[Federal Register Volume 77, Number 82 (Friday, April 27, 2012)]
[Rules and Regulations]
[Pages 25042-25055]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-10120]


=======================================================================
-----------------------------------------------------------------------

SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG32


Small Business Investment Companies--Early Stage SBICs

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.

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

SUMMARY: In this final rule, the U.S. Small Business Administration 
(SBA) is defining a new sub-category of small

[[Page 25043]]

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 final 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, the final rule makes certain technical 
changes to the SBIC regulations.

DATES: This rule is effective April 27, 2012.

FOR FURTHER INFORMATION CONTACT: Carol Fendler, Office of Investment, 
(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, 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.
    On December 9, 2011, SBA published a proposed rule to define an 
Early Stage SBIC and to establish the features of the Early Stage SBIC 
initiative. The proposed rule also included several new regulatory 
provisions intended to reduce the risk that an Early Stage SBIC would 
default on its leverage and to improve SBA's recovery prospects should 
a default occur. The preamble to the proposed rule also discussed key 
aspects of the Early Stage initiative that are not addressed in the 
regulations, including the limits on the aggregate amount of debenture 
leverage that will be made available to Early Stage SBICs, and SBA's 
intention to make leverage available to Early Stage SBICs in two forms: 
(1) A debenture that requires quarterly interest payments throughout 
its term; and (2) a debenture that is issued at a discount and does not 
require interest payments during the first five years of its term.
    SBA received ten sets of comments on the proposed rule. Some were 
general comments on the Early Stage initiative and others were specific 
to individual sections of the proposed regulations. SBA discusses the 
comments in the following sections.

II. General Comments

    Need for Initiative. SBA received six comments that included 
general statements of support for the goals of the Early Stage 
initiative. These commenters agreed with SBA's assessment that there is 
a gap in the availability of capital for early stage equity investing 
and that the Early Stage initiative could help to provide early stage 
small businesses with access to much-needed capital. However, two 
commenters suggested that SBA address the needs of early stage 
companies through a new program, separate from the existing SBIC 
debenture program, to avoid the possibility that failures among higher 
risk Early Stage SBICs could jeopardize the ability of the current 
debenture program to operate on a break-even basis. As discussed in the 
proposed rule, SBA considered seeking legislation to authorize a new 
program specifically focused on early stage investing, but ultimately 
chose to pursue an initiative through the existing debenture program 
because of the compelling need to begin assisting early stage small 
businesses as quickly as possible.
    SBA agrees that the stability of the existing debenture program 
must be maintained, and has designed the Early Stage initiative with 
multiple protections to achieve that goal. These protections include: 
(1) Limiting the total leverage committed to Early Stage SBICs to a 
maximum of $200 million per year over a five year period; (2) limiting 
the maximum leverage available to an individual Early Stage SBIC to the 
lesser of $50 million or 100 percent of its Regulatory Capital (as 
opposed to the lesser of $150 million or 300 percent of Regulatory 
Capital for standard debenture SBICs); and (3) establishing special 
distribution rules to require pro rata repayment of SBA leverage when 
an Early Stage SBIC makes distributions to its investors. The higher 
risks of early stage investing have been accounted for in 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.
    Cost of the Initiative. SBA received four comments expressing 
concern about the increased leverage fees attributable to the Early 
Stage initiative. For SBA leverage commitments issued in fiscal year 
2012, the initiative adds 13.7 basis points to the annual fee. For 
fiscal year 2013, the impact of the initiative on the annual fee will 
be slightly lower, 11.5 basis points, based on updated assumptions. The 
commenters felt it was unfair or inappropriate to impose the additional 
costs of the Early Stage initiative on other users of debenture 
leverage. They indicated that the initiative should not be pursued 
unless it could break even on a stand-alone basis. Some commenters 
expressed concern not only about the added cost for fiscal year

[[Page 25044]]

2012, but also about the extent to which the annual fee might increase 
in future years. These commenters noted the large losses that SBA 
incurred on participating securities, a type of SBA leverage that was 
offered in the past to SBICs focused on equity investing, much of which 
was early stage; they also speculated that fees could rise based on the 
impact of the statutorily mandated ``energy saving debentures'' that 
will be available to SBICs making certain types of energy-related 
investments.
    SBA understands that managers of a debenture SBIC may feel that 
they are being unfairly required to ``subsidize'' the higher-risk 
investment strategy of an Early Stage SBIC. However, debenture SBICs 
already pursue a range of investment strategies that present varying 
degrees of risk to SBA, yet SBA does not formulate separate fees based 
on these differences; rather, the leverage fees are calculated based on 
analysis of the overall SBIC program portfolio. Although the Early 
Stage initiative does result in a small increase in the annual fee for 
all new debenture leverage commitments, the resulting fee of roughly 80 
basis points for fiscal year 2012 is well below the statutory maximum 
of 1.38 percent and is also below the actual fees charged in many 
previous years.
    SBA notes that the fiscal year 2012 annual fee reflects the impact 
of both the Early Stage initiative and the energy saving debentures. In 
addition, in developing the Early Stage initiative, SBA gave extensive 
consideration to the lessons learned from the participating securities 
program.
    Leverage availability. The proposed rule stated that SBA would 
allocate up to $200 million of debenture leverage per year to Early 
Stage SBICs, to a total of up to $1 billion over a five-year period. 
Two commenters noted that an Early Stage SBIC may need leverage after 
its fifth year of operations, because either a portion of its leverage 
commitment expired or it did not obtain commitments for the full amount 
of leverage it was eligible for. The commenters stated that SBA should 
ensure that adequate leverage will be available for Early Stage SBICs 
throughout their partnership terms.
    SBA currently intends to issue commitments for Early Stage 
debenture leverage only until the end of fiscal year 2016. However, SBA 
recognizes that it is important for Early Stage SBICs to be able to 
obtain the leverage for which they are eligible, and will explore 
various options to ensure availability. These options may include 
allowing an Early Stage SBIC to apply for a new leverage commitment to 
replace an expired commitment, provided that SBA has the budget 
authority to do so, or permitting an Early Stage SBIC to draw the 
remaining balance of a leverage commitment prior to its expiration, 
even if does not have a current need for the funds. Because SBA cannot 
ensure that any of these options will be available in the future, Early 
Stage SBICs will need to be prepared to manage their portfolios within 
the existing limitations.
    Capital Impairment. SBA did not propose any exceptions to the 
existing Capital Impairment regulations for Early Stage SBICs. However, 
SBA received two comments stating that Early Stage SBICs should receive 
additional forbearance because of the kind of investments they will be 
making. The commenters felt that Early Stage SBICs should benefit from 
the same types of exceptions that the regulations provided for 
participating securities SBICs, such as a maximum allowable Capital 
Impairment Percentage (CIP) of 85 percent for the five years after a 
fund's first issuance of leverage.
    SBA believes that adopting this suggestion would result in an 
unacceptable increase in risk. SBA incurred losses on a large majority 
of participating securities SBICs that reached an 85 percent CIP, and 
especially on those that reached 85 percent sooner rather than later. 
However, SBA recognizes that an Early Stage SBIC is more likely than a 
regular debenture SBIC to have some early losses that, combined with a 
lack of current income, may put upward pressure on the CIP even though 
the fund's overall portfolio ultimately proves to be sound. SBA has 
considered whether there is a low-risk way to offer Early Stage SBICs 
more flexibility in their CIP calculation, and believes that a change 
can safely be made in the treatment of ``Class 2'' unrealized 
appreciation. Class 2 appreciation arises when an SBIC holds an 
investment in a company that subsequently receives a new round of 
financing at a higher price, provided the new round includes a 
substantial investment by a sophisticated, new, non-strategic investor 
in an arm's length transaction. SBA regulations allow Class 2 
appreciation (discounted by 50 percent) to offset realized losses in 
the CIP computation, but in most cases only for 24 months after the new 
round of financing takes place.
    For Early Stage SBICs, SBA believes the 24-month limit can be made 
more flexible without increasing program risk. In general, at the end 
of the initial 24 months, an Early Stage SBIC with ``expiring'' Class 2 
appreciation will be able to request an extension based on an 
independent third-party valuation of the investment and any other 
relevant information, as determined by SBA. In addition, in certain 
instances, based on the valuation of the investment and other relevant 
information, SBA will permit the Early Stage SBIC to use the Class 2 
appreciation in its CIP computation without the 50 percent discount. 
Full details of these changes are discussed in the section-by-section 
analysis under new Sec.  107.1845.
    SBA believes these capital impairment changes are also responsive 
in part to a concern that may be implicit in two comments received on 
proposed Sec.  107.1182, under which SBA has the right to require 
valuations of an Early Stage SBIC's investments. In asking how SBA 
plans to use these valuations and whether SBA will be bound by them, 
the comments may reflect a concern that SBA is more likely to mandate 
the write-down of an investment based on a valuation than it is to 
allow a write-up. While SBA is not adopting a general policy of 
allowing Early Stage SBICs to write up investments based on independent 
valuations, this final rule does provide Early Stage SBICs with a 
degree of assurance that they will continue to receive credit for their 
Class 2 Appreciation when it is supported by an acceptable third party 
valuation.

III. Section by Section Analysis

A. Early Stage Initiative Provisions

    Section 107.50--Definitions. To implement the Early Stage 
initiative, SBA proposed to add the defined term ``Early Stage SBIC'' 
and revise the existing defined term ``Payment Date''.
Early Stage SBIC
    SBA received three sets of comments suggesting various changes to 
the proposed definition. SBA particularly sought input from the public 
on whether 50 percent was appropriate as the required minimum level of 
early stage investments, and all comments received on the definition 
focused on this issue. One commenter suggested that an Early Stage SBIC 
should be required to invest at least 75 percent of its total financing 
dollars in small businesses classified as ``early stage'' at the time 
of the SBIC's initial investment. The commenter felt that later stage 
investments would not support the intent of the initiative and could 
distract SBIC managers from focusing on their early stage investments. 
The commenter also viewed early stage investing as a specialized skill. 
In contrast, two other commenters suggested a change in the

[[Page 25045]]

definition to require at least 25 percent of all financing dollars to 
be invested in later stage investments structured to produce current 
income. They thought this change would reduce risk and might eliminate 
the need for the interest reserve required under Sec.  107.1181, which 
would increase an Early Stage SBIC's total funds available for 
investment.
    SBA has not adopted either of these comments because it believes 
the commenters' contrasting points of view illustrate the benefits of 
maintaining the flexibility that the proposed definition provided. SBA 
expects that some management teams will focus exclusively on early 
stage companies, while others will opt for a mixed portfolio. 
Applicants may propose to manage risk in a number of different ways, 
including making some later-stage investments, taking less than one 
tier of leverage, or using leverage primarily for follow-on investments 
in portfolio companies that are performing well. SBA believes that fund 
managers are in the best position to develop an investment strategy 
based on their own skills, experience and analysis of market 
opportunities.
    The only other comment received on the Early Stage definition was a 
suggested clarification. Two commenters thought it would be helpful for 
the definition to refer specifically to Sec.  107.1810(f)(11), which 
specifies the time frame within which an Early Stage SBIC must satisfy 
the early stage investment requirement. SBA agrees and has added a 
cross-reference to the cited section.
    The other key points of the definition were that: (1) An Early 
Stage SBIC must be organized as a limited partnership; and (2) a small 
business would be considered ``early stage'' if it has not yet achieved 
positive cash flow from operations in any full fiscal year. SBA 
received no comments on these aspects of the definition and is 
finalizing them without change.
Payment Date
    SBA proposed special distribution rules in Sec.  107.1180 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 designated March 1, June 1, September 
1, and December 1 of each year as the dates on which debenture 
prepayments could be made and required interest payments would be due.
    SBA received two comments suggesting a requirement for semi-annual 
interest payments (the same as for standard debentures), while 
preserving the option for an Early Stage SBIC to prepay debentures and 
make interest payments on a quarterly basis. The commenters reasoned 
that this added flexibility would be a better fit with the type of 
investing that Early Stage SBICs will do.
    SBA proposed the quarterly Payment Date structure expressly to 
provide Early Stage SBICs with more frequent distribution opportunities 
than standard debentures afford. SBA believes that a hybrid structure 
with both required and optional interest payments would result in 
excessive administrative burden for SBICs, SBA, and debenture 
purchasers. Accordingly, SBA is finalizing the Payment Date definition 
as proposed.
    Section 107.210--Minimum capital requirements for Licensees. 
Proposed Sec.  107.210(a)(3) required 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.
    Two commenters noted that SBA will consider geographic diversity as 
one factor in evaluating applicants for an Early Stage SBIC license. 
Based on the presumption that a fund investing in underserved areas 
might be able to operate effectively with less than $20 million of 
capital, they suggested language that would allow SBA to license an 
Early Stage SBIC with Regulatory Capital as low as $10 million, 
provided SBA is satisfied that the fund would be economically viable.
    In the proposed rule, SBA specifically requested public input on 
the $20 million private capital minimum. The very limited response to 
this request suggests that the proposed minimum capital requirement was 
acceptable to most readers. Although SBA recognizes that operating 
costs differ across geographic locations, SBA's experience in the 
regular debenture program has not shown a strong connection between the 
geographic areas in which an SBIC plans to invest and the amount of 
capital it raises. In light of historical data showing that SBA has 
experienced higher loss rates on smaller SBICs, with performance 
statistics improving as private capital approaches $20 million, SBA 
does not see a compelling reason to reduce the minimum capital 
requirement and is finalizing Sec.  107.210 as proposed.
    Section 107.300--License application form and fee. Three commenters 
addressed this section. One commenter expressed concern that small 
businesses seeking financing from an Early Stage SBIC might be required 
to pay a $25,000 fee. That is not the case; the $25,000 fee would be 
paid by applicants for an Early Stage SBIC license. The other two 
commenters each submitted two identical comments. First, they requested 
clarification that SBA would refund the licensing fee if it did not 
accept an application for processing. The proposed rule characterized 
the licensing fee as ``non-refundable''; however, if SBA received an 
application that could not be accepted for processing, and the 
applicant did not correct the deficiencies, SBA would return the 
licensing fee along with the application itself. In SBA's experience, 
this situation has rarely if ever occurred and does not need to be 
specifically addressed in the regulation. Consistent with current 
practice, SBA will not refund the fee for an application that is 
denied, withdrawn, or otherwise dismissed after being accepted for 
processing.
    The commenters also urged SBA to cease adding $10,000 to the 
application fee because an applicant is organized as a partnership. The 
intent of this comment is unclear. For many years, Sec.  107.300 has 
included an additional $5,000 charge for partnerships, and the proposed 
rule did not change that provision. SBA imposed this additional cost 
because of the more extensive document review that a partnership 
application requires. It is possible that the commenters intended to 
address the $10,000 difference in the licensing fee for an Early Stage 
SBIC applicant versus a regular debenture applicant ($25,000 versus 
$15,000, assuming both are organized as partnerships). SBA believes the 
difference is justified by processing differences between the two types 
of applications, including compressed processing times for Early Stage 
applications which will require SBA to supplement its licensing staff 
with outside consultants. Therefore, the proposed section has been 
finalized without change.
    Section 107.305--Evaluation of license applicants. In the proposed 
rule, SBA specifically requested input from the public on the factors 
used by SBA to evaluate applicants to the SBIC program, including 
applicants for an Early Stage SBIC license. These factors were grouped 
in four broad categories: Management qualifications, performance of 
managers' prior investments, the applicant's proposed investment 
strategy, and the applicant's

[[Page 25046]]

proposed organizational structure and fund economics. Only two 
commenters addressed this section, submitting nearly identical 
comments. SBA is finalizing the proposed section without change, for 
the reasons discussed in the following paragraphs.
    Proposed Sec.  107.305(a) included experience in ``implementing 
best practices for investment firms'' as one aspect of management 
qualifications that SBA would evaluate. The two commenters described 
this criterion as an amorphous standard on which there is no consensus, 
and suggested deleting it. SBA disagrees. SBA believes that many best 
practices are widely acknowledged and disseminated by organizations 
such as the Institutional Limited Partners Association, the National 
Venture Capital Association, and the Private Equity Industry Guidelines 
Group.
    Proposed Sec.  107.305(b) included ``the contribution of prior 
investments to the growth of portfolio company revenues and number of 
employees'' as one of the factors SBA would consider in evaluating the 
performance of fund managers' prior investments. The two commenters 
suggested eliminating employment growth as a criterion because 
investment funds do not usually track this information. SBA understands 
that not all fund managers will have employment data for the companies 
in which they previously invested, and will not disqualify an applicant 
that does not have these data. However, job growth is a critical part 
of the SBIC program's mission and SBA believes it should be considered. 
In fact, the current SBIC license application (which Early Stage SBIC 
will also use) already requests information on the growth of portfolio 
company employees and revenues, and most applicants have been able to 
provide it.
    Proposed Sec.  107.305(c) included compliance with SBA regulations 
as a factor in SBA's evaluation of an applicant's investment strategy; 
proposed Sec.  107.305(d) similarly included regulatory compliance with 
respect to an applicant's organizational structure and fund economics. 
The two commenters felt that compliance was relevant only to applicants 
that have previously managed an SBIC. However, the provisions relate 
not to an applicant's prior funds, but to the likelihood of compliance 
of the strategy and structure of the proposed new SBIC. Therefore, 
these provisions pertain to all applicants.
    Section 107.310--When and how to apply for licensing as an Early 
Stage SBIC. 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. SBA received one 
comment stating that Early Stage SBIC managers should be able to access 
leverage across multiple funds at the same time, as this modification 
would strengthen the community of investment firms and individuals that 
finance early stage companies. SBA has not adopted this comment because 
portfolio diversification is particularly important with only a five 
year licensing period for the Early Stage initiative and a limited 
total leverage allocation.
    The proposed section also provided that SBA would accept Early 
Stage SBIC applications only during specified periods, which would be 
announced by Federal Register notice. One commenter thought, depending 
on the number of applications received, that SBA might turn down 
applicants even though they meet the qualification standards for 
licensing. The commenter suggested that any qualified applicant that is 
not given a green light to apply for an Early Stage SBIC license should 
receive a green light to apply for a regular debenture SBIC license. An 
Early Stage SBIC applicant that does not meet the licensing 
qualification standards is not prohibited from separately pursuing a 
regular debenture SBIC license.
    Section 107.320--Evaluation of Early Stage SBICs. Proposed Sec.  
107.320 stated 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. In addition, proposed Sec.  
107.320(a) and (b) added two selection criteria specific to Early Stage 
SBICs, giving SBA the right to consider: (1) Diversification of Early 
Stage SBICs with respect to ``vintage year'' (the year in which an 
investment fund draws its initial capital from investors), and (2) 
diversification of Early Stage SBICs with respect to geographic 
location. SBA received no comments specific to this section and is 
finalizing it without change.
    Section 107.565--Restrictions on third-party debt of Early Stage 
SBICs. Proposed Sec.  107.565 required an Early Stage SBIC to obtain 
SBA approval to have, incur or refinance any third-party debt, whether 
secured or unsecured. The proposed rule made an exception for 
``accounts payable from routine business operations''. Two commenters 
were concerned that ``routine business operations'' could be 
interpreted too narrowly; one asked whether it would include certain 
legal expenses or specialized audit work performed as part of an Early 
Stage SBIC's due diligence on a potential investment. SBA considers the 
ordinary expenses of operating an SBIC to come within this exception 
and other extraordinary expenses would require SBA's prior approval. 
SBA is finalizing Sec.  107.565 as proposed.
    Section 107.585--Voluntary decrease in Licensee's Regulatory 
Capital. The proposed rule required any reduction of Regulatory Capital 
under Sec.  107.585 by an Early Stage SBIC to be approved by SBA in 
writing. SBA received two comments suggesting that an Early Stage SBIC 
that has repaid all of its leverage should be exempt from this prior 
approval requirement. The requested exemption is available under 
existing Sec.  107.1000(b), which applies to all SBICs (including Early 
Stage SBICs) with no outstanding leverage.
    Section 107.692--Examination fees. SBA received two comments 
addressing this section. Both suggested that partnership SBICs should 
not be charged an additional $10,000 examination fee; however, neither 
the existing regulations nor the proposed rule included such a fee. The 
proposed amendments to Sec.  107.692, which SBA is finalizing without 
change, require an Early Stage SBIC to pay 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. The existing 
regulation also includes a 5 percent addition to the base fee for 
partnerships. The maximum base fee is $14,000, so the 5 percent and 10 
percent premiums combined cannot exceed $2,100. SBA charges more for 
partnerships based on the documentation that must be reviewed; for 
Early Stage SBICs, SBA expects that the value of unrealized investments 
will require more review than is needed for other debenture SBICs.
    Section 107.1120--General eligibility requirements for Leverage. 
Proposed paragraph (k) of this section provided 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. The proposed certification was not specific 
as to when the early stage investment requirement would be met, and two 
commenters suggested that the clarity of the provision would be 
improved by adding a cross-reference to the timing requirements in 
Sec.  107.1810(f)(11). SBA agrees and has revised the final rule 
accordingly.

[[Page 25047]]

    Section 107.1150--Maximum amount of leverage for a section 301(c) 
licensee. In this section, SBA proposed special limits on the maximum 
amount of leverage that will be available to an Early Stage SBIC. Among 
other limitations, 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. SBA received two comments suggesting that Early 
Stage SBICs should be able to obtain additional leverage if they invest 
in low income geographic areas. This benefit is available to other 
SBICs under existing Sec.  107.1150(c). SBA has not adopted this 
comment based on its concern that increasing the leverage for which an 
Early Stage SBIC is eligible would result in increased risk and could 
ultimately increase the leverage fees that all debenture SBICs must 
pay.
    Section 107.1180--Required distributions to SBA by Early Stage 
SBICs. In this section, SBA proposed to add distribution requirements 
that would apply only to Early Stage SBICs. To reduce the risk of the 
Early Stage initiative, the proposed rule required an Early Stage SBIC 
to make a distribution to SBA whenever it made 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. The 
Early Stage SBIC would have to be current on its debenture interest and 
fees before making a distribution. SBA received two comments pointing 
out a possible conflict in the proposed regulatory language. They noted 
that proposed Sec.  107.1180 used the existing defined term 
``Distribution'', which includes ``any transfer of cash or non-cash 
assets to SBA, its agent or Trustee''. Thus, the definition could be 
presumed to include payments of interest and fees to SBA, which 
therefore would be subject to the various restrictions on Distributions 
in the proposed rule. To avoid any confusion, SBA has revised Sec.  
107.1180(a) to clarify that Early Stage SBIC with outstanding leverage 
may pay interest, annual fees, and maturing debenture principal 
pursuant to the terms of its debentures, and that these payments are 
not subject to the ``Distribution'' requirements in Sec.  107.1180.
    SBA also received two comments on the provision in proposed Sec.  
107.1180(b) that allowed debentures issued by Early Stage SBICs to be 
prepaid in whole but not in part. The commenters asked how SBA would 
handle a distribution if the amount received was not sufficient to pay 
off a debenture in full. SBA has experience with this issue through the 
participating securities program, which includes many SBICs that have 
also issued debentures. These SBICs have pre-planned their 
distributions so that the amount payable to SBA will be the amount 
needed to pay off one or more debentures in full. SBICs have the 
flexibility to issue debentures in fairly small increments, and most do 
so; as a result, it should not be difficult to arrange a distribution 
so that debenture prepayments work out properly.
    Proposed Sec.  107.1180(d) stated that 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. At a CIP of 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. However, if the CIP reached 50 percent or more, SBA 
would receive 100 percent of any distribution until all outstanding 
debentures have been repaid. If the Early Stage SBIC reduced its CIP 
below 50 percent, it could resume distributions to its investors.
    SBA received one comment on these distribution priority provisions. 
The commenter stated that for Early Stage SBICs that maintain a low 
ratio of leverage to Leverageable Capital (for example, funds that 
raise $2 or $3 of private capital for every $1 of leverage), SBA should 
not take all distributions when the CIP reaches 50 percent because the 
SBA leverage would still be fully protected. The commenter proposed a 
variable formula to determine the CIP at which SBA would be entitled to 
priority in distributions, suggesting that this change would make the 
Early Stage initiative more attractive to potential investors. SBA 
believes that a variable threshold introduces too much complexity, but 
also agrees that an Early Stage SBIC that takes substantially less than 
one tier of leverage does represent a lower risk to SBA and should 
receive the benefit of more favorable distribution rules. Accordingly, 
SBA is revising Sec.  107.1180(d) so that SBA will be entitled to 100 
percent of distributions only if the CIP is 50 percent or greater and 
the Early Stage SBIC's highest leverage ratio is greater than 0.5. In 
other words, an Early Stage SBIC that uses at least $2 of private 
capital for every $1 of leverage will be permitted to continue making 
pro rata distributions to SBA and its private investors even if its CIP 
reaches or exceeds 50 percent, as long as it does not have a condition 
of capital impairment under Sec.  107.1830.
    Section 107.1181--Interest reserve requirements for Early Stage 
SBICs. Two commenters addressed this section, which required an Early 
Stage SBIC to maintain funds in reserve to cover interest and Charges 
on each of its outstanding debentures over the first five years of its 
term.
    The proposed rule provided an exception to the interest reserve 
requirement for 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.
    For standard debentures, the proposed rule required a reserve 
sufficient to pay interest and Charges for the first 21 Payment Dates 
following issuance of a debenture, and both commenters thought the 
correct period should be 20 Payment Dates, to correspond to a five year 
period. However, SBA notes that the first of the 21 Payment Dates will 
come at the end of a ``stub period'' that is less than a full quarter. 
The proposed rule correctly provided for the stub period followed by 20 
quarters.
    Both commenters suggested that SBA should consider permitting Early 
Stage SBICs to issue discounted debentures as an alternative to the 
reserve requirements. SBA clearly stated its intention to do so in the 
preamble to the proposed rule. In the proposed and final rules, Sec.  
107.1181(a) states that the reserve requirement applies only to 
debentures that require periodic interest payments to SBA during the 
first five years of their term.
    Finally, both commenters recommended that the regulation state 
explicitly that the required reserve on a debenture will be reduced 
each time the issuing Early Stage SBIC makes an interest payment. SBA 
believes this point is implicit in the regulation (it was also made 
explicitly in the preamble to the proposed rule), but has added it to 
the final rule for avoidance of doubt.
    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

[[Page 25048]]

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. Two commenters asked how SBA plans to use the valuations, and 
whether Early Stage SBICs will be able to contest them. SBA has not 
adopted standard procedures for acting upon third-party valuations, in 
part because valuations are often provided in ranges and have varying 
degrees of uncertainty associated with them. SBA will use the 
valuations as additional data points to assess the Early Stage SBIC's 
financial condition and the repayment prospects of outstanding SBA 
leverage, as it currently does with valuations for other debenture 
SBICs. SBICs always have the right to provide additional information if 
they disagree with a valuation.
    Section 107.1810--Events of default and SBA's remedies for 
Licensee's noncompliance with terms of Debentures. SBA proposed four 
changes in this section that would apply only to Early Stage SBICs. SBA 
received no specific comments on this section and is finalizing it as 
proposed. The change is a revision of Sec.  107.1810(f)(2), which 
provides that an improper distribution made by an SBIC is an event of 
default. In the final rule, Sec.  107.1810(f)(2)(iv) adds 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 Sec.  107.1810(f)(11), it is 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. 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, Sec.  107.1810(j) provides 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 interest and principal of an Early 
Stage SBIC's debentures, upon such payment SBA has 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 rule.
    Section 107.1830--Licensee's Capital Impairment--definitions and 
general requirements. As discussed in the preamble to the proposed 
rule, SBA did not propose to change the maximum permitted Capital 
Impairment Percentages set forth in Sec.  107.1830. Under the existing 
regulation, the maximum allowable CIP for a debenture SBIC with one 
tier of leverage or less is 70 percent. SBA received one comment 
suggesting that the maximum allowable CIP should be raised to 80 
percent for an Early Stage SBIC with a highest leverage ratio of 0.4 or 
less. SBA agrees that a lower leverage ratio corresponds to lower 
credit risk, but has declined to adopt this suggestion, primarily 
because the CIP formula already allows a fund with a low leverage ratio 
to incur substantially higher dollar losses than a more highly 
leveraged fund of the same size before becoming impaired. For example, 
an Early Stage SBIC with $30 million of private capital and $30 million 
of leverage (i.e., a leverage ratio of 1.0) would be impaired (based on 
a CIP of 70 percent) if it incurred total net losses of $21 million. In 
contrast, an Early Stage SBIC with $40 million of private capital and 
$20 million of leverage (i.e., a leverage ratio of 0.5), and the same 
$21 million of losses, would have a CIP of only 52.5 percent and would 
not be impaired.
    Section 107.1840--Computation of Licensee's Capital Impairment 
Percentage. SBA did not propose any changes to this section, but is 
making one change in this final rule in response to comments regarding 
the need for more flexible capital impairment regulations for Early 
Stage SBICs. As discussed under ``General Comments'' in section II of 
this preamble, SBA is adding an exception for Early Stage SBICs that 
affects the way Class 2 appreciation is accounted for in the 
computation of the Capital Impairment Percentage. In Sec.  
107.1840(d)(3)(iii) and (d)(4), the final rule provides for the 
exception and refers the user to new Sec.  107.1845 for the applicable 
information.
    Section 107.1845--Computation of Capital Impairment Percentage for 
Early Stage SBICs. This new section provides the specific details of a 
change in the treatment of Class 2 appreciation for Early Stage SBICs. 
This section represents an exception, for Early Stage SBICs only, to 
certain provisions of existing Sec.  107.1840(d). Under Sec.  
107.1840(d)(3), appreciation qualifies as Class 2 only if it is based 
on a financing that occurred within 24 months of the date when the SBIC 
is computing its CIP, or if the financed small business meets a test 
for positive net operating cash flow. Under Sec.  107.1840(d)(4), an 
SBIC can use 50 percent of its Class 2 appreciation in the calculation 
of its ``adjusted unrealized gain'', which in turn is the amount that 
the SBIC can use to offset realized losses in the CIP computation.
    Under Sec.  107.1845, at the end of the initial 24 months, an Early 
Stage SBIC with ``expiring'' Class 2 appreciation will be able to 
request an extension. In considering this request, SBA may obtain its 
own valuation of the investments or require the Early Stage SBIC to 
obtain a valuation performed by an independent third party acceptable 
to SBA. SBA may also consider any other information that it deems 
relevant. If supported by the valuation and other information, SBA may 
grant an extension allowing the Early Stage SBIC to use all or part of 
the orginal Class 2 appreciation for up to an additional 24 months; 
reasons for granting a shorter or no extension might include a high 
degree of uncertainty associated with the valuation or the expectation 
that events occurring within a shorter period will further clarify or 
determine a company's value. At the end of any extension period, the 
Early Stage SBIC could request a further extension, repeating the 
original steps. SBA may

[[Page 25049]]

reconsider its approval of an extension at any time based on new 
information that may affect the value of an investment.
    At the time of any extension request, an Early Stage SBIC will also 
be able to request an exception to the requirement to discount Class 2 
appreciation by 50 percent in the ``adjusted unrealized gain'' 
calculation. SBA may grant this exception based on its consideration of 
relevant information, including its determination that the appreciation 
on the Early Stage SBIC's investment, based on its current fair value, 
is at least two times the original Class 2 appreciation. If the 
exception is granted, the Early Stage SBIC will be able to use the 
original Class 2 appreciation in its CIP computation without the 50 
percent discount, for the duration of the extension period.

B. Technical Changes to Regulations

    Section 107.130--Requirement for qualified management. SBA proposed 
one clarification in this section, which has been finalized without 
change. The revision makes clear that a licensed SBIC (including an 
Early Stage SBIC) must have qualified management not only when applying 
for a license, but as long as it holds the license.
    Section 107.1130--Leverage fees and additional charges payable by 
Licensee. This section, which SBA is finalizing as proposed, includes 
two changes to bring the regulation into conformity with statutory 
requirements for determining the annual Charge to be paid by SBICs on 
their outstanding SBA leverage.

IV. Justification for Immediate Effective Date

    The Administrative Procedure Act (APA), 5 U.S.C. 553(d)(3), 
requires that ``publication or service of a substantive rule shall be 
made not less than 30 days before its effective date, except * * * as 
otherwise provided by the agency for good cause found and published 
with the rule.''
    The purpose of this provision is to provide interested and affected 
members of the public sufficient time to adjust their behavior before 
the rule takes effect. In the case of this rulemaking, however, there 
should be no need for any member of the public, including any SBIC, to 
make any changes in order to prepare for the rule taking effect. This 
rule implements changes to the SBIC program to stimulate private sector 
investment in early stage companies, which are expected to contribute 
to the important goals of creating jobs and fostering innovation. Any 
further delay in making leverage available to Early Stage SBICs will 
only hold back the potential benefits of investment in early stage 
small businesses. SBA therefore finds that there is good cause for 
making this rule effective immediately instead of observing the 30-day 
period between publication and effective date.

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. In 
the proposed rule, SBA set forth its initial regulatory impact 
analysis, which addressed the following: (1) Necessity of the 
regulation; (2) alternative approaches to the proposed rule; and (3) 
the potential benefits and costs of the regulation. SBA received 
comments which addressed both alternative approaches to and potential 
costs of the regulation. Those comments are discussed in the final 
Regulatory Impact Analysis 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. This final rule includes a number of 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 Stage SBICs as a very small percentage of its 
portfolio.
2. Alternative Approaches to Regulation
    SBA considered several alternatives to these 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

[[Page 25050]]

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 
required only 50 percent of an Early Stage SBIC's portfolio to be in 
early stage investments. SBA received one comment suggesting that Early 
Stage SBICs should be required to invest at least 75% of their 
investment dollars in early stage small businesses. However, two other 
commenters believed not only that the 50% requirement was sufficient, 
but that SBA should also consider requiring an Early Stage SBIC to 
invest at least 25% of its total financing dollars in current pay 
investments in later stage businesses. The commenters felt this would 
decrease the risks of Early Stage SBICs, thereby lowering the costs, 
and could perhaps offset the need for an interest reserve. SBA believes 
these varying points of view illustrate that fund managers are in the 
best position to identify the portfolio mix that would be best suited 
to their skills and experience, and has finalized the Early Stage SBIC 
definition as proposed.
    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 some 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 rule will 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 $1 billion in leverage guaranteed by the Early Stage 
initiative will result in approximately $125 million annually in 
financings to small businesses over an 8 to 10 year period.
    As stated in the proposed rule, Early Stage debentures will 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. For FY 2013, SBA has 
budgeted $200 million in leverage commitments to Early Stage SBICs, 
representing approximately 8.3 percent of all new expected debenture 
commitments. This 8.3 percent allocation would increase the annual fee 
on all new debenture commitments by approximately 11.5 basis points 
using updated model assumptions. The fee increases reflect the 
additional risk associated with 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 basis. 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. SBA announced a series of public Webinars regarding the 
Early Stage Initiative during the comment period. 76 FR 81430 (December 
28, 2011). SBA also placed explanatory material on its Web site to 
assist the public with understanding the program, as proposed. http://www.sba.gov/content/early-stage-small-business-investment-company-sbic-inititative. The public Webinars attracted a range of participants, 
including individuals with prior experience managing either 
participating securities SBICs or non-SBIC equity funds; SBIC industry 
service providers; and current debenture program participants. The 
Webinar presentations provided a general introduction to the SBIC 
program as well as to the goals and proposed structure of the Early 
Stage initiative. Among other things, participants asked questions 
about the timetable for implementing the initiative, when an Early 
Stage SBIC applicant would have

[[Page 25051]]

to complete its fundraising, and procedures for submitting license 
application and obtaining a leverage commitment. Participants were 
broadly supportive of using the SBIC program to expand the financing 
options available to early stage small businesses, while adding key 
protective provisions to manage program risk.

Executive Order 13132

    SBA has determined that this final 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 final 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 final 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 a final regulatory 
flexibility analysis (FRFA) 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 a FRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This final rule affects all SBICs issuing debentures, of which there 
are approximately 150, most of which are small entities. Therefore, SBA 
has determined that this final 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 than if 
there were no Early Stage SBICs. For FY 2012, SBA estimates $150 
million in 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. For FY 2013, SBA estimates $200 
million in leverage commitments to Early Stage SBICs, which increases 
the annual fee charged to all SBICs seeking new debenture commitments 
by approximately 11.5 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 final rule will not 
have a significant impact on a substantial number of small entities. In 
the proposed rule, SBA solicited comments from the public regarding any 
perceived significant impact, either on SBICs or on companies that 
receive funding from SBICs, and received none.

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 amends part 107 of 
title 13 of the Code of Federal Regulations as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

0
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.


0
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  Definition 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 (see also Sec.  107.1810(f)(11)). 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.
* * * * *

0
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. * * *


0
4. Amend Sec.  107.210 by revising paragraph (a)(1) subject heading and 
the first sentence of its introductory text and by adding a 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. * * *
* * * * *

[[Page 25052]]

    (3) Early Stage SBICs. An Early Stage SBIC must have Regulatory 
Capital of at least $20 million.
* * * * *

0
5. Amend Sec.  107.300 by revising the introductory text and adding a 
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:
* * * * *
    (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.


0
6. Add Sec.  107.305 to subpart C 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.


0
7. Add Sec.  107.310 to subpart C 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.


0
8. Add Sec.  107.320 to subpart C 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.


0
9. Add Sec.  107.565 to subpart E 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.


0
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. * * *

0
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-- %                                      addition-- %
           Examination fee discounts                of base         Examination fee additions         of base
                                                  examination                                       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
----------------------------------------------------------------------------------------------------------------


[[Page 25053]]

* * * * *
0
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 in 
accordance with Sec.  107.1810(f)(11), 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.

0
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 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. * * *
* * * * *

0
14. Amend Sec.  107.1150 by revising the first sentence of the 
introductory text, redesignating paragraphs (c) and (d) and paragraphs 
(d) and (e), respectively, and adding a new paragraph (c) 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. * * *
* * * * *
    (c) 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.

0
15. Amend subpart I of part 107 by adding an undesignated center 
heading and 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.
107.1181 Interest reserve requirements for Early Stage SBICs.
107.1182 Valuation requirements for Early Stage SBICs based on 
Capital Impairment Percentage.
* * * * *


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 section. See also Sec.  107.585. 
For the purposes of this section, ``Distributions'' do not include 
required payments to SBA of interest and Charges and payments of 
Leverage principal at maturity, all of which shall be paid in 
accordance with the terms of the Leverage. 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 section 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 section 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 or your Highest 
Leverage Ratio equals 0.5 or less, except as provided in paragraph 
(d)(2)(iii) of this section, 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 and your Highest 
Leverage Ratio is greater than 0.5, SBA's percentage share of 
cumulative Distributions equals 100 percent.
    (iii) If you have a condition of Capital Impairment under Sec.  
107.1830 and your Highest Leverage Ratio equals 0.5 or less 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.

[[Page 25054]]

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) The required reserve associated with an individual Debenture 
shall be reduced on each Payment Date upon payment of the required 
interest and Charges. If you prepay a Debenture prior to the 21st 
Payment Date following its date of issuance, the reserve requirement 
associated with that Debenture shall be correspondingly eliminated.
    (c) 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 all of your Loans 
and Investments, as designated by SBA.

0
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' pro-rata 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.

0
17. Amend Sec.  107.1840 by revising paragraph (d)(3)(iii) and 
paragraph (d)(4) introductory text to read as follows:


Sec.  107.1840  Computation of Licensee's Capital Impairment 
Percentage.

* * * * *
    (d) * * *
    (3) * * *
    (iii) Except as provided for Early Stage SBICs in Sec.  107.1845, 
such financing occurred within 24 months of the date of the Capital 
Impairment computation, or the Small Business's pre-tax cash flow from 
operations for its most recent fiscal year was at least 10 percent of 
the Small Business's average contributed capital for such fiscal year.
    (4) Except as provided for Early Stage SBICs in Sec.  107.1845, 
perform the appropriate computation from the following table:
* * * * *

0
18. Add Sec.  107.1845 to read as follows:


Sec.  107.1845  Determination of Capital Impairment Percentage for 
Early Stage SBICs.

    This section applies to Early Stage SBICs only. Except as modified 
by this section, all provisions of Sec.  107.1840 apply to an Early 
Stage SBIC.
    (a) To determine your Class 2 Appreciation under Sec.  
107.1840(d)(3), use the following provisions instead of Sec.  
107.1840(d)(3)(iii):
    (1) Such financing occurred within 24 months of the date of the 
Capital Impairment computation. At the end of the 24 month period 
following the financing, you may request SBA's written approval to 
retain the use of the original Class 2 Appreciation on the investment 
for up to 24 additional months.
    (2) In considering your request, SBA may obtain its own valuation 
of the investment, require you to obtain a valuation performed by an 
independent third party acceptable to SBA, and may consider any other 
information that it deems relevant. To the extent that the valuation 
and any other relevant information conclusively support the original 
Class 2 appreciation, SBA may approve an extension to use all or part 
of the original Class 2 Appreciation for up to an additional 24 months 
(the ``extension period'').
    (3) At the end of any extension period, you may submit a new 
request to retain the use of the original Class 2 Appreciation, 
repeating the steps in paragraphs (a)(1) and (2) of this section.

[[Page 25055]]

    (4) SBA may reconsider its approval to retain the use of the 
original Class 2 Appreciation at any time based on information that may 
affect the value of an investment.
    (b) Any time you submit a request for SBA approval to retain the 
use of the original Class 2 Appreciation under paragraph (a) of this 
section, you may also request SBA's written approval to modify your 
computation of Adjusted Unrealized Gain under Sec.  107.1840(d)(4) as 
provided in paragraph (c) of this section.
    (c) If SBA determines that the appreciation on an investment, based 
on its current fair value, is at least two times the original Class 2 
Appreciation on the investment, SBA may allow you, based on relevant 
information, to compute your Adjusted Unrealized Gain for the duration 
of the extension period as follows:
    (1) Compute Adjusted Unrealized Gain in accordance with Sec.  
107.1840(d)(4).
    (2) If your result in paragraph (c)(1) of this section was computed 
using the first line of the table in Sec.  107.1840(d)(4):
    (i) Calculate 50 percent of the original Class 2 Appreciation on 
the individual investment that is the subject of this paragraph (c), 
and
    (ii) Add it to the result from paragraph (c)(1) of this section to 
determine your Adjusted Unrealized Gain.
    (3) If your result in paragraph (c)(1) of this section was computed 
using the second line of the table in Sec.  107.1840(d)(4):
    (i) Calculate 50 percent of the original Class 2 Appreciation on 
the individual investment that is the subject of this paragraph (c).
    (ii) Subtract your Class 1 Appreciation from your Net Appreciation, 
and multiply the result by 50 percent.
    (iii) Add the lesser of (c)(3)(i) and (ii) of this section to the 
result from paragraph (c)(1) of this section to determine your Adjusted 
Unrealized Gain.

Karen G. Mills,
Administrator.
[FR Doc. 2012-10120 Filed 4-26-12; 8:45 am]
BILLING CODE 8025-01-P