[Federal Register Volume 76, Number 237 (Friday, December 9, 2011)]
[Proposed Rules]
[Pages 76907-76917]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-31658]
[[Page 76907]]
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SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
RIN 3245-AG32
Small Business Investment Companies--Early Stage SBICs
AGENCY: U.S. Small Business Administration.
ACTION: Proposed rule.
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SUMMARY: In this proposed rule, the U.S. Small Business Administration
(SBA) is defining a new sub-category of small business investment
companies (SBICs) which will focus on making equity investments in
early stage small businesses. By licensing and providing SBA leverage
to these ``Early Stage SBICs,'' SBA seeks to expand entrepreneurs'
access to capital and encourage innovation as part of President Obama's
Start-Up America Initiative launched on January 31, 2011. This proposed
rule also sets forth regulations applicable to Early Stage SBICs with
respect to licensing, capital requirements, non-SBA borrowing,
examination fees, leverage eligibility, distributions, and capital
impairment. In addition, this proposed rule makes certain technical
changes to SBA regulations.
DATES: Comments must be received on or before February 7, 2012.
ADDRESSES: You may submit comments, identified by RIN 3245-AG32, by any
of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail, Hand Delivery/Courier: Sean Greene, Associate
Administrator for Investment, U.S. Small Business Administration, 409
Third Street SW., Washington, DC 20416.
SBA will post all comments to this proposed rule without change on
http://www.regulations.gov. If you wish to submit confidential business
information (CBI) as defined in the User Notice at http://www.regulations.gov, please submit the information to Carol Fendler,
Investment Division, 409 Third Street SW., Washington, DC 20416.
Highlight the information that you consider to be CBI and explain why
you believe this information should be held confidential. SBA will
review the information and make the final determination of whether it
will publish the information or not.
FOR FURTHER INFORMATION CONTACT: Carol Fendler, Investment Division,
(202) 205-7559 or sbic@sba.gov.
SUPPLEMENTARY INFORMATION:
I. Background Information
On January 31, 2011, President Obama announced the ``Start-Up
America Initiative'' to encourage American innovation and job creation
by promoting high-growth entrepreneurship across the country with new
initiatives to help encourage private sector investment in job-creating
startups and small firms, accelerate research, and address barriers to
success for entrepreneurs and small businesses. The SBIC program will
play a key role in accomplishing these goals by expanding access to
capital for early stage businesses.
Early stage businesses face difficult challenges accessing capital,
particularly those without the necessary assets or cash flow for
traditional bank funding. Although the venture capital industry
provided over $22 billion in financings to U.S. businesses in calendar
year 2010, this represented over a 23% decline from 2007. Less than a
third of these financing dollars went to early stage or start-up
businesses. Of the financings that went to early stage and start-up,
over two-thirds went to businesses located in three states: California,
Massachusetts, and New York. (Source: ThomsonOne VentureXpert) As a
result, less than 10% of U.S. venture financing dollars went to early
stage and start-up businesses not in those three states. SBA will seek
to expand access to capital for early stage small businesses throughout
the United States by allocating from its current debenture
authorization up to $200 million per year (up to $1 billion total over
five years) beginning in FY 2012 to Early Stage SBICs.
SBA has not typically provided leverage in the form of SBA-
guaranteed debentures to SBICs that plan to provide early stage venture
capital financing to small businesses. The standard debenture is
generally appropriate for investments in small businesses that generate
sufficient cash flow to pay interest and/or dividends, so that SBICs in
turn can make semi-annual interest payments on their debentures.
Investments in early stage companies, which typically cannot make
current interest or dividend payments, do not fit naturally with the
structure of debenture leverage.
Furthermore, early stage companies have inherently higher risk;
although they can offer potentially higher returns than later stage
equity or mezzanine debt investments, the returns are much more
volatile. Because the debenture program is required by law to operate
at zero cost to taxpayers, the Early Stage SBIC initiative contemplates
a number of strategies to mitigate risk and limit the initiative's
impact on leverage fees, although fee increases will still be
necessary. First, SBA intends to limit the amount of debenture leverage
available to Early Stage SBICs to a small percentage of SBA's overall
portfolio. Second, SBA is proposing several new regulatory provisions
to reduce the risk that an Early Stage SBIC will default on its
leverage and to improve SBA's recovery prospects when a default does
occur. Third, SBA intends to act immediately to declare an event of
default when an Early Stage SBIC has a condition of Capital Impairment
and to exercise all available remedies, including acceleration of the
Early Stage SBIC's leverage, if the default is not cured within the
allotted time (see existing Sec. Sec. 107.1830 and Sec. 107.1810(f)
and (g)). SBA is not proposing to change the current maximum permitted
Capital Impairment Percentages set forth in Sec. 107.1830 and expects
that, for most Early Stage SBICs, the applicable percentage would be 70
percent.
Once the Early Stage initiative has been implemented, the actual
performance of Early Stage SBICs would become a factor in the annual
adjustment of leverage fees to maintain the overall debenture program
at zero taxpayer cost.
To provide Early Stage SBICs with added flexibility, SBA expects to
make two forms of leverage available to them: a debenture that requires
quarterly interest payments throughout its term, and a debenture that
is issued at a discount and does not require interest payments during
the first five years of its term. Both debentures would have a 10-year
maturity and would be subject to the SBA leverage fee structure
currently in effect, including a 3 percent origination fee and an
annual charge that is adjusted at the beginning of each fiscal year and
applied to new leverage commitments issued in that year.
II. Section by Section Analysis
A. Early Stage Initiative Provisions
Section 107.50--Definitions. To implement the Early Stage
initiative, SBA proposes to add the defined term ``Early Stage SBIC''
and revise the existing defined term ``Payment Date''.
Early Stage SBIC
The regulatory definition of Early Stage SBIC has several key
points. First, an Early Stage SBIC must be organized as a limited
partnership. Although the current regulations permit other forms of
organization, the vast majority of existing SBICs are limited
partnerships. SBA believes that having a degree of
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uniformity in organizational structure will facilitate a more efficient
licensing process for Early Stage SBICs.
Second, the definition makes clear that the ``Early Stage SBIC''
designation would apply only to SBICs licensed pursuant to the new
provisions in this rule. The SBIC program currently includes, and SBA
continues to license, SBICs that make at least some early stage
investments. With few exceptions, these funds are either: (1) ``Non-
leveraged'' SBICs, which use only private investor capital to make
investments, (2) older SBICs that used SBA leverage in the form of
participating securities, which are no longer available, or (3) SBICs
using debenture leverage that make a few early stage investments as
part of their portfolio. Such SBICs are excluded from the ``Early Stage
SBIC'' definition.
Third, an Early Stage SBIC must invest at least 50 percent of its
financing dollars in small businesses that are classified as ``early
stage'' at the time of the SBIC's initial investment. SBA believes that
the 50 percent threshold indicates a significant focus, while still
giving SBICs flexibility in developing their portfolios. Since a key
goal of the Early Stage initiative is to promote the growth of early
stage businesses, any follow-on investments in a portfolio company that
was ``early stage'' at the time of the SBIC's initial investment would
count towards the 50 percent requirement.
Fourth, a small business would be considered ``early stage'' if it
has not yet achieved positive cash flow from operations in any full
fiscal year. A start-up company with no prior operating history may
qualify under this definition. The venture capital industry employs
various definitions of ``early stage'', most of which describe a
business with or without revenues that is not yet profitable or
generating positive cash flow. SBA chose to define early stage
companies based on operating cash flow because it is less vulnerable to
manipulation or distortion than other measures and because the
availability of adequate cash is crucial to a business's ability to
survive. Although definitions of ``early stage'' sometimes include the
number of years the company has been in business, SBA did not include
age as a factor. Many companies develop slowly over a number of years
before they are positioned to grow significantly, and SBA believes that
the definition should not exclude such companies.
Payment Date
SBA is proposing special distribution rules (see proposed Sec.
107.1180) for Early Stage SBICs which would require Early Stage SBICs
to make mandatory prepayments of outstanding debentures at the same
time they make distributions to their private limited partners. The
proposed revision of the ``Payment Date'' definition in Sec. 107.50
would designate March 1, June 1, September 1, and December 1 of each
year as the dates on which debenture prepayments can be made and
required interest payments will be due.
Section 107.210--Minimum capital requirements for Licensees.
Proposed Sec. 107.210(a)(3) would require an Early Stage SBIC to have
at least $20 million of Regulatory Capital (consisting of paid-in
capital contributions from private investors plus binding capital
commitments from Institutional Investors, as defined in existing Sec.
107.50). In comparison, the minimum Regulatory Capital is $5 million
for other debenture SBICs and $10 million for participating securities
SBICs. SBA considered a number of factors in setting the $20 million
threshold. First, Early Stage SBICs will have access to at most one
``tier'' of leverage (a one-to-one match between leverage and private
capital), while most other SBICs have access to at least two tiers.
Second, historical data show that SBA has experienced higher loss rates
on smaller SBICs, with performance statistics improving as private
capital approaches $20 million. Third, SBA attaches high importance to
the market validation evidenced by the ability of an Early Stage SBIC's
management team to raise funds from private investors. Although SBA
believes the overall $40 million in total capital (private capital plus
leverage) is appropriate to manage fund risk, SBA requests public input
on the $20 million private capital minimum.
The proposed rule does not require an Early Stage SBIC applicant to
have $20 million of Regulatory Capital at the time of application, only
at the time of licensing and thereafter. However, the time available
for additional fundraising after submission of an application may be
limited, and SBA may require evidence of fundraising progress at the
time of application. SBA expects to provide further details regarding
the Early Stage SBIC application process via Federal Register notice
prior to accepting Early Stage SBIC applications.
Section 107.300--License application form and fee. This section
includes a technical correction and clarification, as well as a
proposed substantive change. The current regulation refers to SBA Form
415, an old SBIC license application form. This outdated reference
would be replaced by the correct reference to current SBA Forms 2181
(the license application) and 2182 (exhibits to the license
application). The proposed rule would also clarify that the licensing
fee is non-refundable, consistent with longstanding SBA policy.
Finally, because Early Stage SBICs would require special processing,
proposed Sec. 107.300(d) would require such applicants to pay an
additional licensing fee of $10,000, bringing their total licensing fee
to $25,000.
Section 107.305--Evaluation of license applicants. Proposed Sec.
107.305 discusses the factors used by SBA to evaluate applicants to the
SBIC program, including applicants for an Early Stage SBIC license,
which are grouped in four broad categories: Management qualifications,
performance of managers' prior investments, the applicant's proposed
investment strategy, and the applicant's proposed organizational
structure and fund economics. Although this section would be a new
addition to the regulations, it does not represent a change in SBA's
licensing criteria. Rather, it would improve public access to useful
information about the SBIC program by including it in the regulations
along with the other requirements for obtaining an SBIC license
(minimum private capital requirements, management-ownership diversity,
etc.). SBA may still issue further guidance to potential applicants in
other formats, as needed. SBA requests input from the public on these
evaluation criteria.
Section 107.310--When and how to apply for licensing as an Early
Stage SBIC. Because SBA plans to commit only $200 million of leverage
per year to Early Stage SBICs, demand may exceed supply. Under proposed
Sec. 107.310, SBA would not license two Early Stage SBICs under common
control if both would have SBA leverage or leverage commitments
outstanding at the same time. For example, the same managers could not
receive two licenses at the same time or in close proximity, but could
seek a second license after their first fund had repaid all of its
leverage and did not intend to seek any more. By limiting the amount of
leverage in the hands of one owner or management group, this
restriction would improve diversification of SBA's overall Early Stage
SBIC portfolio. In addition, the proposed section provides that SBA
would accept Early Stage SBIC applications only during specified
periods, which would be announced by Federal Register notice. By
creating periodic application windows, SBA will be able to gauge the
overall demand for leverage and allocate the available funds among all
successful applicants. Up to
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a maximum of $50 million per fund, SBA intends to make one full tier of
leverage available to each licensed Early Stage SBIC (unless the SBIC
requests less) and will stop licensing new funds when the aggregate
private capital of existing licensees is sufficient to utilize all of
the leverage (up to $1 billion in total) allocated to the Early Stage
initiative. Depending on demand, SBA may need to commit leverage to
Early Stage SBICs in tranches spread over several years, rather than
providing a full one-tier commitment at the time of licensing.
Section 107.320--Evaluation of Early Stage SBICs. Proposed Sec.
107.320 states that SBA would evaluate Early State SBIC applicants
using the same set of factors applicable to SBIC applicants in general,
as set forth in proposed Sec. 107.305. This does not mean that a
successful debenture SBIC applicant and a successful Early Stage SBIC
applicant would look similar. Rather, it means that each applicant's
investment strategy must be appropriate for the type of SBA leverage it
intends to use, and each applicant's management team must have a
successful investment track record that is relevant to its strategy.
Early Stage applicants will need to demonstrate superior qualifications
in the key areas identified in the proposed rule. SBA will not relax
licensing standards to achieve numerical licensing goals or ensure that
the full amount allocated to the Early Stage initiative is used.
Proposed Sec. 107.320(a) and (b) would add two selection criteria
specific to Early Stage SBICs. For risk management purposes, SBA
considers it important to have adequate diversification of Early Stage
SBICs with respect to ``vintage year'' (the year in which an investment
fund draws its initial capital from investors). Because of the cyclical
nature of venture capital, vintage year has a major impact on the
return expectations of a fund and excessive concentration in a single
year could substantially increase program risk. Therefore, SBA will
reserve the right, when licensing Early Stage SBICs, to maintain
diversification across vintage years.
Similarly, SBA will reserve the right to maintain diversification
of Early Stage SBICs with respect to geographic location. SBA's primary
concern in terms of geography is to ensure that the Early Stage
initiative includes assistance to small businesses located in areas
outside the traditional hubs for venture capital investment.
SBA expects that the Early Stage licensing process, like the
standard SBIC licensing process, will have two phases: (1) An initial
review focused primarily on management qualifications and planned
investment strategy, for which applicants submit a Management
Assessment Questionnaire (MAQ); and (2) a licensing phase requiring
submission of a complete license application, including the licensing
fee, organizational documents for the proposed SBIC, principals'
fingerprints and personal history statements that will be used to
perform criminal history checks, and evidence that the applicant has
raised sufficient private capital to carry out its business plan.
Applicants who submit a MAQ in the first phase progress to the second
phase only if SBA issues a ``green light'' letter inviting them to do
so. In the standard licensing process, the green light letter is valid
for 18 months, allowing the applicant time to raise private capital and
prepare the full application. In the interests of making capital
available to early stage small businesses as quickly as possible, SBA
expects to have a more compressed licensing process for Early Stage
SBICs. Although applicants may be able to continue their fundraising
activities for a limited time after submitting an application, SBA
anticipates that they will be required to show substantial progress
towards their targeted private capital by the application deadline.
After this rule has been finalized, SBA intends to publish a Federal
Register notice with further details regarding licensing of Early Stage
SBICs, including the period during which applications will be accepted.
Section 107.565--Restrictions on third-party debt of Early Stage
SBICs. Proposed new Sec. 107.565 would apply to any non-SBA debt of an
Early Stage SBIC. Current Sec. 107.550 requires an SBIC with
outstanding leverage to obtain SBA's prior written approval of any
secured third party debt, but no approval is required for unsecured
debt. The proposed rule would require an Early Stage SBIC to obtain SBA
approval to have, incur or refinance any third-party debt, even if it
is unsecured. SBA believes this is a prudent restriction for Early
Stage SBICs because of their higher risk profile. Even debt that is
unsecured increases SBA's credit risk because SBA leverage is never
senior to the claims of other unsecured creditors: The first $10
million of SBA leverage is generally subordinated to other unsecured
debt of an SBIC, and leverage above $10 million is pari passu with
other unsecured debt.
Section 107.585--Voluntary decrease in Licensee's Regulatory
Capital. The current regulation permits an SBIC to reduce its
Regulatory Capital by as much as two percent in any fiscal year. Any
reduction in excess of two percent requires SBA's prior written
approval. A reduction in Regulatory Capital typically occurs when an
SBIC returns capital to its investors. SBA is proposing special
distribution rules for Early Stage SBICs to mitigate the additional
risk associated with early stage investing (see proposed Sec.
107.1180). To avoid any possible inconsistency between current Sec.
107.585 and proposed Sec. 107.1180, the proposed rule would require
any reduction of Regulatory Capital under Sec. 107.585 by an Early
Stage SBIC to be approved by SBA in writing.
Section 107.692--Examination fees. SBA intends to closely monitor
the performance of Early Stage SBICs to help manage the higher risk
associated with early stage investing. All SBICs undergo periodic
regulatory compliance examinations, and SBA expects that examinations
of Early Stage SBICs will include particular attention to the value of
unrealized investments. Under the proposed amendments to Sec. 107.692,
SBA would charge Early Stage SBICs an examination fee that is 10
percent higher than the base fee until all debenture leverage has been
repaid and no further leverage will be issued. This is the same fee
structure applied to participants in SBA's Participating Securities
SBIC program.
Section 107.1120--General eligibility requirements for Leverage.
Proposed paragraph (k) of this section would provide for a new
certification by Early Stage SBICs seeking an SBA leverage commitment
or draw. The Early Stage SBIC would be required to certify that it will
provide at least 50 percent of the aggregate dollar amount of its
financings to ``early stage'' companies, in accordance with the Early
Stage SBIC definition in Sec. 107.50. SBA seeks input from the public
on whether 50% minimum is an appropriate level of early stage
investments. SBA has proposed a prospective certification, rather than
a certification stating that the Early Stage SBIC currently complies
with the early stage investment requirement, to provide flexibility for
a fund to take advantage of good investment opportunities when they
occur. SBA intends to monitor Early Stage SBICs' performance in making
early stage investments, and would treat a failure to meet the 50
percent requirement as an event of default under an Early Stage SBIC's
leverage (see proposed Sec. 107.1810(f)(11)).
Section 107.1150--Maximum amount of Leverage for a Section 301(c)
Licensee. In this section, SBA is proposing special limits on the
maximum amount of leverage that will be available to an Early Stage
SBIC.
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First, the maximum amount that SBA would commit to an Early Stage SBIC
on a lifetime basis would be 100 percent of the SBIC's highest
Regulatory Capital or $50 million, whichever is less. In addition, the
maximum leverage that an Early Stage SBIC could have outstanding at any
time would be limited to 100 percent of its paid-in private capital
(``Leverageable Capital'') or $50 million, whichever is less. Finally,
the cumulative amount of leverage drawn by an Early Stage SBIC could
not exceed the cumulative amount of private capital paid into the fund
by its investors. The reason for these limits is two-fold. First, early
stage investing is an inherently high risk activity. Second, SBA plans
to allocate a relatively small amount of leverage to the Early Stage
initiative (up to $200 million per year over five years). Under the
existing rules for leverage eligibility, which permit a single SBIC to
have outstanding leverage of up to $150 million, the entire allocation
could be used up by a very small number of SBICs, resulting in
insufficient portfolio diversification and increased risk to SBA.
Although a leverage ceiling of less than $50 million per fund would
improve diversification still further, SBA believes a lower limit could
make the Early Stage initiative unattractive to many prospective fund
managers and investors.
Section 107.1180--Required distributions to SBA by Early Stage
SBICs. In this section, SBA is proposing to add distribution
requirements that would apply only to Early Stage SBICs. The current
regulations generally allow a debenture SBIC to distribute profits to
its investors, with no obligation to prepay debentures prior to their
maturity date (although SBICs may prepay debentures in whole at any
time without penalty). SBA believes that applying these rules to Early
Stage SBICs would result in an unacceptably high risk of default.
Compared to most debenture SBICs, the returns realized by Early Stage
SBICs are expected to be irregular and unpredictable, with a few
investments producing large profits while many other investments may
result in complete or partial losses. Depending on when profits are
realized, the existing distribution rules could result in losses to SBA
even if an Early Stage SBIC generates positive returns overall. For
example, an Early Stage SBIC that earned large profits early in its
life could distribute all of those profits to its private investors,
assuring them of a net positive return on their investment, and
thereafter perform poorly and default on its SBA leverage. To reduce
this type of risk, the proposed rule would require an Early Stage SBIC
to make a distribution to SBA whenever it makes a distribution to its
investors. Distributions could be made on any quarterly Payment Date
(March 1, June 1, September 1, or December 1). SBA would apply any such
distribution to the repayment of the SBIC's outstanding debentures.
Proposed Sec. 107.1180(b) states that all distributions to SBA would
be applied to repayment of outstanding debentures in the same order as
they were issued. Like other debenture leverage, debentures issued by
Early Stage SBICs could be prepaid in whole but not in part. Under
proposed Sec. 107.1180(c), payment of all interest and Charges due and
payable on outstanding debentures would be required as a condition of
making a distribution; such interest and Charges could be paid either
prior to or simultaneously with a distribution.
Proposed Sec. 107.1180 would apply equally to all distributions,
including distributions of profits and returns of invested capital.
However, Early Stage SBICs would still be subject to Sec. 107.585 (as
revised by this proposed rule), which limits an SBIC's ability to
reduce its Regulatory Capital. The practical effect of this limitation
is that an Early Stage SBIC would have to obtain SBA's prior written
approval for any distribution that is not from profits. For a
distribution that is from profits, an Early Stage SBIC must notify SBA
in writing at least 10 business days before the planned distribution
date.
SBA's share of a distribution would depend on the Early Stage
SBIC's ``highest ratio'' of outstanding leverage to Leverageable
Capital, and its Capital Impairment Percentage (CIP), as determined
under existing Sec. 107.1840. Under proposed Sec. 107.1180(d)(2)(i),
if the CIP is less than 50 percent, distributions would be allocated
pro rata (based on the ``highest ratio'') between SBA (up to the amount
of the outstanding debenture leverage) and the Early Stage SBIC's
investors. For example, if an Early Stage SBIC with a CIP of less than
50 percent has $25 million of contributed capital from its investors
and has drawn $25 million of leverage from SBA, the distribution would
be allocated 50% to the investors and 50% to SBA. If the Early Stage
SBIC has $30 million of contributed capital from its investors and has
drawn only $20 million of leverage from SBA, the distribution would be
allocated 60% to the investors and 40% to SBA. An Early Stage SBIC's
``highest ratio'' of outstanding leverage to Leverageable Capital,
rather than the ratio at the time of the distribution, will be used to
determine SBA's share of a distribution. Thus, even if the Early Stage
SBIC repays SBA leverage or other events occur that cause a reduction
in the Early Stage SBIC's ratio of outstanding leverage to Leverageable
Capital, it would continue to base the allocation of future
distributions on the ``highest ratio'' rather than the current ratio.
Under proposed Sec. 107.1180(d)(2)(ii), if the CIP reached 50
percent or more, SBA would receive 100 percent of any distribution
until all outstanding debentures have been repaid. However, if the
Early Stage SBIC reduces its CIP below 50 percent, it could resume
distributions to its investors, as described above. SBA expects that
all or nearly all Early Stage SBICs will have a maximum allowable CIP
of 70 percent, as determined under existing Sec. 107.1830, so a 50
percent CIP would not indicate a condition of Capital Impairment.
However, SBA believes that its ability to take priority in
distributions when the CIP reaches 50 percent is an appropriate risk
reduction measure for the Early Stage initiative, based on historical
data showing that a high proportion of SBICs that reach a 50 percent
CIP go on to exceed their maximum allowable CIP.
Proposed Sec. 107.1180(d)(3) and (d)(4) would provide for a
``true-up'' of cumulative distributions each time an Early Stage SBIC
makes a distribution. SBA believes that with the true-up, the proposed
distribution rules would operate more consistently, with fewer
distortions created by differences among SBICs in the timing of gains
and losses.
Proposed Sec. 107.1180(d)(3) would multiply an Early Stage SBIC's
total cumulative distributions (including the SBIC's current proposed
distribution) by SBA's percentage share of cumulative distributions
calculated under Sec. 107.1180(d)(2). The sum of all prior
distributions to SBA would then be subtracted from this cumulative
result to calculate the amount distributable to SBA under proposed
Sec. 107.1180(d)(4). Under proposed Sec. 107.1180(d)(5), the actual
dollar amount to be distributed to SBA would be the smallest of three
figures: The amount calculated under Sec. 107.1180(d)(4); the total
amount of the SBIC's planned distribution; and the total debenture
leverage outstanding.
Following is an example of the distribution mechanics for an Early
Stage SBIC with a ``highest leverage ratio'' of 1:
First distribution: SBIC's outstanding leverage and Leverageable
Capital are both equal to $5 million and its CIP is zero. The SBIC
wants to distribute profits of $20 million. The SBIC is current on all
debenture interest and
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fees. On a pro rata basis, SBA and the SBIC's investors would each
receive 50 percent of the distribution, or $10 million. However, the
most that SBA can receive is $5 million, the total amount of leverage
outstanding. Therefore, the SBIC's investors would receive $15 million.
Second distribution: SBIC's outstanding leverage is $15 million,
Leverageable Capital is $20 million, and CIP is zero. The SBIC wants to
distribute profits of $10 million. The SBIC's highest leverage ratio
remains at 1. Total cumulative distributions (prior and current) equal
$30 million, of which SBA's share under Sec. 107.1180(d)(3) would
equal $15 million. Under Sec. 107.1180(d)(4), the $5 million that SBA
received from the first distribution must then be subtracted from the
$15 million. The result, $10 million, is the smallest of the three
amounts under proposed Sec. 107.1180(d)(5), so SBA would receive $10
million and the SBIC's investors would receive no distribution. On a
cumulative basis, SBA and the investors would have received $15 million
each that shows each step of the calculation listed in Table 1, Early
Stage SBIC Distribution Example:
Table 1--Early Stage SBIC Distribution Example
(Dollars in millions)
------------------------------------------------------------------------
Distribution 1 Distribution 2
------------------------------------------------------------------------
(1) Leverageable capital............ $5.0 $20.0
(2) Outstanding leverage............ 5.0 15.0
(3) Cumulative leverage issued...... 5.0 20.0
(4) Leverage ratio.................. 1.00 0.75
(5) Current proposed distribution... 20.0 10.0
(6) Cumulative distributions........ 20.0 30.0
(7) Highest leverage ratio.......... 1.00 1.00
(8) Capital impairment percentage... 0% 0%
(9) [Highest Leverage Ratio/(Highest 50.0% 50.0%
Leverage Ratio + 1)] x 100.........
(10) Line (6) x Line (9)............ 10.0 15.0
(11) Prior distributions to SBA..... 0.0 5.0
(12) Line (10) minus Line (11)...... 10.0 10.0
(13) Amount of distribution to SBA ................ ................
equals least of:...................
(i) Line (12)................... 10.0 10.0
(ii) Line (5)................... 20.0 10.0
(iii) Line (2).................. 5.0 15.0
SBA's Share of Distribution. 5.0 10.0
Investors' Share of 15.0 ................
distribution...............
Post Distribution: Cumulative 5.0 15.0
Distributions to SBA...............
Cumulative Distributions to 15.0 15.0
investors..........................
------------------------------------------------------------------------
Proposed Sec. 107.1180(e) would allow an Early Stage SBIC to
prepay debenture leverage in order of issue without making any
distribution to its investors. This type of voluntary prepayment could
be made on any quarterly Payment Date.
Section 107.1181--Interest reserve requirements for Early Stage
SBICs. This section would require an Early Stage SBIC to maintain funds
in reserve to cover interest and Charges on its outstanding debentures.
This provision is an important element of risk management for the Early
Stage initiative because Early Stage SBICs are not expected to generate
current interest or dividend income, which for most debenture SBICs is
the primary source of cash used to service their SBA debt.
SBA expects that some Early Stage SBICs will seek SBA leverage in
the form of a discounted debenture, which will not require cash
interest payments during the first five years of its term. Instead, the
proceeds received by the Early Stage SBIC when the debenture is issued
will be discounted; over the first five years following issuance, the
carrying value of the debenture will accrete until it reaches face
value, and semi-annual interest payments will be required beginning in
year six. No interest reserve will be required for these discounted
debentures.
For standard debentures, an Early Stage SBIC would be required to
maintain a reserve equal to the total interest and annual Charge that
will be payable on each such debenture over the first five years of its
term. The reserve may consist of binding unfunded commitments from the
Early Stage SBIC's Institutional Investors and/or ``restricted'' cash
held by the Early Stage SBIC. Neither such unfunded commitments nor
such restricted cash could be used for any purpose other than payment
of interest, Charges, and any other amounts due to SBA. Restricted cash
would be held in a separate bank account and reported separately from
other cash in the Early Stage SBIC's financial statements. The required
reserve associated with an individual debenture would be reduced on
each Payment Date as the Early Stage SBIC made the required payment of
interest and Charges. Furthermore, if the Early Stage SBIC prepaid a
debenture, the reserve requirement associated with that debenture would
be correspondingly eliminated. The interest reserve requirement and the
associated restrictions on the general partner's ability to call
capital would have to be included in the Early Stage SBIC's limited
partnership agreement.
Section 107.1182--Valuation requirements for Early Stage SBICs
based on Capital Impairment Percentage. This section would require an
Early Stage SBIC to notify SBA in writing if it has a Capital
Impairment Percentage of at least 50 percent, even if its maximum
allowable CIP is higher. When SBA receives this notification, or makes
its own determination that the CIP is at least 50 percent, SBA would
have the right to require the Early Stage SBIC to engage a third party
valuation expert, acceptable to SBA, to perform valuations of some or
all of the licensee's investments, as determined by SBA. This provision
would give SBA an important monitoring tool to guide decision-making
with respect to Early Stage SBICs that have begun to experience some
financial difficulty.
[[Page 76912]]
Section 107.1810--Events of default and SBA's remedies for
Licensee's noncompliance with terms of Debentures. SBA is proposing
four changes in this section that would apply only to Early Stage
SBICs. First, existing Sec. 107.1810(f)(2) provides that an improper
distribution made by an SBIC is an event of default. Proposed Sec.
107.1810(f)(2)(iv) would add distributions by Early Stage SBICs, as
permitted under proposed Sec. 107.1180, to the list of specific
distributions that would not be considered improper distributions.
Second, under proposed new Sec. 107.1810(f)(11), it would be an
event of default if an Early Stage SBIC fails to meet the requirement
to invest at least 50 percent of its financing dollars in early stage
companies, as defined under the proposed Early Stage SBIC definition in
Sec. 107.50. This provision would require an Early Stage SBIC to meet
the 50 percent requirement as soon as the total dollars invested to
date are equal to or greater than Regulatory Capital. At that point, a
typical Early Stage SBIC would have deployed at least half of its total
funds available for investment and thus would have had ample
opportunity to seek a variety of investment opportunities. Third, under
proposed new Sec. 107.1810(f)(12), it would be an event of default if
an Early Stage SBIC fails to maintain the interest reserve required
under proposed Sec. 107.1181, as discussed earlier in this preamble.
The conditions in proposed Sec. 107.1810(f)(11) and (f)(12) would
both be in the category of events of default with opportunity to cure.
If the Early Stage SBIC fails to cure to SBA's satisfaction, SBA could
invoke the remedies in existing Sec. 107.1810(g), which include the
right to declare outstanding debenture leverage immediately due and
payable.
Finally, proposed new Sec. 107.1810(j) would provide SBA with
additional remedies to help maximize recoveries from Early Stage SBICs
that have been transferred to a liquidation status. Under this section,
if SBA must honor its guarantee and pay the principal of an Early Stage
SBIC's debentures, upon such payment SBA would have the right to
prohibit the SBIC from making additional investments without SBA
approval (except for any investments the SBIC had already legally
committed itself to make); to prohibit Distributions by the SBIC to any
party other than SBA until all leverage and other amounts due to SBA
have been repaid; to require all the SBIC's investor commitments to be
funded at the earliest time(s) permitted under the SBIC's limited
partnership agreement and other applicable documents; to review and re-
determine the SBIC's approved Management Expenses (as defined in
existing Sec. 107.520); and to the appointment of SBA or its designee
as receiver for the SBIC. The receivership would be for the purpose of
continuing the SBIC's operations; the appointment of a liquidating
receiver is governed by existing provisions of the Small Business
Investment Act and is not affected by this proposed rule.
B. Technical Changes to Regulations
Section 107.130--Requirement for qualified management. SBA is
proposing one clarification in this section. The current regulation
provides that an applicant must show ``[w]hen applying for a license''
that it has a qualified management team with the knowledge and
experience to make the type of investments contemplated by the
applicant's business plan and SBA regulations. SBA has interpreted this
section as requiring an SBIC to also maintain a qualified management
team post-licensing, and has taken measures including suspending
leverage draws when it determines that a qualified management team is
not present. The proposed rule would make clear that a licensed SBIC
(including an Early Stage SBIC) must have qualified management as long
as it has a license.
Section 107.1130--Leverage fees and additional charges payable by
Licensee. This section includes two changes to bring the regulation
into conformity with statutory requirements. Current Sec. 107.1130(d)
provides for a 1 percent annual fee (``Charge'') that SBICs must pay on
their outstanding SBA leverage, whether in the form of debentures or
participating securities. However, section 303(b) of the Act (as
amended by section 2(a)(1)(B) of P.L. 107-100, December 21, 2001)
provides for the Charge on debentures to be adjusted annually as
necessary to keep the debenture program at zero cost to taxpayers, and
sets a maximum annual Charge of 1.38 percent. Section 303(g)(2) of the
Act (as amended by section 117 of Pub. L 108-84, September 30, 2003)
provides for the Charge on participating securities to be similarly
adjusted and sets a maximum annual Charge of 1.46 percent. Proposed
Sec. 107.1130(d)(1) and (d)(2) would conform to these two statutory
provisions and to SBA's actual practice in determining the annual
Charge to be paid by SBICs.
Compliance With Executive Orders 12866, 12988 and 13132, the Paperwork
Reduction Act (44 U.S.C. Ch. 35) and the Regulatory Flexibility Act (5
U.S.C. 601-612)
Executive Order 12866
The Office of Management and Budget has determined that this rule
is a ``significant'' regulatory action under Executive Order 12866. The
Regulatory Impact Analysis is set forth below.
1. Necessity of Regulation
The Small Business Investment Act of 1958 identifies the SBIC
program's mission as follows: ``to stimulate and supplement the flow of
private equity capital and long-term loan funds which small business
concerns need for the sound financing of their business operations and
for their growth, expansion, and modernization, and which are not
available in adequate supply * * *'' Based on venture capital industry
data (ThomsonOne VentureXpert), SBA believes that early stage
businesses lack access to needed financing capital. Although the
venture industry provided over $22 billion in financings to U.S.
businesses in calendar year 2010, this represented over a 23% decline
from 2007. Less than a third of these financing dollars went to early
stage or start-up businesses. Given the decline in venture capital
financings over the past 3 years, SBA seeks to expand access to early
stage businesses by implementing an initiative to provide up to $1
billion in debenture leverage over five years (beginning in FY 2012) to
a limited number of SBICs focused on early stage investments.
If SBA debenture leverage is to be used to finance early stage
small businesses, the high risk associated with such investments
indicates the need for more protections than those provided by the
standard SBIC debenture and current regulations to mitigate risk and
cost to the taxpayer. SBA is proposing regulatory changes to manage the
risks associated with an early stage portfolio, including: (1) Limiting
leverage for an individual Early Stage SBIC to 100 percent of
Regulatory Capital or $50 million, whichever is less; (2) establishing
special distribution rules to require repayment of leverage whenever an
Early Stage SBIC makes distributions to its investors; and (3)
implementing risk monitoring actions appropriate to SBA's leverage
guarantor/creditor status. Even with these actions, in order to
maintain an initial subsidy rate of zero for the debenture program
while limiting the increase in leverage fees, SBA can only issue
leverage to Early
[[Page 76913]]
Stage SBICs as a very small percentage of its portfolio.
2. Alternative Approaches to Regulation
SBA considered several alternatives to these proposed regulations.
The first alternative was for SBA not to pursue the Early Stage
initiative and continue with its current credit policy of not providing
debenture leverage to SBICs that focus on early stage equity investing.
SBA rejected this alternative because of the critical need for early-
stage funding, particularly in the $1 to $5 million range that fits
well with SBA's small business size standards.
SBA also considered seeking legislation for a new program
specifically focused on investing in early stage small businesses.
Although such an alternative could have provided an opportunity to
introduce useful risk-management provisions, such as SBA profit
sharing, SBA chose not to pursue this alternative because of the
compelling need to begin assisting early stage small businesses as
quickly as possible. A third alternative was for SBA to modify its
credit policies to license and approve leverage to qualified early
stage focused SBICs without changes in program regulations or in the
terms of debenture leverage. SBA believes that doing so would not be
financially responsible and would present an excessively high risk of
losses to the taxpayer. Ultimately, SBA decided that it could
responsibly license a limited number of early stage SBICs after
implementing appropriate regulatory changes to manage the associated
risk.
In proposing the definition for an Early Stage SBIC, SBA considered
both the type of investment that should qualify as ``early stage'' and
whether an Early Stage SBIC's portfolio should be limited to early
stage investments exclusively. Many small businesses in the earliest
stages of product development (``seed stage'' companies) could benefit
from access to additional capital. However, SBA chose not to limit the
Early Stage initiative to seed stage investments because of their high
risk and the long holding periods they typically require. Although
Early Stage SBICs would not be prohibited from investing in seed stage
companies, to use SBA debenture leverage successfully they will likely
need to start generating cash returns on investments within 4 to 6
years after licensing. This timing concern is also why the proposed
definition requires only 50 percent of an Early Stage SBIC's portfolio
to be in early stage investments. This standard would allow Early Stage
SBICs to make some later stage investments that may produce current
income or have shorter holding periods, thereby reducing the risk of
default on SBA leverage.
In determining the maximum amount of leverage for which an Early
Stage SBIC would be eligible, SBA decided that a one-to-one match
between leverage and private capital (one ``tier'' of leverage) would
provide the best balance between program cost and attractiveness to
fund managers and investors. A second tier of leverage would result in
a much higher projected loss rate, and a correspondingly greater
increase in annual leverage fees for all debenture SBICs receiving new
leverage commitments. SBA also considered a model in which SBA would
have provided only half a tier of leverage. This lower ratio of
leverage to private capital would have a much lower impact on leverage
fees but would be unlikely to attract high quality fund managers and
investors.
SBA also considered various dollar limits on the maximum leverage
available to an Early Stage SBIC, in order to avoid an excessive
concentration of risk in a small number of funds. A low dollar limit
could allow more funds to be licensed, but could be unattractive to
stronger applicants with the ability to raise and deploy larger amounts
of capital. SBA believes the proposed limit of $50 million is
sufficient to attract high quality applicants. SBA also believes that
$50 million of leverage, in combination with at least $50 million of
private capital, is more than adequate to support a primarily early
stage portfolio, with most financings expected to be in the $1 to $5
million range.
3. Potential Benefits and Costs
SBA anticipates that this proposed rule would provide significant
benefit to early stage small businesses seeking investments by Early
Stage SBICs. In estimating the impact, SBA considered that $1 billion
in anticipated leverage will be matched by a minimum of $1 billion in
private capital over the next 5 years, beginning in FY 2012. SBA
expects that Early Stage SBICs will invest over a 5 to 7 year period
after licensing. Allowing for payment of management expenses and
interest, SBA estimates that the Early Stage initiative will result in
approximately $125 million annually in financings to small businesses
over an 8 to 10 year period.
The proposed rule would impose additional cost in the form of
increased annual fees on all debenture SBICs seeking new leverage
commitments. The estimated cost has been incorporated into the program
formulation model which determines the annual fee needed to keep the
debenture program's original subsidy cost at zero, as required by law.
For FY 2012, SBA has budgeted $150 million in leverage commitments to
Early Stage SBICs, within the anticipated appropriated SBIC Debenture
loan levels, representing approximately 7 percent of total expected
debenture commitments. This 7 percent allocation would increase the
annual fee on all new debenture commitments by approximately 13.7 basis
points. This increase reflects the additional risk associated the early
stage equity investments contemplated by the Early Stage initiative.
Early stage investing is higher-risk than the typical SBIC portfolio,
and would have required fees in excess of statutory caps, if operated
on a stand-alone bases. To align fees and costs to the taxpayers with
the overall policy goals, the Early Stage initiative incorporates terms
designed to mitigate risk, and is limited to no more than $200 million
per fiscal year to keep the annual fees at reasonable levels. The cost
is expected to vary each year based on the factors and assumptions used
to develop the annual fee, including the total amount of debenture
leverage commitments estimated, the amount committed to Early Stage
SBICs, and interest rates.
Executive Order 12988
This action meets applicable standards set forth in section 3(a)
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize
litigation, eliminate ambiguity, and reduce burden. The action does not
have retroactive or presumptive effect.
Executive Order 13563
A description of the need for this regulatory action and benefits
and costs associated with this action is included above in the
Regulatory Impact Analysis under Executive Order 12866.
In connection with the launch of the President's ``Start-Up America
Initiative'', SBA announced its commitment to making financing
available to early stage small businesses through the SBIC program. In
an effort to engage interested parties in this regulatory action, SBA
has since made presentations at SBIC association meetings, Start-up
America-related public events, and venture capital industry forums to
discuss both the market need for new sources of early stage financing
and key issues associated with the design of the Early Stage
initiative. Participants were broadly supportive of using the SBIC
program to expand the financing options available to early stage small
[[Page 76914]]
businesses, while adding key protective provisions to manage program
risk.
Executive Order 13132
SBA has determined that this proposed rule will not have
substantial, direct effects on the States, on the relationship between
the national government and the States, or on the distribution of power
and responsibilities among the various levels of government. Therefore,
for the purposes of Executive Order 13132, Federalism, SBA has
determined that this proposed rule has no federalism implications
warranting the preparation of a federalism assessment.
Paperwork Reduction Act, 44 U.S.C. Ch. 35
SBA has determined that this Early Stage SBIC proposed rule will
not impose additional reporting or recordkeeping requirements. Early
Stage SBIC applicants will submit the same license application form as
other SBIC program applicants (OMB Control Number 3245-0062). Post-
licensing, Early Stage SBICs will have the same recordkeeping and
reporting requirements as any other licensed SBIC.
Regulatory Flexibility Act, 5 U.S.C. 601-612
When an agency promulgates a rule, the Regulatory Flexibility Act
(5 U.S.C. 601-612) requires the agency to prepare an initial regulatory
flexibility analysis (IRFA) describing the potential economic impact of
the rule on small entities and alternatives that may minimize that
impact. Section 605 of the RFA allows an agency to certify a rule, in
lieu of preparing an IRFA, if the rulemaking is not expected to have a
significant economic impact on a substantial number of small entities.
This proposed rule affects all SBICs issuing debentures, of which there
are approximately 160, most of which are small entities. Therefore, SBA
has determined that this proposed rule will have an impact on a
substantial number of small entities. However, SBA has determined that
the impact on entities affected by the rule will not be significant.
SBA intends to maintain the SBIC program's initial subsidy cost to
taxpayers at zero by charging up front and annual fees on its leverage.
SBA calculates the annual fee each year using historical data to assess
the appropriate fee to offset expected losses. The actual costs for
SBIC guarantees may be higher or lower, and SBA will monitor program
performance closely. Because SBA expects Early Stage SBICs to be
riskier than standard SBICs, the annual fees needed to keep the
debenture program's original subsidy cost at zero are higher. For FY
2012, SBA estimates $150 million leverage commitments to Early Stage
SBICs, which increases the annual fee charged to all SBICs seeking new
debenture commitments by approximately 13.7 basis points. Since annual
leverage fees were introduced in FY 1998, the annual fee has ranged
from a high of 100 basis points (1 percent) to a low of 29 basis
points, with a 13-year median of 88 basis points. Although the cost
will vary in the future based on economic factors and assumptions used
to develop the annual fee, SBA expects the fee to remain under 1
percent, comparable to historical annual fees and below the statutory
maximum of 1.38 percent. For debenture leverage committed and drawn by
SBICs in FY 2012, SBA estimates that the sum of the debenture interest
rate plus the annual fee will be in the vicinity of 5 percent.
Debenture SBICs typically use the proceeds of debenture leverage to
make loans to small businesses at interest rates in the 12 to 16
percent range, providing them with a significant spread over their cost
of funds. Accordingly, the Administrator of the SBA hereby certifies
that this rule will not have a significant impact on a substantial
number of small entities. SBA welcomes comment from members of the
public who believe there will be a significant impact either on SBICs,
or on companies that receive funding from SBICs.
List of Subjects in 13 CFR Part 107
Investment companies, Loan programs--business, Reporting and
recordkeeping requirements, Small businesses.
For the reasons stated in the preamble, SBA proposes to amend part
107 of title 13 of the Code of Federal Regulations as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for part 107 continues to read as
follows:
Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d,
687g, 687m and Pub. L. 106-554, 114 Stat. 2763; and Pub. L. 111-5,
123 Stat. 115.
2. Amend Sec. 107.50 by adding a definition of ``Early Stage
SBIC'' and revising the definition of ``Payment Date,'' to read as
follows:
Sec. 107.50 Definitions of terms.
* * * * *
Early Stage SBIC means a Section 301(c) Partnership Licensee,
licensed pursuant to Sec. 107.310 of this part, in which at least 50
percent of all Loans and Investments (in dollars) must be made to Small
Businesses that are ``early stage'' companies at the time of the
Licensee's initial Financing. For the purposes of this definition, an
``early stage'' company is one that has never achieved positive cash
flow from operations in any fiscal year.
* * * * *
Payment Date means:
(1) For a Participating Securities issuer, each February 1, May 1,
August 1, and November 1 during the term of a Participating Security,
or
(2) For an Early Stage SBIC, each March 1, June 1, September 1, and
December 1 during the term of a Debenture.
* * * * *
3. Amend Sec. 107.130 by revising the first sentence to read as
follows:
Sec. 107.130 Requirement for qualified management.
When applying for a license, and while you have a license, you must
show, to the satisfaction of SBA, that your current or proposed
management team is qualified and has the knowledge, experience and
capability necessary for investing in the types of businesses
contemplated by the Act, the regulations in this part 107, and your
business plan. * * *
4. Amend Sec. 107.210 by revising the paragraph subject heading
and the first sentence of paragraph (a)(1) introductory text and adding
paragraph (a)(3) to read as follows:
Sec. 107.210 Minimum capital requirements for Licensees.
(a) * * *
(1) Licensees other than Participating Securities issuers and Early
Stage SBICs. Except for Participating Securities issuers and Early
Stage SBICs, a Licensee must have Regulatory Capital of at least
$5,000,000. * * *
* * * * *
(3) Early Stage SBICs. An Early Stage SBIC must have Regulatory
Capital of at least $20 million.
* * * * *
5. Amend Sec. 107.300 by revising the introductory text and adding
paragraph (d) to read as follows:
Sec. 107.300 License application form and fee.
The license application must be submitted on SBA Form 2181 together
with all applicable exhibits on SBA Form 2182 and a non-refundable
processing fee computed as follows:
* * * * *
[[Page 76915]]
(d) All applicants seeking to be licensed as Early Stage SBICs will
pay the fee for a Partnership Licensee plus an additional $10,000 fee,
for a total of $25,000.
6. Add Sec. 107.305 to read as follows:
Sec. 107.305 Evaluation of license applicants.
SBA will evaluate a license applicant based on the submitted
application materials, any interviews with the applicant's management
team, and the results of background investigations, public record
searches, and other due diligence conducted by SBA and other Federal
agencies. SBA's evaluation will consider factors including the
following:
(a) Management qualifications, including demonstrated investment
skills and experience as a principal investor; business reputation;
adherence to legal and ethical standards; record of active involvement
in making and monitoring investments and assisting portfolio companies;
successful history of working as a team; and experience in developing
appropriate processes for evaluating investments and implementing best
practices for investment firms.
(b) Performance of managers' prior investments, including
investment returns measured both in percentage terms and in comparison
to appropriate industry benchmarks; the extent to which investments
have been realized as a result of sales, repayments, or other exit
mechanisms; and the contribution of prior investments to the growth of
portfolio company revenues and number of employees.
(c) Applicant's proposed investment strategy, including clarity of
objectives; strength of management's rationale for pursuing the
selected strategy; compliance with this part 107 and applicable
provisions of part 121 of this chapter; fit with management's skills
and experience; and the availability of sufficient resources to carry
out the proposed strategy.
(d) Applicant's proposed organizational structure and fund
economics, including compliance with this part 107; soundness of
financial projections and underlying assumptions; a compensation plan
that provides managers with appropriate economic incentives; a
reasonable basis for allocations of profits and fees to Persons not
involved in management; and governance procedures that provide
appropriate checks and balances.
7. Add Sec. 107.310 to read as follows:
Sec. 107.310 When and how to apply for licensing as an Early Stage
SBIC.
From time to time, SBA will publish a Notice in the Federal
Register, inviting the submission of applications for licensing as an
Early Stage SBIC. SBA will not consider an application from an Early
Stage SBIC applicant that is under Common Control with another Early
Stage SBIC applicant or an existing Early Stage SBIC (unless it has no
outstanding Leverage or Leverage commitments and will not seek
additional Leverage in the future). Applicants must comply with both
the regulations in this part 107 and any requirements specified in the
Notice, including submission deadlines. The Notice will specify
procedures for a particular application period.
8. Add Sec. 107.320 to read as follows:
Sec. 107.320 Evaluation of Early Stage SBICs.
SBA will evaluate an Early Stage SBIC license applicant based on
the same factors applicable to other license applicants, as set forth
in Sec. 107.305, with particular emphasis on managers' skills and
experience in evaluating and investing in early stage companies. In
addition, SBA reserves the right to maintain diversification among
Early Stage SBICs with respect to:
(a) The year in which they commence operations, and
(b) Their geographic location.
9. Add Sec. 107.565 to read as follows:
Sec. 107.565 Restrictions on third-party debt of Early Stage SBICs.
If you are an Early Stage SBIC and you have outstanding Leverage or
a Leverage commitment, you must get SBA's prior written approval to
have, incur, or refinance any third-party debt other than accounts
payable from routine business operations.
10. Amend Sec. 107.585 by revising the first sentence to read as
follows:
Sec. 107.585 Voluntary decrease in Licensee's Regulatory Capital.
You must obtain SBA's prior written approval to reduce your
Regulatory Capital by more than two percent in any fiscal year, unless
otherwise permitted under Sec. Sec. 107.1560 and 107.1570, provided
however, that if you are an Early Stage SBIC, you must obtain SBA's
prior written approval for any reduction of your Regulatory Capital,
including any reduction pursuant to a Distribution under Sec. 107.1180
of this part. * * *
11. Amend Sec. 107.692 by redesignating paragraphs (c)(4) and (5)
as paragraphs (c)(5) and (6), adding a new paragraph (c)(4), and
revising the table in paragraph (d) to read as follows:
Sec. 107.692 Examination fees.
* * * * *
(c) * * *
(4) If you are an Early Stage SBIC with outstanding Leverage or
Leverage commitments, you will pay an additional charge equal to 10% of
your base fee;
* * * * *
(d) * * *
----------------------------------------------------------------------------------------------------------------
Amount of Amount of
discount--% of addition--% of
Examination fee discounts base examination Examination fee additions base examination
fee fee
----------------------------------------------------------------------------------------------------------------
No prior violations..................... 15 Partnership or limited liability 5
company.
Responsiveness.......................... 10 Participating Security Licensee. 10
Records/Files at multiple 10
locations.
Early Stage SBIC................ 10
----------------------------------------------------------------------------------------------------------------
* * * * *
12. Amend Sec. 107.1120 by adding paragraph (k) to read as
follows:
Sec. 107.1120 General eligibility requirements for Leverage.
* * * * *
(k) If you are an Early Stage SBIC, certify in writing that at
least 50 percent of the aggregate dollar amount of your Financings will
be provided to ``early stage'' companies as defined under the
definition of Early Stage SBIC in Sec. 107.50 of this part.
13. Amend Sec. 107.1130 by revising the first sentence of
paragraph (d)(1) and the first sentence of paragraph (d)(2) to read as
follows:
Sec. 107.1130 Leverage fees and additional charges payable by
Licensee.
* * * * *
(d) * * *
(1) Debentures. You must pay to SBA a Charge, not to exceed 1.38
percent per annum, on the outstanding amount of your Debentures issued
on or after October 1, 1996, payable under the same
[[Page 76916]]
terms and conditions as the interest on the Debentures. * * *
(2) Participating Securities. You must pay to SBA a Charge, not to
exceed 1.46 percent per annum, on the outstanding amount of your
Participating Securities issued on or after October 1, 1996, payable
under the same terms and conditions as the Prioritized Payments on the
Participating Securities. * * *
* * * * *
14. Amend Sec. 107.1150 by revising the first sentence of the
introductory text and adding paragraph (d) to read as follows:
Sec. 107.1150 Maximum amount of Leverage for a Section 301(c)
Licensee.
A Section 301(c) Licensee, other than an Early Stage SBIC, may have
maximum outstanding Leverage as set forth in paragraphs (a) through (c)
of this section. An Early Stage SBIC may have maximum outstanding
Leverage as set forth in paragraph (d) of this section. * * *
* * * * *
(d) Early Stage SBICs. Subject to SBA's credit policies, if you are
an Early Stage SBIC:
(1) The total amount of any and all Leverage commitments you
receive from SBA shall not exceed 100 percent of your highest
Regulatory Capital or $50 million, whichever is less;
(2) On a cumulative basis, the total amount of Leverage you have
issued shall not exceed the total amount of capital paid in by your
investors; and
(3) The maximum amount of Leverage you may have outstanding at any
time is the lesser of:
(i) 100 percent of your Leverageable Capital, or
(ii) $50 million.
15. Amend Subpart I of Part 107 by adding an undesignated center
heading and by adding new Sec. Sec. 107.1180, 107.1181, and 107.1182
to read as follows:
Subpart I--SBA Financial Assistance for Licenses (Leverage)
* * * * *
Special Rules for Leverage Issued by an Early Stage SBIC
Sec. 107.1180 Required distributions to SBA by Early Stage SBICs.
(a) Distribution requirement. If you are an Early Stage SBIC with
outstanding Leverage, you may make Distributions to your investors and
to SBA only as permitted under this Sec. 107.1180. You may make a
Distribution on any Payment Date. Unless SBA permits otherwise, you
must notify SBA in writing of any planned distribution under this
section, including computations of the amounts distributable to SBA and
your investors, at least 10 business days before the distribution date.
(b) How SBA will apply Distributions. Any amounts you distribute to
SBA, or its designated agent or Trustee, under this Sec. 107.1180 will
be applied to repayment of principal of outstanding Debentures in order
of issue. You may prepay any Debenture in whole, but not in part, on
any Payment Date without penalty.
(c) Condition for making a Distribution. You may make a
Distribution under this Sec. 107.1180 only if you have paid all
interest and Charges on your outstanding Debentures that are due and
payable, or will pay such interest and Charges simultaneously with your
Distribution.
(d) SBA's share of Distribution. For each proposed Distribution,
determine SBA's share of the Distribution as follows:
(1) Determine the highest ratio of outstanding Leverage to
Leverageable Capital that you have ever attained (your ``Highest
Leverage Ratio''). For the purpose of determining your Highest Leverage
Ratio, any deferred interest Debentures issued at a discount must be
included in the computation at their face value.
(2) Determine SBA's percentage share of cumulative Distributions:
(i) If your Capital Impairment Percentage under Sec. 107.1840 is
less than 50 percent as of the Distribution date, SBA's percentage
share of cumulative Distributions equals:
[Highest Leverage Ratio/(Highest Leverage Ratio + 1)] x 100
For example, if your Highest Leverage Ratio equals 1, then SBA's
share of any distribution you make will be 50 percent.
(ii) If your Capital Impairment Percentage under Sec. 107.1840 is
50 percent or greater as of the Distribution date, SBA's percentage
share of cumulative Distributions equals 100 percent.
(3) Multiply the sum of all your prior Distributions and your
current proposed Distribution (including Distributions to SBA, your
limited partners and your General Partner) by SBA's percentage share of
cumulative Distributions as determined in paragraph (d)(2) of this
section.
(4) From the result in paragraph (d)(3) of this section, subtract
the sum of all your prior Distributions to SBA under this Sec.
107.1180.
(5) The amount of your Distribution to SBA will be the least of:
(i) The result in paragraph (d)(4) of this section;
(ii) Your current proposed Distribution; or
(iii) Your outstanding Leverage.
(e) Additional Leverage prepayment. On any Payment Date, subject to
the terms of your Leverage, you may make a payment to SBA to be applied
to repayment of the principal of one or more outstanding Debentures in
order of issue, without making any Distribution to your investors.
Sec. 107.1181 Interest reserve requirements for Early Stage SBICs.
(a) Reserve requirement. If you are an Early Stage SBIC with
outstanding Leverage, for each Debenture which requires periodic
interest payments to SBA during the first five years of its term, you
must maintain a reserve sufficient to pay the interest and Charges on
such Debenture for the first 21 Payment Dates following the date of
issuance. This reserve may consist of any combination of the following:
(1) Binding unfunded commitments from your Institutional Investors
that cannot be called for any purpose other than the payment of
interest and Charges to SBA, or the payment of any amounts due to SBA;
and
(2) Cash maintained in a separate bank account or separate
investment account permitted under Sec. 107.530 of this part and
separately identified in your financial statements as ``restricted
cash'' available only for the purpose of paying interest and Charges to
SBA, or for the payment of any amounts due to SBA.
(b) Your limited partnership agreement must incorporate the reserve
requirement in paragraph (a) of this section.
Sec. 107.1182 Valuation requirements for Early Stage SBICs based on
Capital Impairment Percentage.
(a) If you are an Early Stage SBIC, you must compute your Capital
Impairment Percentage and determine whether you have a condition of
Capital Impairment in accordance with Sec. Sec. 107.1830 and 107.1840
of this part.
(b) You must promptly notify SBA in writing if your Capital
Impairment Percentage is at least 50 percent, even if your maximum
permitted Capital Impairment Percentage is higher.
(c) Upon receipt of your notification under paragraph (b) of this
section, or upon making its own determination that your Capital
Impairment Percentage is at least 50 percent, SBA has the right to
require you to engage, at your expense, an independent third party,
acceptable to SBA, to prepare valuations of some or
[[Page 76917]]
all of your Loans and Investments, as designated by SBA.
16. Amend Sec. 107.1810 by revising paragraphs (f)(2)(ii) and
(iii) and adding paragraphs (f)(2)(iv), (f)(11), (f)(12), and (j) to
read as follows:
Sec. 107.1810 Events of default and SBA's remedies for Licensee's
noncompliance with terms of Debentures.
* * * * *
(f) * * *
(2) * * *
(ii) Payments from Retained Earnings Available for Distribution
based on either the shareholders' prorata interests or the provisions
for profit distributions in your partnership agreement, as appropriate;
(iii) Distributions by Participating Securities issuers as
permitted under Sec. Sec. 107.1540 through 107.1580; and
(iv) Distributions by Early Stage SBICs as permitted under Sec.
107.1180.
* * * * *
(11) Failure by an Early Stage SBIC to meet investment
requirements. You are an Early Stage SBIC and, beginning on the first
fiscal quarter end when your cumulative total Financings (in dollars)
are at least equal to your Regulatory Capital, you have not made at
least 50 percent of such Financings to Small Businesses that at the
time of your initial Financing were ``early stage'' companies, as
defined under the definition of Early Stage SBIC in Sec. 107.50 of
this part.
(12) Failure by an Early Stage SBIC to maintain required interest
reserve. You are an Early Stage SBIC and you fail to maintain a
sufficient reserve to pay interest and Charges on your Debentures as
required under Sec. 107.1181 of this part.
* * * * *
(j) Additional SBA remedies applicable to Debentures issued by
Early Stage SBICs.
If you are an Early Stage SBIC, upon SBA's payment pursuant to its
guarantee of any of your Debentures, SBA shall have the following
additional rights and you consent to SBA's exercise of any or all of
such rights:
(1) To prohibit you from making any additional investments except
for investments under legally binding commitments you entered into
before such payment by SBA and, subject to SBA's prior written
approval, investments that are necessary to protect your investments;
(2) Until all Leverage is repaid and amounts related thereto are
paid in full, to prohibit Distributions by you to any party other than
SBA, its agent or Trustee;
(3) To require all your commitments from investors to be funded at
the earliest time(s) permitted in accordance with your Articles;
(4) To review and re-determine your approved Management Expenses;
and
(5) To the appointment of SBA or its designee as your receiver
under section 311(c) of the Act for the purpose of continuing your
operations.
Dated: December 6, 2011.
Karen G. Mills,
Administrator.
[FR Doc. 2011-31658 Filed 12-8-11; 8:45 am]
BILLING CODE 8025-01-P