[House Report 105-450]
[From the U.S. Government Publishing Office]



105th Congress                                                   Report
 2d Session             HOUSE OF REPRESENTATIVES                105-450
_______________________________________________________________________


 
  SMALL BUSINESS INVESTMENT COMPANY TECHNICAL CORRECTIONS ACT OF 1998

                                _______
                                

 March 17, 1998.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______


    Mr. Talent, from the Committee on Small Business, submitted the 
                               following

                              R E P O R T

                        [To accompany H.R. 3412]

      [Including cost estimate of the Congressional Budget Office]

  The Committee on Small Business, to whom was referred the 
bill (H.R. 3412) to amend and make technical corrections in 
title III of the Small Business Investment Act, having 
considered the same, report favorably thereon with an amendment 
and recommend that the bill as amended do pass.
  The amendment (stated in terms of the page and line numbers 
of the introduced bill) is as follows:
  On page 2, line 11, strike ``revenues'' and insert ``income'' 
and on line 12 strike ``revenue'' both places it appears and 
insert ``income''.

                                Purpose

    The purpose of H.R. 3412 is make certain technical 
amendments to Title III of the Small Business Investment Act of 
1958. This title authorizes the activities of the Small 
Business Investment Company program. Small Business Investment 
Companies (SBICs) are venture capital firms licensed by the 
Small Business Administration that use SBA guarantees to 
leverage private capital for investment in small businesses.
    The technical corrections proposed by H.R. 3412 will 
improve the flexibility of the SBIC program and allow improved 
access to this program by small businesses.

                          Need for Legislation

    Congress revamped the SBIC program in the 103d Congress to 
provide for a new form of leverage geared specifically towards 
equity investment in small businesses. Over the ensuing years, 
as the new program has become established, certain deficiencies 
have come to light; in addition, certain statutory provisions 
have become obsolete.
    Moreover, the nature of the SBIC industry has changed. The 
result is a participating securities industry made up primarily 
of smaller SBICs. The fact that these smaller SBICs are 
dominating the program points to shifting dynamics in the SBIC 
program. Smaller, start-up investments are more typical and, 
therefore, the demand for leverage has shifted to smaller 
individual placements.
    H.R. 3412 seeks to correct these deficiencies, and remove 
provisions that may produce confusion due to changes in law and 
the character of the SBIC program. Under H.R. 3412, a provision 
in the Small Business Investment Act that reserves leverage for 
smaller SBICs will be repealed. Changes in SBA policy regarding 
applications for leverage, statutory changes in the 
availability of commitments for SBICs, and the makeup of the 
industry present the possibility that that provision may, in 
fact, create conflicts and confusion.
    H.R. 3412 modifies a test for determining the eligibility 
of small businesses for SBIC financing. Current statutory 
language does not account for small businesses organized in 
pass-through tax structures such as S corporations, limited 
liability companies, and certain partnerships. These 
organizations do not pay taxes at the enterprise level but 
instead pass through income and the ensuing tax liabilities to 
their partners and shareholders. Consequently, many of these 
small businesses face difficulties when the income test is 
applied to them, and are often declared ineligible for 
financing they should receive.
    Finally, H.R. 3412 will allow the SBA greater flexibility 
in issuing trust certificates to finance the SBIC program's 
investments in small businesses. Current law allows fundings to 
be issued every six months or more frequently. This inhibits 
the ability of the SBICs and the SBA to form pools of 
certificates that are large enough to generate serious investor 
interest. Allowing more time between fundings will permit SBA 
and the industry to form larger pools for sale in the market, 
thereby increasing investor interest and improving the interest 
rates for the small businesses financed.

                            Committee Action

    On Thursday, March 12, 1998, the Committee on Small 
Business held a hearing to consider the provisions of H.R. 
3412. Testifying at the hearing was Mr. Lee Mercer, President 
of the National Association of Small Business Investment 
Companies. Mr. Mercer testified to the beneficial effects that 
H.R. 3412 would have on the SBIC program. He recognized the 
improvements in management that have occurred in the program 
over recent years and recommended the corrections contained in 
H.R. 3412. Mr. Mercer explained the three provisions and the 
effect they would have in detail.
    Chairman Talent questioned Mr. Mercer regarding the concern 
that the provision that removed the reserve of leverage for 
smaller SBICs might impair access to leverage for those firms. 
Mr. Mercer responded that his organization, which is composed 
primarily of smaller SBICs, endorsed the provision. He also 
stated that demands for leverage in the participating 
securities were generally for small individual placements 
rather than any single large investments that would seriously 
deplete funding. Ms. Velazquez then questioned Mr. Mercer about 
the correction of the after-tax income test, and asked if he 
could supply any specific firms who had been denied eligibility 
due to the current test. Mr. Mercer stated that he could not 
name any specific firms but that he had heard of several such 
firms.
    Ms. Velazquez, Mr. Davis and Mrs. Kelly then asked Mr. 
Mercer several questions concerning the SBIC industry's efforts 
to attract more minority and women-owned businesses for 
financing assistance. Mr. Mercer described a number of 
initiatives that his organization had started to achieve those 
ends. Ms. Velazquez also requested that Mr. Mercer and his 
organization develop and provide an outreach program for 
minority and women-owned businesses.
    Immediately after the hearing, Chairman Talent called the 
Committee to order for the purpose of marking up and reporting 
H.R. 3412. The bill was introduced, considered as read, and 
opened for amendment. Chairman Talent offered a single 
technical amendment which was accepted by voice vote. The 
motion was then made to report H.R. 3412, as amended. By voice 
vote, a quorum being present, the Committee passed the bill, 
H.R. 3412, and ordered it reported.

                      Section-by-Section Analysis

                        Section 1. short title.

    Designates the bill as ``The Small Business Investment 
Company Technical Corrections Act of 1998''.

                   Section 2. technical corrections.

    (1) This paragraph removes subparagraph (13) of Section 
303(g) of the Small Business Investment Act (15 U.S.C. 683(g)). 
That provision reserves 50% of participating securities 
leverage for Small Business Investment Companies with private 
capital of less than $20 million until the fourth fiscal 
quarter. While the Committee continues to be interested that 
all SBICs have access to the funding needed to complete their 
investments, we also recognize that this provision is no longer 
necessary. Only 12 of the 60 SBICs in the participating 
leverage program have more than $20 million in private capital, 
and the original concern that a few large SBICs would dominate 
the program has proved unfounded. It appears that most SBIC 
equity placements are in smaller early-stage businesses and 
consequently most participating securities SBICs are 
established as small funds.
    (2) This paragraph establishes a test for small businesses 
formed as tax ``pass-through'' entities such as S corporations, 
or limited liability companies. Such businesses will have their 
small business investment eligibility determined by multiplying 
their net income by the combined federal and state corporate 
tax rate and then subtracting the result from their net income. 
That result will serve as the small business' estimated 
``after-tax income'' for the purpose of determining 
eligibility. This removes an uncertainly in the statute that 
meant a C corporation with as much as $9 million in pretax 
income could be a small business but a pass-through S 
corporation with $6,000,001 in income was ineligible.
    (3) The final paragraph changes Section 320 of the Small 
Business Investment Act to allow issuance of Small Business 
Administration-backed trust certificates not less than every 
twelve months rather than the current standard of every six 
months. SBA would retain the discretion to issue guarantees and 
trust certificates at shorter intervals if appropriate. The 
change will give SBA increased flexibility in negotiating the 
terms and costs associated with the placement of certificates, 
either by contract or public offering. This will ultimately 
benefit the small businesses seeking financing since the rates 
sought by SBICs are reflected in the rates charged to small 
businesses.

                                     U.S. Congress,
                               Congressional Budget Office,
                                    Washington, DC, March 16, 1998.
Hon. James M. Talent,
Chairman, Committee on Small Business,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 3412, the Small 
Business Investment Company Technical Corrections Act of 1998.
    If your wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Mary 
Maginniss.
            Sincerely,
                                             James L. Blum,
                                   (For June E. O'Neill, Director).
    Enclosure.

               congressional budget office cost estimate

H.R. 3412--Small Business Investment Company Technical Corrections Act 
        of 1998

    CBO estimates that enacting this bill would not have a 
significant impact on the federal budget. Because H.R. 3412 
would not affect direct spending or receipts, pay-as-you-go 
procedures would not apply. H.R. 3412 contains no 
intergovernmental or private-sector mandates as defined in the 
Unfunded Mandates Reform Act of 1995 and would not affect the 
budgets of state, local, or tribal governments.
    H.R. 3412 would make a number of technical corrections to 
the Small Business Investment Act of 1958. It would allow the 
Small Business Administration (SBA) to allocate the 
appropriations available to fund small business investment 
companies (SBICs) more evenly over the course of a year by 
eliminating a provision in current law that reserves funds for 
smaller SBICs until the last quarter of the fiscal year. It 
also would allow a more accurate comparison of the revenues of 
small businesses seeking eligibility for the SBIC program by 
requiring SBA to compare a firm's revenues assuming that it has 
paid all required income taxes. (Certain corporate structures, 
such as ``S'' corporations, pass all income through to the 
stockholders. This makes comparing revenues with firms that do 
not pass through income, but instead pay taxes at the corporate 
level, misleading.) Finally, H.R. 3412 would give SBA more 
flexibility in issuing certificates that help finance SBIC 
activities by increasing the minimum placement period for 
public offerings from 6 months to 12 months.
    The Congress annually limits total SBA commitments for 
financing SBICs through the appropriation process. CBO expects 
that enacting H.R. 3412 would affect SBA procedures and might 
change the mix of eligibility for participating in the SBIC 
programs, but would result in no significant additional cost to 
the federal government.
    The CBO staff contact for this estimate is Mary Maginniss. 
This estimate was approved by Robert A. Sunshine, Deputy 
Assistant Director for Budget Analysis.

                 Statement of Constitutional Authority

    Pursuant to clause 2(l)(4) of rule XI of the Rules of the 
House of Representatives, the Committee finds the authority for 
this legislation in Article I, Section 8, Clause 18 of the 
Constitution of the United States.

                           Oversight Findings

    In accordance with clause 2(l)(3)(D) of rule XI of the 
Rules of the House of Representatives, the Committee states 
that no oversight findings or recommendations have been made by 
the Committee on Government Reform and Oversight with respect 
to the subject matter contained in H.R. 3412.
    In accordance with clause 2(l)(3)(D) of rule XI of the 
Rules of the House of Representatives, the oversight findings 
and recommendations of the Committee on Small Business with 
respect to the subject matter contained in H.R. 3412 are 
incorporated into the descriptive portions of this report.

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3 of rule XIII of the Rules of the 
House of Representatives, changes in existing law made by the 
bill, as reported, are shown as follows (existing law proposed 
to be omitted is enclosed in black brackets, new matter is 
printed in italic, existing law in which no change is proposed 
is shown in roman):

                 SMALL BUSINESS INVESTMENT ACT OF 1958

          * * * * * * *

             TITLE III--SMALL BUSINESS INVESTMENT COMPANIES

          * * * * * * *
  Sec. 303. (a) * * *
          * * * * * * *
  (g) In order to encourage small business investment companies 
to provide equity capital to small businesses, the 
Administration is authorized to guarantee the payment of the 
redemption price and prioritized payments on participating 
securities issued by such companies which are licensed pursuant 
to section 301(c) of this Act, and a trust or a pool acting on 
behalf of the Administration is authorized to purchase such 
securities. Such guarantees and purchases shall be made on such 
terms and conditions as the Administration shall establish by 
regulation. For purposes of this section, (A) the term 
``participating securities'' includes preferred stock, a 
preferred limited partnership interest or a similar instrument, 
including debentures under the terms of which interest is 
payable only to the extent of earnings and (B) the term 
``prioritized payments'' includes dividends on stock, interest 
on qualifying debentures, or priority returns on preferred 
limited partnership interests which are paid only to the extent 
of earnings. Participating securities guaranteed under this 
subsection shall be subject to the following restrictions and 
limitations, in addition to such other restrictions and 
limitations as the Administration may determine:
          (1) * * *
          * * * * * * *
          [(13) Participating securities for smaller small 
        business investment companies.--
                  [(A) In general.--Subject to the provisions 
                of subparagraph (B), of the amount of the 
                annual program level of participating 
                securities approved in appropriations Acts, 50 
                percent shall be reserved for funding small 
                business investment companies with private 
                capital of not more than $20,000,000.
                  [(B) Exception.--During the last quarter of 
                each fiscal year, if the Administrator 
                determines that there is a lack of qualified 
                applicants with private capital of not more 
                than $20,000,000, the Administrator may utilize 
                all or any part of the program level for 
                securities reserved under subparagraph (A) for 
                qualified applicants with private capital of 
                more than $20,000,000.]
          * * * * * * *

                             miscellaneous

  Sec. 308. (a) * * *
          * * * * * * *
  (j) For the purposes of sections 304 and 305, in a case in 
which an incorporated or unincorporated business is not 
required by law to pay Federal income taxes at the enterprise 
level but is required to pass income through to its 
shareholders or partners, an eligible small business or smaller 
enterprise may be determined by computing the after-tax income 
of such business by deducting from the net income an amount 
equal to the net income multiplied by the combined marginal 
Federal and State income tax rate for corporations.
          * * * * * * *

         periodic issuance of guarantees and trust certificates

  Sec. 320. The Administration shall issue guarantees under 
section 303 and trust certificates under section 319 at 
periodic intervals of not less than every [6] 12 months and 
shall do so at such shorter intervals as its deems appropriate, 
taking into consideration the amount and number of such 
guarantees or trust certificates.
          * * * * * * *

                                
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