businesses), and 107.885
(disposition of assets to Licensee's Associate).
Proposed paragraphs (h) and (i) specify the conditions under which
an Associate's involvement in a concern, either through positions held
or ownership interests, causes that concern to become an Associate of a
Licensee. The two paragraphs are comparable to paragraph (f) of the
current definition, with the following exceptions:
First, under paragraph (h), the presence of an Associate as a
director of a concern would no longer cause the concern to become an
Associate of the Licensee. SBA believes that an Associate functioning
as an outside director is unlikely to create a conflict of interest,
and often can provide insight into a company that a Licensee may find
useful.
Second, under paragraph (i), a concern would not become an
Associate of a Licensee because of its relationship with a Secondary
Relative, unless that relative had a majority equity interest in the
concern (or controlled it through other means), either alone or with
other Associates. For example, a concern in which the uncle of the
president of the Licensee had a 10 percent equity interest would not be
an Associate of the Licensee (as it is under the current definition).
However, if the uncle were the majority owner of the concern, it would
be an Associate. SBA has proposed this change to exclude from the
definition of Associate those concerns that are only marginally related
to the Licensee.
c. ``Control Person''
The definition of ``Control Person'' was developed in part to
identify persons that might control, or at least influence, a
Partnership Licensee's general partner and thus the Licensee itself,
even though they themselves might have no direct relationship with the
Licensee. This designation is important for regulatory purposes because
Control Persons are considered Associates of the Licensee.
A portion of the current definition identifies as a Control Person
(1) any investor that has at least a 10 percent ownership interest in a
Licensee's general partner and participates in the general partner's
investment decisions concerning the Licensee; or (2) any passive
investor that has at least a 40 percent ownership interest in a
Licensee's general partner.
The proposed rule would make the following change to the definition
of Control Person:
Under paragraphs (c) and (d), the same criteria that cause an
investor in a Licensee's general partner to become a Control Person
would also be applied to a direct investor in the Licensee. For
example, under paragraph (d), a 40 percent limited partner in the
Licensee's general partner would be a Control Person, and so would a 40
percent limited partner in the Licensee itself. This proposal reflects
SBA's belief that a limited partner's potential influence on a
partnership Licensee is no different from that of a limited partner
with an equivalent ownership interest in a partnership serving as the
Licensee's general partner.
d. ``Equity Capital Investment''
A Licensee with Participating Securities must make ``Equity Capital
Investments'' in an amount at least equal to the total amount of
Participating Securities issued. In addition, the amount of Equity
Capital Investments in its portfolio at the end of each fiscal year
must remain at least equal to the amount of its outstanding
Participating Securities. SBA is not proposing any substantive change
in the definition of Equity Capital Investments, but is proposing to
clarify that an investment classified as a Debt Security is not
precluded from qualifying as an Equity Capital Investment.
There are two general categories of Debt Securities that may
qualify as Equity Capital Investments. First, the definition of Equity
Capital Investments specifically includes ``subordinated debt with
equity features if such debt provides only for interest payments
contingent upon and limited to the extent of earnings.'' Such debt must
also be unsecured and non-amortizing in order to qualify.
Second, certain equity interests may qualify as Equity Capital
Investments even if they have covenants and/or redemption provisions
that require them to be classified as Debt Securities for regulatory
purposes. Such an investment may qualify if a Licensee's ability to
recover its investment and/or realize returns is subject to essentially
the same conditions that apply to a qualifying subordinated debt
instrument. For example, a Licensee could purchase the preferred stock
of a Small Business, with a provision requiring the issuer to redeem it
after five years at its original cost plus any accumulated unpaid
dividends. Because of the mandatory redemption provision, the
investment would be treated as a Debt Security under proposed
Sec. 107.800. However, as long as dividends were payable only from
retained earnings, the investment would qualify as an Equity Capital
Investment.
e. ``Financing''
In the current regulations, ``Financings'' are defined to include
commitments made to Small Businesses in addition to amounts actually
invested and amounts guaranteed. The proposed definition would exclude
such commitments. SBA is proposing this change to make the definition
of Financing more objective, and to eliminate the regulatory compliance
issues that sometimes arise when Licensees keep making commitments
without actually making investments for an extended period of time.
f. ``Institutional Investor''
The ``Institutional Investor'' definition identifies those
investors in a Licensee whose unfunded binding commitments may be
included in the Licensee's Private Capital. Institutional Investors may
be entities or individuals. SBA proposes three non-substantive changes

[[Page 58534]]
to this definition which are intended to clarify the Agency's
interpretation:
First, proposed paragraph (a)(6), which permits a qualified
employee benefit or pension plan to be an Institutional Investor, would
clarify that 401(k) plans are excluded. This treatment is consistent
with SBA's interpretation of the current regulation.
Second, proposed paragraph (a)(10) would clarify the circumstances
under which an entity that invests the funds of others can qualify as
an Institutional Investor. The purpose of the clarification is to
reflect more precisely the original intent of this paragraph, which is
to allow a ``fund of funds'' to qualify as an Institutional Investor if
it is investing on behalf of other entities that also meet the
Institutional Investor criteria.
Third, under proposed paragraph (b)(1), an individual with net
worth of less than $2 million would qualify as an Institutional
Investor only if his/her commitment were backed by a letter of credit
from a State or National bank acceptable to SBA. This is a
clarification of the current definition, which requires only that the
letter of credit be issued by a ``qualified Institutional Investor.''
SBA has proposed the new language to minimize confusion as to the
meaning of a ``qualified'' Institutional Investor.
f. ``Lending Institution''
The definition of ``Lending Institution'' is used in proposed
Sec. 107.730 (comparable to current Sec. 107.903), which provides an
exemption from the conflict of interest rules for certain transactions
involving Lending Institutions that are Associates of the Licensee.
Under the current definition, a Lending Institution must be an entity
subject to federal or state regulation, such as a bank or savings and
loan association. SBA recognizes, however, that other types of entities
now extend credit in a manner similar to banks. Therefore, SBA proposes
that the term ``Lending Institution'' be expanded to include
corporations engaged in activities similar to those performed by
commercial lenders, if they have assets in excess of $500 million and
their shares are publicly traded and listed on a recognized stock
exchange or NASDAQ. SBA believes that such entities, although not
regulated in the same manner as banks, have sufficient oversight under
federal securities laws.
g. ``Disadvantaged Business''
SBA is proposing to change the defined term ``Disadvantaged
Concern'' to ``Disadvantaged Business''; however, the Agency is not
proposing any change in the definition itself at this time. SBA is
reviewing the definition as part of an examination of various issues
affecting the SSBIC program, and intends to work with the SSBIC
industry to develop a revised definition which will be proposed at a
later date.

3. Subpart C--Qualifying for an SBIC License

a. Permitted Forms of Organization for Licensees
Proposed Secs. 107.100 and 107.110 describe the permitted forms of
organization for Section 301(c) and Section 301(d) Licensees,
respectively; these provisions are currently found in Sec. 107.3. The
proposed sections would delete limited liability companies as a
permitted form of organization because this form is not currently
authorized by the Act. SBA plans to seek a legislative change that
would permit SBICs to organize as limited liability companies.
b. 1940 Act and 1980 Act Companies
Under proposed Sec. 107.115, SBA would license 1940 and 1980 Act
Companies only if they do not elect to be taxed as regulated investment
companies under section 851 of the Internal Revenue Code. The same
criteria would be applied to existing Licensees seeking to convert to
1940 Act or 1980 Act Companies. This reflects current program policy in
the licensing area, and is being formalized because the tax code
conflicts with the distribution regulations applicable to Participating
Securities as mandated by the Act, and with SBIC program accounting
guidelines that limit other profit distributions to the amount of a
Licensee's Retained Earnings Available for Distribution. Such
distribution regulations are designed to reduce risk to SBA by
protecting its investment or creditor position.
c. SBIC management
Proposed Sec. 107.130 would continue the general requirement in
current Sec. 107.101(a) that each Licensee must have qualified
management approved by SBA. However, two changes are proposed. First,
the specific requirement that the manager be ``available to the public
during normal business hours'' would be eliminated, giving Licensees
greater flexibility in their management arrangements. Second, each
Licensee would be required to designate at least one individual as the
official responsible for contact with SBA. This change would allow SBA
to address communications to a specific person, who would be
responsible for routing information to the appropriate persons within
the Licensee's organization.
d. SBA approval of initial Management Expenses
Under proposed Sec. 107.140, all new license applicants would be
required to obtain SBA approval of their initial Management Expenses.
Currently, SBA approves initial Management Expenses only if an
applicant plans to issue Participating Securities, or if an applicant
plans to issue Debentures and utilizes an Investment Advisor/Manager.
Otherwise, SBA approves only management compensation. With the proposed
change, SBA seeks to have consistency in controlling excessive expenses
of Licensees, regardless of management structure or the type of
Leverage an applicant expects to issue.
e. Management and Ownership Diversity
Proposed Sec. 107.150 would require all license applicants planning
to obtain Leverage to have diversity between management and ownership.
This represents an expansion of current Sec. 107.241(c), which requires
such diversity only for applicants that plan to issue Participating
Securities. SBA's intent in broadening the diversity requirement is for
all new leveraged Licensees to have investors who are independent of
management and who have a substantial stake in the Licensee's financial
performance. The Agency believes that the presence of such investors
will reduce the potential for self-dealing and help to assure that
Licensees are operated with the objective of optimizing returns and
protecting the interests of all investors. Under current
Sec. 107.241(c), the diversity criteria may be satisfied either by a
Licensee or by its ``ultimate parent'' (an entity that has an interest
in the Licensee's Regulatory Capital of more than 50 percent). Proposed
Sec. 107.150 would not change the diversity criteria, but would require
them to be satisfied by the Licensee itself unless SBA agreed to accept
diversity achieved at the parent level as a substitute. The Agency
believes that it must have this discretion in order to assure that a
Licensee has genuine diversity between management and ownership, as
opposed to an ownership structure that provides ``technical'' diversity
but does not satisfy the intent of the regulation.
Finally, under proposed Sec. 107.150, any SBIC that was required to
have diversity in order to be licensed would also have to maintain
diversity as long as it had outstanding Leverage or Earmarked Assets in
its portfolio. A Licensee that failed to maintain

[[Page 58535]]
diversity would have to re-establish it within six months.
f. Special Rules for Partnership Licensees
Proposed Sec. 107.160(b) would allow an Entity General Partner to
be organized for the sole purpose of serving as the general partner of
one or more Licensees. Under the current regulation (Sec. 107.4), an
entity may serve as the general partner of only one Licensee. The
proposed change would reduce the expense and administrative burden of
general partners that Control more than one company in the SBIC
program.
g. Minimum Capital Requirements
Proposed Sec. 107.220 would require any company licensed after the
regulation is finalized to have Regulatory Capital of at least
$5,000,000 in order to apply for Debentures, unless it demonstrates to
SBA's satisfaction that it can be financially viable over the long term
with a lower amount. A review of the financial performance of Licensees
supports the conclusion that Regulatory Capital below $5 million
significantly reduces the likelihood of profitable operation over the
long term. Companies licensed before the effective date of the final
rule would be grandfathered under proposed Secs. 107.210(a) or (b), or
Sec. 107.220(c), depending on the date they were licensed.
h. Qualified Non-private Funds
Proposed Sec. 107.230(d) would broaden the definition of
``qualified non-private funds'' which may be included in the Private
Capital of Section 301(d) Licensees. Currently, a nonprofit entity that
has received state or local government grant funds may invest only the
income derived from such grant funds in a Section 301(d) Licensee. The
proposed change would allow a nonprofit entity to invest the principal
of the grant funds in a Section 301(d) Licensee as long as: (1) the
nonprofit entity exercises discretionary authority over such funds, and
(2) SBA determines that such funds have taken on a private character
and that the nonprofit entity is not simply acting as a conduit for
government funds.
i. License Application Fees
Proposed Sec. 107.300 would raise the license application fee in
order to reflect the true costs of processing applications and to
reimburse SBA for such costs. In accordance with applicable statutory
provisions, the Administration has taken into consideration direct and
indirect costs to SBA of necessary services performed, value to the
recipients, the public policy interest served, and other pertinent
factors involved. The base fee would be raised from $5,000 to $10,000
for all applicants. There would be a surcharge of $5,000 for a
Partnership applicant and an additional $5,000 surcharge for an
applicant planning to issue Participating Securities. Thus, a
Partnership applicant that intends to issue Participating Securities
would pay a fee of $20,000.

4. Subpart D--Changes in Ownership, Control or Structure of Licensee;
Transfer of License

a. Fees for Transfer of Control or Change in Form of Organization
Proposed Sec. 107.410 would raise the processing fee for an
application to transfer Control of a Licensee from $5,000 to $10,000.
The fee would be the same as the base amount charged for a new license
application, as discussed under subpart C. Proposed Sec. 107.470 would
require a $5,000 processing fee for a change in a Licensee's form of
organization (from a corporation to a partnership, or vice versa) which
does not involve a change of Control.
b. Licensees under Common Control
Under current Sec. 107.602, SBA generally must approve common
management or ownership of two or more Licensees. Section 301(d)
Licensees, however, are exempt from this requirement. Proposed
Sec. 107.460(b) would narrow the exemption, limiting it to a Section
301(d) Licensee and its parent Section 301(c) Licensee. SBA considers
this to be an issue of safety and soundness which is equally applicable
to Section 301(c) and Section 301(d) Licensees.

5. Subpart E--Managing the Operations of a Licensee

a. Identification as a Licensee
Under current Sec. 107.704, a Licensee must identify itself to the
public as ``A Federal licensee under the Small Business Investment Act
of 1958'' on all written communications. Proposed Sec. 107.501 would
limit this requirement only to Financing documents (commitment letters,
closing documents, etc.), where SBA believes the requirement is most
meaningful. This change would accommodate the increasing number of
Licensees that utilize Investment Advisor/Managers, by allowing such
managers to handle correspondence on behalf of Licensees using their
own letterhead.
b. Responsibility for Licensee's Valuations
Current Sec. 107.101(g)(1) states that a Licensee's board of
directors or general partners shall have ``sole responsibility'' for
valuing the Licensee's Loans and Investments. This regulation was not
intended to mean that SBA would abandon its obligation as a regulatory
agency to exercise oversight over this critical area of a Licensee's
operations. Therefore, proposed Sec. 107.503(c) would clarify SBA's
original intention by stating that the board of directors or general
partners are solely responsible for using the Licensee's approved
valuation policy to prepare the Licensee's valuations of its Loans and
Investments for submission to SBA. The Agency would reserve the right
to review or independently establish valuations.
c. Facsimile Receiving Capability
Proposed Sec. 107.505 would require Licensees to be capable of
receiving fax messages 24 hours a day. In order to make the most
efficient use of limited resources, most communications from SBA to
SBICs are done at night through broadcast faxes.
d. Internal Control
Current Sec. 107.100 contains many specific requirements concerning
internal control procedures and the safeguarding of a Licensee's
assets. Under proposed Sec. 107.506(a), the requirements for dual
control over cash disbursements and securities (or alternative bond
coverage) would be eliminated. The general requirement that Licensees
adopt a plan to safeguard their assets and maintain an adequate
internal control environment would remain. SBA believes that proper
safeguards and controls are essential if Licensees are to operate
soundly and profitably, but that Licensees themselves are in the best
position to determine the appropriate procedures.
e. SBA Approval of Contract With Investment Adviser/Manager
Proposed Sec. 107.510 would require SBA's prior approval of a
contract with an Investment Adviser/Manager only for Licensees that
have Leverage or plan to seek Leverage. Prior approval is currently
required for all Licensees. SBA considers this provision to be
unnecessary when the Agency has no financial interest to protect.
Although it is not addressed in the regulations, SBA's current
policy concerning a Licensee's contract with an Investment Adviser/
Manager requires that such contracts contain a provision allowing for
termination, without

[[Page 58536]]
penalty to the SBIC, on not more than 60 days notice (see SBA Policy
and Procedural Release #2001). SBA intends to eliminate this
requirement because it believes that such a provision is a matter for
negotiation between the two parties.
f. Management Expenses
Current Sec. 107.241(d) requires Licensees with Participating
Securities or Earmarked Assets to have their Management Expenses
approved by SBA at the time of licensing and before any proposed
increases in such expenses. Proposed Sec. 107.520, together with
proposed Sec. 107.140 (discussed above), would extend this requirement
to Licensees with any type of outstanding Leverage. Under proposed
Sec. 107.520(c), a leveraged Licensee whose Management Expenses had not
already been approved by SBA would be required to submit such expenses
for approval with its SBA Form 468 for its first fiscal year ending
after the effective date of the final rule. SBA believes that this
review of the expenses of leveraged Licensees is consistent with its
obligation to ensure the safety and soundness of the SBIC program.
In evaluating the expenses of Licensees, particularly those that
have been in the program for some time, SBA does not intend to impose
any specific expense ceiling or formula. Rather, the Agency will
compare Licensees with similar profiles to determine whether a Licensee
is out of line with its peers in terms of its operating costs.
SBA is also proposing a non-substantive change in the definition of
Management Expenses. This proposed rule would delete language from the
definition (currently found in Sec. 107.3) which states that Management
Expenses do not include ``the cost of services provided by any
Associate of the Licensee which are not part of the normal process of
making and monitoring venture capital financings.'' This language is
found in the Act and SBA does not intend to change the meaning of
Management Expenses as a result of the deletion. Rather, SBA believes
that this exclusion is encompassed in proposed Sec. 107.520(b), which
excludes from Management Expenses the cost of services provided by
``specialized outside consultants, outside lawyers and independent
public accountants, if they perform services not generally performed by
a venture capital company.'' As SBA interprets this provision,
``outside'' consultants and lawyers may be Associates of the Licensee,
so it is not necessary to include a separate provision dealing with
Associates in the regulations.
g. Limitations on Third-party Debt
Under current Sec. 107.210(f)(6), Licensees with outstanding
Leverage must obtain SBA's prior written approval before incurring
secured third-party debt. Under proposed Sec. 107.550(a), expansion of
the scope of a security interest or lien associated with existing debt
would also require SBA approval. This proposal is intended to address
SBA's concern about situations in which SBICs have given blanket liens
on all their assets to third-party creditors, even when the amount of
money borrowed is very small by comparison.
A similar concern underlies proposed Sec. 107.550(c), which states
specifically that SBA would look unfavorably upon any request involving
a blanket lien on all assets, or a security interest in the Licensee's
unfunded investor commitments in excess of 1.25 times the amount to be
borrowed. Under proposed Sec. 107.550(d), proposed borrowings would
qualify for expedited approval by SBA only if the security interest
given were limited either to the assets acquired with the borrowed
funds or to an asset coverage ratio of no more than 1.25 to 1.
h. Activity Requirement
Proposed Sec. 107.590 would revise the test used to determine
whether an SBIC is actively making Financings. The current test is
based upon the amount of Financings made over an 18-month period
relative to a Licensee's average idle funds balance for the period.
With the change in the Act made in 1992 that recognized commitments
from Institutional Investors as part of a Licensee's Regulatory
Capital, along with associated ``lockstep'' takedowns of Leverage, most
new SBICs take down funds only when needed, and make distributions to
their investors as they realize income or gains on their portfolios.
Thus, very little idle funds would be maintained by Licensees.
Proposed Sec. 107.590(a) would institute a two-part activity test.
In order to be considered active, a Licensee could have no more than 20
percent of its total assets in idle funds at the end of its fiscal
year, and must have invested an amount equal to at least 20 percent of
its Regulatory Capital over the previous 18 months. In Sec. 107.590(b),
there would be recognized exemptions to the activity tests, taking into
account the chronological unevenness of investing and profit-taking by
SBICs. For example, a Licensee may have excess idle funds at the end of
its fiscal year because it recently received Leverage, raised
additional capital, or liquidated an investment.
Under proposed Sec. 107.590(c), the activity requirements would be
inapplicable to any Licensee that has filed a ``Wind-up Plan'' approved
by SBA. Such a Licensee would no longer be making investments other
than follow-on Financings of existing portfolio companies. This new
provision accommodates the normal operating pattern of a limited-life
investment company.
Proposed Sec. 107.590(d) would provide a phase-in period for the
new activity requirements above. During such period, any Licensee that
is in compliance with the current regulation would be considered
active.
The activity requirements would also be affected by the proposed
change in the definition of ``Financing'' that is discussed under
Subpart A. As a result of this change, Licensees would no longer be
able to meet the activity test by making commitments to invest in Small
Businesses; only actual investments (and guarantees) would count.

6. Subpart F--Record keeping, Reporting, and Examination Requirements
for Licensees

a. Record Keeping Requirements
For Licensees with more than one business location, proposed
Sec. 107.600(b) would clarify that records relating to an individual
Financing transaction may be kept at the branch with primary
responsibility for the transaction. For all Licensees, paragraph (b)(3)
would clarify that a Licensee's securities may be held in a safe
deposit box or by a licensed securities broker, provided the securities
are covered by the broker's insurance.
Current Sec. 107.1002(b)(1) requires a Licensee to preserve certain
business and accounting records for a period of 20 years. Proposed
Sec. 107.600(c)(1) would reduce the period to 15 years for a
corporation or two years beyond the date of liquidation for a
partnership. SBA believes that shorter time periods are adequate to
protect the Agency's interests.
Proposed Sec. 107.610 includes two new documentation requirements
for Loans and Investments. Paragraph (c) would implement a recent
change in the Act by requiring a Section 301(d) Licensee to have a
completed ``Financing Eligibility Statement'' (SBA Form 1941) for each
Financing, certifying that the concern being financed is a
Disadvantaged Business. Paragraph (d) would require each concern being
financed to certify its intended use of the financing

[[Page 58537]]
proceeds. This change is intended to make it easier for Licensees to
satisfy Sec. 107.620 (the equivalent of current Sec. 107.304(b)), which
requires that information be obtained regarding a Small Business's
intended use of Financing proceeds.
b. Insurance Requirement for Independent Public Accountants
Proposed Sec. 107.630(a)(2) would require all accountants who
perform audits of SBICs to carry errors and omissions insurance or be
self-insured with a net worth acceptable to SBA. The Agency is
proposing this change because, in a number of instances, substandard
audits have resulted in a misleading presentation of a Licensee's
financial condition. The change would create a source of recovery for
monetary damages in the event SBA or the SBIC were injured as a result
of an auditor's negligence. SBA recognizes that the regulation, as
proposed, does not provide adequate guidance, particularly as far as
the amounts of insurance or net worth that would be ``acceptable to
SBA.'' The Agency strongly encourages Licensees, accountants, and other
interested parties to submit any suggestions on this topic.
c. SBA Access to Accountant's Work Papers
Proposed Sec. 107.691 would require the agreement between a
Licensee and the independent public accountant performing its annual
audit to allow SBA personnel, including examiners, to have access to
the accountant's work papers. Although SBA does not expect to review
accountants' work papers on a routine basis, the Agency believes that
it needs such access to carry out its regulatory oversight function.
d. Examination Fees
Proposed Sec. 107.692(a) would increase the examination fees
charged to SBICs. Fees would continue to be assessed based on total
assets of the Licensee, but at higher rates as shown in the table
included in the proposed rule. The proposed fee schedule was designed
to produce total revenue sufficient to cover the current direct costs
to SBA of conducting examinations. The change would help to sustain the
examination function, which is a key element in maintaining the
integrity of the SBIC program.
Proposed Sec. 107.692 would reflect inflation and the actual costs
of delay to SBA, by increasing from $250 to $500 per day the fee
imposed if an examination is delayed due to a Licensee's lack of
cooperation or based on the condition of its records. Licensees are
required to cooperate with SBA's examination; Licensees are also
required to maintain their records in a reasonable and businesslike
manner. This section is designed as an incentive to SBICs to cooperate
with the examination and to compensate SBA for costs incurred if they
do not.

7. Subpart G--Financing of Small Businesses by Licensees

a. Financings of Smaller Businesses
Although proposed Sec. 107.710 contains approximately the same
wording as current Sec. 107.101(i), the requirement to finance Smaller
Businesses would be affected by the proposed change in the definition
of ``Financing.'' As discussed under Subpart A, this term would no
longer include commitments to make investments. Thus, only actual
loans, investments, or guarantees would be counted when measuring the
amount of ``Financing'' extended to Smaller Businesses.
Another change is proposed in Sec. 107.710(e), which deals with
Licensees that have not achieved the required percentage of Financings
to Smaller Businesses. The current regulation states that such
Licensees may provide Financing only to Smaller Businesses until they
are in compliance. The proposed rule would allow greater flexibility,
requiring only that such Licensees reach the required percentage by the
end of their next fiscal year.
b. Passive Businesses
Existing Sec. 107.901(f) prohibits the Financing of passive
businesses; however, the term ``passive'' is inadequately defined.
Proposed Sec. 107.720(b) would provide more specific criteria. For
example, the proposed rule would clarify that a business is passive if
its employees are not making the day to day operating decisions of the
company, or if it passes substantially all of the Financing proceeds
through to another entity. The proposed changes are consistent with the
public purpose of the SBIC program, which is to provide capital to
operating small businesses to stimulate the economy and create jobs.
c. Real Estate Investments
Financing of most real estate leasing and development activities is
prohibited or restricted under current Secs. 107.901(c) and 107.101(c)
since SBA considers that the Section 504 program is specifically
designed to finance real estate. In addition, most real estate
investments tend to be ``project''-oriented rather than the financing
of an on-going long-term business. Proposed Sec. 107.720(c) would
recognize these realities by narrowing the range of permitted real
estate-related financing. Financing of real estate subdividers and
developers (who subdivide and improve building lots), and of
``operative builders'' (who build homes or other buildings) would be
prohibited. Currently, these activities are permitted, though only on a
limited basis (see current Sec. 107.101(c)). The section would also
prohibit financing of businesses that buy real estate for the purpose
of improving and reselling it, an activity currently permitted under
Sec. 107.901(c)(2)(ii).
However, the Financing of the acquisition of real estate by an
operating concern for its own use would still be permitted, and the
restrictions in current Sec. 107.101(c) that limit investment in
companies that operate hotels and motels would be removed.
d. Project Financing
Proposed Sec. 107.720(d) would prohibit project financing (such as
dams, oil and gas wells, and motion pictures). Although this
prohibition does not appear in the current regulations, it has been in
effect as a matter of policy for more than ten years, reflecting SBA's
view that project financing is essentially short-term in nature and is
inconsistent with the goals of the Act. An investment is considered
project financing if the assets of the business are reduced as the life
of the business progresses (as opposed to a continuing business that
regularly replenishes its inventory, for example) and the business
provides a stream of cash payments to its investors or lenders as
assets are sold (for example, payments made as oil is pumped from a
well and sold). An investment is also considered project financing if
its major purpose is to fund production of a specific item (such as a
motion picture), over a limited period of time, by a company whose
major activity consists of such production. The company need not have
been formed for the specific purpose of carrying out the project,
although this is often the case.
e. Foreign Investment
The current Sec. 107.901(e) requires at least 51 percent of the
``assets and activities'' of a Financed Small Business to remain within
the United States. The term ``assets and activities'' has never had a
definitive interpretation. Proposed Sec. 107.720(g) would clarify the
restriction on foreign investment by requiring at least 60 percent of
the employees and at least 60 percent of the tangible assets to remain
within the United States for one year after the Financing unless the
SBIC can demonstrate, to SBA's satisfaction,

[[Page 58538]]
that the proceeds were used for a specific domestic purpose.
f. Conflicts of Interest
Proposed Sec. 107.730(a)(4) would permit a Licensee to provide
financing that the Small Business will use to repay an obligation to a
Lending Institution that is an Associate of the Licensee, provided the
obligation was incurred in the normal course of business. The current
requirement that such obligations be short-term would be removed, in
order to give Small Businesses greater flexibility in meeting their
financing needs.
Proposed Sec. 107.730(d) would replace the current rules on ``Joint
Financings with Associates'' (which cover investments by a Licensee and
its Associate that take place no more than 6 months apart) with new
provisions on ``Financings with Associates'' (which cover all
situations in which a Licensee and its Associate finance the same Small
Business, regardless of when each party invests). The basic requirement
for such Financings is that a Licensee be able to demonstrate that the
terms and conditions are fair and equitable to the Licensee (paragraph
(d)(2)). This reflects SBA's fundamental concern that a Licensee not be
disadvantaged relative to its Associates when these parties co-invest.
The proposed regulation would also establish certain categories of
Financings with Associates that would require SBA's prior written
approval (paragraph (d)(1)), and other categories that would be exempt
from such requirement (paragraph (d)(3)).
In addition to the specific changes proposed, Sec. 107.730 would
also be affected throughout by the proposed changes in the definition
of ``Associate'' that are discussed under Subpart A.
g. Overline Limitation
Under current Sec. 107.303(c), a Licensee may increase its
``overline'' limit (the maximum amount it is permitted to invest in any
one company) if it has net unrealized appreciation on ``marketable
securities.'' Proposed Sec. 107.740 contains the same rule, but would
replace the term ``marketable'' with the very similar defined term
``Publicly Traded and Marketable'' used elsewhere in the regulations.
The only effect of the change would be on the number of market makers
that a non-listed stock must have in order to qualify (two under the
proposed rule, compared with three under the current rule).
h. Definition of ``Equity Securities''
Under proposed Sec. 107.800(b), an apparent equity financing would
be considered Debt Financing for regulatory purposes if the Financing
agreement included covenants or compliance provisions with remedies
typical of debt, such as acceleration. This change is consistent with
current SBA policy, under which the Agency looks to the substance of an
investment rather than its form in order to determine whether it is
debt disguised as equity.
Under the current regulation, securities that the Small Business
must redeem at a fixed price are classified as Debt Securities rather
than equity. Under proposed Sec. 107.800(b) in combination with
Sec. 107.850(b), this provision would remain in effect with one
clarification: If the fixed redemption price is no higher than the
amount the Licensee originally paid for the security, then the security
would still qualify as an Equity Security.
As used in proposed Sec. 107.850(b), ``redemption price'' includes
all amounts that the Small Business is required to pay at redemption,
including accumulated dividends. Thus, if a Licensee purchased the
preferred stock of a Small Business for $500,000, and the Financing
agreement required the Small Business to pay $500,000 at the time of
redemption, the Licensee's investment would be considered an Equity
Security. However, if the required payment at the time of redemption
was $500,000 plus cumulative dividends of 8 percent per year, the
investment would be considered a Debt Security.
i. Options Received from Small Businesses
Proposed Sec. 107.815(a) would require a Licensee to pay some
consideration (even if only $1) for any options acquired from a Small
Business, in order to establish a basis for such options.
Proposed Sec. 107.815(b) would restrict the ability of a Licensee's
employees, officers, directors, or general partners to receive options
in a Small Business financed by the Licensee. Such persons could
receive options only if they participated in the Financing on the same
terms and conditions as the Licensee or if approved by SBA. The Agency
believes that officers and partners of SBICs should share in the
overall profits of an SBIC, but should not have special beneficial side
deals.
j. Guarantees of the Obligations of Small Businesses
Proposed Sec. 107.820 would delete two provisions from the current
rules on guarantees. Current Sec. 107.401(a)(6), which permits a
Licensee to guarantee a Small Business's obligation to an Associate if
approved by SBA under the rules governing conflicts of interest, would
be eliminated. This type of arrangement is covered in the conflict of
interest provisions and does not need to be repeated in this section.
The second proposed change is that guarantees would no longer be
limited to 100 percent of Regulatory Capital. Guarantees are considered
Financings and are included in a Licensee's overline computation, since
the risk to the Licensee is the same whether a cash investment is made
or whether a guarantee is utilized. Thus, SBA should not have a
preference for one type of Financing over another, so long as a Small
Business benefits.
k. Fees Paid to Associate Underwriters
Proposed Sec. 107.828(c) would allow an underwriter who is an
Associate of a Licensee to receive fees from Licensees that purchase
securities in an initial public offering, including the Licensee with
which it has the Associate relationship. However, if the underwriter
and the Licensee are Associates, the total fees or charges paid by the
Licensee may not exceed the total of the application and closing fees
and reimbursable expenses permitted by proposed Sec. 107.860. The
current regulations prohibit an underwriter who is an Associate of a
Licensee from receiving fees from any Licensee, and thus effectively
requires Licensees to purchase from non-Associate underwriters. This
proposed regulation recognizes the risks involved in underwriting and
allows an underwriter to be compensated.
l. Minimum Term of Financings
Under proposed Sec. 107.830(b), the entire portfolio of a Section
301(d) Licensee could consist of Financings with a minimum term of four
years instead of five. Currently, such Financings are limited to 50
percent of a Section 301(d) Licensee's portfolio. This change is
intended to give Section 301(d) Licensees greater flexibility in
structuring their Financings.
Currently, short-term Financings permitted under Sec. 107.403 are
limited, in the aggregate, to 20 percent of a Licensee's ``total
adjusted assets'' (total assets minus outstanding Leverage and current
liabilities). Proposed Sec. 107.835 would remove this limitation for
most types of permitted short-term Financings. For short-term
Financings of changes of ownership in a Small Business, the limit would
be set at 20 percent of total Loans and Investments (at cost). SBA is
proposing these changes to give Licensees greater flexibility to
respond to the needs of

[[Page 58539]]
Small Businesses. However, Licensees should bear in mind that the
purpose of the SBIC program, as stated in the Act, is to provide equity
capital and long-term loan funds to Small Businesses. Thus, Licensees
should not plan to have the bulk of their portfolios in short-term
investments; to do so would constitute engaging in activities not
contemplated by the Act.
m. Amortization of Loan Principal
Proposed Sec. 107.845 would establish uniform amortization rules
for all Loans and Debt Securities. This change would eliminate the
accelerated amortization of principal permitted, to a limited extent,
under current Sec. 107.403(b)(2). SBA considers straight-line
amortization to be fair to both Licensees and Small Businesses,
particularly when coupled with the right of Small Businesses to prepay
loans voluntarily at any time.
n. Redemption of Equity Securities
Proposed Sec. 107.850 would provide certain exceptions to the
general rule that Equity Securities cannot be redeemed in less than
five years. Earlier redemption would be allowed if the Small Business
makes a public offering, incurs a change of management or control,
files for bankruptcy protection, or materially breaches the Financing
agreement. In addition, when a Licensee makes a follow-on investment,
the minimum redemption period would be counted from the date of the
first closing, so that the follow-on Financing could be redeemed in
less than five years.
o. Cost of Money
Under proposed Sec. 107.855, SBA's Cost of Money rules would be
substantively revised in some respects and clarified throughout.
Paragraph (c) would raise the minimum Cost of Money ceiling for a Loan
from 15 percent to 19 percent, allowing an SBIC that does not receive
any equity interest in a firm to charge a higher interest rate
commensurate with risk. The minimum ceiling for a Debt Security would
remain unchanged at 14 percent.
Proposed Sec. 107.855(d) would allow Licensees to recalculate their
``Cost of Capital'' quarterly rather than annually. The proposed term
``Cost of Capital'' replaces the current unwieldy term ``Weighted
Average Cost of Qualified Borrowing.'' Paragraph (e) would reduce the
paperwork burden by eliminating the current requirement for Licensees
to submit their Cost of Capital computations to SBA. However, SBICs
would have to document such computations and make them available for
SBA's review, upon request.
SBA is aware that many private firms do not want to give up any
equity at all to outside shareholders, yet would like to grow faster
than retained earnings would allow. At the same time, an SBIC must
achieve an equity type return if it is taking equity type risks. To
accommodate these needs, proposed Sec. 107.855(g) would permit a
Licensee to receive a one-time ``bonus'' from a Small Business at the
end of the term of a Debt Financing in lieu of an equity participation,
and to exclude such a bonus from the Cost of Money if it meets the
criteria in proposed Sec. 107.855(i). Paragraph (g) also explicitly
sets forth the fees and expenses that are excluded from Cost of Money
calculations; currently, these exclusions are found in the definition
of Cost of Money in Sec. 107.3.
Finally, proposed Sec. 107.855(h) would eliminate a great deal of
current confusion over how to make the calculations that determine
whether an SBIC is in compliance with Cost of Money ceilings. This
paragraph would require that the evaluation of compliance with a Cost
of Money ceiling always be performed on a discounted cash flow basis,
based solely upon actual cash outflows and inflows.
p. Financing Fees Charged to Small Businesses
Proposed Sec. 107.860 would replace the ``processing fee'' that a
Licensee may charge under current Sec. 107.402 with an ``application
fee'' and ``closing fee'' that are very easy to administer. A Licensee
would be able to charge a nonrefundable one percent application fee to
review a Financing application, and a two percent (for Loans) or four
percent (for Debt or Equity Securities) closing fee when it actually
disburses funds to a Small Business. All the complex provisions in the
current regulation concerning the circumstances under which a
processing fee must be partially or fully refunded would be eliminated.
q. Control of a Small Business
Proposed Sec. 107.865 would modify the restrictions on Control of a
Small Business by a Licensee. As in the current regulations, paragraph
(b) of the proposed section would establish a presumption of Control
based on a Licensee's percentage of ownership. However, proposed
paragraph (c) would allow the presumption of Control to be rebutted if
the management of the Small Business owns at least 25 percent of the
voting securities and can elect at least 40 percent of the board of
directors (and Licensees and their Associates can elect no more than 40
percent). By defining conditions under which Licensees can avoid the
time-consuming process of seeking a waiver from SBA, this provision is
intended to make it easier for Licensee to co-invest with non-SBIC
investors.
Proposed paragraph (d) would expand the circumstances under which a
Licensee may take temporary Control of a Small Business to include the
following: (1) If the Small Business has materially breached the
Financing agreement; (2) if there has been during the past two years,
or will be as a result of the Financing, a substantial change in the
Small Business's operations or products, and the Licensee (or investor
group including the Licensee) is the concern's major source of capital;
or (3) if the Financing is a Start-up Financing, and the Licensee (or
investor group including the Licensee) is the concern's major source of
capital. These changes are intended to encourage investment by giving
Licensees an increased ability to protect their investment positions,
particularly in high-risk areas such as start-ups.
Proposed Sec. 107.865(d) would eliminate the current requirement to
file a plan of divestiture when a Licensee takes temporary Control of a
concern. Instead, a Licensee would file a ``Control certification''
stating the date on which it took Control and the reason for its
action, and the Licensee's agreement to relinquish Control within five
years. SBA is persuaded that the typical plan of divestiture represents
nothing more than guesswork as to future events, and therefore serves
no practical purpose.
r. Assets Acquired in Liquidation of Portfolio Securities
Proposed Sec. 107.880(b)(2) would eliminate the prior approval
requirement for reasonably necessary expenditures to improve acquired
assets and make them salable, as long as an overline does not occur as
a result. Paragraph (c) would limit the prior approval requirement for
expenditures involving overlines to leveraged Licensees only. SBA
believes that these changes will not adversely affect the Agency's
financial interests and will reduce the regulatory burden on Licensees.
s. Management Services Provided to Small Businesses
SBA is proposing to liberalize the rules governing management
services provided to a Small Business. Under proposed Sec. 107.900, a
Licensee could provide management services to a Financed Small Business
without SBA's prior approval, as long as the contract met the criteria
in Sec. 107.900(a). The

[[Page 58540]]
proposed regulation would not apply at all to services provided to a
Small Business not financed by the Licensee; SBA believes that in such
cases, any agreement between the parties is likely to be a true arm's-
length transaction, in which the Small Business does not require any
special protections.
Proposed Sec. 107.900(e) would allow Licensees to charge reasonable
``transaction fees'' for services performed in connection with a public
or private offering made by the Small Business or the sale of all or
part of the business. In addition, this paragraph generally would allow
an Associate of the Licensee to charge market rate investment banking
fees to a Small Business in connection with Financing provided by
anyone other than the Licensee.

8. Subpart H--Non-Leveraged Licensees--Exceptions to Regulations

The primary purpose of certain regulations is to protect the
government's interest as a creditor or investor in a Licensee. If a
Licensee does not have outstanding Leverage and has no plans to seek
Leverage, the safeguards provided by many regulations are unnecessary.
Proposed Sec. 107.1000 would provide a consolidated listing of
those regulatory provisions from which a non-Leveraged Licensee would
be exempt. This section would include provisions in the current
regulations such as those relating to portfolio diversification
(overline) and deposits of idle funds. It would also include several
provisions that appeared in a proposed rule published in the Federal
Register on February 7, 1994 (59 FR 5552). That proposed rule is hereby
withdrawn.
Proposed Sec. 107.1000(a)(4) would exempt non-leveraged Licensees
from the limitations on expenses incurred to maintain or improve assets
acquired in liquidation of portfolio securities (see proposed
Sec. 1007.880).
Paragraph (b)(1) would allow non-leveraged Licensees to reduce
their Regulatory Capital by more than two percent per year without SBA
approval (see proposed Sec. 107.585).
Paragraph (b)(2) would permit non-leveraged Licensees to dispose of
assets to an Associate without SBA approval (see proposed
Sec. 107.885).
Paragraph (b)(3) would allow non-leveraged Licensees to contract
with an Investment Adviser/Manager without SBA approval; Licensees
would only be required to notify SBA of the compensation paid under the
contract (see proposed Sec. 107.510).
For ease of reference, proposed Sec. 107.1000 would incorporate the
current exemptions for non-leveraged Licensees from the rules governing
overline investments, third party debt, and idle funds. Regarding the
investment of idle funds, proposed Sec. 107.1000(a)(2) states that non-
Leveraged Licensees are exempt from the restrictions in Sec. 107.530,
provided they do not engage in activities not contemplated by the Act.
SBA is proposing this language in order to emphasize that a licensed
SBIC, whether leveraged or not, must be formed for the purpose of
making long-term investments in Small Businesses. It is not appropriate
under the Act, for example, for a non-leveraged Licensee to invest its
``idle funds'' in commodities futures or financial derivatives to the
extent that such investing becomes a major component of its operations.

9. Subpart I--SBA Financial Assistance for Licensees (Leverage)

a. Eligibility for Leverage
Under proposed Sec. 107.1120(a), with respect to determining
eligibility for Leverage, a Licensee that had invested at least 50
percent of its Leverageable Capital would be presumed to lack
sufficient funds for investment only in connection with its first
takedown of Leverage. Currently, the presumption applies to all
issuances of Leverage and refers to the investment of ``50 percent of
Leverageable Capital and outstanding Leverage.'' Regardless of how this
ambiguous wording is interpreted, SBA believes the presumption is not
appropriate for later takedowns of Leverage, since a Licensee could be
presumed eligible while having a significant dollar amount of
uninvested capital.
b. Eligibility For Fourth Tier of Leverage and Second Tier of Preferred
Securities
Proposed Secs. 107.1160 (c) and (d) would eliminate the current
minor distinctions between the types of investments needed for a
Section 301(d) Licensee to qualify for a fourth tier of Leverage
(currently, ``Venture Capital Financings'') and for a second tier of
Preferred Securities (currently, ``Qualified Investments''). The change
is intended to simplify the process of establishing and maintaining the
required investment amounts and ratios by substituting a single
category of qualifying investments (to be called ``Venture Capital
Financings'') for use in determining eligibility for both types of
Leverage. The proposed definition of Venture Capital Financing would
include equity securities and those debt securities that are unsecured
and subordinated to all other borrowings of the issuer.
c. SBA Leverage Commitment to Licensees
Proposed Sec. 107.1200 would reduce the minimum amount of a
Leverage commitment from $1 million to $500,000; proposed Sec. 107.1230
would make the same reduction in the minimum amount of a Licensee's
draw request. These changes are intended to give Licensees greater
flexibility and to recognize the current limitations on the
availability of Leverage funds.
d. Earmarked Profit computation for Participating Securities issuers
Proposed Sec. 107.1510 would simplify the computation of Earmarked
Profit (Loss) for Participating Securities issuers that have both
Earmarked Assets and non-Earmarked Assets in their portfolios
(currently, there are no such Licensees). The proposed regulation would
replace requirements to identify whether certain revenues and expenses
are specifically attributable to Earmarked or non-Earmarked Assets with
a simpler percentage allocation system. Capital gains and losses would
continue to be classified as Earmarked or non-Earmarked based on the
specific assets from which they are derived.
e. Computation of the Profit Participation Rate for Participating
Securities Issuers
Proposed Sec. 107.1530(e) would clarify the method of computing the
ratio of Participating Securities to Leverageable Capital (the ``PLC
ratio''), which a Participating Securities issuer uses in determining
SBA's Profit Participation Rate for a particular distribution. The
current regulation does not always produce a definitive answer when a
Licensee increases its Leverageable Capital. The proposed rule also
would add a ``lockout period'' of 120 days before the date as of which
Profit Participation is computed; increases in Leverageable Capital
within that period could not be used to reduce the PLC ratio. SBA
considers this change necessary to protect the Agency from a sharp
decrease in its Profit Participation when a Licensee increases its
capital shortly before performing its distribution calculations.
Proposed Sec. 107.1530(g)(2) would make a technical correction in
the method of time weighting outstanding issuances of Participating
Securities for the purpose of indexing the Profit Participation Rate.
The current method incorrectly causes the Profit Participation Rate to
go to zero after all

[[Page 58541]]
Participating Securities have been redeemed.
f. ``Payment Dates'' for Participating Securities
This proposed rule would add the defined term ``Payment Dates'' to
the regulations for issuers of Participating Securities, reflecting the
terms of the public fundings of Participating Securities that have
already taken place. Payment Dates have been established as each
February 1, May 1, August 1, and November 1 during the term of a
Participating Security, and represent the dates on which Trust
Certificate holders receive interest payments and any returns of
principal to which they are entitled. To accommodate this structure,
Participating Securities issuers would be permitted to make
distributions only on Payment Dates. SBA recognizes, however, that
there is one situation in which this arrangement may present
difficulties for Licensees, and is requesting comments and suggestions
to help resolve the following issue:
Under proposed Sec. 107.1550 (equivalent to current
Sec. 107.245(b)), a partnership Licensee may make an annual ``tax
distribution'' to its private investors and SBA. The recipients of this
distribution may or may not be taxable investors. However, for those
who are taxable and need to receive cash in order to pay taxes by the
April 15 filing deadline, the timing of the Payment Dates may present a
problem: For a Licensee with a December 31 fiscal year end, it is
unlikely that a distribution based on audited year end figures could be
made as early as February 1; on the other hand, the next Payment Date
(May 1) is after the tax filing deadline. SBA is willing to consider an
exception that would permit a tax distribution to be made on a date
other than a Payment Date, but is asking interested parties to assist
the Agency in developing an effective approach.

10. Subpart J--Licensee's Non-Compliance with Terms of Leverage

a. Capital Impairment Computation
The determination of a Licensee's Capital Impairment would be
clarified in two ways. In the computation of Adjusted Unrealized Gain
for Capital Impairment purposes, proposed Sec. 107.1840(d)(3) would
clarify that a Licensee claiming unrealized appreciation on non-
Publicly Traded and Marketable Securities based on subsequent rounds of
equity financing at a higher price (``Class 2 Appreciation'') must
substantiate, to SBA's satisfaction, that such appreciation meets the
required criteria. Proposed Sec. 107.1840(d)(6) would require
unrealized gains on securities that are pledged or encumbered to be
reduced by the amount of the related borrowing or other obligation.
These changes reflect current SBA policy in the administration of the
Capital Impairment regulations.

Compliance With Executive Orders 12612, 12778, and 12866, the
Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork
Reduction Act (44 U.S.C. Ch. 35)

SBA certifies that this proposed rule would not be a significant
regulatory action for purposes of Executive Order 12866 because it
would not have an annual effect on the economy of more than $100
million, and that it would not have a significant economic impact on a
substantial number of small entities within the meaning of the
Regulatory Flexibility Act, 5 U.S.C. 601, et seq. The primary purpose
of the proposed rule is to streamline the regulations governing the
SBIC program by eliminating obsolete regulations and reorganizing the
remainder in a more logical and readable format.
Two areas of the proposed regulations would have some economic
effect, including possible effects on small entities. First, license
application fees and examination fees would be raised. An SBIC license
applicant would pay a fee of $10,000 to $20,000, compared with the
current $5,000. This increase is not significant relative to the
private capital of an average Licensee, which exceeds $10 million. Exam
fees would continue to be based on the total assets of a Licensee, but
at higher rates. The largest Licensees, generally those with assets of
at least $25 million, could experience fee increases of $20,000 or
more; however, the number of such Licensees is currently very small.
Second, the proposed changes in the regulations governing ``Cost of
Money'' (the maximum amount a Licensee can charge on loans and debt
securities) would potentially affect the borrowing costs of small
entities. Although the interest rate on loans is determined primarily
by market forces, the proposed rule would raise the interest rate
ceiling on loans extended by Licensees from 15 percent to 19 percent.
The total amount of loans provided to small businesses by Licensees is
approximately $240 million per year. Even if the additional four
percentage points were charged on the entire balance of such loans, the
annual economic impact would be less than $10 million.
For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA
certifies that this proposed rule, if adopted in final form, would
contain no new reporting or record keeping requirements that have not
already been approved by the Office of Management and Budget. The
``Financing Eligibility Statement'' (SBA Form 1941) which would be
required under proposed Sec. 107.610 has already been approved by OMB
under Control Number 3245-0301.
For purposes of Executive Order 12612, SBA certifies that this rule
would not have any federalism implications warranting the preparation
of a Federalism Assessment.
For purposes of Executive Order 12778, SBA certifies that this rule
is drafted, to the extent practicable, in accordance with the standards
set forth in Section 2 of that Order.
For the reasons set forth above, SBA hereby proposes to amend Part
107 of Title 13 of the Code of Federal Regulations as follows:
1. 107.1 through 107.1202 and all center headings are removed the
authority citation for Part 107 continues to read as set forth below,
and new subparts A through L are added to read as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

Subpart A--Introduction to Part 107

107.20 Legal basis and applicability of Part 107.
107.30 Amendments to Act and regulations.
107.40 How to read Part 107.

Subpart B--Definition of Terms Used in Part 107

107.50 Definition of terms.

Subpart C--Qualifying for an SBIC License

Organizing an SBIC

107.100 Organizing a Section 301(c) Licensee.
107.110 Organizing a Section 301(d) Licensee.
107.115 1940 Act and 1980 Act Companies.
107.120 Special rules for a Section 301(d) Licensee owned by
another Licensee.
107.130 Requirement for qualified management.
107.140 SBA approval of initial Management Expenses.
107.150 Management and ownership diversity requirement.
107.160 Special rules for Licensees formed as limited partnerships.

Capitalizing an SBIC

107.200 Adequate capital for Licensees.
107.210 Minimum capital requirements for Licensees.
107.220 Special minimum capital requirements for Licensees issuing
Leverage.

[[Page 58542]]

107.230 Permitted sources of Private Capital for Licensees.
107.240 Limitations on accepting non-cash capital contributions.
107.250 Issuance of stock options by Licensees.

Applying for an SBIC License

107.300 License application form and fee.
Subpart D--Changes in Ownership, Control, or Structure of Licensee;
Transfer of License

Changes in Control or Ownership of Licensee

107.400 Changes in ownership of 10 percent or more of Licensee but
no change of Control.
107.410 Changes in Control of Licensee (through change in ownership
or otherwise).
107.420 Prohibition on exercise of ownership or Control rights in
Licensee before SBA approval.
107.430 Notification to SBA of transactions that may change
ownership or Control.
107.440 Standards governing prior SBA approval for a proposed
transfer of Control.
107.450 Notification to SBA of pledge of Licensee's shares.

Restrictions on Common Control or Ownership of Two or More Licensees

107.460 Restrictions on Common Control or ownership of two (or
more) Licensees.

Change in Structure of Licensee

107.470 SBA approval of merger, consolidation, or reorganization of
Licensee.

Transfer of License

107.475 Transfer of license.

Subpart E--Managing The Operations of a Licensee

General Requirements

107.500 Lawful operations under the Act.
107.501 Identification as a Licensee.
107.502 Representations to the public.
107.503 Licensee's adoption of an approved Valuation Policy.
107.504 Computer capability requirements of Licensee.
107.505 Facsimile requirement.
107.506 Safeguarding Licensee's assets/Internal controls.
107.507 Violations based on false filings and nonperformance of
agreements with SBA.
107.508 Accessible office.
107.509 Employment of SBA officials.

Management and Compensation

107.510 SBA approval of Licensee's Investment Adviser/Manager
107.520 Management Expenses of a Licensee.

Cash Management by a Licensee

107.530 Restrictions on investments of idle funds by leveraged
Licensees.

Borrowing by Licensees From Non-SBA Sources

107.550 Prior approval of secured third-party debt of leveraged
Licensees.
107.560 Subordination of SBA's creditor position.
107.570 Restrictions on third-party debt of issuers of
Participating Securities.

Voluntary Decrease in Licensee's Regulatory Capital

107.585 Voluntary decrease in Licensee's Regulatory Capital.

Requirement To Conduct Active Investment Operations

107.590 Licensee's requirement to maintain active operations.
Subpart F--Record keeping, Reporting, and Examination Requirements for
Licensees

Recordkeeping Requirements for Licensees

107.600 General requirement for Licensee to maintain and preserve
records.
107.610 Required certifications for Loans and Investments.
107.620 Requirements to obtain information from Portfolio Concerns.

Reporting Requirements for Licensees

107.630 Requirement for Licensees to file financial statements with
SBA (Form 468).
107.640 Requirement to file Portfolio Financing Reports (SBA Form
1031).
107.650 Requirement to report portfolio valuations to SBA.
107.660 Other items required to be filed by Licensee with SBA.
107.670 Application for exemption from civil penalty for late
filing of reports.
107.680 Reporting changes in Licensee not subject to prior SBA
approval.

Examinations of Licensees by SBA for Regulatory Compliance

107.690 Examinations.
107.691 Responsibilities of Licensee during examination.
107.692 Examination fees.

Subpart G--Financing of Small Businesses by Licensees

Determining the Eligibility of a Small Business for SBIC Financing

107.700 Compliance with size standards in Part 121 of this chapter
as a condition of Assistance.
107.710 Requirement to finance Smaller Businesses.
107.720 Small Businesses that may be ineligible for Financing.
107.730 Financings which constitute conflicts of interest.
107.740 Portfolio diversification (``overline'' limitation).
107.750 Conditions for financing a change of ownership of a Small
Business.
107.760 How a change in size or activity of a Portfolio Concern
affects the Licensee and the Portfolio Concern.

Structuring Licensee's Financing of Eligible Small Businesses: Types of
Financing

107.800 Financings in the form of Equity Securities.
107.810 Financings in the form of Loans.
107.815 Financings in the form of Debt Securities.
107.820 Financings in the form of guarantees.
107.825 Commitments to Small Businesses.
107.828 Purchasing Securities from an underwriter or other third
party.

Structuring Licensee's Financing of an Eligible Small Business: Terms
and Conditions of Financing

107.830 Minimum duration/term of financing.
107.835 Exceptions to minimum duration/term of Financing.
107.840 Maximum term of Financing.
107.845 Maximum rate of amortization on Loans and Debt Securities.
107.850 Restrictions on redemption of Equity Securities.
107.855 Interest rate ceiling and limitations on fees charged to
Small Businesses (``Cost of Money'').
107.860 Financing fees and expense reimbursements a Licensee may
receive from a Small Business.
107.865 Restrictions on Control of a Small Business by a Licensee.
107.880 Assets acquired in liquidation of Portfolio securities.

Limitations on Disposition of Assets

107.885 Disposition of assets to Licensee's Associates or to
competitors of Portfolio Concern.

Management Services and Fees

107.900 Management fees for services provided to a Small Business
by Licensee or its Associate.

Subpart H--Non-Leveraged Licensees--Exceptions to Regulations

107.1000 Licensees without Leverage--exceptions to the regulations.

Subpart I--SBA Financial Assistance for Licensees (Leverage)

General Information About Obtaining Leverage

107.1100 Types of Leverage available.
107.1110 How to apply for Leverage.
107.1120 General eligibility requirements for Leverage.
107.1130 Leverage fees payable by Licensee.
107.1140 Licensee's acceptance of SBA remedies under Secs. 107.1800
through 107.1820.

Maximum Amount of Leverage for Which a Licensee is Eligible

107.1150 Maximum amount of Leverage for a Section 301(c) Licensee.
107.1160 Maximum amount of Leverage for a Section 301(d) Licensee.
107.1170 Maximum amount of Participating Securities for any
Licensee.

[[Page 58543]]

Conditional Commitments by SBA to Reserve Leverage for a Licensee

107.1200 SBA's Leverage commitment to a Licensee--application
procedure, amount, and term.
107.1210 Commitment fees payable by Licensee.
107.1220 Requirement for Licensee to file quarterly financial
statements.
107.1230 Draw-downs by Licensee under SBA's Leverage commitment.
107.1240 Funding of Licensee's draw request through sale to short-
term investor.

Exchange of Outstanding Debentures for Participating or Preferred
Securities--Section 301(d) Licensees

107.1350 Exchange by Section 301(d) Licensee of Debentures for
Preferred or Participating Securities.

Preferred Securities Leverage--Section 301(d) Licensees

107.1400 Stock dividends or partnership distributions on 4 percent
Preferred Securities.
107.1410 Requirement to redeem 4 percent Preferred Securities.
107.1420 Articles requirements for 4 percent Preferred Securities
issuers.
107.1430 Redeeming 4 percent Preferred Securities with proceeds of
non-subsidized Debentures.
107.1440 Three percent preferred stock issued before November 21,
1989. 107.1450 Optional redemption of Preferred Securities.

Participating Securities Leverage

107.1500 General description of Participating Securities.
107.1505 Liquidity requirements for Licensees issuing Participating
Securities.
107.1510 How a Licensee computes Earmarked Profit (Loss).
107.1520 How a Licensee computes and allocates Prioritized Payments
to SBA.
107.1530 How a Licensee computes SBA's Profit Participation.
107.1540 Distributions by Licensee--Prioritized Payments and
Adjustments.
107.1550 Distributions by Licensee--permitted ``tax Distributions''
to private investors and SBA.
107.1560 Distributions by Licensee--required Distributions to
private investors and SBA.
107.1570 Distributions by Licensee--optional Distribution to
private investors and SBA.
107.1580 Special rules for In-Kind Distributions by Licensees.
107.1590 Special rules for companies licensed on or before March
31, 1993.

Funding Leverage by Use of SBA-Guaranteed Trust Certificates (``TCs'')

107.1600 SBA authority to issue and guarantee Trust Certificates.
107.1610 Terms and conditions of Trust Certificates.
107.1620 SBA authority to pay subsidy amount on subsidized
Debentures.
107.1630 Effect of prepayment or early redemption of Leverage on a
Trust Certificate.
107.1640 Subrogation of SBA upon payment under Trust Certificate
Program.
107.1650 Formation of a Pool or Trust holding Leverage securities.
107.1660 Functions of agents, including Central Registration Agent,
Selling Agent and Fiscal Agent.
107.1670 SBA regulation of Brokers and Dealers and disclosure to
purchasers of Leverage or Trust Certificates.
107.1680 SBA access to records of the CRA, Brokers, Dealers and
Pool or Trust assemblers.

Miscellaneous

107.1700 Characteristics of SBA's guarantee.
107.1710 Transfer by SBA of its interest in Licensee's Leverage
security.
107.1720 SBA authority to collect or compromise its claims.

Subpart J--Licensee's Noncompliance With Terms of Leverage

107.1800 Licensee's agreement to terms and conditions in
Secs. 107.1810 and 107.1820.
107.1810 Events of default and SBA's remedies for Licensee's
noncompliance with terms of Debentures.
107.1820 Conditions affecting issuers of Preferred Securities and/
or Participating Securities.

Computation of Licensee's Capital Impairment

107.1830 Licensee's Capital Impairment--Definition and General
Requirements.
107.1840 Computation of Licensee's Capital Impairment Percentage.
107.1850 Exceptions to Capital Impairment provisions for Licensees
with outstanding Participating Securities.

Subpart K--Ending Operations as a Licensee

107.1900 Surrender of license.

Subpart L--Miscellaneous

107.1910 Non-waiver of SBA's rights or terms of Leverage security.
107.1920 Licensee's application for exemption from a regulation in
Part 107.
107.1930 Effect of changes in Part 107 on transactions previously
consummated.
* * * * *
Authority: Title III of the Small Business Investment Act, 15
U.S.C. 681 et seq., as amended; 15 U.S.C. 687(c); 15 U.S.C. 683; 15
U.S.C. 687d; 15 U.S.C. 687g; 15 U.S.C. 687b; 15 U.S.C. 687m, as
amended by Pub. L. 102-366.

Subpart A--Introduction to Part 107

Sec. 107.20 Legal basis and applicability of Part 107.

(a) The regulations in this part implement Title III of the Small
Business Investment Act of 1958, as amended. All Licensees, including
Section 301(d) Licensees, must comply with all applicable regulations,
accounting guidelines and valuation guidelines for Licensees.
(b) Provisions of this part which are not mandated by the Act shall
not supersede existing State law. A party claiming that a conflict
exists shall submit an opinion of independent counsel, citing
authorities, for SBA's resolution of the issues involved.

Sec. 107.30 Amendments to Act and regulations.

A Licensee shall be subject to all existing and future provisions
of the Act and Parts 107 and 112 of title 13 of the Code of Federal
Regulations.

Sec. 107.40 How to read Part 107.

(a) Center headings. All references in this part to SBA forms, and
instructions for their preparation, are to the current issue of such
forms. Center headings are descriptive and are used for convenience
only. They have no regulatory effect.
(b) Capitalizing defined terms. Terms defined in Sec. 107.50 are
capitalized hereafter.
(c) The pronoun ``you'' as used in this Part 107 means a Licensee
or license applicant, as appropriate, unless otherwise noted.

Subpart B--Definition of Terms Used in Part 107

Sec. 107.50 Definition of terms.

Accumulated prioritized payments has the meaning set forth in
Sec. 107.1520.
Act means the Small Business Investment Act of 1958, as amended.
Adjustments has the meaning set forth in Sec. 107.1520.
Affiliate or Affiliates has the meaning set forth in Sec. 121.401.
Articles mean articles of incorporation or charter for a Corporate
Licensee and the partnership agreement or certificate for a Partnership
Licensee.
Assistance or Assisted means Financing of or management services
rendered to a Small Business by a Licensee pursuant to the Act and
these regulations.
Associate of a Licensee means any of the following:
(1)(i) An officer, director, employee or agent of a Corporate
Licensee;
(ii) A Control Person, employee or agent of a Partnership Licensee;
(iii) An Investment Adviser/Manager of any Licensee, including any
Person who contracts with a Control Person of a Partnership Licensee to
be the Investment Adviser/Manager of such Licensee; or
(iv) Any Person regularly serving a Licensee in the capacity of
attorney at law.

[[Page 58544]]

(2) Any Person who owns or controls, or who has entered into an
agreement to own or control, directly or indirectly, at least 10
percent of any class of stock of a Corporate Licensee or a limited
partner's interest of at least 10 percent of the partnership capital of
a Partnership Licensee. However, a limited partner in a Partnership
Licensee is not considered an Associate if such Person is an entity
Institutional Investor whose investment in the Partnership, including
commitments, represents no more than 33 percent of the partnership
capital of the Licensee and no more than five percent of such Person's
net worth.
(3) Any officer, director, partner (other than a limited partner),
manager, agent, or employee of any Associate described in paragraph (1)
or (2) of this definition.
(4) Any Person that directly or indirectly Controls, or is
Controlled by, or is under Common Control with, a Licensee.
(5) Any Person that directly or indirectly Controls, or is
Controlled by, or is under Common Control with, any Person described in
paragraphs (1) and (2) of this definition.
(6) Any Close Relative of any Person described in paragraphs
(1),(2), (4), and (5) of this definition.
(7) Any Secondary Relative of any Person described in paragraphs
(1), (2), (4), and (5) of this definition.
(8) Any concern in which--
(i) Any Person described in paragraphs (1) through (6) of this
definition is an officer; or
(ii) Any such Person(s) singly or collectively Control or own,
directly or indirectly, an equity interest of at least 10 percent
(excluding interests that such Person(s) own indirectly through
ownership interests in the Licensee).
(9) Any concern in which any Person(s) described in paragraph (7)
of this definition singly or collectively own (including beneficial
ownership) a majority equity interest, or otherwise have Control. As
used in this paragraph (9), ``collectively'' means together with any
Person(s) described in paragraphs (1) through (7) of this definition.
(10) For the purposes of this definition, if any Associate
relationship described in paragraphs (1) through (7) of this definition
exists at any time within six months before or after the date that a
Licensee provides Financing, then that Associate relationship is
considered to exist on the date of the Financing.
(11) If any Licensee has any ownership interest in another
Licensee, the two Licensees are Associates of each other.
Capital impairment has the meaning set forth in Sec. 107.1830(c).
Central Registration Agent or CRA means one or more agents
appointed by SBA for the purpose of issuing TCs and performing the
functions enumerated in Sec. 107.1660 and performing similar functions
for Debentures and Participating Securities funded outside the pooling
process.
Close Relative of an individual means:
(1) A current or former spouse;
(2) A father, mother, guardian, brother, sister, son, daughter; or
(3) A father-in-law, mother-in-law, brother-in-law, sister-in-law,
son-in-law, or daughter-in-law.
Combined Capital means the sum of Regulatory Capital and
outstanding Leverage.
Commitment has the meaning set forth in Sec. 107.825.
Common Control means a condition where two or more Licensees either
through ownership, management, contract, or otherwise, are under the
Control of one group or Person. Two or more Licensees are presumed to
be under Common Control if they are Affiliates of each other by reason
of common ownership or common officers, directors, or general partners;
or if they are managed or their investments are significantly directed
either by a common independent investment advisor or managerial
contractor, or by two or more such advisors or contractors that are
Affiliates of each other. This presumption may be rebutted by evidence
satisfactory to SBA.
Control means the possession, direct or indirect, of the power to
veto or to direct or cause the direction of the management and policies
of a Licensee or other concern, whether through the ownership of voting
securities, by contract, or otherwise.
Control Person means any Person that controls a Licensee, either
directly or through an intervening entity. A Control Person includes:
(1) A general partner of a Partnership Licensee;
(2) Any Person serving as the general partner, officer, director,
or manager (in the case of a limited liability company) of any entity
that controls a Licensee, either directly or through an intervening
entity;
(3) Any Person that--
(i) Controls or owns, directly or through an intervening entity, at
least 10 percent of a Partnership Licensee or any entity described in
paragraphs (1) or (2) of this definition; and
(ii) Participates in the investment decisions of the general
partner of such Partnership Licensee;
(4) Any Person that controls or owns, directly or through an
intervening entity, at least 40 percent of a Partnership Licensee or
any entity described in paragraphs (1) or (2) of this definition.
Corporate Licensee. See definition of Licensee in this section.
Cost of Money has the meaning set forth in Sec. 107.855.
Debenture Rate means the interest rate, as published from time to
time in the Federal Register by SBA, for ten year debentures issued by
Licensees and funded through public sales of certificates bearing SBA's
guarantee. User or guarantee fees, if any, paid by a Licensee are not
considered in determining the Debenture Rate.
Debentures means debt obligations issued by Licensees pursuant to
section 303(a) of the Act and held or guaranteed by SBA.
Debt Securities has the meaning set forth in Sec. 107.815.
Disadvantaged Business means a Small Business that is at least 50
percent owned, and controlled and managed, on a day to day basis, by a
person or persons whose participation in the free enterprise system is
hampered because of social or economic disadvantages.
Distribution means any transfer of cash or non-cash assets to SBA,
its agent or Trustee, or to partners in a Partnership Licensee, or to
shareholders in a Corporate Licensee. Capitalization of Retained
Earnings Available for Distribution constitutes a Distribution to the
Licensee's non-SBA partners or shareholders.
Earmarked Assets has the meaning set forth in Sec. 107.1510(b).
(See also Sec. 107.1590.)
Earmarked Profit (Loss) has the meaning set forth in Sec. 107.1510.
Earned Prioritized Payments has the meaning set forth in
Sec. 107.1520.
Equity Capital Investments means investments in a Small Business in
the form of common or preferred stock, limited partnership interests,
options, 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 must not require amortization.
Equity Capital Investments may be guaranteed; however, neither Equity
Capital Investments nor such guarantee may be collateralized or
otherwise secured. Investments classified as Debt Securities (see
Secs. 107.800 and 107.815) are not precluded from qualifying as Equity
Capital Investments.

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Entity General Partner has the meaning set forth in
Sec. 107.160(b).
Equity Securities has the meaning set forth in Sec. 107.800.
Financing or Financed means outstanding financial assistance
provided to a Small Business by a Licensee, whether through:
(1) Loans;
(2) Debt Securities;
(3) Equity Securities;
(4) Guarantees; or
(5) Purchases of securities of a Small Business through or from an
underwriter (see Sec. 107.805).
Guaranty Agreement means the contract entered into by SBA which is
a guarantee backed by the full faith and credit of the United States
Government as to timely payment of principal and interest on Debentures
or the Redemption Price of and Prioritized Payments on Participating
Securities and SBA's rights in connection with such guarantee.
Includible Non-Cash Gains means those non-cash gains (as reported
on SBA Form 468) that are realized in the form of Publicly Traded and
Marketable securities or investment grade debt instruments. For
purposes of this definition, investment grade debt instruments means
those instruments that are rated ``BBB'' or ``Baa'', or better, by
Standard & Poor's Corporation or Moody's Investors Service,
respectively. Non-rated debt may be considered to be investment grade
if Licensee obtains 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.
Institutional Investor means:
(1) Entities. Any of the following entities if the entity has a net
worth (exclusive of unfunded commitments from investors) of at least $1
million, or such higher amount as is specified below. (See also
Sec. 107.230(b)(4) for limitations on the amount of an Institutional
Investor's commitment that may be included in Private Capital.)
(i) A State or National bank, trust company, savings bank, or
savings and loan association.
(ii) An insurance company.
(iii) A 1940 Act Investment Company or Business Development Company
(each as defined in the Investment Company Act of 1940, as amended).
(iv) A holding company of any entity described in paragraph (1)(i),
(ii)or (iii) of this definition.
(v) An employee benefit or pension plan established for the benefit
of employees of the Federal government, any State or political
subdivision of a State, or any agency or instrumentality of such
government unit.
(vi) An employee benefit or pension plan (as defined in the
Employee Retirement Income Security Act of 1974, as amended, excluding
plans established under section 401(k) of the Internal Revenue Code of
1986, as amended).
(vii) A trust, foundation or endowment exempt from Federal income
taxation under the Internal Revenue Code of 1986, as amended.
(viii) A corporation, partnership or other entity with a net worth
(exclusive of unfunded commitments from investors) of more than $10
million.
(ix) A State, a political subdivision of a State, or an agency or
instrumentality of a State or its political subdivision.
(x) An entity whose primary purpose is to manage and invest non-
Federal funds on behalf of at least three Institutional Investors
described in paragraphs (1)(i) through (1)(ix) of this definition, each
of whom must have at least a 10 percent ownership interest in the
entity.
(xi) Any other entity that SBA determines to be an Institutional
Investor.
(2) Individuals. (i) Any of the following individuals if he/she is
also a permanent resident of the United States:
(A) An individual who is an Accredited Investor (as defined in the
Securities Act of 1933, as amended) and whose commitment to the
Licensee is backed by a letter of credit from a State or National bank
acceptable to SBA.
(B) An individual whose personal net worth is at least $2 million
and at least ten times the amount of his or her commitment to the
Licensee. The individual's personal net worth must not include the
value of any equity in his or her most valuable residence.
(C) An individual whose personal net worth (determined in
accordance with paragraph (2)(i)(B) of this definition) is at least $10
million.
(ii) Any individual who is not a permanent resident of the United
States but who otherwise satisfies paragraph (2)(i) of this definition
provided such individual has irrevocably appointed an agent within the
United States for the service of process.
Investment Adviser/Manager means any Person who furnishes advice or
assistance with respect to operations of a Licensee under a written
contract executed in accordance with the provisions of Sec. 107.510.
Lending Institution means a concern that is operating under
regulations of a state or Federal licensing, supervising, or examining
body, or whose shares are publicly traded and listed on a recognized
stock exchange or NASDAQ and which has assets in excess of $500
million; and which, in either case, holds itself out to the public as
engaged in the making of commercial and industrial loans and whose
lending operations are not for the purpose of financing its own or an
Associates's sales or business operations.
Leverage means financial assistance provided to a Licensee by SBA,
either through the purchase or guaranty of a Licensee's Debentures or
Participating Securities, or the purchase of a Licensee's Preferred
Securities, and any other SBA financial assistance evidenced by a
security of the Licensee.
Leverageable Capital means Regulatory Capital, excluding unfunded
commitments and Qualified Non-private Funds whose source is Federal
funds.
Licensee means either a corporation (Corporate Licensee), or a
limited partnership organized pursuant to Sec. 107.160 (Partnership
Licensee), to which a license has been granted pursuant to the Act. For
certain purposes, the Entity General Partner of a Partnership Licensee
is treated as if it were a Licensee (see Sec. 107.160(b)(2)).
Loan has the meaning set forth in Sec. 107.810.
Loans and Investments means Portfolio Securities, Assets Acquired
in Liquidation of Portfolio Securities, Operating Concerns Acquired,
and Notes and Other Securities Received, as set forth in the Statement
of Financial Position of SBA Form 468.
Management Expenses has the meaning set forth in Sec. 107.520.
1940 Act Company means a Licensee which is registered under the
Investment Company Act of 1940.
1980 Act Company means a Licensee which is registered under the
Small Business Investment Incentive Act of 1980.
Original Issue Price means the price paid by the purchaser for
securities at the time of issuance.
Participating Securities means preferred stock, preferred limited
partnership interests, or similar instruments issued by Licensees,
including debentures having interest payable only to the extent of
earnings, all of which are subject to the terms set forth in
Secs. 107.1500 through 107.1590 and section 303(g) of the Act.
Partnership Licensee. See definition of Licensee in this section.
Payment Date means, for a Participating Securities issuer, each
February 1, May 1, August 1, and November 1 during the term of a
Participating Security.
Person means a natural person or legal entity.
Pool means an aggregation of SBA guaranteed Debentures or SBA

[[Page 58546]]
guaranteed Participating Securities approved by SBA.
Portfolio means the securities representing a Licensee's total
outstanding Financing of Small Businesses. It does not include idle
funds or assets acquired in liquidation of Portfolio securities.
Portfolio Concern means a Small Business Assisted by a Licensee.
Preferred Securities means nonvoting preferred stock issued to SBA
by a for-profit Section 301(d) Corporate Licensee, or securities having
similar characteristics issued by a Section 301(d) Licensee organized
as a nonprofit corporation, or nonvoting preferred limited partnership
interests issued by a Section 301(d) Partnership Licensee.
Prioritized Payments has the meaning set forth in Sec. 107.1520.
Private Capital has the meaning set forth in Sec. 107.230.
Profit Participation has the meaning set forth in
Sec. 107.1500(c)(3).
Publicly Traded and Marketable means securities that are salable
without restriction or that are salable within 12 months pursuant to
Rule 144 of the Securities Act of 1933, as amended, by the holder
thereof (or in the case of an In-kind Distribution by the distributee
thereof), and are of a class which is traded on a regulated stock
exchange, or is listed in the Automated Quotation System of the
National Association of Securities Dealers (NASDAQ), or has, at a
minimum, at least two market makers as defined in the relevant sections
of the Securities Exchange Act of 1934, as amended, and in all cases
the quantity of which can be sold over a reasonable period of time
without having an adverse impact upon the price of the stock.
Qualified Non-private Funds has the meaning set forth in
Sec. 107.230.
Redemption Price means the amount required to be paid by the
issuer, or successor to the issuer, of Preferred or Participating
Securities to repurchase such securities from the holder. The
Redemption Price shall be the Original Issue Price less any prepayments
or prior redemptions.
Regulatory Capital means:
(1) General. Regulatory Capital means Private Capital, excluding
non-cash assets contributed to a Licensee or a license applicant, and
non-cash assets purchased by a license applicant, unless such assets
have been converted to cash or have been approved by SBA for inclusion
in Regulatory Capital. For purposes of this definition, sales of
contributed non-cash assets with recourse or borrowing against such
assets shall not constitute a conversion to cash.
(2) Exclusion of questionable commitments. An investor's commitment
to a Licensee is excluded from Regulatory Capital if SBA determines
that the collectibility of the commitment is questionable.
Retained Earnings Available for Distribution means Undistributed
Net Realized Earnings less any Unrealized Depreciation on Loans and
Investments (as reported on SBA Form 468), and represents the amount
that a Licensee may distribute to investors (including SBA) as a profit
Distribution, or transfer to Private Capital.
SBA means the Small Business Administration, 409 Third Street, SW.,
Washington, DC 20416.
Secondary Relative of an individual means:
(1) A grandparent, grandchild, or any other ancestor or lineal
descendent who is not a Close Relative;
(2) An uncle, aunt, nephew, niece, or first cousin; or
(3) A spouse of any person described in paragraph (1) or (2)of this
definition.
Section 301(c) Licensee has the meaning set forth in Sec. 107.100.
Section 301(d) Licensee has the meaning set forth in Sec. 107.110.
Short-term Financing means Financing for a term of less than five
years in accordance with the regulations.
SIC Manual means the latest issue of the Standard Industrial
Classification Manual, prepared by the Office of Management and Budget,
and available from the U.S. Government Printing Office, Superintendent
of Documents, P.O. Box 371954, Pittsburgh, Pa., 15250-7954.
Small Business means a small business concern as defined in section
103(5) of the Act (including its Affiliates), which for purposes of
size eligibility, meets the applicable criteria set forth in part 121
of this chapter.
Smaller Business has the meaning set forth in Sec. 107.710.
Start-up Financing means an Equity Capital Investment in a Small
Business that--
(1) Engages in technology development or commercialization,
manufacturing, and/or exporting;
(2) At the time of Licensee's initial Financing has not existed, in
any form, for more than three fiscal years;
(3) Has not had sales exceeding $5,000,000 or positive cash flow in
any fiscal year; and
(4) Was not formed to acquire any existing business.
Temporary Debt has the meaning set forth in Sec. 107.570.
Trust means the legal entity created for the purpose of holding
guaranteed Debentures or Participating Securities and the guaranty
agreement related thereto, receiving, holding and making any related
payments, and accounting for such payments.
Trust Certificate Rate means a fixed rate determined at the time
Participating Securities are issued by the Secretary of the Treasury
taking into consideration the current average market yield on
outstanding marketable obligations of the United States with maturities
comparable to the maturities of the Trust Certificates being guaranteed
by SBA, adjusted to the nearest one-eighth of one percent.
Trust Certificates (TCs) means certificates issued by SBA, its
agent or Trustee and representing ownership of all or a fractional part
of a Trust or Pool of Debentures or Participating Securities.
Trustee means the trustee or trustees of a Trust.
Undistributed Net Realized Earnings means Undistributed Realized
Earnings less Non-cash Gains/Income, each as reported on SBA Form 468.
Unrealized Appreciation means the amount by which a Licensee's
valuation of Loans and Investments, as determined by its Board of
Directors or General Partner(s) in accordance with Licensee's valuation
policies, exceeds the cost basis thereof.
Unrealized Depreciation means the amount by which a Licensee's
valuation of Loans and Investments, as determined by its Board of
Directors or General Partner(s) in accordance with Licensee's valuation
policies, is below the cost basis thereof.
Unrealized Gain (Loss) on Securities Held means the sum of the
Unrealized Appreciation and Unrealized Depreciation on all of a
Licensee's Loans and Investments, less estimated future income tax
expense or estimated realizable future income tax benefit, as
appropriate.
Venture Capital Financing has the meaning set forth in
Sec. 107.1160.
Wind-up Plan has the meaning set forth in Sec. 107.590.

Subpart C--Qualifying for an SBIC License

Organizing an SBIC

Sec. 107.100 Organizing a Section 301(c) Licensee.

Section 301(c) Licensee means a company licensed under section
301(c) of the Act. It may be organized as a for-profit corporation or
as a limited partnership created in accordance with the special rules
of Sec. 107.160.

[[Page 58547]]

Sec. 107.110 Organizing a Section 301(d) Licensee.

Section 301(d) Licensee means a company licensed under section
301(d) of the Act that may provide Assistance only to Disadvantaged
Businesses. A Section 301(d) Licensee may be organized as a for-profit
corporation, a non-profit corporation, or as a limited partnership
created in accordance with the special rules of Sec. 107.160.

Sec. 107.115 1940 Act and 1980 Act Companies.

For license applications received on or after November 28, 1995,
SBA will license a 1940 Act or 1980 Act Company only if such company
does not elect to be taxed as a regulated investment company under
section 851 of the Internal Revenue Code of 1986, as amended. After
such date, a request by an existing Licensee to convert to a 1940 Act
or 1980 Company will be approved by SBA only if the same criteria are
satisfied.

Sec. 107.120 Special rules for a Section 301(d) Licensee owned by
another Licensee.

A Section 301(d) Licensee may be licensed to operate as the
subsidiary of one or more Licensees (participant Licensee), with or
without non-Licensee participation, subject to the following:
(a) Application. In reviewing the license application, SBA will
consider what effect, if any, a capital contribution to the proposed
Section 301(d) Licensee will have on the participant Licensee.
(b) Participant Licensees. Each participant Licensee must propose
to own at least twenty percent of the voting securities of the proposed
Section 301(d)Licensee.
(c) Capital contribution. A subsidiary Section 301(d) Licensee must
receive capital contributions in cash, in an amount at least equal to
the minimum capital requirement under Sec. 107.210. Capital contributed
by a participant Licensee in excess of the required minimum may be in
the form of securities of a Disadvantaged Business, valued at the lower
of cost or fair value. A participant Licensee must treat its entire
capital contribution to the subsidiary as a reduction of its
Leveragable Capital. The participant Licensee's remaining Leverageable
Capital must be sufficient to support its outstanding Leverage.
(d) No transfer of Leverage. A participant Licensee may not
transfer its Leverage to a subsidiary Section 301(d) Licensee.

Sec. 107.130 Requirement for qualified management.

When applying for a license, you must show, to the satisfaction of
SBA, that your current or proposed management is qualified and has the
knowledge, experience, and capability necessary for investing in the
types of businesses contemplated by the Act, these regulations and your
business plan. You must designate at least one individual as the
official responsible for contact with SBA.

Sec. 107.140 SBA approval of initial Management Expenses.

You must have your Management Expenses approved by SBA at the time
of licensing. (See Sec. 107.520 for the definition of Management
Expenses.)

Sec. 107.150 Management and ownership diversity requirement.

You must have diversity between management and ownership in order
to be licensed, unless you do not plan to obtain Leverage. To establish
diversity, you must meet the requirements in paragraphs (a) and (b) of
this section unless SBA approves otherwise.
(a) Requirement one. You must satisfy either paragraph (a)(1) or
paragraph (a)(2) of this section.
(1) You must have at least three shareholders or limited partners,

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A95-28757. Public record. Not legal advice.