[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: 94-7845]


[[Page Unknown]]

[Federal Register: April 8, 1994]


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SMALL BUSINESS ADMINISTRATION
13 CFR Part 121

 

Small Business Size Standards: Increase Size Standard of Small 
Business Concerns Eligible for Assistance by Small Business Investment 
Companies

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: The Small Business Administration (SBA) is revising one of the 
two size standards that establish eligibility criteria for small 
business concerns applying for assistance from Small Business 
Investment Companies (SBICs). This action increases the ceilings on the 
primary standard used, the SBIC Standard, from $6 million net worth and 
$2 million after-tax net income, to $18 million net worth and $6 
million after-tax net income.
    This action is consistent with the current program restructuring 
resulting from the enactment of recent legislation, and updates the 
existing standard for inflation since the last adjustments in 1979.
    The increased standard benefits small businesses by restoring 
eligibility to many concerns that lost this status solely because of 
the effects of inflation. The increased standard also permits the SBICs 
with higher levels of private capital, particularly those new licensees 
entering the Program as a result of the legislative changes, to provide 
follow-on investments and equity-oriented financing to growth-oriented 
small business concerns.

EFFECTIVE DATE: April 25, 1994.

FOR FURTHER INFORMATION CONTACT:
Robert D. Stillman, Associate Administrator for Investment, Small 
Business Administration, 409 3rd Street, SW., suite 6300, Washington, 
DC 20416.

SUPPLEMENTARY INFORMATION:

Background

    In the Federal Register of July 29, 1993, (58 FR 40603), SBA 
published a Proposed Rule to revise the two-test standard that SBICs 
use as the primary size standard determining eligibility for small 
business concerns applying for financial and/or management assistance 
under the SBIC Program.
    Concerns applying for assistance must be eligible for the Program 
under one of two standards: The two-test standard for net worth and 
after-tax net income (herein called the ``SBIC Standard'' or 
``Standard'') [Sec. 121.802 (a)(2)(i)] or, the single-test standard, 
stated in number of employees or annual revenues, that is specified for 
the applicant's industry [Sec. 121.802(a)(2)(ii)].
    SBA proposed to increase only the two tests in the SBIC Standard. 
The net worth test would be increased from $6 million to $18 million 
and the after-tax net income test would be increased from $2 million to 
$6 million. As an alternative, the applicant concern would continue to 
have the option of qualifying under the industry size standard.
    The current action dates from a September 1990 proposal to 
reinstate a third test, an assets test, in the SBIC Standard. The 
assets test had been eliminated by a regulatory amendment in 1979. In 
1990, a gross assets test of $20 million was proposed to be applied 
only to SBIC change of ownership financings. The purpose of this 
proposal was to prevent SBICs from participating in highly leveraged 
transactions where the concern financed appeared to be other than 
small. While SBIC regulations do not preclude change of ownership 
transactions, SBA found it necessary to have the ability to monitor and 
control these transactions to prevent the violation of Program 
integrity. Following Federal Register publication and evaluation of the 
public comments received in response, SBA withdrew this proposal, in 
July 1991, for further analysis.
    SBA's July 29, 1993, proposal for a change in the SBIC Standard was 
the result of an extensive review and restructuring of the SBIC Program 
which occurred over the intervening two-year period. The proposal 
focused on an update of the net worth and net income components of the 
Standard to facilitate the Program changes underway, particularly the 
legislative changes recently enacted, and to adjust for inflation. SBA 
no longer proposed to reinstate an assets test to address the leveraged 
buyout issue as the administration of these transactions was determined 
to be an eligibility issue suitable for coverage in the SBIC financing 
regulations rather than a size issue. Consequently, SBA sought, through 
a separate proposed rule (58 FR 41852) which covered a number of 
operating regulations, to amend the SBIC regulations applicable to 
change of ownership transactions (Sec. 107.711) in order to address 
this issue.
    The proposed SBIC Standard was a vital part of the structural 
changes, along with the revisions in part 107, that were initiated to 
strengthen and improve the SBIC Program. Overall, the Program 
revitalization efforts underway are designed to enhance the SBIC 
Program to be a more effective tool in providing small business 
concerns access to risk capital in a way that will result in job 
creation, economic growth, and other national objectives being 
achieved.

Discussion of Comments

    In response to the July 29, 1993, proposal, SBA received 30 letters 
from: managers of currently licensed SBICs, investors and venture 
capitalists planning to form SBICs, investors who have submitted 
license applications for new SBICs, individual members of SBA's 
Investment Advisory Council, and trade associations representing SBICs. 
Almost all comments, except for one, supported the proposed increase in 
the SBIC Standard and contained one or more comments regarding the need 
for an increased standard and its benefits.
    Typical comments in support of the increase were that the proposal: 
Was a long-overdue and appropriate adjustment; would increase capital 
available for financing; was more in line with the larger capital 
structures of businesses now approaching SBICs for financing, 
particularly since new starts have become more capital intensive in the 
1990s; would allow for multiple rounds of financing for established 
small businesses; and would increase financing for small businesses 
having the potential for growth and job creation. One commentator also 
recommended that there be periodic, automatic adjustments in the size 
standard to offset inflation.
    The one exception offered a counter proposal for a small increase 
than SBA proposed. The counter proposal maintained that, while the 
Proposed Rule met the expectations of the SBIC industry, only an 
inflation adjustment should be made to double the present Standard, to 
a net worth of $12 million and net income of $4 million.

Response

    The Proposed Rule stated that there were two elements contributing 
to the increase in the Standard. About half of the increase in the 
Standard was attributable to the restructuring of the SBIC Program as a 
result of title IV of Public Law 102-366 in order to address the need 
for financing growth-oriented and development-stage small businesses. 
The remainder of the increase was an inflationary adjustment.
    However, the counter proposal would limit the increase in the 
Standard to only an inflation adjustment thus eliminating a significant 
portion of the SBICs' capability to provide the type of small business 
financing envisioned by Public Law 102-366.
    In addition, limiting the increase would restrict the formation of 
SBICs with higher amounts of private capital, as also envisioned by the 
legislation which has key provisions intended to encourage SBICs to 
significantly increase their levels of private capital. Under these 
provisions, some SBICs will continue to have private capital of less 
than $10 million, while some new SBICs will have as much as $50 million 
in private capital. The optimum size of SBICs electing to issue the new 
security, created by the legislation, is expected to be $15 to $20 
million in private capital. These SBICs will typically invest from 
$200,000 to $1 million in one small business since each SBIC is able to 
invest up to 20% of its private capital in any one small business 
concern. The increased SBIC Standard will allow the SBICs with higher 
amounts of private capital the flexibility to invest up to 20% of their 
private capital in the multiple rounds of financings needed to grow a 
small business from its initial founding to its take-off as a 
successful venture.
    In essence, increasing the SBIC Standard by only an inflation 
adjustment would accommodate retroactive, or historical, trends and 
restore the purchasing power of the dollar which was eroded from 1979 
to 1992. However, such an increase would ignore the current and 
prospective goals of the Program restructuring already underway. This 
restructuring is designed to strengthen and expand the capabilities of 
SBICs to finance small businesses so that they can increase their 
contribution to economic growth and job creation.
    Therefore, after careful review of the public comments noted above 
together with other Program and economic data, SBA is adopting the rule 
as proposed, with both a historical inflation adjustment and an 
adjustment for current Program needs.

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

Executive Order 12866 and Regulatory Flexibility Act

    Although this final rule is expected to have a significant economic 
impact on a substantial number of small entities for purposes of the 
Regulatory Flexibility Act (5 U.S.C. 601, et seq), it will not 
constitute a significant rule for the purpose of Executive Order 12866, 
since its annual economic effect is less than $100 million. An initial 
regulatory flexibility analysis of this proposal is as follows.
(1) Description of Entities to Which the Rule Applies
    SBA estimates that 99.7% of all firms in the United States could be 
eligible for SBIC financing after the adoption of this final rule 
(estimate based on Internal Revenue Service Statistics of Income, 1988 
for active corporations). By comparison, when the current standard was 
adopted in 1979, approximately 99.6% of all firms were eligible for 
SBIC assistance. In absolute terms, under the proposed standard, 
approximately 7,000 additional firms would gain eligibility as small 
businesses. Many of these concerns probably had small business status 
under the 1979 standard, but since then have lost eligibility because 
of general price increases due to inflation.
    However, it should be noted that the Standard sets the ceiling on 
how the target population is defined and on the entire population 
potentially eligible for SBIC assistance. In practice, the level of 
private capital invested in an individual SBIC and the SBIC's 
investment plan actually set the limits on each small business 
financing.
    Actual Program experience shows the enormous gap between the total 
population eligible for SBIC financing and the number that actually 
participate in the Program. The total number of business concerns that 
fit under the current SBIC Standard and, therefore, are potentially 
eligible for SBIC assistance, is approximately 3.6 million small 
concerns. By contrast, the number of financings annually from both 
Regular SBICs and Specialized SBICs averages 2,000 per year, based on 
Fiscal 1991 and 1992 data. Overall, from 1960 to 1991, almost 70,000 
different small business concerns received financing under the SBIC 
Program.
    Moreover, a review of the initial capitalization of SBICs indicates 
that based on the levels of private capital there are three types of 
SBICs each serving a limited segment of potentially eligible concerns 
for SBIC financing: the Regular SBICs with a minimum private capital of 
$2.5 million and having a balanced portfolio with a primary emphasis on 
providing debt financing to small business; the SSBICs with minimum 
private capital of $1.5 million and specializing in financing small 
businesses that are owned by persons who are socially or economically 
disadvantaged; and venture capital SBICs which tend to have higher 
levels of private capital in order to provide equity oriented 
financings to growth oriented small business concerns.
    Since current Program changes are designed to expand the private 
capital of all types of SBICs, the proposed Standard will allow SBICs 
with higher levels of private capital to provide larger amounts of 
financings to small business concerns. However, the optimum size 
venture capital SBIC is expected to be $10 to $20 million in private 
capital. There will be SBICs with private capital of less than $10 
million and some SBICs will have as much as $50 million in private 
capital. At the lower levels (e.g., from $1 million to $5 million), an 
SBIC will typically invest from $200,000 to $1 million in one small 
business since each SBIC is able to invest up to 20% of its private 
capital in any one small business concern.
    Moreover, the SBIC Standard is a program Standard applicable only 
to small business concerns that apply for financing from an SBIC. As 
such, the change affects only potential clients of SBICs and does not 
alter the definition of a small business for the wide variety of 
business development, financial assistance and procurement assistance 
programs offered by SBA.
    The proposed Standard does not impose a regulatory burden because 
it does not regulate or control business behavior.
(2) Description of Reasons Why This Action Is Being Taken and 
Objectives of Rule
    SBA has provided above in the Supplementary Information a 
description of the reasons why this action is being taken and a 
statement of the reasons for and objectives of this proposed rule.
(3) Legal Basis for the Proposed Rule
    The legal basis for this rule is sections 3(a) and 5(b) of the 
Small Business Act, 15 U.S.C. 632(a) and 634(b)(6).
(4) Federal Rules
    There are no Federal rules which duplicate, overlap or conflict 
with this proposed rule. SBA has statutorily been given exclusive 
jurisdiction in establishing size standards for small business 
concerns.
(5) Significant Alternatives to Proposed Rule
    This rule sets forth changes from the current size standard in 
order to establish the most appropriate definition of small business 
concerns eligible for assistance under the SBIC Program. There are no 
significant alternatives to defining a small business concern other 
than developing another alternative size standard. As discussed in the 
Supplementary Information above, the SBIC Program already provides two 
options for determining the eligibility of applicant concerns, and this 
proposal applies to only one of those options. A review of the SBIC 
portfolio indicated that almost all applicant concerns were eligible 
under the single size standard covering the industry in which the 
applicant concern was primarily engaged even though these firms chose 
to qualify under the SBIC Standard instead of the industry-based 
standards.

Executive Order 12612

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

Paperwork Reduction Act

    SBA certifies that this rule, promulgated as final, will not add 
any new reporting or recordkeeping requirements under the Paperwork 
Reduction Act of 1980, 44 U.S.C., Chapter 35.

Executive Order 12778

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

List of Subjects in 13 CFR Part 121

    Financial assistance--small business concerns, Small Business 
Investment Companies, Small Business Investment Company Program.

    Accordingly, part 121 of 13 CFR is amended as follows:

PART 121--SMALL BUSINESS SIZE REGULATIONS

    1. The authority citation for part 121 continues to read as 
follows:

    Authority: 15 U.S.C. 632(a), 634(b)(6), 637(a) and 644(c).


Sec. 121.802  [Amended]

    2. Section 121.802(a)(2) is amended by removing the words ``Small 
Business Investment Company,''.
    3. Section 121.802 is amended by redesignating paragraph (a)(3) as 
paragraph (a)(4) and by adding a new paragraph (a)(3) to read as 
follows:


Sec. 121.802  Establishment of the Size Standard.

    (a) * * *
    (3) SBIC Standard. For financial and/or management/technical 
assistance under the Small Business Investment Company Program, an 
applicant concern must meet one of the following standards:
    (i) Together with its affiliates, it does not have net worth in 
excess of $18 million, and does not have average net income after 
Federal income taxes (excluding any carry-over losses) for the 
preceding 2 completed fiscal years in excess of $6 million; or
    (ii) Together with its affiliates, it meets the size standard for 
the industry in which it is primarily engaged and, excluding its 
affiliates, meets the size standard for the industry in which it is 
primarily engaged. These size standards are set forth in Sec. 121.601.
* * * * *
    Dated: March 1, 1994.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-7845 Filed 4-7-94; 8:45 am]
BILLING CODE 8025-01-M