[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: 94-7844]


[[Page Unknown]]

[Federal Register: April 8, 1994]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

 

Small Business Investment Companies; Definitions of Various 
Terms; Miscellaneous Final Rules; Valuation Guidelines

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: This final rule adopts proposed rules published by the Small 
Business Administration (SBA) on August 5, 1993. The purpose of this 
rule is to implement certain provisions of the Small Business Equity 
Enhancement Act of 1992, and to clarify and simplify the regulations 
governing Small Business Investment Companies (Licensees) in order to 
encourage increased private investment in Licensees.

EFFECTIVE DATE: April 25, 1994.

ADDRESSES: Robert D. Stillman, Associate Administrator for Investment; 
Small Business Administration; suite 6300; 409 3rd Street, SW., 
Washington, DC 20416.

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

SUPPLEMENTARY INFORMATION:

Alter Ego Financing

    SBA had proposed to amend its regulations in order to permit 
Licensees to extend Financial Assistance to a Small Concern whose sole 
business was the leasing of commercial or industrial real estate to an 
operating concern under identical ownership. In the Small Business 
Investment Company Program there has never been an ``alter ego'' 
exception to the general rule that forbids Financial Assistance to 
Small Concerns engaged in leasing real estate, although other programs 
administered by SBA had such exceptions in their rules. See 13 CFR 
Secs. 108.8(d) and 120.101-2(e). One reason for the proposal was to 
bring the rules of the Small Business Investment Company Program into 
greater, though not absolute, conformity with these rules. However, SBA 
has since published proposals that would change these other ``alter 
ego'' rules. Accordingly, SBA has decided to defer consideration of the 
rule proposed on August 5, 1993 until it has completed the rule-making 
process with respect to Parts 108 and 120 of its regulations. It should 
be clearly understood that the proposed rule is neither withdrawn nor 
adopted in final to become effective simultaneously with the adoption 
of final amendments to Parts 108 and 120. Licensees also are reminded 
that no existing rule forbids the extension of Financial Assistance to 
an eligible Small Concern for the acquisition of industrial or 
commercial real estate on which their business operations will be 
conducted.

Associate of a Licensee

    The proposal to amend the definition of Control Person in 
connection with the proposal to allow limited partnerships to serve as 
a general partner of a Licensee elicited a number of comments raising 
issues that SBA deemed best addressed by a change in the definition of 
Associate of a Licensee.
    Generally speaking, an investor with an equity interest of 10 
percent or more in a Licensee will continue to fall within the 
definition of Associate of a Licensee, without regard to whether that 
equity interest consists of stock or a limited partner's interest. The 
rule reflects SBA's assumption that anyone with a 10 percent equity 
interest in a Licensee will have a degree of influence with the 
Licensee's management, even if such influence can't be openly exercised 
by virtue of the investor's status as a limited partner. However, the 
statutory changes intended to make the program more attractive to large 
institutional investors, and the response received by SBA in connection 
with its proposal to amend the definition Control Person, have 
persuaded SBA of the necessity to draw a distinction between a limited 
partner whose policy in dealing with the Licensee and/or the general 
partner is likely to be ``hands off'', and a limited partner that is 
likely to seek to influence the general partner. Accordingly, the 
distinction is being drawn between the generality of investors with a 
stake of 10 percent or more in the Licensee, and an Institutional 
Investor whose investment as a limited partner in the Licensee does not 
represent more than 33 percent of the Licensee's partnership capital 
and does not exceed 5 percent of such investor's net worth.

Commitment

    Although the proposed new definition of ``Commitment'' is being 
adopted without change, the comments received indicate a need for a 
more detailed explanation of SBA's underlying purpose. Since 
``Commitment'' is being defined as an undertaking by a Licensee to 
Finance a Small Concern, there was some concern as to whether the use 
of the word ``commitment'' to describe an Institutional Investor's 
undertaking to make future investments in a Licensee might not be 
unduly confusing. Upon consideration, the term ``commitment'', which is 
the term used in the Act, will continue to be used to describe an 
Institutional Investor's undertaking or obligation; the context will 
preclude confusion on the reader's part.
    SBA intends to apply the new definition primarily to determine 
whether a Licensee is inactive within the meaning of Sec. 107.902, and 
whether the Licensee is obligated to return part of any processing fee 
it may have collected pursuant to Sec. 107.402(d), as adopted this day. 
Therefore SBA has no particular concern with the terms of any 
Commitment or purported Commitment extended after the adoption of this 
regulation that has been fully funded by a Financing to a Small 
Concern.
    The new definition of ``Commitment'' assigns a meaning to the term 
that is narrower than the sense in which many Licensees have used the 
term. SBA, in practice, has never considered a general statement of 
willingness to extend Financing to constitute a Commitment. Now, SBA's 
position is a matter of record. Even though the new definition of 
``Commitment'' excludes a number of letters that some Licensees may 
have previously considered to be commitments, the effect of such 
exclusion will not be as disruptive as some comments have predicted.
    In general, the new definition will not be used to test a 
Licensee's need for Leverage. However, the definition of Commitment 
will be used in the review of any application submitted for Preferred 
Securities Leverage in excess of 100 percent of the Licensee's 
Leverageable Capital, or Leverage in excess of 300 percent of the 
Licensee's Leverageable Capital. This distinction is mandated by the 
language of sections 303(c)(1)(E) and 303(c)(4) of the Act, 
respectively, both of which speak of ``funds * * * legally committed''.
    Some comments had expressed concern that the new definition of 
Commitment would impair the right of a Licensee to provide additional 
Financing, pursuant to Sec. 107.706, to a portfolio concern that was no 
longer a Small Concern. In response to these and other comments, SBA 
has revised paragraph (a) of Sec. 107.706 to eliminate existing 
restrictions or preconditions with respect to further Financing of 
portfolio concerns that have ceased to be eligible solely because they 
have ceased to be Small Concerns, but which have not yet made a public 
offering of their securities.
    Two themes ran through almost all the comments submitted to SBA. 
One was that ``reasonable conditions precedent'' should be further 
defined or described; the other was that completion of the Licensee's 
due diligence process with results satisfactory to the Licensee should 
be considered a reasonable condition precedent. Although SBA is 
reluctant to provide a list of reasonable conditions precedent in the 
regulation for fear that such list might be regarded as an exclusive 
one, it is willing to describe ``reasonable conditions precedent'' in 
general terms. A ``reasonable condition precedent'' is one that does 
not lie within the Licensee's ability to cause or prevent. ``Completion 
of due diligence with results satisfactory to the Licensee'' is an 
example of a condition precedent that lies within the Licensee's 
control. On the other hand, requirements that a disinterested person 
verify the value of the Small Concern's assets or its net worth, or 
that there be no adverse change in the Small Concern's financial 
condition between the date of the commitment and the scheduled 
disbursement date, or that the Small Concern do or achieve something 
that lies reasonably within its capacity would all be considered a 
``reasonable condition precedent.''

Common Control

    The proposed definitions of ``Common Control'' and of ``Control'' 
are adopted with an editorial change. The last two sentences of the 
proposed definition of ``Control'', beginning with the words ``Two or 
more Licensees * * *'' have been moved, without change, to the 
definition of ``Common Control.''
    A change in the present definition of ``Control'' and a new 
definition, ``Common Control'' both were made necessary because section 
402 of Public Law 102-366 (September 4, 1992) imposed a $90 million 
ceiling on the aggregate amount of Leverage of all forms that might be 
outstanding in any Licensee, or in any group of Licensees under common 
control, ``unless the Administration determines on a case by case basis 
to permit a higher amount for companies under common control and 
imposes such additional terms and conditions as it determines 
appropriate to minimize the risk of loss to the Administration in the 
event of default.''
    SBA believes that Congress did not intend the words ``commonly 
controlled'' to mean only ``commonly owned'', since there are many 
different methods of control other than mere ownership of record. 
Rather, SBA believes that Congress intended to limit the dollar amount 
for which SBA would be at risk as a result of the business judgment of 
a single management group, even though the managers are not the owners. 
Consequently, the intention of this regulation is that two or more 
Licensees will be presumed to be ``commonly controlled'' if there is an 
affiliate relationship between or among them, which could be based upon 
ownership of stock or partnership capital of the Licensees, or upon 
management (including arrangements that are characterized as investment 
advisory contracts in which the adviser participates in the selection 
of the Licensee's investments) by affiliated persons or entities, even 
if there is no affiliation between or among the owners of the 
Licensees. The presumption that two or more Licensees are ``Commonly 
Controlled'' is not precluded solely because of the absence of any 
affiliation between or among their respective owners, or any interlock 
of their respective officers and/or directors, or general partners or 
Control Persons. Subject to the right of any Licensee to present 
evidence or arguments in rebuttal, Licensees shall be presumed to be 
under ``Common Control'' under the terms of the proposed rule if day-
to-day management is contracted out to a single entity, or to two or 
more affiliated entities.
    The fact of common ownership need not compel the conclusion of 
Common Control if it can be satisfactorily demonstrated to SBA that, 
for example, two or more Licensees under common ownership operate under 
entirely different management teams, are located in different regions, 
and pursue different investment plans. On the other hand, the 
presumption of Common Control would not be rebutted by a showing that 
two or more Licensees are separately owned and that each has a separate 
board of directors or general partner, if it also appeared that each 
board or general partner had effectively delegated operational control 
to a common adviser/manager.
    Although public comment was generally favorable, one comment 
considered the $90 million Leverage ceiling for a single Licensee to be 
excessive. It is apparent from other provisions of Public Law 102-366 
that Congress intended to make as much as $90 million available to 
qualifying Licensees.
    Another comment urged that two or more Licensees with different 
ownership and different directors and/or general partners not be 
considered under Common Control solely because the day-to-day 
management has been delegated to a common manager.
    SBA believes that any definition of ``Common Control'' that did not 
cover the case of a common manager would be too narrow, especially with 
regard to a company whose investors were led to believe that their 
company would be run by a particular management team.
    Yet another comment objected to the use of the words ``or 
otherwise'' in the first sentences of the respective definitions of 
``Control'' and ``Common Control.'' In each case, ``or otherwise'' 
appears at the end of a list of the means by which one might obtain or 
exercise control over a business. Concern was expressed that an 
institutional investor intending ultimately to form its own wholly 
owned Licensee might be reluctant to become a 10 percent limited 
partner in another Licensee lest SBA consider both Licensees to be 
under common control, thus limiting the amount of Leverage available to 
the wholly owned Licensee.
    SBA understands these concerns, which are believed to arise not so 
much from the definitions of Common Control and Control as from the 
definition of Control Person, which has also been revised.
    With regard to Common Control and Control, the point of both 
definitions is to address the factual issue of whether A controls 
Licensee X, without distinction as to how A came to control X. SBA does 
not wish to leave open the possibility that someone might control a 
Licensee and yet not be covered by these definitions; and it is not 
confident that an enumeration consisting only of ``ownership, 
management, [or] contract'' represents all the ways by which A might 
control X. For example, if A were a 10 percent limited partner in 
Licensee X, and the general partner received no salary or management 
fee from X, but was instead an at-will employee of A, A's control of 
the general partner's salary might justify a conclusion that A actually 
controls X, even though A is only a 10 percent limited partner.

Control Person

    The proposed amendment is adopted with changes to meet some of the 
concerns touched upon in the discussion of Common Control and Control. 
Some of these concerns have already been touched upon in discussing the 
change in the definition of ``Associate of a Licensee''.
    The term ``Control Person'' is concededly a misnomer as applied to 
some of the persons described in the definition. For many years SBA's 
regulations have defined the term ``Associate of a Licensee'' to 
include any person with an equity interest of 10 percent or more in a 
Licensee; it was thought that a person with a 10 percent interest or 
more would have a significant, even if sometimes informal, influence 
over the Licensee's operations. When SBA decided to allow Licensees 
organized as limited partnerships to have a corporate general partner, 
it was necessary to coin a term to cover those persons that might 
control, or at least influence, the Licensee's corporate general 
partner and thus the Licensee itself even though they themselves might 
have no direct relationship to the Licensee. The term chosen to 
describe such persons was ``Control Person'', even though it is defined 
in language that includes persons that could only be described as 
potentially having an influential, but not controlling, voice in the 
Licensee's affairs. On the one hand, SBA's intention was to bring such 
persons within the definition of ``Associate of a Licensee'' in order 
to prevent self-dealing by or in favor of such persons. On the other 
hand, it was never SBA's intention to create a presumption that an 
ownership interest of 10 percent or more in an entity that serves as a 
general partner of the Licensee would, by itself, constitute control 
over the Licensee, even though the language of the proposal may have 
given that impression. Accordingly, the final regulation draws a 
distinction between a Person that has an interest in a corporation or 
partnership, including a limited partnership interest, that serves 
directly or indirectly as a general partner of a Licensee, and also 
participates in that entity's operations and thus ultimately in the 
Licensee's investment decisions; and, in contrast, a passive investor 
in the same kind of entity. In the case of a participant in the 
entity's affairs, an interest of 10 percent or more will bring such 
Person within the definition of Control Person. A passive investor with 
an interest of less than 33 percent in an entity that serves directly 
or indirectly as a general partner of a Licensee is now excluded from 
the definition of Control Person.

Cost of Money (COM)

    SBA proposed three regulatory changes intended to increase the 
income a Licensee might derive from Loans and Debt Security Financings.
    The first proposal, amending the definition of COM to allow 
Licensees to impose upon Small Concerns certain additional fees and 
charges that would be excluded from the computation of COM, is adopted 
as final without change. The other two regulatory proposals intended to 
allow a Licensee to charge more for Financial Assistance will be 
discussed hereafter.
    All comments were favorable, though some expressed the view that 
SBA had not gone far enough. One comment urged that the definition of 
COM explicitly exclude, in addition to any other excluded fees, charges 
and fees paid to non-Associate consultants, accountants, and lawyers.
    SBA does not believe that any further amendment to the definition 
is needed to accomplish the objective sought by this comment. COM is 
defined in terms of payments to a Licensee and its Associates. Thus, 
payments to non-Associates for technical and professional services are 
already excluded from the definition.
    Another comment had urged that a Licensee be allowed to charge a 
fee, excluded from COM calculation, for arranging financing from an 
Associate of that Licensee regularly engaged in investment banking. 
While SBA considers this proposal to be worthy of serious 
consideration, SBA declines to adopt it at this time.
    The amended definition of COM no longer excludes commitment fees. 
Instead, the definition permits Licensees to charge a processing fee of 
up to 3 percent of the requested amount of Financing, without including 
it in COM; and to collect this fee, in full or in part, before 
processing the Small Concern's application. In other words, a Licensee 
may charge interest at the maximum permissible rate, and collect an 
additional processing fee, not to exceed 3 percent of the amount of the 
Financing. If the Financing closes, the Licensee may collect or retain 
the full amount of the processing fee, even if no commitment was 
extended, and no part of this fee will be included in the computation 
of COM. On the other hand, if the Licensee has collected a processing 
fee equal to 3 percent of the requested Financing, any additional fee, 
whether based on the extension of a commitment, or otherwise, will be 
included in computation of COM.
    Although the regulatory changes will permit a Licensee to require a 
processing fee before processing an application for Financing, 
Sec. 107.402 makes it clear that it is not intended that any Licensee 
will derive a profit from a rejected application. In such a case, the 
Licensee must return the entire amount of any processing fee collected 
in excess of certain specified out-of-pocket costs. See Sec. 107.402, 
as adopted. If the application is rejected, the Small Concern will have 
no obligation to reimburse the Licensee for any additional expenses the 
Licensee may have incurred, even if the Licensee has previously charged 
a smaller advance processing fee than it might have charged, or no 
processing fee at all.
    If the Licensee does provide Financing, the Small Concern also may 
be required to reimburse the Licensee for out-of-pocket conveyance and/
or recordation fees, taxes, and reasonable closing costs. Such 
reimbursement, which may be required in addition to the processing fee, 
is not to be included in the computation of COM.
    The definition of COM also would allow Licensees to impose upon 
Small Concerns three other charges, in addition to presently-excluded 
charges, that would be excluded from the computation of COM.
    By agreement with a Small Concern, a Licensee may receive a 
reasonable fee for its efforts in arranging financing from non-SBIC 
non-Associate sources, and the amount of such fee, whether or not the 
Licensee itself participates in the financing, is excluded from the 
computation of COM.
    A Licensee may require the Small Concern to reimburse it for the 
reasonable and necessary costs incurred by the Licensee in monitoring 
the Financing, and the amount of such reimbursement is excluded from 
computation of COM.
    A Licensee that has a ``watchdog'' director serving on the board of 
a Small Concern pursuant to Sec. 107.903(f) may receive reasonable 
director's fees, not in excess of those paid to outside directors; and 
such fees are not to be included in computing COM.
    Finally, the language presently found in the definition of COM that 
requires a Licensee, in the event of prepayment under certain 
circumstances, to refund unearned front-end charges has been moved to 
Sec. 107.402(f), and will be discussed later.

Disadvantaged Concern

    The definition is revised to reflect SBA's current position, but 
SBA expects to undertake a separate rule-making in the near future on 
this subject.

Institutional Investor

    Section 410 of Public Law 102-366 added a definition of ``private 
capital'' to the Act that, among other things, requires SBA to 
recognize ``unfunded commitments from Institutional Investors that meet 
criteria established by the Administration'' as part of a Licensee's 
Private Capital for certain purposes. Accordingly, SBA proposed a 
definition of ``Institutional Investor'' which is now adopted with a 
number of changes.
    The most important change entails the imposition, with one 
exception, of a minimum net worth requirement on all entities or 
persons that which to be considered Institutional Investors, so that 
their unfunded commitments may be recognized by SBA as a part of a 
Licensee's Private Capital for regulatory purposes. The net worth 
requirement does not affect any Person that actually makes an equity 
investment in a Licensee, but only SBA's recognition of an unfunded 
commitment for regulatory purposes.
    Even though SBA does not extend Leverage against unfunded 
commitments, the inability of an investor to fund a commitment may 
adversely affect SBA's risks with respect to Leverage previously 
extended. Although it was SBA's intention to define ``Institutional 
Investor'' broadly and inclusively it is also important that there be a 
substantial probability that the commitment recognized by SBA will be 
fully funded when the time comes. This probability does not necessarily 
exist with respect to every institution that falls within the proposed 
definition of Institutional Investor. Accordingly, SBA has determined 
to impose a $1 million minimum net worth test upon all entities that 
seek to qualify as Institutional Investors, and a $2 million minimum 
net worth standard upon all persons that seek to qualify. However, 
while the final rule exempts individuals who are Accredited Investors 
from the $2 million net worth test, such individuals will be considered 
Institutional Investors only if such person's commitment is backed by a 
letter of credit from another Institutional Investor.
    At this point it is appropriate to note that while an Accredited 
Investor with a net worth of less than $2 million is the only kind of 
individual who will be required to provide a letter of credit in order 
to be considered an Institutional Investor, it does not follow that SBA 
will automatically recognize as a part of a Licensee's Private Capital 
the full amount of the commitment made by every individual 
Institutional Investor with a net worth of $2 million or more.
    Unless an individual Institutional Investor has a net worth of $10 
million or more, a letter of credit from another Institutional Investor 
will be required to back up that part of the commitment that exceeds 10 
percent of the Institutional Investor's net worth. See the definition 
of Private Capital.
    Another change relates to the requirement of a letter of credit. A 
number of comments had pointed out that compliance with the proposed 
requirement that an individual investor's (unfunded) commitment be 
backed by a letter of credit from a qualified Institutional Investor 
was not feasible in the case of a commitment that was not to be fully 
funded within one year; banks and similar Institutional Investors 
normally do not issue letters of credit with terms in excess of one 
year.
    Upon reflection, SBA will recognize a commitment backed by a one-
year letter of credit as long as the letter of credit is renewed or 
replaced at its expiration with another letter equal to the unfunded 
amount of the commitment, expiring on the anniversary of its issuance 
or on the date the commitment is to be fully funded, whichever shall 
first occur. An unfunded commitment not backed by a current letter of 
credit shall cease to be recognized as a part of Regulatory Capital as 
of the date the letter of credit expires, which may cause the Licensee 
to be in violation of any regulatory restrictions or requirements that 
are expressed in terms of the Licensee's Regulatory Capital.
    Another change represents a response to certain inquiries 
concerning foreign investors. SBA never intended that an individual 
investor who meets the standards set forth in the definition of 
``Institutional Investor'' should be excluded from the definition 
solely because he or she was not a permanent resident of the United 
States, as long as he or she irrevocably designates an agent in the 
United States for service of process. The definition is amended to 
reflect this intention.

Private Capital

    With one significant change, and with three changes of an editorial 
nature, the definition of Private Capital is adopted as proposed.
    The proposed definition had allowed ``funds invested which are 
income derived from the investment of grants that have been made by a 
state or local government agency or instrumentality into a nonprofit 
corporation or institution exercising discretionary authority with 
respect to such funds; and funds invested by a State financing agency, 
or similar agency or instrumentality, to the extent such funds are 
derived from such agency's income and not from appropriated State or 
local funds'' to be included in the Regulatory Capital of a Section 
301(d) Licensee, subject to the limitation that the aggregate amount of 
such funds and funds invested in the Licensee directly by any State or 
local government or instrumentality might not exceed 40 percent of that 
Licensee's Regulatory Capital. This 40 percent limit is not in the 
final version. Thus, a Section 301(d) Licensee may be capitalized 
entirely with such indirect funds.
    However, it does not follow that a State or local governmental 
entity supplying such funds to a section 301(d) Licensee can control 
the Licensee. Section 301(b) of the Act requires SBA to make a positive 
determination as to the probability of successful operation by any 
applicant before it may issue a license, specifically considering the 
applicant's prospects of ``adequate profitability''. In making this 
determination, SBA considers it essential that control of a Licensee be 
in hands other than the representatives of public sector investors.
    One editorial change has been made to reflect the fact that, while 
the law requires unfunded binding commitments to invest in a Licensee 
to be treated as a part of the Licensee's Regulatory Capital for some 
purposes, fundamental accounting principles forbid the inclusion of 
unfunded commitments in ``paid-in capital and paid-in surplus.''
    The proposed definition of Private Capital included a paragraph (4) 
providing in relevant part that for the purpose of determining whether 
a Licensee was in compliance with certain cited regulations, the term 
Private Capital used in each such regulation should be considered to 
mean ``Regulatory Capital''. For ease of reference, the term Regulatory 
Capital has been substituted in each cited regulation and the 
corresponding language of paragraph ((4) is deleted.
    To encourage license applicants to assist Small Concerns as soon as 
they are able, even before they receive a license, language has been 
added to make it clear that securities of eligible Small Concerns 
Financed by an applicant or by the applicant's investors after the date 
its license application has been physically received by the Office of 
Investment, but before the license is issued, will be regarded as a 
part of Regulatory Capital for Licensing and other purposes, subject to 
SBA approval. The added language reflects SBA's present practice.

Section 301(d) Licensee

    The proposed definition is adopted with editorial changes that 
conform to the changes in the definition of Disadvantaged Concern.

Limited Partnerships

    The proposed rule is adopted with one significant change. The 
requirement that the funds of a corporate or limited partnership 
general partner not invested in the Licensee be either co-invested with 
those of the Licensee or invested in ``idle funds'' investments is 
eliminated. SBA has never Leveraged such funds, and SBA does not hold 
general partners as such personally liable for the repayment of 
Leverage obligations. No purpose is served by treating such general 
partners differently from unleveraged Licensees.

Operational Requirements

    Except as hereafter noted, SBA adopts as final its proposal to 
amend Sec. 107.101 regarding operational requirements in order both to 
increase the chances of successful operation on the part of Licensees, 
and to minimize SBA's exposure to loss.
    A company that applies for a license, or a Licensee that applies 
for leverage, must demonstrate to SBA that its management has something 
more than general business experience. Such applicant or Licensee must 
show that management has experience making the sizes and types of loans 
or investments in Small Concerns of the sizes and types contemplated in 
the Licensee's Plan of Operations.
    SBA's experience has shown that companies entering the SBIC program 
with only the statutory minimum amount of capital have little chance of 
carrying on the ``successful operations'' and achieving the ``adequate 
profitability'' required by section 301(c) of the Act. Accordingly, 
every applicant will be required to have sufficient capital in excess 
of the minimum to operate soundly and profitably within the context of 
its plan of operations as approved by SBA. Each prospective Licensee 
must have sufficient capital so that it will be able to pay its 
expenses without dissipating its Regulatory Capital. Based on SBA's 
experience, given Licensees' fixed expenses for management and rent, 
and their costs of due diligence, even in the case of straight loans, 
SBA believes that a stand-alone company bearing the full expense of 
rent, management, accounting services, etc. has only a limited prospect 
of profitability if its Regulatory Capital is less than $5 million. 
Accordingly, SBA would prefer that applicants have minimum capital of 
$5 million before admission to the program. It does not follow, though, 
that SBA will never hereafter license a company with Regulatory Capital 
of less than $5 million. In appropriate cases, consideration will be 
given to the possibility that the applicant's overhead expenses may be 
substantially less than customary because they will be shared with 
other companies having similar investment policies, or underwritten by 
the applicant's investors.
    SBA's experience also has shown that the portfolio valuation 
process is a weakness of some Licensees. Accordingly, SBA has taken 
steps to improve the process and the valuation standards. Each Licensee 
is required to adopt a policy for the valuation of its portfolio 
investments, to evaluate portfolio investments in accordance with such 
policy, and to report such evaluations to SBA. For their guidance, SBA 
adds an Appendix III to Part 107 setting forth the basis upon which 
valuation guidelines should be framed. Appendix III as adopted differs 
somewhat from its proposed form because of SBA's response to comments 
it has received.
    With the widespread use of computers in virtually all businesses, 
SBA is in the process of developing systems to enable SBICs to perform 
their reporting requirements through electronic transmission from the 
most commonly used types of personal computers. SBA will provide SBICs 
with custom software that will enable SBICs to perform their reporting 
tasks more easily, more accurately, and more quickly. To this end, SBA 
is requiring all SBICs to have personal computers, to run SBA-provided 
software, and to report electronically as directed by SBA by June 30, 
1994.
    The final version of Sec. 107.101 adopted today includes a new 
paragraph (i) that was not a part of the original proposal. The 
combination of the tendency within the Small Business Investment 
Company industry toward the formation of larger companies and increases 
in the size standards applicable to the industry (see 58 FR 40603, 
proposed July 29, 1993 and adopted as final simultaneously herewith) 
raises the possibility that the flow of investment capital into smaller 
concerns may be substantially reduced. Accordingly, SBA will require 
Licensees to ensure that a percentage of the Financings they extend in 
the future go to Smaller Concerns--concerns that qualify as Small 
either under the standard set forth in 13 CFR Sec. 121.802(a)(2)(i) as 
in effect on January 1, 1993, or under the industry size standard in 
effect at the time of the Financing--as defined in Sec. 107.3. A 
Licensee that fails to meet the goal set forth in this regulation may 
make no Financings of concerns that do not qualify as Smaller Concerns 
until it has brought itself into compliance.
    At the end of each Licensee's first full fiscal year following the 
adoption of this rule, at least 10 percent of the dollar amount of all 
Financings made by the Licensee between those dates shall have been 
extended to such Smaller Concerns. At the end of each subsequent fiscal 
year following the adoption of this rule, the cumulative dollar amount 
of Financings extended to such Smaller Concerns by each Licensee since 
the adoption of this rule must equal at least 20 percent of the 
cumulative total of Financings over the same period. For the purpose of 
determining whether a Licensee has achieved these objectives, a change 
of ownership Financing pursuant to Sec. 107.711 in which the resulting 
concern qualifies as a Smaller Concern will be counted as a Financing 
of such Smaller Concern.
    The purpose of this rule is to insure a continued flow of Financial 
Assistance to Smaller Concerns despite the adoption of a new size 
standard. Therefore the rule does not mean that a certain percentage of 
the Licensee's portfolio as of the end of any (full) fiscal year 
following the adoption of this rule must consist of investments in 
Smaller Concerns. In the case of any present Licensee, 100 percent of 
its portfolio on the date of this final rule would consist of 
investments in Smaller Concerns. Thus, such Licensee would be free to 
operate for a number of years without Financing any Smaller Concerns if 
the rule were addressed to a specific percentage of portfolio as of the 
close of a fiscal year. Such a result would be inconsistent with the 
previously-declared purpose of the rule, which is aimed at future 
investments. Given the purpose of the rule, events such as prepayments, 
the sale or exchange of portfolio securities, or the write-down or 
write-off of portfolio securities will not affect the Licensee's 
compliance.
    Nor does the rule necessarily require a specific percentage of 
Financings to Smaller Concerns within any given fiscal year; the object 
of the rule is a cumulative percentage as of the end of a period. The 
wording of the rule is intended to imply a carry-forward from one 
fiscal year to the next, of Financings to Smaller Concerns made after 
the effective date of the rule.

Calculation of Cost of Money Ceiling

    The proposal to allow Licensees to calculate an alternative Cost of 
Money Ceiling based on their own weighted average cost of money is 
adopted with a number of significant changes.
    Until now, the maximum permissible rate of interest that any 
Licensee might impose upon any Small Concern was calculated with 
reference to the rate of interest on the SBA-guaranteed debentures 
underlying the most recent offering of trust certificates to the 
public. While the existing rule facilitated the determination of a 
uniform ceiling throughout the industry, it ignored the actual interest 
expense on the debenture leverage drawn down by any individual 
Licensee.
    SBA had originally proposed to amend Sec. 107.302 to allow 
Licensees that have been leveraged through the sale of debentures to 
use their own weighted average cost of funds borrowed from SBA, or with 
SBA's guarantee, as the case may be, as an alternative basis for 
calculating their respective interest rate ceilings. Although companies 
licensed under section 301(d) of the Act that sell debentures to SBA 
(or to the public with SBA's guarantee) may enjoy the benefits of a 
subsidized interest rate for the first five years of the debenture's 
term, this subsidy is to be disregarded in the calculation of the 
alternative interest rate ceiling. On the other hand, Licensees that 
have sold Preferred Securities (stock or limited partnership interests) 
or Participating Securities may not include dividends or distributions 
on such securities in the calculation of their alternative interest 
rate ceilings.
    The entire focus of the proposal was on Leveraged Licensees, partly 
because section 305 of the Act, as amended by section 411 of Public Law 
102-366, spoke only of ``companies which have issued debentures 
pursuant to this Act'', and partly because it was assumed that non-
Leveraged Licensees did not utilize borrowed funds. The final 
regulation reflects the numerous comments that informed SBA that non-
Leveraged Licensees do indeed have borrowings, albeit from other 
sources. Accordingly, the final rule will allow a Licensee to utilize 
Weighted Average Cost of Qualified Borrowings (including SBA-guaranteed 
Debentures) rather than Weighted Average Cost of Leverage as an 
alternative basis for the calculation of its Cost of Money limit.
    The use of the term ``Qualified Borrowings'', defined in 
Sec. 107.3, is intended to discourage a Licensee's acceptance of 
extremely high (above-market) interest loans, presumably from 
Associates, for the purpose of maximizing the COM that the Licensee may 
then impose upon a Small Concern.
    It should be understood that under the terms of the regulation as 
proposed and adopted, the Weighted Average Cost of Qualified Borrowings 
that is to be used by a Licensee is its cost over the Licensee's 
preceding fiscal year, certified to SBA when the Licensee's Annual 
Report (Form 468) is transmitted. However, it is also SBA's intention 
to make this alternative method available as soon as possible to any 
Licensee that may wish to use it without waiting until the end of its 
fiscal year.
    Following the publication of this final rule, any Licensee may 
promptly certify its Weighted Average Cost of Qualified Borrowings to 
SBA as if this regulation had been in effect prior to the close of the 
Licensee's preceding fiscal year. Solely for the purposes of 
determining whether the notification is timely within the meaning of 
Sec. 107.302(f), SBA will regard the effective date of this rule as the 
closing date of the Licensee's fiscal year. In other words, if the 
Licensee's fiscal year ends on December 31, and this rule is adopted as 
final on the following May 1, a Licensee may certify a Weighted Average 
Cost of Borrowed Funds based on the fiscal year that closed on the 
preceding December 31, and the required notification to SBA will be 
considered timely if made within 30 days after May 1.
    If a Licensee does not make a timely certification of its Weighted 
Average Cost of Qualified Borrowings, it will be presumed that its 
Weighted Average Cost of Borrowed Funds for the preceding fiscal year 
is zero, so that the COM ceiling applicable to its Financings will be 
that based on the current Debenture Rate. It should be understood 
clearly that the interest rate ceiling based on the Debenture Rate 
remains the only permissible ceiling applicable to Loans or Debt 
Security Financings committed or disbursed prior to the certification 
of the Licensee's Weighted Average Cost of Qualified Borrowings.
    Since each Licensee may have its own individual COM ceiling, SBA 
proposed a solution to the question of the applicable ceiling when two 
or more Licensees participate in a joint financing. See Sec. 107.302(g) 
as proposed. In response to comments, SBA has determined to adopt a 
simpler final rule. The applicable COM limit for a joint financing is 
the highest of any of the three following ceilings:
    (1) A ceiling based on the current Debenture Rate, which is the 
same for all Licensees at any given time;
    (2) A ceiling determined with reference to the lead lender's 
Weighted Average Cost of Qualified Borrowings; or
    (3) A ceiling equal to the weighted average of the highest ceiling 
available to each participating Licensee. If a Licensee has not 
certified a Weighted Average Cost of Qualified Borrowings to SBA at the 
time it participates in a joint financing, or has no Qualified 
Borrowings, the ``highest ceiling available'' to such Licensee is, of 
course, a ceiling based on the current Debenture Rate. SBA acknowledges 
that on occasion some participating Licensees may be able to collect 
interest and/or other charges for the use of money in excess of the 
limit that would apply if they had done the Financing separately; but 
SBA considers that such situations will arise only rarely, and the 
excess cost to the Small Concern will be minimal.
    SBA had proposed to adopt a new rule that would limit both the 
amount of default penalty that a Licensee may impose, and the 
circumstances under which a penalty might be imposed. Based upon the 
comments received, SBA now believes that a rule limiting post-default 
interest to the maximum rate permitted by the Cost of Money ceiling in 
effect at the time of default may be insufficient to deter deliberate 
default. Accordingly, the final rule will permit a Licensee to impose 
and collect a default penalty not to exceed 7 percentage points over 
the rate specified in the Note or Loan Agreement, for as long as the 
default shall continue.
    As proposed, the rule would have allowed a default penalty to be 
imposed only if the Small Concern failed to make payment in accordance 
with the terms of its obligation. The final rule will also allow a 
default penalty to be imposed for failure to furnish required reports 
or other information. Inasmuch as SBA will require Licensees to furnish 
information concerning the economic impact of the loans and investments 
they make, and to verify the use of Financing proceeds by Small 
Concerns; and to obtain the necessary documentation pertaining to such 
use and to economic impact generally, SBA considers the Licensee's 
ability to impose a monetary sanction on the Small Concern both an 
inducement to the Licensee to force compliance by the Small Concern and 
an indispensable tool for that purpose.

Regulatory Relief for Unleveraged Licensees

    As directed by section 408 of Public Law 102-366, SBA reviewed and 
proposed to revise those regulations ``intended to provide for the 
safety and soundness of'' leveraged Licensees with a view toward 
exempting unleveraged Licensees from compliance with such regulations, 
or promulgating different rules for unleveraged Licensees. SBA's 
proposal to exempt unleveraged Licensees from compliance with 
Sec. 107.303 (overline limitation) is adopted as proposed.
    SBA's proposal to relieve unleveraged Licensees from compliance 
with Sec. 107.708 (idle funds) is also adopted without change. SBA's 
proposal to amend Sec. 107.708 as it applies to Leveraged Licensees 
will be discussed later.
    The language of Sec. 107.708 now reflects SBA's position with 
respect to a Licensee's deposit of idle funds in an Associate bank, 
which has always been that such a deposit does not constitute the 
Financing of an Associate unless the Licensee is receiving a lower 
interest rate than the Associate gives the public. In the case of an 
unleveraged Licensee, SBA will not consider the deposit of funds with 
an Associate bank to constitute self-dealing, even if the Licensee 
accepts a lower interest rate than the Associate gives the public.
    SBA does not intend that any Licensee shall simultaneously be 
leveraged and exempted from compliance with Secs. 107.303 and 107.708, 
or with any other regulations that may later be made inapplicable to 
unleveraged Licensees. Accordingly, no Leverage is to be made available 
to any unleveraged Licensee that is not, at the time of the request for 
Leverage, in compliance with regulations applicable to Licensees with 
outstanding Leverage.

Economic Impact

    SBA had proposed to add a paragraph (c) to Sec. 107.304 to require 
that each Portfolio Financing Report (Form 1031) set forth the economic 
impact expected to result from the financing in terms of job creation 
or retention, expanded business activity, or other identified 
indicators of economic impact. In response to comments, SBA has 
determined that it would be more appropriate to require the Licensee to 
include in its own annual reports to SBA additional information 
reflecting the actual economic impact of its Financing on each 
Portfolio Concern, instead of requiring the Licensee to submit its 
predictions of economic impact.

Verification of Use of Proceeds

    SBA's proposal to require Licensees to take reasonable steps to 
verify the use of Financing proceeds by portfolio concerns is adopted 
with certain changes intended to clarify what is expected of Licensees.
    The purpose of this regulation is to reduce the possibility that 
Licensee funds may be used for purposes beyond the contemplation of the 
Act or for purposes forbidden by the regulations; it is intended to 
make existing prohibitions more effective.
    For example, Sec. 107.901(c) has long forbidden the extension of 
Financing to concerns engaged in the operation of rental real estate, 
but the scope of the prohibition is not limited to concerns that openly 
hold themselves out (to the Licensee, at least) as being engaged in the 
operation of rental real estate. Also prohibited is the use of Licensee 
funds to acquire or improve rental real estate even if the Small 
Concern's primary business (at least immediately before the Financing) 
is classifiable other than as a prohibited Major Group 65 activity. SBA 
seeks to make it as difficult as possible for a Small Concern to divert 
funds from the legitimate purpose represented to the Licensee and 
reported to SBA on the Form 1031. As the preceding sentence suggests, 
SBA considers the diversion-of-proceeds problem to be one primarily 
involving innocent Licensees that have been wrongfully induced by a 
Small Concern to make a Financing.
    Certainly a Small Concern's representations pertaining to the 
eligibility of the end use of its funds are as material as those 
pertaining to the value of its assets or its revenues. Nor should a 
Small Concern be able to deceive Licensees with impunity as to the 
ultimate intended use of Financing proceeds. While the cooperation of 
Licensees is necessary to prevent such deceit, the real obligation 
should fall upon the Small Concerns themselves. Accordingly, the 
regulation adopted today clarifies the Licensee's duty to verify that 
the use of funds was in accordance with the representations made to the 
Licensee. To assist the Licensee in obtaining such information, SBA has 
adopted other regulations that will permit a Licensee to impose a 
substantial default penalty on a Small Concern that fails to furnish 
required post-financing information (see Sec. 107.302(h)) and that 
allow a Licensee to recover from the Small Concern the reasonable and 
necessary out-of-pocket expenses incurred in monitoring the Financing 
(see paragraph (7) of the definition of Cost of Money).
    Accordingly, Licensees will be required to enter in their own 
files, and to maintain therein, the expected date of a post-closing 
review for the purpose of monitoring use of proceeds, which shall be 
not later than 90 days after the scheduled use of the funds.
    In conducting a post-closing review or monitoring the subsequent 
activities of a portfolio concern, Licensees should be alert to the 
possibility of diversion of proceeds. If post-Financing financial 
statements from the Small Concern, or visits to the Small Concern, 
disclose substantial amounts of newly-created non-trade receivables or 
investment assets, suspicion is warranted.
    Similarly, since ``working capital'' is always understood to mean 
money for use in the portfolio concern's business, as represented to 
the Licensee and reported on the Form 1031, a request for a ``working 
capital'' loan that seems wholly out of proportion for an enterprise of 
the Small Concern's size in the same line of business should be a 
warning signal.

Prepayment Penalties

    Most of the substance of the proposed Sec. 107.402 has already been 
discussed in connection with the proposed definition of Cost of Money. 
However, the proposed Sec. 107.402 reflected a new approach to the 
treatment of prepayment penalties by a Licensee that has also charged 
front-end fees. Under the rule adopted today, which is substantially as 
proposed, every Licensee may charge a reasonable prepayment penalty for 
voluntary prepayment without regard to front-end charges, but a 
Licensee that charges an excessive prepayment penalty shall be required 
to refund the entire amount of the penalty to the Small Concern.
    A number of comments had sought some guidance as to what SBA would 
consider a reasonable prepayment penalty. Accordingly, the regulation 
clarifies that SBA will presume that a prepayment penalty equal to 5 
percent of the outstanding balance in the first year of the Financing's 
term, and declining by one percentage point per year until the fifth 
year, is a reasonable prepayment penalty. The formula is that employed 
in the case of prepayment of SBA-guaranteed Debentures. SBA considers 
this a more precise and useful standard than one referring to a penalty 
``customary for financial institutions in the geographic area in which 
the financing is being made.''
    If a Licensee has imposed front-end charges that are not 
specifically excluded from computation of COM (such as points, 
discounts, or processing fees in excess of 3 percent) such charges 
shall be prorated over the stated term of the Financing and if the sum 
of interest and unearned front-end charges exceeds the applicable COM 
limit, the excess shall be repaid to the Small Concern.

Special Situations for Short-Term Financing

    The proposal to amend Sec. 107.403(b)(1) by adding a narrow 
exception to the general requirement that all Financings have a term of 
at least five years is adopted without change. The new exception is 
created in favor of Small Concerns that have received government 
contracts under Federal, State, or local set-aside programs for 
``minority'' or ``disadvantaged'' concerns, so that Licensees may 
provide the short-term contract financing that the Small Concern needs 
to perform the contract.
    Although such Financing would only go to firms receiving contracts 
under set-aside programs wherein eligibility had been established by 
the contracting agency, Licensees extending short-term contract 
Financing would have a responsibility to assure that the Small Concern 
in question is a ``Disadvantaged Concern'', as defined in Sec. 107.3.

Consideration for Issuance of Licensee's Securities

    The proposal to amend Sec. 107.705 to allow a Licensee to issue its 
securities in exchange for non-cash assets approved by SBA is adopted 
with an editorial change.
    Paragraph (4) of the definition of ``Private Capital'', as 
originally proposed, had included a warning concerning future 
Financings of, and/or assumptions of Control over, concerns whose 
securities were exchanged with the Licensee for stock or partnership 
interests therein. The intended gist of the warning was that if the 
legality of a certain action or Financing depends upon the need to 
protect a Licensee's investment, a Licensee that has only issued its 
stock or partnership interests in exchange for securities of a Small 
Concern is not considered to have any investment to protect. This 
warning language, adopted without change, will now be a part of 
Sec. 107.705 as adopted; it is transferred from paragraph (4) of the 
definition of Private Capital. However, this restriction will not apply 
to securities of eligible Small Concerns that SBA has approved for 
inclusion in Regulatory Capital.

Retention of Investments

    The final version of Sec. 107.706 differs substantially from the 
proposed version. Section 107.706 originally had addressed the right of 
a Licensee to retain its investment in, and to provide additional 
Financing to, a concern that had ceased to be a Small Concern. SBA had 
proposed to broaden the scope of the regulation to cover the case in 
which a concern's eligibility is lost, either because it ceases to be 
an alter ego of another eligible concern, or because it has shifted its 
activity into an ineligible line of business. The policy decision, 
previously discussed, to defer adoption of an alter ego rule required 
the elimination of all such references in the proposed rule. The other 
changes, discussed below, respond to comments received from the public.
    The proposed rule would have left untouched the present rule 
restricting the right of Licensees to provide additional Financing to 
concerns whose growth and expansion was such as to take them out of the 
definition of Small Concern. After further consideration, SBA is 
persuaded that growth and expansion are desirable processes that should 
neither restrict the access of the successful portfolio concern to 
additional Financing from the Licensees that Financed it when it was 
small, or the right of the Licensees to take additional advantage of an 
unusually promising investment opportunity. Accordingly, paragraph (a) 
has been revised to allow a Licensee with a pre-existing investment in 
a concern that is no longer small to make additional investments until 
the portfolio concern makes a public offering of its securities; and, 
even after that, to exercise options, warrants or other rights to 
acquire Equity Securities of the portfolio concern.
    The regulation adopted this day with respect to additional 
Financing of concerns that have become ineligible by reason of a change 
in business operations represents the reconciliation of two conflicting 
policy considerations. On the one hand, if SBA regulations declare 
Small Concerns engaged in certain lines of business to be ineligible, 
it makes no sense to allow Licensees to Finance an initially-eligible 
concern so that it can shift its business activities into an ineligible 
area. On the other hand, SBA recognizes that subsequent and unforeseen 
occurrences may require a Small Concern to shift its activities into an 
ineligible area.
    Accordingly, the final regulation distinguishes between the case of 
a concern that becomes ineligible by reason of a change in its business 
activities within one year after the Licensee's Financing and that of a 
concern that changes its business activities more than a year after the 
Licensee's Financing. The regulation provides that if the concern moves 
into an ineligible line of business within one year from the date of 
the Licensee's Financing, a rebuttable presumption will arise that the 
change in business activity was contemplated by the Small Concern at 
the time of the Licensee's Financing. Accordingly, the Licensee shall 
have the right to treat such change as a default or other breach of 
covenant on the Small Concern's part, and to sue for any resulting 
damages. See Sec. 107.305. The Licensee may also divest itself of the 
investment if it considers such action to be in its best interests. 
However, the Licensee's retention of such an investment in its 
portfolio is a matter of balancing of program integrity against 
possible loss to the Licensee, which is something that can only be done 
on a case-by-case basis. Accordingly, requests for retention of the 
investment should be accompanied by evidence tending to rebut the 
presumption of bad faith on the part of the Small Concern by a showing 
that the change in the Small Concern's business was prompted by a 
change in circumstances subsequent to the date of the Licensee's 
Financing and not reasonably foreseeable by the Small Concern.
    If the change in business activity takes place more than one year 
or more after the Licensee's Financing, of if the presumption of 
regulatory violation has been rebutted, the Licensee may provide 
additional Financing, but only to the extent necessary to prevent loss 
of its original investment. SBA intends to allow only the most narrow 
exception to its policy forbidding the Financing of concerns engaged in 
ineligible business activities.
    A change that takes place within one year gives the Licensee the 
option to treat the event as a default and to accelerate the maturity 
of all obligations. If the Licensee wishes to retain its investment in 
the portfolio concern, it must obtain SBA's approval; and to obtain 
such approval, it must rebut the presumption that the change was within 
the contemplation of the parties, and, hence, in violation of the 
applicable regulation, at the time of the Licensee's Financing. The 
Licensee may rebut this presumption with evidence that the change was 
the result of changed circumstances, unforeseen at the time of the 
Licensee's Financing.
    A change that takes place more than a year after the Licensee's 
Financing may be treated by the Licensee as a default, but there is 
neither a presumption that the change was within the contemplation of 
the parties at the time of the Licensee's Financing, nor a requirement 
of SBA approval should the Licensee decide to retain its investment.

Purchase of Portfolio Securities From SBA or From Licensees in 
Liquidation

    SBA's proposal to amend Sec. 107.707 to clarify the authority of 
Licensees to purchase securities of Small Concerns from SBA, as either 
the receiver or the assignee of another Licensee, is adopted without 
change.
    Licensees are reminded that Sec. 107.403(b)(3) presently allows 
them to purchase securities of a Small Concern, including its 
promissory notes, from any (non-Associate) non-issuer (including the 
receiver of a failed financial institution), provided such acquisition 
``constitutes a reasonably necessary part of the overall sound 
financing of such concern.'' In contrast, Sec. 107.707 contains no such 
restriction and is therefore narrowly drawn. SBA has determined that no 
benefit to the Program or to small business would result from 
broadening the scope of Sec. 107.707 to allow the purchase of a Small 
Concern's Notes from the liquidators of a failed lending institution 
when such purchase is made for its own sake, and not as a ``reasonably 
necessary part of the overall sound financing of such concern.''

Idle Funds Investments

    So far as this proposal deals with unleveraged Licensees, its 
effects have already been discussed. That part of the proposal dealing 
with investments of idle funds by Leveraged Licensees is adopted with 
certain changes.
    The final regulation clarifies in two ways the authority of 
Leveraged Licensees to invest in repurchase agreements (repos).
    The subject matter of the repo may only be obligations of, or 
obligations guaranteed as to principal and interest by, the United 
States; it is not enough that such Federal or Federally-guaranteed 
obligations serve as collateral security for the performance of a repo 
whose subject is some other kind of security.
    The securities underlying the repo must be maintained in a 
custodial account at a Federally-insured institution. They may not 
remain in the hands of a party that is not itself Federally-insured; 
and they may not be held as commingled assets of the custodial 
institution.
    The proposed regulation would not have allowed Licensees to 
maintain idle funds deposits in excess of the insurance limit. The 
final regulation permits Licensees to maintain idle funds in a 
Federally-insured institution in excess of the insurance limit, but 
only if that institution is ``well capitalized'' in accordance with the 
standard set forth in 12 CFR 325.103(b)(1), as amended from time to 
time.

Financing Changes of Ownership

    The proposed rule is adopted with three changes.
    The effect of the only significant substantive change is to allow 
non-Leveraged Licensees to Finance changes of ownership if the debt-to-
equity ratio of the resulting concern is no higher than 8 to 1. As 
proposed, the ratio had been 7 to 1.
    The focus of Sec. 107.711 as proposed and adopted is the concern 
that would emerge from the transfer of ownership, giving effect to all 
financings, mergers and reorganizations contemplated by the parties. In 
fact, the term ``contemplated'' has been substituted for ``agreed to'' 
to cover the case in which two or more parties agree in principle on a 
general course of conduct, but have not reached definitive agreement on 
all points.
    If the concern resulting from the consummated acquisition will have 
no more than 500 full-time equivalent employees, the Licensee may 
finance the acquisition. If the concern resulting from the consummated 
acquisition will have more than 500 full-time equivalent employees, the 
Licensee may still finance the acquisition if, and only if, the 
resulting concern also meets either one of two alternative debt/equity 
ratio tests. If the Licensee in question has outstanding Leverage, the 
resulting concern's debt/equity ratio may not exceed 5:1; in the case 
of an unleveraged Licensee, the applicable debt/equity ratio may not 
exceed 8:1.
    The regulation contains a paragraph (b)(2)(iii) that excludes 
certain classes of debt and other obligations from the category of 
``debt'' for the purpose of determining the resulting concern's debt/
equity ratio. To preclude confusion, the paragraph has been slightly 
modified to include contingent liabilities within the definition of 
``debt''.
    It should be understood that Sec. 107.711 does not constitute an 
amendment of the size standards. The standards to be set forth in 
Sec. 107.711 are applicable only in the context of financing a change 
of ownership.

Minimum Capital Requirements

    The proposal to amend Sec. 107.712(c) is adopted without change; 
the amendment is a clerical one, mandated by statute.

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

    This final rule will be a significant regulatory action for 
purposes of Executive Order 12866 because it will have an annual effect 
on the economy of more than $100 million, and, for purposes of the 
Regulatory Flexibility Act, 5 U.S.C. 601, et seq., it is likely to have 
a substantial impact upon a number of small entities.
    Much of this final rule is adopted pursuant to a statutory mandate 
(section 415 of Pub. L. 102-366) that requires SBA to promulgate 
regulations implementing The Small Business Equity Enhancement Act of 
1992.
    Among the statutory provisions to be implemented by regulation is a 
definition of ``Private Capital'' that includes funds invested by State 
and local governments and their instrumentalities, and by pension funds 
managed by State or local government officials. Another provision 
mandates the recognition of unfunded commitments of institutional 
investors as a part of ``Private Capital'' for certain purposes. The 
effect of these provisions is to encourage the investment of additional 
capital in the Small Business Investment Company program; and the 
amount of such new capital, together with SBA Leverage, is expected to 
be substantially in excess of $100 million per year.
    The potential benefits of this regulation have been set forth under 
Supplementary Information. The potential cost of this regulation cannot 
be quantified or estimated.

Executive Order 12612

    SBA certifies that this regulation will not have federalism 
implications warranting the preparation of a Federalism Assessment in 
accordance with Executive Order 12612.

Executive Order 12278

    For the purposes of Executive Order 12278, SBA certifies that this 
rule is drafted, to the extent practicable, in accordance with the 
standards set forth in section 2 of that Order.

Paperwork Reduction Act

    This final rule will impose only minimal additional recordkeeping 
and reporting requirements on Licensees and on the Small Concerns 
Financed by them. SBA believes that much of the information needed to 
ensure that funds advanced by Licensees are used by Small Concerns in 
accordance with the Act and regulations, or to verify the effect of the 
program in terms of job creation and additional tax purposes, or to 
verify that Licensee Financing of changes of ownership serves a public 
purpose by encouraging the preservation or creation of jobs, is 
customarily provided by Small Concerns as part of their business plan 
projections, or developed by Licensees as part of its due diligence.

(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, Small businesses.

    For the reasons set forth above, part 107 of title 13, Code of 
Federal Regulations is hereby 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., as amended; 15 U.S.C. 687(c); 15 U.S.C. 683; 15 
U.S.C. 687d; 15 U.S.C. 687g; 15 U.S.C. 687b; 15 U.S.C. 687m, as 
amended by Pub. L. 102-366.

    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 of 
``Control'', ``Control Person'', ``Cost of Money'', ``Disadvantaged 
Concern'' ``Private Capital'', and ``Section 301(d) Licensee'' and by 
adding definitions of ``Commitment'', ``Common Control'', 
``Institutional Investor'', ``Leverageable Capital'', ``Qualified 
Borrowing'', ``Regulatory Capital'', ``Section 301(c) Licensee'', and 
``Smaller Concern'' in the appropriate alphabetical order and by 
revising paragraph (b) of the definition of ``Associate of a 
Licensee'', to read as follows:


Sec. 107.3  Definition of terms.\2\
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    \2\Terms defined in this section are capitalized hereafter.
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* * * * *
    Associate of a Licensee means:
* * * * *
    (b)(1) Any Person owning or controlling, directly or indirectly, 
ten percent or more of any class of stock of a Corporate Licensee; or 
(2) any Person owning or controlling, directly or indirectly, a limited 
partner's interest representing ten percent or more of the partnership 
capital of an Unincorporated Licensee; Provided, however, That if a 
Person described in the preceding paragraph (b)(2) of this definition 
is an Institutional Investor and the amount of such Person's investment 
in a Licensee, including commitments, does not exceed 5 percent of that 
Person's net worth, then such Person shall not be considered an 
Associate unless the amount of such Person's limited partnership 
interest represents 33 percent or more of partnership capital.
* * * * *
    Commitment means a written agreement between a Licensee and a Small 
Concern that obligates the Licensee to provide Financing (except a 
guarantee) to a Small Concern (whose eligibility has already been 
determined by the Licensee) in a fixed or determinable sum, by a fixed 
or determinable future date. In this context the term ``agreement'' 
means that there has been agreement on the principal economic terms of 
the Financing; Provided, however, that the terms of the Commitment may 
include reasonable conditions precedent not within the control of the 
Licensee to the Licensee's obligation to fund the Commitment.
* * * * *
    Common Control means a condition where two or more Licensees either 
through ownership, management, contract, or otherwise, are under the 
Control of one group or Person. Two or more Licensees are presumed to 
be under Common Control if they are affiliates of each other by reason 
of common ownership or common officers, directors, or general partners; 
or if they are managed or their investments are significantly directed 
either by a common independent investment advisor or managerial 
contractor, or by two or more such contractors that are affiliates of 
each other. This presumption may be rebutted by evidence satisfactory 
to SBA. The term ``affiliate'' is defined in Sec. 121.401 of this 
title.
    Control means the possession, direct or indirect, of the power to 
direct or cause the direction of the management and policies of a 
Licensee or a Small Concern, whether through the ownership of voting 
securities, by contract, or otherwise.
    Control Person means (a) A general partner of an Unincorporated 
Licensee, including all general partners of a partnership serving 
either as a general partner of an Unincorporated Licensee or as a 
general partner of any other (intervening) partnership, limited or 
general, that serves directly or indirectly as a general partner of an 
Unincorporated Licensee;
    (b) Any officer, director, agent or employee of a corporate general 
partner of an Unincorporated Licensee, or of any corporation that is a 
general partner in a partnership serving as a general partner of an 
Unincorporated Licensee, or as a general partner of any other 
(intervening) partnership, limited or general, that serves directly or 
indirectly as a general partner of an Unincorporated Licensee;
    (c) Any Person that participates in the investment decisions of the 
general partner of an Unincorporated Licensee and owns or controls, 
directly or indirectly, an interest of 10 percent or more as a 
stockholder in, or limited partner of, any corporation or limited 
partnership that serves directly or indirectly as a general partner of 
such Unincorporated Licensee;
    (d) Any Person that does not participate in the investment 
decisions of the general partner of an Unincorporated Licensee and owns 
or controls, directly or indirectly, an interest of 40 percent or more 
as a stockholder in, or limited partner of, any corporation or limited 
partnership that serves directly or indirectly as a general partner of 
such Unincorporated Licensee.
* * * * *
    Cost of Money generally includes all consideration that a Small 
Concern and/or its affiliates is (are) contractually obligated to pay 
to a Licensee and/or the Associates of such Licensee in connection with 
Financial Assistance from such Licensee, such as interest, discounts, 
points, fees, commissions, and any other thing of value, except as 
hereinafter set forth.
    (a) The following fees and charges are not to be included in 
calculating Cost of Money:
    (1) Processing fees determined in accordance with Sec. 107.402;
    (2) Out-of-pocket conveyance and/or recordation fees and taxes;
    (3) Reasonable closing costs;
    (4) A reasonable fee for arranging financing from non-SBIC non-
Associate sources of capital, whether or not the Licensee participates 
in such financing, if there is a written agreement in advance with the 
Small Concern to pay such fee;
    (5) Fees for management consulting services, but only if calculated 
on a per hour, commercially reasonable basis for services actually 
rendered,
    (6) Prepayment penalties pursuant to Sec. 107.402;
    (7) Reasonable and necessary out-of-pocket expenses incurred in 
monitoring the financing; and
    (8) Board of Director fees not to exceed those paid to other 
outside directors and pursuant to Sec. 107.903(f).
    (b) All other fees and charges shall be included in calculating 
Cost of Money.
* * * * *
    Disadvantaged Concern means a Small Concern that is at least 50 
percent owned, and controlled and managed, by a person or persons whose 
participation in the free enterprise system is hampered because of 
social or economic disadvantages.
* * * * *
    Institutional Investor means any of the following classes of 
entities having a net worth of not less than $1 million; or of persons 
having a net worth of not less than $2 million, exclusive of the value 
of the equity in his or her most valuable residence, unless otherwise 
specified:
    (a) Entities. (1) Any State or National bank, trust company, 
savings bank, or savings and loan association, including any such 
institution investing the funds of others in a fiduciary capacity;
    (2) Any insurance company
    (3) Any 1940 Act Investment Company or Business Development 
Company, as defined in the Investment Company Act of 1940, as amended;
    (4) Any holding company of the foregoing;
    (5) Any employee benefit or pension plan established for the 
benefit of employees of the Federal government or any State, their 
political subdivisions, or any agency or instrumentality thereof;
    (6) Any employee benefit or pension plan, as defined in the 
Employee Retirement Income Security Act of 1974, as amended;
    (7) Any trust, foundation or endowment exempt from Federal income 
taxation under the Internal Revenue Code, as amended;
    (8) Any corporation, partnership, or other entity with a net worth 
in excess of $10,000,000;
    (9) Any State, its respective political subdivisions, or any agency 
or instrumentality thereof;
    (10) Any entity whose primary purpose is to manage and invest non-
Federal funds on behalf of any of the foregoing Institutional 
Investors; or
    (11) Any other entity that SBA shall determine to be an 
Institutional Investor.
    (b) Persons. (1)(i) Any individual with a personal net worth of 
less than $2 million who is an Accredited Investor as defined by the 
Securities Act of 1933, as amended, and whose commitment to the 
Licensee is backed by a letter of credit from a qualified Institutional 
Investor;
    (ii) Any individual whose personal net worth (exclusive of the 
value of his or her most valuable residence) is equal to not less than 
ten times the amount of his or her commitment; or
    (iii) Any individual whose personal net worth (exclusive of the 
value of any equity in his or her most valuable residence) equals or 
exceeds $10 million: Provided, however, That the commitment of any 
individual who is not a permanent resident of the United States shall 
also be backed by an irrevocable appointment of an agent within the 
United States for the service of process.
    (2) See paragraph (b) of the definition of Private Capital for 
restrictions on the amount of an Institutional Investor's commitment 
that will be recognized by SBA as a part of a Licensee's Private 
Capital. See also the definition of Regulatory Capital in Sec. 107.3, 
and Sec. 107.241(c).
* * * * *
    Leverageable Capital means Regulatory Capital, excluding unfunded 
commitments and qualified non-private funds whose source is Federal 
funds.
* * * * *
    Private Capital--(a) General. Private Capital means the combined 
private (non-governmental) paid-in capital and paid-in surplus of a 
Corporate Licensee, or the private (non-governmental) partnership 
capital of an Unincorporated Licensee, plus unfunded binding 
commitments by an Institutional Investor (including commitments 
evidenced by a promissory note) to purchase stock or limited 
partnership interests in, or to make capital contributions to a 
Licensee. The private paid-in capital and paid-in surplus of a 
Corporate Licensee, or the private partnership capital of an 
Unincorporated Licensee, may include funds invested by a public or 
private pension fund; and qualified nonprivate funds as described in 
paragraph (c) of this definition. Notwithstanding the foregoing, non-
cash assets purchased by a license applicant and non-cash assets 
contributed to a Licensee or a license applicant will not be considered 
part of Private Capital, except as permitted by Sec. 107.705(a) (1) 
through (6), or unless approved by SBA.
    (b) Exclusions. Private Capital shall not include:
    (1) Funds borrowed by a Licensee from any source,
    (2) Leverage funds obtained as a result of SBA's purchase or 
guarantee of securities,
    (3) Funds obtained directly or indirectly from any Federal, State, 
or local government, or agency or instrumentality thereof, unless such 
funds are qualified nonprivate funds, or
    (4) That part of a commitment from an Institutional Investor with a 
net worth of less than $10 million that exceeds 10 percent of such 
Institutional Investor's net worth, except to the extent that such 
excess is backed by a letter of credit from another Institutional 
Investor.
    (c) Qualified nonprivate funds. ``Qualified nonprivate funds'' 
means:
    (1) Funds directly or indirectly invested in any Licensee on or 
before August 16, 1982 by any Federal agency except SBA, pursuant to a 
statute explicitly mandating the inclusion of such funds in ``Private 
Capital'';
    (2) Funds directly or indirectly invested in any Licensee by any 
Federal agency pursuant to a statute that is enacted after September 4, 
1992, explicitly mandating the inclusion of such funds in ``Private 
Capital'';
    (3) Funds invested in any Licensee by any State or local government 
entity, including the amount of any guarantee extended by such entity; 
and
    (4) In any section 301(d) Licensee or such applicant, funds 
invested which are income derived from the investment of grants that 
have been made by a state or local government agency or instrumentality 
into a nonprofit corporation or institution exercising discretionary 
authority with respect to such funds; and funds invested by a State 
financing agency, or similar agency or instrumentality, to the extent 
such funds are derived from such agency's income and not from 
appropriated State or local funds; Provided, however, that for any 
Licensee or applicant, the funds described in paragraph (c)(3) of this 
definition shall not exceed 33% of Regulatory Capital.
* * * * *
    Qualified Borrowing means a loan to a Licensee bearing interest at 
a rate not in excess of the usual rate charged on the date of the loan 
by banks in the locality in which the Licensee's principal office is 
located; and/or a Debenture purchased or guaranteed by SBA. See 
Sec. 107.302.
* * * * *
    Regulatory Capital.--(a) General. Regulatory Capital means Private 
Capital, excluding non-cash assets contributed to a Licensee or a 
license applicant and non-cash assets purchased by a license applicant 
unless such assets have been converted to cash or have been approved by 
SBA for inclusion in Regulatory Capital. For purposes of this 
definition, sales of contributed non-cash assets with recourse or 
borrowing against such assets shall not constitute a conversion to 
cash.
    (b) Exclusions. The amount of a commitment, the collectibility of 
which SBA determines to be questionable, shall also be excluded from 
Regulatory Capital.
* * * * *
    Section 301(c) Licensee means an SBIC organized as a for-profit 
corporation, a limited liability company or a limited partnership 
organized in accordance with Sec. 107.4, and licensed pursuant to 
section 301(c) of the Act.
     Section 301(d) Licensee means an SBIC organized as a for-profit 
corporation, a non-profit corporation, a limited liability company or a 
limited partnership organized in accordance with section 107.4, and 
licensed pursuant to section 301(d) of the Act. Such Licensees are 
permitted to provide assistance only to Disadvantaged Concerns.
* * * * *
    Smaller Concern means a concern that together with its affiliates 
does not have net worth in excess of $6.0 million, and does not have 
average net income after Federal income taxes (excluding any carry-over 
losses) for the preceding two years in excess of $2.0 million; or a 
concern that together with its affiliates, meets the size standard in 
effect at the time of the Financing for the industry in which it is 
then primarily engaged, and excluding its affiliates meets the size 
standard in effect at the time of the Financing for the industry in 
which it is then primarily engaged.
* * * * *
    4. Section 107.4 is amended by revising paragraphs (b) (1), (2) and 
(3)(i), by revising the fourth sentence in paragraph (c), and by adding 
a new paragraph (f), to read as follows:


Sec. 107.4  Limited Partnership SBIC.

* * * * *
    (b) Application. * * *
    (1) Number of General Partners. A Licensee shall have as its 
general partners at least two individuals; or one or more corporations 
(including limited liability corporations), or one or more partnerships 
(including limited partnerships), or any combination of individuals, 
and/or corporations, and/or partnerships. General partners of a general 
partner of an Unincorporated Licensee shall be considered for all 
purposes to be general partners of such Licensee. For the status of 
limited partners of a limited partnership that serves as a general 
partner of a Licensee, see the definition of Control Person in 
Sec. 107.3.
    (2) General Partner. A general partner which is a corporation, 
limited liability company or limited partnership (an ``Entity General 
Partner'') shall be organized under state law solely for service as 
such and its Articles or Certificate of Incorporation or Limited 
Partnership Agreement or other similar governing instrument (which, in 
each case, shall accompany the license application) shall specify that 
no person shall serve as an officer, director or general partner 
without SBA's approval. No Entity General Partner may serve as such for 
any other Licensee and where an Entity General Partner is a limited 
partnership, such partnership shall be subject to the number of general 
partners defined in paragraph (b)(1) of this section. An Entity General 
Partner is subject to the same examination and reporting requirements 
as a Licensee under Sec. 310(b) of the Act. The restrictions and 
obligations imposed upon a Licensee by Secs. 107.210 through 107.263, 
and 107.601, 107.603, 107.701, 107.702, 107.703, 107.709, 107.801, 
107.802, 107.803, 107.1001, 107.1002, and 107.1004 apply also to an 
Entity general partner of a Licensee.
    (3) Articles of Partnership. * * *
    (i) The partnership shall have a minimum duration of not less than 
the longer of ten years or two years following the maturity of the 
last-maturing security issued by the partnership evidencing Leverage 
from SBA. After 10 years and provided all Leverage has been repaid or 
redeemed and provided that all amounts due SBA, its agency, or trustee 
have been paid, the partnership may be terminated by a vote of the 
Licensee's partners. (For purposes of this provision SBA shall not be 
considered a partner.)
* * * * *
    (c) Obligations of a Control Person. * * * The conditions specified 
in Secs. 107.210 through 107.263 shall apply to all general partners; 
the conditions specified in Sec. 107.210(e) shall apply to all Control 
Persons. * * *
* * * * *
    (f) Special Leverage requirement. Prior to the extension of any 
Leverage, an Unincorporated Licensee shall furnish SBA with evidence 
that it qualifies as a partnership for tax purposes, either by a ruling 
from the Internal Revenue Service, or by any opinion of counsel.
    5. Section 107.101 is amended by revising paragraph (a), by 
redesignating paragraphs (d) and (e) as paragraphs (e) and (f), by 
adding a new paragraph (d), by revising the introductory text of newly 
designated paragraph (e), and by adding new paragraphs (g), (h) and 
(i), to read as follows:


Sec. 107.101  Operational requirements.

* * * * *
    (a) Management. Each Licensee shall have and maintain qualified 
management (or an Investment Adviser/Manager pursuant to Sec. 107.709) 
in charge of its operations who will be available during normal 
business hours to the public. Any manager of a Licensee shall be deemed 
an officer thereof. When applying for a license or for Leverage, a 
Licensee must demonstrate, to the satisfaction of SBA, that its 
management has the knowledge, experience and capability necessary for 
investing in the types of businesses contemplated by the Act, these 
regulations, and Licensee's Plan of Operations. Neither management, nor 
any board of directors, nor any general partner shall be controlled 
either directly or indirectly by investors of qualified non-private 
funds.
 * * * * *
    (d) General capital requirements. Each company shall have at 
licensing, and thereafter shall maintain Regulatory Capital adequate to 
assure a reasonable prospect that the company will be operated soundly 
and profitably over the long term, and managed actively and prudently 
in accordance with its articles or partnership agreement and within the 
context of its Plan of Operations, as approved by SBA. In this regard, 
SBA shall determine the ability of the company to be economically 
viable, both prior to licensing and prior to approving any request for 
financing, taking into consideration the income and losses which the 
company anticipates on its Loans and Investments, and the experience 
and qualifications of the company's owner's and managers. Compliance 
with these requirements shall be determined within the context of 
capital impairment and other regulations that relate to safety and 
soundness.
    (e) Minimum Capital. Any company licensed after April 8, 1994 shall 
have Regulatory Capital in U.S. dollars sufficient to meet the 
requirements of paragraph (d) of this section, but in no case shall a 
Licensee have Regulatory Capital (not including commitments to invest 
in a Licensee) less than the following minimum levels:
 * * * * *
    (g) Valuation guidelines and responsibility. (1) Each Licensee 
shall adopt a written Valuation Policy for its use in determining the 
value of its Loans and Investments, and each applicant for a License 
shall submit such Policy as part of its application. Such Policy shall 
adhere to the provisions of Appendix III. The boards of directors of 
corporations and the general partners of partnerships shall have sole 
responsibility for adopting the Licensee's valuation policy and, 
pursuant thereto, for valuing Loans and Investments of such Licensee. 
Loans and Investments shall be valued individually and in the aggregate 
by the Board of Directors or General Partners at least semiannually--as 
of the end of the second quarter of Licensee's fiscal year and as of 
the end of Licensee's fiscal year, Provided however, That Licensees 
without Leverage need only perform valuations as of the end of the 
fiscal year. On a case-by-case basis, SBA may require valuations to be 
made more frequently.
    (2) Licensee shall forward valuation reports to SBA within 90 days 
of the end of the fiscal year in the case of annual valuations, and 
within thirty days following the close of other reporting periods. 
Material changes in valuations shall be reported not less often than 
quarterly within thirty days following the close of the quarter.
    (3) Only valuations performed as of the fiscal year-end are 
required to be reviewed by the Licensee's independent public 
accountant. Such accountant shall have responsibility to review the 
Licensee's valuation procedures and the implementation of such 
procedures, including adequacy of documentation. Such accountant also 
shall have reporting responsibilities regarding the results of this 
review (see Appendix I, section III and section V, paragraphs I and J).
    (4) Any Licensee that adopts the exact wording of those parts of 
section III of Appendix III, entitled ``Valuation Policy'', that are 
set in bold type, without any additions or changes will be presumed to 
have an acceptable Valuation Policy. A Licensee may write a policy 
which differs from the bold type, but must have such policy approved by 
SBA, in writing. Applicants for either a 301(c) or 301(d) license must 
submit their Valuation Policies for approval as part of the licensing 
application process.
    (h) Computer requirements. By June 30, 1994 all Licensees shall 
have a personal computer facility with modem capable of running 
software provided by SBA and person(s) trained in the use of SBA-
provided software and shall electronically transmit information and 
reports as required by SBA. Such Licensees shall use such software for 
the purpose of reporting specific financial information required by 
SBA.
    (i) Financing of Smaller Concerns. As of the close of the 
Licensee's first full fiscal year commencing on or after April 8, 1994, 
at least 10 percent of the cumulative dollar amount of Financing 
extended during the period between April 8, 1994 and the close of such 
fiscal year shall consist of Financings of Smaller Concerns. As of the 
close of each subsequent fiscal year, the cumulative dollar amount of 
Financing extended to Smaller Concerns shall be no less than 20 percent 
of the total dollar amount of Financing extended since April 8, 1994. 
Unless a Licensee is in compliance with the requirements of this 
paragraph, Financing may be extended only to a Smaller Concern. A 
Financing extended pursuant to Sec. 107.711 in which the resulting 
concern qualifies as a Smaller Concern will be considered a Financing 
of a Smaller Concern.
    6. Section 107.103 is revised to read as follows:


Sec. 107.103  Public notice.

    SBA shall publish notice of the license application in the Federal 
Register. It shall include such appropriate information as the name and 
location of the proposed Corporate Licensee, its area of operation, the 
names and addresses of its officers, directors, and owners of, or 
persons controlling 10 or more percent of its voting stock; and in the 
case of an Unincorporated Licensee, its name, location, and area of 
operation, and the names and addresses of its Control Persons. If any 
Control Person is a corporation, the notice shall set forth the names 
and addresses of any officers, directors, and owners of, or persons 
controlling 10 percent or more of the stock of such corporation. In the 
case of an Unincorporated Licensee, the notice shall also include the 
name and address of each owner of 10 percent or more of the Licensee's 
Regulatory Capital. The public shall be afforded reasonable opportunity 
for the submission of written comments. The proposed Licensee shall 
publish a similar notice in a newspaper of general circulation in the 
city or proposed area of operation, and shall furnish a certified copy 
to SBA within 10 days of the date of publication.
    7. Section 107.302 is revised to read as follows:


Sec. 107.302  Cost of money; loans and debt securities.

    Subject to lower ceilings prescribed by local law, Cost of Money on 
Loans and Debt Securities shall not exceed the higher of the following:
    (a) Loans. The higher of either the Licensee's certified Weighted 
Average Cost of Qualified Borrowings, computed in accordance with 
paragraph (e) of this section, or the current Debenture Rate, plus, in 
either case, 7 percentage points, rounded off to the next lower eighth 
of one percent; Provided, however; That if the current Debenture Rate 
is 8 percent per annum or lower, a Licensee is permitted to charge up 
to 15 percent.
    (b) Debt securities. The higher of either the Licensee's certified 
Weighted Average Cost of Qualified Borrowings, computed in accordance 
with paragraph (e) of this section, or the current Debenture Rate, 
plus, in either case, 6 percentage points, rounded off to the next 
lower eighth of one percent; Provided, however; That if the current 
Debenture Rate is 8 percent per annum or lower, a Licensee is permitted 
to charge up to 14 percent.
    (c) Maximum Cost of Money. The maximum Cost of Money on any 
specific Financing shall be determined with reference to either the 
Licensee's certified Weighted Average Cost of Qualified Borrowings or 
the Debenture Rate in effect as of the day the Licensee collects a 
processing fee or enters into a Commitment, or makes the first 
disbursement, whichever shall first occur.
    (d) Effective date. The Cost of Money limitation in effect on April 
24, 1994 shall remain applicable to all Financings committed or 
disbursed on or before that date.
    (e) Computation of Weighted Average Cost of Qualified Borrowings. 
Licensee's Weighted Average Cost of Qualified Borrowings (as a percent) 
shall be computed as follows:

TR08AP94.000

where:

W=Weighted Average Cost of Qualified Borrowings
A=Dollar amount of Interest on Qualified Borrowings still outstanding 
at the end of the prior fiscal year, as found on Form 468. (SSBICs are 
presumed to have paid interest at the coupon rate, without regard to 
any subsidy payments by SBA)
P=Outstanding principal amount of Qualified Borrowings at the end of 
the prior fiscal year, net of related fees
D=Days outstanding for prior fiscal year
i=Individual Note, Debenture, or other debt instrument
n=Number of Notes, Debentures, or other debt instruments outstanding at 
end of fiscal year
=sum of

This equation is read as: Multiply the principal balance (net of 
Leverage fees) of each Note, Debenture, or other debt instrument still 
outstanding at the end of the preceding fiscal year by the number of 
days that the instrument was outstanding in that fiscal year and divide 
this product by 365; take the sum of these amounts and divide that sum 
into total interest expense for those Qualified Borrowings still 
outstanding at the end of the fiscal year; finally multiply the 
resulting number by 100.
    (f) Notification of Weighted Average Cost of Qualified Borrowings. 
A Licensee that wishes to utilize its Weighted Average Cost of 
Qualified Borrowings as the basis of an alternative COM ceiling for its 
next succeeding fiscal year shall transmit a written certification of 
its Weighted Average Cost of Qualified Borrowings to SBA as a part of 
its Annual Financial Report (SBA Form 468) for the prior fiscal year; 
provided however, that where such licensee provides Financing using the 
Weighted Average Cost of Qualified Borrowings before submitting its 
Annual Financial Report, such Licensee shall submit its certified 
Weighted Average Cost of Qualified Borrowings as an attachment to the 
SBA Form 1031 for each such financing. Such Weighted Average Cost of 
Qualified Borrowings shall be reviewed by the Licensee's independent 
public accountant, who shall provide a certification that the Weighted 
Average Cost of Qualified Borrowings was calculated in accordance with 
SBA's regulations. Failure to submit timely a certified Weighted 
Average Cost of Qualified Borrowings in such manner shall constitute a 
binding waiver of Licensee's right to use its Weighted Average Cost of 
Qualified Borrowings as the basis for an alternative Cost of Money 
limitation for the remainder of the Licensee's fiscal year, unless for 
good cause shown, SBA grants written approval for its use.
    (g) Application of Weighted Average Cost of Qualified Borrowings to 
Financings Involving Multiple Licensees. (1) If two or more Licensees 
participate in the same Financing of a Small Concern, the basis for 
determining the applicable COM ceiling shall be the highest of any of 
the following:
    (i) The current Debenture Rate; or
    (ii) The certified Weighted Average Cost of Qualified Borrowings of 
the lead Licensee in the Financing; or
    (iii) The weighted average of the Weighted Average Cost of 
Qualified Borrowings of all Licensees participating in the Financing.
    (2) For the purposes of the calculation in paragraph (q)(1)(iii) of 
this section, the Weighted Average Cost of Qualified Borrowings of a 
Licensee that has not certified such cost to SBA or that has no 
outstanding Qualified Borrowings shall be the Debenture Rate in effect 
at the time of the Financing.
    (h) Default Penalties. In the event of a monetary default by a 
Small Concern or a failure to provide any post-Financing report or 
other document required by the terms of the Loan Agreement or SBA 
regulations, Licensees may, by way of default penalty and without 
regard to any Cost of Money limit that may otherwise be applicable, 
raise the interest rate by as much as seven percentage points over the 
rate specified in the Financing, until such time as the default shall 
be cured.
    8. Section 107.303 is amended by revising paragraph (a), by 
redesignating paragraph (b) as paragraph (c), by adding a new paragraph 
(b), and by revising the newly designated paragraph (c) introductory 
text, (c)(6) and the example that follows newly designated paragraph 
(c)(7), to read as follows:


Sec. 107.303  Overline limitation.

    (a) Leveraged Licensees. Without written SBA approval, the 
aggregate amount of funds disbursed for securities acquired (exclusive 
of write-down), and of Commitments and guaranties issued for a Small 
Concern (including affiliated concerns as defined in Sec. 121.401 of 
this chapter) shall not exceed twenty percent of a Licensee's 
Regulatory Capital: Provided, however, That for section 301(d) 
Licensees the limitation shall be thirty percent.
    (b) Non-Leveraged Licensees. Any Licensee that does not have 
outstanding Leverage shall be exempt from this section; Provided, 
however, that no Leverage will be extended to any Licensee until such 
Licensee is in compliance with paragraph (a) of this section.
    (c) Increased Limit. For purposes of this section only, Regulatory 
Capital may include the net unrealized gains of a Licensee represented 
by marketable securities and support an additional overline limitation 
(increased limit) subject to the following conditions:
* * * * *
    (6) By availing itself of this increased limit, Licensee agrees 
that, in the event the net unrealized gains show a reduction on the 
first business day of any calendar quarter and for at least thirty days 
thereafter, below seventy percent of the net unrealized gains, Licensee 
will (not later than ninety (90) days from such date) cause to be 
injected sufficient Regulatory Capital to restore support for the 
increased limit or reduce the increased limit of its investments to a 
point at which no investment exceeds 20 percent of the sum of its 
Regulatory Capital plus the remaining net unrealized appreciation 
represented by marketable securities.
* * * * *
    Example: On January 15, 1995 the Licensee documents net 
unrealized gains of $100,000. Licensee adds $100,000 to its 
Regulatory Capital and increases its overline limitation 
accordingly. Licensee now makes one or more investments in reliance 
on this increased limit. Hereafter, on each subsequent first 
business day of April, July, October, and January, Licensee must 
document net unrealized gains of a least $100,000. On April 15, 1996 
Licensee can document further net unrealized gains for an aggregate 
of $150,000 and invest pursuant to an increased limit of $30,000 
(20% of $150,000). Following the first business day of April, 1997, 
Licensee documents net unrealized gains of only $120,000. All 
investments within the increased limit remain undiminished in the 
portfolio. Licensee is now required to cause to be injected 
sufficient cash into Regulatory Capital before July 1, 1997, so that 
the sum of the remaining net unrealized gains and the added cash 
equals at least five times the increased limit of its largest 
investment. In the alternative, Licensee must reduce before July 1, 
1997, its overline investments made in reliance on this subsection 
so that none will exceed 20 percent of Regulatory Capital plus 
$24,000. Any further reduction of net unrealized gains will require 
additional proportionate injection of cash or reduction of 
investments.
* * * * *
    9. Section 107.304 is amended by revising the heading and 
paragraphs (a)(1) and (b) and by adding paragraph (c) to read as 
follows:


Sec. 107.304  Size status, financial report, and non-discrimination.

    (a) * * *
    (1) The Licensee has determined that the concern being assisted is 
a Small Concern based on the financial size standards set forth in 
Sec. 121.802(a)(3)(i) or the single industry standard covering the 
industry in which the applicant Small Concern is, or will be, primarily 
engaged as set forth in Sec. 121.802(a)(3)(ii); or SBA has determined 
at the request of the Licensee or of such concern that the latter is a 
Small Concern. The Licensee and the Small Concern shall execute SBA 
Form 480, Size Status Declaration, including Licensee's representation 
that applicable size standards have been met, unless the size 
determination has been made by SBA.
* * * * *
    (b) Financial reports.--(1) Initial Financing decision. In 
considering any Financing for a Small Concern the Licensee shall 
require the concern to submit such financial statements, plans of 
operation (including intended use of financing proceeds), cash flow 
analyses and projections as are necessary to support the Licensee's 
investment decisions, considering the size and type of the business and 
the amount of the Financing being considered. Such materials shall be 
in English and shall be retained by, and become a part of the permanent 
record of, the Licensee.
    (2) Subsequent reports. The terms of the Financing shall require 
each assisted Small Concern to forward to the Licensee, at least 
annually, such financial statements (including verification of the use 
of financing proceeds) as are necessary to verify not only the 
financial condition of the Small Concern for the purpose of valuing the 
Licensee's investment therein, but also the continued eligibility of 
such Small Concern. Such statements shall be in English and be 
certified by the chief financial officer, general partner, or 
proprietor of such Small Concern and shall be retained by, and become a 
part of the permanent records of, the Licensee. If the Licensee shall 
deem it appropriate, considering the size and type of the business 
involved, the Licensee may accept, for financial and valuation purposes 
only, a complete copy of the Federal income tax return, including all 
appropriate schedules thereto, filed by the business or by the 
proprietor, as the case may be. The foregoing requirements shall not 
apply, however, when the Licensee acquires the securities from an 
underwriter in a public offering (see 107.404), in which event the 
Licensee shall keep copies of all reports furnished by such Small 
Concern to the holders of its securities.
    (c) Economic impact. When a Licensee's Form 468 is forwarded to SBA 
it shall be accompanied by an assessment of the economic impact of each 
Financing, specifying the full-time equivalent jobs created or 
retained, the impact of the financing on the business in terms of 
expanded revenue and taxes, and other appropriate economic benefits 
including, but not limited to, technology development or 
commercialization, minority business development, urban or rural 
business development, expansion of exports and assistance to 
manufacturing firms (SIC Major Groups 20-39)

    .10. Part 107 is amended by adding a new Sec. 107.305 before the 
heading ``Equity Capital'' to read as follows:


Sec. 107.305  Use of proceeds.

    Proceeds of financings by a Licensee shall be used by the Small 
Concern for its sound financing and for its growth, modernization, or 
expansion and such use shall be reported on SBA Form 1031. Accordingly, 
Licensees shall obtain sufficient information to give reasonable 
assurance that the proposed financing will be used for purposes 
intended by the Act and this Part of the regulations. Financing 
documents shall contain provisions which require the Small Concern to 
provide information specified in Sec. 107.304(b), and which give the 
Licensee and/or SBA access to the Small Concern's records to confirm 
such use of proceeds. The Licensee shall conduct a reasonable post 
closing review within 90 days after disbursement of the proceeds to 
assure that proceeds were used for the intended purposes. The financing 
documents shall also provide that any diversion by a Small Concern of 
financing proceeds from their reported use without the Licensee's prior 
written consent shall constitute an event of default when the Licensee 
has made a loan or a violation of a covenant with the Licensee when the 
Licensee has made an investment. The financing documents also shall 
specify that such event of default or covenant violation shall give the 
Licensee the right to demand immediate repayment of the financing. 
Nothing in this paragraph shall be construed to restrict the Licensee's 
right to sue the Small Concern for any additional damages it may 
sustain as a result of the improper diversion of funds or to bring suit 
against the individuals responsible for such diversion of funds. Any 
unauthorized diversion that comes to the attention of a Licensee shall 
be reported promptly to SBA for such action against the Small Concern 
as SBA may consider proper. See also Sec. 107.906(b).

    11. Section 107.401(a)(5) is revised to read as follows:


Sec. 107.401  SBIC guaranty of loans.

    (a) * * *
    (5) The total guaranties issued and outstanding for all Small 
Concerns shall not exceed one hundred percent of Regulatory Capital.
* * * * *
    12. Section 107.402 is amended by revising paragraphs (a) and (d) 
and adding paragraphs (e), (f), and (g) to read as follows:


Sec. 107.402  Commitments.

    (a) General. A Licensee is authorized to enter into a written 
Commitment to furnish Financing to a Small Concern.
* * * * *
    (d) Processing fees. A Licensee is authorized to charge a 
processing fee, in no event to exceed three percent of the amount of 
Financing requested: Provided, however, That if the amount of Financing 
offered in response by the Licensee and agreed to by the Small Concern 
is a lesser amount, the maximum processing fee may not exceed three 
percent of such lesser amount. A processing fee that does not exceed 
the foregoing limits shall not be considered part of the Small 
Concern's Cost of Money. A processing fee that exceeds the foregoing 
limits shall, to the extent of such excess, be considered part of the 
Small Concern's Cost of Money.
    (1) Collection of processing fee. (i) The processing fee may be 
collected, in full or in part, when the Licensee accepts the Small 
Concern's application for financing, or such fee may be deducted from 
Financing proceeds. When the application is accepted for processing, 
however, the Licensee shall furnish the applicant Small Concern with a 
written statement setting forth:
    (A) The maximum Cost of Money determined with reference to 
Licensee's certified Weighted Average Cost of Qualified Borrowings, if 
any, or the present Debenture Rate, as appropriate;
    (B) A date by which Licensee will notify the applicant of its 
decision; and
    (C) The specific processing services to be performed by the 
Licensee.
    (ii) Failure to furnish such statement shall cause the amount of 
any processing fee to be included in Cost of Money if the requested 
Financing closes, or shall obligate Licensee to refund the entire 
amount of the processing fee if the request for Financing is denied.
    (2) Partial refund of processing fee when Financing does not close.
    (i) No Commitment extended. If the Licensee has not provided a 
Commitment and the Small Concern and the Licensee do not close the 
Financing, that part of the processing fee in excess of Eligible Costs, 
hereafter enumerated, that were incurred by the Licensee shall be 
refunded within thirty days to the Small Concern, together with a 
detailed accounting of the Eligible Costs incurred by the Licensee.
    (ii) Commitment extended. If the Licensee has provided a Commitment 
and the Small Concern and the Licensee do not close the Financing, any 
refund of the processing fee, in whole or in part, is dependent upon 
which party caused the Financing not to close, as follows:
    (A) Failure to close attributable to Small Concern. If the 
Financing does not close due to actions of the Small Concern, the 
Licensee is entitled to retain the processing fee, not to exceed three 
percent of the amount of the Licensee's Commitment. If Eligible Costs 
exceed the processing fee, Licensee may obtain reimbursement for such 
excess Eligible Costs only if the Small Concern has entered into a 
contractual agreement providing for such reimbursement. If no such 
contractual agreement exists, a Small Concern shall not be required to 
pay an additional processing fee, even if the amount of the Licensee's 
Eligible Costs exceed the amount of the processing fee advanced by the 
Small Concern.
    (B) Failure to close attributable to Licensee. If the failure to 
close is attributable to actions of the Licensee, that part of the 
processing fee in excess of Eligible Costs incurred by the Licensee 
shall be refunded to the Small Concern within thirty days, together 
with a detailed accounting of the Eligible Costs incurred by the 
Licensee.
    (3) Eligible costs. As used in this Section, Eligible Costs means: 
(i) Actual computed costs incurred in the segregation of money to fund 
a Commitment, if one was extended;
    (ii) Ordinary and reasonable out-of-pocket expenses necessary to 
process the application and perform due diligence, and
    (iii) Actual costs paid to non-Associates of the Licensee for 
specialized application processing services which are not ordinarily 
performed by the Licensee.
    (e) Additional fees. If the Small Concern and the Licensee close 
the Financing, Licensee is authorized to deduct from the proceeds the 
unpaid remainder of any processing fee previously agreed upon, not to 
exceed 3 percent of the total Financing provided at the closing, and, 
in addition, to charge the Small Concern for Eligible Costs incurred by 
the Licensee and reasonable closing costs. Such fees and charges shall 
not be included in the calculation of Cost of Money.
    (f) Prepayment penalties. A Licensee may charge a reasonable 
penalty for prepayment of a Financing which shall be excluded from the 
Cost of Money calculation. If such prepayment penalty is considered by 
SBA to be unreasonable, however, Licensee shall not be entitled to such 
prepayment penalty, and if the penalty has been collected, shall refund 
the entire prepayment penalty to the Small Concern. A prepayment 
penalty equal to 5 percent of the outstanding balance during the first 
year of any Financing, declining by one percentage point per year 
through the fifth year, will be considered a reasonable penalty.
    (g) Front-end charges. If a Licensee has imposed front end charges 
such as points, discount, loan origination fee, a processing fee to the 
extent it exceeds three percent, or other such charges, regardless of 
the label the Licensee may apply, that are not specifically excluded 
from Cost of Money, such charges shall be prorated over the stated term 
of the Financing. In that case, the sum of interest and unearned front-
end charges shall not exceed the Cost of Money limit in effect at the 
time of the Financing; and in the event of prepayment, any resulting 
excess Cost of Money shall be returned to the Small Concern.

    13. Section 107.403 is amended by revising paragraph (b)(1), to 
read as follows:


Sec. 107.403   Other Permissible Financing.

* * * * *
    (b) * * *
    (1) Short-term Financing. Financing with a term of less than five 
years when it constitutes:
    (i) Interim financing in contemplation of long-term Financing of a 
Small Concern by the Licensee or a group including the Licensee and 
others in an amount at least equal to such total interim financing: 
Provided, however, That the maximum aggregate period for short-term 
Financing in contemplation of long-term Financing shall not exceed one 
year; or
    (ii) Protection of prior investments; or
    (iii) Financing ownership change pursuant to Sec. 107.711; or
    (iv) Financing required by a Small Concern to perform a contract 
that it has been awarded under any Federal, State, or local government 
set-aside program for ``minority'' or ``disadvantaged'' contractors.

This paragraph (b)(1) supplements the authority to make short term 
investments in Disadvantaged Concerns under Sec. 107.301(a).
* * * * *
    15. Section 107.501(c) is amended by revising the last sentence 
thereof, to read as follows:


Sec. 107.501  Management services.

* * * * *
    (c) Management Services Corporation. * * * Licensee's investments 
in and receivables from such corporation shall not exceed 3 percent of 
the Licensee's Regulatory Capital.
    15. Section 107.601 is amended by revising the first sentence of 
paragraph (g) and by revising paragraph (h)(1), to read as follows:


Sec. 107.601  Changes in ownership or control of Licensee.

* * * * *
    (g) Public notice. SBA shall publish notice in the Federal Register 
concerning the application for approval of a proposed transfer of 
Control over a Licensee, including such appropriate information as the 
name and location of the Licensee and of the proposed transferees who 
will own ten or more percent of any class of its Regulatory Capital. * 
* *
    (h) Standards governing SBA approval. (1) SBA may, as a condition 
of approving a proposed transfer of Control, require an increase in 
Licensee's Regulatory Capital.
* * * * *
    16. Section 107.705 is amended by adding a new paragraph (a)(8) to 
read as follows:


Sec. 107.705  Consideration for issuance of Licensee securities.

    (a) * * *
    (8) With SBA's prior written approval, contributed non-cash assets: 
Provided, however, That for the purposes of Secs. 107.403(b), 
107.706(b), and 107.710, under which the legality of certain Financings 
is conditional upon a need to protect the Licensee's investment, and 
for the purpose of Sec. 107.801, under which assumption of control over 
a Small Concern is permitted only to protect the Licensee's investment, 
Licensees are not considered to have any investment to protect in such 
contributed assets unless such assets are included in Regulatory 
Capital.
* * * * *
    17. Section 107.706 is revised to read as follows:


Sec. 107.706  Retention of investments.

    (a) Change in size. A Licensee may retain its investment in a 
concern which qualified as small at the time of initial financing, but 
which subsequently became large. Subject to Sec. 107.303, additional 
Financing may be provided at any time before such concern makes a 
public offering of its securities. In addition, stock options, 
warrants, or other rights to purchase Equity Securities of such 
concern, if acquired while the concern qualified as a Small Concern, 
may be exercised even after a public offering has been made.
    (b) Change in business activity or ownership--(1) Change within one 
year of Licensee Financing. Without SBA's written approval, a Licensee 
may not retain its investment in a Portfolio Concern, small or 
otherwise, that has become ineligible by reason of a subsequent change 
in such concern's business activity within one year from the date of 
the Licensee's initial Financing. Any such change shall be presumed to 
have been within the contemplation of the Small Concern at the time of 
the Licensee's Financing, and shall constitute a default or breach of 
the terms of the Licensee's Financing by the Small Concern, thereby 
giving the Licensee the right to demand immediate repayment of all 
indebtedness and redemption of all equity investments in such concern. 
See Sec. 107.305. A Licensee's request to SBA for approval to retain 
its investment shall be accompanied by evidence sufficient to rebut 
this presumption that the Small Concern's change to an ineligible 
business activity within one year of the Licensee's Financing was 
within the contemplation of the Small Concern at the time the Licensee 
provided Financing and, hence, in violation of applicable regulations. 
Such presumption may be rebutted by a showing that the change in 
business activity was prompted by an unforeseen change in 
circumstances.
    (2) Change more than one year after Financing; additional 
Financing. If SBA has granted approval for the retention of an 
investment as provided in paragraph (b)(1) of this section, or if the 
change to an ineligible business has taken place more than one year 
after the Licensee's initial Financing, additional Financing may be 
provided to the extent necessary to protect the Licensee against the 
loss of the amount of its original investment.
    18. Section 107.707 is revised to read as follows:


Sec. 107.707  Purchases of securities from another Licensee or from 
SBA.

    A Licensee may exchange with or purchase for cash from another 
Licensee, or from SBA as the receiver or assignee of another Licensee 
or former Licensee, Portfolio securities (or any interest therein), but 
only on a non-recourse basis, and only if:
    (a) The Licensee shall not have at any time more than one-third of 
its total assets (valued at cost) invested in such securities; and
    (b) The Licensee, if it has previously sold Portfolio securities 
(or any interest therein) on a recourse basis, shall include the amount 
for which it may be contingently liable in its overline limit under 
Sec. 107.303.

    19. Section 107.708 is revised to read as follows:


Sec. 107.708  Deposits and investments of idle funds.

    (a) General. Except as set forth in paragraphs (b) and (c) of this 
section, all funds of a Licensee (other than a petty cash fund of up to 
$2,000) shall be deposited without delay in an account in a federally 
insured financial institution.
    (b) Leveraged Licensees. (1) Funds of a Licensee with outstanding 
Leverage, or that has applied for Leverage, that are not invested in 
Small Concerns and not reasonably needed for its day-to-day operations 
shall be invested in:
    (i) Direct obligations of, or obligations guaranteed as to 
principal and interest by the United States, the remaining maturities 
of which do not exceed fifteen months; or
    (ii) In repurchase agreements with federally insured institutions, 
the maturity of which does not exceed seven days, in which the 
securities being sold and repurchased shall only be direct obligations 
of, or obligations guaranteed as to principal and interest by the 
United States, such securities to be maintained in a custodial account 
at a federally insured institution; or
    (iii) In certificates of deposit maturing within one year or less 
issued by a federally insured institution, up to the amount of 
insurance; or
    (iv) In a deposit account in a federally insured institution, up to 
the amount of the insurance, subject to a withdrawal restriction not to 
exceed one year;
    (2) Provided, however, That funds in excess of the insured amount 
may be maintained in certificates of deposit or a deposit account in a 
federally insured institution which is deemed to be ``well 
capitalized'' in accordance with the definition set forth in 
regulations of the Federal Deposit Insurance Corporation, as amended 
(12 CFR 325.103); and Provided, further, That nothing in this paragraph 
shall be interpreted to forbid the temporary deposit, not to exceed 30 
days, of Licensee's funds in excess of the insured amount in a 
federally insured institution in a transfer account established to 
facilitate the receipt and disbursement of funds or to hold funds 
necessary to honor Commitments issued by the Licensee. For the purposes 
of this paragraph (b) a deposit in, or repurchase agreement with, a 
federally insured institution that is an Associate of the Licensee 
shall not be considered a Financing of such Associate if the terms of 
such deposit or repurchase agreement are the same, or more favorable, 
than those available to the general public.
    (c) Non-Leveraged Licensees. Funds of an unleveraged Licensee that 
are not invested in Small Concerns and not reasonably needed for its 
day-to-day operations and exempt from the provisions of paragraph (b) 
of this section, but nothing contained in this paragraph shall be 
deemed to authorize any Licensee to Finance an Associate in violation 
of Sec. 107.903, or to engage in any other activity prohibited by this 
part. No Leverage will be extended to any Licensee until such Licensee 
is in compliance with paragraph (b) of this section. For purpose of 
this paragraph, a Licensee's deposit of funds in a federally insured 
institution that is an Associate of the Licensee is not considered a 
Financing of an Associate under Sec. 107.903.

    20. Section 107.710 is amended by revising paragraph (b)(3), to 
read as follows:


Sec. 107.710  Assets in liquidation.

* * * * *
    (b) Preservation of assets. * * *
    (3) In addition to the amounts authorized by paragraphs (a) and (b) 
of this section, a Licensee may make the following required 
expenditures allocable to such assets in an aggregate amount which, 
together with its total investment attributable thereto, and its 
expenditures pursuant to paragraphs (a) and (b) of this section do not 
exceed 35 percent of its Regulatory Capital, except as specifically 
approved in writing by SBA: Prior mortgage interest; principal 
payments; taxes and necessary insurance coverage.
* * * * *
    21. Section 107.711 is revised to read as follows:


Sec. 107.711  Financing changes of ownership.

    (a) General. A Licensee may finance a change of ownership in a 
Small Concern when it will promote the sound development or preserve 
the existence of the Small Concern; or will assist in creation of a 
Small Concern as a result of a corporate divestiture, or facilitate 
ownership in a Disadvantaged Concern.
    (b) Special size standard; debt/equity ratios. In determining 
whether the existence of a Small Concern has been preserved, or whether 
a Small Concern has been created as a result of a divestiture, the 
Licensee must make an assessment of the concern as though the change of 
control had been accomplished, giving effect to all contemplated 
financings, mergers, and acquisitions.
    (1) Concerns with not more than 500 employees. Such Financings 
shall be permitted where the resulting concern has been determined to 
be small (see Sec. 107.304(a)(1)) and its full-time equivalent 
employment does not exceed 500 employees.
    (2) Concerns with more than 500 employees. If the full-time 
equivalent employment exceeds 500 employees, the Financing will only be 
permitted when the concern meets one of the following debt/equity ratio 
tests:
    (i) If the Financing is provided by a Licensee with outstanding 
Leverage, the Concern's ratio of debt to equity is no more than 5 to 1;
    (ii) If the Financing is provided by a Licensee with no outstanding 
Leverage, the Concern's ratio of debt to equity is no more than 8 to 1.
    (iii) As used herein, ``debt'' means long-term debt, including 
contingent liabilities, but exclusive of accounts payable, short-term 
working capital loans which require that the Concern have no 
outstanding balance for at least 30 consecutive days during its fiscal 
year, operating leases, letters of credit and subordinated notes 
payable to the seller, and any other liabilities approved by SBA on a 
case-by-case basis; and ``equity'' means common and preferred stock in 
the case of a corporation, or contributed capital in the case of a 
partnership.

    22. Section 107.712 is amended by revising the first sentence of 
paragraph (c) to read as follows:


Sec. 107.712  Section 301(d) Licensee wholly or partly owned by 
Licensee companies.

* * * * *
    (c) Capital contribution. The capital contribution of a participant 
Licensee in excess of the minimum capital ($1,500,000, which shall be 
in cash or cash equivalents, in U.S. dollars) of the section 301(d) 
Licensee, may (notwithstanding Sec. 107.705(a)) be represented by 
securities of Small Concerns eligible for investment by a section 
301(d) Licensee, at cost or value, whichever is lower. * * *
* * * * *
    23. Section 107.901(a) is amended by revising the last sentence 
thereof to read as follows:


Sec. 107.901  Prohibited uses of funds.

    No funds may be provided to a Small Concern:
    (a) Relending, reinvesting, etc. * * * Without SBA's prior written 
approval, all Financings pursuant to this proviso shall not exceed the 
Licensee's Regulatory Capital as of the close of any full fiscal 
year.\8\
---------------------------------------------------------------------------

    \8\1940 Act Companies are reminded that sections 12(d) (2) and 
(3) of that Act impose additional restrictions on certain 
investments otherwise permitted by this Sec. 107.901(a).
---------------------------------------------------------------------------

* * * * *
    24. Part 107 is amended by adding, at the end thereof, a new 
Appendix III, to read as follows:

Appendix III to Part 107--Valuation Guidelines for SBICs

I. Introduction

    This appendix describes the policies and procedures to which 
Licensees (SBICs and SSBICs) must conform in valuing their Loans and 
Investments and provides guidance as to the techniques and standards 
which are generally applicable to such valuations.
    The need for clearly defined valuation policies and procedures 
and understandable techniques arises in connection with the 
requirement that Licensees report the worth of their portfolios to 
investors and SBA. This information assists SBA in its assessment of 
the overall operational performance and financial condition of 
individual Licensees and of the industry.

II. Overall Guidelines

A. Definitions

    1. Asset Value means the amount that the general partners or 
board of directors of an SBIC have established as a current value in 
accordance with its Valuation Policy.
    2. Marketable Securities means securities for which market 
quotations are readily available and the market is not ``thin'', 
either in absolute terms, or relative to the potentially saleable 
holdings of the Licensee and other investors with saleable blocks of 
such securities. These securities are valued as follows:
    (a) For over-the-counter stocks, taking the average of the bid 
price at the close for the valuation date and the preceding two 
days, and
    (b) For listed stocks, taking the average of the close for the 
valuation date and the preceding two days. This classification does 
not include securities which are subject to resale restrictions, 
either under securities laws or contractual agreements, although 
other securities of the same class may be freely marketable.
    3. Other Securities means all Loans and Investments not defined 
in paragraph A.(2) of this section. Such securities shall be valued 
at Asset Value. Most SBIC and SSBIC investments will fall in this 
classification.
    4. Valuation Policy means the official document of a Licensee 
that definitively sets forth the Licensee's methods of valuing Loans 
and Investments in accordance with the requirements of Sec. 101(g) 
and this appendix.

B. Objective

    The goal of a Licensee's valuation process is to value its Loans 
and Investments. However, the very nature of Licensees' investments 
sometimes makes the determination of fair market value 
problematical. In most cases there is no market for the investment 
at the time of valuation. Therefore, except where market quotations 
are readily available and the markets are not ``thin'', the Boards 
of Directors or General Partners are necessarily responsible for 
determining in good faith the value of Loans and Investments.
    Determination of value will depend upon the circumstances in 
each case. No exact formula can be devised that will be generally 
applicable to the multitude of different valuation issues that will 
arise. This is especially true for semiannual valuation updates of 
relatively new investments for which current results either exceed 
or do not meet the Small Concern's forecasts. A sound valuation 
should be based upon all of the relevant facts, with common sense 
and informed judgment influencing the process of weighing those 
facts and determining their significance in the aggregate.

C. General Considerations

    The Asset Value of Loans and Investments will depend upon the 
circumstances of each individual case and will be based upon the 
nature of the asset and the stage of a company's existence.
    In negotiating the terms and conditions of an investment with a 
Small Concern, the Licensee, in effect, establishes an initial 
valuation for the investment, which is cost. Cost shall be the Asset 
Value until there is a basis to increase or decrease the valuation.
    Unrealized appreciation should be recognized when warranted, but 
should be limited to those investments that have a sustained 
economic basis for an increase in value. Temporary market 
fluctuations or a temporary increase in earnings should not be the 
cause or sole reason for appreciation.
    Unrealized depreciation should be recorded when portfolio 
companies show sustained unfavorable financial performance. 
Continuous close scrutiny of Loans and Investments will provide 
insight into the business cycles and problems encountered by small 
business concerns. This insight will allow the Licensee to 
differentiate between a temporary downturn or setback and a long-
term problem indicating a measurable decline in Asset Value.
    When a decline in Asset Value appears permanent, a complete or 
partial write-off of the asset (i.e., recording a realized loss 
rather than unrealized depreciation) should occur. Some of the more 
obvious indications of permanent impairment of an investment include 
the termination of business operations, a petition for bankruptcy 
protection or liquidation, or the absence of a verifiable forwarding 
address of the business or its proprietor(s). Less obvious 
situations may include the loss of major revenue accounts, the shut 
down of a critical distribution channel, an adverse legal or 
regulatory ruling, or the expiration of a priority claim on 
collateral in a distressed Small Concern. These and other possible 
circumstances should be assessed on a case-by-case basis, with 
supporting documentation on file.

D. Valuation Responsibility

    As specified in 13 CFR 107.101(g), the Licensee's Board of 
Directors or General Partners have the sole responsibility for 
determining Asset Value. In determining Asset Value, the Board of 
Directors or General Partners must satisfy themselves that all 
appropriate factors relevant to a good faith valuation have been 
considered and that the methods used are reasonable and prudent and 
are consistently applied. Although the Board of Directors or General 
Partners have the ultimate responsibility for determining Asset 
Value, they may appoint management or other persons to assist them 
in such determinations and to provide supporting data and make the 
necessary calculations pursuant to the Board's or General Partner's 
direction. It is essential that a careful, conservative, yet 
realistic approach be taken by Licensees in determining the Asset 
Value of each Loan and Investment.
    As part of the annual audit of the Licensee's financial 
statements, the Licensee's independent public accountant has 
responsibility to review the Licensee's valuation procedures and 
implementation of such procedures including adequacy of 
documentation. The independent public accountant also has reporting 
responsibility regarding the results of this review. (See appendix I 
to this part, section III and section V, paragraphs I and J).

E. Frequency of Valuation

    Loans and Investments shall be valued individually and in the 
aggregate by the Board of Directors or General Partners at least 
semiannually--as of the end of the second quarter of Licensee's 
fiscal year and as of the end of Licensee's fiscal year, Provided 
however, That Licensees without Leverage need only perform 
valuations once a year. On a case-by-case basis, SBA may require 
valuations to be made more frequently. Only valuations performed as 
of the fiscal year-end are required to be reviewed by the Licensee's 
independent public accountant, as discussed in paragraph D. of this 
section. Each Licensee shall forward a valuation report to SBA 
within 90 days of the end of its fiscal year in the case of annual 
valuations, and within thirty days following the close of other 
reporting periods. Material changes in valuations shall be reported 
not less often than quarterly within thirty days following the close 
of the quarter. Since the valuations will only be as sound as the 
timeliness of the financial information upon which they are based, 
Licensees shall require frequent financial statements from Small 
Concerns. Monthly financial statements are normally appropriate.

F. Written Valuation Policy

    Each Licensee shall establish a written Valuation Policy 
approved by its Board of Directors or General Partners that includes 
a statement of policies and procedures that are consistent with 
section III of this appendix.

G. Documentation

    Each Licensee shall prepare and retain in its permanent files a 
valuation report as of each valuation date documenting, for each 
portfolio security, the cost, the current Fair Value and the 
previous Fair Value, plus the methodology and supporting data used 
to determine the value of each such portfolio security. The minutes 
of meetings of Boards of Directors or General Partners at which 
valuations are determined will contain a resolution confirming that 
the valuations of each portfolio security were determined in 
accordance with Licensee's duly adopted valuation procedures and 
will incorporate by reference the valuation report signed by each 
Director or General Partner along with any dissenting valuation 
opinions.

H. Instructions

    In section III below, certain sentences are in bold type and 
others are in regular type. Those sentences that are in bold type 
generally should be included in the Valuation Policy of each 
Licensee. However, this exact wording is not mandatory and may be 
modified, substituted, added to, or omitted. Sentences in regular 
type are commentary provided by SBA that need not be included in a 
Licensee's Valuation Policy, but may be adapted, if desired.

I. Approval

    1. Any Licensee that utilizes the exact wording of Section III 
that is set in bold type, without any additions, deletions, or 
changes will be presumed to have an acceptable Valuation Policy. 
However, it is acknowledged that this wording may not be directly 
applicable to all Licensees, and if a Valuation Policy by an 
existing Licensee is written which differs from the bold type, 
approval by SBA, in writing, of the Valuation Policy must be 
obtained. If changes from the bold type are minor, it is suggested 
that the Licensee indicate deletions with a caret (caret) and 
underline additions.
    2. Applicants for either a 301(c) or 301(d) License must submit 
their Valuation Policies for approval as part of the licensing 
application process.

III. Valuation Policy

A. General

    1. The Board of Directors [General Partners] have sole 
responsibility for determining the Asset Value of each of the Loans 
and Investments and of the portfolio in the aggregate.
    2. Loans and Investments shall be valued individually and in the 
aggregate at least semi-annually--as of the end of the second 
quarter of the fiscal year-end and as of the end of the fiscal year. 
[* * * at least annually--as of the end of the fiscal year.] Fiscal 
year-end valuations are audited as set forth in 13 CFR part 107 
appendix III, section II, paragraph D.
    3. This Valuation Policy is intended to provide a consistent, 
conservative basis for establishing the Asset Value of the 
portfolio. The Policy presumes that Loans and Investments are 
acquired with the intent that they are to be held until maturity or 
disposed of in the ordinary course of business.

B. Interest-Bearing Securities

    1. Loans shall be valued in an amount not greater than cost with 
Unrealized Depreciation being recognized when value is impaired. The 
valuation of loans and associated interest receivables on interest-
bearing securities should reflect the portfolio concern's current 
and projected financial condition and operating results, its payment 
history and its ability to generate sufficient cash flow to make 
payments when due.
    2. When a valuation relies more heavily on asset versus earnings 
approaches, additional criteria should include the seniority of the 
debt, the nature of any pledged collateral, the extent to which the 
security interest is perfected, the net liquidation value of 
tangible business assets, and the personal integrity and overall 
financial standing of the owners of the business. In those instances 
where a loan valuation is based on an analysis of certain 
collateralized assets of a business or assets outside the business, 
the valuation should, at a minimum, consider the net liquidation 
value of the collateral after reasonable selling expenses. Under no 
circumstances, however, shall a valuation based on the underlying 
collateral, be considered as justification for any type of loan 
appreciation.
    3. Appropriate unrealized depreciation on past due interest 
which is converted into a security (or added to an existing 
security) should be recognized when collection is doubtful. 
Collection is presumed to be in doubt when one or both of the 
following conditions occur:
    (i) Interest payments are more than 120 days past due; or
    (ii) The small concern is in bankruptcy, insolvent, or there is 
substantial doubt about its ability to continue as a going concern.
    a. Licensees may rebut this presumption by providing evidence of 
collectibility satisfactory to SBA. Such evidence may include the 
existence of collateral, the value of which has been verified 
through an appraisal by an independent professional appraiser 
acceptable to SBA. Such an appraisal shall be at liquidation value 
(net of liquidation costs) and shall have been performed within the 
12 months immediately preceding the valuation date. In considering 
whether collateral provides an appropriate basis for valuations, SBA 
will review the Licensee's operating history for evidence concerning 
its willingness and ability to pursue available remedies (including 
foreclosure) in default situations.
    b. For those Licensees primarily involved in making loans, the 
use of a loan classification system is strongly encouraged to help 
manage portfolios and determine Asset Values, with loans that 
warrant extra attention being flagged by SBIC management. Such a 
``watch list'' can also be used to report to the Board of Directors 
or General Partner(s). For each loan placed on the watch list, a 
reason or statement should describe the particular situation. Danger 
signals that should alert the SBIC to potential problems include 
delinquency, a lack of profitability, weak or decreasing equity, 
increasing debt load, a deteriorating cash position, an abnormal 
increase in accounts payable, inaccurate financial information, 
insurance cancellation, judgments and tax liens, family problems, 
loss of employees, collateral problems, slowdown in inventory 
turnover, poor maintenance of plant and equipment, and heavy 
reliance on short term debt.
    c. Upon careful consideration of all the relevant factors, the 
Board of Directors or General Partners shall determine which loans 
require recognition of Unrealized Depreciation. It is a good rule of 
operation for an SBIC to perform downward valuations earlier rather 
than later. When the quality of a loan recovers, a higher Asset 
Value may subsequently be assigned.
    4. The carrying value of interest bearing securities shall not 
be adjusted for changes in interest rates.
    5. Valuation of convertible debt may be adjusted to reflect the 
value of the underlying equity security net of the conversion price.
    a. Accepted methods for valuing convertible debentures generally 
involve one of two approaches. The first approach views the 
debenture as a debt obligation. Under this approach, the SBIC or 
SSBIC should utilize the loan valuation techniques described in this 
section above. The second approach considers the conversion of all 
convertible securities of the same class into their common stock 
equivalent, taking into account dilution, and a subsequent valuation 
of the SBIC's or SSBIC's proportionate equity interest. Valuation of 
this equity interest should follow the equity valuation techniques 
described in Paragraph C. of this section.
    b. Normally, the reported value is the higher of these two 
alternatives. However, Licensees should disregard higher equity 
values and retain lower debt-based valuations if there are 
circumstances which make conversion undesirable. When equity 
considerations govern the Asset Value assigned, all underlying 
factors should be disclosed.

C. Equity Securities--Private Companies

    1. Investment cost is presumed to represent value except as 
indicated elsewhere in these guidelines.
    2. Valuation should be reduced if a company's performance and 
potential have significantly deteriorated. If the factors which led 
to the reduction in valuation are overcome, the valuation may be 
restored.
    3. The anticipated pricing of a Small Concern's future equity 
financing should be considered as a basis for recognizing Unrealized 
Depreciation, but not for Unrealized Appreciation. If it appears 
likely that equity will be sold in the foreseeable future at a price 
below the Licensee's current valuation, then that prospective 
offering price should be weighed in the valuation process.
    4. Valuation should be adjusted to a subsequent significant 
equity financing that includes a meaningful portion of the financing 
by a sophisticated, unrelated new investor. A subsequent significant 
equity financing that includes substantially the same group of 
investors as the prior financing should generally not be the basis 
for an adjustment in valuation. A financing at a lower price by a 
sophisticated new investor should cause a reduction in value of 
prior securities.
    5. If substantially all of a significant equity financing is 
invested by an investor whose objectives are in large part 
strategic, or if the financing is led by such an investor, it is 
generally presumed that no more than 50% of the increase in 
investment price compared to the prior significant equity financing 
is attributable to an increased valuation of the company.
    6. Where a company has been self-financing and has had positive 
cash flow from operations for at least the past two fiscal years, 
Asset Value may be increased based on a very conservative financial 
measure regarding P/E ratios or cash flow multiples, or other 
appropriate financial measures of similar publicly-traded companies, 
discounted for illiquidity. Should the chosen valuation cease to be 
meaningful, the valuation may be restored to a cost basis, or in the 
event of significant deterioration in performance or potential, to a 
valuation below cost to reflect impairment.
    a. Under these conditions, valuation factors that may be 
considered, include:
    (1) The utilization of a multiple of earnings, cash flow, or 
revenues, which are commensurate with the multiples which the market 
currently accords to comparable companies in similar businesses and 
industries, with an appropriate discount for conditions such as 
illiquidity or a minority position. Care should be taken to use only 
comparable companies, including not only business similarities but 
also similarities as to size, financial condition, and earnings 
outlook. However, in order for comparative market prices to be 
meaningful, data for a representative sample or similar companies 
must be available.
    (2) Among the more important factors to be considered in a 
particular case are (i) The nature of the business, (ii) the risk 
involved, and (iii) the growth, stability or irregularity of 
earnings and cash flows. A company with a positive earnings trend 
and a favorable outlook may command a capitalization factor 
(multiplier) in the marketplace that will result in a stock 
valuation well above book value. When the gross value of a small 
concern is computed by applying a capitalization rate to pre-
interest, pre-tax earnings, the value of equity securities is 
derived by subtracting the outstanding debt of the concern from the 
gross value. While capitalization rates do vary, an appropriate rate 
can be determined by analyzing rates for comparable companies in the 
same industry. Investigating similar companies in the same industry 
or geographic area can be done directly or through published 
material from sources such as the Value Line, Standard and Poor's, 
Robert Morris and Associates, or any other of the numerous sources 
available for comparative industry data.
    (3) Another method discounts the present value of estimated 
future proceeds to a Licensee including dividend income and sales of 
securities, using a discount rate that reflects the degree of risk 
of the equity interest.
    (4) One may also utilize the recent sale prices of comparable 
blocks of the issuer's securities in arm's length transactions.
    b. Equity interests or limited partnership interests without the 
benefit of stock certificates and which generally define a certain 
percentage of the profits to be allocated to each of the investors 
based on its relative contributions should be valued in a manner 
similar to the valuation methods described in this section.
    7. With respect to portfolio companies that are likely to face 
bankruptcy or discontinue operations for some other reason, 
liquidating value may be employed. This value may be determined by 
estimating the realizable value (often through professional 
appraisals or firm offers to purchase) of all assets and then 
subtracting all liabilities and all associated liquidation costs.
    a. Liquidation value will depend on the decreasing value of 
wasting assets, the costs experienced by the business being 
liquidated, the expenses borne by the Licensee in order to be able 
to realize any liquidating value, the elapsed time until such net 
proceeds can be realized, the ranking of the Licensee's claims 
relative to other security interests and subordination agreements, 
and the probability of any ultimate realization of value.
    b. Incorporating this approach as a normal step in valuation can 
provide improved understanding of the downside of an investment.
    c. Licensees should recognize unrealized appreciation or 
depreciation, as appropriate, on Assets Acquired in liquidation of 
Loans and Investments. In order to recognize Unrealized 
Appreciation, asset values must be verified by an appraisal which 
meets all the conditions specified in the preceding paragraph; 
provided, however, that if the assets acquired constitute a going 
concern, such assets may be appraised as a going concern rather than 
at liquidation value. Unrealized Appreciation may not be recognized 
if the Licensee does not benefit from such appreciation. For 
example, an asset acquired through foreclosure should not be carried 
at a value greater than the defaulted loan balance plus any expenses 
and penalties to which the Licensee is entitled.
    8. Warrants should be valued at the excess of the value of the 
underlying security over the exercise price.
    a. Valuation of debt with detachable warrants can be done 
similarly to convertible debt by treating the debt and warrants as a 
unit, or, alternatively, the debt can be valued on its own basis as 
a debt instrument, and the warrants separately. If the warrants are 
valued separately, the following factors must be taken into account:
    (1) Current value of issued shares.
    (2) The differential between the exercise price and the 
underlying share values if the current share values are higher than 
the exercise price.
    (3) Time until expiration dates are reached or dates of changes 
in terms of exercise prices.
    (4) Number of shares into which the warrants are exercisable on 
various dates.
    (5) Restrictions on sale of the underlying stock.
    (6) Restrictions on the transferability of the warrants.
    (7) Registration rights for the warrants or the underlying 
shares.
    (8) Financial ability of the Licensee to perform the exercise of 
its rights or to sell it warrants.
    (9) The ultimate desirability, if any, of exercising the rights 
given by the warrants.

D. Equity Securities--Public Companies

    1. Public securities should be valued as follows:
    (a) For over-the-counter stocks, take the average of the bid 
price at the close for the valuation date and the preceding two 
days, and
    (b) For listed stocks, take the average of the close for the 
valuation date and the preceding two days.
    a. However, securities are not deemed to be freely marketable in 
those situations wherein such securities are very thinly or 
infrequently traded, or may be lacking in truly representative 
market quotations, or where the market for such securities cannot 
absorb the quantity of shares which the Licensee and similar 
investors may want to sell.
    b. In such cases, Asset Value must be determined by the Board of 
Directors or General Partners.
    2. The valuation of public securities that are restricted should 
be discounted appropriately until the securities may be freely 
traded. Such discounts typically range from 10% to 40%, but the 
discounts can be more or less, depending upon the resale 
restrictions under securities laws or contractual agreements.
    3. When the number of shares held is substantial in relation to 
the average daily trading volume, the valuation should be discounted 
by at least 10%, and generally by more.

    Dated: March 1, 1994.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-7844 Filed 04-07-94; 8:45 am]
BILLING CODE 8025-01-M