[Federal Register Volume 59, Number 68 (Friday, April 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-7843]


[[Page Unknown]]

[Federal Register: April 8, 1994]


_______________________________________________________________________

Part II





Small Business Administration





_______________________________________________________________________



13 CFR Parts 107 and 121



Small Business Investment Companies and Small Business Size Standards; 
Rules
SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

 

Small Business Investment Companies; Leverage; Participating 
Securities; Conditions Affecting Good Standing of Licensees

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: This final rule implements certain of the changes to the Small 
Business Investment Act of 1958, as amended, made by the ``Small 
Business Equity Enhancement Act of 1992 (September 4, 1992).'' The 
changes implemented by this rule relate to Leverage provided to SBICs 
by SBA, and include increasing from $35 million to $90 million the 
amount of Leverage that may be outstanding to any one Licensee or group 
of Licensees under common control, incrementally reducing the maximum 
ratio of Leverage to capital as capital is increased, establishing a 
new form of Leverage (Participating Securities) which will be available 
to Licensees that make Equity Capital Investments in small concerns, 
permitting Specialized SBICs that are organized as limited partnerships 
to obtain Leverage from SBA in the form of a preferred limited 
partnership interest, and making other technical changes necessary to 
implement the legislation.

DATES: This final rule is effective April 25, 1994.

FOR FURTHER INFORMATION CONTACT: Marvin D. Klapp, Acting Director, 
Office of Program Development; telephone (202) 205-6515.

SUPPLEMENTARY INFORMATION: On August 5, 1993, SBA published two 
proposed rules to implement certain changes to the Small Business 
Investment Act of 1958, as amended (Act), made by title IV of Public 
Law 102-366 (September 4, 1992). See 58 FR 41852 and 58 FR 41882. The 
first of the two rules proposed changes in the way financial assistance 
(Leverage) is provided to small business investment companies (SBICs or 
Licensees), including the creation of a new form of Leverage called 
Participating Securities, which would be available to Licensees making 
equity-type investments in small concerns. The second of the two rules 
proposed changes affecting the licensing and operations of SBICs.
    The public was afforded a sixty-day period in which to submit 
comments on the two proposed rules to the Agency. In recognition of the 
complexity of the subject matter involved, SBA reopened and extended 
the comment period on both proposed rules until November 18, 1993. See 
58 FR 57568 (October 26, 1993).
    After receiving and giving careful consideration to approximately 
109 comment letters, SBA is today finalizing both proposed rules. This 
final rule finalizes the proposed rule concerning Leverage, 
Participating Securities and other miscellaneous matters. The final 
rule immediately following this rule in the Federal Register 
(Operations Rule) finalizes the proposed rule concerning licensing and 
operations of SBICs.
    In addition, SBA is simultaneously finalizing in this separate part 
of the Federal Register the proposed rule published on July 29, 1993 
(58 FR 40603), which revises one of the size standards for the SBIC 
Program (Size Rule).

1. General Leverage Provisions

a. Introduction

    SBA is finalizing the renumbering and reorganization of the 
``Leverage'' sections of the SBIC Program regulations (Sec. 107.210 
through Sec. 107.263) as proposed. SBA intends, at a later date, to 
conform the remainder of the SBIC Program regulations (part 107 of 
title 13 of the Code of Federal Regulations) to the new numbering 
system used in the Leverage sections.
    As in the proposed rule, the term ``Licensee'' used in this final 
rule always includes SBICs licensed under the authority of section 
301(c) of the Act (section 301(c) Licensees) and SBICs licensed under 
the authority of section 301(d) of the Act (section 301(d) Licensees). 
A section 301(c) Licensee is sometimes referred to as a Regular SBIC 
because there is no restriction on the type of Small Concern that it 
may assist. A section 301(d) Licensee is sometimes referred to as a 
Specialized SBIC or SSBIC because it is only authorized to assist Small 
Concerns owned by persons whose participation in the free enterprise 
system is hampered because of social or economic disadvantages.

b. Application Procedures

    In proposed Sec. 107.210, SBA set forth the application procedures 
and basic eligibility requirements for obtaining Leverage from SBA. SBA 
received fifty-eight (58) comment letters on this section, many of 
which addressed the requirement in Sec. 107.210(c)(2) that applicants 
for Leverage demonstrate a need for the Leverage funds.
    The requirement for a demonstration of need is not a new concept 
for the SBIC Program. Historically, a Licensee was considered to 
``need'' Leverage if sixty-five percent (65%) of its private capital 
had been invested or committed to investments in Small Concerns. 
However, if a Licensee had significant available resources of its own 
(e.g., unfunded commitments from investors), it was generally 
considered not to be in need of Leverage.
    SBA proposed an exception to this general rule for applicants for 
Participating Securities Leverage: SBA would disregard the applicant's 
temporary excess liquidity resulting from unfunded commitments or 
drawdowns of commitments if the Licensee had invested at least fifty 
percent (50%) of its Leverageable Capital\1\ and Leverage in Equity 
Capital Investments (the required investment category for issuers of 
Participating Securities). Under this exception, though, Licensees with 
unfunded commitments would probably find themselves ineligible for 
their first issuance of Participating Securities Leverage unless fifty 
percent (50%) of their Leverageable Capital had already been invested 
in Equity Capital Investments.
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    \1\This term and the related term ``Regulatory Capital'' are 
defined in the Operations Rule.
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    The comments received by SBA questioned the appropriateness of 
requiring Licensees to make Equity Capital Investments in order to be 
eligible for Participating Securities Leverage. They argued that such a 
requirement was inconsistent with the intent of the legislation, which 
required that Equity Capital Investments be made with the proceeds of 
Participating Securities.
    The comments also argued in favor of extending to Debenture and 
Preferred Securities issuers the same ability to demonstrate a need for 
Leverage while commitments from investors remain unfunded.
    SBA agrees with the comments. If any Licensee has invested fifty 
percent (50%) of its Leverageable Capital plus outstanding Leverage and 
is in compliance with SBA regulations, it should be eligible for SBA 
Leverage. This should be true for all Licensees, not just those that 
issue Participating Securities, and should be true regardless of the 
type of investments that have been made by the Licensee (assuming, of 
course, that the Licensee's past investments have been in eligible 
Small Concerns). The proposed rule has been revised and finalized 
accordingly.
    It should be noted here that eligibility for Leverage does not mean 
that Leverage necessarily will be available and forthcoming. In the 
event that the demand for Leverage exceeds the available supply, SBA 
will allocate Leverage among the eligible applicants unless and until 
additional funds or guarantee authority is made available to meet such 
demand.

c. Fees

    As proposed, Sec. 107.210(d) increased the user fee charged in 
connection with obtaining Leverage to two percent (2%) of the face 
amount of Debentures, and instituted the same two percent (2%) fee for 
Participating Securities. SBA received twenty-two (22) comments on this 
subject, some objecting to an increased fee for Debenture Leverage 
unless there were a corresponding increase in the cost of administering 
such Leverage, and others objecting to increased fees in general unless 
the fees could be used to offset the costs of managing the SBIC 
Program.
    SBA believes the increased fees are necessary to maintain the 
current Debenture program and implement the new Participating 
Securities program. SBA currently is able to use such fees to pay the 
costs associated with the Leverage fundings, including the fees of 
parties with which it contracts to perform services attendant to these 
fundings. Any excess fees are deposited in the U.S. Treasury and are 
counted when determining the ``subsidy rate'' of the particular SBIC 
program that generated the fees. The subsidy rate for a program is a 
measurement that determines the multiple of SBA guarantee authority 
that can be made available for each dollar appropriated to that program 
by Congress. Fees in excess of actual costs associated with the 
Leverage fundings have the effect of reducing the particular SBIC 
program's subsidy rate, thereby resulting in more ``guarantee dollars'' 
being available for the program participants. This is a benefit to all 
Licensees seeking Leverage, especially when appropriated funds are 
being curtailed due to budgetary constraints. SBA is therefore 
finalizing the provision as proposed: the new user fee will be two 
percent (2%) for all Debenture and Participating Securities issuers.

d. Subordination of Debentures

    Proposed Sec. 107.210(f)(5) clarified that when SBA agrees to 
subordination with respect to Debentures guaranteed after July 1, 1991, 
the amount of indebtedness to which such subordination applies is fixed 
at the time SBA subordinates, and is limited then and later to the 
lesser of two hundred percent (200%) of the Licensee's Leverageable 
Capital, or $10 million. Any indebtedness of the Licensee in excess of 
that amount, whether in existence at the time SBA subordinates or 
acquired subsequently, will not benefit from SBA's subordination.
    The comments received on this provision were supportive of the 
change. The provision is adopted as proposed.

e. Restrictions on Third Party Debt

    As explained under the proposed rule, Licensees have been permitted 
to apply for and obtain financing from third parties without obtaining 
SBA's prior approval or even notifying the Agency, except upon the 
filing of annual financial statements. Third party lenders have viewed 
SBA Leverage, which is unsecured and generally subordinate, as part of 
the capital base of the Licensee. In some cases, third party financing, 
when aggregated with Leverage, has exceeded a prudent level of 
indebtedness, and SBA has been forced to suffer large losses upon the 
distribution of a Licensee's assets in liquidation, receivership or 
bankruptcy proceedings.
    Concern over SBA's creditor position prompted the Agency to tighten 
its terms of subordination in July 1991. See 56 FR 31777. The 
subordination limits then adopted, however, have not discouraged some 
Licensees from incurring large amounts of secured third party debt. 
Recognizing its obligation to further protect its exposure as the 
largest creditor of most debtor Licensees, SBA proposed that it have 
the right to approve all new third party debt of a Licensee.
    As proposed, Sec. 107.210(f)(6) required that, after September 30, 
1993, Licensees would need to obtain the written approval of SBA before 
incurring or refinancing any third party debt or obtaining any line of 
credit. In addition to conventional third party debt, this restriction 
covered guarantees by Licensees and other voluntarily assumed 
contingent liabilities. Licensees with existing lines of credit were 
required to have such lines approved by SBA before increasing the 
amounts outstanding above the balance owed on September 30, 1993.
    SBA received 45 comments on this provision; all were opposed to the 
proposal as written. The comments expressed concern that the need for 
prior approval from SBA could be very damaging to SBIC business 
operations. They suggested elimination of the requirement of prior 
approval for a Licensee's normal business credit arrangements, for its 
short-term bridge debt and, up to a certain safe-harbor level, for any 
third-party debt.
    After considering these comments, SBA has concluded that it can 
eliminate entirely the requirement for prior approval of a Licensee's 
unsecured third-party debt and still protect the Agency's interest in 
the Licensee. This change, reflected in the final rule, should allow 
Licensees to engage in their ordinary business credit arrangements 
without interference from SBA.
    SBA is not convinced, however, that secured third-party debt, of 
any amount, should be incurred by a Licensee without SBA's prior 
approval. SBA understands the SBIC industry's concern regarding the 
prior approval process; in the past, SBA may not have been able to 
respond to SBIC requests for approval in other matters as expeditiously 
as both the SBICs and SBA might have liked. While SBA expects to deal 
with all requests for prior approval on a timely basis, SBA is prepared 
to commit itself to a thirty-day turn-around on certain requests. Thus, 
the final rule provides that if a Licensee is in regulatory compliance 
and has SBA Leverage not in excess of 1.5 times its Leverageable 
Capital, and if the Licensee's request is for approval of a secured 
line of credit which would not cause its aggregate third-party debt to 
exceed fifty percent (50%) of Leverageable Capital, then the Licensee's 
request for prior approval will be considered approved unless SBA 
notifies it otherwise within thirty (30) days of receiving the request. 
It should be noted that all debt, whether secured or unsecured, will be 
aggregated to determine whether the Licensee may avail itself of the 
thirty-day turn-around.
     When making its determination as to whether a Licensee's request 
for secured third-party debt should be approved, SBA will take into 
consideration various factors including, but not limited to, the amount 
of secured indebtedness relative to other debt of the Licensee and the 
amount of secured indebtedness relative to the value of the Licensee's 
collateral proposed to be granted as security.
    Licensees are reminded that once a line of credit is approved by 
SBA, subsequent draw-downs under the line of credit do not require SBA 
approval.
    The final rule extends the date after which SBA approval will be 
required from September 30, 1993, to the date of publication of this 
final rule. Licensees with existing secured lines of credit are 
reminded to obtain SBA approval of such lines before increasing the 
amounts outstanding above the balance owed on the date of publication.
    The final rule also clarifies that if a Licensee has no Leverage, 
it is not required to have its third-party debt approved by SBA.

f. Maintenance of Unimpaired Capital

(i) General
    Former Sec. 107.203(d) required Leveraged Licensees to maintain 
Private Capital in an amount sufficient to avoid a condition of Capital 
Impairment. Under that regulation, a section 301(c) Licensee was 
Capitally Impaired and was in violation of Sec. 107.203(d) if its 
Undistributed Net Realized Earnings deficit, together with any 
Unrealized Depreciation in excess of Unrealized Appreciation, exceeded 
fifty percent (50%) of Private Capital. For a section 301(d) Licensee, 
the applicable percentage was seventy-five percent (75%).
    The proposed regulation on Capital Impairment (Sec. 107.210(h)) 
allowed, for the first time, varying degrees of impairment depending 
upon differences in the composition of the portfolios of Licensees. The 
proposal took the form of two grid structures, each consisting of nine 
(9) categories for section 301(c) and section 301(d) Licensees, 
respectively. The proposed rule continued to permit a higher percentage 
of impairment for a section 301(d) Licensee than for a section 301(c) 
Licensee whose situation was otherwise identical. However, the 
differential was reduced to five (5) percentage points from the former 
twenty-five (25) percentage points. In addition, the proposed rule 
recognized the delay in profitability that is expected to occur in 
venture investing.
    The rationale for moving to a grid structure that would allow an 
equity investor SBIC a higher permissible level of capital impairment 
than a lender SBIC was set forth in the proposed rule. Essentially, the 
proposed structure recognized that in a venture portfolio, especially 
during the early years, there are likely to be considerable losses 
before profits are realized, and a Capital Impairment Percentage of 
fifty percent (50%) or more may exist even when the portfolio has 
genuine long-term value. However, for a Licensee which only provides 
loan financing, a Capital Impairment Percentage of fifty percent (50%) 
generally indicates a significant operating deficit that cannot be 
offset by appreciation in the portfolio.
    Also new in the proposed regulation on Capital Impairment was the 
treatment of net Unrealized Appreciation. Under the old Capital 
Impairment concept, Licensees have been required to treat net 
Unrealized Depreciation as if it represented realized losses, but they 
received no corresponding credit for net Unrealized Appreciation. The 
proposed regulation acknowledged the existence of net Unrealized 
Appreciation in a Licensee's portfolio, yet attempted to avoid 
providing incentives for Licensees to inflate their portfolio values 
artificially. Thus, SBA proposed to allow partial recognition of net 
Unrealized Appreciation in the computation of Capital Impairment, to an 
extent which would vary depending on whether or not the portfolio 
securities were Publicly Traded and Marketable.
    The proposed rule also provided that a violation of the Capital 
Impairment regulation would constitute an event of default with respect 
to Debentures and Preferred Securities (Sec. 107.261(d)), and that such 
a violation also would affect the good standing of a Licensee issuing 
Participating Securities (Sec. 107.262(d)). In all cases, Licensees 
were afforded an opportunity to cure a violation before SBA could 
impose any of the remedies available to it under the proposed 
regulations.
    The thirty-nine (39) comments received on the Capital Impairment 
proposal generally were unfavorable. While there was little objection 
to the grid structure per se, there was strong objection to the 
permissible Capital Impairment percentages located within the grid. The 
respondents happily accepted the relatively high percentages available 
to the equity-investor SBICs, but felt that the proposed percentages 
for lender SBICs were excessively low. Specialized SBICs also argued 
that the percentages for section 301(d) Licensees were unfair, and that 
SBA should return to a single percentage (75%) for all Specialized 
SBICS, regardless of portfolio composition or amount of Leverage.
    SBA has decided to retain the grid structure for the section 301(c) 
Licensees, and to increase their permissible levels of Capital 
Impairment by five (5) percentage points across the board. Thus, a 
section 301(c) Licensee would be permitted to have impaired Regulatory 
Capital of anywhere from thirty-five percent (35%) to seventy percent 
(70%), depending on the Licensee's portfolio mix and its Leverage 
ratio. SBA believes this is an appropriate resolution as it balances 
its own concerns with those of SBICs, as expressed in the comments.
    For section 301(d) Licensees, SBA intends to return to the current 
permissible level of Capital Impairment. All Specialized SBICs will be 
permitted a Capital Impairment level of seventy-five percent (75%), 
regardless of portfolio mix or Leverage ratio. The differential between 
the Regular and Specialized SBICs will be from five (5) percentage 
points for an equity investor Licensee to forty (40) points for a 
lender Licensee. This differential is a recognition of the more 
limited, and often riskier, pool of small business concerns in which a 
Specialized SBIC may make investments.
    There were also a number of comments on the subject of net 
Unrealized Appreciation, arguing, for the most part, in favor of full 
recognition of all net Unrealized Appreciation as an offset to realized 
losses, or for looser standards for recognizing net Unrealized 
Appreciation on private securities.
    SBA continues to believe that full recognition of all net 
Unrealized Appreciation is inappropriate and that the proposed 
standards for recognizing net Unrealized Appreciation on private 
securities are sufficiently liberal. Licensees will now, for the first 
time, be permitted some credit for net Unrealized Appreciation. 
Accordingly, SBA is not prepared to loosen these criteria further.
    The final Capital Impairment issue addressed in the comment letters 
was the length of the forbearance periods for issuers of Participating 
Securities. SBA understands the industry's desire for a longer period 
of forbearance, but believes that the four and five year allowances 
that were proposed, together with the increased permissible percentages 
agreed to in this final rule, should be adequate for a Licensee with a 
minimally successful portfolio.
    SBA also reminds the SBIC industry that Capital Impairment is a 
curable violation. See Secs. 107.261(d)(5) and 107.262(d)(3). In fact, 
special cure methods are available to Participating Securities issuers. 
See Sec. 107.210(h)(7).
    One final change has been made to the proposed Capital Impairment 
provision; it concerns the inclusion of non-cash gains in the 
computation of Capital Impairment. Under the former definition of 
Capital Impairment, all amounts required by SBA accounting rules to be 
classified as Non-cash Gains/Income (as reported on SBA Form 468) were 
excluded from the Capital Impairment formula. SBA believes this 
provision was too stringent, and that Licensees should be able to 
receive credit in the impairment computation for non-cash gains under 
certain circumstances. However, when the Agency rewrote the Capital 
Impairment test in the proposed rule, full credit was mistakenly 
permitted for all Non-cash Gains/Income of a Licensee, regardless of 
the source. This error was the consequence of using the term 
``Undistributed Realized Earnings,'' which includes all Non-cash Gains/
Income, in the computation. The unintended result of this change was 
that delinquent accrued interest converted into a note, interest income 
accrued on deferred-interest notes and other components of Non-cash 
Gains/Income which may be uncertain as to collectibility would be 
counted as realized earnings in determining Capital Impairment.
    It was SBA's intent when drafting the proposed Capital Impairment 
provision to give capital gains credit only for certain Non-cash Gains/
Income: Specifically, those that the Agency felt had the greatest 
certainty of measurement and collectibility. In this final rule, SBA 
has clarified that the only Non-cash Gains/Income that may be counted 
when computing Capital Impairment are those Non-cash Gains/Income that 
are realized in the form of Publicly Traded and Marketable securities 
or investment grade debt instruments.
    A debt instrument would not be considered investment grade for 
purposes of this rule unless it had actually been rated ``BBB'' or 
``Baa'', or better, by Standard & Poor's Corporation or Moody's 
Investment Service, respectively. A non-rated debt instrument issued by 
a company with outstanding investment grade debt also could be 
considered investment grade if the Licensee were to obtain a written 
opinion from an investment banking firm acceptable to SBA stating that 
the non-rated debt instrument is equivalent in risk to the issuer's 
investment grade debt.
    The following is an example of how this rule operates: If a 
Licensee sells a portfolio investment with a basis of $200,000 and 
receives, exchange, General Electric stock worth $300,000 plus a below 
investment grade promissory note for $150,000, the Licensee should 
include in the Capital Impairment computation $100,000 of the $250,000 
of Non-cash Gains/Income it received.
    In order to implement this change, the final rule adds a new 
defined term, ``Includible Non-cash Gains/Income'', to Sec. 107.3 to 
represent those non-cash gains for which SBA will give credit for 
purposes of Capital Impairment. In the final version of 
Sec. 107.210(h), the Licensee computes Capital Impairment by starting 
with Undistributed Net Realized Earnings, which is net of all Non-cash 
Gains/Income, and adds back Includible Non-cash Gains/Income. 
Undistributed Net Realized Earnings has been added to the definitions 
section of the regulation. This should be a familiar term to all 
Licensees because of its appearance on SBA Form 468. See Sec. 107.3.
    The final rule also clarifies that a Licensee's Unrealized Gain 
(Loss) on Securities Held must reflect the estimated tax effects 
associated with the future realization of gains or losses. See the 
definition of Unrealized Gain (Loss) on Securities Held (Sec. 107.3).
    In summary, the Capital Impairment proposal is finalized as 
proposed except for a five (5) percentage point increase for Regular 
SBICs, a return to the seventy-five percent (75%) test for Specialized 
SBICS, and the inclusion of only a limited class of non-cash gains.
    This final rule repeats the summary of the computation of Capital 
Impairment as it appeared in the summary of the proposed rule. The only 
change is the use of ``Undistributed Net Realized Earnings plus 
Includible Non-cash Gains/Income'' instead of ``Undistributed Realized 
Earnings'', as discussed above.
(ii) Computation of Capital Impairment Percentage
    If Unrealized Gain (Loss) on Securities Held is zero or positive, 
and the sum of Undistributed Net Realized Earnings plus Includible Non-
cash Gains/Income is also zero or positive, no Capital Impairment 
exists and no further calculations are necessary. If either or both 
amounts are less than zero, the Licensee must make the calculations 
described in Secs. 107.210(h) (3) and (4). Depending upon the results 
of interim calculations in these paragraphs, the Licensee may be 
required to compute a Capital Impairment Percentage.
(iii) Determination of Capital Impairment Violation
    As with the proposed rule, a Licensee will not be in violation of 
Sec. 107.210(h) simply by having a Capital Impairment Percentage 
greater than zero. Violations of Sec. 107.210(h) arise out of an 
excessive Capital Impairment Percentage. For section 301(d) Licensees, 
Capital Impairment of more than seventy-five percent (75%) is 
considered excessive; for section 301(c) Licensees, maximum permissible 
Capital Impairment percentages are set forth in a table in the 
regulation.
(iv) Special Rules for Licensees With Outstanding Participating 
Securities
    (A) General. All Leveraged Licensees, including Licensees with 
outstanding Participating Securities, are required to compute their 
Capital Impairment Percentages in the same manner. A Licensee with 
outstanding Participating Securities may, for as long as five years 
following its initial issuance of Participating Securities, have a 
Capital Impairment Percentage higher than the applicable table permits 
(but not as high as eighty-five percent (85%)) without thereby being in 
violation of Sec. 107.210(h) if it meets the other requirements set 
forth in Sec. 107.210(h)(7). In addition, a Licensee that meets the 
requirements set forth in Sec. 107.210(h)(7) (i) or (ii) will be 
afforded an opportunity to cure on terms that may be more favorable 
than those available to other Licensees.
    (B) Curable Capital Impairment Percentage during first 48 months 
following initial issuance of Participating Securities. During the 
first forty-eight (48) months after initially issuing Participating 
Securities, a Licensee with outstanding Participating Securities will 
not be impaired if: (1) Its Capital Impairment Percentage is less than 
eighty-five percent (85%); (2) at least two-thirds of its outstanding 
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Equity Capital 
Investments.
    (C) Curable Capital Impairment Percentage during first 60 months 
following initial issuance of Participating Securities. During the 
first sixty (60) months after initially issuing Participating 
Securities, a Licensee with outstanding Participating Securities will 
not be impaired if: (1) Its Capital Impairment Percentage is less than 
eighty-five percent (85%); (2) at least two-thirds of its outstanding 
Leverage consists of Participating Securities; and (3) at least two-
thirds of its Loans and Investments, valued at cost, are Start-up 
Financings. For the purposes of this regulation, a Start-up Financing 
is an Equity Capital Investment in a growth-oriented Small Concern 
that, at the time of the investment, (1) has not been in existence, in 
any form, for more than three fiscal years, (2) has not had positive 
cash flow or sales exceeding $5 million in any fiscal year, and (3) is 
not formed for the purpose of acquiring any existing business.
    (D) Cure of Capital Impairment. During the fifth year following its 
initial issuance of Participating Securities, a Licensee that meets the 
requirements described in paragraph (B) above may cure its Capital 
Impairment by taking one or more of the following actions within thirty 
(30) days after it determines that it has a condition of Capital 
Impairment. The Licensee may increase its Regulatory Capital\2\ by 
depositing in an escrow account satisfactory to SBA a cash contribution 
equal to fifteen percent (15%) of outstanding Leverage; or it may 
provide SBA with a guarantee satisfactory to SBA, for the benefit of 
SBA, equal to fifteen percent (15%) of its outstanding Leverage. In 
addition to the normal credit considerations that would determine 
whether a guarantee is satisfactory to SBA, the terms of the guarantee 
must provide that any guarantee fee that otherwise would be due the 
guarantor from the Licensee, and any other sums that would be due the 
guarantor by virtue of the guarantor's right of subrogation, must be 
deferred and subordinated to the full repayment of all outstanding 
Leverage plus any unpaid Earned Prioritized Payments (as defined in 
Sec. 107.3) and earned Adjustments (discussed below under 
Sec. 107.243(d)).
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    \2\This increase in Regulatory Capital operates only to cure 
what would otherwise be a Capital Impairment. It does not increase 
the Licensee's eligibility for Leverage.
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    During the sixth year following its initial issuance of 
Participating Securities, a Licensee that meets the above requirements 
may cure its Capital Impairment by taking one of the actions described 
in the preceding paragraph, except that the amount of the cash deposit 
or guarantee shall be equal to thirty percent (30%) of outstanding 
Leverage. Any amount deposited previously may be used as a credit 
against the thirty percent (30%) requirement.

2. Leverage for Section 301(c) Licensees

    No comments were received on proposed Sec. 107.220; accordingly, it 
is finalized as proposed. This section provides Leverage requirements 
for section 301(c) Licensees, and reflects amendments to the Act 
contained in Section 402 of Public Law 102-366. Section 107.220 permits 
SBA to provide Leverage to section 301(c) Licensees through the 
purchase or guarantee of Debentures and/or Participating Securities. 
After March 31, 1993, a section 301(c) Licensee's amount of Leverage 
outstanding at any time shall not exceed three hundred percent (300%) 
of its Leverageable Capital up to $15 million; two hundred percent 
(200%) of its Leverageable Capital of more than $15 million, but not 
more than $30 million; and an amount, not exceeding $15 million, which 
is equal to one-hundred percent (100%) of its Leverageable Capital over 
$30 million. The aggregate amount of outstanding Leverage by any 
Licensee or group of two or more Licensees under Common Control\3\ 
shall not exceed $90 million. On a case-by-case basis, SBA may grant an 
exception to this ceiling to a group of Licensees under Common Control 
and permit a higher amount, subject to such terms and conditions as SBA 
considers appropriate to minimize risk of loss in the event of default. 
In no event, however, shall the aggregate amount of a Licensee's 
Participating Securities exceed two hundred percent (200%) of 
Leverageable Capital.
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    \3\This term is defined in the Operations Rule.
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    A ``grandfather clause'' is provided for Licensees that, on March 
31, 1993, have outstanding Debentures in excess of three hundred 
percent (300%) of Leverageable Capital, so that such Licensees are not 
required to prepay such excess. Such Licensees also may apply to issue 
additional Debentures or Participating Securities solely to pay the 
amount due on such maturing Debentures. The maturity date of any new 
Debenture or Participating Securities issued for this purpose may not 
be later than September 30, 2002.

3. Leverage for Section 301(d) Licensees

    In proposed Sec. 107.230, SBA described some of the terms and 
conditions of Leverage for section 301(d) Licensees. SBA may provide 
Leverage to section 301(d) Licensees through the purchase or guarantee 
of Debentures and/or Participating Securities, and/or through the 
purchase of Preferred Securities. As further described below, the 
proposed rule provided that section 301(d) Licensees would be eligible 
for subsidized Debenture Leverage and for Preferred Securities Leverage 
up to a maximum of four hundred percent (400%) of Leverageable Capital 
or $35 million, whichever is less. Leverage in excess of that amount 
would be nonsubsidized.
    Six (6) comments were received on proposed Sec. 107.230. The 
comments were supportive of the proposal, except for the ceiling of $35 
million for subsidized Leverage. As the comments recognized, however, 
the $35 million ceiling on subsidized Leverage is statutory in origin. 
Section 402 of Public Law 102-366, which increased the general Leverage 
ceiling for the SBIC program above its prior level of $35 million, 
established the subsidized Leverage ceiling for section 301(d) 
Licensees. The regulation cannot permit a higher amount of subsidized 
Leverage than is permitted by the Act.
    SBA therefore is finalizing Sec. 107.230 as proposed, with the 
exception of one minor change, designed to correct an error: The four 
percent (4%) dividend on preferred stock and the four percent (4%) 
return on the preferred limited partnership interest accrue on an 
annual basis (rather than on a daily basis, as stated in the proposed 
rule).
    The Articles of section 301(d) Licensees are required to be 
conformed to the requirements discussed in paragraphs a. or b. below, 
as appropriate, in order to issue Preferred Securities after the date 
hereof.

a. Preferred Stock

    In the case of corporate Licensees, the preferred stock purchased 
by SBA prior to November 21, 1989, shall be non-voting stock with a 
three percent (3%) cumulative preferred dividend paid out of Retained 
Earnings Available for Distribution. Preferred stock issued after 
November 21, 1989, shall provide for four percent (4%) preferred 
cumulative dividends payable out of Retained Earnings Available for 
Distribution. Four percent (4%) preferred stock shall be redeemed not 
later than fifteen (15) years after issuance at a price not less than 
par value plus unpaid dividends accrued to the redemption date. SBA may 
guarantee non-subsidized Debentures offered for sale by a Licensee 
immediately prior to the redemption of its four percent (4%) preferred 
stock in such amounts as will permit simultaneous redemption of such 
stock.

b. Preferred Limited Partnership Interest

    Section 412 of Public Law 102-366 authorizes unincorporated section 
301(d) Licensees to issue preferred limited partnership interests to 
SBA which would have the same terms and conditions as the four percent 
(4%) preferred stock described immediately above (that is, a preferred 
and cumulative return at an annual rate of four percent (4%), payable 
from Retained Earnings Available for Distribution). Such preferred 
limited partnership interests shall be redeemed not later than fifteen 
(15) years from the date of issuance at a price not less than SBA's 
contributed capital plus accumulated and unpaid distributions through 
the redemption date. SBA may guarantee non-subsidized Debentures issued 
by a section 301(d) Licensee immediately preceding such redemption in 
such amounts as will permit simultaneous redemption of such preferred 
limited partnership interests.

C. Leverage Ceiling

    As in the proposed rule, Sec. 107.230(c) establishes maximum 
Leverage eligibility for section 301(d) Licensees. All types of 
Leverage issued by such Licensees shall be aggregated for purposes of 
determining Leverage eligibility, including aggregation of Leverage 
issued by Licensees under Common Control. As stated earlier, section 
301(d) Licensees are eligible for maximum subsidized Leverage 
(consisting of Preferred Securities and Debentures issued with a rate 
reduction) of four hundred percent (400%) of Leverageable Capital or 
$35 million, whichever is less. Section 301(d) Licensees also are 
eligible for nonsubsidized Leverage in excess of $35 million, subject 
to the amounts and conditions specified for section 301(c) Licensees.
    In order to qualify for Leverage exceeding three hundred percent 
(300%) of Leverageable Capital, at least thirty percent (30%) of the 
Licensee's Total Funds Available for Investment must be invested in or 
committed to Venture Capital Financing of Disadvantaged Concerns, and a 
Licensee must maintain thirty percent (30%) of its Total Funds 
Available for Investment in such investments while Leverage in excess 
of three hundred percent (300%) of Leverageable Capital is outstanding. 
For the purpose of meeting the thirty percent (30%) test, the Venture 
Capital Financings shall be valued at cost. The present definition of 
Venture Capital Financing remains unchanged and is set forth in 
Sec. 107.230(c)(3)(iii).

d. Second Tier of Preferred Securities

    As in the proposed rule, SBA is authorized to purchase Preferred 
Securities in amounts in excess of one hundred percent (100%) of 
Leverageable Capital, but not in excess of two hundred percent (200%) 
of Leverageable Capital, from certain Licensees. These are section 
301(d) Licensees with Leverageable Capital of $500,000 or more, or 
section 301(d) Licensee licensed on or before October 13, 1971, 
regardless of the amount of Leverageable Capital. In either case, a 
Licensee must have Qualified Investments (as defined in 
Sec. 107.230(c)(4)(iv)) equal, at cost, to the amount of Preferred 
Securities in excess of one hundred percent (100%) of Leverageable 
Capital. Commitments to make Qualified Investments may be counted to 
satisfy this requirement.
    It should be noted that the definition of Qualified Investments is 
similar, but not identical to, the definition of Venture Capital 
Financing as set forth in Sec. 107.230(c)(3)(iii). The most important 
difference is that a secured debt instrument may qualify as a Venture 
Capital Financing but would not qualify as a Qualified Investment.

e. Participating Securities

    Section 107.230(c)(6) authorizes section 301(d) Licensees to issue 
Participating Securities in an amount not exceeding two hundred percent 
(200%) of Leverageable Capital, less an amount equal to Licensee's 
outstanding Preferred Securities. Prioritized Payments and Profit 
Participation on Participating Securities issued by section 301(d) 
Licensees shall not be subsidized.

f. Other Provisions

    Section 107.230(d) describes the types of Debentures which section 
301(d) Licensees may issue, and Sec. 107.230(e) permits section 301(d) 
Licensees, in SBA's discretion, to retire Debentures through the 
issuance of Preferred or Participating Securities.
    Section 107.230(f) is a recodification of former 
Sec. 107.201(a)(2)(iii).

4. Participating Securities

    As proposed, Secs. 107.240 through 107.247 described special rules 
which would apply to Licensees issuing Participating Securities.
    SBA received many comments on these proposed rules. Most were very 
supportive, although many suggestions for improving the proposal were 
received. Comments related to specific provisions of the Participating 
Securities are addressed in the discussion of those respective sections 
of the rule.
    The Small Business Equity Enhancement Act of 1992 (title IV of Pub. 
L. 102-366) was a mandate for a new relationship between SBA and the 
venture capital community. The salient feature of this new relationship 
is the creation of Participating Securities. These are equity-type 
securities with the characteristics of preferred stock or a preferred 
limited partnership interest.
    SBA recognizes that venture capital companies usually make initial 
equity capital investments, manage their portfolios (making follow-on 
investments as necessary), and finally sell their investments as they 
mature, with the objective of realizing capital gains. As investments 
are sold, funds customarily are distributed to investors rather than 
reinvested.
    Under this rule, as a means of financing Licensees that issue 
Participating Securities, SBA will guarantee the payment of Prioritized 
Payments on, and the Redemption Price of, the Participating Securities 
to an authorized Trust or pool which purchases the Participating 
Securities. Prioritized Payments are the equivalent of dividend 
payments of the Participating Securities. As an inducement for its 
guarantee, SBA will be entitled to a share in the profits that are 
generated from investments made while the Participating Securities are 
outstanding (Profit Participation).
    Pass-through Trust Certificates evidencing rights in the Trust or 
pools of guaranteed Participating Securities will be sold to investors. 
The rights and obligations evidenced in the Trust Certificates also 
will be guaranteed by SBA. The proceeds of the sale of the Trust 
Certificates will be used to fund the Participating Securities.
    SBA anticipates that the Prioritized Payments made by Licensees 
that issue Participating Securities normally will not be adequate to 
fund debt service obligations of the guaranteed Trust Certificates in 
the early years of the Participating Securities' existence. 
Accordingly, SBA will be called upon to make such payments. Over the 
duration of a Participating Security's life, SBA expects to be repaid 
most of such guarantee payments through a combination of Earned 
Prioritized Payments and Profit Participation. Since Prioritized 
Payments on Participating Securities are payable only to the extent of 
earnings, SBA realizes that the repayment of its guarantee payments 
will depend upon the ability of its Licensees to operate profitably as 
equity investors.
    SBA understands that venture capital equity investments in Small 
Concerns are risky on an individual basis, and that losses on such 
investments frequently occur earlier than profits. It anticipates that 
Licensees issuing Participating Securities will incur losses in the 
early years of their investment cycle as investments in a limited 
number of portfolio concerns prove unprofitable and are written off. 
SBA recognizes that it must be patient in expecting profitable 
operations from Licensees with Participating Securities. At the same 
time, SBA has the responsibility to assure that publicly-guaranteed 
funds are administered prudently by capable managers. Accordingly, SBA 
has sought to formulate an economic and regulatory structure which will 
enhance the likelihood that Licensees participating in the program will 
be successful.
    In issuing this final rule, SBA believes that it can fulfill the 
objectives of the Small Business Equity Enhancement Act of 1992 to 
foster a venture capital industry that is able to serve the needs of 
eligible Small Concerns, create or retain jobs, expand the tax base, 
and achieve other objectives such as commercialization of technology, 
supporting manufacturing firms, fostering urban and rural business 
development, and stimulating exports.
    SBA recognizes that its guarantee of Participating Securities will 
be an essential factor in the decision of investors to fund Licensees, 
and that such investors will need to have confidence in SBA's long-term 
investment philosophy. While SBA intends that Participating Securities 
serve as patient capital, investors must recognize SBA's special 
responsibilities to protect public funds and assure compliance with 
program objectives and regulations.
    It should be noted that section 410 of Public Law 102-366 
authorized inclusion in a Licensee's private capital of investments by 
public and private pension funds as well as limited investments by 
state and local governments. The form of Participating Securities has 
been structured with the intention of avoiding the imposition of 
Unrelated Business Taxable Income (UBTI) on certain tax-exempt 
investors. SBA believes that pension funds and other tax-exempt 
investors will find it advantageous to invest in SBICs using 
Participating Securities. Since such institutional investors 
historically have provided investment capital to the private venture 
capital industry and have acquired expertise in selecting managers and 
monitoring investments, SBA anticipates that SBICs will benefit from 
this investor expertise. SBA also hopes to benefit from the expertise 
of institutional investors to help assure the profitability of the 
Licensees that issue Participating Securities.

a. General Provisions

    Proposed Sec. 107.241 set forth general provisions for Licensees 
issuing Participating Securities. This section reflects SBA's effort to 
use marketplace dynamics to assure a successful program.
(i) Minimum Regulatory Capital
    Proposed Sec. 107.241(a) set forth minimum capital requirements for 
eligibility to issue Participating Securities. In general, a Licensee 
would be required to have Regulatory Capital of at least $10 million in 
order to be considered eligible to issue Participating Securities. A 
Licensee with less than $10 million, but not less than $5 million, in 
Regulatory Capital also could be eligible if it were able to 
demonstrate to SBA's satisfaction that if could be financially viable 
over the long term.
    SBA received nineteen (19) comments on this provision, with some 
comments favoring the minimum capital requirements and others opposing 
them. Many of those opposed to the requirements argued in favor of a $5 
million threshold, and voiced the concern that larger SBICs may not 
serve the needs of smaller businesses and early-stage companies.
    SBA shares the concern that SBICs capitalized at over $10 million 
may not be oriented toward investing in smaller concerns. SBA is 
addressing that concern by requiring all Licensees to make a certain 
percentage of their investments in companies that are smaller than the 
maximum size permitted under the Size Rule. This requirement appears in 
Sec. 107.101(i) and is more fully discussed in the Operations Rule.
    In view of this requirement, SBA is comfortable with the $10 
million minimum capital requirement, and feels it is warranted for the 
following reasons:
    (1) A Licensee making venture capital type investments with 
Regulatory Capital of less than $10 million normally will be incurring 
excessively high fixed and marginal costs relative to the amount of its 
capital; and
    (2) Successfully raising $10 million for venture capital 
investments constitutes a significant affirmation by the investment 
community of the management capabilities of a Licensee. A more detailed 
discussion of SBA's rationale for adopting the $10 million threshold 
may be found in the proposed rule at 58 FR 41856.
    As stated above, SBA will consider authorizing the issuance of 
Participating Securities by a Licensee with Regulatory Capital of less 
than $10 million, but not less than $5 million, if the Licensee can 
show that it has a reasonable prospect of being profitable over the 
long term. Thus, a Licensee with Regulatory Capital of less than $10 
million might qualify to issue Participating Securities if it is a 
subsidiary of a bank, bank holding company, or other large organization 
which undertakes to subsidize management expenses of the Licensee and 
to provide management personnel and operation support.
    A Licensee with Regulatory Capital of less than $10 million also 
may be acceptable to SBA if it operates in a rural area or within a 
specific geographic area, such as a reasonably compact and focused 
urban area. Any such Licensee must have management with proven 
expertise in the types of investments proposed and must show, through 
its plan of operations, how it can be operated soundly and profitably 
over the long term without depleting its capital base through excessive 
overhead.
    It should be noted that some readers may have misunderstood the 
significance of the $10 million threshold. Raising $10 million will not 
automatically qualify an applicant for licensing as an SBIC that will 
issue Participating Securities. As has always been the case, applicants 
for licensing must demonstrate financial viability and qualified 
management, regardless of the amount of their Regulatory Capital. It is 
possible that a license applicant with $10 million in Regulatory 
Capital will have such high overhead expenses or such inexperienced 
management that its likelihood of profitability is put into question. 
SBA would not issue a license under such circumstances. Under ordinary 
circumstances, however, it can be expected that $10 million should 
serve as adequate capital for licensing as an SBIC in the Participating 
Securities program.
(ii) Equity Capital Investments
    Since no comments were received on proposed Sec. 107.241(b), SBA is 
finalizing it as proposed. This section requires Licensees issuing 
Participating Securities to invest an amount equal to the Original 
Issue Price of such securities solely in Equity Capital Investments. 
Equity Capital Investments must be maintained at such level and may be 
reduced only by the amount of repayments of such Participating 
Securities. ``Equity Capital Investments'' means common or preferred 
stock, limited partnership interests, options, and warrants or similar 
equity instruments, including subordinated debt with equity features if 
such debt provides only for interest payments contingent upon and 
limited to the extent of earnings. Equity Capital Investments in the 
form of debt may not be amortized.
(iii) Management and Ownership Diversity
    Proposed Sec. 107.241(c) required that there be some diversity 
between the ownership and the management of a Licensee that issues 
Participating Securities. The eight comments on this provision were 
mixed, with some supporting the proposal as an appropriate means of 
preventing self-dealing, and others opposing the proposal as unduly 
restrictive.
    SBA believes that the benefits of this proposal far outweigh any 
inconvenience to Licensees. It is important that Licensees issuing 
Participating Securities have investors who are independent of 
management and who have a substantial stake in the Licensee's financial 
performance. SBA believes that the presence of such investors will help 
to assure that Licensees are operated with the objective of optimizing 
returns and protecting the interests of all investors, including SBA. 
The proposal is therefore finalized without change.
    Under paragraph (1) of Sec. 107.241(c), SBA will consider the 
diversity requirement satisfied if at least three (3) unaffiliated 
shareholders or limited partners (only one is required in the case of 
Institutional Investors) own, in the aggregate, at least thirty percent 
(30%) of a Licensee or Licensee's ultimate parent entity. Such 
diversity also will be deemed to be achieved if a Licensee or its 
ultimate parent entity is publicly traded under U.S. securities laws. 
The independence and ability of investors to exercise oversight is 
maintained by the prohibition against the delegation of voting rights 
contained in paragraph (2) of Sec. 107.241(c). An exception is made for 
certain proxies and the use of unaffiliated advisors so as not to 
interfere with the routine operations of a Licensee.
(iv) Management Fees
    Under proposed Sec. 107.241(d), a Licensee issuing Participating 
Securities would be subject to a ceiling on its Management Expenses of 
2.5% of Combined Capital (Regulatory Capital plus outstanding 
Leverage), plus $125,000 in the case of Licensees with Combined Capital 
of less than $20 million. SBA could permit a higher amount or, in the 
case of larger funds, require a lower amount.
    SBA received sixteen (16) comments on this proposal. A frequently-
appearing objection was that the regulatory provision was more 
restrictive than the underlying statutory provision. Another objection 
concerned SBA's ability to unilaterally reduce allowable Management 
Expenses for larger funds.
    It is true that the proposal was more restrictive than the 
underlying statutory provision. Section 403 of Public Law 102-366 
provided a ceiling on Management Expenses only for purposes of 
computing SBA's Profit Participation. In the proposed rule, SBA 
extended the ceiling to a Participating Securities issuer's actual 
expenditures for Management Expenses, but allowed for an amount in 
excess of the ceiling if there were a clearly demonstrable need. SBA 
felt that the Management Expenses allowed under the proposal were 
adequate for most Licensees and were consistent with current venture 
capital industry practices.
    Based on the comments, SBA has reconsidered its position. Under 
this final rule, a Licensee issuing Participating Securities will be 
subject to the limits discussed above only for purposes of computing 
Earmarked Profits, which (as further discussed below) determine the 
amounts that may be allocated to Earned Prioritized Payments and to 
Profit Participation. See Sec. 107.242(d). Accordingly, 
Sec. 107.241(d), as finalized, no longer provides that a Licensee's 
actual Management Expenses are subject to percentage limits; however, 
the section still provides that actual Management Expenses must be 
approved by SBA.
    It should be understood by readers new to the SBIC Program that SBA 
presently approves, and will continue to approve, the management 
compensation for all Licensees, not just issuers of Participating 
Securities.\4\ Management compensation is but one component of 
Management Expenses, which includes such additional items as office 
expenses and office and equipment rentals. See the definition of 
Management Expenses in Sec. 107.3. Depending on the particular 
circumstances of the Licensee, approved management compensation and 
Management Expenses for a larger fund may be lower, on a percentage 
basis, than approved amounts for a smaller fund.
---------------------------------------------------------------------------

    \4\Licensees with outstanding Leverage must have increases in 
their management compensation approved before such increases are 
adopted. Licensees with no outstanding Leverage may have increases 
in their management compensation approved after the fact.
---------------------------------------------------------------------------

    This final rule also now provides that Licensees placed under 
``restricted operations'' under Sec. 107.262(d) are required to re-
obtain SBA's approval of their Management Expenses (or, for issuers of 
Preferred Securities, their management compensation) at the time 
restricted operations are imposed.
(v) Third-Party Debt (Temporary Debt)
    Proposed Sec. 107.241(e) limited the type and amount of third-party 
debt that a Licensee issuing Participating Securities could incur, and 
required that the Licensee obtain the written approval of SBA before 
incurring any such debt. Under the proposal, the only third-party debt 
that Licensees issuing Participating Securities would be permitted to 
have would be ``Temporary Debt'' in an amount not to exceed fifty 
percent (50%) of Leverageable Capital. Licensees would have to pay off 
and remain free of all Temporary Debt for at least thirty (30) 
consecutive days during each fiscal year.
    The fifteen (15) comments received on this provision objected to 
the requirement that a Licensee obtain prior SBA approval in order to 
incur Temporary Debt. The requirement was characterized as unduly 
restrictive and unnecessary. As with the comments discussed above under 
''Third-party Debt'' (subsection 1.(e) above), concern was expressed 
over possible delays in SBA's response time.
    SBA continues to believe that prior SBA approval of third-party 
debt is an important component of its administration of the SBIC 
Program. This is true for all Licensees, including those that issue 
Participating Securities. In order to unify its approach to third-party 
debt, SBA is finalizing Sec. 107.241(e) so that it conforms to the 
general Third-party Debt provision discussed above. In other words, if 
an issuers of Participating Securities is in regulatory compliance and 
has Leverage not in excess of 1.5 times its Leverageable Capital, and 
if the Licensee's request is for approval of a secured line of credit 
which would not cause its aggregate third-party debt to exceed the 
Temporary Debt limitation of fifty percent (50%) of Leverageable 
Capital, then the Licensee's request shall be considered approved 
unless SBA notifies it otherwise within thirty (30) days of receiving 
the request. Unsecured Temporary Debt up to the permissible level of 
Temporary Debt shall not require prior approval.
(vi) Liquidity Requirement
    Proposed Sec. 107.241(f) established a liquidity requirement for 
Licensees issuing Participating Securities in order to assure that such 
Licensees have sufficient cash to cover their operating overhead during 
the ensuing year. A Licensee would have a condition of Liquidity 
Impairment if the Liquidity Ratio (as defined in Sec. 107.241(f)(2)) 
obtained by dividing Total Current Funds Available\5\ by Total Current 
Funds Required is less than 1.20. No Distributions could be made if 
they would cause a condition of Liquidity Impairment.
---------------------------------------------------------------------------

    \5\Section 107.241(f)(2) includes a self-explanatory chart that 
shows how the respective values for Total Current Funds Available 
and Total Current Funds Required are to be determined.
---------------------------------------------------------------------------

    Few comments were received on this provision. Some opposed the 
concept as an unnecessary administrative burden; others recommended 
different weightings to some of the calculation inputs.
    SBA considers this provision important and does not agree that it 
is burdensome to the Licensee. SBA considers it essential that 
Licensees maintain a level of liquid assets sufficient to meet 
operating expenses, make necessary follow-on investments, and allow 
investments to be held until they mature and can be sold in the normal 
course of business. Accordingly, SBA is finalizing the provision 
without change.
(vii) Mandatory Redemption
    No comments were received on proposed Sec. 107.241(g), which 
required that Participating Securities be redeemed not later than 
fifteen (15) years after their issue date. The provision is finalized 
without change. As stated in the proposed rule, the redemption date 
generally will be ten (10) years after the date of issue and always 
will be the same as the maturity date of the Trust Certificates.
(viii) Priority in Liquidation
    No comments were received on proposed Sec. 107.241(h), which 
provided that upon liquidation of a Licensee, the Redemption Price of 
any Participating Securities, plus any Prioritized Payments, Profit 
Participation and other amounts that may be due SBA, shall be senior in 
priority to all other equity interests of the Licensee. The provision 
is finalized without change.
    As explained in the proposed rule, SBA recognizes that Prioritized 
Payments and Profit Participation are distributable only to the extent 
of profits on Earmarked Assets, notwithstanding the cumulative feature 
of Prioritized Payments. When a Licensee is liquidated, however, there 
can be no Distributions to investors before amounts due SBA, its agent, 
or Trustee are paid.

b. Computation of Earmarked Profits (Losses)

    SBA received no comments on the computation of Earmarked Profits 
(Losses), proposed Sec. 107.242. The provision is finalized as it was 
proposed, except for minor wording changes in the paragraph on 
Earmarked Investment Expenses. Since it should prove useful to have a 
complete summary of the Participating Securities regulations in one 
document, SBA is reprinting here the discussion on the computation of 
Earmarked Profits (Losses) that appeared in the proposed rule.
    There are seven steps in the computation of Earmarked Profits 
(Losses) as set forth in Sec. 107.242. (Please note that SBA will 
provide the spreadsheet templates and/or other software necessary for 
making the ensuing calculations.)
(i) Step 1: Determination of Earmarked Assets
    Earmarked Assets are a Licensee's Loans and Investments\6\ that are 
outstanding at the time a Licensee issues Participating Securities\7\ 
or acquired while Participating Securities are outstanding, plus any 
non-cash assets given in consideration for the disposition or exchange 
of any such asset. Even after all Participating Securities have been 
redeemed, Earmarked Assets maintain such status. See Sec. 107.242(b).
---------------------------------------------------------------------------

    \6\``Loans and Investments'' is a term that is defined in this 
rule as ``Portfolio Securities, Assets Acquired in Liquidation, 
Operating Concerns Acquired, and Other Securities Received as set 
forth in the Statement of Financial Position (SBA Form 468)''.
    \7\A company licensed on or before March 31, 1993 may elect to 
exclude its entire portfolio as it existed on that date (but not 
less than its entire portfolio) from the category of ``Earmarked 
Assets.'' In addition, if a company licensed on or before such date 
is refinancing outstanding Debentures by the issuance of 
Participating Securities, the company's entire portfolio must be 
included in Earmarked Assets. Special rules for such Licensees are 
located in Sec. 107.247.
---------------------------------------------------------------------------

(ii) Step 2: Calculating the Earmarked Asset Ratio
    This step establishes the percentage of a portfolio that is 
earmarked. Since a Licensee may have non-Earmarked Assets deriving from 
assets acquired after all Participating Securities have been redeemed, 
or determined under the special rules governing SBICs licensed on or 
before March 31, 1993 (see Sec. 107.247), it is necessary that all 
Licensees calculate an Earmarked Asset Ratio (EAR) as delineated in 
Sec. 107.242(c). The ratio is calculated on a weighted average basis 
(that is, on a month-by-month basis, which is then averaged) for the 
year or fraction of the year in question. For companies licensed after 
March 31, 1993 that have not yet redeemed any Participating Securities, 
EAR will equal one hundred percent (100%). The formula is:

EAR=[(EA+UPPS)/(L&I+UPPS)] x 100

where:

EA=Earmarked Assets valued at cost
UPPS=Uninvested proceeds of Participating Securities
L&I=Total Loans and Investments (valued at cost).

    The example that follows would apply only to companies licensed on 
or before March 31, 1993. Assume that such a Licensee had $15 million 
in Loans and Investments, issued $10 million of Participating 
Securities two months prior to the close of its fiscal year, and had 
elected to exclude its pre-existing portfolio from being Earmarked 
Assets (as permitted in Sec. 107.247). The following calculations would 
apply:


                       Values at Close of Month 1                       
------------------------------------------------------------------------
                               Uninvested                               
      Earmarked assets          proceeds        Loans and investments   
------------------------------------------------------------------------
Zero.......................     $10,000,000  $15,000,000 (acquired on or
                                              before 3/31/93).          
------------------------------------------------------------------------

    If the Licensee invested $2 million from the proceeds of 
Participating Securities during the next month, and sold $1 million of 
assets for cash, the following would occur:

                       Values at Close of Month 2                       
------------------------------------------------------------------------
                                            Uninvested       Loans and  
            Earmarked assets                 proceeds       investments 
------------------------------------------------------------------------
$2,000,000..............................      $8,000,000     $16,000,000
------------------------------------------------------------------------

    As of the close of Month 1, the Licensee's (interim) EAR was 40 
percent [(0=10,000,000)/(15,000,000=10,000,000)].
    As of the close of Month 2, for Month 2, (interim) EAR was 41.666 
percent [(2,000,000+8,000,000)/(16,000,000+8,000,000)].
    As of the close of the Licensee's fiscal year, the Licensee's EAR 
was 40.833 percent [(40+41.666)/2] or [(2,000,000+18,000,000)/
(31,000,000+18,000,000)]. For the purposes of the calculations 
hereafter discussed, this Licensee's EAR is 40.833 percent.
(iii) Step 3: Ascertaining Earmarked Investment Income
    Earmarked Investment Income (EII) is defined in Sec. 107.242(d)(1) 
by the formula:

EII=IDA+([IIF+OI] x EAR)

where

IDA=All income directly attributable to Earmarked Assets
IIF=Interest on idle funds
OI=Other income not attributable to specific assets
EAR=Earmarked Asset Ratio

    Thus, if IDA were $1,000,000 and other income not attributable to 
specific assets were $500,000, EII would be:

($1,000,000+($500,000 x 40.833%)) or $1,204,165.
(iv) Step 4: Calculating Earmarked Investment Expenses
    As defined in Sec. 107.242(d)(2), Earmarked Investment Expenses has 
two components--Management Expenses and non-Management Expenses.
    For the purposes of the calculations in Sec. 107.242(d)(2), 
Management Expenses means the lesser of (1) Licensee's approved 
Management Expenses multiplied by its EAR; or (2) 2.5 percent of the 
product of the Licensee's Combined Capital, multiplied by its EAR 
(plus, in the case of a Licensee whose Combined Capital is less than 
$20 million, an additional sum equal to the product of $125,000 and the 
Licensee's EAR). Expressed in formula terms, this would be:

Management Expense (ME)=0.025 x (CC x EAR) for a Licensee with Combined 
Capital (CC) of $20 million or more.
ME = [(0.025 x {CC x EAR}) + ($125,000 x EAR)] for a Licensee with 
Combined Capital of less than $20 million.

    The second component of Earmarked Investment Expense is non-
Management Expense. Some non-Management Expenses can be attributed 
directly to Earmarked Assets and, of course, are to be allocated to 
Earmarked Investment Expenses. In addition, Licensee must allocate to 
Earmarked Investment Expense a sum equal to the product of non-
Management Expense not attributable to specific assets (specifically 
including interest on SBA-guaranteed Debentures) times Licensee's 
Earmarked Asset Ratio. See Sec. 107.242(d)(2)(ii).
    The sum of the above-described Management and non-Management 
Expenses constitutes Earmarked Investment Expenses.
(v) Step 5: Determining Earmarked Net Investment Income (Loss)
    Subtract Earmarked Investment Expenses (step 4) from Earmarked 
Investment Income to determine Earmarked Net Investment Income (Loss) 
(step 3).
(vi) Step 6: Determining Earmarked Realized Gain (Loss) on Securities
    Section 107.242(e) sets forth rules for determining gain or loss on 
securities that constitute Earmarked Assets (Earmarked Realized Gain 
(Loss) on Securities). For the purpose of determining whether a gain or 
a loss has been realized\8\ on the sale of an Earmarked Asset, the 
asset's cost basis and net sales price shall be used. The asset's cost 
basis shall not be increased, even by capitalization of unpaid 
interest, except that if the basis of an investment in an 
unincorporated Small Concern is appropriately determined by using the 
equity method of accounting, the Licensee's basis may be increased by 
the Licensee's share of the Small Concern's income. See 
Sec. 107.242(e)(3).
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    \8\Unrealized Appreciation or Unrealized Depreciation, as the 
case may be, on Earmarked Assets that are Distributed shall be 
recognized as if the appreciation or depreciation were realized at 
the time of the In-Kind Distribution. See Sec. 107.242(3)(4), and 
see also Sec. 107.245(e)(3), which relates to In-Kind Distributions.
---------------------------------------------------------------------------

(vii) Step 7: Computing Earmarked Profits (Losses)
    Earmarked Profits (Losses) must be computed no less frequently than 
annually as of the close of a Licensee's fiscal year, and at such other 
times as Licensee elects to make a Distribution. See Sec. 107.242(a). 
The computation is simple enough: Earmarked Profits (Losses) is the 
sum, positive or negative, of Earmarked Net Investment Income (Loss) 
and Earmarked Realized Gain (Loss) on Securities. See Sec. 107.242(f).

c. Computation, Allocation, and Distribution of Prioritized Payments

(i) Introduction
    Proposed Sec. 107.243 provided for the computation, allocation, and 
payment of Prioritized Payments. These payments are preferred and 
cumulative at the Trust Certificate Rate, which is the rate SBA 
guarantees to pay annually to the Trust Certificate holders. 
Prioritized Payments resemble dividends on preferred stock or 
equivalent distribution on preferred or senior limited partnership 
interests.
    The few comments received on this portion of the proposed rule 
objected only to the Adjustments to the Prioritized Payments. In 
general, the Adjustments are additional amounts that become payable to 
SBA in the event the Licensee has sufficient profits. They are the 
result of the compounding that must be performed by a Licensee if it 
does not pay, at the end of its fiscal year, an amount equal to its 
annual Prioritized Payments. During the course of that year, SBA will 
have been making the interest payments as they come due under Trust 
Certificates issued against a pool containing the Licensee's 
Participating Securities. SBA's payment will be an amount equal to the 
Prioritized Payments on all the Participating Securities in the pool. 
The Licensees are not expected to be able to reimburse SBA immediately 
for those payments; SBA may wait years for reimbursement, and may never 
be reimbursed fully. The Adjustments are intended as partial 
compensation to SBA for the time-value of the payments the Agency makes 
in the interim. The Adjustments also help to lower the subsidy rate for 
the Participating Securities program. For these reasons, SBA feels it 
is important to retain the proposed concept of compounding of 
Prioritized Payments in this final rule. It should be emphasized that 
the Adjustments, like the Prioritized Payments themselves, are not due 
and payable unless the Licensee has sufficient Earmarked Profits to pay 
them.
    As a reminder to the reader, the calculation of Prioritized 
Payments is to be performed at least annually within ninety (90) days 
after the end of the Licensee's fiscal year, and also at the end of any 
fiscal quarter for which a Distribution is contemplated. If the 
Licensee has cumulative Earmarked Profits, Prioritized Payments up to 
the amount of such profits are characterized as Earned Prioritized 
Payments and are to be distributed automatically within (90) days after 
the end of the Licensee's fiscal year, except to the extent that such 
Distribution would create a condition of Liquidity Impairment.
    A Licensee with Participating Securities or Earmarked Assets in its 
portfolio is prohibited from making any Distributions that are 
considered to be a return on capital until all Prioritized Payments 
have been distributed. Before returns of capital can be made, all 
Earned Prioritized Payments must have been distributed. See 
Sec. 107.245. We repeat in paragraphs (ii) through (vii) below, for the 
reader's benefit, the detailed discussion of the computation of Earned 
Prioritized Payments and Earned Adjustments that appeared in the 
proposed rule. There are no changes to the related regulatory 
provisions in this final rule.
(ii) Establishment of Prioritized Payment Accounts
    To assist in the process of determining whether, or when, a 
Licensee is responsible for making payments, two Prioritized Payment 
accounts must be established: A Prioritized Payment Accumulation 
Account (AA) which is a memorandum account, and a Prioritized Payment 
Distribution Account (DA) which is a liability account. For the sake of 
simplicity, the hypothetical examples set forth in paragraphs (iii) and 
(iv) below illustrate the computations at the fiscal year end following 
the first issuance of Participating Securities.
(iii) Initial allocations to Prioritized Payment Accumulation Account
    The Prioritized Payment Accumulation Account initially reflects the 
``accrual'' (as a memorandum entry only) of Prioritized Payments. 
Computations involving this account always begin with the entry of a 
sum equal to all Prioritized Payments for the fiscal period in 
question. For example, if a Licensee had issued $10 million of eight 
percent (8%) Participating Securities at the beginning of its fiscal 
year, the initial amount to be added to the AA at the close of the 
fiscal year would be $800,000. See Sec. 107.243(b)(1). As subsequently 
explained, the Adjustments referred to above may also be added to this 
account.
(iv) Initial Allocations to Prioritized Payment Distribution Account 
(DA)
    The first step in determining what should be added to the DA is to 
ascertain cumulative Earmarked Profits (Losses). If, at the fiscal year 
end following the first issuance of Participating Securities, the 
Licensee has cumulative Earmarked Profits, that sum constitutes 
Distributable Earmarked Profits.
    The second step is to compare Distributable Earmarked Profits with 
the balance in the AA. The lesser of the two is subtracted from the AA 
and is added to the DA. This amount now constitutes Earned Prioritized 
Payments. See Sec. 107.243(c).
    For example, suppose that Earmarked Profits were $20,000. Since 
$20,000 is less than the $800,000 of Prioritized Payments, $20,000 is 
subtracted from the AA and is added to the DA. At this point there 
would be $780,000 in the AA and $20,000 in the DA. The latter sum 
represents Earned Prioritized Payments and is the amount the Licensee 
will distribute to SBA or the Trust, unless such Distribution would 
cause a Liquidity Impairment. See Sec. 107.243(c).
(v) Subsequent Allocations to Prioritized Payment Accumulation Account 
and to Prioritized Payment Distribution Account
    Subsequent allocations to these accounts will be made similarly, 
except that Distributable Earmarked Profits for subsequent years are 
calculated by subtracting from cumulative Earmarked Profits all 
previous Earned Prioritized Payments and all earned Adjustments (as 
described below) for prior fiscal periods.
    In our example, at the end of the second year following issuance of 
$10 million of eight percent (8%) Participating Securities, an 
additional $800,000 would be allocable preliminarily to the AA, 
bringing that account (temporarily) up to $1,580,000. If Earmarked 
Profits for the second year were $40,000, cumulative Earmarked Profits 
would be $60,000. Ignoring for the moment ``earned Adjustments'', 
Distributable Earmarked Profits for Year 2 would be $40,000. Since 
$40,000 is less than 41,580,000, the sum of $40,000 would be added to 
the DA and subtracted from the AA. Thus, at the close of Year 2, the 
balance in the AA would be $1,540,000 (exclusive of any Adjustments) 
and, assuming no Distribution of Earned Prioritized Payments had been 
made to SBA, the balance in the DA would be $60,000.
    In making these calculations, Earmarked Losses are disregarded. 
Thus, if the Licensee had Earmarked Profits of $20,000 for the first 
year and Earmarked Losses of $100,000 during the second year, the 
$20,000 ``obligation'' already reflected in the DA would have been 
unaffected. See Sec. 107.243(d).
(vi) Distributions of Prioritized Payments
    With one exception, a Licensee is required to remit the balance in 
its DA to SBA, its agent or Trustee within 90 days after the end of the 
Licensee's fiscal year, or before any Distribution is made to its own 
investors, as appropriate. Any amount remitted to SBA is subtracted 
from the DA. If a Licensee has issued Participating Securities on more 
than one occasion, Prioritized Payments are made in order of maturity 
of the underlying Participating Security.
    As an exception, a Licensee is excused from remitting the balance 
in the DA to the extent that such remittance would cause the Licensee 
to violate the liquidity requirement set forth in Sec. 107.241(f). 
Thus, if a Licensee has Earned Prioritized Payments of $1,400,000, and 
a cash balance of $1,800,000, but needs to retain $1,000,000 in cash to 
attain the required liquidity ratio, the Licensee must remit only 
$800,000 to SBA. See Sec. 107.243(c)(3)(iii). Failure to make 
Distributions because of insufficient liquidity does not trigger a 
regulatory violation.
(vii) Adjustments to Prioritized Payments
    A Licensee's failure to make timely distributions of Earned 
Prioritized Payments in an amount equal to Prioritized Payments results 
in the accumulation of additional amounts which may become payable to 
SBA, subject to the existence of sufficient Earmarked Profits. If, at 
the end of any fiscal year, there is an unpaid balance in the AA, an 
amount equal to the average monthly balance in that account is 
multiplied by a rate equal to the average of the rates on new Trust 
Certificates (TCs) sold to the public\9\ during the Licensee's fiscal 
year, and the product is added to the balance in the AA as a supplement 
to Prioritized Payments. See Sec. 107.243(d)(1).
---------------------------------------------------------------------------

    \9\SBA will publish a notice of the TC rate from time to time in 
the Federal Register.
---------------------------------------------------------------------------

    Similarly, if there is an unpaid balance in the DA account at the 
end of the Licensee's fiscal year, an amount equal to the average 
monthly balance in that account is multiplied by a rate equal to the 
average of the rates on new TCs sold to the public during the 
Licensee's fiscal year, and the product is added to the balance in the 
AA, not to the balance in the DA. See Sec. 107.243(d)(2).
    These additional amounts added to the AA are referred to as 
``Adjustments''. Once added to the AA, the Adjustments are 
indistinguishable from Prioritized Payments; they are characterized as 
``earned'' and transferred to the DA in the same manner as Prioritized 
Payments are characterized as ``earned.''
    As long as unpaid Earned Prioritized Payments, including earned 
Adjustments, are outstanding, the Licensee must make the calculations 
described in this paragraph ``c'' as of the end of each subsequent 
fiscal quarter until all such amounts are paid in full. See 
Sec. 107.243(c)(3).

d. Calculation and Allocation of Profit Participation

(i) Introduction
    In proposed Sec. 107.244, SBA described its right to a percentage 
of the profits of a Licensee issuing Participating Securities. In 
consideration for its guarantee of a Licensee's Participating 
Securities, SBA\10\ has a contractual right to Profit Participation 
consisting of a specified percentage of the Licensee's Earmarked 
Profits. The percentage is determined, in part, by the ratio of 
outstanding Participating Securities Leverage to Leverageable Capital.
---------------------------------------------------------------------------

    \10\Neither the holders of TCs, nor the Trust itself has any 
interest in the Profit Participation to which SBA may be entitled.
---------------------------------------------------------------------------

    SBA received eighteen (18) comments on the subject of the Profit 
Participation. Most complained that the regulations should provide a 
mechanism for offsetting prior distributions of profits to SBA against 
subsequent losses of the Licensee. This so-called ``levelling up'' is a 
component of many venture capital funds, and is designed to ensure that 
partners ultimately receive only their agreed-upon profit shares.
    SBA was aware of this issue when it drafted the proposed rule. 
Under the Distributions section of the preamble to the proposed rule 
(section 4.e.(vi)), SBA discussed the reasons for not including a 
level-up in the proposed rule. See 58 FR 41862. SBA believed then, and 
continues to believe, that Section 403 of Public Law 102-366 prohibits 
a recharacterization of amounts already distributed to SBA. There is no 
discretion on SBA's part to include a ``levelling-up'' provision in 
this final rule.
    Even if a recharacterization of distributed amounts were legally 
permissible, SBA believes that it would be extremely difficult to 
calculate because of the complexity produced by changes in SBA's profit 
share (the Profit Participation) and its share of Distributions under 
Secs. 107.245 (c) and (d). SBA's profit share in a Licensee is 
increased when new Participating Securities are issued by the Licensee 
and/or the Licensee's Leverageable Capital is decreased. SBA's profit 
share is decreased when approved increases in Leverageable Capital 
occur. At the same time, SBA's share of Distributions (in the form of 
returns on capital or returns of capital) is changed as increases or 
decreases occur in either the Licensee's Leverageable Capital or its 
Leverage outstanding. See discussion of Secs. 107.245 (c) and (d) 
below. SBA currently does not have a mechanism that can account 
accurately for all these changes in order to identify what SBA's share 
of Distributions would have been if ``losses after profits'' were taken 
into account.
    SBA also believes that there should be less need for a 
recharacterization of distributed amounts if the Licensee has been 
valuing its portfolio investments fairly, especially the determination 
of Unrealized Depreciation on Loans and Investments. SBA regulations 
require Licensees to reduce their Undistributed Net Realized Earnings 
by their Unrealized Depreciation on Loans and Investments in order to 
determine Retained Earnings Available for Distribution (READ). See 
Sec. 107.3. Distributions of SBA's Profit Participation, which the 
commenters would like to be able to recharacterize as a return of 
capital, can only be made out of the Licensee's READ. Therefore, if the 
Licensee has not grossly underestimated its Unrealized Depreciation, 
the Licensee's READ and consequently its Distributions of Profit 
Participation to SBA should already reflect, to some degree, future 
realized losses. There should be reduced need for a major 
recharacterization of earlier distributed amounts when the later losses 
are actually realized.
    In conclusion, in the absence of a statutory amendment allowing for 
a recharacterization, a satisfactory mechanism to implement the change, 
and a compelling justification of the need for it, SBA is finalizing 
the proposed rule without incorporating a level-up or 
recharacterization of prior distributions. SBA expects that discussions 
on the subject will continue between it and interested industry members 
and that it might at some time in the future propose a different 
resolution.
    The method for computing, allocating and distributing the Profit 
Participation is described below. Although the method has been 
simplified from that set forth in the proposed rule, the result is 
identical.
    In summary, Sec. 107.244 mandates the establishment of a Profit 
Participation Account to reflect the allocation and distribution of the 
Profit Participation due SBA. The sum to be allocated is determined by 
multiplying the Base for Profit Participation, if positive, by the 
applicable Profit Participation Rate.
(ii) Computing the Profit Participation Base
    The computation of the Profit Participation Base is to be made at 
the end of the Licensee's fiscal year and at the end of any fiscal 
quarter for which a Distribution is contemplated. Briefly, the Base for 
Profit Participation (Base) is a number equal to year-to-date Earmarked 
Profits (Losses) minus year-to-date Prioritized Payments and 
Adjustments, minus any unused loss carryforward, as determined in the 
manner hereafter discussed.
(iii) Determination of Unused Loss Carryforward
    To determine its unused loss carryforward, a Licensee must look 
back to the Base computed at the end of its previous fiscal year (the 
``Previous Base''). If the Previous Base was zero or greater, then the 
Licensee's unused loss carryforward is zero. However, if the Previous 
Base was less than zero, then the unused loss carryfoward is equal to 
the Previous Base. During or at the end of its first year of operation, 
a Licensee has no Previous Base and, therefore, no loss carryforward.
    In effect, a Previous Base which is negative reflects all prior 
losses and Accumulated Prioritized Payments of the Licensee, which are 
carried forward to offset future earnings. Conversely, a Previous Base 
which is positive is not carried forward because once Earmarked Profits 
are used as the basis for an allocation to the Profit Participation 
Account, they are disregarded in any subsequent allocation or 
computation. See Sec. 107.244(b)(2).
    Some illustrations may help clarify this concept. Assume that a 
Licensee had issued $10 million of 8 percent Participating Securities 
on July 1, 1994, the first day of its fiscal year, and had Earmarked 
Profits of $20,000 as of the close of the fiscal year, June 30, 1995. 
The Licensee's Base would be ($780,000), computed by subtracting 
Prioritized Payments of $800,000 for Earmarked Profits of $20,000 (the 
unused loss carryfoward would be zero because the Licensee had not 
previously computed a Base). Now assume that fiscal year 1995-96 was 
extremely successful and that the Licensee's Earmarked Profits for that 
year were $2 million. Since the Previous Base was negative, it would be 
the Licensee's unused loss carryforward. The new Base, therefore, would 
be $420,000: ([$2,000,000 current period Earmarked Profits--$800,000 
current period Prioritized Payments]-$780,000 unused loss 
carryforward).
    As a second example, assume that the Licensee had instead posted an 
Earmarked Loss of $20,000 during the first year that Participating 
Securities were outstanding. The unused loss carryforward would be 
$820,000. At the end of the second year, the Base for Profit 
Participation would be only $380,000 ([$2,000,000-$800,000]-$820,000).
(iv) Computing Profit Participation Rates
    (A) When computation is required; general rules. Computation of a 
Profit Participation Rate for the relevant fiscal period must be made 
at least annually or prior to any Distribution. A Licensee should use 
one of the two formulas, as appropriate, which are set forth in 
paragraphs (B) and (C), below. Except as described in paragraph (E) 
below, the Profit Participation Rate that any particular Licensee must 
use depends on the highest ratio of Leverageable Capital to 
Participating Securities outstanding which has ever been computed for 
such Licensee. This is the Participating Securities to Leverageable 
Capital (PLC) ratio.
    (B) Participating Securities not at any time in excess of 
Leverageable Capital. Subject to the indexing described in paragraph 
(D) below, for a Licensee whose outstanding Participating Securities 
have never exceeded its Leverageable Capital, the Profit Participation 
Rate is equal to the PLC ratio multiplied by nine percent (9%). Thus, 
the Profit Participation Rate=PLC ratio x 0.09. For a Licensee that has 
a PLC ratio equal to exactly one hundred percent (100%) of Leverageable 
Capital, the Profit Participation Rate is nine percent (9%); for every 
other Licensee described in this paragraph (B), the Profit 
Participation Rate is less than nine percent (9%).
    (C) Participating Securities in excess of Leverageable Capital at 
any time. Subject to the indexing described in paragraph (D), for a 
Licensee whose outstanding Participating Securities have exceeded its 
Leverageable Capital, the Profit Participation Rate is equal to nine 
percent (9%) plus an additional percentage equal to the product of .03 
multiplied by an amount obtained by subtracting one (1) from the PLC 
ratio. In other words, Profit Participation Rate=.09+(.03 x [PLC 
ratio-1]). If a Licensee has $10 million in Leverageable Capital and 
$15 million in Participating Securities, the PLC ratio =1.5 and Profit 
Participation Rate equals 10.5 percent, .09+(.03 x [1.5-1]).
    (D) Indexing. No indexing of the Profit Participation Rate is 
required if, on the date the Participating Securities were issued, the 
yield-to-maturity rate on Treasury bonds with a remaining term of ten 
years (the ``Treasury Rate'') is exactly eight percent (8%). Otherwise, 
the Profit Participation Rate calculated in accordance with 
Sec. 107.244(c) (2) or (3) shall be adjusted upward or downward 
proportionately to such Treasury Rate (that is, by the percentage, 
rather than the same number of percentage points or basis points, by 
which the Treasury Rate may be above or below eight percent (8%)).
    For example, if the Treasury Rate were ten percent (10%) and the 
unindexed Profit Participation Rate were nine percent (9%), the 
appropriate indexed Rate would be 11.25 percent. Ten (10) is twenty-
five percent (25%) more than eight (8); 125 percent of nine percent 
(9%) is 11.25 percent.
    If a Licensee has issued Participating Securities on two or more 
occasions, any indexing of the Profit Participation Rate will be based 
on the average Treasury Rate for all such issuances, weighted to 
reflect the dollar amount of each issue and the portion of the fiscal 
period during which each issue was outstanding. See 
Sec. 107.244(c)(4)(ii).
    (E) Approved increases in Leverageable Capital. Computation of the 
Profit Participation Rate is not to be affected by any subsequent 
increase in Leverageable Capital, except to the extent that (1) the 
increase in Leverageable Capital is the result of the funding of 
unfunded commitments or the conversion to cash of assets previously 
recognized by SBA as a part of Private Capital, but not of Leverageable 
Capital, or (2) such increase is expressly provided for in a plan of 
operations previously approved by SBA. See Sec. 107.244(c)(5).
(v) Computing Profit Participation
    The amount of SBA's Profit Participation for a fiscal year or 
fiscal year-to-date is computed by multiplying the Base as of the end 
of such period by the Profit Participation Rate for such period, and 
subtracting from the result any amounts of Profit Participation that 
were paid or reserved for payment to SBA for any prior interim period 
during the same fiscal year.
    Any computation of Profit Participation made as of the close of an 
interim fiscal quarter is subject to adjustment whenever any subsequent 
interim distributions are contemplated, and at the end of the fiscal 
year, in order to account for any increase in the Profit Participation 
Rate. If the Profit Participation Rate decreases as a result of an 
approved increase in Leverageable Capital, Profit Participations 
already computed for any interim periods shall not be adjusted. See 
Sec. 107.244(d)(3).
(vi) Allocation of Profit Participation
    Prior to any Distributions, and in any event within 90 days 
following the end of the Licensee's fiscal year, the amount of any 
Profit Participation calculated in accordance with Sec. 107.244(d) 
shall be allocated to a Profit Participation Account. Funds equal to 
the amount allocated to this account shall be reserved for SBA and 
shall not be available for reinvestment in Small Concerns or for any 
other use by the Licensee; these funds shall be distributed only to 
SBA.
(vii) Distribution of Profit Participation
    Distribution of allocated Profit Participation shall be made at the 
same time that profits are distributed to the Licensee's investors, 
either as a tax Distribution or as a return on capital.

e. Distributions

(i) General
    Proposed Sec. 107.245 set forth restrictions and other conditions 
on a Licensee's Distributions other than Prioritized Payments. All 
Prioritized Payments must be paid before any Distributions are made 
that are classified as a tax Distribution or a return on capital. 
Earned Prioritized Payments and earned Adjustments, as recorded in the 
DA, must be paid before any Distributions are made that are classified 
as returns of capital. Distributions pursuant to Sec. 107.245 may be 
made only to the extent that they do not cause a condition of Liquidity 
Impairment. See Sec. 107.241(f).
    Comments received on proposed Sec. 107.245 are addressed in the 
particular subsection (Tax Distributions, Returns on Capital, or 
Returns of Capital) to which such comments relate.
(ii) Tax Distributions
    (A) General. Pursuant to proposed Sec. 107.245(b), a Licensee that 
is organized as a limited partnership, S Corporation, or similar pass-
through entity, could elect to make an annual Distribution from 
Retained Earnings Available for Distribution (READ) to each of its 
investors (specifically including SBA) in amounts not greater than the 
``Maximum Tax Liability'' (as computed in paragraph (B) below) for 
Federal and State income taxes on the Federal taxable income imputed to 
each investor for that fiscal year. Since SBA is not a tax-paying 
entity, the amount of SBA's share of any such Distribution would be 
determined by multiplying the tax Distribution to all partners by SBA's 
``Profit Participation Rate'', determined in accordance with 
Sec. 107.244. Anything that SBA received as its share of a tax 
Distribution would be credited first against Profit Participation as 
described below.
    Some comments warned that the Agency's interest would not be 
protected adequately if Licensees were permitted to make tax 
Distributions based on annual profits, without regard to the tax 
benefit that had been conferred on investors by prior years' losses. A 
cumulative measure of income comparable to that used for Prioritized 
Payments or returns on capital was recommended.
    While not disagreeing with the need for protection, SBA believes 
that the final rule offers adequate safeguards against an unfair 
result. A Licensee's ability to make a tax Distribution is always 
dependent upon the existence of sufficient Retained Earnings Available 
for Distribution. Tax Distributions can only be made from a Licensee's 
READ, which is a cumulative measure of income. Although a Licensee may 
compute a Maximum Tax Liability (which is based on annual income) in 
excess of its Retained Earnings Available for Distribution, its tax 
Distribution can never exceed its READ. Thus, prior years' losses do 
affect a Licensee's ability to make a tax Distribution.
    Furthermore, SBA has revised the proposed tax Distribution 
provision to clarify that to the extent a Licensee is unable or elects 
not to make a tax Distribution for any fiscal year within ninety (90) 
days following the end of such fiscal year, it shall have no right to 
make such Distribution at any later date. With this clarification, SBA 
has decided to finalize the proposal on tax Distributions.
    There are two other important limitations on the right of a 
Licensee to make tax Distributions. There can be no unpaid Prioritized 
Payments and the Distribution can not cause the Licensee to have a 
``Liquidity Impairment''.
    Although Sec. 107.245(b) refers to ``tax Distributions'', the 
amounts distributed may exceed any true tax liability (particularly for 
those investors that are exempt from Federal or State taxation). Other 
than SBA, every investor in a Licensee that is a pass-through entity is 
presumed conclusively (1) to be a resident, for tax purposes, of the 
State in which the Licensee's principal office is located; and (2) to 
be liable to pay Federal and State income taxes at the highest marginal 
tax rates applicable to each category of income (such as ordinary 
income as opposed to capital gains). If individuals are taxed at a 
higher rate than corporations, every investor will be presumed 
conclusively to be an individual even if actually a corporation or a 
pension fund. See Sec. 107.245(b).
    (B) Computation of tax Distribution to Investors. The maximum 
amount potentially distributable to all investors (including SBA) is 
determined by multiplying the aggregate amounts of ordinary income and 
capital gains imputed to investors by the highest combined marginal 
Federal and State tax rates applicable to each category, taking into 
account the deductibility of State taxes when computing Federal taxes. 
Local taxes (for example, county and city taxes) are disregarded for 
this purpose.
    By way of illustration, assume that at the end of the Licensee's 
first fiscal year, $1,000 in ordinary income had been imputed to all 
investors (including tax-exempt organizations). If the highest rate of 
Federal tax on ordinary income is thirty-five percent (35%) and the 
highest rate of State tax on ordinary income is five percent (5%), it 
is conclusively presumed that investors will have to pay $50 in State 
income taxes on the $1,000 in the Licensee's hands. But since the $50 
payable to the State is deductible from the investors' Federal taxable 
income, their Federal income tax liability is based on only $950, and 
is therefore equal to $332.50. The maximum amount that may be 
distributed to investors (including SBA) pursuant to Sec. 107.245(b) 
would be $332.50 plus $50.00 or $382.50 (not $400, which would be forty 
percent (40%) of $1,000).
    The proposed rule incorrectly suggested that SBA's share of the tax 
Distribution was in addition to the tax Distribution to investors as 
computed above. SBA is here clarifying that, in accordance with section 
403 of Public Law 102-366, the tax Distribution to investors as 
computed above includes SBA's tax Distribution. In other words, the 
amount calculated as the tax Distribution for all investors is not 
available for distribution to all non-SBA investors; SBA's portion must 
be deducted for distribution to SBA.
    (C) Computation of tax Distributions to SBA. The amount to be 
remitted to SBA is computed by multiplying the total tax Distribution 
as computed above by the Profit Participation Rate computed in 
accordance with Sec. 107.244(c). The amount of such tax Distribution to 
SBA shall be subtracted from the Profit Participation Account referred 
to above.
(iii) Returns on Capital
    (A) General. Proposed Sec. 107.245(c) established requirements for 
all Distributions in the form of returns on capital and some 
Distributions in the form of returns of capital. The proposal provided 
that after making all Prioritized Payments and any tax Distributions, a 
Licensee with READ would be required, within 90 days following the 
close of its fiscal year (or in its discretion, a fiscal quarter), to 
make Distributions under this section to its investors and SBA to the 
extent that they would not cause a Liquidity Impairment. In appropriate 
circumstances, SBA could waive this requirement. All such Distributions 
to investors must be made from READ (and would be returns on capital); 
Distributions to SBA may or may not be from READ (and may be returns on 
capital or returns of capital).
    A number of comments indicated dissatisfaction with the requirement 
that Distributions be made within 90 days of the Licensee's fiscal year 
end. They argued that it can often be imprudent for a Licensee to 
distribute all of its profits, and expressed concern over potential 
delays in obtaining waivers from SBA.
    SBA is particularly sympathetic to issues affecting the prudent 
management of Licensees. The Liquidity Impairment test itself is 
imposed on all Distributions to ensure that Licensees are prudent 
managers of their cash flows. Still, SBA recognizes that prudent 
management of cash flow and investments means more than merely 
satisfying the Liquidity Impairment test, and that there will be times 
when a Licensee should refrain from distributing all profits. While SBA 
believes that the waiver provision will help to prevent the imprudent 
distribution of a Licensee's profits, it agrees with the need for 
prompt consideration of waiver requests.
    In order to assure Licensees that requests for prior approval will 
be processed on a timely basis, the final rule provides that the 
Licensee's request for prior approval will be considered approved 
unless SBA notifies it otherwise within thirty (30) days of receiving 
the request. All requests for prior approval should be accompanied by 
sufficient information for SBA to make an informed decision.
    SBA has concluded that Licensees may need more than ninety (90) 
days after their respective fiscal year-ends to calculate and make 
Distributions under Sec. 107.245(c). Accordingly, this final rule 
provides that a Licensee is required to make such Distributions within 
120 days of the end of its fiscal year.
    Each Licensee that expects to need prior approval under 
Sec. 107.245(c) should make sure its request is received by SBA before 
the ninetieth day after its fiscal year end so that SBA is able to 
respond before the arrival of the 120th day, when Distributions must be 
made. SBA believes that with the addition of a definitive thirty-day 
response time, Licensees should be able to plan for their needs and yet 
meet the requirements of the regulation.
    The balance of Sec. 107.245(c) is finalized as it was proposed. It 
provides that while the dollar amount of Profit Participation is 
determined by formula according to the ratio of Participating 
Securities to Leverageable Capital, the actual amount to be distributed 
to SBA when there is a return on capital to private investors is a 
function of the ratio of total Leverage (Debentures, and Preferred 
Securities, and Participating Securities) to Leverageable Capital. See 
Sec. 107.245(c).
    As with the proposed rule, if SBA determines that the value of the 
Licensee's assets are materially overstated and if SBA provides the 
Licensee with timely notice of such determination in advance of a 
proposed Distribution, SBA reserves the right to restrict 
Distributions.
    Distributions paid to SBA under Sec. 107.245(c) are applied in the 
following sequence:
    (i) Profit Participation;
    (ii) Dividends or equivalent distributions on Preferred Securities;
    (iii) Redemption or prepayment of outstanding Participating 
Securities;
    (iv) Redemption or prepayment of outstanding Preferred Securities; 
and
    (v) Repayment of principal of outstanding Debentures. If there are 
restrictions on prepayment of outstanding Debentures, that part of 
SBA's share of a Distribution that is to be applied toward such 
prepayment shall be deposited in an escrow account on such terms and 
conditions as SBA may prescribe.
    It is noted that Distributions to SBA will be made from READ only 
to the extent of Profit Participation and dividends or equivalent 
distributions, if any, on Preferred Securities. To the extent that a 
Distribution is applied as a repayment or redemption of Leverage, it 
shall not reduce READ.
    (B) Computation of SBA's share. As in the proposed rule, if 
outstanding Leverage is more than two hundred percent (200%) of 
Leverageable Capital, SBA's share of any Distribution under 
Sec. 107.245(c) shall be in the ratio of Leverage to Leverageable 
Capital. In other words, if a Licensee has outstanding Leverage equal 
to three hundred percent (300%) of Leverageable Capital, SBA's share 
shall be \3/4\ or seventy-five percent (75%) of any such Distribution 
and SBA would be entitled to $3 for every $1 distributed to other 
investors. If outstanding Leverage were two hundred fifty percent 
(250%) of Leverageable Capital, SBA would be entitled to $2.50 for 
every $1 distributed to other investors.
    If outstanding Leverage is more than one hundred percent (100%) of 
Leverageable Capital, but not more than two hundred percent (200%), 
SBA's share of any such Distribution shall be equal to the aggregate 
shares of all other investors. For every $1 distributed to other 
investors, SBA shall receive $1.
    If outstanding Leverage is not more than one hundred percent (100%) 
of Leverageable Capital, SBA's share of any such Distribution shall be 
a percentage equal to the Profit Participation Rate.
(iv) Returns of Capital
    Under this heading, it is appropriate to discuss comments received 
regarding the definition of ``Retained Earnings Available for 
Distribution'' (READ). Any changes in that definition would affect the 
allocation of Distributions between returns on capital and returns of 
capital for companies with Participating Securities. It should be 
noted, however, that READ is a defined term which applies to all 
Licensees. Any change in the definition would actually have a more 
significant effect on Licensees without Participating Securities 
because they are subject to much stricter limitations on their ability 
to return capital to investors.
    In general, the comments expressed the opinion that READ should 
include Unrealized Appreciation as an offset to Unrealized 
Depreciation. In other words, READ would be defined to mean 
Undistributed Net Realized Earnings less net Unrealized Depreciation.
    SBA understands the arguments of the industry, including issues of 
fairness and good faith, but remains unconvinced. As a general rule, 
the portfolio valuation process is not sufficiently reliable to allow 
Unrealized Appreciation to be a component of READ without introducing 
an undue risk of premature distributions. While the calculation of 
Capital Impairment allows for an offset of Unrealized Appreciation 
against Unrealized Depreciation, and even gives credit against realized 
losses for some net Unrealized Appreciation, Capital Impairment and 
READ serve different purposes in the SBIC Program. The former is a 
regulatory measure of financial health; the latter is the basis for 
distributing cash out of the company. Accordingly, SBA intends to 
retain the conservative measure of READ in its final rule, defining 
READ to mean Undistributed Net Realized Earnings less Unrealized 
Depreciation.
    SBA recognizes that there may be occasions when otherwise 
unauthorized distributions should be approved. A Licensee may request 
SBA's prior approval to make a distribution in excess of READ in 
accordance with the provisions of Sec. 107.1201. In considering such 
requests, SBA will consider all relevant factors, including the 
existence of Unrealized Appreciation.
    Since there were no other comments on Sec. 107.245(d), SBA is 
finalizing it without any other change. It provides that after paying 
all Earned Prioritized Payments including earned Adjustments in the DA, 
and all allocated Profit Participation, and provided the Licensee does 
not have a condition of Capital Impairment, a Licensee that has either 
outstanding Participating Securities or Earmarked Assets in its 
portfolio may return capital to its investors and SBA, pursuant to the 
terms set forth in Sec. 107.245(d). This provision allows an exception 
to Sec. 107.802, which prohibits Licensees from distributing capital in 
excess of two percent (2%) per year without the prior written approval 
of SBA, subject to certain restrictions. However, unless SBA decides 
otherwise on a case-by-case basis, any such Distribution shall be 
subject to the liquidity requirement in Sec. 107.241(f).
    Generally, Distributions in the form of returns of capital shall be 
made to SBA and private investors in the ratio of Leverage to 
Leverageable Capital as of the date of the proposed Distribution. For 
example, if outstanding Leverage is equal to three hundred percent 
(300%) of Leverageable Capital, SBA's share will be $3 for every $1 
distributed to the private investors.
    If, however, a Licensee has a Capital Impairment Percentage greater 
than zero, the relative shares of SBA and the private investors must be 
computed differently. In such a case, Leverageable Capital for the 
purposes of Sec. 107.245(d) is deemed to be Leverageable Capital 
multiplied by a percentage equal to the difference between one hundred 
percent (100%) and the Licensee's Capital Impairment Percentage. 
Assuming a Licensee had $10,000,000 of Leverageable Capital and a 
Capital Impairment Percentage of forty-two percent (42%), the 
Licensee's Leverageable Capital for purposes of this computation will 
be deemed to be $5,800,000 ([100%-42%]  x  [$10,000,000]).
    The proceeds of SBA's share of any capital Distribution shall be 
credited in the manner prescribed for returns on capital under 
Sec. 107.245(c), as set forth in Sec. 107.245(c)(5).
(v) In-Kind Distributions
    No comments were received on the subject of In-kind Distributions, 
proposed Sec. 107.245(e). The provision is therefore finalized in the 
form in which it was proposed. Under Sec. 107.245(e), Distributions of 
READ or of capital need not be in cash, but may be in the form of 
portfolio securities, subject to certain restrictions. The securities 
to be distributed must be Publicly Traded and Marketable, as defined in 
Sec. 107.3, at the time of Distribution.
    At the time a corporate Licensee declares an In-kind Distribution, 
or an Unincorporated Licensee actually makes one, the Licensee must 
impute a gain or loss to the securities in question, determined as of 
the date of the declaration or distribution, as the case may be. Such 
imputed gain or loss shall be used to calculate Earmarked Profits 
pursuant to Sec. 107.242(e) as if it were a realized gain or loss.
    All Distributions of securities that constitute part of an In-kind 
Distribution must be made on a pro-rata basis to each investor, 
including SBA, as if the securities previously had been converted to 
cash and the proceeds constituted the entire Distribution. A Licensee 
may not distribute a disproportionate percentage of the stock of 
company A to investor X and a disproportionate share of the stock of 
company B to investor Y, even if the values of the shares of A and B 
are equal.
    SBA's share of an In-kind Distribution shall be deposited with the 
Central Registration Agent (CRA) unless SBA and the Licensee agree that 
the Licensee will dispose of SBA's share of such securities. If the 
Licensee disposes of SBA's share of securities, it shall remit the 
proceeds promptly to SBA or to SBA's designated agent or Trustee.

f. Post-Redemption Obligations

    No comments were received on proposed Sec. 107.246, which described 
the continuing obligations of Participating Securities issuers after 
their Participating Securities have been redeemed. The section is 
finalized without change, except to clarify that post-redemption 
Distributions of Accumulated Prioritized Payments are to be computed 
and paid on a quarterly basis, but otherwise in the same manner as 
before redemption.
    If, after redeeming all of its outstanding Participating 
Securities, a Licensee has both Earmarked Assets in its portfolio and 
an unpaid outstanding balance in the Prioritized Payment Accumulation 
Account (AA), the Licensee remains ``obligated'' to determine, at the 
end of each fiscal quarter, whether any Prioritized Payments have 
become Earned Prioritized Payments and to distribute such amounts to 
SBA in accordance with Sec. 107.243. See Sec. 107.246(a). After the 
last Earmarked Asset has been disposed of, and any resulting Earned 
Prioritized Payments paid to SBA, the Licensee is under no further 
obligation to pay the remaining balance, if any, in the AA. See 
Sec. 107.246(b).
    Section 107.246(c) overrides the language of Sec. 107.245(e) (In-
kind Distributions) in cases involving In-kind Distributions to be made 
after redemption of all Participating Securities if there are also 
unpaid Prioritized Payments. Under Sec. 107.246(c), no In-kind 
Distributions of Earmarked Assets may be made unless SBA is paid a sum 
equal to the full amount of the unpaid Prioritized Payments or the full 
amount of Unrealized Appreciation on the Earmarked Assets in question, 
whichever is less. Subject to this rule, a Licensee that has fully 
redeemed its Participating Securities may distribute Earmarked Assets 
that are not Publicly Traded and Marketable if it has SBA's prior 
written consent to such Distribution and to the valuation assigned by 
the Licensee.

g. Special Rules for Companies Licensed On or Before March 31, 1993

(i) General
    SBA did not receive any comments on proposed Sec. 107.247, the 
special rules for companies licensed on or before March 31, 1993. The 
section is therefore finalized without change. It provides that a 
company licensed on or before March 31, 1993 that thereafter applies 
for SBA's guarantee of its Participating Securities must meet certain 
procedural requirements not applicable to other Licensees. These 
companies are also afforded certain exemptions or options not available 
to companies licensed after March 31, 1993. See Sec. 107.247. The 
details are set forth below.
(ii) Special Requirements
    When applying for SBA's guarantee of a first issuance of 
Participating Securities, any company licensed on or before March 31, 
1993 must submit:
    (a) A valuation report for each portfolio asset as of the date of 
the financial statements that accompany the application, and as of the 
end of each of the preceding three years, and
    (b) A copy of each portfolio concern's last annual report and/or 
fiscal year-end financial statements, and most recent interim financial 
statements. See Sec. 107.247(d). This information is required in 
addition to the financial information that all Licensees, including 
companies licensed after March 31, 1993, are required to submit in 
connection with an application for SBA's guarantee of their 
Participating Securities.
    If the Licensee has negative Undistributed Realized Earnings and/or 
a net Unrealized Loss on Securities Held, SBA may make its approval of 
the Licensee's request for a guarantee of Participating Securities 
contingent upon a quasi-reorganization in accordance with generally 
accepted accounting principles. See Sec. 107.247(d)(2).
    If the financial statements of the Licensee submitted with the 
application are interim financial statements, the Licensee shall have a 
limited scope audit performed by its SBA-approved independent 
accountants. These accountants shall use whatever auditing procedures 
are necessary to enable them to express an opinion on the Licensee's 
Statement of Financial Position and the accompanying Schedule of 
Investments.
(iii) Refinancing of Debentures
    Subject to the two following conditions, a company licensed on or 
before March 31, 1993 may use part or all of the proceeds of 
Participating Securities to repay or prepay Debentures outstanding on 
that date. The Licensee must demonstrate to SBA that it has outstanding 
Equity Capital Investments, valued at cost, in an amount equal to the 
amount of Participating Securities that would be used to refinance the 
outstanding Debentures that are to be repaid or prepaid. The Licensee 
also may not elect to exclude any of its pre-existing portfolio from 
the category of Earmarked Assets.
    A Licensee that pays or prepays an outstanding Debenture after it 
has issued Participating Securities is presumed to have used the 
proceeds of the Participating Securities for this purpose unless it can 
demonstrate the availability of other funds to pay the principal amount 
of the Debenture in question. See Sec. 107.247(a).
(iv) Exclusion of Pre-Existing Portfolio Assets
    Unless a Licensee intends to use part or all of the proceeds from 
the issuance of Participating Securities to repay or prepay a Debenture 
outstanding on March 31, 1993, it may elect, when its first application 
for SBA's guarantee is submitted, to exclude all, but not less than 
all, portfolio assets outstanding on March 31, 1993 from the category 
of Earmarked Assets. In such event, SBA is not obligated to extend its 
guarantee if it concludes that exclusion of the Licensee's March 31, 
1993 portfolio would significantly decrease SBA's chances of obtaining 
a satisfactory return on its guarantee.

5. Financing by Use of SBA Guaranteed Trust Certificates

    Proposed Sec. 107.250 was a recodification of existing 
Sec. 107.201(c), revised to include the new Participating Securities. 
No comments were received on the proposal, which is therefore finalized 
without substantive change.

6. Conditions Affecting Good Standing of Leveraged Licensees

a. Introduction

    SBA received forty-three (43) comment letters concerning SBA's 
proposed remedies for regulatory violations by Leveraged Licensees 
(Sec. Sec. 107.261 and 107.262). SBA had proposed to separate the 
remedies for violations by issuers of Debentures and Preferred 
Securities (Sec. 107.261) from the remedies for violations by issuers 
of Participating Securities (Sec. 107.262). The comments supported the 
distinction made between Debentures and Participating Securities. The 
suggestion that remedies be different for Preferred Securities and 
Participating Securities, however, was opposed by Specialized SBICs. 
These Licensees objected to the characterization of Preferred 
Securities as more akin to Debentures than Participating Securities. 
They argued that the Preferred Security, which has attributes of both 
debt and equity securities, should be treated as an equity security for 
purposes of the remedies section. They expressed concern that if 
Preferred Securities continue to carry the same remedies as Debentures, 
tax-exempt entities such as pension funds will refrain from investing 
in Specialized SBICs in order to avoid incurring Unrelated Business 
Taxable Income (UBTI).
    SBA expresses no opinion as to whether tax-exempt entities 
investing in Specialized SBICs that issue Preferred Securities would 
incur UBTI as a result of SBA's former remedies (former Sec. 107.203) 
or its proposed remedies (proposed Sec. 107.261). Nevertheless, SBA 
believes that there is sufficient justification for treating Preferred 
Securities as if they were an equity-type security and relocating them 
into the Participating Securities remedies section (Sec. 107.262). The 
rule is finalized with this change.
    The overall structure of the remedies sections remains otherwise 
intact. In order to maintain the separation between the two sections on 
remedies, no cross-default provisions are provided between Debentures, 
on the one hand, and Preferred Securities and Participating Securities, 
on the other. If a Licensee has both Debentures and Participating 
Securities, a default under the former will not automatically trigger a 
``default'' under the latter, and vice versa.

b. General Conditions and Remedies

    Many comments on the proposed remedies sections objected to the 
requirement that all Licensees issuing Leverage after publication of 
this final rule amend their articles of incorporation or partnership 
agreements to indicate consent, in advance, to SBA's right to require 
the removal of officers, directors, or general partners and to the 
appointment of SBA or its designee as receiver of the Licensee for the 
purpose of continuing to operate the company. See Sec. Sec. 107.261(f) 
and 107.262 (b) and (c). Such remedies would only take effect upon the 
occurrence of certain specified violations involving, for the most 
part, fraudulent activities or willful actions.
    The principal effect of the consent to a receivership would be that 
SBA would be entitled to the receivership promptly, as a matter of 
right. Except upon the occurrence of an automatic event of default 
under a Debenture (see Sec. 107.261(b)), Licensee's consent would not 
include consent to a receivership for the purpose of liquidating the 
company.
    The comments objected strongly to the consent provision, 
particularly as it relates to Debenture issuers (Sec. 107.261(f)). They 
recommended that SBA rely upon its current statutory authority for 
removal of management and/or the appointment of a receiver, which 
allows a Licensee the opportunity to challenge, in advance, SBA's 
intended action. Unfortunately, SBA has found that SBICs have used that 
opportunity to delay the availability of SBA's remedy while they file 
for protection under Federal bankruptcy laws.
    SBA looked carefully at the specific violations that could trigger 
the advance consent remedies. The Agency is convinced that, with one 
small exception, the advance consent is appropriate for the very 
serious nature of the defaults in question.
    The one exception is the payment default by issuers of Debentures 
(Sec. 107.261(c)(7)). SBA intends to continue its customary practice of 
affording Licensees an opportunity to cure payment defaults. The 
proposed rule would have permitted SBA to use its remedial powers 
before allowing the Licensee an opportunity to cure its payment 
default. Accordingly, SBA is moving the default referred to as 
``Failure to make payment'' from the category of non-curable defaults 
(Sec. 107.261(c)) to the category of curable defaults 
(Sec. 107.261(d)).
    With this change, a Licensee issuing Debentures after the effective 
date of this rule will be required to consent in advance to the forced 
removal of management and the appointment of an operating receivership 
for the following events: fraud, fraudulent transfers, willful 
conflicts of interest, willful noncompliance, repeated events of 
default, transfer of control of the Licensee, uncured excessive fees, 
uncured improper Distributions and uncured payment defaults.
    These consent provisions will not apply to any Licensee which only 
has Leverage issued prior to the effective date of this final rule. 
Prospectively, however, the consent will be incorporated in all newly-
issued Debentures, Preferred Securities, and Participating Securities. 
As a result, for Licensees with Leverage issued both before and after 
the effective date of this rule, the Licensee will be deemed to have 
consented to a receivership upon the occurrence of a default under 
Leverage issued after such date, but not if the default is only under 
Leverage issued before such date.
    SBA also is making clear in this final rule that while the Agency 
determines appropriate cure periods for curable violations on a case-
by-case basis, the cure period under Sec. 107.261 or Sec. 107.262 will 
never be less than fifteen (15) days. As with the proposed rule, an 
opportunity to cure is made available in the final rule under 
Secs. 107.261(d) and 107.262(c). In response to comments from 
Licensees, this final rule also affords an issuer of Participating 
Securities or Preferred Securities an opportunity to cure before being 
placed under ``restricted operations.'' See Sec. 107.262(d).
    SBA does not agree with the recommendation in some comment letters 
that, in the case of bankruptcy, voluntary assignment for the benefit 
of creditors, and transfers of control, Licensees issuing Participating 
or Preferred Securities still should have the opportunity to remove the 
responsible party and/or otherwise effect a cure before SBA can use its 
remedial powers. SBA believes strongly that if one of these violations 
occurs, the Agency must be free to exercise its remedies as rapidly as 
possible, since time may be of the essence in preserving any value left 
in the company.
    SBA is concerned that it may have risked ceding too much of its 
regulatory responsibility in formulating the proposed remedy for 
Capital Impairment for Participating Securities issuers (and now 
Preferred Securities issuers) under Sec. 107.262(d)(3), which remedy 
may not be adequate in the case of ``extreme'' Capital Impairment. The 
remedy proposed for Capital Impairment was to place the Licensee under 
restricted operations, a status which allows SBA to control the flow of 
money in and out of the Licensee until the violation is cured. This is 
appropriate for Capital Impairment levels of under one hundred percent 
(100%), when a Licensee's Regulatory Capital (but not SBA's investment) 
has essentially been lost. When Capital Impairment equals or exceeds 
one hundred percent (100%), SBA believes it must have the ability to 
take necessary action to protect its investment.
    Since SBA considers Capital Impairment of at least one hundred 
percent (100%) as equivalent in risk to actual insolvency because it 
means that the Licensee has lost one hundred percent (100%) of its 
Regulatory Capital, the remedies available for a Licensee's insolvency 
will now be available for extreme Capital Impairment. These remedies 
include Licensee's consent to the forced removal of management and/or 
the appointment of a receiver for the purpose of continuing to operate 
the company. Accordingly, in this final rule, a provision for extreme 
Capital Impairment is added to the insolvency default. Since issuers of 
Participating Securities can be expected to have high Capital 
Impairment during the earlier years of the security's life, with the 
impairment level declining as later profits are taken, such Licensees 
will be exempted from the extreme Capital Impairment provision until 
the end of the eighth (8th) year following the Licensee's initial 
issuance of Participating Securities.
    A Licensee with extreme Capital Impairment will be afforded an 
opportunity to cure such impairment only if it has not already been 
afforded an opportunity to cure a lesser degree of Capital Impairment 
under Sec. 107.262(d)(3). In other words, SBA does not intend to permit 
a second cure period if a Licensee has failed to cure during its prior 
opportunity.
    The remaining provisions in the remedies sections are finalized as 
proposed. A more detailed discussion of the violations and associated 
remedies for the different types of Leverage securities is provided in 
paragraphs c. and d. below.

c. Licensees With Outstanding Debentures; Events of Default

    As finalized, Sec. 107.261 will apply to all Licensees issuing 
Debentures after the effective date of this rule. As with the former 
regulation (Sec. 107.203), all such Licensees will be deemed to have 
consented to the remedies provision in effect on the date of issuance 
of Debentures as if such remedies were fully set forth in the 
Debentures. Such remedies include, but are not limited to, a right to 
acceleration or redemption of the Debentures and the establishment of a 
receivership with SBA or its designee as receiver.
    As with the proposed rule, Sec. 107.261 sets forth three (3) 
categories of defaults or violations that could result in the 
acceleration of a Licensee's outstanding Leverage and the appointment 
of SBA as receiver of the Licensee. The first such category, set forth 
in Sec. 107.261(b), consists of three (3) events that automatically 
accelerate all outstanding Leverage without notice or demand to the 
Licensee, and allow SBA to apply for receivership of the Licensee 
without Licensee's objection.
    The events in question are insolvency, a voluntary assignment for 
the benefit of creditors, and the filing of a voluntary or involuntary 
petition for relief under the Bankruptcy Code. A Licensee is insolvent 
for purposes of this regulation and Sec. 107.262(b) if its liabilities 
exceed its assets or if it is unable to pay its debts as they come due, 
even if its assets exceed its liabilities at the time.
    Under the second category of defaults, upon written notice, SBA may 
demand immediate repayment or redemption of all outstanding Debentures, 
or take any other action permitted under the Act. See Sec. 107.261(c). 
As finalized, nine (9) defaults are included in this category, all of 
which include an element of either willfulness or actual fraud. No 
opportunity to cure the default will be afforded the Licensee. 
Moreover, for six (6) of the defaults in this category the Licensee 
already will have consented to SBA's right to require the Licensee to 
replace officers, directors, or general partners with persons approved 
by SBA, and to SBA's appointment as receiver for the purpose of 
continuing Licensee's operations. See Sec. 107.261(f). It should be 
noted that the written notice contemplated under Sec. 107.261(c) is 
notification by SBA that the Licensee's Leverage must be immediately 
repaid or redeemed, not a notice that SBA will make such a demand in 
the future.
    With respect to the third category of nine (9) violations or 
defaults, SBA will afford the Licensee the opportunity to cure its 
violations. See Sec. 107.261(d). ``Failure to make payment'' has been 
moved to this section of the regulations, and is now a curable default. 
As discussed above, SBA will never require that a default be cured in 
less than fifteen (15) days. If the Licensee fails to cure to SBA's 
satisfaction, SBA may accelerate and/or, in the case of three (3) of 
the violations, pursue the other remedies discussed in the previous 
paragraph. See Sec. 107.261(f).
    Section 107.261(e) authorizes SBA to impose a limited sanction on 
Licensees that repeatedly fail to comply with one or more ``non-
substantive'' provisions of the Act or the regulations. Such Licensees 
will be denied additional Leverage, and also may be required to take 
actions necessary to come into full compliance. If, under such 
circumstances, a Licensee were to fail to take the steps necessary to 
accomplish the remedial actions required by SBA, such Licensee's 
Debentures could be accelerated, or other remedies, including a 
receivership, could be instituted. See Sec. 107.261(c)(7).
    SBA is repeating here the guidance it provided in the proposed rule 
regarding the distinction between ``substantive'' and ``non-
substantive'' provisions of the Act and the regulations promulgated 
under it. SBA considers each of the provisions of the Act and the 
regulations to have an important purpose. Even a regulation as 
seemingly minor as the one that requires all Licensees to maintain a 
listed telephone number and regular business hours serves a significant 
purpose: Licensees should be accessible to their communities, not just 
their friends. An unlisted telephone number or irregular business 
hours, in the absence of other violations, should not be equated with 
more serious violations, however. Thus such violations are not as 
significant or ``substantive'' as are violations due to unacceptably 
high levels of capital impairment or financings that are tainted by 
conflicts of interest. Accordingly, phone listing and business hour 
requirements will be characterized as ``non-substantive'', as will 
other housekeeping-type requirements. All other requirements under the 
Act and the regulations, specifically including the filing of required 
financial and disclosure forms with SBA, will be considered 
``substantive''.

d. Licensees With Outstanding Participating Securities and/or Preferred 
Securities; Conditions Affecting Licensee's Good Standing

    As discussed above, SBA is extending the reach of Sec. 107.262 to 
cover violations under Preferred Securities in addition to those under 
Participating Securities. As finalized, Sec. 107.262 will apply to any 
Licensee that issues Participating Securities or, after the date 
hereof, Preferred Securities. It will continue to apply until the 
Licensee repays or redeems its Preferred Securities, or repays or 
redeems its Participating Securities and sells or otherwise liquidates 
its Earmarked Assets.
    Section Sec. 107.262 sets forth four (4) categories of events that 
would affect prejudicially a Licensee's good standing. The remedies 
available to SBA under this section, and the Licensee's consent to such 
remedies, are required to be set forth in the articles of incorporation 
or partnership agreement of the Licensee prior to its issuance of 
Participating Securities or, after the effective date of this rule, 
Preferred Securities.
    The first category of events set forth in Sec. 107.262(b) consists 
of six (6) events, the occurrence of any of which will permit SBA to 
take certain action. If the offending Licensee is a corporation, SBA 
can, upon notice to the Licensee, require the Licensee to replace, with 
individuals approved by SBA, one or more of its officers and/or a 
sufficient number of its directors to constitute a majority of the 
board. If the offending Licensee is a partnership, SBA can, upon notice 
to the Licensee, require the removal of the responsible party and/or 
require replacement of the general partner by a new general partner 
selected by the Licensee but approved by SBA. Alternatively, or in 
addition to the remedies just described, SBA can apply for the 
institution of an operating receivership, with SBA or its designee as 
receiver. As in the case of Debenture Leverage, Licensees with 
Participating Securities or Preferred Securities will be deemed to have 
consented to such receivership.
    Section 107.262(c) lists three (3) events with remedies identical 
to those provided under Sec. 107.262(b). SBA would have the right to 
avail itself of such remedies only if the Licensee failed to remove the 
person(s) identified by SBA as responsible for the violation and/or to 
cure the violation within a time period of not less than fifteen (15) 
days, as determined by SBA. One of the three (3) events in this 
category is the willful or repeated noncompliance by the Licensee with 
the substantive provisions of the Act or regulations. Repeated 
noncompliance should be understood to mean an additional violation of a 
statutory or regulatory provision after the Licensee has been notified 
of the initial violation. If a Licensee willfully distributes amounts 
in excess of Distributions permitted by SBA, such action will 
constitute willful noncompliance under Sec. 107.262(c), not merely an 
``improper distribution'' under Sec. 107.262(d).
    Section 107.262(d) lists eleven (11) events, the occurrence of any 
of which will allow SBA, on written notice to the Licensee, to take 
certain action aimed at controlling the flow of money in and out of the 
Licensee until such time as the Licensee were to cure the event(s) to 
SBA's satisfaction. SBA may prohibit Distributions to parties other 
than SBA, its agent or Trustee. SBA also may prohibit the Licensee from 
investing in any Small Concern which it is not currently financing 
unless it were legally bound to make such investment. SBA may require 
that any unfunded commitments to invest in the Licensee be funded as 
soon as possible. If the Licensee fails to comply with the restrictions 
imposed by SBA (as described above), SBA can apply for the institution 
of an operating receivership with SBA or its designee as receiver, 
again without any objection from the Licensee. As mentioned above under 
the discussion of Management Expenses, Licensees placed under 
restricted operations will be required to re-obtain SBA's approval of 
their Management Expenses or, in the case of Preferred Securities 
issuers, their management compensation.
    Section 107.262(e), regarding repeated non-substantive violations, 
corresponds to Sec. 107.261(e), previously discussed. If a Licensee 
fails to take the steps necessary to accomplish the remedial actions 
required by SBA under Sec. 107.262(e), SBA may take the actions 
described in the preceding paragraph to control the flow of money in 
and out of the Licensee.

e. Non-Waiver

    No comments were received on proposed Sec. 107.263, which is a 
recodification and amplification of the non-waiver provision formerly 
found in Sec. 107.203(b)(5). It has been and will continue to be SBA's 
policy to attempt to resolve all problems with a Licensee before taking 
formal remedial action. Section 107.263 clarifies that if SBA does not 
resort to the full measure of the remedies available under 
Secs. 107.261 and 107.262, or does so only after a delay, SBA will not 
be deemed to have waived its right to pursue such remedies in 
connection with either the original default or any subsequent default.

Compliance With Executive Orders 12866, 12612 and 12778 and the 
Regulatory Flexibility and Paperwork Reduction Acts

Executive Order 12866 and Regulatory Flexibility Act

    This final rule will be a significant regulatory action for 
purposes of E.O. 12866 because it will have an annual effect on the 
economy of more than $100 million. For purposes of the Regulatory 
Flexibility Act, 5 U.S.C. 601 et seq., it also will have a significant 
economic impact on a substantial number of small entities.
    This final rule is being adopted pursuant to a statutory mandate 
(Section 415 of Pub. L. 102-366) which requires SBA to promulgate 
regulations implementing The Small Business Equity Enhancement Act of 
1992.
    Prominent among the statutory provisions implemented by this final 
rule is the creation of a new class of SBA-guaranteed securities 
(Participating Securities), as further described in this rule. The 
potential benefits of this final rule, and in particular the 
Participating Securities provisions, include attracting new capital 
into the SBIC Program from a variety of sources. This new capital, 
together with SBA Leverage, will substantially exceed $100 million per 
year and ultimately will be invested by SBICs in eligible small 
business concerns.
    Financing small concerns is consistent with the Administration's 
goal to encourage the formation of new businesses and the growth of 
existing businesses. While it is not possible to quantify the 
anticipated benefits of this regulatory action, it is expected that the 
availability of new capital to small businesses will result in a 
substantial number of new jobs and associated increases in payroll, 
corporate and capital gains tax revenues.
    The potential costs of this regulation cannot be quantified or 
estimated. A portion of the cost to the government of administering the 
Participating Securities program is expected to be offset by the two 
percent (2%) user fee imposed on Licensees issuing such securities. 
Potential costs of this regulation to Licensees can not be quantified; 
however, no Licensee is ever require to issue Participating Securities 
or any other form of Leverage.
    There are no reasonably feasible alternatives to this final rule 
that would accomplish the intent and direction of Title IV of Public 
Law 102-366.

Executive Order 12612

    SBA certifies that this final rule will have no Federalism 
implications warranting the preparation of a Federalism Assessment in 
accordance with Executive Order 12612.

Executive Order 12778

    SBA certifies that this final rule is drafted, to the extent 
practicable, in accordance with the standards set forth in Section 2 of 
E.O. 12778.

Paperwork Reduction Act

    For purposes of the Paperwork Reduction Act, 44 U.S.C., ch. 35, SBA 
certifies that this final rule will impose no additional reporting or 
recordkeeping requirements.

[Catalog of Federal Domestic Assistance Program No. 59.011, Small 
Business Investment Companies]

List of Subjects in 13 CFR Part 107

    Investment companies, Loan programs-business, Reporting and record-
keeping requirements, Small businesses.

    For the reasons set forth above, part 107 of title 13, Code of 
Federal Regulations is amended as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

    1. The authority citation for part 107 is revised to read as 
follows:

    Authority: Title III of the Small Business Investment Act, 15 
U.S.C. 681 et seq.; 15 U.S.C. 687(c); 15 U.S.C. 683; 15 U.S.C. 687d; 
15 U.S.C. 687g; 15 U.S.C. 687b; 15 U.S.C. 687m, as amended by Pub. 
L. 102-366.

    2. Section 107.1 is amended by adding at the end the following two 
sentences, to read as follows:


Sec. 107.1  Scope of Part 107.

    * * * Provisions of this part which are not mandated by the Act 
shall not supersede existing State law. A party claiming that a 
conflict exists shall submit an opinion of independent counsel, citing 
authorities, for SBA's resolution of the issues involved.

    3. Section 107.3 is amended by revising the definitions for 
``Leverage'' and ``SBA'' and by adding additional definitions, in 
alphabetical order, to read as follows:


Sec. 107.3  Definition of terms.\2\
---------------------------------------------------------------------------

    \2\Terms defined in this section are capitalized hereafter.
---------------------------------------------------------------------------

    Accumulated Prioritized Payments means Prioritized Payments which 
are not payable as of any given date because the Licensee has 
insufficient cumulative Earmarked Profits. It is the aggregate of 
cumulative Prioritized Payments less Earned Prioritized Payments.
* * * * *
    Affiliate or Affiliates has the meaning set forth in Sec. 121.401.
* * * * *
    Central Registration Agent or CRA means one or more agents 
appointed by SBA for the purpose of issuing TCs and performing the 
functions enumerated in Sec. 107.250(b) and performing similar 
functions for Debentures and Participating Securities funded outside 
the pooling process.
* * * * *
    Combined Capital means the sum of Regulatory Capital and 
outstanding Leverage.
* * * * *
    Debentures means debt obligations issued by Licensees pursuant to 
section 303(a) of the Act and held or guaranteed by SBA.
* * * * *
    Distributable Earmarked Profits shall have the meaning set forth in 
Sec. 107.243(c)(2) and shall be the source for allocation of 
Prioritized Payments pursuant to Section 303(g)(2) of the Act.
    Distribution means any transfer of cash or non-cash assets to SBA, 
its agent or Trustee, or to partners in an Unincorporated Licensee, or 
to shareholders in a Corporate Licensee. Distributions shall include 
interest on Debentures, returns on Preferred Securities, Prioritized 
Payments and adjustments thereto pursuant to Sec. 107.243(d), Profit 
Participation, returns on capital to private investors, repayment of 
Leverage and returns of Private Capital. Capitalization of Retained 
Earnings Available for Distribution shall constitute a Distribution.
    Earmarked Assets shall have the meaning set forth in 
Sec. 107.242(b) (See also Sec. 107.247).
    Earmarked Profits (Losses) mean the aggregate amount of Earmarked 
Net Investment Income (Loss) and Earmarked Realized Gain (Loss) on 
Securities which becomes the basis for Prioritized Payments and Profit 
Participation (See Sec. 107.242).
    Earned Prioritized Payments means Prioritized Payments which have 
been distributed, or are distributable or deferred in accordance with 
Sec. 107.243(c).
    Equity Capital Investments means investments in a Small Concern in 
the form of common or preferred stock, limited partnership interests, 
options, warrants, or similar equity instruments, including 
subordinated debt with equity features if such debt provides only for 
interest payments contingent upon and limited to the extent of 
earnings. Equity Capital Investments shall not require amortization. 
Equity Capital Investments may be guaranteed; however, neither Equity 
Capital Investments nor such guarantee shall be collateralized or 
otherwise secured.
* * * * *
    Guaranty Agreement means the contract entered into by SBA which is 
a guarantee of the full faith and credit of the United States 
Government as to timely payment of principal and interest on Debentures 
or the redemption price of and Prioritized Payments on Participating 
Securities and SBA's rights in connection with such guarantee.
    Includible Non-Cash Gains means those non-cash gains (as reported 
on SBA Form 468) that are realized in the form of Publicly Traded and 
Marketable Securities or investment grade debt instruments. For 
purposes of this definition, investment grade debt instruments means 
those instruments that are rated ``BBB'' or ``Baa'', or better, by 
Standard & Poor's Corporation or Moody's Investors Service, 
respectively. Non-rated debt may be considered to be investment grade 
if Licensee obtains a written opinion from an investment banking firm 
acceptable to SBA stating that the non-rated debt instrument is 
equivalent in risk to the issuer's investment grade debt.
* * * * *
    Leverage means the aggregate outstanding amount of the Original 
Issue Price of a Licensee's Debentures, Participating Securities, and 
Preferred Securities.
* * * * *
    Loans and Investments means Portfolio Securities, Assets Acquired 
in Liquidation of Portfolio Securities, Operating Concerns Acquired, 
and Notes and Other Securities Received, as set forth in the Statement 
of Financial Position (SBA Form 468).
    Management Expenses means, for Licensees which have Participating 
Securities or have Earmarked Assets in their portfolios, those expenses 
that include salaries, office expenses, travel, business development, 
office and equipment rental, bookkeeping and the development, 
investigation and monitoring of investments, but shall not include the 
cost of services provided by specialized outside consultants, outside 
lawyers and independent public accountants, if they perform services 
not generally expected of a venture capital company, nor shall such 
term include the cost of services provided by any Associate of the 
Licensee which are not part of the normal process of making and 
monitoring venture capital financings. See also Sec. 107.903.
* * * * *
    Original Issue Price means the price paid by the purchaser for 
securities at the time of issuance.
    Participating Securities means preferred stock, preferred limited 
partnership interests, or similar instruments, including debentures 
having interest payable only to the extent of earnings, all of which 
are subject to the terms set forth in Secs. 107.240 through 107.247 and 
section 303(g) of the Act.
* * * * *
    Pool means an aggregation of SBA guaranteed Debentures or SBA 
guaranteed Participating Securities approved by SBA.
* * * * *
    Preferred Securities means nonvoting preferred stock issued to SBA 
by a for-profit section 301(d) Corporate Licensee, or securities having 
similar characteristics issued by a section 301(d) Licensee organized 
as a nonprofit corporation, or nonvoting preferred limited partnership 
interests issued by a section 301(d) Unincorporated Licensee. (See also 
Sec. 107.230)
    Prioritized Payments means amounts which are preferred and 
cumulative and are distributable to the holder of Participating 
Securities provided the issuing Licensee has sufficient cumulative 
Earmarked Profits, and may be represented by dividends on preferred 
stock or interest on qualifying Debentures issued by a corporate 
Licensee, or priority returns on preferred limited partnership 
interests issued by limited partnership Licensees. For a given fiscal 
period, Prioritized Payments shall be the amount resulting from 
multiplying the Redemption Price of Participating Securities by the 
Trust Certificate Rate, weighted to reflect the number of days such 
securities were outstanding.
* * * * *
    Profit Participation means a specified percentage of a Licensee's 
Earmarked Profits which is computed in accordance with Sec. 107.244 and 
to which SBA is entitled, by agreement, in consideration for its 
guarantee of such Licensee's Participating Securities.
    Publicly Traded and Marketable means securities that are salable 
without restriction or that are salable within 12 months pursuant to 
Rule 144 of the Securities Act of 1933, as amended, by the holder 
thereof (or in the case of an In-kind Distribution by the distributee 
thereof), and are of a class which (a) is traded on a regulated stock 
exchange, or (b) is listed in the Automated Quotation System of the 
National Association of Securities Dealers (NASDAQ), or (c) has, at a 
minimum, at least two market makers as defined in the relevant sections 
of the Securities Exchange Act of 1934, as amended, and in all cases 
the quantity of which can be sold over a reasonable period of time 
without having an adverse impact upon the price of the stock.
    Qualified Investments shall have the meaning set forth in 
Sec. 107.230(c)(4)(iv).
* * * * *
    Realized Gain (Loss) on Securities means the amount by which 
proceeds from the disposition of Loans and Investments are greater than 
(less than) the cost or other basis permitted by SBA. Disposition of 
Loans and Investments shall include sale, exchange, write-off, 
recoveries from prior disposition, or any other such transaction 
resulting in recognition of a gain or loss.
    Redemption Price means the amount required to be paid by the 
issuer, or successor to the issuer, of Preferred or Participating 
Securities to repurchase such securities from the holder. The 
Redemption Price shall be the Original Issue Price less any prepayments 
or prior redemptions.
    Retained Earnings Available for Distribution means Undistributed 
Net Realized Earnings less any Unrealized Depreciation on Loans and 
Investments (as reported on SBA Form 468), and represents the amount 
that may be distributed to investors (including SBA) or transferred to 
Private Capital.
    SBA means the Small Business Administration, 409 Third Street, SW., 
Washington, DC 20416.
* * * * *
    Trust means the legal entity created for the purpose of holding 
guaranteed Debentures or Participating Securities and the guaranty 
agreement related thereto, receiving, holding and making any related 
payments, and accounting for such payments.
    Trust Certificate Rate means a fixed rate determined at the time 
Participating Securities are issued by the Secretary of the Treasury 
taking into consideration the current average market yield on 
outstanding marketable obligations of the United States with maturities 
comparable to the maturities of the Trust Certificates being guaranteed 
by SBA, adjusted to the nearest one-eighth of one percent.
    Trust Certificates (TCs) means certificates issued by SBA, its 
agent or Trustee and representing ownership of all or a fractional part 
of a Trust or Pool of Debentures or Participating Securities.
    Trustee means the trustees or trustees of a Trust.
    Undistributed Net Realized Earnings means Undistributed Realized 
Earnings less Non-cash Gains/Income as reported on SBA Form 468.
    Undistributed Realized Earnings means the cumulative sum of Net 
Investment Income plus Realized Gain (Loss) on Sale of Securities, less 
the cumulative sum of Distributions of Earned Prioritized Payments and 
Other Distributions made from Retained Earnings Available for 
Distribution.
* * * * *
    Unrealized Appreciation means the amount by which a Licensee's 
valuation of Loans and Investments, as determined by its Board of 
Directors or General Partner(s) in accordance with Licensee's valuation 
policies, exceeds the cost basis thereof.
    Unrealized Depreciation means the amount by which a Licensee's 
valuation of Loans and Investments, as determined by its Board of 
Directors or General Partner(s) in accordance with Licensee's valuation 
policies, is below the cost basis thereof.
    Unrealized Gain (Loss) on Securities Held means the amount by which 
a Licensee's aggregate valuation of its Loans and Investments is above 
(below) their aggregate cost basis, and is equal to the sum of the 
Unrealized Appreciation and Unrealized Depreciation on all Loans and 
Investments, net of estimated future income tax expense or estimated 
realizable future income tax benefit, as appropriate.
    Venture Capital Financing shall have the meaning set forth in 
Sec. 107.230(c)(3).

    4. Part 107, title 13, of the Code of Federal Regulations is 
amended by removing the undesignated center heading ``Borrowing by 
Licensee'' and Secs. 107.201 through Sec. 107.205 and by adding after 
Sec. 107.105 the undesignated center heading ``Leverage'' and 
Secs. 107.210 through 107.263 to read as follows:
Leverage


Sec. 107.210  Leverage--General.

    (a) General. (1) SBA may purchase or guarantee three types of 
Licensee securities:
    (i) Debentures,
    (ii) Preferred Securities, and
    (iii) Participating Securities.
    (2) All Licensees issuing Preferred Securities after August 16, 
1982, or Debentures or Participating Securities shall be deemed to have 
agreed to the terms and conditions set forth in Secs. 107.260 through 
107.263 as in effect at the time of such issuance and as if fully set 
forth in such Preferred Securities, Debenture or Participating 
Securities.
    (b) Application procedures. All Leverage applications shall be 
filed with SBA's Investment Division located at 409 Third Street SW., 
Washington, DC 20416.
    (1) A section 301(c) Licensee may apply for Debentures pursuant to 
section 303(b) of the Act on SBA Form 1022, and for Participating 
Securities pursuant to section 303(g) of the Act on SBA Form 1022B, in 
accordance with accompanying instructions.
    (2) A section 301(d) Licensee may apply for Debentures pursuant to 
section 303(b) of the Act on SBA Form 1022, for Preferred Securities 
pursuant to section 303(c) of the Act on SBA Form 1022A, and for 
Participating Securities pursuant to section 303(g) of the Act on SBA 
Form 1022B, in accordance with accompanying instructions.
    (c) Basic requirements. Leverage applicants shall demonstrate to 
SBA's satisfaction that they meet the following requirements:
    (1) Eligibility for the amount of Leverage requested in accordance 
with Sec. 107.220 for section 301(c) Licensees and Sec. 107.230 for 
section 301(d) Licensees.
    (2) A need for Leverage as evidenced by Licensee's investment 
activity and its lack of sufficient funds available for investment; 
Provided, however, that a Leverage applicant that has invested at least 
fifty percent (50%) of its aggregate Leverageable Capital and 
outstanding Leverage shall be presumed to lack sufficient funds 
available for investment.
    (3) Adequacy of Private Capital and an ability to meet its 
obligations.
    (4) Applicants for Participating Securities shall meet the 
requirements of Sec. 107.241 in addition to all other Leverage 
requirements.
    (5) Compliance with the regulations as set forth in this part.
    (d) Fees and charges. (1) Licensees offering Debentures or 
Participating Securities for sale to, or for guarantee by, SBA are 
required to pay a one-time fee equal to two percent (2%) of the face 
amount of the Participating Securities or of the Debentures.
    (2) The fee on Debentures or Participating Securities which are 
issued for the purpose of refunding maturing obligations shall be paid 
before such Debentures or Participating Securities are purchased or 
guaranteed. If the Licensee's Debentures or Participating Securities 
evidence a new indebtedness, as distinguished from the refinancing of a 
pre-existing indebtedness, the fee shall be deducted from the proceeds 
remitted to the Licensee.
    (3) No portion of the fee shall be refundable upon prepayment of 
any Debenture or early redemption of any Participating Security by the 
Licensee.
    (4) SBA may establish a fee structure for the performance of 
services by the CRA; however, SBA shall not collect any fee for the 
guarantee of TCs.
    (e) Employment of SBA officials. Without the prior written consent 
of SBA, for a period of two years after the date of the most recent 
Leverage issued by Licensee (or the receipt of any SBA Assistance as 
defined in part 105 of this chapter), Licensee shall not employ, or 
tender any offer of employment to, or retain for professional services, 
any person who on or within one year prior to such date:
    (1) Served as an officer, attorney, agent, or employee of SBA; and
    (2) As such, occupied a position or engaged in activities which SBA 
shall have determined involved discretion with respect to the granting 
of Assistance under the Act.
    (f) SBA guarantee. (1) SBA may in its discretion agree to guarantee 
a Licensee's Debentures or Participating Securities unconditionally, 
irrespective of the validity, regularity or enforceability of such 
Debentures or Participating Securities or any other circumstances which 
might constitute a legal or equitable discharge or defense of a 
guarantor and, pursuant to its guarantee, make timely payments of 
principal and interest on such Debentures or the Redemption Price of 
and Prioritized Payments on such Participating Securities, irrespective 
of any default by the issuing Licensee or acceleration of the maturity 
of such Debentures by SBA, or the inability of the Licensee to pay the 
Redemption Price of or to make the Prioritized Payments on such 
Participating Securities, or any early redemption of the Participating 
Securities by SBA pursuant to Sec. 107.245.
    (2) SBA in its discretion may arrange for public or private 
financing under its guarantee authority. Such financing arranged by SBA 
may be accomplished by the sale of individual Debentures or 
Participating Securities, aggregations of Debentures or Participating 
Securities, or Pools or Trusts of Debentures or Participating 
Securities issued or sold pursuant to Sec. 107.250. Persons interested 
in providing funds to Licensees with SBA's guarantee shall notify SBA 
by letter, certifying any direct or indirect beneficial interest, or 
actual or potential voting rights, in any Licensee, or in any person 
directly or indirectly controlling, controlled by or under common 
control with, any Licensee. These reporting requirements are approved 
under OMB No. 3245-0081.
    (3) No SBA guarantee shall be extended to any entity:
    (i) Having a direct or indirect beneficial interest of ten or more 
percent in the Regulatory Capital of the Licensee whose securities are 
to be guaranteed, or in any Person directly or indirectly controlling, 
controlled by, or under Common Control with, such Licensee; or
    (ii) Having such interest in another Licensee which has received or 
is about to receive, pursuant to any understanding, arrangement, cross-
dealing, reciprocal or circular arrangement, any direct or indirect 
financing (or commitment for financing) from another lender with SBA's 
guarantee.
    (iii) SBA may void any guarantee obtained in violation of this 
paragraph (f)(3), but the foregoing shall not apply to lenders whose 
borrowers are selected or approved by SBA or its agents.
    (4) In the event SBA pays a claim under its guarantee, it shall be 
subrogated fully to the rights satisfied by such payment; and no state 
law, and no Federal law, shall preclude or limit SBA's exercise of its 
ownership rights acquired by subrogation upon payment under its 
guarantee.
    (5) With respect to Debentures guaranteed after July 1, 1991, SBA's 
claim against any Licensee shall be subordinated, as of the effective 
date of SBA's guarantee, in the event of the insolvency of such 
Licensee, only in favor of existing and future indebtedness outstanding 
to lenders, not including Associates of a Licensee, and only to the 
extent that the aggregate amount of such indebtedness does not exceed 
the lesser of two hundred percent (200%) of such Licensee's Regulatory 
Capital, or $10 million; Provided, however,
    (i) That in its sole discretion SBA may agree in advance and in 
writing to a subordination in favor of an Associate or in favor of one 
or more loans from Lending Institutions or other lenders that would 
cause the aggregate amount of outstanding senior debt to exceed the 
foregoing limitation;
    (ii) That nothing contained in these regulations shall limit the 
authority of SBA to refuse to subordinate its claims against any 
Licensee if SBA determines at the time of issuing its guarantee, that 
the exercise of reasonable investment prudence and the financial 
soundness of the Licensee warrant such a refusal; and
    (iii) That nothing contained in these regulations shall affect the 
seniority of any indebtedness created prior to July 11, 1991, over the 
claims of SBA derived from any debenture(s) and/or guarantee(s) 
outstanding as of that date.
    (6) After April 8, 1994, no Licensee with outstanding Leverage may 
incur secured debt or refinance existing indebtedness with secured debt 
without the prior written approval of SBA. If a Licensee is in 
regulatory compliance and has Leverage not in excess of one hundred 
fifty percent (150%) of its Leverageable Capital, and the request is 
for approval of a secured line of credit which would not cause its 
aggregate indebtedness (other than Leverage) to exceed fifty percent 
(50%) of its Leverageable Capital, then the Licensee may consider its 
request approved unless notified otherwise by SBA within thirty (30) 
days of SBA's receipt of such request. This paragraph (f)(6) applies to 
secured debt, secured guarantees and other contingent obligations 
voluntarily assumed, and the establishment of secured lines of credit. 
Unless otherwise agreed to by SBA in writing, Licensees with existing 
secured lines of credit shall have such lines approved before 
increasing the amounts outstanding thereunder. SBA's approval under 
this paragraph may be conditioned upon such restrictions and 
limitations as it may determine.
    (g) SBA sale of Leverage securities. Upon such conditions and for 
such consideration as it deems reasonable, SBA may sell, assign, 
transfer, or otherwise dispose of any Preferred Security, Debenture, 
Participating Security, or other security held by or on behalf of SBA 
in connection with Leverage. Upon notice by SBA, Licensee will make all 
payments of principal, dividends, interest, Prioritized Payments, and 
redemptions as shall be directed by SBA. Licensee shall be liable for 
all damage or loss which SBA may sustain by reason of such disposal, up 
to the amount of Licensee's liability under such security, plus court 
costs and reasonable attorney's fees incurred by SBA.
    (h) Maintenance of unimpaired capital. Each Licensee with Leverage 
shall maintain its Regulatory Capital in sufficient amounts to avoid a 
condition of Capitol Impairment. A condition of Capital Impairment 
shall be a condition affecting Licensee's good standing pursuant to 
Secs. 107.261(d) and 107.262(d).
    (1) Definition of Capital Impairment. A condition of Capital 
Impairment shall exist when a Licensee's Capital Impairment Percentage 
exceeds the maximum permissible level set forth in paragraph (h)(5) of 
this section.
    (2) Preliminary Impairment Test. If Unrealized Gain (Loss) on 
Securities Held is zero or greater, and the sum of Undistributed Net 
Realized Earnings plus Includible Non-Cash Gains is also zero or 
greater, no Capital Impairment exists and no further procedures shall 
be performed pursuant to this paragraph (h). Otherwise, a Licensee 
shall compute its ``Adjusted Unrealized Gain (Loss) on Securities 
Held'' in accordance with paragraph (3) below.
    (3) Adjusted Unrealized Gain (Loss) on Securities Held. (i) When a 
Licensee has Unrealized Depreciation in excess of Unrealized 
Appreciation on securities held, the Licensee's Adjusted Unrealized 
Gain (Loss) on Securities Held shall be equal to its Unrealized Gain 
(Loss) on Securities Held.
    (ii) When a Licensee has Unrealized Appreciation in excess of 
Unrealized Depreciation on securities held, the Licensee's Adjusted 
Unrealized Gain (Loss) on Securities Held shall be the sum, net of 
estimated future income tax expense, of eighty percent (80%) of the 
portion of such excess which consists of Unrealized Appreciation on 
Publicly Traded and Marketable securities and fifty percent (50%) of 
the portion of such excess which consists of Unrealized Appreciation on 
securities which meet the following criteria:
    (A) The Small Concern which issued the security received a 
significant subsequent equity financing by an investor whose objectives 
were not primarily strategic and at a price that, in SBA's judgment, 
would conclusively support the Unrealized Appreciation;
    (B) Such financing represents a substantial investment in the form 
of an arm's length transaction by a sophisticated new investor in the 
issuer's securities; and
    (C) Such financing occurred within twenty-four (24) months of the 
date of the calculation of the Impairment Percentage or, if the 
financing did not occur within such twenty-four (24) month period, the 
Small Concern's pre-tax cash flow from operations for the most recent 
fiscal year was at least ten percent (10%) of the Small Concern's 
average contributed capital for such fiscal year.
    (4) Computing the Capital Impairment Percentage. Licensee shall add 
Adjusted Unrealized Gain (Loss) on Securities Held to the sum of 
Undistributed Net Realized Earnings plus Includible Non-Cash Gains. If 
the result is zero or greater, no Capital Impairment exits and no 
further computations shall be performed pursuant to this paragraph (h). 
If the result is less than zero, Licensee shall drop the negative sign, 
divide by Regulatory Capital (excluding Treasury Stock), and multiply 
by one hundred (100). The result shall be Licensee's Capital Impairment 
Percentage.
    (5) Determination of maximum permissible Capital Impairment 
Percentage. (i) A section 301(c) Licensee shall determine its maximum 
permissible Capital Impairment Percentage at the intersection of its 
Leverage Percentage and its Equity Investment Percentage in the table 
in paragraph (h)(6) of this section. As used in such table, ``Equity 
Investments'' includes those Debt Securities which, after consideration 
of all of the terms, conditions and documentation of such financing, 
are determined by Licensee's Board of Directors or General Partner(s) 
to have in excess of fifty percent (50%) of the anticipated return on 
such financing represented by the potential for equity appreciation.
    (ii) A section 301(d) Licensee's maximum permissible Capital 
Impairment Percentage is seventy-five percent (75%).
    (6) Capital Impairment condition. If Licensee's Capital Impairment 
Percentage is greater than its maximum permissible Capital Impairment 
Percentage, Licensee has a condition of Capital Impairment; Provided, 
however,  that until the close of Licensee's fiscal year next 
succeeding April 25, 1995, a section 301(c) Licensee shall not have a 
condition of Capital Impairment if its Capital Impairment Percentage is 
less than or equal to fifty percent (50%).

    Note: The symbols used below have the following meanings: > 
means ``greater than'';  means ``greater than or equal 
to''; < means ``less than''; and  means ``not greater 
than''.

  Maximum Permissible Capital Impairment Percentages For Section 301(c) 
                                Licensees                               
------------------------------------------------------------------------
                                    Percentage of portfolio in equity   
                                          investments (at cost)         
      Leverage percentage       ----------------------------------------
                                 67%  40%    <40% 
                                     equity          equity       equity
------------------------------------------------------------------------
>200...........................           50              40          35
200................           60              50          40
100................           70              55          45
------------------------------------------------------------------------

    (7) Forbearance for Licensees with outstanding Participating 
Securities. (i) At any time during the first forty-eight (48) months 
following its initial issuance of Participating Securities, any 
Licensee which has Leverage consisting of a minimum of two-thirds 
Participating Securities and has at least two-thirds of its Loans and 
Investments, at cost, in Equity Capital Investments, shall not be 
considered to have a condition of Capital Impairment unless such 
Licensee's Capital Impairment Percentage equals or exceeds eighty-five 
percent (85%).
    (ii) At any time during the first sixty (60) months following its 
initial issuance of Participating Securities, a Licensee which has 
Leverage consisting of a minimum of two-thirds Participating Securities 
and has at least two-thirds of its Loans and Investment, at cost, in 
Start-up Financings shall not be considered to have a condition of 
Capital Impairment unless such Licensee's Capital Impairment Percentage 
equals or exceeds eighty-five percent (85%). ``Start-up Financing'' 
shall mean an Equity Capital Investment in a growth-oriented Small 
Concern which:
    (A) Is engaged in activities including, but not limited to, 
technology development or commercialization, manufacturing, and/or 
exporting;
    (B) At the time of the investment has not been in existence, in any 
form, for more than three fiscal years;
    (C) Has not had sales exceeding $5 million or positive cash flow in 
any fiscal year; and
    (D) Is not formed for the purpose of acquiring any existing 
business.
    (iii) At any time during the fifth year following its initial 
issuance of Participating Securities, any Licensee which meets the 
Leverage and investment ratios set forth in paragraph (h)(7)(i) of this 
section, and does not have a Capital Impairment Percentage which equals 
or exceeds eighty-five percent (85%), shall not be considered to have a 
condition of Capital Impairment if, within thirty (30) days of 
Licensee's determination that it has a condition of Capital Impairment, 
such Licensee either:
    (A) Increases its Regulatory Capital by a cash contribution equal 
to fifteen percent (15%) of its outstanding Leverage and places such 
funds in an escrow account, or other account satisfactory to SBA, for 
the benefit of SBA, or
    (B) Provides SBA with a guarantee satisfactory to SBA, for the 
benefit of SBA, equal to fifteen percent (15%) of its outstanding 
Leverage.
    (iv) At any time during the sixth year following its initial 
issuance of Participating Securities, any Licensee which meets the 
Leverage and investment ratios set forth in paragraph (h)(7)(i) of this 
section, and does not have a Capital Impairment Percentage which equals 
or exceeds eighty-five percent (85%), shall not be considered to have a 
condition of Capital Impairment if, within thirty (30) days of 
Licensee's determination that it has a condition of Capital Impairment, 
such Licensee either:
    (A) Increases its Regulatory Capital by a cash contribution equal 
to thirty percent (30%) of its outstanding Leverage and places such 
funds in an escrow account, or other account satisfactory to SBA, for 
the benefit of SBA, or
    (B) Provides SBA with a guarantee satisfactory to SBA, for the 
benefit of SBA, equal to thirty percent (30%) of its outstanding 
Leverage; Provided, however, that any escrowed funds or guarantee 
received pursuant to paragraphs (h)(7)(iii) of this section shall be 
credited toward the requirements of this paragraph (h)(7)(iv).
    (v) Any funds placed in an escrow or other account pursuant to 
paragraph (h)(7) (iii) or (iv) of this section shall not be eligible 
for Leverage purposes.
    (vi) Any fee and/or any claim to repayment by the party making the 
capital contribution or by the guarantor must be deferred and 
subordinate to all outstanding Leverage plus any unpaid Earned 
Prioritized Payments and other earned amounts.
    (vii) Any funds in the escrow account and/or any guarantee received 
by SBA under this paragraph (h)(7) of this section shall be utilized to 
pay or repay any amounts due SBA in the event of an acceleration or 
mandatory redemption under Sec. 107.261, or shall be released and 
returned to Licensee at such time as the sum of Licensee's Adjusted 
Unrealized Gain (Loss) on Securities Held and Undistributed Net 
Realized Earnings plus Includible Non-Cash Gains is determined by SBA 
to be zero or greater.
    (8) Quarterly Requirement and Procedure. Each Licensee is 
responsible, on a quarterly basis, for determining whether it has a 
condition of Capital Impairment and for promptly notifying SBA if it 
has such condition; Provided, however, that SBA is not precluded from 
making it with determination.
    (i) Collection or compromise of SBA claims. SBA may, upon such 
conditions and for such consideration as it deems reasonable, collect 
or compromise all claims relating to Preferred or Participating 
Securities or obligations held or guaranteed by SBA, and all legal or 
equitable rights accruing to SBA.


Sec. 107.220  Leverage for 301(c) Licensees.

    (a) General. SBA may provide Leverage to any Section 301(c) 
Licensee through the purchase or guarantee of Debentures and/or 
Participating Securities.
    (b) Leverage formula. After March 31, 1993, the amount of Leverage 
a section 301(c) Licensee may have outstanding at any time shall not 
exceed the following amounts:
    (1) If Leverageable Capital is not more than $15,000,000, Leverage 
shall not exceed three hundred percent (300%) of Leverageable Capital;
    (2) If Leverageable Capital is more than $15,000,000 but not more 
than $30,000,000, Leverage shall not exceed $45,000,000 plus two 
hundred percent (200%) of the mount of Leverageable Capital over 
$15,000,000;
    (3) If Leverageable Capital is more than $30,000,000, Leverage 
shall not exceed $75,000,000 plus one hundred percent (100%) of the 
amount of Leverageable Capital over $30,000,000, but not to exceed an 
additional $15,000,000.
    (c) Maximum limits and exceptions. Notwithstanding paragraph (b) of 
this section, in no event shall the aggregate amount of outstanding 
Leverage of any Licensee or group of two or more Licensees (including 
both section 301(c) and section 301(d) Licensees) under Common Control 
exceed $90,000,000 unless SBA determines, on a case-by-case basis, to 
permit a higher aggregate amount for companies under Common Control and 
SBA imposes such additional terms and conditions as it determines 
appropriate to minimize the risk of loss to SBA in the event of 
default.
    (d) Grandfather clause. Nothing in these provisions shall require 
any section 301(c) Licensee that on March 31, 1993, has outstanding 
Debentures in excess of three hundred percent (300%) of Leverageable 
Capital to prepay such excess. Any such Licensee may apply for an 
additional Debenture guarantee or Participating Security guarantee, 
provided that the proceeds are used solely to pay the amount due on any 
such maturing Debenture. The maturity of such new Debenture or 
Participating Security shall not be later than September 30, 2002.
    (e) Limits on Participating Securities. The aggregate amount of 
Participating Securities outstanding from a Licensee shall not exceed 
two hundred percent (200%) of Leverageable Capital.


Sec. 107.230  Leverage for 301(d) Licensees.

    (a) General. SBA may provide Leverage to any Section 301(d) 
Licensee through the purchase or guarantee of Debentures and/or 
Participating Securities, and/or through the purchase of Preferred 
Securities.
    (b) Articles requirements for Preferred Securities Leverage. In 
addition to the requirements specified in Sec. 107.101, no Preferred 
Securities will be acquired by SBA from any Section 301(d) Licensee 
unless the following provisions are contained in such Licensee's 
Articles:
    (1) Corporate Section 301(d) Licensees. (i) Payment of dividends to 
SBA. Preferred stock issued by a corporate Section 301(d) Licensee to 
SBA after November 21, 1989, shall provide for the preferred payment of 
cumulative dividends at a rate of four percent (4%) per annum on the 
par value of such stock, accruing from the date of issuance to the date 
of payment, both inclusive. Such dividends shall be declared and 
payable from Retained Earnings Available for Distribution before any 
amount shall be set aside for or paid to any other class of stock. In 
the event SBA has received less than four percent (4%) in any fiscal 
year, the deficiency shall be payable on a preferred basis from 
subsequent Retained Earnings Available for Distribution without 
interest thereon. Before any declaration of dividends or any 
Distribution (other than to SBA), all dividends accumulated and unpaid 
on Preferred Securities issued to SBA shall be paid. The dividend rate 
on nonvoting Preferred Securities purchased by SBA prior to November 
21, 1989, shall remain three percent (3%) of their par value and 
otherwise be subject to the provisions of this paragraph.
    (ii) Mandatory redemption of Preferred Securities. Preferred 
Securities purchased by SBA on or after November 21, 1989, shall be 
redeemed by the issuer not later than fifteen (15) years from the date 
of issuance, at a price not less than the par value, plus any unpaid 
dividends accrued to the redemption date. SBA may, in its discretion, 
guarantee Debentures offered for sale by such Licensee at the Debenture 
sale immediately preceding such fifteenth anniversary date, pursuant to 
section 321 of the Act, in such amounts as will permit the simultaneous 
redemption of such Preferred Securities, including all or any part of 
accrued and unpaid dividends, for immediate payment to SBA. SBA shall 
not pay any part of the interest on such Debentures except pursuant to 
its guarantee. See also Sec. 107.230(f).
    (2) Unincorporated Section 301(d) Licensees. (i) Payment of 
Distributions to SBA. Preferred limited partnership interests issued to 
SBA by a limited partnership section 301(d) Licensee shall provide for 
Distributions to SBA on a preferred and cumulative basis at an annual 
rate of four percent (4%) on the entire amount of SBA's capital 
contribution (with no adjustments other than those reflecting prior 
returns of capital), accruing from the date of issuance to the date of 
Distribution, both inclusive. SBA shall be paid from Retained Earnings 
Available for Distribution. In the event SBA has received less than 
four percent (4%) in any fiscal year, the deficiency shall be payable 
on a preferred basis from subsequent Retained Earnings Available for 
Distribution without interest thereon. Before any allocation or 
Distribution (other than to SBA), all accumulated and unpaid 
Distributions on preferred limited partnership interests issued to SBA 
shall be paid.
    (ii) Mandatory redemption of preferred limited partnership 
interest. Preferred limited partnership interests shall be redeemed by 
the issuer not later than fifteen (15) years from the date of issuance, 
at a price not less than the amount of SBA's contributed capital, with 
no adjustments other than those reflecting prior returns of capital, 
plus any accumulated and unpaid Distribution to and including the 
redemption date. SBA may, in its discretion, guarantee Debentures 
offered for sale by such Licensee at the Debenture sale immediately 
preceding such fifteenth anniversary date, pursuant to section 321 of 
the Act, in such amounts as will permit the simultaneous redemption of 
such preferred limited partnership interests, including all or any part 
of accumulated and unpaid Distributions, for immediate payment to SBA. 
SBA shall not pay any part of the interest on such Debentures except 
pursuant to its guarantee. See also Sec. 107.230(f).
    (c) Maximum Leverage--General. All Leverage issued by Section 
301(d) Licensees shall be aggregated for purposes of determining 
Leverage eligibility. Subject to the limitations on Leverage issued by 
Licensees under Common Control set forth in Sec. 107.220(c), the total 
amount of Leverage permissible to a section 301(d) Licensee shall be 
determined as follows:
    (1) Maximum Subsidized Leverage. A section 301(d) Licensee or group 
of such Licensees under Common Control shall be eligible for maximum 
subsidized Leverage of four hundred percent (400%) of Leverageable 
Capital or $35,000,000, whichever is less, subject to the exceptions 
and limitations set forth in paragraphs (c) (3) through (6) of this 
section. For purposes of this paragraph, ``subsidized Leverage'' means 
Preferred Securities and Debentures issued with a rate reduction or 
subsidy.
    (2) Leverage above $35,000,000. A section 301(d) Licensee is 
eligible for Leverage in excess of $35,000,000, in the amounts and 
subject to the conditions set forth in Sec. 107.220 (b) and (c); 
Provided, however, that the aggregate amount of subsidized Leverage 
issued by such Licensee or group of such Licensees under Common Control 
shall not exceed $35,000,000.
    (3) Conditions for Leverage exceeding 300 percent. (i) To qualify 
for Leverage exceeding three hundred percent (300%) of Leverageable 
Capital, at least thirty percent (30%) of a section 301(d) Licensee's 
Total Funds Available for Investment must be invested in (or committeed 
to) Venture Capital Financings. Licensee must maintain thirty percent 
(30%) of its Total Funds Available for Investment in such investments, 
at their cost basis, subsequent to issuing Leverage in excess of three 
hundred percent (300%) of Leverageable Capital. See also 
Secs. 107.261(d)(9) and 107.262(d)(9).
    (ii) ``Total Funds Available for Investment'' means ninety percent 
of the sum of total current assets plus Loans and Investments on a cost 
basis and net of current maturities.
    (iii) ``Venture Capital Financing'' means an investment in a 
Disadvantaged Concern represented by Equity Securities as defined in 
Sec. 107.3 with no repurchase requirement for at least five (5) years, 
except as may be approved specifically by SBA under Sec. 107.801 for 
purposes of relinquishing Control over a Small Concern; any right to 
purchase Equity Securities in conjunction with the purchase of Equity 
or Debt Securities which, after consideration of all of the terms, 
conditions and documentation of such financing, are determined by 
Licensee's Board of Directors or General Partner(s) to have in excess 
of fifty percent (50%) of the anticipated return on such financing 
represented by the potential for equity appreciation; or Debt 
Securities or Loans which are subordinated by their terms to all 
borrowings of the issuer, except borrowings from officers, directors, 
and owners of the Small Concern, or Close Relatives thereof, and which 
are not amortized during the first three (3) years. A Financing which 
originally qualified as a Venture Capital Financing but which is 
currently carried as ``assets acquired in liquidation of portfolio 
securities'' or ``operating concerns acquired'' shall continue to 
qualify as a Venture Capital Financing, at original cost.
    (4) Second Tier Preferred Securities Leverage. SBA is authorized to 
purchase Preferred Securities from a section 301(d) Licensee in amounts 
in excess of one hundred percent (100%) of Leverageable Capital, but 
not in excess of two hundred percent (200%) of Leverageable Capital, 
Provided:
    (i) Its license was issued on or before October 13, 1971; or
    (ii) Its license was issued after October 13, 1971, and Licensee 
has Leverageable Capital of $500,000 or more; and
    (iii) In either case, it has Qualified Investments (or commitments 
to make such investments), at cost, equal to the amount of Preferred 
Securities in excess of one hundred percent (100%) of Leverageable 
Capital--See also Sec. 107.262(d)(9).
    (iv) For this purpose, ``Qualified Investments'' means, subject to 
Secs. 107.320 and 107.801, an investment in a Disadvantaged Concern 
represented by stock of any class (including preferred stock) or 
limited partnership interests, or shares of any eligible syndicate, 
business trust, joint stock company or association, mutual corporation, 
cooperative or other joint venture for profit; or unsecured debt 
instruments which are subordinated by their terms to all other 
borrowings (as distinguished from all other debts and obligations) of 
the issuer and which, after consideration of all of the terms, 
conditions and documentation of such instruments, are determined by 
Licensee's Board of Directors or General Partner(s) to have in excess 
of fifty percent (50%) of the anticipated return on such financing 
represented by the potential for equity appreciation. ``Qualified 
Investments'' shall not include a debt secured by any agreement with a 
third party, whether or not a security interest has been created in any 
asset of such third party, with or without recourse against such third 
party.
    (5) Non-Cumulative. If a Financing qualifies as both a Venture 
Capital Financing and a Qualified Investment, such Financing may be 
construed as both a Venture Capital Financing and a Qualified 
Investment.
    (6) Participating Securities Leverage. The aggregate of a section 
301(d) Licensee's outstanding Participating Securities and Preferred 
Securities shall not exceed two hundred percent (200%) of Leverageable 
Capital. The Prioritized Payments and the Profit Participation on 
Participating Securities issued by section 301(d) Licensees shall not 
be adjusted by any subsidy or rate reduction.
    (d) Debentures issued by section 301(d) Licensees. Subject to the 
limitations of paragraph (c) of this section, section 301(d) Licensees 
may issue three types of Debentures:
    (1) Debentures guaranteed by SBA pursuant to section 303(c) of the 
Act. During the first five (5) years of the term of such Debentures, 
the rate of interest payable by the issuer shall be three hundred (300) 
basis points below the interest rate stated on the face of the 
Debenture.
    (2) Debentures guaranteed by SBA pursuant to section 303(b) of the 
Act. Such Debentures are not entitled to a reduced interest rate.
    (3) Debentures purchased by SBA pursuant to section 303(c) of the 
Act. Such Debentures shall be entitled to a reduced interest rate 
determined according to section 317 of the Act. They shall specify both 
the subsidized interest rate and the non-subsidized interest rate (as 
prescribed by sections 317 and 303(b) of the Act), together with the 
dates between which each applies.
    (e) Exchange of outstanding Debentures for Preferred or 
Participating Securities. (1) Subject to the conditions applicable to 
the issuance of Preferred or Participating Securities, a section 301(d) 
Licensee may, in SBA's discretion, retire Debentures through the 
issuance of such securities. A section 301(d) Licensee proposing to 
exchange its outstanding Debentures shall be required to pay all unpaid 
accrued interest plus any applicable prepayment penalties, fees, and 
other charges as a condition of such exchange.
    (2) Notwithstanding the provisions of paragraph (e)(1) of this 
section paragraph, Debentures purchased or guaranteed by SBA on the 
basis of funds not included in Leverageable Capital may not be retired 
through issuance of Preferred or Participating Securities. Such 
Debentures, to the extent purchased or guaranteed by SBA on the basis 
of ineligible funds, shall be paid at maturity, unless such maturity is 
extended by SBA. In this regard, SBA shall have discretion to extend 
such maturity to a date not more than fifteen (15) years from the date 
of issuance if it believes such extension is necessary to achieve an 
orderly liquidation of the indebtedness.
    (f) Preferred Securities--voluntary redemption rights. A section 
301(d) Licensee may redeem Preferred Securities purchased by SBA, in 
whole or in part, on any dividend payment date or distribution of 
capital date (provided that it gives SBA at least thirty days prior 
written notice). It shall do so by paying SBA the Original Issue Price 
of such securities, but not less than $50,000 in any one transaction, 
plus any dividends or distributions accumulated and unpaid to the date 
of redemption. SBA is authorized to sell Preferred Securities purchased 
on or before November 20, 1989 to the issuer at a price less than the 
sum of the Original Issue Price and any unpaid dividends or 
distributions. SBA shall determine the sale price of such Preferred 
Securities in its sole discretion after considering such factors as it 
deems appropriate. These factors shall include, but not be limited to, 
the market value of such securities, the value of benefits previously 
provided and anticipated to accrue to the issuer, the amount of 
dividends previously paid, accrued, and anticipated, and SBA's estimate 
of any anticipated redemption. In such event, SBA may guarantee 
Debentures issued by the Licensee in order to accomplish the repurchase 
of such Preferred Securities; Provided, however, that SBA shall not pay 
any part of the interest on such Debentures, except pursuant to its 
guarantee. See also Secs. 107.230(b)(1)(ii) and 107.230(b)(2)(ii).


Sec. 107.240  Participating Securities.

    The provisions of Secs. 107.241 through 107.247 shall apply to 
Participating Securities and all Licensees issuing such securities.


Sec. 107.241  Participating Securities--General.

    (a) Minimum capital. Subject to Sec. 107.101(d), a Licensee with 
Regulatory Capital of $10 million or more shall be eligible to issue 
Participating Securities. A Licensee with Regulatory Capital of less 
than $10 million shall be eligible to issue Participating Securities if 
it demonstrates to SBA's satisfaction that it can be financially viable 
over the long term with such lesser amount; Provided, however, that no 
application to issue Participating Securities shall be considered if 
the Licensee's Regulatory Capital is less than $5 million.
    (b) Investment requirements. Any Licensee issuing Participating 
Securities shall invest an amount equal to the Original Issue Price of 
such securities solely in Equity Capital Investments. After the initial 
investment of such funds, unless SBA permits otherwise, such Licensee 
shall maintain Equity Capital Investments as of the end of each fiscal 
year with an original cost of not less than the outstanding balance of 
Participating Securities.
    (c) Management and ownership diversity. Unless otherwise approved 
by SBA, Licensee applying for Participating Securities shall have 
diversity between management and ownership. As long as any Earmarked 
Assets remain in its portfolio, the Licensee shall maintain such 
diversity. This diversity may be established only by satisfying both of 
the following requirements:
    (1) The Licensee shall meet at least one of the following three 
conditions:
    (i) The Licensee or its ultimate parent shall have three or more 
shareholders or limited partners who, in the aggregate, have not less 
than a thirty percent (30%) interest in such Licensee's Regulatory 
Capital and who (except for such status as a shareholder or limited 
partner) are not Associates of, or Affiliates of any Associate of, such 
Licensee; or
    (ii) The Licensee or its ultimate parent shall have one or more 
Institutional Investors that are:
    (A) Regulated by state or Federal authorities satisfactory to SBA,
    (B) Public or private employee pension funds,
    (C) Trusts, foundations, or endowments which are exempt from 
Federal income taxation, or
    (D) Other Institutional Investors satisfactory to SBA, who directly 
or indirectly have in the aggregate not less than a thirty percent 
(30%) interest in such Licensee's Regulatory Capital and who (except 
for such status as a shareholder or limited partner) are not Associates 
of, or Affiliates of any Associate of, such Licensee; or
    (iii) The common stock or limited partnership interests of 
Licensee, or at least one class of voting common stock or the limited 
partnership interests of the ultimate parent (if any) of Licensee, is 
publicly traded. For purposes of this paragraph (c)(1), ``ultimate 
parent'' shall mean an entity that directly or indirectly has an 
interest of more than fifty percent (50%) of the Regulatory Capital of 
a Licensee.
    (2) Shareholders or limited partners of a Licensee shall not have 
delegated their voting rights to any other person or entity without 
prior SBA approval. Publicly traded Licensees are exempt from this 
provision. This restriction also shall not apply to proxies given to 
vote at single specified meetings, or to delegation of such rights to 
investment advisors that are not Affiliates of the Licensee except for 
their shareholder or partner status.
    (d) Approved Management Expense. Every Licensee that has 
Participating Securities outstanding or has Earmarked Assets in its 
portfolio shall have its Management Expenses approved by SBA at the 
time of licensing and prior to any proposed increases in such Expenses.
    (e) Temporary Debt. (1) The only debt other than Leverage that any 
Licensee with outstanding Participating Securities may incur shall be 
Temporary Debt. Each such Licensee must obtain the prior written 
approval of SBA before incurring any secured Temporary Debt. If a 
Licensee which is in regulatory compliance and which has Leverage not 
in excess of one hundred fifty percent (150%) of its Leverageable 
Capital shall request approval for a secured line of credit which would 
not cause its aggregate indebtedness (other than Leverage) to exceed 
fifty percent (50%) of Leverageable Capital, then the Licensee may 
consider its request approved unless notified otherwise within thirty 
(30) days of SBA's receipt of such request.
    (2) For this purpose, the term ``Temporary Debt'' means qualified 
short-term borrowings of a Licensee for the purposes of providing funds 
for a particular Financing of a Small Concern or funds to maintain a 
Licensee's operating liquidity, which are borrowed from regulated 
financial institutions or regulated credit companies or, if approved by 
SBA on a case-by-case basis, from non-regulated lenders, including 
shareholders or partners.
    For a borrowing to qualify as Temporary Debt, total borrowings 
outstanding may not exceed fifty percent (50%) of Licensee's 
Leverageable Capital, and all such borrowings must be paid off for at 
least thirty (30) consecutive days during the Licensee's fiscal year so 
that Licensee has no Temporary Debt during such thirty-day period. A 
Licensee with indebtedness which does not meet the requirements of 
Temporary Debt must eliminate such indebtedness to qualify for issuance 
of Participating Securities.
    (f) Liquidity requirements. A Licensee with outstanding 
Participating Securities shall maintain adequate liquidity so as to 
avoid a condition of Liquidity Impairment (as defined in paragraph 
(f)(1) of this section). Such a condition shall affect the Licensee's 
good standing pursuant to Sec. 107.262(c).
    (1) Definition of Liquidity Impairment. A condition of Liquidity 
Impairment shall exist when a Licensee's Liquidity Ratio, as determined 
in paragraph (f)(2) of this section is less than 1.20. Each Licensee is 
responsible for calculating whether it has a condition of Liquidity 
Impairment as of the close of its fiscal year, at the time of 
application for Leverage, or at such time as Licensee contemplates 
making any Distribution. SBA shall have the right to make the final 
determination in this regard.
    (2) Computation of Liquidity Ratio. Licensee's Liquidity Ratio 
shall be equal to its Total Current Funds Available divided by its 
Total Current Funds Required, as determined in accordance with the 
following table:

                   Calculation of SBIC Liquidity Ratio                  
------------------------------------------------------------------------
                                              As                        
                                           reported                     
            Financial account               on SBA     Wt.      Weighted
                                           form 468              amount 
                                                                        
------------------------------------------------------------------------
Cash and Invested Idle Funds.............  ........      1.00           
Commitments From Investors...............  ........      1.00           
Other Current Assets.....................  ........      1.00           
Current Portion of Maturities............  ........       .50           
Publicly Traded & Marketable Securities..  ........       .65           
Anticipated Operating Revenue for next 12                               
 months..................................     (\1\)      1.00           
                                          ------------------------------
    Total Ccurrent Funds Available.......  ........  ........         A 
                                          ==============================
Current Liabilities......................  ........      1.00           
Commitments Outstanding..................  ........       .75           
Anticipated Operating Revenue for next 12                               
 months..................................     (\1\)      1.00           
Anticipated Interest Expense for next 12                                
 months..................................     (\1\)      1.00           
Contingent Liabilities (Guarantees)......  ........       .25           
                                          ------------------------------
    Total Current Funds Required.........  ........  ........         B 
                                          ------------------------------
    Liquidity Ratio: (A/B)...............  ........  ........           
------------------------------------------------------------------------
\1\As determined by Licensee's management, pursuant to a plan of        
  operations.                                                           

    (g) Redemption. The redemption date of Participating Securities 
shall be the same as the maturity date of the Trust Certificates for 
the Trust containing such securities. In no event shall such date be 
later than fifteen (15) years after the issue date. Participating 
Securities shall be redeemed at the Redemption Price plus any unpaid 
Earned Prioritized Payments and any additional earned amounts due 
pursuant to Sec. 107.243 (c) and (d).
    (h) Priority in Liquidation. In the event of liquidation of a 
Licensee, the Redemption Price of Participating Securities, together 
with any Prioritized Payments, any additional amounts due pursuant to 
Sec. 107.243 (c) and (d), and any Profit Participation allocated 
pursuant to Sec. 107.244(e), shall be senior in priority for all 
purposes to all other equity interests in the issuing Licensee, 
whenever created.


Sec. 107.242  Computation of Earmarked Profits (Losses).

    (a) Frequency of Calculation. A Licensee that has Participating 
Securities outstanding or has Earmarked Assets in its portfolio shall 
compute Earmarked Profits (Losses) no less frequently than at the end 
of its fiscal year and at such other times as Licensee elects to make a 
Distribution.
    (b) Earmarked Assets. ``Earmarked Assets'' means Loans and 
Investments that exist at the time Participating Securities are issued 
or that are acquired by Licensee while Participating Securities are 
outstanding and non-cash assets received in exchange for any such 
assets. Notwithstanding Licensee's redemption of all or part of its 
Participating Securities, Licensee's Earmarked Assets shall retain such 
status until their disposition. Investments made subsequent to the 
complete repayment or redemption of all Participating Securities are 
not considered Earmarked Assets unless Licensee issues additional 
Participating Securities, at which time all of Licensee's Loans and 
Investments again become Earmarked Assets. For special rules providing 
exclusions applicable to companies licensed prior to March 31, 1993, 
see Sec. 107.247.
    (c) Earmarked Asset Ratio. To compute Earmarked Profits (Losses), 
Licensee first shall compute an Earmarked Asset Ratio for the fiscal 
year or portion thereof, as appropriate. Earmarked Asset Ratio means, 
at cost basis, the ratio of Earmarked Assets plus the proceeds of 
Participating Securities not yet invested to Licensee's total Loans and 
Investments plus the proceeds of Participating Securities not yet 
invested, stated as a percentage. The Earmarked Asset Ratio shall be 
computed on the respective weighted average amounts of Earmarked 
Assets, total Loans and Investments, and uninvested proceeds of 
Participating Securities outstanding during such fiscal year or portion 
thereof.
    (d) Determining Earmarked Net Investment Income (Loss).
    (1) Determining Earmarked Investment Income. (i) Licensee shall 
allocate to Earmarked Investment Income all income which is directly 
attributable to such Earmarked Assets.
    (ii) Licensee shall multiply interest on idle funds and other 
income not attributable to specific assets by the Earmarked Asset 
Ratio.
    (iii) The aggregate of (d)(1) (i) and (ii) of this section shall be 
Earmarked Investment Income.
    (2) Determining Earmarked Investment Expenses. (i) Earmarked 
Investment Expenses. Earmarked Investment Expenses shall be equal to 
the sum of:
    (A) Management Expenses as computed pursuant to paragraph 
(d)(1)(ii) of this section and
    (B) Non-Management Expenses as computed pursuant to paragraph 
(d)(1)(iii) of this section.
    (ii) Management Expenses. For the purpose of determining Earmarked 
Investment Expenses, Management Expenses shall be the lesser of:
    (A) Licensee's approved Management Expenses times its Earmarked 
Asset Ratio, or
    (B) An amount determined by multiplying Licensee's Combined Capital 
times its Earmarked Asset Ratio times 2.5 percent, and adding $125,000 
times the Earmarked Asset Ratio to the product if Licensee's Combined 
Capital is less than $20,000,000.
    (iii) Non-Management Expenses. Licensee shall allocate to Earmarked 
Assets those non-Management Expenses which are directly attributable to 
such assets. Licensee shall add to this amount the product obtained by 
multiplying the Earmarked Asset Ratio by those non-Management Expenses 
not attributable to specific assets. Interest on Debentures shall be 
considered a non-Management Expense.
    (3) Earmarked Net Investment Income (Loss). Earmarked Investment 
Income in paragraph (d)(1) of this section shall be reduced by 
Earmarked Investment Expenses in paragraph (d)(2) of this section to 
determine Earmarked Net Investment Income (Loss).
    (e) Determining Earmarked Realized Gain (Loss) on Securities. 
Licensee shall compute its Earmarked Realized Gain (Loss) on Securities 
by subtracting the basis of such assets from their net sales price, in 
accordance with the following:
    (1) The cost of an asset shall be the basis used for computing 
Realized Gain (Loss), unless another basis is permitted by SBA.
    (2) If an exchange of assets occurs, the basis of the acquired 
asset(s) shall be the cost of the original asset being exchanged.
    (3) The basis of Earmarked Assets shall be increased only by 
additional financings to the Small Concern, or by Licensee's share of 
the income of an unincorporated Small Concern in which Licensee's basis 
is appropriately determined using the equity method of accounting. The 
basis of Earmarked Assets shall not be increased by capitalization of 
interest.
    (4) Unrealized Appreciation or (Unrealized Depreciation) on 
Earmarked Assets that are being distributed as an In-Kind Distribution 
shall be recognized as Realized Gain (Loss) on Securities. (See 
Sec. 107.245(e)(3))
    (f) Determining Earmarked Profits (Losses). The aggregate of 
Earmarked Net Investment Income (Loss) and Earmarked Realized Gain 
(Loss) on Securities (paragraphs (d) and (e) of this section shall be 
Earmarked Profits (Losses) for the relevant period.


Sec. 107.243  Computation, Allocation, and Distribution of Prioritized 
Payments.

    (a) General. Prioritized Payments shall be classified as either 
Accumulated Prioritized Payments or Earned Prioritized Payments. Earned 
Prioritized Payments (and additional ``earned'' amounts determined 
under this section) shall be allocated from Distributable Earmarked 
Profits and distributed from the Prioritized Payment Distribution 
Account. Such Distributions shall occur before any other Distribution 
and accordingly shall not be included in Distributions to SBA as set 
forth in Sec. 107.245.
    (b) Accounts. Licensee shall establish the following two accounts 
in its books and records:
    (1) Prioritized Payment Accumulation Account. The Prioritized 
Payment Accumulation Account shall be a memorandum account to which 
Licensee shall add all Prioritized Payments on its Participating 
Securities and any additional amounts (``Adjustments'') required under 
paragraphs (d)(1) and (d)(2) of this section. Licensee shall deduct 
from the Prioritized Payment Accumulation Account all Earned 
Prioritized Payments and those Adjustments which are considered 
``earned'' according to the same criteria applied to Prioritized 
Payments in paragraph (c) of this section. The balance in this account 
shall represent Licensee's Accumulated Prioritized Payments and 
unearned Adjustments.
    (2) Prioritized Payment Distribution Account. The Prioritized 
Payment Distribution Account shall be a liability account to which 
Licensee shall add all Earned Prioritized Payments and earned 
Adjustments and from which Licensee shall deduct all Distributions of 
Earned Prioritized Payments and earned Adjustments. The balance in this 
account shall represent Licensee's undistributed Earned Prioritized 
Payments and earned Adjustments.
    (c) Allocation and Distribution of Prioritized Payments. At the end 
of each fiscal year, and at the end of any fiscal quarter for which a 
Distribution is contemplated, Licensee shall perform the following 
procedures:
    (1) Add to the Prioritized Payment Accumulation Account all 
Prioritized Payments for the relevant fiscal period.
    (2) Determine the cumulative sum of Earmarked Profits (Losses) and 
subtract from such sum all Earned Prioritized Payments and earned 
Adjustments previously allocated to the Prioritized Payment 
Distribution Account. The result, if greater than zero, shall be 
Licensee's Distributable Earmarked Profits.
    (3) If Licensee has Distributable Earmarked Profits:
    (i) Licensee shall allocate to the Prioritized Payment Distribution 
Account an amount equal to the lesser of Distributable Earmarked 
Profits or the balance in the Prioritized Payment Accumulation Account.
    (ii) Licensee shall reduce the Prioritized Payment Accumulation 
Account by the amount allocated to the Prioritized Payment Distribution 
Account in paragraph (c)(3)(i) of this section.
    (iii) Subjects to the liquidity requirement set forth in 
Sec. 107.241(f) Licensee shall distribute an amount equal to the 
balance in its Prioritized Payment Distribution Account to SBA, or its 
designated agent or Trustee, within ninety (90) days after the end of 
Licensee's fiscal year or before any other Distribution is made, as 
appropriate. The Prioritized Payment Distribution Account balance shall 
be reduced by such Distribution.
    (iv) If Licensee has issued Participating Securities on more than 
one occasion, Prioritized Payments shall be made on such Participating 
Securities in order of issue date.
    (4) If a Licensee has no Distributable Earmarked Profits, no 
allocation shall be made to the Prioritized Payment Distribution 
Account.
    (d) Adjustments to Prioritized Payment Accumulation Account. The 
Prioritized Payment Accumulation Account shall be subject to the 
following adjustments:
    (1) If, at the end of any fiscal year, there exists any balance in 
the Prioritized Payment Accumulation Account, Licensee shall add to 
such account an amount equal to the product of the average balance in 
such account during such fiscal year, multiplied by the average Trust 
Certificate Rate in effect during such fiscal year.
    (2) If, at the end of any fiscal year, there remains any 
undistributed balance in the Prioritized Payment Distribution Account, 
Licensee shall compute an additional amount equal to the product of the 
average outstanding balance in such account during such fiscal year, 
multiplied by the average Trust Certificate Rate in effect during such 
fiscal year. Such amount shall be added to the Prioritized Payment 
Accumulation Account.
    (3) If, after Licensee has performed the procedures required in 
paragraphs (c), (d)(1) and (d)(2) of this section, there remains any 
undistributed balance in the Prioritized Payment Distribution Account, 
Licensee shall continue to perform the procedures in this Sec. 107.243 
as of the end of each subsequent fiscal quarter until such amounts are 
paid in full.


Sec. 107.244  Computation and Allocation of Profit Participation.

    (a) Profit Participation Account. Licensee shall establish a Profit 
Participation Account in its books and records which shall reflect the 
allocation and distribution of Profit Participation. This account shall 
be reduced by any tax Distribution made to SBA, or its designated agent 
or Trustee, pursuant to 107.245(b) or other Distributions pursuant to 
107.245(c).
    (b) Computing the Base for Profit Participation. At the end of each 
fiscal year, and at the end of any fiscal quarter for which a 
Distribution is contemplated, Licensee shall compute and maintain a 
record of its Base for Profit Participation (``Base'') according to the 
following procedure:
    (1) Base. The Base shall be equal to Earmarked Profits (Losses) 
minus Prioritized Payments and any Adjustments for the fiscal year or 
fiscal year-to-date, as appropriate, minus any unused loss carryforward 
from prior fiscal years.
    (2) Unused loss carryforward. If Licensee has not previously 
computed a Base for Profit Participation at the end of a fiscal year, 
or if the Base computed at the end of Licensee's previous fiscal year 
(the ``Previous Base'') was zero or greater, Licensee's unused loss 
carryforward shall be zero. If the Previous Base was less than zero, 
Licensee's unused loss carryforward shall be equal to Previous Base.
    (c) Profit Participation Rates. A Licensee which issues 
Participating Securities shall compute a Profit Participation Rate for 
the relevant fiscal year or fiscal year-to-date in accordance with the 
following procedure:
    (1) Subject to paragraph (c)(5) of this section, the applicable 
Profit Participation Rate shall be based upon the highest ratio of 
Participating Securities Leverage to Leverageable Capital which has 
ever been outstanding for such Licensee, regardless of any repayment or 
redemption (the ``PLC ratio'').
    (2) Subject to any indexing required in paragraph (c)(4) of this 
section if the PLC Ratio is one or less, the Profit Participation Rate 
shall be equal to the PLC ratio times nine percent (9%).
    (3) Subject to any indexing required in paragraph (4) of this 
section, if the PLC Ratio is more than one but not greater than two, 
the Profit Participation Rate shall be computed as follows:
    (i) Nine percent (9%), plus
    (ii) The PLC Ratio minus one, times three percent (3%).
    (4) The Profit Participation Rate shall be indexed to the yield-to-
maturity on Treasury bonds with a remaining term of ten (10) years (the 
``Treasury Rate''), according to the following procedures:
    (i) Licensees that have issued Participating Securities on only one 
occasion. If, on the date Participating Securities are issued, the 
Treasury Rate is other than eight percent (8%), the Profit 
Participation Rates specified in paragraphs (c) (2) and (3) of this 
section shall be adjusted proportionately, that is, by the percentage 
difference between such Treasury Rate and eight percent (8%). For 
example, if the Treasury Rate were eight percent (8%) when a Licensee 
issued Participating Securities equal to one hundred percent (100%) of 
Leverageable Capital, the Profit Participation Rate would be nine 
percent (9%) pursuant to paragraph (c)(2) of this section. If the 
Treasury Rate were ten percent (10%) at the time of issuance, however, 
the Licensee's Profit Participation Rate would be 11.25 percent

[{<.10-.08}/.08)+1} x .09 x 100=11.25%]

    (ii) Licensees that have issued Participating Securities on more 
than one occasion. If, on any of the dates Participating Securities are 
issued, the Treasury Rate is other than eight percent (8%):
    (A) Licensee shall compute an average of such Treasury Rates for 
all issuances of Participating Securities, weighted to reflect the 
dollar amount of each issuance and the portion of the fiscal period 
during which each issuance was outstanding. For example, if a Licensee 
issued $10 million of Participating Securities on the first day of its 
fiscal year when the Treasury Rate was eight percent (8%), and another 
$15 million on the 300th day of its fiscal year when the Treasury Rate 
was ten percent (10%), then the weighted average Treasury Rate computed 
as of the end of the fiscal year would be 8.42%. [15,000,000 x  
(365-300)/365=2,671,233; 10,000,000+2,671,233=12,671,233 weighted 
average Participating Securities; 
{(10,000,000 x .08)+(2,671,233 x .10)}/12,671,233=8.42% weighted 
average Treasury Rate]
    (B) The Profit Participation Rates specified in paragraphs (c) (2) 
and (3) of this section then shall be adjusted by the percentage 
difference between the weighted average Treasury Rate and eight percent 
(8%). In the example given in paragraph (c)(4)(ii)(A) of this section, 
if the $25 million of Participating Securities issued were equal to two 
hundred percent (200%) of Leverageable Capital, the Profit 
Participation Rate for the fiscal year would be 12.63%.

[{(<.0842-.08 /.08)+1} x .12 x 100=12.63%]

    (5) The computation of the Profit Participation Rate shall not be 
modified due to an increase in the Leverageable Capital of Licensee 
unless the increase:
    (i) Is the result of the takedown of commitments or the conversion 
of non-cash assets, provided such commitments or assets were included 
in the Licensee's Private Capital; or
    (ii) Is expressly provided for in a plan of operations submitted to 
and approved by SBA in writing.
    (d) Computing the Profit Participation. If the Base for the 
relevant fiscal period, as determined in paragraph (b) of this section, 
is greater than zero, Licensee shall compute the Profit Participation 
in accordance with the following procedure:
    (1) The Profit Participation for the fiscal year or fiscal year-to-
date shall be the result obtained by multiplying the Base by the Profit 
Participation Rate determined in paragraph (c) of this section.
    (2) Such Profit Participation shall be reduced by any amounts of 
Profit Participation that were distributed or reserved for distribution 
to SBA, or its designated agent or Trustee, for any interim period(s) 
during such fiscal year.
    (3) Any computation of Profit Participation made on the basis of an 
interim fiscal quarter shall be adjusted, both at fiscal year-end and 
whenever any additional interim Distributions are made, to account for 
any increase in the Profit Participation Rate.
    (e) Allocation of Profit Participation. Prior to any Distribution 
and in any event within ninety (90) days following the end of the 
Licensee's fiscal year, the Licensee shall allocate to its Profit 
Participation Account the amount of Profit Participation calculated 
pursuant to paragraph (d) of this section. Funds equal to amounts 
allocated to the Licensee's Profit Participation Account shall be 
reserved for distribution to SBA, its designated agent or Trustee; such 
amounts shall not be available for reinvestment in Small Concerns or 
for any other use by the Licensee.
    (f) Distribution of Allocated Profit Participation. Distribution of 
allocated Profit Participation shall be made at the same time that 
profits are distributed to private capital investors either as tax 
Distributions or as other returns on capital (see Sec. 107.245).


Sec. 107.245  Distributions.

    (a) General. Distributions shall only be made based on computations 
and allocations as of the end of a Licensee's fiscal year or fiscal 
quarter (reflecting results for the fiscal year-to-date). For purposes 
of this Sec. 107.245, Prioritized payments shall not be considered a 
Distribution, but Profit Participation shall be considered a 
Distribution and shall be included in Distributions made to SBA, or its 
designated agent or Trustee, under paragraphs (b) and/or (c) of this 
section.
    (b) Distributions for tax purposes. After all Prioritized Payments 
have been paid, and subject to the liquidity requirements set forth in 
Sec. 107.241(f), a Licensee that is operating as a limited partnership, 
an ``S Corporation'', or an equivalent pass-through entity for tax 
purposes, may make an annual distribution from Retained Earnings 
Available for Distribution to its investors (including SBA) in an 
amount not greater than the Licensee's Maximum Tax Liability. SBA, or 
its designated agent or Trustee, shall receive a ``tax Distribution'' 
equal to its Profit Participation Rate specified in Sec. 107.244(c) 
times the Maximum Tax Liability. For purposes of this paragraph, the 
term ``Maximum Tax Liability'' means the aggregate amount of income 
allocated to partners or shareholders for Federal income tax purposes 
with respect to the fiscal year of the Licensee immediately preceding 
such Distribution, multiplied by the highest combined marginal Federal 
and State income tax rates for corporations or individuals, whichever 
is higher, on each type of income included in such return. For purposes 
of this paragraph, the term ``State income tax'' means the state income 
tax of the State where the Licensee's principal place of business is 
located.
    (c) Returns on Capital. After all Prioritized Payments and tax 
Distributions permitted under paragraph (b) of this section have been 
made, and the liquidity requirement set forth in Sec. 107.241(f) has 
been satisfied, a Licensee which has Participating Securities 
outstanding or has Earmarked Assets shall make Distributions to its 
investors, specifically including SBA, or its designated agent or 
Trustee, as if it were an investor, in the ratios/percentages specified 
below within one hundred twenty (120) days after Licensee's fiscal year 
end. Subject to prior written approval from SBA, a Licensee may 
withhold from such Distributions reasonable reserves necessary to 
protect Licensee's investments or relative position in Loans and 
Investments and to meet contingent liabilities, without giving rise to 
a payment failure in violation of Sec. 107.262(d)(6). Under no 
circumstances shall such reserves be used to make investments in 
additional portfolio companies. A Licensee requesting prior approval 
under this paragraph may consider its request approved if SBA has not 
notified the Licensee otherwise within thirty (30) days of receipt of 
such request. A Licensee may make Distributions pursuant to this 
paragraph (c) as of the end of any fiscal quarter, subject to the same 
restrictions as provided in this section. All Distributions under this 
paragraph (c) to private investors shall be from Retained Earnings 
Available for Distribution and shall be a return on capital. 
Distributions of Profit Participation to SBA, its designated agent or 
Trustee, also shall be from Retained Earnings Available for 
Distribution. Distributions under this paragraph to SBA, its designated 
agent or Trustee, which are in excess of the Profit Participation shall 
be from Retained Earnings Available for Distribution if they are 
applied to dividends or equivalent distributions on Preferred 
Securities (as provided in paragraph (c)(5) of this section, but shall 
be from other than Retained Earnings Available for Distribution if they 
are applied as a repayment or redemption of Leverage (see paragraph 
(c)(5) of this section). All Distributions pursuant to this paragraph 
shall be calculated as follows:
    (1) When the amount of Leverage outstanding as of the date of the 
proposed Distribution is more than two hundred percent (200%) of 
Leverageable Capital, Distribution to the private investors and to SBA, 
its designated agent or Trustee, shall be made in the ratio of 
Leverageable Capital to Leverage.
    (2) When the amount of Leverage outstanding as of the date of the 
proposed Distribution is more than one hundred percent (100%) but not 
more than two hundred percent (200%) of the amount of Leverageable 
Capital, Distributions to private investors and to SBA, its designated 
agent or Trustee, shall be made in a one-to-one (1:1) ratio.
    (3) When the amount of Leverage outstanding as of the date of the 
proposed Distribution is one hundred percent (100%), or less, of the 
amount of Leverageable Capital, SBA's percentage share of such 
Distribution shall be at the Profit Participation Rate.
    (4) SBA may restrict Distributions under this paragraph (c) if SBA 
determines that the value of Licensee's assets are materially 
overstated, provided that SBA gives the Licensee notice of such 
determination in advance of the proposed Distribution.
    (5) Distributions to SBA, its designated agent or Trustee, under 
this paragraph (c) shall be applied first to Profit Participation; 
second, to the extent there remain any Retained Earnings Available for 
Distribution, to dividends or equivalent distributions on Preferred 
Securities; third, as a redemption of Participating Securities; fourth, 
as a redemption of Preferred Securities; and fifth, as the repayment of 
principal of any outstanding Debentures, such repayment to be made into 
escrow on terms and conditions determined by SBA.
    (d) Returns of capital. Notwithstanding Sec. 107.802, after all 
Earned Prioritized Payments and any additional earned amounts computed 
pursuant to Sec. 107.243 (c) and (d) and all Profit Participation 
computed pursuant to Sec. 107.244(e) have been distributed, and 
provided Licensee does not have a condition of Capital Impairment, a 
Licensee which has Participating Securities outstanding or has 
Earmarked Assets may return capital to its investors, specifically 
including SBA, its designated agent or Trustee, as if it were an 
investor. It may do so, however, only if the amount of such 
Distribution does not reduce Licensee's Regulatory Capital below the 
minimum required, or cause Licensee to have excess Leverage contrary to 
Section 303 of the Act. Any return of capital under this paragraph 
shall be made to private investors and to SBA in the ratio of 
Leverageable Capital to Leverage as of the date of the proposed 
Distribution; Provided, however, that if a Licensee is required to 
compute a Capital Impairment Percentage under Sec. 107.210(h), such 
ratio shall be modified by replacing Leverageable Capital with the 
product of Leverageable Capital multiplied by the complement of the 
Capital Impairment Percentage. For this purpose, ``complement'' means a 
percentage equal to one hundred percent (100%) minus the Capital 
Impairment Percentage, but not less than zero. Notwithstanding the 
above, returns of capital shall be subject to the liquidity requirement 
set forth in Sec. 107.241(f) unless SBA's prior written approval is 
obtained. Any amounts received by SBA, its designated agent or Trustee, 
under this paragraph (d) shall be applied to Leverage in the order set 
forth in paragraph (c)(5) of this section.
    (e) In-Kind Distributions. A Licensee making a Distribution 
pursuant to paragraph (c) or (d) of this section may elect to make such 
Distribution in the form of securities (an In-Kind Distribution), 
subject to the following conditions:
    (1) An In-Kind Distribution may be made only if the specific 
securities to be distributed are Publicly Traded and Marketable at the 
time of Distribution.
    (2) An In-Kind Distribution may be made only if the Distribution of 
each security is made to all investors and to SBA, its designated agent 
or Trustee, pro-rata based on the amounts that would have been 
distributed to each if such Distributions were in cash.
    (3) A Licensee making an In-Kind Distribution shall impute a gain 
(loss) on the securities being distributed as if such securities were 
being sold, using the value of such securities as of the declaration 
date of the planned Distribution in the case of a corporate Licensee, 
and on the distribution date in the case of an Unincorporated Licensee. 
Such gain (loss) shall be included in the calculation of Earmarked 
Profits (Losses) pursuant to Sec. 107.242(e) as if it were realized.
    (4) A Licensee making an In-Kind Distribution shall deposit SBA's 
share of such securities for disposition with the CRA which will select 
a Disposition Agent. Alternatively, if Licensee agrees, SBA may direct 
that the Licensee dispose of SBA's share. If Licensee disposes of SBA's 
share, it shall remit the proceeds promptly to SBA, its designated 
agent or Trustee. As used in this paragraph, the term ``Disposition 
Agent'' means a Person who is knowledgeable about and proficient in the 
marketing of thinly traded securities.


Sec. 107.246  Post-redemption obligations.

    After all Participating Securities have been redeemed, a Licensee 
shall have the following obligations:
    (a) When a Licensee has Accumulated Prioritized Payments as 
specified in Sec. 107.243 and has not disposed of all Earmarked Assets 
as specified in Sec. 107.242(b), Licensee's obligation to distribute 
such Accumulated Prioritized Payments shall continue and Distributions 
shall be made, at the end of each fiscal quarter, from Distributable 
Earmarked Profits, if any, computed as set forth in Sec. 107.243.
    (b) After the disposition of all Earmarked Assets, if there remain 
any Accumulated Prioritized Payments, the obligation to make such 
payments shall be extinguished.
    (c) Notwithstanding Sec. 107.245, from the time of redemption of 
all Participating Securities and until all Earmarked Assets have been 
disposed of, Licensee shall not make any In-Kind Distributions of such 
assets unless it pays to SBA such sums, up to the amount of the 
Unrealized Appreciation on such assets, as may be necessary to pay in 
full any Accumulated Prioritized Payments. Prior to making any such 
distribution of assets which are not Publicly Traded and Marketable, 
Licensee shall obtain the written approval of SBA, specifically 
including approval of the valuation of such asset(s).


Sec. 107.247  Special Rules for Companies Licensed on or Before March 
31, 1993.

    Companies licensed on or before March 31, 1993 that apply for 
Participating Securities are subject to the following special rules:
    (a) Election to exclude pre-existing portfolio. If the proceeds of 
the Participating Security are not used to refinance outstanding 
Debentures at the time of its first application for Participating 
Securities, such Licensee may elect to have its entire portfolio in 
existence as of March 31, 1993 excluded from classification as 
Earmarked Assets. Payment or prepayment of any outstanding Debenture 
shall be presumed to be a refinancing of such Debenture unless Licensee 
can demonstrate to the satisfaction of SBA that it had financial 
resources to pay the principal amount due on the Debenture independent 
of the proceeds of the Participating Securities.
    (b) Non-Election. If such Licensee does not elect to exclude such 
assets, they shall be considered Earmarked Assets, and SBA shall 
receive a Profit Participation on such Earmarked Assets in accordance 
with the conditions specified in Sec. 107.244.
    (c) Refinancing Debentures with Participating Securities. SBA may 
permit the proceeds of a Participating Security to be used to pay the 
principal amount due on outstanding Debentures of such Licensee, 
provided Licensee has outstanding Equity Capital Investments in an 
amount, at cost, equal to the amount of the Debentures being 
refinanced, and Licensee has not elected to exclude assets from 
Earmarked Assets.
    (d) Requirements for first issuance of Participating Securities. 
Whether or not a company licensed prior to March 31, 1993 elects to 
exclude its portfolio under paragraph (a) of this section, such 
Licensee's application for a guarantee of its first issuance of 
Participating Securities shall be subject to the following 
requirements:
    (1) Licensee shall submit a valuation report for each of its Loans 
and Investments as of the date of the financial statements submitted 
with its application and as of the end of each of the prior three 
fiscal years, together with the last annual report (and/or fiscal year-
end financial statements) and most recent interim financial statements 
of each Small Concern.
    (2) If Licensee has negative Undistributed Realized Earnings and/or 
a net Unrealized Loss on Securities Held, SBA may require Licensee to 
undergo a quasi-reorganization in accordance with generally accepted 
accounting principles.
    (3) If Licensee's financial statements submitted with its 
application are interim financial statements, Licensee shall have a 
limited scope audit performed by its SBA-approved independent public 
accountant. For purposes of this paragraph, ``limited scope audit'' 
means auditing procedures sufficient to enable the independent public 
accountant to express an opinion on the Statement of Financial Position 
and the accompanying Schedule of Investments.


Sec. 107.250  Financing by use of SBA Guaranteed Trust Certificates 
(``TCs'').

    (a) Authority. (1) Full Faith and Credit. Sections 321 (a) and (b) 
of the Act authorize SBA or its CRA to issue TCs, and SBA to guarantee 
the timely payment of the principal and interest thereon. Any guarantee 
by SBA of such TC shall be limited to the principal and interest due on 
the Debentures or the Redemption Price of and Prioritized Payments on 
Participating Securities in any Trust or Pool backing such TC. The full 
faith and credit of the United States is pledged to the payment of all 
amounts due under the guarantee of any TC.
    (2) Periodic Exercise of Authority. SBA shall issue guarantees of 
Debentures and Participating Securities under section 303 and of TCs 
under section 321 of the Act at three month intervals, or at shorter 
intervals, taking into account the amount and number of such guarantees 
or TCs.
    (3) Terms and Conditions of the TCs. TCs shall provide for a pass-
through to their holders of all amounts of principal and interest paid 
on the Debentures, or the Redemption Price of and Prioritized Payments 
on the Participating Securities, in the Pool or Trust against which 
they are issued. SBA shall determine the legal and other terms and 
conditions of TCs in conjunction with the Secretary of the Treasury and 
its own statutory authority and such other requirements as may be 
mandated by law. The interest rate on Debentures or the Prioritized 
Payment rate on the Participating Securities in a Trust or Pool shall 
be determined pursuant to section 303 (b) or (g), respectively, of the 
Act.
    (4) Section 301(d) Subsidy. Subject to the limits of 
Sec. 107.203(c), if SBA guarantees Debentures of a section 301(d) 
Licensee, section 303(d) of the Act requires SBA to make payments to 
the CRA, or to the holder of any such Debenture, sufficient to reduce 
the effective rate of interest to such Licensee during the first five 
years of the term of such Debenture by three percentage points.
    (5) Rights of Prepayment of Debentures or Early Redemption of 
Participating Securities on a TC.
    (i) The rights, if any, of a Licensee to prepay any Debenture or 
make early redemption of any Participating Security are established by 
the terms of such securities, and no such right is created or denied by 
the regulations in this part.
    (ii) SBA's rights to purchase or prepay and Debenture without 
premium are established by the terms of the Guaranty Agreement relating 
to the Debenture. SBA's rights to redeem, at any time, any 
Participating Security without premium are established by the terms of 
the Guaranty Agreement relating to the Participating Security.
    (iii) Any prepayment of a Debenture or early redemption of a 
Participating Security pursuant to the terms of the Guaranty Agreement 
relating to such securities, shall reduce the SBA guarantee of timely 
payment of principal and interest on a TC in proportion to the amount 
of principal or Redemption Price that such prepaid Debenture or 
redeemed Participating Security represents in the Trust or Pool backing 
such TC.
    (iv) SBA shall be discharged from its guarantee obligation to the 
holder or holders of any TC, or any successor or transferee of such 
holder, to the extent of any such prepayment, whether or not such 
successor or transferee shall have notice of any such prepayment.
    (v) Interest on prepaid Debentures and Prioritized Payments on 
Participating Securities shall accrue only through the date of such 
voluntary prepayment or SBA payment, as the case may be.
    (vi) In the event that all Debentures or Participating Securities 
constituting a Trust or Pool are prepaid, the TCs backed by such Trust 
or Pool shall be redeemed by payment of the unpaid principal and 
interest on the TCs; Provided, however, that in the case of the 
prepayment of a Debenture pursuant to the provisions of the Guaranty 
Agreement relating to the Debenture, the CRA shall pass through pro 
rata to the holders of the TCs any such prepayments including any 
prepayment penalty paid by the obligor Licensee pursuant to the terms 
of the Debenture.
    (6) SBA ownership rights. In the event SBA pays a claim under the 
guarantee of a TC, it shall be subrogated fully to the rights satisfied 
by such payment; no state or Federal law shall preclude or limit SBA's 
exercise of its ownership rights acquired by subrogation upon payment 
under its guarantee.
    (7) Pool or Trust approval. SBA shall approve the formation of each 
Pool or Trust.
    (8) Pool or Trust attributes. SBA may, in its discretion, establish 
the size of the Pools and their composition, the interest rate on the 
TCs issued against Trusts or Pools, fees, discounts, premiums and other 
charges made in connection with the Pools, Trusts, and TCs, and any 
other characteristics of a Pool or Trust it deems appropriate.
    (b) Functions of the CRA. Pursuant to a contract entered into with 
SBA, the CRA shall do the following as agent of SBA:
    (1) Issuance of the TCs. Upon the formation of any Pool or Trust 
approved by SBA, CRA shall issue TCs, in the form prescribed by SBA, 
upon the primary sale of Debentures or Participating Securities, and 
shall issue or effect the transfer of TCs upon the sale of original 
issue TCs in any secondary market transaction.
    (2) Receipt of amounts due on Debentures and Participating 
Securities. CRA shall receive payments from Licensees of amounts due on 
Debentures and Participating Securities, and amounts paid under 
voluntary prepayments or prepayments by SBA pursuant to the terms of 
the relevant Guaranty Agreements.
    (3) Payments of amounts due on TCs. CRA shall make periodic 
payments as scheduled or required by the terms of the TCs, and pay all 
amounts required to be paid upon prepayment of Debentures or redemption 
of Participating Securities.
    (4) Custody of Debentures and Participating Securities and 
Documentation. CRA shall hold and safeguard all Debentures and 
Participating Securities constituting Trusts or Pools and shall 
release, upon instructions of SBA, the Dentures and Participating 
Securities paid in full at maturity or prepaid in full prior to 
maturity. CRA also shall be custodian of such other documentation as 
SBA shall direct by written instructions.
    (5) Registration of Debentures and Participating Securities and 
TCs. CRA shall provide for the registration of all pooled Debentures 
and Participating Securities, all Pools and Trusts, and all TCs. With 
respect to each sale of Debentures or Participating Securities, such 
registration shall include:
    (i) The identification of the selling License;
    (ii)The interest rate to be paid on the Debentures;
    (iii) The Prioritized Payment rate to be paid on the Participating 
Securities;
    (iv) All commissions, fees, and/or discounts paid to brokers and 
dealers in TCs or others;
    (v) Identification of each purchaser and any subsequent purchaser 
of any TC;
    (vi) The interest rate on any TC;
    (vii) The price paid by any purchaser for a TC;
    (viii) The fee of the CRA; and
    (ix) Such other information as SBA may deem appropriate or that may 
be customary in the markets for transactions of similar type.
    (6) Fidelity bond or insurance. CRA shall provide a fidelity bond 
or insurance in such amount as SBA may require to fully protect the 
interest of the government.
    (7) Other necessary functions. CRA shall perform such other 
functions as SBA may deem necessary to implement the provisions of this 
section.
    (c) SBA regulation of disclosure and Brokers and Dealers. (1) 
Disclosure to purchasers. Prior to any sale of a Debenture, 
Participating Security, or TC, SBA shall require the seller, or the 
broker or dealer as agent for the seller, to disclose to the purchaser, 
in a form prescribed or approved by SBA, specified information on the 
terms, conditions, and yield of such instrument.
    (2) Brokers and Dealers. Each broker, dealer, and Pool or Trust 
assembler approved by SBA pursuant to these regulations shall either be 
regulated by a Federal financial regulatory agency, or be a member of 
the National Association of Securities Dealers (NASD), and shall be in 
good standing in respect to compliance with the financial, ethical, and 
reporting requirements of such body. They also shall be in good 
standing with SBA as determined by the SBA Associate Administrator for 
Investment (see paragraph (c)(3)(v) of this section) and shall provide 
a fidelity bond or insurance in such amount as SBA may require. Nothing 
in these provisions shall affect the applicability of the securities 
laws, as that term is defined in section 3(a)(47) of the Securities 
Exchange Act of 1934, or any of the rules and regulations thereunder, 
or otherwise supersede or limit the jurisdiction of the Securities and 
Exchange Commission or any authority at any time conferred under the 
securities laws.
    (3) Suspension and/or termination of Broker or Dealer. SBA shall 
exclude from the sale and all other dealings in Debentures, 
Participating Securities or TCs any broker or dealer:
    (i) If such broker's or dealer's authority to engage in the 
securities business has been revoked or suspended by a supervisory 
agency. When such authority has been suspended, such broker or dealer 
will be suspended by SBA for the duration of such suspension by the 
supervisory agency.
    (ii) If such broker or dealer has been indicted or otherwise 
formally charged with a misdemeanor or felony bearing on its fitness to 
participate in the market for Debentures, Participating Securities or 
TCs, such broker or dealer may be suspended while the charge is 
pending. Upon conviction, participation may be terminated.
    (iii) When such broker or dealer has suffered an adverse final 
civil judgment, holding that such broker or dealer has committed a 
breach of trust or violation of law or regulation protecting the 
integrity of business transactions or relationships, participation in 
the market for Debentures, Participating Securities or TCs may be 
terminated.
    (iv) When such broker or dealer has failed to make full disclosure 
of the information required by Sec. 107.250(c)(1) of this part, such 
broker's or dealer's participation in the market for Debentures, 
Participating Securities or TCs may be terminated.
    (v) Proceedings to terminate such broker's or dealer's 
participation in the market for Debentures, Participating Securities or 
TCs shall be conducted in accordance with Part 134 of this Title. SBA 
may, for any of the reasons stated above, suspend the privilege of any 
broker or dealer to participate in this market. SBA shall give written 
notice at least ten (10) business days prior to the effective date of 
such suspension. Such notice shall inform the broker or dealer of the 
opportunity for a hearing pursuant to part 134 of this Title. The 
Assistant Administrator of the Office of Hearings and Appeals or an 
Administrative Law Judge of such office shall be the reviewing official 
for purposes of Secs. 134.32(b)(7) and 134.34.
    (d) Access to records. The CRA and any broker, dealer and Pool or 
Trust assembler operating under the regulations in this part shall make 
all books, records and related materials associated with Debentures, 
Participating Securities and TCs available to SBA for review and 
copying purposes. Such access shall be at such party's primary place of 
business during normal business hours.
    (e) Selling Debentures, Participating Securities and TCs. The 
function of locating purchasers, and negotiating and closing the sale 
of Debentures, Participating Securities and TCs, may be performed 
either by SBA or an agent appointed by SBA. Nothing in the regulations 
in this part shall be interpreted to prevent the CRA from acting as 
SBA's agent for this purpose.
    (f) Agents. SBA will appoint or cause to be appointed agent(s) to 
perform functions necessary to market and service Debentures, 
Participating Securities, or TCs pursuant to this part.
    (1) Selling Agent. As a condition of guaranteeing a Debenture or 
Participating Security, SBA shall cause each Licensee to appoint a 
Selling Agent to perform functions which include, but are not limited 
to:
    (i) Selecting qualified entities to become pool or Trust assemblers 
(``Poolers''). Such actions shall be subject to SBA prior written 
approval and to the provisions of paragraph (c)(2) of this section.
    (ii) Receiving guaranteed Debentures and Participating Securities 
as well as negotiating the terms and conditions of periodic offerings 
of Debentures and/or TCs with Poolers on behalf of Licensees.
    (iii) Directing and coordinating periodic sales of Debentures and 
Participating Securities and/or TCs.
    (iv) Arranging for the production of the Offering Circular, 
certificates, and such other documents as may be required from time to 
time.
    (2) Fiscal Agent. SBA shall appoint a Fiscal Agent to:
    (i) Establish performance criteria for Poolers.
    (ii) Monitor and evaluate the financial markets to determine those 
factors that will minimize or reduce the cost of funding Debentures or 
Participating Securities.
    (iii) Monitor the performance of the Selling Agent, Poolers, CRA, 
and the Trustee.
    (iv) Perform such other functions as SBA, from time to time, may 
prescribe.


Sec. 107.260  Conditions affecting good standing of Licensees with 
Leverage.

    Licensees with outstanding Debentures issued after April 25, 1994 
are subject to the provisions of Sec. 107.261. Licensees with 
outstanding Preferred Securities issued after April 25, 1994 and/or 
with outstanding Participating Securities or with Earmarked Assets in 
their portfolios are subject to the provisions of Sec. 107.262.


Sec. 107.261  Conditions affecting issuers of Debentures.

    (a) Applicability. The provisions of this section apply to 
Licensees issuing Debentures after April 25, 1994. All such Licensees 
shall be deemed to have agreed to the terms, conditions and remedies 
set forth in this section, as in effect at the time of such issuance 
and as if fully set forth in such Debentures. Debentures issued prior 
to April 25, 1994 shall continue to be governed by the remedies in 
effect at the time of their issuance.
    (b) Automatic Events of Default. Without notice, presentation or 
demand, the entire indebtedness evidenced by Debentures, including 
accrued interest, and any other amounts owed SBA with respect thereto, 
shall be immediately due and payable, and Licensee shall be deemed to 
have consented to the appointment of SBA or its designee as receiver of 
Licensee pursuant to Section 311(c) of the Act, upon the occurrence of 
any one or more of the following events:
    (1) Insolvency. Licensee becomes equitably or legally insolvent.
    (2) Voluntary assignment. Licensee makes a voluntary assignment for 
the benefit of creditors without SBA's prior written approval.
    (3) Bankruptcy. A petition is filed by Licensee in commencement of 
any bankruptcy or reorganization proceeding, receivership, dissolution 
or other similar creditors' rights proceeding, or such action is 
initiated against Licensee and is not dismissed within 60 days.
    (c) Events of Default with notice. Upon written notice, SBA may 
declare the entire indebtedness evidenced by Debentures, including 
accrued interest, and/or any other amounts owed SBA with respect 
thereto, immediately due and payable, and SBA may avail itself of any 
remedy available under the Act, specifically including institution of 
proceedings for the appointment of SBA or its designee as receiver of 
Licensee pursuant to Section 311(c) thereof, upon the occurrence of any 
one or more of the following events as determined by SBA:
    (1) Fraud. Licensee commits a fraudulent act which causes detriment 
to SBA's position as a creditor or guarantor.
    (2) Fraudulent transfers. Licensee makes any transfer or incurs any 
obligation that is fraudulent under the terms of 11 U.S.C. 548.
    (3) Willful conflicts of interest. Licensee willfully violates 
Sec. 107.903.
    (4) Willful non-compliance. Licensee willfully violates one or more 
of the substantive provisions of the Act, specifically including but 
not limited to the provisions summarized in Section 310(c) of the Act, 
or any substantive regulation promulgated under the Act.
    (5) Repeated Events of Default. At any time after being notified by 
SBA of the occurrence of an Event of Default under paragraph (d) of 
this section, Licensee engages in similar behavior which results in 
another occurrence of the same Event of Default.
    (6) Transfer of Control. Licensee violates Sec. 107.104 and/or 
willfully violates Sec. 107.601, and such violation results in a 
transfer of Control of Licensee.
    (7) Non-cooperation under Sec. 107.261(e). Licensee fails to take 
appropriate steps, satisfactory to SBA, to accomplish such action as 
SBA may have required pursuant to paragraph (e) of this section.
    (8) Non-notification of Events of Default. Licensee fails to notify 
SBA as soon as it knows or reasonably should have known that any Event 
of Default exists as set forth in this section.
    (9) Non-notification of defaults to others. Licensee fails to 
notify SBA in writing within ten days from the date of a declaration of 
an event of default or nonperformance by Licensee under any note, 
debenture or indebtedness of Licensee issued to, or held by, anyone 
other than SBA.
    (d) Events of Default with opportunity to cure. Upon written notice 
by SBA to a Licensee of the existence of one or more of the following 
Events of Default as determined by SBA, and the provision by SBA of an 
opportunity to cure such default(s) within a time period of not less 
than fifteen (15) days, and only if Licensee fails to cure such 
default(s) to SBA's satisfaction within such time period, SBA may 
declare the entire indebtedness evidenced by Debentures, including 
accrued interest, and/or any other amounts owed SBA with respect 
thereto, to be immediately due and payable, and SBA may avail itself of 
any remedy available under the Act, specifically including institution 
of proceedings for the appointment of SBA or its designee as receiver 
of Licensee pursuant to Section 311(c) thereof:
    (1) Excessive fees. (i) If SBA has previously approved an aggregate 
amount to be paid for salaries or other compensation of officers, 
directors, employees, or fees paid to Investment Advisers/Managers, and 
such amount has increased without SBA's prior written approval, or (ii) 
if SBA has previously approved a formula for the aggregate amount to be 
paid for salaries or other compensation of officers, directors, or 
employees, or fees paid to Investment Advisers/Managers, and the 
aggregate amount paid exceeds the formula amount or the formula has 
changed without SBA's prior written approval.
    (2) Improper Distributions. Licensee makes any Distribution to its 
shareholders or partners, except with the prior written consent of SBA, 
other than:
    (i) As permitted under Sec. 107.802;
    (ii) Payments out of Retained Earnings Available for Distribution 
based on either the shareholders' pro-rata interests or the provisions 
for profit distributions in Licensee's partnership agreement, as 
appropriate; and
    (iii) Distributions by Licensees issuing Participating Securities 
as permitted under Secs. 107.243 and 107.245.
    (3) Failure to make payment. Unless otherwise approved by SBA, 
failure by Licensee to make timely payment of any amount due under any 
security or obligation of Licensee, issued to, held or guaranteed by 
SBA.
    (4) Failure to maintain Regulatory Capital. Licensee fails to 
maintain its minimum Regulatory Capital as required under these 
regulations or, without the prior written consent of SBA, reduces its 
Regulatory Capital, except as permitted by Secs. 107.245 and 107.802.
    (5) Capital Impairment. Licensee has a condition of Capital 
Impairment as determined under Sec. 107.210(h).
    (6) Cross-default. Failure of Licensee to pay any amount when due 
on any obligation greater than $100,000 or the occurrence of any event 
or the existence of any condition, the effect of which default or event 
or condition is to cause or to permit such obligation to become due or 
to become payable (with or without notice) prior to its stated 
maturity, unless Licensee pays such amount within any applicable grace 
period or contests the payment of such obligation in good faith by 
appropriate proceedings.
    (7) Nonperformance. Nonperformance or violation by Licensee of one 
or more of the terms and conditions of any note, Debenture, or other 
obligation of Licensee issued to, held or guaranteed by SBA, or of any 
agreement with or conditions imposed by SBA in its administration of 
the Act and the regulations promulgated thereunder.
    (8) Noncompliance. Except as otherwise provided in paragraph (c)(5) 
of this section, failure of Licensee, as determined by SBA, to comply 
with one or more of the substantive provisions of the Act, specifically 
including but not limited to the provisions summarized in section 
310(c) of the Act, or any substantive regulation promulgated under the 
Act.
    (9) Failure to maintain investment ratios. Failure of Licensee to 
maintain the investment ratio for Leverage in excess of three hundred 
percent (300%) of Leverageable Capital (Sec. 107.230(c)(3)), if 
applicable to such Licensee, as of the end of each fiscal year. For 
this purpose, any prepayment, sale, or disposition of Venture Capital 
Financing, increase in Leverageable Capital, and receipt of additional 
Leverage, within 120 days prior to the end of the fiscal year shall be 
disregarded in determining whether Licensee meets the foregoing 
requirement as of the close of its fiscal year.
    (e) Repeated non-substantive violations. If a Licensee repeatedly 
fails to comply with any one or more of the non-substantive provisions 
of the Act or any non-substantive regulation promulgated thereunder, 
SBA, after written notification to the Licensee and until such 
condition is cured to SBA's satisfaction, shall deny additional 
Leverage to such Licensee and/or require such Licensee to take such 
actions as SBA may determine to be appropriate under the circumstances.
    (f) Consent to removal of officers, directors, or general partners 
and/or appointment of receiver. The Articles of any Licensee issuing 
Debentures after April 25, 1994, shall include the following provisions 
as a condition to the purchase or guarantee by SBA of such Leverage. 
Upon the occurrence of any of the events specified in 13 CFR 107.261(c) 
(1) through (6) or 107.261(d) (1) through (3) as determined by SBA, SBA 
shall have the right, and Licensee consents to SBA's exercise of such 
right:
    (1) With respect to a Corporate Licensee, upon written notice, to 
require Licensee to replace, with individuals approved by SBA, one or 
more of Licensee's officers and/or such number of directors of 
Licensee's board of directors as is sufficient to constitute a majority 
of such board; or
    (2) With respect to an Unincorporated Licensee, upon written 
notice, to require Licensee to remove the person(s) responsible for 
such occurrence and/or to remove the general partner of Licensee, which 
general partner shall then be replaced in accordance with Licensee's 
Articles by a new general partner approved by SBA; and/or
    (3) With respect to either a Corporate or Unincorporated Licensee, 
to obtain the appointment of SBA or its designee as receiver of 
Licensee pursuant to section 311(c) of the Act for the purpose of 
continuing to operate Licensee. The appointment of a receiver to 
liquidate a Licensee shall not be within such consent, but shall 
instead be governed by the relevant provisions of the Act.


Sec. 107.262  Conditions affecting issuers of Preferred Securities and/
or Participating Securities.

    (a) Applicability. The conditions of this section apply to 
Licensees issuing Preferred Securities after April 25, 1994, and to 
Licensees with outstanding Participating Securities or with Earmarked 
Assets in their portfolios. The Articles of any such Licensee shall 
include the provisions of this Sec. 107.262 as a condition to the 
purchase by SBA of Preferred Securities, or as a condition to the 
guarantee by SBA of Participating Securities and for so long as the 
Licensee owns Earmarked Assets. Preferred Securities issued prior to 
April 25, 1994 shall continue to be governed by the remedies in effect 
at the time of their issuance.
    (b) Consent to removal of officers, directors, or general partners, 
and/or appointment of receiver. Upon the occurrence of any of the 
conditions set forth below, as determined by SBA, SBA shall have the 
following rights, and Licensee consents to SBA's exercise of any or all 
of such rights: With respect to a Corporate Licensee, upon written 
notice, to require Licensee to replace, with individuals approved by 
SBA, one or more of Licensee's officers and/or such number of directors 
of Licensee's board of directors as is sufficient to constitute a 
majority of such board; or with respect to an Unincorporated Licensee, 
upon written notice, to require Licensee to remove the person(s) 
responsible for such occurrence and/or to remove the general partner of 
Licensee, which general partner shall then be replaced in accordance 
with Licensee's Articles by a new general partner approved by SBA; and/
or with respect to either a Corporate or Unincorporated Licensee, to 
the appointment of SBA or its designee as receiver of Licensee pursuant 
to section 311(c) of the Act for the purpose of continuing to operate 
Licensee. The appointment of a receiver to liquidate a Licensee shall 
not be within such consent, but shall instead be governed by the 
relevant provisions of the Act. The conditions shall be as follows:
    (1) Insolvency or extreme Capital Impairment. Licensee becomes 
equitably or legally insolvent, or has a Capital Impairment Percentage 
of one hundred percent (100%) or more (``extreme Capital Impairment'') 
and has not cured such Capital Impairment within the time limits set by 
SBA in writing. In this regard, no issuer of Participating Securities 
shall be deemed to have a condition of extreme Capital Impairment 
during the first eight (8) years following its initial issuance of 
Participating Securities, and no Licensee shall be afforded an 
opportunity to cure under this paragraph if it has already been 
afforded an opportunity to cure its Capital Impairment under paragraph 
(d)(3) of this section.
    (2) Voluntary assignment. Licensee makes a voluntary assignment for 
the benefit of creditors.
    (3) Bankruptcy. Licensee commences any bankruptcy or reorganization 
proceeding, receivership, dissolution or other similar creditors' 
rights proceeding, or such action is initiated against Licensee and is 
not dismissed within sixty (60) days.
    (4) Transfer of Control. Licensee violates Sec. 107.104 and/or 
willfully violates Sec. 107.601, and such violation results in a 
transfer of Control of Licensee.
    (5) Fraud. Licensee commits a fraudulent act which causes serious 
detriment to SBA's position as a guarantor.
    (6) Fraudulent transfers. Licensee makes any transfer or incurs any 
obligation that is fraudulent under the terms of 11 U.S.C. 548.
    (c) Failure to remove. Upon the occurrence of any of the conditions 
set forth below, as determined by SBA, and only if Licensee fails to 
remove the person(s) SBA identifies as responsible for such occurrence 
and/or cure such occurrence to SBA's satisfaction within a time period 
determined by SBA (but not less than fifteen (15) days), SBA shall have 
the following rights, and Licensee consents to SBA's exercise of any or 
all of such rights: With respect to a Corporate Licensee, upon written 
notice, to replace one or more of Licensee's officers and/or such 
number of directors of Licensee's board of directors as is sufficient 
to constitute a majority of such board; or with respect to an 
Unincorporated Licensee, upon written notice, to require Licensee to 
remove the person(s) responsible for such occurrence and/or to remove 
the general partner of Licensee, which general partner shall then be 
replaced in accordance with Licensee's Articles by a new general 
partner approved by SBA; and/or with respect to either a Corporate or 
Unincorporated Licensee, to obtain the appointment of SBA or its 
designee as receiver of Licensee pursuant to section 311(c) of the Act 
for the purpose of continuing to operate Licensee. The appointment of a 
receiver to liquidate a Licensee shall not be within such consent, but 
shall instead be governed by the relevant provisions of the Act. The 
conditions shall be as follows:
    (1) Willful conflicts of interest. Licensee willfully violates 
Sec. 107.903.
    (2) Willful or repeated noncompliance. Licensee willfully or 
repeatedly violates one or more of the substantive provisions of the 
Act, specifically including but not limited to the provisions 
summarized in section 310(c) of the Act, or any substantive regulation 
promulgated under the Act.
    (3) Failure to comply with restrictions under Section 107.262(d). 
Licensee fails to comply with the restrictions imposed by SBA under 
paragraph (d) of this section.
    (d) Consent to restricted operations. Upon the occurrence of any of 
the conditions set forth in this paragraph (d), as determined by SBA, 
and until such condition(s) are cured to SBA's satisfaction within a 
time period determined by SBA (but not less than fifteen (15) days), 
upon written notice SBA shall have the following rights, and Licensee 
consents to SBA's exercise of any or all of such rights: To prohibit 
Licensee from making any additional investments except for investments 
pursuant to legally binding commitments entered into by Licensee prior 
to such notice and, subject to SBA's prior written approval, 
investments that are necessary to protect Licensee's investment; until 
all Leverage is redeemed and amounts due are paid, to prohibit 
Distributions by the Licensee to any party other than SBA, its agent or 
Trustee; to require all commitments to Licensee to be funded at the 
earliest time(s) permitted in accordance with Licensee's Articles; and 
to review and re-determine Licensee's approved Management Expenses or, 
for Preferred Securities issuers, Licensee's approved management 
compensation. The conditions shall be as follows:
    (1) Removal Conditions. Any condition occurs which is listed in 
paragraph (b) or (c) of this section.
    (2) Failure to maintain Regulatory Capital. Licensee fails to 
maintain its minimum Regulatory Capital as required by these 
regulations.
    (3) Capital or Liquidity Impairment. Licensee has a condition of 
Capital Impairment as determined under Sec. 107.210(h) or, if 
applicable to such Licensee, a condition of Liquidity Impairment as 
determined under Sec. 107.241(f), and fails to cure the impairment 
within time limits set by SBA in writing.
    (4) Improper Distributions. A Licensee makes any Distribution to 
its shareholders or partners other than those permitted by 
Secs. 107.245 and 107.802.
    (5) Excessive Management Expenses or fees. Without the prior 
written consent of SBA:
    (i) Licensee incurs Management Expenses in excess of those 
permitted under Sec. 107.241(d), if applicable to such Licensee; or
    (ii) If SBA has previously approved an aggregate amount to be paid 
for salaries or other compensation of officers, directors, employees, 
or fees paid to Investment Advisers/Managers, Licensee increases such 
amount; or
    (iii) If SBA has previously approved a formula for the aggregate 
amount to be paid for salaries or other compensation of officers, 
directors, or employees, or fees paid to Investment Advisers/Managers, 
Licensee pays an aggregate amount in excess of the formula amount or 
changes the formula.
    (6) Failure to make payment. Licensee fails to pay any amounts due 
under Preferred Securities or required by Secs. 107.240 through 
107.247, unless otherwise permitted by SBA.
    (7) Noncompliance. Except as otherwise provided for in paragraphs 
(c)(1) and (c)(2) of this section, SBA determines that Licensee has 
failed to comply with one or more of the substantive provisions of the 
Act, specifically including but not limited to the provisions 
summarized in section 310(c) of the Act, or any substantive regulation 
promulgated under the Act.
    (8) Failure to maintain diversity. Licensee fails to maintain 
diversity between management and ownership as required by 
Sec. 107.241(c), if applicable to such Licensee.
    (9) Failure to maintain investment ratios. Licensee fails to 
maintain the investment ratios or amounts required for Participating 
Securities (Sec. 107.241(b)) or Leverage in excess of three hundred 
percent (300%) of Leverageable Capital (Sec. 107.230(c)(3)) or 
Preferred Securities in excess of one hundred percent (100%) of 
Leverageable Capital (Sec. 107.230(c)(4)), if applicable to such 
Licensee, as of the end of each fiscal year. In this regard, any
    (i) Prepayment, sale, or disposition of Equity Capital Investments 
or Venture Capital Financing or Qualified Investments, as appropriate,
    (ii) Increase in Leverageable Capital, or
    (iii) Receipt of additional Leverage, occurring within one hundred 
twenty (120) days prior to the end of the fiscal year shall be 
disregarded in determining whether Licensee meets the foregoing 
requirements as of the close of its fiscal year.
    (10) Nonperformance. Licensee violates or fails to perform one or 
more of the terms and conditions of any Participating Security or 
Preferred Security or of any agreement with or conditions imposed by 
SBA in its administration of the Act and the regulations promulgated 
thereunder.
    (11) Noncooperation under Section 107.262(e). Licensee fails to 
take appropriate steps, satisfactory to SBA, to accomplish such action 
as SBA may have required pursuant to paragraph (e) of this section.
    (e) Repeated non-substantive violations. If a Licensee repeatedly 
fails to comply with any one or more of the non-substantive provisions 
of the Act or any non-substantive regulation promulgated thereunder, 
SBA, after written notification to the Licensee and until such 
condition is cured to SBA's satisfaction, shall deny additional 
Leverage to such Licensee and/or require such Licensee to take such 
actions as SBA may determine to be appropriate under the circumstances.


Sec. 107.263  Non-waiver.

    No failure to exercise or delay in exercising any right or remedy 
under the Act or the regulations in this part shall operate as a waiver 
of any such right or remedy by SBA. No failure(s) by SBA to require the 
performance by Licensee of any one or more of the terms or provisions 
of any debt instrument, Preferred Security or Participating Security of 
Licensee issued to, held, or guaranteed by SBA shall in any way affect 
SBA's right to enforce the same. Similarly, SBA's waiver of, or failure 
to enforce, any term or provision of any debt instrument, Preferred 
Security or Participating Security of Licensee issued to, held, or 
guaranteed by SBA or of any event or condition set forth in 
Secs. 107.261 or 107.262 shall not be taken or held to be a waiver of 
any succeeding breach of any such term or provision or condition.
    5. Section 107.901 is amended by revising the first sentence of 
paragraph (a) to read as follows:


Sec. 107.901  Prohibited use of funds.

* * * * *
    (a) Relending, reinvesting, etc. For relending or reinvesting, if 
its primary business activity involves, directly or indirectly, 
providing funds to others, the purchase of debt obligations, factoring, 
or long-term leasing of equipment with no provision for maintenance or 
repair; Provided, however, that Venture Capital Financings (as defined 
in Sec. 107.230(c)(3)) of a Disadvantaged Concern engaged primarily in 
relending or reinvesting activities shall be permitted, except for 
banks and savings and loan associations not insured by agencies of the 
Federal Government, and agricultural credit companies.* * *
* * * * *
    6. Section 107.906 is amended by revising paragraph (a) to read as 
follows:


Sec. 107.906  Violations based on false filings and nonperformance of 
agreements with SBA.

* * * * *
    (a) Nonperformance. Nonperformance of any of the requirements of 
any Debenture, Participating Security or Preferred Security issued to, 
held or guaranteed by SBA, or of any written agreement with SBA.
* * * * *
    7. Section 107.1004 is amended by revising the first sentence of 
paragraph (a) to read as follows:


Sec. 107.1004  Reporting changes not subject to prior SBA approval.

    (a) Changes to be reported. Any change of Licensee's name, address, 
telephone number, officers, directors, or other participants in the 
management of Licensee, articles, operating area, investment policy, or 
increase in capitalization not otherwise required to be submitted for 
prior approval (see, for example, Sec. 107.601) shall be reported to 
SBA not later than thirty days after these events. * * *
* * * * *
    Dated: February 25, 1994.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-7843 Filed 4-7-94; 8:45 am]
BILLING CODE 8025-01-M