[Federal Register Volume 60, Number 228 (Tuesday, November 28, 1995)]
[Proposed Rules]
[Pages 58530-58578]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-28757]



 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
 ========================================================================
 

  Federal Register / Vol. 60, No. 228 / Tuesday, November 28, 1995 / 
Proposed Rules  

[[Page 58530]]


SMALL BUSINESS ADMINISTRATION

13 CFR Part 107


Small Business Investment Companies

AGENCY: Small Business Administration.

ACTION: Proposed rule.

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

SUMMARY: In response to President Clinton's government-wide regulatory 
reform initiative, the Small Business Administration (SBA) is proposing 
to restructure its existing regulations. This proposed rule is intended 
to streamline the regulations governing the Small Business Investment 
Company (SBIC) program. To this end, SBA proposes to eliminate obsolete 
regulations and to reorganize the remaining regulations in a more 
readable format.
    In addition to changes in organization, the proposed regulations 
include a number of substantive changes, many of which are intended to 
reduce the regulatory burden on Licensees, as well as SBA's 
administrative burden. Other proposed changes would provide additional 
protection for SBA's position as a creditor of, or investor in, 
Licensees with outstanding Leverage. At the same time, certain 
requirements would be made inapplicable to non-leveraged Licensees, 
which pose no financial risk to the Agency.

DATES: Comments must be submitted on or before December 28, 1995.

ADDRESSES: Written comments should be addressed to David R. Kohler, 
Regulatory Reform Initiative Team Leader, Office of General Counsel, 
U.S. Small Business Administration, 409 3rd Street, S.W., Suite 13, 
Washington, D.C. 20416, Attn. Part 107.

FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division, 
at (202) 205-6510.

SUPPLEMENTARY INFORMATION: On March 4, 1995, President Clinton issued a 
Memorandum to all federal agencies, directing them to simplify their 
regulations. In response to this directive, SBA has completed a page-
by-page, line-by-line review of all of its existing regulations to 
determine which might be revised or eliminated. As a result of its 
review of the regulations governing the SBIC program, SBA is proposing 
to eliminate obsolete or redundant regulations, substantively revise 
others, and reorganize all of Part 107 in a more readable format.
    In this proposed rule, all sections are renumbered for purposes of 
clarity and improved organization, and the regulations are organized 
into the following new subparts:
    (A) Introduction to Part 107.
    (B) Definition of Terms Used in Part 107.
    (C) Qualifying for an SBIC License. (D) Changes in Ownership, 
Control, or Structure of Licensee; Transfer of License.
    (E) Managing the Operations of a Licensee.
    (F) Record keeping, Reporting, and Examination Requirements for 
Licensees.
    (G) Financing of Small Businesses by Licensees.
    (H) Non-leveraged Licensees, Exceptions to the Regulations.
    (I) SBA Financial Assistance for Licensees (Leverage).
    (J) Licensee's Noncompliance with Terms of Leverage.
    (K) Ending Operations as a Licensee.
    (L) Miscellaneous.
    For convenience, this preamble includes a chart listing the current 
section numbers in Part 107 and matching them to either a corresponding 
proposed regulation or indicating that the current section is deleted 
in the proposed regulations. The chart also identifies the character of 
any changes to the current regulations.
    Following the chart is a two-part analysis of the proposed changes 
to the SBIC regulations. Part I details regulations that would be 
eliminated. Part II describes proposed modifications of the current 
regulations and the policy reasons for them.

                                 Part 107: Current and Proposed Section Numbers                                 
----------------------------------------------------------------------------------------------------------------
                                                         Revised (non-    Revised                               
         Current section             Proposed section    substantive)  (substantive)     Deleted      No change 
----------------------------------------------------------------------------------------------------------------
107.1............................  107.20..............  ............  .............  ............            X 
107.2............................  107.40..............  ............             X   ............  ............
107.3............................  107.50..............  ............             X   ............  ............
107.4............................  107.160.............            X              X   ............  ............
107.101(a).......................  107.130, 107.230(d).            X              X   ............  ............
107.101(b).......................  107.508.............            X   .............  ............  ............
107.101(c).......................  ....................  ............  .............            X   ............
107.101(d).......................  107.200.............            X   .............  ............  ............
107.101(e).......................  107.210.............            X   .............  ............  ............
107.101(f).......................  107.230(e)..........            X   .............  ............  ............
107.101(g).......................  107.503.............            X   .............  ............  ............
107.101(h).......................  107.504.............            X   .............  ............  ............
107.101(i).......................  107.710.............            X   .............  ............  ............
107.102(a).......................  107.300.............  ............             X   ............  ............
107.102(b).......................  107.400(b),                     X   .............  ............  ............
                                    107.680(b).                                                                 
107.103..........................  ....................  ............  .............            X   ............
107.104..........................  107.475.............            X   .............  ............  ............
107.105..........................  107.1900............            X   .............  ............  ............
107.210(a)-(d)...................  107.1100-107.1140...            X   .............  ............  ............
107.210(e).......................  107.509.............            X   .............  ............  ............

[[Page 58531]]
                                                                                                                
107.210(f)(1)-(4)................  107.1700............  ............  .............  ............            X 
107.210(f)(5)....................  107.560.............            X   .............  ............  ............
107.210(f)(6)....................  107.550.............  ............             X   ............  ............
107.210(g).......................  107.1710............  ............  .............  ............            X 
107.210(h).......................  107.1830-107.1850...            X   .............  ............  ............
107.210(i).......................  107.1720............  ............  .............  ............            X 
107.215..........................  107.1200-107.1240...            X   .............  ............  ............
107.215(a).......................  107.1200(c).........  ............             X   ............  ............
107.215(f)(1)....................  107.1230(b).........  ............             X   ............  ............
107.220(a)-(b)...................  107.1150(a).........            X   .............  ............  ............
107.220(c).......................  107.1150(b).........            X   .............  ............  ............
107.220(d).......................  107.1150(b)(2)......  ............  .............  ............  ............
107.220(e).......................  107.1170............            X   .............  ............  ............
107.230(a).......................  107.1100(b).........            X   .............  ............  ............
107.230(b).......................  107.1400-107.1430...            X   .............  ............  ............
107.230(c)(1)-(5)................  107.1160............            X   .............  ............  ............
107.230(c)(3)(iii)...............  107.1160(f).........  ............             X   ............  ............
107.230(c)(4)(iv)................  107.1160(f).........  ............             X   ............  ............
107.230(c)(6)....................  107.1170............            X   .............  ............  ............
107.230(d).......................  107.1100(c).........            X   .............  ............  ............
107.230(e).......................  107.1350............            X   .............  ............  ............
107.230(f).......................  107.1450............            X   .............  ............  ............
107.241(a).......................  107.220.............            X   .............  ............  ............
107.241(b).......................  107.1500(b)(4)......            X   .............  ............  ............
107.241(c).......................  107.150.............  ............             X   ............  ............
107.241(d).......................  107.140, 107.510....  ............             X   ............  ............
107.241(e).......................  107.570.............            X   .............  ............  ............
107.241(f).......................  107.1505............            X   .............  ............  ............
107.241(g).......................  107.1500(e).........            X   .............  ............  ............
107.241(h).......................  107.1500(f).........            X   .............  ............  ............
107.242..........................  107.1510............  ............             X   ............  ............
107.243..........................  107.1520, 107.1540..            X   .............  ............  ............
107.244..........................  107.1530............            X   .............  ............  ............
107.245(a).......................  107.1540(a).........            X   .............  ............  ............
107.245(b).......................  107.1550............            X   .............  ............  ............
107.245(c).......................  107.1560............            X   .............  ............  ............
107.245(d).......................  107.1570............            X   .............  ............  ............
107.245(e).......................  107.1580............            X   .............  ............  ............
107.246..........................  107.1520(g).........            X   .............  ............  ............
107.247..........................  107.1590............            X   .............  ............  ............
107.250..........................  107.1600- 107.1680..  ............  .............  ............            X 
107.260..........................  107.1800............            X   .............  ............  ............
107.261..........................  107.1810............            X   .............  ............  ............
107.262..........................  107.1820............            X   .............  ............  ............
107.263..........................  107.1910............  ............  .............  ............            X 
107.301(a).......................  107.830.............  ............             X   ............  ............
107.301(b).......................  107.845.............            X   .............  ............  ............
107.302..........................  107.855.............  ............             X   ............  ............
107.303..........................  107.740.............            X   .............  ............  ............
107.304(a).......................  107.610, 107.700....            X   .............  ............  ............
107.304(b).......................  107.620.............            X   .............  ............  ............
107.304(c).......................  107.630(e)..........            X   .............  ............  ............
107.305..........................  ....................  ............  .............            X   ............
107.320(a).......................  107.800.............            X   .............  ............  ............
107.320(b).......................  107.815(a)..........            X   .............  ............  ............
107.321..........................  107.850.............  ............             X   ............  ............
107.322..........................  ....................  ............  .............            X   ............
107.401..........................  107.820.............  ............             X   ............  ............
107.402(a).......................  107.825.............            X   .............  ............  ............
107.402(b)-(c)...................  ....................  ............  .............            X   ............
107.402(d)-(e)...................  107.860.............  ............             X   ............  ............
107.402(f).......................  107.830(d)(3).......            X   .............  ............  ............
107.402(g).......................  107.855.............  ............             X   ............  ............
107.403(a).......................  ....................  ............  .............            X   ............
107.403(b)(1)....................  107.835.............  ............             X   ............  ............
107.403(b)(2)....................  ....................  ............  .............            X   ............
107.403(b)(3)....................  107.828.............            X   .............  ............  ............
107.404..........................  107.828.............  ............             X   ............  ............
107.501..........................  107.900.............  ............             X   ............  ............
107.601..........................  107.410-107.440.....            X   .............  ............  ............

[[Page 58532]]
                                                                                                                
107.601(e).......................  107.1120(f).........            X   .............  ............  ............
107.601(g).......................  ....................  ............  .............            X   ............
107.602..........................  107.460.............  ............             X   ............  ............
107.603..........................  107.450.............            X   .............  ............  ............
107.701..........................  107.30..............  ............  .............  ............            X 
107.702..........................  ....................  ............  .............            X   ............
107.703..........................  107.500.............  ............  .............  ............            X 
107.704..........................  107.501.............  ............             X   ............  ............
107.705(a).......................  107.240.............            X   .............  ............  ............
107.705(b).......................  107.250.............            X   .............  ............  ............
107.706..........................  107.760.............            X   .............  ............  ............
107.707(b).......................  107.828(d)..........            X   .............  ............  ............
107.708(a)&(b)...................  107.530.............            X   .............  ............  ............
107.708(c).......................  107.1000............            X   .............  ............  ............
107.709..........................  107.510.............  ............             X   ............  ............
107.710..........................  107.880.............  ............             X   ............  ............
107.711..........................  107.750.............            X   .............  ............  ............
107.712..........................  107.120.............            X   .............  ............  ............
107.801..........................  107.865.............  ............             X   ............  ............
107.802..........................  107.585.............            X   .............  ............  ............
107.803..........................  107.470.............            X   .............  ............  ............
107.804..........................  107.720(e)..........            X   .............  ............  ............
107.901(a).......................  107.720(a)..........            X   .............  ............  ............
107.901(b).......................  107.720(i)..........            X   .............  ............  ............
107.901(c).......................  107.720(c)..........  ............             X   ............  ............
107.901(d).......................  107.720(f)..........            X   .............  ............  ............
107.901(e).......................  107.720(g)..........  ............             X   ............  ............
107.901(f).......................  107.720(b)..........  ............             X   ............  ............
107.901(g).......................  107.720(h)..........            X   .............  ............  ............
107.902..........................  107.590.............  ............             X   ............  ............
107.903..........................  107.730.............            X   .............  ............  ............
107.904..........................  107.885.............            X   .............  ............  ............
107.905..........................  107.502.............            X   .............  ............  ............
107.906..........................  107.507.............            X   .............  ............  ............
107.1001.........................  107.690-107.692.....  ............             X   ............  ............
107.1002(a)-(b)..................  107.600.............  ............             X   ............  ............
107.1002(c)-(d)..................  107.660.............            X   .............  ............  ............
107.1002(e)......................  107.630.............  ............             X   ............  ............
107.1003(a)......................  107.506.............            X   .............  ............  ............
107.1003(b)......................  ....................  ............  .............            X   ............
107.1004.........................  107.680.............            X   .............  ............  ............
107.1101.........................  107.670.............            X   .............  ............  ............
107.1201.........................  107.1920............            X   .............  ............  ............
107.1202.........................  107.1930............            X   .............  ............  ............
----------------------------------------------------------------------------------------------------------------



Part I

Eliminated Sections

    SBA proposes deletion of the following sections of the current 
regulations. The effect of the proposed deletion and the reason for the 
action is provided.
    Current Sec. 107.103 would be deleted, eliminating the requirement 
for giving public notice of license applications. Similarly, 
Sec. 107.601(g) requiring public notice of an application for a change 
in a proposed transfer of Control over a Licensee would be deleted. The 
Agency has received few comments in the past on either type of 
application and believes these requirements unnecessarily lengthen the 
application process.
    Current Sec. 107.305 would be deleted, eliminating the requirement 
for Licensees to conduct a ``post closing review'' of each Financing of 
a Small Business in order to assure that the proceeds were used for the 
intended purposes. The requirement that Financing documents contain 
certain standard provisions restricting the use of proceeds, and the 
requirement for Licensees to report any unauthorized diversion of funds 
to SBA, would also be eliminated. SBA believes these provisions are 
burdensome because of the special documentation requirements imposed, 
and essentially redundant because other regulations require an SBIC to 
identify and monitor a Small Business's use of financing proceeds. In 
particular, under proposed Sec. 107.620 (which would replace current 
Sec. 107.304(b)), a Licensee must obtain information about a Small 
Business's intended use of proceeds before extending any Financing and 
must obtain updated financial information sufficient to verify the 
actual use of proceeds.
    Current Sec. 107.322, which allows an SBIC making an equity 
investment to place restrictions on current and future indebtedness of 
the financed Small Business, would be deleted. This deletion would not 
restrict the rights of Licensees in any way, since the practices 
described are specifically permitted under the Act. See 15 U.S.C. 
section 684(b). 

[[Page 58533]]


Part II

1. Subpart A--Introduction to Part 107

    As part of its effort to make the regulations more readable, SBA 
has used ``you'' to refer to a Licensee or a license applicant, as 
appropriate, throughout Part 107. Proposed Sec. 107.40(c) explains this 
convention.

2. Subpart B--Definition of Terms Used in Part 107

    SBA proposes revising the following definitions currently found in 
Sec. 107.3 of the regulations.
a. ``Close Relative'' and ``Secondary Relative''
    The definition of ``Close Relative'' would be narrowed to cover 
only immediate relatives (spouses, along with parents, children, 
brothers and sisters, and their spouses). Other relatives, such as 
grandparents and grandchildren, aunts, uncles, and first cousins, would 
be defined as ``Secondary Relatives.'' The two separate categories have 
been proposed so that a distinction between them can be made in the 
definition of ``Associate'', which is discussed below. The effect of 
the change is to limit the circumstances under which concerns with only 
a peripheral relationship to a Licensee, through a Secondary Relative, 
become its Associates.
b. ``Associate''
    SBA proposes two modifications to the definition of ``Associate'', 
a key term that appears extensively in the conflict of interest rules 
(proposed Sec. 107.730), and in various other regulations including 
proposed Secs. 107.150 (management and ownership diversity 
requirement), 107.865 (Control of Small Businesses), and 107.885 
(disposition of assets to Licensee's Associate).
    Proposed paragraphs (h) and (i) specify the conditions under which 
an Associate's involvement in a concern, either through positions held 
or ownership interests, causes that concern to become an Associate of a 
Licensee. The two paragraphs are comparable to paragraph (f) of the 
current definition, with the following exceptions:
    First, under paragraph (h), the presence of an Associate as a 
director of a concern would no longer cause the concern to become an 
Associate of the Licensee. SBA believes that an Associate functioning 
as an outside director is unlikely to create a conflict of interest, 
and often can provide insight into a company that a Licensee may find 
useful.
    Second, under paragraph (i), a concern would not become an 
Associate of a Licensee because of its relationship with a Secondary 
Relative, unless that relative had a majority equity interest in the 
concern (or controlled it through other means), either alone or with 
other Associates. For example, a concern in which the uncle of the 
president of the Licensee had a 10 percent equity interest would not be 
an Associate of the Licensee (as it is under the current definition). 
However, if the uncle were the majority owner of the concern, it would 
be an Associate. SBA has proposed this change to exclude from the 
definition of Associate those concerns that are only marginally related 
to the Licensee.
c. ``Control Person''
    The definition of ``Control Person'' was developed in part to 
identify persons that might control, or at least influence, a 
Partnership Licensee's general partner and thus the Licensee itself, 
even though they themselves might have no direct relationship with the 
Licensee. This designation is important for regulatory purposes because 
Control Persons are considered Associates of the Licensee.
    A portion of the current definition identifies as a Control Person 
(1) any investor that has at least a 10 percent ownership interest in a 
Licensee's general partner and participates in the general partner's 
investment decisions concerning the Licensee; or (2) any passive 
investor that has at least a 40 percent ownership interest in a 
Licensee's general partner.
    The proposed rule would make the following change to the definition 
of Control Person:
    Under paragraphs (c) and (d), the same criteria that cause an 
investor in a Licensee's general partner to become a Control Person 
would also be applied to a direct investor in the Licensee. For 
example, under paragraph (d), a 40 percent limited partner in the 
Licensee's general partner would be a Control Person, and so would a 40 
percent limited partner in the Licensee itself. This proposal reflects 
SBA's belief that a limited partner's potential influence on a 
partnership Licensee is no different from that of a limited partner 
with an equivalent ownership interest in a partnership serving as the 
Licensee's general partner.
d. ``Equity Capital Investment''
    A Licensee with Participating Securities must make ``Equity Capital 
Investments'' in an amount at least equal to the total amount of 
Participating Securities issued. In addition, the amount of Equity 
Capital Investments in its portfolio at the end of each fiscal year 
must remain at least equal to the amount of its outstanding 
Participating Securities. SBA is not proposing any substantive change 
in the definition of Equity Capital Investments, but is proposing to 
clarify that an investment classified as a Debt Security is not 
precluded from qualifying as an Equity Capital Investment.
    There are two general categories of Debt Securities that may 
qualify as Equity Capital Investments. First, the definition of Equity 
Capital Investments specifically includes ``subordinated debt with 
equity features if such debt provides only for interest payments 
contingent upon and limited to the extent of earnings.'' Such debt must 
also be unsecured and non-amortizing in order to qualify.
    Second, certain equity interests may qualify as Equity Capital 
Investments even if they have covenants and/or redemption provisions 
that require them to be classified as Debt Securities for regulatory 
purposes. Such an investment may qualify if a Licensee's ability to 
recover its investment and/or realize returns is subject to essentially 
the same conditions that apply to a qualifying subordinated debt 
instrument. For example, a Licensee could purchase the preferred stock 
of a Small Business, with a provision requiring the issuer to redeem it 
after five years at its original cost plus any accumulated unpaid 
dividends. Because of the mandatory redemption provision, the 
investment would be treated as a Debt Security under proposed 
Sec. 107.800. However, as long as dividends were payable only from 
retained earnings, the investment would qualify as an Equity Capital 
Investment.
e. ``Financing''
    In the current regulations, ``Financings'' are defined to include 
commitments made to Small Businesses in addition to amounts actually 
invested and amounts guaranteed. The proposed definition would exclude 
such commitments. SBA is proposing this change to make the definition 
of Financing more objective, and to eliminate the regulatory compliance 
issues that sometimes arise when Licensees keep making commitments 
without actually making investments for an extended period of time.
f. ``Institutional Investor''
    The ``Institutional Investor'' definition identifies those 
investors in a Licensee whose unfunded binding commitments may be 
included in the Licensee's Private Capital. Institutional Investors may 
be entities or individuals. SBA proposes three non-substantive changes 

[[Page 58534]]
to this definition which are intended to clarify the Agency's 
interpretation:
    First, proposed paragraph (a)(6), which permits a qualified 
employee benefit or pension plan to be an Institutional Investor, would 
clarify that 401(k) plans are excluded. This treatment is consistent 
with SBA's interpretation of the current regulation.
    Second, proposed paragraph (a)(10) would clarify the circumstances 
under which an entity that invests the funds of others can qualify as 
an Institutional Investor. The purpose of the clarification is to 
reflect more precisely the original intent of this paragraph, which is 
to allow a ``fund of funds'' to qualify as an Institutional Investor if 
it is investing on behalf of other entities that also meet the 
Institutional Investor criteria.
    Third, under proposed paragraph (b)(1), an individual with net 
worth of less than $2 million would qualify as an Institutional 
Investor only if his/her commitment were backed by a letter of credit 
from a State or National bank acceptable to SBA. This is a 
clarification of the current definition, which requires only that the 
letter of credit be issued by a ``qualified Institutional Investor.'' 
SBA has proposed the new language to minimize confusion as to the 
meaning of a ``qualified'' Institutional Investor.
f. ``Lending Institution''
    The definition of ``Lending Institution'' is used in proposed 
Sec. 107.730 (comparable to current Sec. 107.903), which provides an 
exemption from the conflict of interest rules for certain transactions 
involving Lending Institutions that are Associates of the Licensee. 
Under the current definition, a Lending Institution must be an entity 
subject to federal or state regulation, such as a bank or savings and 
loan association. SBA recognizes, however, that other types of entities 
now extend credit in a manner similar to banks. Therefore, SBA proposes 
that the term ``Lending Institution'' be expanded to include 
corporations engaged in activities similar to those performed by 
commercial lenders, if they have assets in excess of $500 million and 
their shares are publicly traded and listed on a recognized stock 
exchange or NASDAQ. SBA believes that such entities, although not 
regulated in the same manner as banks, have sufficient oversight under 
federal securities laws.
g. ``Disadvantaged Business''
    SBA is proposing to change the defined term ``Disadvantaged 
Concern'' to ``Disadvantaged Business''; however, the Agency is not 
proposing any change in the definition itself at this time. SBA is 
reviewing the definition as part of an examination of various issues 
affecting the SSBIC program, and intends to work with the SSBIC 
industry to develop a revised definition which will be proposed at a 
later date.

3. Subpart C--Qualifying for an SBIC License

a. Permitted Forms of Organization for Licensees
    Proposed Secs. 107.100 and 107.110 describe the permitted forms of 
organization for Section 301(c) and Section 301(d) Licensees, 
respectively; these provisions are currently found in Sec. 107.3. The 
proposed sections would delete limited liability companies as a 
permitted form of organization because this form is not currently 
authorized by the Act. SBA plans to seek a legislative change that 
would permit SBICs to organize as limited liability companies.
b. 1940 Act and 1980 Act Companies
    Under proposed Sec. 107.115, SBA would license 1940 and 1980 Act 
Companies only if they do not elect to be taxed as regulated investment 
companies under section 851 of the Internal Revenue Code. The same 
criteria would be applied to existing Licensees seeking to convert to 
1940 Act or 1980 Act Companies. This reflects current program policy in 
the licensing area, and is being formalized because the tax code 
conflicts with the distribution regulations applicable to Participating 
Securities as mandated by the Act, and with SBIC program accounting 
guidelines that limit other profit distributions to the amount of a 
Licensee's Retained Earnings Available for Distribution. Such 
distribution regulations are designed to reduce risk to SBA by 
protecting its investment or creditor position.
c. SBIC management
    Proposed Sec. 107.130 would continue the general requirement in 
current Sec. 107.101(a) that each Licensee must have qualified 
management approved by SBA. However, two changes are proposed. First, 
the specific requirement that the manager be ``available to the public 
during normal business hours'' would be eliminated, giving Licensees 
greater flexibility in their management arrangements. Second, each 
Licensee would be required to designate at least one individual as the 
official responsible for contact with SBA. This change would allow SBA 
to address communications to a specific person, who would be 
responsible for routing information to the appropriate persons within 
the Licensee's organization.
d. SBA approval of initial Management Expenses
    Under proposed Sec. 107.140, all new license applicants would be 
required to obtain SBA approval of their initial Management Expenses. 
Currently, SBA approves initial Management Expenses only if an 
applicant plans to issue Participating Securities, or if an applicant 
plans to issue Debentures and utilizes an Investment Advisor/Manager. 
Otherwise, SBA approves only management compensation. With the proposed 
change, SBA seeks to have consistency in controlling excessive expenses 
of Licensees, regardless of management structure or the type of 
Leverage an applicant expects to issue.
e. Management and Ownership Diversity
    Proposed Sec. 107.150 would require all license applicants planning 
to obtain Leverage to have diversity between management and ownership. 
This represents an expansion of current Sec. 107.241(c), which requires 
such diversity only for applicants that plan to issue Participating 
Securities. SBA's intent in broadening the diversity requirement is for 
all new leveraged Licensees to have investors who are independent of 
management and who have a substantial stake in the Licensee's financial 
performance. The Agency believes that the presence of such investors 
will reduce the potential for self-dealing and help to assure that 
Licensees are operated with the objective of optimizing returns and 
protecting the interests of all investors. Under current 
Sec. 107.241(c), the diversity criteria may be satisfied either by a 
Licensee or by its ``ultimate parent'' (an entity that has an interest 
in the Licensee's Regulatory Capital of more than 50 percent). Proposed 
Sec. 107.150 would not change the diversity criteria, but would require 
them to be satisfied by the Licensee itself unless SBA agreed to accept 
diversity achieved at the parent level as a substitute. The Agency 
believes that it must have this discretion in order to assure that a 
Licensee has genuine diversity between management and ownership, as 
opposed to an ownership structure that provides ``technical'' diversity 
but does not satisfy the intent of the regulation.
    Finally, under proposed Sec. 107.150, any SBIC that was required to 
have diversity in order to be licensed would also have to maintain 
diversity as long as it had outstanding Leverage or Earmarked Assets in 
its portfolio. A Licensee that failed to maintain 

[[Page 58535]]
diversity would have to re-establish it within six months.
f. Special Rules for Partnership Licensees
    Proposed Sec. 107.160(b) would allow an Entity General Partner to 
be organized for the sole purpose of serving as the general partner of 
one or more Licensees. Under the current regulation (Sec. 107.4), an 
entity may serve as the general partner of only one Licensee. The 
proposed change would reduce the expense and administrative burden of 
general partners that Control more than one company in the SBIC 
program.
g. Minimum Capital Requirements
    Proposed Sec. 107.220 would require any company licensed after the 
regulation is finalized to have Regulatory Capital of at least 
$5,000,000 in order to apply for Debentures, unless it demonstrates to 
SBA's satisfaction that it can be financially viable over the long term 
with a lower amount. A review of the financial performance of Licensees 
supports the conclusion that Regulatory Capital below $5 million 
significantly reduces the likelihood of profitable operation over the 
long term. Companies licensed before the effective date of the final 
rule would be grandfathered under proposed Secs. 107.210(a) or (b), or 
Sec. 107.220(c), depending on the date they were licensed.
h. Qualified Non-private Funds
    Proposed Sec. 107.230(d) would broaden the definition of 
``qualified non-private funds'' which may be included in the Private 
Capital of Section 301(d) Licensees. Currently, a nonprofit entity that 
has received state or local government grant funds may invest only the 
income derived from such grant funds in a Section 301(d) Licensee. The 
proposed change would allow a nonprofit entity to invest the principal 
of the grant funds in a Section 301(d) Licensee as long as: (1) the 
nonprofit entity exercises discretionary authority over such funds, and 
(2) SBA determines that such funds have taken on a private character 
and that the nonprofit entity is not simply acting as a conduit for 
government funds.
i. License Application Fees
    Proposed Sec. 107.300 would raise the license application fee in 
order to reflect the true costs of processing applications and to 
reimburse SBA for such costs. In accordance with applicable statutory 
provisions, the Administration has taken into consideration direct and 
indirect costs to SBA of necessary services performed, value to the 
recipients, the public policy interest served, and other pertinent 
factors involved. The base fee would be raised from $5,000 to $10,000 
for all applicants. There would be a surcharge of $5,000 for a 
Partnership applicant and an additional $5,000 surcharge for an 
applicant planning to issue Participating Securities. Thus, a 
Partnership applicant that intends to issue Participating Securities 
would pay a fee of $20,000.

4. Subpart D--Changes in Ownership, Control or Structure of Licensee; 
Transfer of License

a. Fees for Transfer of Control or Change in Form of Organization
    Proposed Sec. 107.410 would raise the processing fee for an 
application to transfer Control of a Licensee from $5,000 to $10,000. 
The fee would be the same as the base amount charged for a new license 
application, as discussed under subpart C. Proposed Sec. 107.470 would 
require a $5,000 processing fee for a change in a Licensee's form of 
organization (from a corporation to a partnership, or vice versa) which 
does not involve a change of Control.
b. Licensees under Common Control
    Under current Sec. 107.602, SBA generally must approve common 
management or ownership of two or more Licensees. Section 301(d) 
Licensees, however, are exempt from this requirement. Proposed 
Sec. 107.460(b) would narrow the exemption, limiting it to a Section 
301(d) Licensee and its parent Section 301(c) Licensee. SBA considers 
this to be an issue of safety and soundness which is equally applicable 
to Section 301(c) and Section 301(d) Licensees.

5. Subpart E--Managing the Operations of a Licensee

a. Identification as a Licensee
    Under current Sec. 107.704, a Licensee must identify itself to the 
public as ``A Federal licensee under the Small Business Investment Act 
of 1958'' on all written communications. Proposed Sec. 107.501 would 
limit this requirement only to Financing documents (commitment letters, 
closing documents, etc.), where SBA believes the requirement is most 
meaningful. This change would accommodate the increasing number of 
Licensees that utilize Investment Advisor/Managers, by allowing such 
managers to handle correspondence on behalf of Licensees using their 
own letterhead.
b. Responsibility for Licensee's Valuations
    Current Sec. 107.101(g)(1) states that a Licensee's board of 
directors or general partners shall have ``sole responsibility'' for 
valuing the Licensee's Loans and Investments. This regulation was not 
intended to mean that SBA would abandon its obligation as a regulatory 
agency to exercise oversight over this critical area of a Licensee's 
operations. Therefore, proposed Sec. 107.503(c) would clarify SBA's 
original intention by stating that the board of directors or general 
partners are solely responsible for using the Licensee's approved 
valuation policy to prepare the Licensee's valuations of its Loans and 
Investments for submission to SBA. The Agency would reserve the right 
to review or independently establish valuations.
c. Facsimile Receiving Capability
    Proposed Sec. 107.505 would require Licensees to be capable of 
receiving fax messages 24 hours a day. In order to make the most 
efficient use of limited resources, most communications from SBA to 
SBICs are done at night through broadcast faxes.
d. Internal Control
    Current Sec. 107.100 contains many specific requirements concerning 
internal control procedures and the safeguarding of a Licensee's 
assets. Under proposed Sec. 107.506(a), the requirements for dual 
control over cash disbursements and securities (or alternative bond 
coverage) would be eliminated. The general requirement that Licensees 
adopt a plan to safeguard their assets and maintain an adequate 
internal control environment would remain. SBA believes that proper 
safeguards and controls are essential if Licensees are to operate 
soundly and profitably, but that Licensees themselves are in the best 
position to determine the appropriate procedures.
e. SBA Approval of Contract With Investment Adviser/Manager
    Proposed Sec. 107.510 would require SBA's prior approval of a 
contract with an Investment Adviser/Manager only for Licensees that 
have Leverage or plan to seek Leverage. Prior approval is currently 
required for all Licensees. SBA considers this provision to be 
unnecessary when the Agency has no financial interest to protect.
    Although it is not addressed in the regulations, SBA's current 
policy concerning a Licensee's contract with an Investment Adviser/
Manager requires that such contracts contain a provision allowing for 
termination, without 

[[Page 58536]]
penalty to the SBIC, on not more than 60 days notice (see SBA Policy 
and Procedural Release #2001). SBA intends to eliminate this 
requirement because it believes that such a provision is a matter for 
negotiation between the two parties.
f. Management Expenses
    Current Sec. 107.241(d) requires Licensees with Participating 
Securities or Earmarked Assets to have their Management Expenses 
approved by SBA at the time of licensing and before any proposed 
increases in such expenses. Proposed Sec. 107.520, together with 
proposed Sec. 107.140 (discussed above), would extend this requirement 
to Licensees with any type of outstanding Leverage. Under proposed 
Sec. 107.520(c), a leveraged Licensee whose Management Expenses had not 
already been approved by SBA would be required to submit such expenses 
for approval with its SBA Form 468 for its first fiscal year ending 
after the effective date of the final rule. SBA believes that this 
review of the expenses of leveraged Licensees is consistent with its 
obligation to ensure the safety and soundness of the SBIC program.
    In evaluating the expenses of Licensees, particularly those that 
have been in the program for some time, SBA does not intend to impose 
any specific expense ceiling or formula. Rather, the Agency will 
compare Licensees with similar profiles to determine whether a Licensee 
is out of line with its peers in terms of its operating costs.
    SBA is also proposing a non-substantive change in the definition of 
Management Expenses. This proposed rule would delete language from the 
definition (currently found in Sec. 107.3) which states that Management 
Expenses do not include ``the cost of services provided by any 
Associate of the Licensee which are not part of the normal process of 
making and monitoring venture capital financings.'' This language is 
found in the Act and SBA does not intend to change the meaning of 
Management Expenses as a result of the deletion. Rather, SBA believes 
that this exclusion is encompassed in proposed Sec. 107.520(b), which 
excludes from Management Expenses the cost of services provided by 
``specialized outside consultants, outside lawyers and independent 
public accountants, if they perform services not generally performed by 
a venture capital company.'' As SBA interprets this provision, 
``outside'' consultants and lawyers may be Associates of the Licensee, 
so it is not necessary to include a separate provision dealing with 
Associates in the regulations.
g. Limitations on Third-party Debt
    Under current Sec. 107.210(f)(6), Licensees with outstanding 
Leverage must obtain SBA's prior written approval before incurring 
secured third-party debt. Under proposed Sec. 107.550(a), expansion of 
the scope of a security interest or lien associated with existing debt 
would also require SBA approval. This proposal is intended to address 
SBA's concern about situations in which SBICs have given blanket liens 
on all their assets to third-party creditors, even when the amount of 
money borrowed is very small by comparison.
    A similar concern underlies proposed Sec. 107.550(c), which states 
specifically that SBA would look unfavorably upon any request involving 
a blanket lien on all assets, or a security interest in the Licensee's 
unfunded investor commitments in excess of 1.25 times the amount to be 
borrowed. Under proposed Sec. 107.550(d), proposed borrowings would 
qualify for expedited approval by SBA only if the security interest 
given were limited either to the assets acquired with the borrowed 
funds or to an asset coverage ratio of no more than 1.25 to 1.
h. Activity Requirement
    Proposed Sec. 107.590 would revise the test used to determine 
whether an SBIC is actively making Financings. The current test is 
based upon the amount of Financings made over an 18-month period 
relative to a Licensee's average idle funds balance for the period. 
With the change in the Act made in 1992 that recognized commitments 
from Institutional Investors as part of a Licensee's Regulatory 
Capital, along with associated ``lockstep'' takedowns of Leverage, most 
new SBICs take down funds only when needed, and make distributions to 
their investors as they realize income or gains on their portfolios. 
Thus, very little idle funds would be maintained by Licensees.
    Proposed Sec. 107.590(a) would institute a two-part activity test. 
In order to be considered active, a Licensee could have no more than 20 
percent of its total assets in idle funds at the end of its fiscal 
year, and must have invested an amount equal to at least 20 percent of 
its Regulatory Capital over the previous 18 months. In Sec. 107.590(b), 
there would be recognized exemptions to the activity tests, taking into 
account the chronological unevenness of investing and profit-taking by 
SBICs. For example, a Licensee may have excess idle funds at the end of 
its fiscal year because it recently received Leverage, raised 
additional capital, or liquidated an investment.
    Under proposed Sec. 107.590(c), the activity requirements would be 
inapplicable to any Licensee that has filed a ``Wind-up Plan'' approved 
by SBA. Such a Licensee would no longer be making investments other 
than follow-on Financings of existing portfolio companies. This new 
provision accommodates the normal operating pattern of a limited-life 
investment company.
    Proposed Sec. 107.590(d) would provide a phase-in period for the 
new activity requirements above. During such period, any Licensee that 
is in compliance with the current regulation would be considered 
active.
    The activity requirements would also be affected by the proposed 
change in the definition of ``Financing'' that is discussed under 
Subpart A. As a result of this change, Licensees would no longer be 
able to meet the activity test by making commitments to invest in Small 
Businesses; only actual investments (and guarantees) would count.

6. Subpart F--Record keeping, Reporting, and Examination Requirements 
for Licensees

a. Record Keeping Requirements
    For Licensees with more than one business location, proposed 
Sec. 107.600(b) would clarify that records relating to an individual 
Financing transaction may be kept at the branch with primary 
responsibility for the transaction. For all Licensees, paragraph (b)(3) 
would clarify that a Licensee's securities may be held in a safe 
deposit box or by a licensed securities broker, provided the securities 
are covered by the broker's insurance.
    Current Sec. 107.1002(b)(1) requires a Licensee to preserve certain 
business and accounting records for a period of 20 years. Proposed 
Sec. 107.600(c)(1) would reduce the period to 15 years for a 
corporation or two years beyond the date of liquidation for a 
partnership. SBA believes that shorter time periods are adequate to 
protect the Agency's interests.
    Proposed Sec. 107.610 includes two new documentation requirements 
for Loans and Investments. Paragraph (c) would implement a recent 
change in the Act by requiring a Section 301(d) Licensee to have a 
completed ``Financing Eligibility Statement'' (SBA Form 1941) for each 
Financing, certifying that the concern being financed is a 
Disadvantaged Business. Paragraph (d) would require each concern being 
financed to certify its intended use of the financing 

[[Page 58537]]
proceeds. This change is intended to make it easier for Licensees to 
satisfy Sec. 107.620 (the equivalent of current Sec. 107.304(b)), which 
requires that information be obtained regarding a Small Business's 
intended use of Financing proceeds.
b. Insurance Requirement for Independent Public Accountants
    Proposed Sec. 107.630(a)(2) would require all accountants who 
perform audits of SBICs to carry errors and omissions insurance or be 
self-insured with a net worth acceptable to SBA. The Agency is 
proposing this change because, in a number of instances, substandard 
audits have resulted in a misleading presentation of a Licensee's 
financial condition. The change would create a source of recovery for 
monetary damages in the event SBA or the SBIC were injured as a result 
of an auditor's negligence. SBA recognizes that the regulation, as 
proposed, does not provide adequate guidance, particularly as far as 
the amounts of insurance or net worth that would be ``acceptable to 
SBA.'' The Agency strongly encourages Licensees, accountants, and other 
interested parties to submit any suggestions on this topic.
c. SBA Access to Accountant's Work Papers
    Proposed Sec. 107.691 would require the agreement between a 
Licensee and the independent public accountant performing its annual 
audit to allow SBA personnel, including examiners, to have access to 
the accountant's work papers. Although SBA does not expect to review 
accountants' work papers on a routine basis, the Agency believes that 
it needs such access to carry out its regulatory oversight function.
d. Examination Fees
    Proposed Sec. 107.692(a) would increase the examination fees 
charged to SBICs. Fees would continue to be assessed based on total 
assets of the Licensee, but at higher rates as shown in the table 
included in the proposed rule. The proposed fee schedule was designed 
to produce total revenue sufficient to cover the current direct costs 
to SBA of conducting examinations. The change would help to sustain the 
examination function, which is a key element in maintaining the 
integrity of the SBIC program.
    Proposed Sec. 107.692 would reflect inflation and the actual costs 
of delay to SBA, by increasing from $250 to $500 per day the fee 
imposed if an examination is delayed due to a Licensee's lack of 
cooperation or based on the condition of its records. Licensees are 
required to cooperate with SBA's examination; Licensees are also 
required to maintain their records in a reasonable and businesslike 
manner. This section is designed as an incentive to SBICs to cooperate 
with the examination and to compensate SBA for costs incurred if they 
do not.

7. Subpart G--Financing of Small Businesses by Licensees

a. Financings of Smaller Businesses
    Although proposed Sec. 107.710 contains approximately the same 
wording as current Sec. 107.101(i), the requirement to finance Smaller 
Businesses would be affected by the proposed change in the definition 
of ``Financing.'' As discussed under Subpart A, this term would no 
longer include commitments to make investments. Thus, only actual 
loans, investments, or guarantees would be counted when measuring the 
amount of ``Financing'' extended to Smaller Businesses.
    Another change is proposed in Sec. 107.710(e), which deals with 
Licensees that have not achieved the required percentage of Financings 
to Smaller Businesses. The current regulation states that such 
Licensees may provide Financing only to Smaller Businesses until they 
are in compliance. The proposed rule would allow greater flexibility, 
requiring only that such Licensees reach the required percentage by the 
end of their next fiscal year.
b. Passive Businesses
    Existing Sec. 107.901(f) prohibits the Financing of passive 
businesses; however, the term ``passive'' is inadequately defined. 
Proposed Sec. 107.720(b) would provide more specific criteria. For 
example, the proposed rule would clarify that a business is passive if 
its employees are not making the day to day operating decisions of the 
company, or if it passes substantially all of the Financing proceeds 
through to another entity. The proposed changes are consistent with the 
public purpose of the SBIC program, which is to provide capital to 
operating small businesses to stimulate the economy and create jobs.
c. Real Estate Investments
    Financing of most real estate leasing and development activities is 
prohibited or restricted under current Secs. 107.901(c) and 107.101(c) 
since SBA considers that the Section 504 program is specifically 
designed to finance real estate. In addition, most real estate 
investments tend to be ``project''-oriented rather than the financing 
of an on-going long-term business. Proposed Sec. 107.720(c) would 
recognize these realities by narrowing the range of permitted real 
estate-related financing. Financing of real estate subdividers and 
developers (who subdivide and improve building lots), and of 
``operative builders'' (who build homes or other buildings) would be 
prohibited. Currently, these activities are permitted, though only on a 
limited basis (see current Sec. 107.101(c)). The section would also 
prohibit financing of businesses that buy real estate for the purpose 
of improving and reselling it, an activity currently permitted under 
Sec. 107.901(c)(2)(ii).
    However, the Financing of the acquisition of real estate by an 
operating concern for its own use would still be permitted, and the 
restrictions in current Sec. 107.101(c) that limit investment in 
companies that operate hotels and motels would be removed.
d. Project Financing
    Proposed Sec. 107.720(d) would prohibit project financing (such as 
dams, oil and gas wells, and motion pictures). Although this 
prohibition does not appear in the current regulations, it has been in 
effect as a matter of policy for more than ten years, reflecting SBA's 
view that project financing is essentially short-term in nature and is 
inconsistent with the goals of the Act. An investment is considered 
project financing if the assets of the business are reduced as the life 
of the business progresses (as opposed to a continuing business that 
regularly replenishes its inventory, for example) and the business 
provides a stream of cash payments to its investors or lenders as 
assets are sold (for example, payments made as oil is pumped from a 
well and sold). An investment is also considered project financing if 
its major purpose is to fund production of a specific item (such as a 
motion picture), over a limited period of time, by a company whose 
major activity consists of such production. The company need not have 
been formed for the specific purpose of carrying out the project, 
although this is often the case.
e. Foreign Investment
    The current Sec. 107.901(e) requires at least 51 percent of the 
``assets and activities'' of a Financed Small Business to remain within 
the United States. The term ``assets and activities'' has never had a 
definitive interpretation. Proposed Sec. 107.720(g) would clarify the 
restriction on foreign investment by requiring at least 60 percent of 
the employees and at least 60 percent of the tangible assets to remain 
within the United States for one year after the Financing unless the 
SBIC can demonstrate, to SBA's satisfaction, 

[[Page 58538]]
that the proceeds were used for a specific domestic purpose.
f. Conflicts of Interest
    Proposed Sec. 107.730(a)(4) would permit a Licensee to provide 
financing that the Small Business will use to repay an obligation to a 
Lending Institution that is an Associate of the Licensee, provided the 
obligation was incurred in the normal course of business. The current 
requirement that such obligations be short-term would be removed, in 
order to give Small Businesses greater flexibility in meeting their 
financing needs.
    Proposed Sec. 107.730(d) would replace the current rules on ``Joint 
Financings with Associates'' (which cover investments by a Licensee and 
its Associate that take place no more than 6 months apart) with new 
provisions on ``Financings with Associates'' (which cover all 
situations in which a Licensee and its Associate finance the same Small 
Business, regardless of when each party invests). The basic requirement 
for such Financings is that a Licensee be able to demonstrate that the 
terms and conditions are fair and equitable to the Licensee (paragraph 
(d)(2)). This reflects SBA's fundamental concern that a Licensee not be 
disadvantaged relative to its Associates when these parties co-invest. 
The proposed regulation would also establish certain categories of 
Financings with Associates that would require SBA's prior written 
approval (paragraph (d)(1)), and other categories that would be exempt 
from such requirement (paragraph (d)(3)).
    In addition to the specific changes proposed, Sec. 107.730 would 
also be affected throughout by the proposed changes in the definition 
of ``Associate'' that are discussed under Subpart A.
g. Overline Limitation
    Under current Sec. 107.303(c), a Licensee may increase its 
``overline'' limit (the maximum amount it is permitted to invest in any 
one company) if it has net unrealized appreciation on ``marketable 
securities.'' Proposed Sec. 107.740 contains the same rule, but would 
replace the term ``marketable'' with the very similar defined term 
``Publicly Traded and Marketable'' used elsewhere in the regulations. 
The only effect of the change would be on the number of market makers 
that a non-listed stock must have in order to qualify (two under the 
proposed rule, compared with three under the current rule).
h. Definition of ``Equity Securities''
    Under proposed Sec. 107.800(b), an apparent equity financing would 
be considered Debt Financing for regulatory purposes if the Financing 
agreement included covenants or compliance provisions with remedies 
typical of debt, such as acceleration. This change is consistent with 
current SBA policy, under which the Agency looks to the substance of an 
investment rather than its form in order to determine whether it is 
debt disguised as equity.
    Under the current regulation, securities that the Small Business 
must redeem at a fixed price are classified as Debt Securities rather 
than equity. Under proposed Sec. 107.800(b) in combination with 
Sec. 107.850(b), this provision would remain in effect with one 
clarification: If the fixed redemption price is no higher than the 
amount the Licensee originally paid for the security, then the security 
would still qualify as an Equity Security.
    As used in proposed Sec. 107.850(b), ``redemption price'' includes 
all amounts that the Small Business is required to pay at redemption, 
including accumulated dividends. Thus, if a Licensee purchased the 
preferred stock of a Small Business for $500,000, and the Financing 
agreement required the Small Business to pay $500,000 at the time of 
redemption, the Licensee's investment would be considered an Equity 
Security. However, if the required payment at the time of redemption 
was $500,000 plus cumulative dividends of 8 percent per year, the 
investment would be considered a Debt Security.
i. Options Received from Small Businesses
    Proposed Sec. 107.815(a) would require a Licensee to pay some 
consideration (even if only $1) for any options acquired from a Small 
Business, in order to establish a basis for such options.
    Proposed Sec. 107.815(b) would restrict the ability of a Licensee's 
employees, officers, directors, or general partners to receive options 
in a Small Business financed by the Licensee. Such persons could 
receive options only if they participated in the Financing on the same 
terms and conditions as the Licensee or if approved by SBA. The Agency 
believes that officers and partners of SBICs should share in the 
overall profits of an SBIC, but should not have special beneficial side 
deals.
j. Guarantees of the Obligations of Small Businesses
    Proposed Sec. 107.820 would delete two provisions from the current 
rules on guarantees. Current Sec. 107.401(a)(6), which permits a 
Licensee to guarantee a Small Business's obligation to an Associate if 
approved by SBA under the rules governing conflicts of interest, would 
be eliminated. This type of arrangement is covered in the conflict of 
interest provisions and does not need to be repeated in this section. 
The second proposed change is that guarantees would no longer be 
limited to 100 percent of Regulatory Capital. Guarantees are considered 
Financings and are included in a Licensee's overline computation, since 
the risk to the Licensee is the same whether a cash investment is made 
or whether a guarantee is utilized. Thus, SBA should not have a 
preference for one type of Financing over another, so long as a Small 
Business benefits.
k. Fees Paid to Associate Underwriters
    Proposed Sec. 107.828(c) would allow an underwriter who is an 
Associate of a Licensee to receive fees from Licensees that purchase 
securities in an initial public offering, including the Licensee with 
which it has the Associate relationship. However, if the underwriter 
and the Licensee are Associates, the total fees or charges paid by the 
Licensee may not exceed the total of the application and closing fees 
and reimbursable expenses permitted by proposed Sec. 107.860. The 
current regulations prohibit an underwriter who is an Associate of a 
Licensee from receiving fees from any Licensee, and thus effectively 
requires Licensees to purchase from non-Associate underwriters. This 
proposed regulation recognizes the risks involved in underwriting and 
allows an underwriter to be compensated.
l. Minimum Term of Financings
    Under proposed Sec. 107.830(b), the entire portfolio of a Section 
301(d) Licensee could consist of Financings with a minimum term of four 
years instead of five. Currently, such Financings are limited to 50 
percent of a Section 301(d) Licensee's portfolio. This change is 
intended to give Section 301(d) Licensees greater flexibility in 
structuring their Financings.
    Currently, short-term Financings permitted under Sec. 107.403 are 
limited, in the aggregate, to 20 percent of a Licensee's ``total 
adjusted assets'' (total assets minus outstanding Leverage and current 
liabilities). Proposed Sec. 107.835 would remove this limitation for 
most types of permitted short-term Financings. For short-term 
Financings of changes of ownership in a Small Business, the limit would 
be set at 20 percent of total Loans and Investments (at cost). SBA is 
proposing these changes to give Licensees greater flexibility to 
respond to the needs of 

[[Page 58539]]
Small Businesses. However, Licensees should bear in mind that the 
purpose of the SBIC program, as stated in the Act, is to provide equity 
capital and long-term loan funds to Small Businesses. Thus, Licensees 
should not plan to have the bulk of their portfolios in short-term 
investments; to do so would constitute engaging in activities not 
contemplated by the Act.
m. Amortization of Loan Principal
    Proposed Sec. 107.845 would establish uniform amortization rules 
for all Loans and Debt Securities. This change would eliminate the 
accelerated amortization of principal permitted, to a limited extent, 
under current Sec. 107.403(b)(2). SBA considers straight-line 
amortization to be fair to both Licensees and Small Businesses, 
particularly when coupled with the right of Small Businesses to prepay 
loans voluntarily at any time.
n. Redemption of Equity Securities
    Proposed Sec. 107.850 would provide certain exceptions to the 
general rule that Equity Securities cannot be redeemed in less than 
five years. Earlier redemption would be allowed if the Small Business 
makes a public offering, incurs a change of management or control, 
files for bankruptcy protection, or materially breaches the Financing 
agreement. In addition, when a Licensee makes a follow-on investment, 
the minimum redemption period would be counted from the date of the 
first closing, so that the follow-on Financing could be redeemed in 
less than five years.
o. Cost of Money
    Under proposed Sec. 107.855, SBA's Cost of Money rules would be 
substantively revised in some respects and clarified throughout. 
Paragraph (c) would raise the minimum Cost of Money ceiling for a Loan 
from 15 percent to 19 percent, allowing an SBIC that does not receive 
any equity interest in a firm to charge a higher interest rate 
commensurate with risk. The minimum ceiling for a Debt Security would 
remain unchanged at 14 percent.
    Proposed Sec. 107.855(d) would allow Licensees to recalculate their 
``Cost of Capital'' quarterly rather than annually. The proposed term 
``Cost of Capital'' replaces the current unwieldy term ``Weighted 
Average Cost of Qualified Borrowing.'' Paragraph (e) would reduce the 
paperwork burden by eliminating the current requirement for Licensees 
to submit their Cost of Capital computations to SBA. However, SBICs 
would have to document such computations and make them available for 
SBA's review, upon request.
    SBA is aware that many private firms do not want to give up any 
equity at all to outside shareholders, yet would like to grow faster 
than retained earnings would allow. At the same time, an SBIC must 
achieve an equity type return if it is taking equity type risks. To 
accommodate these needs, proposed Sec. 107.855(g) would permit a 
Licensee to receive a one-time ``bonus'' from a Small Business at the 
end of the term of a Debt Financing in lieu of an equity participation, 
and to exclude such a bonus from the Cost of Money if it meets the 
criteria in proposed Sec. 107.855(i). Paragraph (g) also explicitly 
sets forth the fees and expenses that are excluded from Cost of Money 
calculations; currently, these exclusions are found in the definition 
of Cost of Money in Sec. 107.3.
    Finally, proposed Sec. 107.855(h) would eliminate a great deal of 
current confusion over how to make the calculations that determine 
whether an SBIC is in compliance with Cost of Money ceilings. This 
paragraph would require that the evaluation of compliance with a Cost 
of Money ceiling always be performed on a discounted cash flow basis, 
based solely upon actual cash outflows and inflows.
p. Financing Fees Charged to Small Businesses
    Proposed Sec. 107.860 would replace the ``processing fee'' that a 
Licensee may charge under current Sec. 107.402 with an ``application 
fee'' and ``closing fee'' that are very easy to administer. A Licensee 
would be able to charge a nonrefundable one percent application fee to 
review a Financing application, and a two percent (for Loans) or four 
percent (for Debt or Equity Securities) closing fee when it actually 
disburses funds to a Small Business. All the complex provisions in the 
current regulation concerning the circumstances under which a 
processing fee must be partially or fully refunded would be eliminated.
q. Control of a Small Business
    Proposed Sec. 107.865 would modify the restrictions on Control of a 
Small Business by a Licensee. As in the current regulations, paragraph 
(b) of the proposed section would establish a presumption of Control 
based on a Licensee's percentage of ownership. However, proposed 
paragraph (c) would allow the presumption of Control to be rebutted if 
the management of the Small Business owns at least 25 percent of the 
voting securities and can elect at least 40 percent of the board of 
directors (and Licensees and their Associates can elect no more than 40 
percent). By defining conditions under which Licensees can avoid the 
time-consuming process of seeking a waiver from SBA, this provision is 
intended to make it easier for Licensee to co-invest with non-SBIC 
investors.
    Proposed paragraph (d) would expand the circumstances under which a 
Licensee may take temporary Control of a Small Business to include the 
following: (1) If the Small Business has materially breached the 
Financing agreement; (2) if there has been during the past two years, 
or will be as a result of the Financing, a substantial change in the 
Small Business's operations or products, and the Licensee (or investor 
group including the Licensee) is the concern's major source of capital; 
or (3) if the Financing is a Start-up Financing, and the Licensee (or 
investor group including the Licensee) is the concern's major source of 
capital. These changes are intended to encourage investment by giving 
Licensees an increased ability to protect their investment positions, 
particularly in high-risk areas such as start-ups.
    Proposed Sec. 107.865(d) would eliminate the current requirement to 
file a plan of divestiture when a Licensee takes temporary Control of a 
concern. Instead, a Licensee would file a ``Control certification'' 
stating the date on which it took Control and the reason for its 
action, and the Licensee's agreement to relinquish Control within five 
years. SBA is persuaded that the typical plan of divestiture represents 
nothing more than guesswork as to future events, and therefore serves 
no practical purpose.
r. Assets Acquired in Liquidation of Portfolio Securities
    Proposed Sec. 107.880(b)(2) would eliminate the prior approval 
requirement for reasonably necessary expenditures to improve acquired 
assets and make them salable, as long as an overline does not occur as 
a result. Paragraph (c) would limit the prior approval requirement for 
expenditures involving overlines to leveraged Licensees only. SBA 
believes that these changes will not adversely affect the Agency's 
financial interests and will reduce the regulatory burden on Licensees.
s. Management Services Provided to Small Businesses
    SBA is proposing to liberalize the rules governing management 
services provided to a Small Business. Under proposed Sec. 107.900, a 
Licensee could provide management services to a Financed Small Business 
without SBA's prior approval, as long as the contract met the criteria 
in Sec. 107.900(a). The 

[[Page 58540]]
proposed regulation would not apply at all to services provided to a 
Small Business not financed by the Licensee; SBA believes that in such 
cases, any agreement between the parties is likely to be a true arm's-
length transaction, in which the Small Business does not require any 
special protections.
    Proposed Sec. 107.900(e) would allow Licensees to charge reasonable 
``transaction fees'' for services performed in connection with a public 
or private offering made by the Small Business or the sale of all or 
part of the business. In addition, this paragraph generally would allow 
an Associate of the Licensee to charge market rate investment banking 
fees to a Small Business in connection with Financing provided by 
anyone other than the Licensee.

8. Subpart H--Non-Leveraged Licensees--Exceptions to Regulations

    The primary purpose of certain regulations is to protect the 
government's interest as a creditor or investor in a Licensee. If a 
Licensee does not have outstanding Leverage and has no plans to seek 
Leverage, the safeguards provided by many regulations are unnecessary.
    Proposed Sec. 107.1000 would provide a consolidated listing of 
those regulatory provisions from which a non-Leveraged Licensee would 
be exempt. This section would include provisions in the current 
regulations such as those relating to portfolio diversification 
(overline) and deposits of idle funds. It would also include several 
provisions that appeared in a proposed rule published in the Federal 
Register on February 7, 1994 (59 FR 5552). That proposed rule is hereby 
withdrawn.
    Proposed Sec. 107.1000(a)(4) would exempt non-leveraged Licensees 
from the limitations on expenses incurred to maintain or improve assets 
acquired in liquidation of portfolio securities (see proposed 
Sec. 1007.880).
    Paragraph (b)(1) would allow non-leveraged Licensees to reduce 
their Regulatory Capital by more than two percent per year without SBA 
approval (see proposed Sec. 107.585).
    Paragraph (b)(2) would permit non-leveraged Licensees to dispose of 
assets to an Associate without SBA approval (see proposed 
Sec. 107.885).
    Paragraph (b)(3) would allow non-leveraged Licensees to contract 
with an Investment Adviser/Manager without SBA approval; Licensees 
would only be required to notify SBA of the compensation paid under the 
contract (see proposed Sec. 107.510).
    For ease of reference, proposed Sec. 107.1000 would incorporate the 
current exemptions for non-leveraged Licensees from the rules governing 
overline investments, third party debt, and idle funds. Regarding the 
investment of idle funds, proposed Sec. 107.1000(a)(2) states that non-
Leveraged Licensees are exempt from the restrictions in Sec. 107.530, 
provided they do not engage in activities not contemplated by the Act. 
SBA is proposing this language in order to emphasize that a licensed 
SBIC, whether leveraged or not, must be formed for the purpose of 
making long-term investments in Small Businesses. It is not appropriate 
under the Act, for example, for a non-leveraged Licensee to invest its 
``idle funds'' in commodities futures or financial derivatives to the 
extent that such investing becomes a major component of its operations.

9. Subpart I--SBA Financial Assistance for Licensees (Leverage)

a. Eligibility for Leverage
    Under proposed Sec. 107.1120(a), with respect to determining 
eligibility for Leverage, a Licensee that had invested at least 50 
percent of its Leverageable Capital would be presumed to lack 
sufficient funds for investment only in connection with its first 
takedown of Leverage. Currently, the presumption applies to all 
issuances of Leverage and refers to the investment of ``50 percent of 
Leverageable Capital and outstanding Leverage.'' Regardless of how this 
ambiguous wording is interpreted, SBA believes the presumption is not 
appropriate for later takedowns of Leverage, since a Licensee could be 
presumed eligible while having a significant dollar amount of 
uninvested capital.
b. Eligibility For Fourth Tier of Leverage and Second Tier of Preferred 
Securities
    Proposed Secs. 107.1160 (c) and (d) would eliminate the current 
minor distinctions between the types of investments needed for a 
Section 301(d) Licensee to qualify for a fourth tier of Leverage 
(currently, ``Venture Capital Financings'') and for a second tier of 
Preferred Securities (currently, ``Qualified Investments''). The change 
is intended to simplify the process of establishing and maintaining the 
required investment amounts and ratios by substituting a single 
category of qualifying investments (to be called ``Venture Capital 
Financings'') for use in determining eligibility for both types of 
Leverage. The proposed definition of Venture Capital Financing would 
include equity securities and those debt securities that are unsecured 
and subordinated to all other borrowings of the issuer.
c. SBA Leverage Commitment to Licensees
    Proposed Sec. 107.1200 would reduce the minimum amount of a 
Leverage commitment from $1 million to $500,000; proposed Sec. 107.1230 
would make the same reduction in the minimum amount of a Licensee's 
draw request. These changes are intended to give Licensees greater 
flexibility and to recognize the current limitations on the 
availability of Leverage funds.
d. Earmarked Profit computation for Participating Securities issuers
    Proposed Sec. 107.1510 would simplify the computation of Earmarked 
Profit (Loss) for Participating Securities issuers that have both 
Earmarked Assets and non-Earmarked Assets in their portfolios 
(currently, there are no such Licensees). The proposed regulation would 
replace requirements to identify whether certain revenues and expenses 
are specifically attributable to Earmarked or non-Earmarked Assets with 
a simpler percentage allocation system. Capital gains and losses would 
continue to be classified as Earmarked or non-Earmarked based on the 
specific assets from which they are derived.
e. Computation of the Profit Participation Rate for Participating 
Securities Issuers
    Proposed Sec. 107.1530(e) would clarify the method of computing the 
ratio of Participating Securities to Leverageable Capital (the ``PLC 
ratio''), which a Participating Securities issuer uses in determining 
SBA's Profit Participation Rate for a particular distribution. The 
current regulation does not always produce a definitive answer when a 
Licensee increases its Leverageable Capital. The proposed rule also 
would add a ``lockout period'' of 120 days before the date as of which 
Profit Participation is computed; increases in Leverageable Capital 
within that period could not be used to reduce the PLC ratio. SBA 
considers this change necessary to protect the Agency from a sharp 
decrease in its Profit Participation when a Licensee increases its 
capital shortly before performing its distribution calculations.
    Proposed Sec. 107.1530(g)(2) would make a technical correction in 
the method of time weighting outstanding issuances of Participating 
Securities for the purpose of indexing the Profit Participation Rate. 
The current method incorrectly causes the Profit Participation Rate to 
go to zero after all 

[[Page 58541]]
Participating Securities have been redeemed.
f. ``Payment Dates'' for Participating Securities
    This proposed rule would add the defined term ``Payment Dates'' to 
the regulations for issuers of Participating Securities, reflecting the 
terms of the public fundings of Participating Securities that have 
already taken place. Payment Dates have been established as each 
February 1, May 1, August 1, and November 1 during the term of a 
Participating Security, and represent the dates on which Trust 
Certificate holders receive interest payments and any returns of 
principal to which they are entitled. To accommodate this structure, 
Participating Securities issuers would be permitted to make 
distributions only on Payment Dates. SBA recognizes, however, that 
there is one situation in which this arrangement may present 
difficulties for Licensees, and is requesting comments and suggestions 
to help resolve the following issue:
    Under proposed Sec. 107.1550 (equivalent to current 
Sec. 107.245(b)), a partnership Licensee may make an annual ``tax 
distribution'' to its private investors and SBA. The recipients of this 
distribution may or may not be taxable investors. However, for those 
who are taxable and need to receive cash in order to pay taxes by the 
April 15 filing deadline, the timing of the Payment Dates may present a 
problem: For a Licensee with a December 31 fiscal year end, it is 
unlikely that a distribution based on audited year end figures could be 
made as early as February 1; on the other hand, the next Payment Date 
(May 1) is after the tax filing deadline. SBA is willing to consider an 
exception that would permit a tax distribution to be made on a date 
other than a Payment Date, but is asking interested parties to assist 
the Agency in developing an effective approach.

10. Subpart J--Licensee's Non-Compliance with Terms of Leverage

a. Capital Impairment Computation
    The determination of a Licensee's Capital Impairment would be 
clarified in two ways. In the computation of Adjusted Unrealized Gain 
for Capital Impairment purposes, proposed Sec. 107.1840(d)(3) would 
clarify that a Licensee claiming unrealized appreciation on non-
Publicly Traded and Marketable Securities based on subsequent rounds of 
equity financing at a higher price (``Class 2 Appreciation'') must 
substantiate, to SBA's satisfaction, that such appreciation meets the 
required criteria. Proposed Sec. 107.1840(d)(6) would require 
unrealized gains on securities that are pledged or encumbered to be 
reduced by the amount of the related borrowing or other obligation. 
These changes reflect current SBA policy in the administration of the 
Capital Impairment regulations.

Compliance With Executive Orders 12612, 12778, and 12866, the 
Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork 
Reduction Act (44 U.S.C. Ch. 35)

    SBA certifies that this proposed rule would not be a significant 
regulatory action for purposes of Executive Order 12866 because it 
would not have an annual effect on the economy of more than $100 
million, and that it would not have a significant economic impact on a 
substantial number of small entities within the meaning of the 
Regulatory Flexibility Act, 5 U.S.C. 601, et seq. The primary purpose 
of the proposed rule is to streamline the regulations governing the 
SBIC program by eliminating obsolete regulations and reorganizing the 
remainder in a more logical and readable format.
    Two areas of the proposed regulations would have some economic 
effect, including possible effects on small entities. First, license 
application fees and examination fees would be raised. An SBIC license 
applicant would pay a fee of $10,000 to $20,000, compared with the 
current $5,000. This increase is not significant relative to the 
private capital of an average Licensee, which exceeds $10 million. Exam 
fees would continue to be based on the total assets of a Licensee, but 
at higher rates. The largest Licensees, generally those with assets of 
at least $25 million, could experience fee increases of $20,000 or 
more; however, the number of such Licensees is currently very small.
    Second, the proposed changes in the regulations governing ``Cost of 
Money'' (the maximum amount a Licensee can charge on loans and debt 
securities) would potentially affect the borrowing costs of small 
entities. Although the interest rate on loans is determined primarily 
by market forces, the proposed rule would raise the interest rate 
ceiling on loans extended by Licensees from 15 percent to 19 percent. 
The total amount of loans provided to small businesses by Licensees is 
approximately $240 million per year. Even if the additional four 
percentage points were charged on the entire balance of such loans, the 
annual economic impact would be less than $10 million.
    For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA 
certifies that this proposed rule, if adopted in final form, would 
contain no new reporting or record keeping requirements that have not 
already been approved by the Office of Management and Budget. The 
``Financing Eligibility Statement'' (SBA Form 1941) which would be 
required under proposed Sec. 107.610 has already been approved by OMB 
under Control Number 3245-0301.
    For purposes of Executive Order 12612, SBA certifies that this rule 
would not have any federalism implications warranting the preparation 
of a Federalism Assessment.
    For purposes of Executive Order 12778, SBA certifies that this rule 
is drafted, to the extent practicable, in accordance with the standards 
set forth in Section 2 of that Order.
    For the reasons set forth above, SBA hereby proposes to amend Part 
107 of Title 13 of the Code of Federal Regulations as follows:
    1. 107.1 through 107.1202 and all center headings are removed the 
authority citation for Part 107 continues to read as set forth below, 
and new subparts A through L are added to read as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

Subpart A--Introduction to Part 107

107.20  Legal basis and applicability of Part 107.
107.30  Amendments to Act and regulations.
107.40  How to read Part 107.

Subpart B--Definition of Terms Used in Part 107

107.50  Definition of terms.

Subpart C--Qualifying for an SBIC License

Organizing an SBIC

107.100  Organizing a Section 301(c) Licensee.
107.110  Organizing a Section 301(d) Licensee.
107.115  1940 Act and 1980 Act Companies.
107.120  Special rules for a Section 301(d) Licensee owned by 
another Licensee.
107.130  Requirement for qualified management.
107.140  SBA approval of initial Management Expenses.
107.150  Management and ownership diversity requirement.
107.160  Special rules for Licensees formed as limited partnerships.

Capitalizing an SBIC

107.200  Adequate capital for Licensees.
107.210  Minimum capital requirements for Licensees.
107.220  Special minimum capital requirements for Licensees issuing 
Leverage. 

[[Page 58542]]

107.230  Permitted sources of Private Capital for Licensees.
107.240  Limitations on accepting non-cash capital contributions.
107.250  Issuance of stock options by Licensees.

Applying for an SBIC License

107.300  License application form and fee.
Subpart D--Changes in Ownership, Control, or Structure of Licensee; 
Transfer of License

Changes in Control or Ownership of Licensee

107.400  Changes in ownership of 10 percent or more of Licensee but 
no change of Control.
107.410  Changes in Control of Licensee (through change in ownership 
or otherwise).
107.420  Prohibition on exercise of ownership or Control rights in 
Licensee before SBA approval.
107.430  Notification to SBA of transactions that may change 
ownership or Control.
107.440  Standards governing prior SBA approval for a proposed 
transfer of Control.
107.450  Notification to SBA of pledge of Licensee's shares.

Restrictions on Common Control or Ownership of Two or More Licensees

107.460  Restrictions on Common Control or ownership of two (or 
more) Licensees.

Change in Structure of Licensee

107.470  SBA approval of merger, consolidation, or reorganization of 
Licensee.

Transfer of License

107.475  Transfer of license.

Subpart E--Managing The Operations of a Licensee

General Requirements

107.500  Lawful operations under the Act.
107.501  Identification as a Licensee.
107.502  Representations to the public.
107.503  Licensee's adoption of an approved Valuation Policy.
107.504  Computer capability requirements of Licensee.
107.505  Facsimile requirement.
107.506  Safeguarding Licensee's assets/Internal controls.
107.507  Violations based on false filings and nonperformance of 
agreements with SBA.
107.508  Accessible office.
107.509  Employment of SBA officials.

Management and Compensation

107.510  SBA approval of Licensee's Investment Adviser/Manager
107.520  Management Expenses of a Licensee.

Cash Management by a Licensee

107.530  Restrictions on investments of idle funds by leveraged 
Licensees.

Borrowing by Licensees From Non-SBA Sources

107.550  Prior approval of secured third-party debt of leveraged 
Licensees.
107.560  Subordination of SBA's creditor position.
107.570  Restrictions on third-party debt of issuers of 
Participating Securities.

Voluntary Decrease in Licensee's Regulatory Capital

107.585  Voluntary decrease in Licensee's Regulatory Capital.

Requirement To Conduct Active Investment Operations

107.590  Licensee's requirement to maintain active operations.
Subpart F--Record keeping, Reporting, and Examination Requirements for 
Licensees

Recordkeeping Requirements for Licensees

107.600  General requirement for Licensee to maintain and preserve 
records.
107.610  Required certifications for Loans and Investments.
107.620  Requirements to obtain information from Portfolio Concerns.

Reporting Requirements for Licensees

107.630  Requirement for Licensees to file financial statements with 
SBA (Form 468).
107.640  Requirement to file Portfolio Financing Reports (SBA Form 
1031).
107.650  Requirement to report portfolio valuations to SBA.
107.660  Other items required to be filed by Licensee with SBA.
107.670  Application for exemption from civil penalty for late 
filing of reports.
107.680  Reporting changes in Licensee not subject to prior SBA 
approval.

Examinations of Licensees by SBA for Regulatory Compliance

107.690  Examinations.
107.691  Responsibilities of Licensee during examination.
107.692  Examination fees.

Subpart G--Financing of Small Businesses by Licensees

Determining the Eligibility of a Small Business for SBIC Financing

107.700  Compliance with size standards in Part 121 of this chapter 
as a condition of Assistance.
107.710  Requirement to finance Smaller Businesses.
107.720  Small Businesses that may be ineligible for Financing.
107.730  Financings which constitute conflicts of interest.
107.740  Portfolio diversification (``overline'' limitation).
107.750  Conditions for financing a change of ownership of a Small 
Business.
107.760   How a change in size or activity of a Portfolio Concern 
affects the Licensee and the Portfolio Concern.

Structuring Licensee's Financing of Eligible Small Businesses: Types of 
Financing

107.800  Financings in the form of Equity Securities.
107.810  Financings in the form of Loans.
107.815  Financings in the form of Debt Securities.
107.820  Financings in the form of guarantees.
107.825  Commitments to Small Businesses.
107.828  Purchasing Securities from an underwriter or other third 
party.

Structuring Licensee's Financing of an Eligible Small Business: Terms 
and Conditions of Financing

107.830  Minimum duration/term of financing.
107.835  Exceptions to minimum duration/term of Financing.
107.840  Maximum term of Financing.
107.845  Maximum rate of amortization on Loans and Debt Securities.
107.850  Restrictions on redemption of Equity Securities.
107.855  Interest rate ceiling and limitations on fees charged to 
Small Businesses (``Cost of Money'').
107.860  Financing fees and expense reimbursements a Licensee may 
receive from a Small Business.
107.865  Restrictions on Control of a Small Business by a Licensee.
107.880  Assets acquired in liquidation of Portfolio securities.

Limitations on Disposition of Assets

107.885  Disposition of assets to Licensee's Associates or to 
competitors of Portfolio Concern.

Management Services and Fees

107.900  Management fees for services provided to a Small Business 
by Licensee or its Associate.

Subpart H--Non-Leveraged Licensees--Exceptions to Regulations

107.1000  Licensees without Leverage--exceptions to the regulations.

Subpart I--SBA Financial Assistance for Licensees (Leverage)

General Information About Obtaining Leverage

107.1100  Types of Leverage available.
107.1110  How to apply for Leverage.
107.1120  General eligibility requirements for Leverage.
107.1130  Leverage fees payable by Licensee.
107.1140  Licensee's acceptance of SBA remedies under Secs. 107.1800 
through 107.1820.

Maximum Amount of Leverage for Which a Licensee is Eligible

107.1150  Maximum amount of Leverage for a Section 301(c) Licensee.
107.1160  Maximum amount of Leverage for a Section 301(d) Licensee.
107.1170  Maximum amount of Participating Securities for any 
Licensee. 

[[Page 58543]]


Conditional Commitments by SBA to Reserve Leverage for a Licensee

107.1200  SBA's Leverage commitment to a Licensee--application 
procedure, amount, and term.
107.1210  Commitment fees payable by Licensee.
107.1220  Requirement for Licensee to file quarterly financial 
statements.
107.1230  Draw-downs by Licensee under SBA's Leverage commitment.
107.1240  Funding of Licensee's draw request through sale to short-
term investor.

Exchange of Outstanding Debentures for Participating or Preferred 
Securities--Section 301(d) Licensees

107.1350  Exchange by Section 301(d) Licensee of Debentures for 
Preferred or Participating Securities.

Preferred Securities Leverage--Section 301(d) Licensees

107.1400  Stock dividends or partnership distributions on 4 percent 
Preferred Securities.
107.1410  Requirement to redeem 4 percent Preferred Securities.
107.1420  Articles requirements for 4 percent Preferred Securities 
issuers.
107.1430  Redeeming 4 percent Preferred Securities with proceeds of 
non-subsidized Debentures.
107.1440  Three percent preferred stock issued before November 21, 
1989. 107.1450 Optional redemption of Preferred Securities.

Participating Securities Leverage

107.1500  General description of Participating Securities.
107.1505  Liquidity requirements for Licensees issuing Participating 
Securities.
107.1510  How a Licensee computes Earmarked Profit (Loss).
107.1520  How a Licensee computes and allocates Prioritized Payments 
to SBA.
107.1530  How a Licensee computes SBA's Profit Participation.
107.1540  Distributions by Licensee--Prioritized Payments and 
Adjustments.
107.1550  Distributions by Licensee--permitted ``tax Distributions'' 
to private investors and SBA.
107.1560  Distributions by Licensee--required Distributions to 
private investors and SBA.
107.1570  Distributions by Licensee--optional Distribution to 
private investors and SBA.
107.1580  Special rules for In-Kind Distributions by Licensees.
107.1590  Special rules for companies licensed on or before March 
31, 1993.

Funding Leverage by Use of SBA-Guaranteed Trust Certificates (``TCs'')

107.1600  SBA authority to issue and guarantee Trust Certificates.
107.1610  Terms and conditions of Trust Certificates.
107.1620  SBA authority to pay subsidy amount on subsidized 
Debentures.
107.1630  Effect of prepayment or early redemption of Leverage on a 
Trust Certificate.
107.1640  Subrogation of SBA upon payment under Trust Certificate 
Program.
107.1650  Formation of a Pool or Trust holding Leverage securities.
107.1660  Functions of agents, including Central Registration Agent, 
Selling Agent and Fiscal Agent.
107.1670  SBA regulation of Brokers and Dealers and disclosure to 
purchasers of Leverage or Trust Certificates.
107.1680  SBA access to records of the CRA, Brokers, Dealers and 
Pool or Trust assemblers.

Miscellaneous

107.1700  Characteristics of SBA's guarantee.
107.1710  Transfer by SBA of its interest in Licensee's Leverage 
security.
107.1720  SBA authority to collect or compromise its claims.

Subpart J--Licensee's Noncompliance With Terms of Leverage

107.1800  Licensee's agreement to terms and conditions in 
Secs. 107.1810 and 107.1820.
107.1810  Events of default and SBA's remedies for Licensee's 
noncompliance with terms of Debentures.
107.1820  Conditions affecting issuers of Preferred Securities and/
or Participating Securities.

Computation of Licensee's Capital Impairment

107.1830  Licensee's Capital Impairment--Definition and General 
Requirements.
107.1840  Computation of Licensee's Capital Impairment Percentage.
107.1850  Exceptions to Capital Impairment provisions for Licensees 
with outstanding Participating Securities.

Subpart K--Ending Operations as a Licensee

107.1900  Surrender of license.

Subpart L--Miscellaneous

107.1910  Non-waiver of SBA's rights or terms of Leverage security.
107.1920  Licensee's application for exemption from a regulation in 
Part 107.
107.1930  Effect of changes in Part 107 on transactions previously 
consummated.
* * * * *
    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.

Subpart A--Introduction to Part 107


Sec. 107.20  Legal basis and applicability of Part 107.

    (a) The regulations in this part implement Title III of the Small 
Business Investment Act of 1958, as amended. All Licensees, including 
Section 301(d) Licensees, must comply with all applicable regulations, 
accounting guidelines and valuation guidelines for Licensees.
    (b) 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.


Sec. 107.30  Amendments to Act and regulations.

    A Licensee shall be subject to all existing and future provisions 
of the Act and Parts 107 and 112 of title 13 of the Code of Federal 
Regulations.


Sec. 107.40  How to read Part 107.

    (a) Center headings. All references in this part to SBA forms, and 
instructions for their preparation, are to the current issue of such 
forms. Center headings are descriptive and are used for convenience 
only. They have no regulatory effect.
    (b) Capitalizing defined terms. Terms defined in Sec. 107.50 are 
capitalized hereafter.
    (c) The pronoun ``you'' as used in this Part 107 means a Licensee 
or license applicant, as appropriate, unless otherwise noted.

Subpart B--Definition of Terms Used in Part 107


Sec. 107.50  Definition of terms.

    Accumulated prioritized payments has the meaning set forth in 
Sec. 107.1520.
    Act means the Small Business Investment Act of 1958, as amended.
    Adjustments has the meaning set forth in Sec. 107.1520.
    Affiliate or Affiliates has the meaning set forth in Sec. 121.401.
    Articles mean articles of incorporation or charter for a Corporate 
Licensee and the partnership agreement or certificate for a Partnership 
Licensee.
    Assistance or Assisted means Financing of or management services 
rendered to a Small Business by a Licensee pursuant to the Act and 
these regulations.
    Associate of a Licensee means any of the following:
    (1)(i) An officer, director, employee or agent of a Corporate 
Licensee;
    (ii) A Control Person, employee or agent of a Partnership Licensee;
    (iii) An Investment Adviser/Manager of any Licensee, including any 
Person who contracts with a Control Person of a Partnership Licensee to 
be the Investment Adviser/Manager of such Licensee; or
    (iv) Any Person regularly serving a Licensee in the capacity of 
attorney at law. 

[[Page 58544]]

    (2) Any Person who owns or controls, or who has entered into an 
agreement to own or control, directly or indirectly, at least 10 
percent of any class of stock of a Corporate Licensee or a limited 
partner's interest of at least 10 percent of the partnership capital of 
a Partnership Licensee. However, a limited partner in a Partnership 
Licensee is not considered an Associate if such Person is an entity 
Institutional Investor whose investment in the Partnership, including 
commitments, represents no more than 33 percent of the partnership 
capital of the Licensee and no more than five percent of such Person's 
net worth.
    (3) Any officer, director, partner (other than a limited partner), 
manager, agent, or employee of any Associate described in paragraph (1) 
or (2) of this definition.
    (4) Any Person that directly or indirectly Controls, or is 
Controlled by, or is under Common Control with, a Licensee.
    (5) Any Person that directly or indirectly Controls, or is 
Controlled by, or is under Common Control with, any Person described in 
paragraphs (1) and (2) of this definition.
    (6) Any Close Relative of any Person described in paragraphs 
(1),(2), (4), and (5) of this definition.
    (7) Any Secondary Relative of any Person described in paragraphs 
(1), (2), (4), and (5) of this definition.
    (8) Any concern in which--
    (i) Any Person described in paragraphs (1) through (6) of this 
definition is an officer; or
    (ii) Any such Person(s) singly or collectively Control or own, 
directly or indirectly, an equity interest of at least 10 percent 
(excluding interests that such Person(s) own indirectly through 
ownership interests in the Licensee).
    (9) Any concern in which any Person(s) described in paragraph (7) 
of this definition singly or collectively own (including beneficial 
ownership) a majority equity interest, or otherwise have Control. As 
used in this paragraph (9), ``collectively'' means together with any 
Person(s) described in paragraphs (1) through (7) of this definition.
    (10) For the purposes of this definition, if any Associate 
relationship described in paragraphs (1) through (7) of this definition 
exists at any time within six months before or after the date that a 
Licensee provides Financing, then that Associate relationship is 
considered to exist on the date of the Financing.
    (11) If any Licensee has any ownership interest in another 
Licensee, the two Licensees are Associates of each other.
    Capital impairment has the meaning set forth in Sec. 107.1830(c).
    Central Registration Agent or CRA means one or more agents 
appointed by SBA for the purpose of issuing TCs and performing the 
functions enumerated in Sec. 107.1660 and performing similar functions 
for Debentures and Participating Securities funded outside the pooling 
process.
    Close Relative of an individual means:
    (1) A current or former spouse;
    (2) A father, mother, guardian, brother, sister, son, daughter; or
    (3) A father-in-law, mother-in-law, brother-in-law, sister-in-law, 
son-in-law, or daughter-in-law.
    Combined Capital means the sum of Regulatory Capital and 
outstanding Leverage.
    Commitment has the meaning set forth in Sec. 107.825.
    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 advisors or contractors that are 
Affiliates of each other. This presumption may be rebutted by evidence 
satisfactory to SBA.
    Control means the possession, direct or indirect, of the power to 
veto or to direct or cause the direction of the management and policies 
of a Licensee or other concern, whether through the ownership of voting 
securities, by contract, or otherwise.
    Control Person means any Person that controls a Licensee, either 
directly or through an intervening entity. A Control Person includes:
    (1) A general partner of a Partnership Licensee;
    (2) Any Person serving as the general partner, officer, director, 
or manager (in the case of a limited liability company) of any entity 
that controls a Licensee, either directly or through an intervening 
entity;
    (3) Any Person that--
    (i) Controls or owns, directly or through an intervening entity, at 
least 10 percent of a Partnership Licensee or any entity described in 
paragraphs (1) or (2) of this definition; and
    (ii) Participates in the investment decisions of the general 
partner of such Partnership Licensee;
    (4) Any Person that controls or owns, directly or through an 
intervening entity, at least 40 percent of a Partnership Licensee or 
any entity described in paragraphs (1) or (2) of this definition.
    Corporate Licensee. See definition of Licensee in this section.
    Cost of Money has the meaning set forth in Sec. 107.855.
    Debenture Rate means the interest rate, as published from time to 
time in the Federal Register by SBA, for ten year debentures issued by 
Licensees and funded through public sales of certificates bearing SBA's 
guarantee. User or guarantee fees, if any, paid by a Licensee are not 
considered in determining the Debenture Rate.
    Debentures means debt obligations issued by Licensees pursuant to 
section 303(a) of the Act and held or guaranteed by SBA.
    Debt Securities has the meaning set forth in Sec. 107.815.
    Disadvantaged Business means a Small Business that is at least 50 
percent owned, and controlled and managed, on a day to day basis, by a 
person or persons whose participation in the free enterprise system is 
hampered because of social or economic disadvantages.
    Distribution means any transfer of cash or non-cash assets to SBA, 
its agent or Trustee, or to partners in a Partnership Licensee, or to 
shareholders in a Corporate Licensee. Capitalization of Retained 
Earnings Available for Distribution constitutes a Distribution to the 
Licensee's non-SBA partners or shareholders.
    Earmarked Assets has the meaning set forth in Sec. 107.1510(b). 
(See also Sec. 107.1590.)
    Earmarked Profit (Loss) has the meaning set forth in Sec. 107.1510.
    Earned Prioritized Payments has the meaning set forth in 
Sec. 107.1520.
    Equity Capital Investments means investments in a Small Business in 
the form of common or preferred stock, limited partnership interests, 
options, warrants, or similar equity instruments, including 
subordinated debt with equity features if such debt provides only for 
interest payments contingent upon and limited to the extent of 
earnings. Equity Capital Investments must not require amortization. 
Equity Capital Investments may be guaranteed; however, neither Equity 
Capital Investments nor such guarantee may be collateralized or 
otherwise secured. Investments classified as Debt Securities (see 
Secs. 107.800 and 107.815) are not precluded from qualifying as Equity 
Capital Investments. 

[[Page 58545]]

    Entity General Partner has the meaning set forth in 
Sec. 107.160(b).
    Equity Securities has the meaning set forth in Sec. 107.800.
    Financing or Financed means outstanding financial assistance 
provided to a Small Business by a Licensee, whether through:
    (1) Loans;
    (2) Debt Securities;
    (3) Equity Securities;
    (4) Guarantees; or
    (5) Purchases of securities of a Small Business through or from an 
underwriter (see Sec. 107.805).
    Guaranty Agreement means the contract entered into by SBA which is 
a guarantee backed by the full faith and credit of the United States 
Government as to timely payment of principal and interest on Debentures 
or the Redemption Price of and Prioritized Payments on Participating 
Securities and SBA's rights in connection with such guarantee.
    Includible Non-Cash Gains means those non-cash gains (as reported 
on SBA Form 468) that are realized in the form of Publicly Traded and 
Marketable securities or investment grade debt instruments. For 
purposes of this definition, investment grade debt instruments means 
those instruments that are rated ``BBB'' or ``Baa'', or better, by 
Standard & Poor's Corporation or Moody's Investors Service, 
respectively. Non-rated debt may be considered to be investment grade 
if Licensee obtains a written opinion from an investment banking firm 
acceptable to SBA stating that the non-rated debt instrument is 
equivalent in risk to the issuer's investment grade debt.
    Institutional Investor means:
    (1) Entities. Any of the following entities if the entity has a net 
worth (exclusive of unfunded commitments from investors) of at least $1 
million, or such higher amount as is specified below. (See also 
Sec. 107.230(b)(4) for limitations on the amount of an Institutional 
Investor's commitment that may be included in Private Capital.)
    (i) A State or National bank, trust company, savings bank, or 
savings and loan association.
    (ii) An insurance company.
    (iii) A 1940 Act Investment Company or Business Development Company 
(each as defined in the Investment Company Act of 1940, as amended).
    (iv) A holding company of any entity described in paragraph (1)(i), 
(ii)or (iii) of this definition.
    (v) An employee benefit or pension plan established for the benefit 
of employees of the Federal government, any State or political 
subdivision of a State, or any agency or instrumentality of such 
government unit.
    (vi) An employee benefit or pension plan (as defined in the 
Employee Retirement Income Security Act of 1974, as amended, excluding 
plans established under section 401(k) of the Internal Revenue Code of 
1986, as amended).
    (vii) A trust, foundation or endowment exempt from Federal income 
taxation under the Internal Revenue Code of 1986, as amended.
    (viii) A corporation, partnership or other entity with a net worth 
(exclusive of unfunded commitments from investors) of more than $10 
million.
    (ix) A State, a political subdivision of a State, or an agency or 
instrumentality of a State or its political subdivision.
    (x) An entity whose primary purpose is to manage and invest non-
Federal funds on behalf of at least three Institutional Investors 
described in paragraphs (1)(i) through (1)(ix) of this definition, each 
of whom must have at least a 10 percent ownership interest in the 
entity.
    (xi) Any other entity that SBA determines to be an Institutional 
Investor.
    (2) Individuals. (i) Any of the following individuals if he/she is 
also a permanent resident of the United States:
    (A) An individual who is an Accredited Investor (as defined in the 
Securities Act of 1933, as amended) and whose commitment to the 
Licensee is backed by a letter of credit from a State or National bank 
acceptable to SBA.
    (B) An individual whose personal net worth is at least $2 million 
and at least ten times the amount of his or her commitment to the 
Licensee. The individual's personal net worth must not include the 
value of any equity in his or her most valuable residence.
    (C) An individual whose personal net worth (determined in 
accordance with paragraph (2)(i)(B) of this definition) is at least $10 
million.
    (ii) Any individual who is not a permanent resident of the United 
States but who otherwise satisfies paragraph (2)(i) of this definition 
provided such individual has irrevocably appointed an agent within the 
United States for the service of process.
    Investment Adviser/Manager means any Person who furnishes advice or 
assistance with respect to operations of a Licensee under a written 
contract executed in accordance with the provisions of Sec. 107.510.
    Lending Institution means a concern that is operating under 
regulations of a state or Federal licensing, supervising, or examining 
body, or whose shares are publicly traded and listed on a recognized 
stock exchange or NASDAQ and which has assets in excess of $500 
million; and which, in either case, holds itself out to the public as 
engaged in the making of commercial and industrial loans and whose 
lending operations are not for the purpose of financing its own or an 
Associates's sales or business operations.
    Leverage means financial assistance provided to a Licensee by SBA, 
either through the purchase or guaranty of a Licensee's Debentures or 
Participating Securities, or the purchase of a Licensee's Preferred 
Securities, and any other SBA financial assistance evidenced by a 
security of the Licensee.
    Leverageable Capital means Regulatory Capital, excluding unfunded 
commitments and Qualified Non-private Funds whose source is Federal 
funds.
    Licensee means either a corporation (Corporate Licensee), or a 
limited partnership organized pursuant to Sec. 107.160 (Partnership 
Licensee), to which a license has been granted pursuant to the Act. For 
certain purposes, the Entity General Partner of a Partnership Licensee 
is treated as if it were a Licensee (see Sec. 107.160(b)(2)).
    Loan has the meaning set forth in Sec. 107.810.
    Loans and Investments means Portfolio Securities, Assets Acquired 
in Liquidation of Portfolio Securities, Operating Concerns Acquired, 
and Notes and Other Securities Received, as set forth in the Statement 
of Financial Position of SBA Form 468.
    Management Expenses has the meaning set forth in Sec. 107.520.
    1940 Act Company means a Licensee which is registered under the 
Investment Company Act of 1940.
    1980 Act Company means a Licensee which is registered under the 
Small Business Investment Incentive Act of 1980.
    Original Issue Price means the price paid by the purchaser for 
securities at the time of issuance.
    Participating Securities means preferred stock, preferred limited 
partnership interests, or similar instruments issued by Licensees, 
including debentures having interest payable only to the extent of 
earnings, all of which are subject to the terms set forth in 
Secs. 107.1500 through 107.1590 and section 303(g) of the Act.
    Partnership Licensee. See definition of Licensee in this section.
    Payment Date means, for a Participating Securities issuer, each 
February 1, May 1, August 1, and November 1 during the term of a 
Participating Security.
    Person means a natural person or legal entity.
    Pool means an aggregation of SBA guaranteed Debentures or SBA 

[[Page 58546]]
    guaranteed Participating Securities approved by SBA.
    Portfolio means the securities representing a Licensee's total 
outstanding Financing of Small Businesses. It does not include idle 
funds or assets acquired in liquidation of Portfolio securities.
    Portfolio Concern means a Small Business Assisted by a Licensee.
    Preferred Securities means nonvoting preferred stock issued to SBA 
by a for-profit Section 301(d) Corporate Licensee, or securities having 
similar characteristics issued by a Section 301(d) Licensee organized 
as a nonprofit corporation, or nonvoting preferred limited partnership 
interests issued by a Section 301(d) Partnership Licensee.
    Prioritized Payments has the meaning set forth in Sec. 107.1520.
    Private Capital has the meaning set forth in Sec. 107.230.
    Profit Participation has the meaning set forth in 
Sec. 107.1500(c)(3).
    Publicly Traded and Marketable means securities that are salable 
without restriction or that are salable within 12 months pursuant to 
Rule 144 of the Securities Act of 1933, as amended, by the holder 
thereof (or in the case of an In-kind Distribution by the distributee 
thereof), and are of a class which is traded on a regulated stock 
exchange, or is listed in the Automated Quotation System of the 
National Association of Securities Dealers (NASDAQ), or has, at a 
minimum, at least two market makers as defined in the relevant sections 
of the Securities Exchange Act of 1934, as amended, and in all cases 
the quantity of which can be sold over a reasonable period of time 
without having an adverse impact upon the price of the stock.
    Qualified Non-private Funds has the meaning set forth in 
Sec. 107.230.
    Redemption Price means the amount required to be paid by the 
issuer, or successor to the issuer, of Preferred or Participating 
Securities to repurchase such securities from the holder. The 
Redemption Price shall be the Original Issue Price less any prepayments 
or prior redemptions.
    Regulatory Capital means:
    (1) 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.
    (2) Exclusion of questionable commitments. An investor's commitment 
to a Licensee is excluded from Regulatory Capital if SBA determines 
that the collectibility of the commitment is questionable.
    Retained Earnings Available for Distribution means Undistributed 
Net Realized Earnings less any Unrealized Depreciation on Loans and 
Investments (as reported on SBA Form 468), and represents the amount 
that a Licensee may distribute to investors (including SBA) as a profit 
Distribution, or transfer to Private Capital.
    SBA means the Small Business Administration, 409 Third Street, SW., 
Washington, DC 20416.
    Secondary Relative of an individual means:
    (1) A grandparent, grandchild, or any other ancestor or lineal 
descendent who is not a Close Relative;
    (2) An uncle, aunt, nephew, niece, or first cousin; or
    (3) A spouse of any person described in paragraph (1) or (2)of this 
definition.
    Section 301(c) Licensee has the meaning set forth in Sec. 107.100.
    Section 301(d) Licensee has the meaning set forth in Sec. 107.110.
    Short-term Financing means Financing for a term of less than five 
years in accordance with the regulations.
    SIC Manual means the latest issue of the Standard Industrial 
Classification Manual, prepared by the Office of Management and Budget, 
and available from the U.S. Government Printing Office, Superintendent 
of Documents, P.O. Box 371954, Pittsburgh, Pa., 15250-7954.
    Small Business means a small business concern as defined in section 
103(5) of the Act (including its Affiliates), which for purposes of 
size eligibility, meets the applicable criteria set forth in part 121 
of this chapter.
    Smaller Business has the meaning set forth in Sec. 107.710.
    Start-up Financing means an Equity Capital Investment in a Small 
Business that--
    (1) Engages in technology development or commercialization, 
manufacturing, and/or exporting;
    (2) At the time of Licensee's initial Financing has not existed, in 
any form, for more than three fiscal years;
    (3) Has not had sales exceeding $5,000,000 or positive cash flow in 
any fiscal year; and
    (4) Was not formed to acquire any existing business.
    Temporary Debt has the meaning set forth in Sec. 107.570.
    Trust means the legal entity created for the purpose of holding 
guaranteed Debentures or Participating Securities and the guaranty 
agreement related thereto, receiving, holding and making any related 
payments, and accounting for such payments.
    Trust Certificate Rate means a fixed rate determined at the time 
Participating Securities are issued by the Secretary of the Treasury 
taking into consideration the current average market yield on 
outstanding marketable obligations of the United States with maturities 
comparable to the maturities of the Trust Certificates being guaranteed 
by SBA, adjusted to the nearest one-eighth of one percent.
    Trust Certificates (TCs) means certificates issued by SBA, its 
agent or Trustee and representing ownership of all or a fractional part 
of a Trust or Pool of Debentures or Participating Securities.
    Trustee means the trustee or trustees of a Trust.
    Undistributed Net Realized Earnings means Undistributed Realized 
Earnings less Non-cash Gains/Income, each as reported on SBA Form 468.
    Unrealized Appreciation means the amount by which a Licensee's 
valuation of Loans and Investments, as determined by its Board of 
Directors or General Partner(s) in accordance with Licensee's valuation 
policies, exceeds the cost basis thereof.
    Unrealized Depreciation means the amount by which a Licensee's 
valuation of Loans and Investments, as determined by its Board of 
Directors or General Partner(s) in accordance with Licensee's valuation 
policies, is below the cost basis thereof.
    Unrealized Gain (Loss) on Securities Held means the sum of the 
Unrealized Appreciation and Unrealized Depreciation on all of a 
Licensee's Loans and Investments, less estimated future income tax 
expense or estimated realizable future income tax benefit, as 
appropriate.
    Venture Capital Financing has the meaning set forth in 
Sec. 107.1160.
    Wind-up Plan has the meaning set forth in Sec. 107.590.

Subpart C--Qualifying for an SBIC License

Organizing an SBIC


Sec. 107.100  Organizing a Section 301(c) Licensee.

    Section 301(c) Licensee means a company licensed under section 
301(c) of the Act. It may be organized as a for-profit corporation or 
as a limited partnership created in accordance with the special rules 
of Sec. 107.160. 

[[Page 58547]]



Sec. 107.110  Organizing a Section 301(d) Licensee.

    Section 301(d) Licensee means a company licensed under section 
301(d) of the Act that may provide Assistance only to Disadvantaged 
Businesses. A Section 301(d) Licensee may be organized as a for-profit 
corporation, a non-profit corporation, or as a limited partnership 
created in accordance with the special rules of Sec. 107.160.


Sec. 107.115  1940 Act and 1980 Act Companies.

    For license applications received on or after November 28, 1995, 
SBA will license a 1940 Act or 1980 Act Company only if such company 
does not elect to be taxed as a regulated investment company under 
section 851 of the Internal Revenue Code of 1986, as amended. After 
such date, a request by an existing Licensee to convert to a 1940 Act 
or 1980 Company will be approved by SBA only if the same criteria are 
satisfied.


Sec. 107.120  Special rules for a Section 301(d) Licensee owned by 
another Licensee.

    A Section 301(d) Licensee may be licensed to operate as the 
subsidiary of one or more Licensees (participant Licensee), with or 
without non-Licensee participation, subject to the following:
    (a) Application. In reviewing the license application, SBA will 
consider what effect, if any, a capital contribution to the proposed 
Section 301(d) Licensee will have on the participant Licensee.
    (b) Participant Licensees. Each participant Licensee must propose 
to own at least twenty percent of the voting securities of the proposed 
Section 301(d)Licensee.
    (c) Capital contribution. A subsidiary Section 301(d) Licensee must 
receive capital contributions in cash, in an amount at least equal to 
the minimum capital requirement under Sec. 107.210. Capital contributed 
by a participant Licensee in excess of the required minimum may be in 
the form of securities of a Disadvantaged Business, valued at the lower 
of cost or fair value. A participant Licensee must treat its entire 
capital contribution to the subsidiary as a reduction of its 
Leveragable Capital. The participant Licensee's remaining Leverageable 
Capital must be sufficient to support its outstanding Leverage.
    (d) No transfer of Leverage. A participant Licensee may not 
transfer its Leverage to a subsidiary Section 301(d) Licensee.


Sec. 107.130  Requirement for qualified management.

    When applying for a license, you must show, to the satisfaction of 
SBA, that your current or proposed management is qualified and has the 
knowledge, experience, and capability necessary for investing in the 
types of businesses contemplated by the Act, these regulations and your 
business plan. You must designate at least one individual as the 
official responsible for contact with SBA.


Sec. 107.140  SBA approval of initial Management Expenses.

    You must have your Management Expenses approved by SBA at the time 
of licensing. (See Sec. 107.520 for the definition of Management 
Expenses.)


Sec. 107.150  Management and ownership diversity requirement.

    You must have diversity between management and ownership in order 
to be licensed, unless you do not plan to obtain Leverage. To establish 
diversity, you must meet the requirements in paragraphs (a) and (b) of 
this section unless SBA approves otherwise.
    (a) Requirement one. You must satisfy either paragraph (a)(1) or 
paragraph (a)(2) of this section.
    (1) You must have at least three shareholders or limited partners, 
or at least one acceptable Institutional Investor, in either case with 
an aggregate ownership interest equal to at least 30 percent of your 
Regulatory Capital. Such investors must not be your Associates (except 
for their status as your shareholders or limited partners) or 
Affiliates of any of your Associates. For purposes of this paragraph 
(a)(1), the following Institutional Investors are acceptable:
    (i) Entities regulated by state or Federal authorities satisfactory 
to SBA;
    (ii) Public or private employee pension funds;
    (iii) Trusts, foundations, or endowments which are exempt from 
Federal income taxation; or
    (iv) Other Institutional Investors satisfactory to SBA.
    (2) Your common stock or limited partnership interests are publicly 
traded.
    (b) Requirement two. Your shareholders or limited partners may not 
delegate their voting rights to any other Person without prior SBA 
approval. This restriction does not apply to:
    (1) Publicly traded Licensees.
    (2) Proxies given to vote at single specified meetings.
    (3) Delegations of voting rights by your investors to their 
investment advisors, provided such advisors are not your Associates 
(except for their status as your shareholder or partner).
    (c) Diversity based on Licensee's parent company. If you do not 
have diversity as defined in paragraphs (a) and (b) of this section, 
SBA in its sole discretion may accept diversity achieved on the same 
basis by your parent company as a substitute. As used in this paragraph 
(c), ``parent company'' means an entity that directly or indirectly has 
an interest of more than 50 percent of your Regulatory Capital.
    (d) Requirement to maintain diversity after licensing. If you were 
required to have diversity between management and ownership at the time 
you were licensed, you must maintain such diversity while you have 
outstanding Leverage or Earmarked Assets, unless SBA approves 
otherwise. If, at any time, you no longer satisfy the diversity 
criteria in paragraph (a) or (b) of this section, you must:
    (1) Notify SBA within 10 days; and
    (2) Re-establish diversity within six months.
    (e) Exception to diversity rule. This Sec. 107.150 does not apply 
if:
    (1) You received your license before November 28, 1995 and you are 
not licensed to issue Participating Securities; or
    (2) SBA received your license application before November 28, 1995 
and, as of such date, you had raised the funds needed to begin 
operations as contemplated in your business plan.


Sec. 107.160  Special rules for Licensees formed as limited 
partnerships.

    A limited partnership organized under State law solely for the 
purpose of performing the functions and conducting the activities 
contemplated under the Act may apply for a license under section 301(c) 
or section 301(d) of the Act (``Partnership Licensee'').
    (a) Number of Licensee's General Partners. If you are a Partnership 
Licensee, you must have as your general partner(s) at least two 
individuals, or at least one corporation, partnership, or limited 
liability company (LLC), or any combination of individuals, 
corporations, partnerships, or LLCs.
    (b) Entity General Partner of Licensee. A general partner which is 
a corporation, limited liability company or partnership (an ``Entity 
General Partner'') shall be organized under state law solely for the 
purpose of serving as the general partner of one or more Licensees.
    (1) SBA must approve any person who will serve as an officer, 
director, manager, or general partner of the Entity General Partner. 
This provision must be 

[[Page 58548]]
stated in an Entity General Partner's Certificate of Incorporation, 
member agreement, Limited Partnership Agreement or other similar 
governing instrument which must, in each case, accompany the license 
application.
    (2) An Entity General Partner is subject to the same examination 
and reporting requirements as a Licensee under section 310(b) of the 
Act. The restrictions and obligations imposed upon a Licensee by 
Secs. 107.1800 through 107.1820, and 107.30, 107.410 through 107.450, 
107.470, 107.475, 107.500, 107.510, 107.585, 107.600, 107.680, 107.690 
through 107.692, 107.865, and 107.1910 apply also to an Entity General 
Partner of a Licensee.
    (3) The general partner(s) of your Entity General Partner(s) will 
be considered your general partner.
    (4) If your Entity General Partner is a limited partnership, its 
limited partners may be considered your Control Person(s) if they meet 
the definition for Control Person in Sec. 107.50.
    (5) If your Entity General Partner is a limited partnership, it is 
subject to paragraph (a) of this section.
    (c) Other requirements for Partnership Licensees. If you are a 
Partnership Licensee:
    (1) You must have a minimum duration of ten years or two years 
following the maturity of your last-maturing Leverage security, 
whichever is longer. After 10 years, if all Leverage has been repaid or 
redeemed and all amounts due SBA, its agent, or Trustee have been paid, 
the Partnership Licensee may be terminated by a vote of your partners. 
(For purposes of this provision SBA is not considered a partner.)
    (2) None of your general partner(s) may be removed or replaced by 
your limited partners without prior written approval of SBA;
    (3) Any transferee of, or successor in interest to, your general 
partner shall have only the rights and liabilities of a limited partner 
pending SBA's written approval of such transfer or succession; and
    (4) You must incorporate all the provisions in this paragraph (c) 
in your Limited Partnership Agreement.
    (d) Obligations of a Control Person. All Control Persons are bound 
by the disciplinary provisions of sections 313 and 314 of the Act and 
by the conflict-of-interest rules under section 312 of the Act. The 
term Licensee, as used in Secs. 107.30, 107.460, and 107.680 includes 
all of the Licensee's Control Persons. The term Licensee as used in 
Sec. 107.670 includes only the Licensee's general partner(s). The 
conditions specified in Secs. 107.1800 through 107.1820 and 
Sec. 107.1910 apply to all general partners.
    (e) Liability of general partner for partnership debts to SBA. 
Subject to section 314 of the Act, your general partner is not liable 
solely by reason of its status as a general partner for repayment of 
any Leverage or debts you owe to SBA unless SBA, in the exercise of 
reasonable investment prudence, and with regard to your financial 
soundness, determines otherwise prior to the purchase or guaranty of 
your Leverage.
    (f) Reorganization of Licensee. A corporate Licensee wishing to 
reorganize as a Partnership Licensee, or a Partnership Licensee wishing 
to reorganize as a Corporate Licensee, may apply to SBA for approval 
under Sec. 107.470.
    (g) Special Leverage requirement. Before the extension of any 
Leverage, you must furnish SBA with evidence that you qualify as a 
partnership for tax purposes, either by a ruling from the Internal 
Revenue Service, or by an opinion of counsel.

Capitalizing an SBIC


Sec. 107.200  Adequate capital for Licensees.

    You must meet the requirements of this Sec. 107.200 to qualify for 
a license, to continue as a Licensee, and to receive Leverage.
    (a) You must have enough Regulatory Capital to provide reasonable 
assurance that:
    (1) You will operate soundly and profitably over the long term; and
    (2) You will be able to operate actively in accordance with your 
Articles and within the context of your business plan, as approved by 
SBA.
    (b) In SBA's sole discretion, you must be economically viable, 
taking into consideration actual and anticipated income and losses on 
your Loans and Investments, and the experience and qualifications of 
your owners and managers.


Sec. 107.210  Minimum capital requirements for Licensees.

    (a) Minimum capital for Section 301(c) Licensees--general rule. A 
Section 301(c) Licensee or applicant must have Regulatory Capital 
(excluding commitments from your investors) of at least $2,500,000.
    (b) Minimum capital for Section 301(d) Licensees--general rule. A 
Section 301(d) Licensee or applicant must have Regulatory Capital 
(excluding commitments from your investors) of at least $1,500,000.
    (c) Exception to general rule--grandfather clause. The minimum 
capital requirements in paragraphs (a) and (b) of this section do not 
apply if you were licensed before October 2, 1990, or if SBA had your 
license application on file before October 2, 1990 and granted you a 
license on the basis of such application. If you qualify for this 
exception, you must have at least the minimum Private Capital required 
by the regulations in effect on October 1, 1990.
    (d) Additional capital requirements for Licensees seeking Leverage. 
If you are a license applicant who intends to seek Leverage, see 
Sec. 107.220.


Sec. 107.220  Special minimum capital requirements for Licensees 
issuing Leverage.

    (a) Participating Securities. You must have Regulatory Capital of 
at least $10,000,000 in order to apply for Participating Securities, 
unless you demonstrate to SBA's satisfaction that you can be 
financially viable over the long term with a lower amount. You are not 
permitted under any circumstances to apply for Participating Securities 
if your Regulatory Capital is less than $5,000,000.
    (b) Debentures. If you are licensed after the effective date of 
this regulation, you must have Regulatory Capital of at least 
$5,000,000 in order to apply for Debentures, unless you demonstrate to 
SBA's satisfaction that you can be financially viable over the long 
term with a lower amount.
    (c) Companies licensed before October 2, 1990. If Sec. 107.210(c) 
applies to you and your Regulatory Capital (excluding commitments from 
investors) is below $2,500,000 (for a Section 301(c) Licensee) or 
$1,500,000 (for a Section 301(d) Licensee):
    (1) You are eligible for Leverage (other than refinancing) only if 
you can demonstrate to SBA's satisfaction that you have been profitable 
for three out of your last four fiscal years before applying for 
Leverage and, on the average, have been profitable for all such fiscal 
years.
    (2) Even if you do not satisfy paragraph (c)(1) of this section, 
you may apply for Leverage needed to refinance any Debenture 
outstanding on October 2, 1990, as follows:
    (i) Any such Debenture which matures on or before December 31, 1995 
may be refinanced, one time only, for a term of not more than ten 
years; and
    (ii) Any such Debenture which matures after December 31, 1995, may 
be refinanced, one time only, for a term of three years.


Sec. 107.230  Permitted sources of Private Capital for Licensees.

    Private Capital means the contributed capital of a Licensee, plus 
unfunded 

[[Page 58549]]
binding commitments by Institutional Investors (including commitments 
evidenced by a promissory note) to contribute capital to a Licensee.
    (a) Contributed capital. For purposes of this section, contributed 
capital means the paid-in capital and paid-in surplus of a Corporate 
Licensee, or the partners' contributed capital of a Partnership 
Licensee, in either case subject to the limitations in paragraph (b) of 
this section.
    (b) Exclusions from Private Capital. Private Capital does not 
include:
    (1) Funds borrowed by a Licensee from any source.
    (2) Funds obtained through the issuance of Leverage.
    (3) Funds obtained directly or indirectly from any Federal, State, 
or local government, or any government agency or instrumentality, 
except for funds invested by a public pension fund and ``Qualified Non-
private Funds'' as defined in paragraph (d) of this section.
    (4) Any portion 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 and is not backed by a letter of 
credit from a State or National bank acceptable to SBA.
    (c) Non-cash capital contributions. Capital contributions in a form 
other than cash are subject to the limitations in Sec. 107.240 of this 
section.
    (d) Qualified Non-private Funds. Private Capital includes 
``Qualified Non-private Funds'' as defined in this paragraph (d); 
however, investors of Qualified Non-private Funds must not control, 
directly or indirectly, a Licensee's management, or its board of 
directors or general partner(s). Qualified Non-private Funds are:
    (1) Funds directly or indirectly invested in any Licensee on or 
before August 16, 1982 by any Federal agency except SBA, under 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 under 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 or license applicant by one or 
more State or local government entities (including any guarantee 
extended by such entities) in an aggregate amount that does not exceed 
33 percent of Regulatory Capital; and
    (4) Funds invested in any Section 301(d) Licensee or such license 
applicant from the following sources:
    (i) A State financing agency, or similar agency or instrumentality, 
if the funds invested are derived from such agency's net income and not 
from appropriated State or local funds; and
    (ii) Grants made by a state or local government agency or 
instrumentality into a nonprofit corporation or institution exercising 
discretionary authority with respect to such funds, if SBA determines 
that such funds have taken on a private character and the nonprofit 
corporation or institution is not a mere conduit.
    (e) You may not accept any capital contribution made with funds 
borrowed by a Person seeking to own an equity interest (whether direct 
or indirect, beneficial or of record) of at least 10 percent of your 
Private Capital. This exclusion does not apply if:
    (1) Such Person's net worth is at least twice the amount borrowed; 
or
    (2) SBA gives its prior written approval of the capital 
contribution.


Sec. 107.240  Limitations on accepting non-cash capital contributions.

    Non-cash capital contributions to a Licensee or license applicant 
are included in Private Capital only if they fall into one of the 
following categories:
    (a) Direct obligations of, or obligations guaranteed as to 
principal and interest by, the United States.
    (b) Services rendered or to be rendered to you, priced at no more 
than their fair market value.
    (c) Tangible assets used in your operations, priced at no more than 
their fair market value.
    (d) Shares in a Disadvantaged Business received by a subsidiary 
Section 301(d) Licensee from its parent Licensee, valued at the lower 
of cost or fair value.
    (e) Other non-cash assets approved by SBA.


Sec. 107.250  Issuance of stock options by Licensees.

    (a) Issuance of stock options. You may issue stock options. A 1940 
Act Company or a 1980 Act Company may issue stock options only as 
permitted under such Acts or orders issued thereunder.
    (b) Stock options not deemed compensation. Stock options issued by 
any Licensee, including a 1940 or 1980 Act company, are not considered 
compensation and therefore do not count as part of a Licensee's 
Management Expenses.

Applying for an SBIC License


Sec. 107.300  License application form and fee.

    The license application must be submitted on SBA Form 415 together 
with a processing fee computed as follows:
    (a) All license applicants will pay a base fee of $10,000.
    (b) All applicants who will be Partnership Licensees will pay an 
additional $5,000 fee, for a total of $15,000.
    (c) All applicants who will be issuing Participating Securities 
will pay an additional $5,000 fee, for a total of $15,000, or a total 
fee of $20,000 if they also intend to be Partnership Licensees.

Subpart D--Changes in Ownership, Control, or Structure of Licensee; 
Transfer of License

Changes in Control or Ownership of Licensee


Sec. 107.400  Changes in ownership of 10 percent or more of Licensee 
but no change of Control.

    (a) Prior approval requirements. You must obtain SBA's prior 
written approval for any proposed transfer or issuance of ownership 
interests that results in the ownership (beneficial or of record) by 
any Person, or group of Persons acting in concert, of at least 10 
percent of any class of your stock or partnership capital.
    (b) Fee. A processing fee of $200 must accompany each such request 
for approval of a change of ownership.


Sec. 107.410  Changes in Control of Licensee (through change in 
ownership or otherwise).

    (a) Prior approval requirements. You must obtain SBA's prior 
written approval for any proposed transaction or event that results in 
Control by any Person(s) not previously approved by SBA.
    (b) Fee. A processing fee of $10,000 must accompany any application 
for approval of one or more transactions or events that will result in 
a transfer of Control.


Sec. 107.420  Prohibition on exercise of ownership or Control rights in 
Licensee before SBA approval.

    Without prior written SBA approval, no change of ownership or 
Control may take effect and no officer, director, employee or other 
Person acting on your behalf shall:
    (a) Register on your books any transfer of ownership interest to 
the proposed new owner(s);
    (b) Permit the proposed new owner(s) to exercise voting rights with 
respect to such ownership interest (including directly or indirectly 
procuring or voting any proxy, consent or authorization as to such 
voting rights at any shareholders' or partnership meeting);
    (c) Permit the proposed new owner(s) to participate in any manner 
in the 

[[Page 58550]]
conduct of your affairs (including exercising control over your books, 
records, funds or other assets; participating directly or indirectly in 
any disposition thereof; or serving as an officer, director, partner, 
employee or agent); or
    (d) Allow ownership or Control to pass to another Person.


Sec. 107.430  Notification to SBA of transactions that may change 
ownership or Control.

    You must promptly notify SBA as soon as you have knowledge of 
transactions or events that may result in a transfer of Control or 
ownership of at least 10 percent of your capital. If there is any doubt 
as to whether a particular transaction or event will result in such a 
change, report the facts to SBA.


Sec. 107.440  Standards governing prior SBA approval for a proposed 
transfer of Control.

    SBA approval is contingent upon full disclosure of the real parties 
in interest, the source of funds for the new owners' interest, and 
other data requested by SBA. As a condition of approving a proposed 
transfer of control, SBA may:
    (a) Require an increase in your Regulatory Capital;
    (b) Require the new owners or the transferee's Control Person(s) to 
assume, in writing, personal liability for your Leverage, effective 
only in the event of their direct or indirect participation in any 
transfer of Control not approved by SBA; or
    (c) Require compliance with any other conditions set by SBA.


Sec. 107.450  Notification to SBA of pledge of Licensee's shares.

    (a) You must notify SBA in writing, within 30 calendar days, of the 
terms of any transaction in which:
    (1) Any Person, or group of Persons acting in concert, pledges 
shares of your stock (or equivalent ownership interests) as collateral 
for indebtedness; and
    (2) The shares pledged are at least 10 percent of your Regulatory 
Capital.
    (b) If the transaction creates a change of ownership or Control, 
you must comply with Sec. 107.400 or Sec. 107.410, as appropriate.

Restrictions on Common Control or Ownership of Two or More Licensees


Sec. 107.460  Restrictions on Common Control or ownership of two (or 
more) Licensees.

    (a) General rule. Without SBA's prior written approval, you must 
not have an officer, director, manager, Control Person, or owner (with 
a direct or indirect ownership interest of at least 10 percent) who is 
also:
    (1) An officer, director, manager, Control Person, or owner (with a 
direct or indirect ownership interest of at least 10 percent) of 
another Licensee; or
    (2) An officer or director of any Person that directly or 
indirectly controls, or is controlled by, or is under Common Control 
with, another Licensee.
    (b) Exception for Section 301(d) Licensees. This Sec. 107.460 does 
not apply to common officers, directors, managers, or owners of a 
Section 301(c) Licensee and its Section 301(d) subsidiary.

Change in Structure of Licensee


Sec. 107.470  SBA approval of merger, consolidation, or reorganization 
of Licensee.

    (a) Prior approval requirements. You may not merge, consolidate, 
change form of organization (corporation or partnership) or reorganize 
without SBA's prior written approval. Any such merger or consolidation 
will be subject to Sec. 107.440.
    (b) Fee. A processing fee of $5,000 must accompany any application 
for approval of a change in your form of organization (from corporation 
to partnership or partnership to corporation).

Transfer of License


Sec. 107.475  Transfer of license.

    You may not transfer your license in any manner without SBA's prior 
written approval.

Subpart E--Managing The Operations of a Licensee

General Requirements


Sec. 107.500  Lawful operations under the Act.

    You must engage only in the activities contemplated by the Act and 
in no other activities.


Sec. 107.501  Identification as a Licensee.

    You must display your SBIC license in a prominent location. You 
must also have a listed telephone number. All Financing documents must 
identify you as ``a Federal Licensee under the Small Business 
Investment Act of 1958, as amended.''


Sec. 107.502 Representations to the public.

    You may not represent or imply to anyone that the SBA, the U.S. 
Government or any of its agencies or officers has approved any 
ownership interests you have issued or obligations you have incurred. 
Be certain to include a statement to this effect in any solicitation to 
investors. Example: You may not represent or imply that ``SBA stands 
behind the Licensee'' or that ``Your capital is safe because SBA's 
experts review proposed investments to make sure they are safe for the 
Licensee.''


Sec. 107.503  Licensee's adoption of an approved Valuation Policy.

    (a) SBA approval. You must have a written valuation policy for use 
in determining the value of your Loans and Investments. You must 
include this policy as part of your initial application to SBA.
    (b) Adopting SBA's valuation guidelines/automatic approval. If you 
adopt the exact wording of the Model Valuation Policy, ``Valuation 
Guidelines for SBICs'', and make absolutely no additions or changes, 
then SBA will automatically accept your Valuation Policy. With SBA's 
prior written approval, you may adopt a policy that differs from the 
model.
    (c) Licensee's adoption of policy. Your board of directors or 
general partners will be solely responsible for adopting your Valuation 
Policy and for using it to prepare valuations of your Loans and 
Investments for submission to SBA. SBA reserves the right to review or 
independently establish valuations of your Loans and Investments.
    (d) Frequency of valuations. (1) If you have outstanding Leverage 
or Earmarked Assets, you must value your Loans and Investments at the 
end of the second quarter of your fiscal year, and at the end of your 
fiscal year.
    (2) Otherwise, you must value your Loans and Investments only at 
your fiscal year end.
    (3) On a case-by-case basis, SBA may require you to perform 
valuations more frequently.
    (4) You must report material changes in valuations at least 
quarterly, within thirty days following the close of the quarter.
    (e) Review of valuations by independent public accountant. Your 
independent public accountant must review only valuations performed as 
of the end of your fiscal year. The accountant's responsibility 
includes reviewing your valuation procedures and the implementation of 
such procedures, including adequacy of documentation. The accountant 
also has reporting responsibilities concerning the results of this 
review.


Sec. 107.504  Computer capability requirements of Licensee.

    You must have a personal computer with a modem, and be able to use 
this equipment to prepare reports (using SBA-provided software) and 
transmit them by modem to SBA. 

[[Page 58551]]



Sec. 107.505  Facsimile requirement.

    You must be able to receive fax messages 24 hours per day at your 
primary office.


Sec. 107.506  Safeguarding Licensee's assets/Internal controls.

    You must adopt a plan to safeguard your assets and monitor the 
reliability of your financial data, personnel, Portfolio, funds and 
equipment. You must provide your bank and custodian with a certified 
copy of your resolution or other formal document describing your 
control procedures.


Sec. 107.507  Violations based on false filings and nonperformance of 
agreements with SBA.

    The following shall constitute a violation of this part:
    (a) Nonperformance. Nonperformance of any of the requirements of 
any Debenture, Participating Security or Preferred Security, or of any 
written agreement with SBA.
    (b) False statement. In any document submitted to SBA:
    (1) Any false statement knowingly made; or
    (2) Any misrepresentation of a material fact; or
    (3) Any failure to state a material fact. A material fact is any 
fact which is necessary to make a statement not misleading in light of 
the circumstances under which the statement was made.


Sec. 107.508  Accessible office.

    You must maintain an office that is convenient to the public and is 
open for business during normal working hours.


Sec. 107.509  Employment of SBA officials.

    Without SBA's prior written approval, for a period of two years 
after the date of your most recent issuance of Leverage (or the receipt 
of any SBA Assistance as defined in part 105 of this chapter), you are 
not permitted to employ, offer employment to, or retain for 
professional services, any person who:
    (a) Served as an officer, attorney, agent, or employee of SBA on or 
within one year before such date; and
    (b) As such, occupied a position or engaged in activities which, in 
SBA's determination, involved discretion with respect to the granting 
of Assistance under the Act.

Management and Compensation


Sec. 107.510  SBA approval of Licensee's Investment Adviser/Manager.

    You may employ an Investment Adviser/Manager who will be subject to 
the supervision of your board of directors or general partner. If you 
have Leverage or plan to seek Leverage, you must obtain SBA's prior 
written approval of the management contract. SBA's approval of an 
Investment/Advisor Manager for one Licensee does not indicate approval 
of that manager for any other Licensee.
    (a) Management contract. The contract must:
    (1) Specify the services the Investment Adviser/manager will render 
to you and to the Small Businesses in your Portfolio;
    (2) Indicate the basis for computing Management Expenses; and
    (3) Be approved annually by your board of directors or principals.
    (b) Material change to approved management contract. If there is a 
material change, both you and SBA must approve such change in advance. 
If you are uncertain if the change is material, submit the proposed 
revision to SBA.


Sec. 107.520  Management Expenses of a Licensee.

    SBA must approve any increases in your Management Expenses if you 
have outstanding Leverage or Earmarked Assets.
    (a) Definition of Management Expenses. Management Expenses include:
    (1) Salaries;
    (2) Office expenses;
    (3) Travel;
    (4) Business development;
    (5) Office and equipment rental;
    (6) Bookkeeping; and
    (7) Expenses related to developing, investigating and monitoring 
investments.
    (b) Management Expenses do not include services provided by 
specialized outside consultants, outside lawyers and independent public 
accountants, if they perform services not generally performed by a 
venture capital company.
    (c) If your Management Expenses have not already been approved by 
SBA, you must submit such expenses for approval with your SBA Form 468 
for your first fiscal year ending after the effective date of this 
Regulation.

Cash Management by a Licensee


Sec. 107.530  Restrictions on investments of idle funds by leveraged 
Licensees.

    (a) Applicability of this section. This Sec. 107.530 applies if you 
have outstanding Leverage or if you have applied for Leverage.
    (b) Permitted investments of idle funds. Funds not invested in 
Small Businesses must be maintained in:
    (1) Direct obligations of, or obligations guaranteed as to 
principal and interest by, the United States, which mature within 15 
months from the date of the investment; or
    (2) Repurchase agreements with federally insured institutions, with 
a maturity of seven days or less. The securities underlying the 
repurchase agreements must be direct obligations of, or obligations 
guaranteed as to principal and interest by, the United States. The 
securities must be maintained in a custodial account at a federally 
insured institution; or
    (3) Certificates of deposit with a maturity of one year or less, 
issued by a federally insured institution; or
    (4) A deposit account in a federally insured institution, subject 
to a withdrawal restriction of one year or less; or
    (5) A checking account in a federally insured institution.
    (c) Deposit of funds in excess of the insured amount. (1) You are 
permitted to deposit funds in a federally insured institution in excess 
of the institution's insured amount, but only if the institution is 
``well capitalized'' in accordance with the definition set forth in 
regulations of the Federal Deposit Insurance Corporation, as amended 
(12 CFR 325.103).
    (2) Exception: You may make a temporary deposit (not to exceed 30 
days) in excess of the insured amount, in a transfer account 
established to facilitate the receipt and disbursement of funds or to 
hold funds necessary to honor Commitments issued.
    (d) Deposit of funds in Associate institution. A deposit in, or a 
repurchase agreement with, a federally insured institution that is your 
Associate is not considered a Financing of such Associate under 
Sec. 107.730, provided the terms of such deposit or repurchase 
agreement are no less favorable than those available to the general 
public.

Borrowing by Licensees From Non-SBA Sources


Sec. 107.550  Prior approval of secured third-party debt of leveraged 
Licensees.

    (a) General rule. If you have outstanding Leverage, you must get 
SBA's written approval before you incur any non-SBA debt secured by any 
of your assets (referred to in this section as ``secured third-party 
debt'') or refinance any debt with secured third-party debt, including 
any renewal of, or increase in, a secured line of credit, or expansion 
of the scope of a security interest or lien. Secured third-party debt 
includes all guarantees and other contingent obligations that you 
voluntarily assume that are secured by any of your assets, all secured 
lines of credit, and any secured Temporary Debt of a Licensee 

[[Page 58552]]
with outstanding Participating Securities.
    (b) Additional rule for secured lines of credit in existence on 
April 8, 1994. If you have outstanding Leverage and you have a secured 
line of credit that was created on or before April 8, 1994, you must 
receive SBA's written approval of the line before you increase the 
amounts outstanding thereunder.
    (c) Conditions for SBA approval. As a condition of granting its 
approval under this Sec. 107.550, SBA may impose such restrictions or 
limitations as it deems appropriate, taking into account your 
historical performance, current financial position, proposed terms of 
the secured debt and amount of aggregate debt you will have outstanding 
(including Leverage). SBA will not favorably consider any requests for 
approval which include a blanket lien on all your assets, or a security 
interest in your investor commitments in excess of 125 percent of the 
proposed borrowing.
    (d) Thirty day approval. Unless SBA notifies you otherwise within 
30 days after it receives your request, you may consider your request 
automatically approved if:
    (1) You are in regulatory compliance;
    (2) The security interest in your assets is limited to either those 
assets being acquired with the borrowed funds or an asset coverage 
ratio of no more than 1.25:1;
    (3) Your Leverage does not exceed 150 percent of your Leverageable 
Capital; and
    (4) Your request is for approval of a secured line of credit that 
would not cause your total outstanding borrowings (not including 
Leverage) to exceed 50 percent of your Leverageable Capital.


Sec. 107.560  Subordination of SBA's creditor position.

    (a) Debentures purchased or guaranteed on or before July 1, 1991. 
Under the terms of any Debenture purchased or guaranteed by SBA on or 
before July 1, 1991, SBA's unsecured claims against you, as a 
Debenture-holder or as subrogee, are subordinated in favor of all your 
other creditors, except to the extent that such claims may be subject 
to equitable subordination in SBA's favor.
    (b) Debentures purchased or guaranteed after July 1, 1991, 
including refinancings of Debentures previously purchased or 
guaranteed. (1) Under the terms of any Debenture purchased or 
guaranteed by SBA after July 1, 1991, SBA's unsecured claims against 
you, as a Debenture-holder or as subrogee, are subordinated only in 
favor of non-Associate lenders; and, to the extent that your 
indebtedness to such lenders exceeds the lesser of $10,000,000 or 200 
percent of your Regulatory Capital (determined as of the date your 
Debentures were purchased or guaranteed), SBA's unsecured claims enjoy 
parity with those of other unsecured creditors, except with respect to 
indebtedness created on or before July 1, 1991.
    (2) In order to induce others to lend you money after your 
Debenture has been purchased or guaranteed, SBA may agree in writing on 
a case-by-case basis to subordinate its unsecured claims, on such terms 
as it may determine, in favor of one or more of your Associates, or in 
favor of other lenders in excess of the amounts mentioned in paragraph 
(b)(1)of this section.
    (3) SBA reserves the authority to refuse to subordinate its claims 
if it determines, at the time you request your Debenture be purchased 
or guaranteed, that the exercise of reasonable investment prudence and 
your financial condition warrant such refusal.


Sec. 107.570  Restriction on third-party debt of issuers of 
Participating Securities.

    (a) General. Temporary Debt is the only debt (other than Leverage) 
that you are permitted to incur if you have applied to issue 
Participating Securities or if you have outstanding Participating 
Securities. For additional rules governing secured Temporary Debt, see 
Sec. 107.550.
    (b) Definition of Temporary Debt. Temporary Debt means your short-
term borrowings if:
    (1) Such borrowings are for the purpose of maintaining your 
operating liquidity or providing funds for a particular Financing of a 
Small Business;
    (2) The funds are borrowed from a regulated financial institution 
or a regulated credit company (or, if approved by SBA on a case-by-case 
basis, from non-regulated lenders including shareholders or partners);
    (3) Your total outstanding borrowings (not including Leverage) do 
not exceed 50 percent of your Leverageable Capital; and
    (4) All such borrowings are fully paid off for at least 30 
consecutive days during your fiscal year so that you have no 
outstanding third-party debt for 30 days.
Voluntary Decrease in Licensee's Regulatory Capital
Sec. 107.585  Voluntary decrease in Regulatory Capital.
    You must obtain SBA's prior written approval to reduce your 
Regulatory Capital by more than two percent in any fiscal year, unless 
otherwise permitted under Secs. 107.1560 and 107.1570. At all times, 
you must retain sufficient Regulatory Capital to meet the minimum 
capital requirements in the Act and Sec. 107.210, and sufficient 
Leverageable Capital to avoid having excess Leverage in violation of 
section 303 of the Act and Secs. 107.1150 through 107.1170.

Requirement To Conduct Active Investment Operations
Sec. 107.590  Licensee's requirement to maintain active operations.

    (a) Activity test. You must conduct active operations, as 
determined under this Sec. 107.590, as a condition of your license. You 
will be considered active if:
    (1) During the eighteen months preceding your most recent fiscal 
year end, you made Financings (excluding Commitments) totaling at least 
20 percent of your Regulatory Capital; and
    (2) Your idle funds did not exceed 20 percent of your total assets 
(at cost) at your most recent fiscal year end.
    (b) Permitted exceptions to activity requirements. You are 
considered active if SBA determines that your failure to meet the 
requirements in paragraph (a) of this section is the result of one or 
more of the following factors:
    (1) Your excess idle funds are the result of recent realized gains, 
repayments, the raising of additional capital or Leverage recently 
received.
    (2) It is necessary for you to maintain excess idle funds to 
conduct your operations because:
    (i) You have no remaining unfunded commitments from investors; and
    (ii) You cannot receive additional Leverage, solely because SBA has 
insufficient funds available.
    (3) You have not made sufficient Financings because of a lack of 
available funds, evidenced by Loans and Investments (at cost) equal to 
at least 90 percent of your Combined Capital as of your most recent 
fiscal year end.
    (4) You have not made sufficient Financings solely because SBA has 
restricted your ability to make investments.
    (c) Applicability of activity requirements. The activity 
requirements in paragraph (a) of this section do not apply if you have 
filed a ``Wind-up Plan'' approved by SBA. ``Wind-up Plan'' means a plan 
that you prepare when you decide that you will no longer make any 
Financings other than follow-on investments, and that you update 
annually when you file your SBA Form 468. The plan must contain your 
best estimates of the following:
    (1) The remaining number of years you expect to operate. 

[[Page 58553]]

    (2) For each of your Loans and Investments, the expected 
liquidation date and anticipated proceeds.
    (3) The timing of your repayment of obligations to SBA.
    (4) The timing and amount of any planned reductions in your 
Management Expenses.
    (d) Phase-in of activity requirements. You must meet the activity 
requirements in this Sec. 107.590 as of the end of your first full 
fiscal year following the effective date of the final regulation. Until 
then, you will be considered active if you meet the activity 
requirements in effect the day before the effective date of the final 
regulation.

Subpart F--Recordkeeping, Reporting, and Examination Requirements 
for Licensees

Recordkeeping Requirements for Licensees


Sec. 107.600  General requirement for Licensee to maintain and preserve 
records.

    (a) Maintaining your accounting records. You must establish and 
maintain your accounting records using SBA's standard chart of accounts 
for Licensee, unless SBA approves otherwise.
    (b) Location of records. You must keep the following records at 
your principal place of business or, in the case of paragraph (b)(3) of 
this section, at the branch office that is primarily responsible for 
the transaction:
    (1) All your accounting and other financial records;
    (2) All minutes of meetings of directors, stockholders, executive 
committees, partners, or other officials; and
    (3) All documents and supporting materials related to your business 
transactions, except for any items held by a custodian under a written 
agreement between you and a Portfolio Concern or non-SBA lender, or any 
securities held in a safe deposit box, or by a licensed securities 
broker in an amount not exceeding the broker's per-account insurance 
coverage.
    (c) Preservation of records. You must retain all the records that 
are the basis for your financial reports. Such records must be 
preserved for the periods specified in this paragraph (c), and must 
remain accessible for the first two years of the preservation period.
    (1) You must preserve for at least 15 years or, in the case of a 
Partnership Licensee, at least two years beyond the date of 
liquidation:
    (i) All your accounting ledgers and journals, and any other records 
of assets, asset valuations, liabilities, equity, income, and expenses.
    (ii) Your Articles, bylaws, minute books, and license application.
    (iii) All documents evidencing ownership of the Licensee including 
ownership ledgers, and ownership transfer registers.
    (2) You must preserve for at least six years all supporting 
documentation (such as vouchers, bank statements, or canceled checks) 
for the records listed in paragraph (b)(1) of this section.
    (3) After final disposition of any item in your Portfolio, you must 
preserve for at least six years:
    (i) Financing applications and Financing instruments.
    (ii) All loan, participation, and escrow agreements.
    (iii) Size status declarations (SBA Form 480) and Financing 
Eligibility Statements (SBA Form 1941).
    (iv) Any capital stock certificates and warrants of the Portfolio 
Concern that you did not surrender or exercise.
    (v) All other documents and supporting material relating to the 
Portfolio Concern, including correspondence.
    (4) You may substitute a microfilm or computer-scanned or generated 
copy for the original of any record covered by this paragraph (c).


Sec. 107.610  Required certifications for Loans and Investments.

    For each of your Loans and Investments, you must have the documents 
listed in this section. You must keep these documents in your files and 
make them available to SBA upon request.
    (a) SBA Form 480, the Size Status Declaration, executed both by you 
and by the concern you are financing. By executing this document, both 
parties certify that the concern is a Small Business. For securities 
purchased from an underwriter in a public offering, you may substitute 
a prospectus showing that the concern is a Small Business.
    (b) SBA Form 652, a certification by the concern you are financing 
that it will not illegally discriminate (see part 112 of this chapter).
    (c) SBA Form 1941 (for Section 301(d) Licensees only), executed 
both by you and by the concern you are financing. By executing this 
document, both parties certify that the concern is a Disadvantaged 
Business.
    (d) A certification by the concern you are financing of the 
intended use of the proceeds. For securities purchased from an 
underwriter in a public offering, you may substitute a prospectus 
indicating the intended use of proceeds.


Sec. 107.620  Requirements to obtain information from Portfolio 
Concerns.

    All the information required by this section is subject to the 
requirements of Sec. 107.600 and must be in English.
    (a) Information for initial Financing decision. Before extending 
any Financing, you must require the applicant to submit such financial 
statements, plans of operation (including intended use of financing 
proceeds), cash flow analyses and projections as are necessary to 
support your investment decision. The information submitted must be 
consistent with the size and type of the business and the amount of the 
proposed Financing.
    (b) Updated financial information. (1) The terms of each Financing 
must require the Portfolio Concern to provide, at least annually, 
sufficient financial information to enable you to perform the following 
required procedures:
    (i) Evaluate the financial condition of the Portfolio Concern for 
the purpose of valuing your investment;
    (ii) Determine the continued eligibility of the Portfolio Concern; 
and
    (iii) Verify the use of Financing proceeds.
    (2) The information submitted to you must be certified by the chief 
financial officer, general partner, or proprietor of the Portfolio 
Concern.
    (3) For financial and valuation purposes, you may accept a complete 
copy of the Federal income tax return filed by the Portfolio Concern 
(or its proprietor) in lieu of financial statements, but only if 
appropriate for the size and type of the business involved.
    (4) The requirements in this paragraph (b) do not apply when you 
acquire securities from an underwriter in a public offering (see 
Sec. 107.828). In that case, you must keep copies of all reports 
furnished by the Portfolio Concern to the holders of its securities.
    (c) Information required for examination purposes. You must obtain 
any information requested by SBA's examiners for the purpose of 
verifying the certifications made by a Portfolio Concern under 
Sec. 107.610. In this regard, your Financing documents must contain 
provisions requiring the Portfolio Concern to give you and/or SBA's 
examiners access to its books and records for such purpose.

Reporting Requirements for Licensees


Sec. 107.630  Requirement for Licensees to file financial statements 
with SBA (Form 468).

    (a) Annual filing of Form 468. For each fiscal year, you must 
submit to SBA financial statements and 

[[Page 58554]]
supplementary information prepared on SBA Form 468. You must file Form 
468 on or before the last day of the third month following the end of 
your fiscal year.
    (1) Audit of Form 468. The annual Form 468 must be audited by an 
independent public accountant acceptable to SBA.
    (2) Insurance requirement for public accountant. Your independent 
public accountant must carry Errors and Omissions insurance in an 
amount acceptable to SBA, or be self-insured and have a net worth 
acceptable to SBA.
    (b) Interim filings of Form 468. When requested by SBA, you must 
file interim reports on Form 468. SBA may require you to file the 
entire form or only certain statements and schedules. You must file 
such reports on or before the last day of the month following the end 
of the reporting period.
    (c) Standards for preparation of Form 468. You must prepare SBA 
Form 468 in accordance with appendix I, Accounting Standards and 
Financial Reporting Requirements for Small Business Investment 
Companies.
    (d) Where to file Form 468. Submit all filings of Form 468 to the 
Investment Division of SBA.
    (e) Reporting of economic impact information on Form 468. Your 
annual filing of SBA Form 468 must include an assessment of the 
economic impact of each Financing, specifying the full-time equivalent 
jobs created or retained, and the impact of the Financing on the 
revenues and profits of the business and on taxes paid by the business 
and its employees.


Sec. 107.640  Requirement to file Portfolio Financing Reports (SBA Form 
1031).

    For each Financing of a Small Business (excluding guarantees), you 
must submit a Portfolio Financing Report on SBA Form 1031 within 30 
days of the closing date.


Sec. 107.650  Requirement to report portfolio valuations to SBA.

    You must determine the value of your Loans and Investments in 
accordance with Sec. 107.503. You must report such valuations to SBA 
within 90 days of the end of the fiscal year in the case of annual 
valuations, and within 30 days following the close of other reporting 
periods. You must report material changes in valuations at least 
quarterly, within thirty days following the close of the quarter.


Sec. 107.660  Other items required to be filed by Licensee with SBA.

    (a) Reports to owners. You must give SBA a copy of any report you 
furnish to your investors, including any prospectus, letter, or other 
publication concerning your financial operations or those of any 
Portfolio Concern.
    (b) Documents filed with SEC. You must give SBA a copy of any 
report, application or document you file with the Securities and 
Exchange Commission.
    (c) Litigation reports. When you become a party to litigation or 
other proceedings, you must give SBA a report within 30 days that 
describes the proceedings and identifies the other parties involved and 
your relationship to them.
    (1) The proceedings covered by this paragraph (c) include any 
action by you, or by your security holder(s) in a personal or 
derivative capacity, against an officer, director, Investment Adviser 
or other Associate of yours for alleged breach of official duty.
    (2) SBA may require you to submit copies of the pleadings and other 
documents SBA may specify.
    (3) Where proceedings have been terminated by settlement or final 
judgment, you must promptly advise SBA of the terms.
    (4) This paragraph (c) does not apply to collection actions or 
proceedings to enforce your ordinary creditors' rights.
    (d) Other reports. You must file any other reports that SBA may 
require by written directive.


Sec. 107.670  Application for exemption from civil penalty for late 
filing of reports.

    (a) If it is impracticable to submit any required report within the 
time allowed, you may apply for an extension. The request for an 
extension must:
    (1) Be filed before the reporting deadline;
    (2) Certify to an extraordinary occurrence, not within your 
control, that makes timely filing of the report impracticable; and
    (3) Be accompanied by written evidence of such occurrence, where 
appropriate.
    (b) Upon receipt of your request, SBA may exempt you from the civil 
penalty provision of section 315(a) of the Act, in such manner and 
under such conditions as SBA determines.


Sec. 107.680  Reporting changes in Licensee not subject to prior SBA 
approval.

    (a) Changes to be reported for post approval. This section applies 
to any changes in your Articles, ownership, capitalization, management, 
operating area, or investment policies that do not require SBA's prior 
approval. You must report such changes to SBA within 30 days for post 
approval. A processing fee of $200 must accompany each request for post 
approval of new officer, directors, or Control Persons.
    (b) Approval by SBA. You may consider any change submitted under 
this section Sec. 107.680 to be approved unless SBA notifies you to the 
contrary within 90 days after receiving it. SBA's approval is 
contingent upon your full disclosure of all relevant facts and is 
subject to any conditions SBA may prescribe.

Examinations of Licensees by SBA for Regulatory Compliance


Sec. 107.690  Examinations.

    SBA will examine all Licensees for the purpose of evaluating 
regulatory compliance.


Sec. 107.691  Responsibilities of Licensee during examination.

    You must make all books, records and other pertinent documents and 
materials available for the examination, including any information 
required by the examiner under Sec. 107.620(c). In addition, the 
agreement between you and the independent public accountant performing 
your audit must provide that any information in the accountant's 
working papers be made available to SBA upon request.


Sec. 107.692  Examination fees.

    (a) SBA will assess fees for examinations. Fees will be assessed 
based on your assets as of the date of your latest certified financial 
statement submitted to SBA prior to the examination. As a general rule, 
SBA will not assess fees for special examinations to obtain specific 
information. The rate table is as follows:

----------------------------------------------------------------------------------------------------------------
        Total assets of licensee              Base rate                       Percent of assets                 
----------------------------------------------------------------------------------------------------------------
$0 to $2,000,000........................            $3,500  +0                                                  
$2,000,001 to $5,000,000................            $3,500  +.24% over $2,000,000                               
$5,000,001 to $10,000,000...............           $10,700  +.12% over $5,000,000                               
$10,000,001 to $15,000,000..............           $16,700  +.06% over $10,000,000                              
$15,000,001 or more.....................           $19,700  +.03% over $15,000,000                              
----------------------------------------------------------------------------------------------------------------

 
[[Page 58555]]

    (b) Delay Fee. If, in the judgment of SBA, the time required to 
complete your examination is delayed due to your lack of cooperation or 
the condition or your records, SBA may assess an additional fee of up 
to $500 per day.

Subpart G--Financing of Small Businesses by Licensees

Determining the Eligibility of a Small Business for SBIC Financing


Sec. 107.700  Compliance with size standards in Part 121 of this 
chapter as a condition of Assistance.

    You are permitted to provide financial assistance and management 
services only to a Small Business. To determine whether an applicant is 
a Small Business, you may use either the financial size standards in 
Sec. 121.802(a)(3)(i) of this chapter or the industry standard covering 
the industry in which the applicant is primarily engaged, as set forth 
in Sec. 121.802(a)(3)(ii) of this chapter.


Sec. 107.710  Requirement to finance Smaller Businesses.

    Your Portfolio must include Financings to Smaller Businesses.
    (a) Definition of Smaller Business. A Smaller Business means a 
business that:
    (1) Together with its Affiliates has a net worth of not more than 
$6.0 million and average net income after Federal income taxes 
(excluding any carry-over losses) for the preceding two years no 
greater than $2.0 million; or
    (2) Both together with its affiliates, and by itself, meets the 
size standard of Sec. 121.601 of this chapter at the time of the 
Financing for the industry in which it is then primarily engaged.
    (b) Phase 1 of Smaller Business Financing requirement. At the close 
of your first complete fiscal year beginning on or after April 25, 
1994, at least 10 percent of the total dollar amount of the Financings 
you extended since April 25, 1994 must have been in Smaller Businesses.
    (c) Phase 2 of Smaller Business Financing requirement. At the close 
of each of your next fiscal years, at least 20 percent of the total 
dollar amount of the Financings you extended since April 25, 1994 must 
have been invested in Smaller Businesses.
    (d) Financing a change of ownership which results in the creation 
of a Smaller Business. The Financing of a change of ownership under 
Sec. 107.750 which results in the creation of a Smaller Business 
qualifies as a Smaller Business Financing.
    (e) Non-compliance with this section. If you have not reached the 
required percentage of Smaller Business Financings at the end of any 
fiscal year, then you must be in compliance by the end of the following 
fiscal year.


Sec. 107.720  Small Businesses that may be ineligible for Financing.

    (a) Relenders or reinvestors. You are not permitted to finance any 
business that is a relender or reinvestor.
    (1) Definition. Relenders or reinvestors are businesses whose 
primary business activity involves, directly or indirectly, providing 
funds to others, purchasing debt obligations, factoring, or long-term 
leasing of equipment with no provision for maintenance or repair.
    (2) Exception. You may provide Venture Capital Financing to 
Disadvantaged Businesses that are relenders or reinvestors (except 
banks or savings and loans not insured by agencies of the federal 
government, and agricultural credit companies). Without SBA's prior 
written approval, total Financings under this paragraph (a)(2) that are 
outstanding as of the close of your fiscal year must not exceed your 
Regulatory Capital.
    (b) Passive Businesses. You are not permitted to finance a passive 
business.
    (1) Definition. A business is passive if:
    (i) It is not engaged in a regular and continuous business 
operation (for purposes of this paragraph (b), the mere receipt of 
payments such as dividends, rents, lease payments, or royalties is not 
considered a regular and continuous business operation); or
    (ii) Its employees are not carrying on the majority of the day to 
day operations; or
    (iii) It passes through substantially all of the proceeds of the 
Financing to another entity.
    (2) Exception. You may finance a passive business if it passes all 
the proceeds of the Financing through to a wholly-owned eligible Small 
Business that is not passive.
    (c) Real Estate Businesses. (1) You are not permitted to finance 
any business classified under Major Group 65 (Real Estate) or Industry 
No. 1532 (Operative Builders) of the SIC Manual, with the following 
exceptions:
    (i) Title Abstract companies (Industry No. 6541); and
    (ii) Companies listed under Industry No. 6531 (for example, real 
estate agents, brokers, escrow agents, managers and multiple listing 
services) that derive at least 80 percent of their revenue from non-
Affiliate sources.
    (2) You are not permitted to finance a business, regardless of SIC 
classification, if the Financing is to be used to acquire realty or to 
discharge an obligation relating to the prior acquisition of realty, 
unless the Small Business:
    (i) Is acquiring an existing building and will use at least 51 
percent of the usable square footage for an eligible business activity; 
or
    (ii) Is building or renovating a building and will use at least 67 
percent of the usable square footage for an eligible business activity.
    (d) Project Financing. You are not permitted to finance a business 
if:
    (1) The assets of the business are to be reduced or consumed, 
generally without replacement, as the life of the business progresses, 
and the nature of the business requires that a stream of cash payments 
be made to the business's financing sources, on a basis associated with 
the continuing sale of assets. Examples include real estate development 
projects and oil and gas wells; or
    (2) The primary purpose of the Financing is to fund production of a 
single item or defined limited number of items, generally over a 
defined production period, and such production will constitute the 
majority of the activities of the Small Business. Examples include 
motion pictures and electric generating plants.
    (e) Farm land purchases. You are not permitted to finance the 
acquisition of farm land. Farm land means land which is or is intended 
to be used for agricultural or forestry purposes, such as the 
production of food, fiber, or wood, or is so taxed or zoned.
    (f) Public interest. You are not permitted to finance any business 
if the proceeds are to be used for purposes contrary to the public 
interest, including but not limited to activities which are in 
violation of law, or inconsistent with free competitive enterprise.
    (g) Foreign investment--(1) General rule. You are not permitted to 
finance a business if:
    (i) The funds will be used substantially for a foreign operation; 
or
    (ii) At the time of the Financing or within one year thereafter, 
more than 40 percent of the employees or tangible assets of the Small 
Business are located outside the United States (unless you can show, to 
SBA's satisfaction, that the Financing was used for a specific domestic 
purpose).
    (2) Exception. This paragraph (g) does not prohibit a Financing 
used to acquire foreign materials and equipment or foreign property 
rights for use or sale in the United States.
    (h) Associated supplier. You are not permitted to finance a 
business that purchases, or will purchase, goods or services from a 
supplier who is your 

[[Page 58556]]
Associate, except under the following conditions:
    (1) The amount of goods and services purchased (or to be purchased) 
from your Associate with the proceeds of the Financing, or with funds 
released as a result of the Financing, is less than 50 percent of the 
total amount of the Financing (75 percent for a Section 301(d) 
Licensee);
    (2) The price of such goods and services is no higher than that 
charged other customers of your Associate; and
    (3) The Small Business purchases no capital goods from your 
Associate.
    (i) Financing Licensees. You are not permitted to provide funds, 
directly or indirectly, that the Small Business will use:
    (1) To purchase stock in or provide capital to a Licensee; or
    (2) To repay an indebtedness incurred for the purpose of investing 
in a Licensee.


Sec. 107.730  Financings which constitute conflicts of interest.

    (a) General rule. You must not self-deal to the prejudice of a 
Small Business, the Licensee, its shareholders or partners, or SBA. 
Unless you obtain a prior written exemption from SBA for special 
instances in which a Financing may further the purposes of the Act 
despite presenting a conflict of interest, you must not directly or 
indirectly:
    (1) Provide Financing to any of your Associates.
    (2) Provide Financing to an Associate of another Licensee if one of 
your Associates has received or will receive any direct or indirect 
Financing or a Commitment from that Licensee or a third Licensee 
(including Financing or Commitments received under any understanding, 
agreement, or cross dealing, reciprocal or circular arrangement).
    (3) Borrow money from:
    (i) A Small Business Financed by you;
    (ii) An officer, director, or owner of at least a 10 percent equity 
interest in such business; or
    (iii) A Close Relative of any such officer, director, or equity 
owner.
    (4) Provide Financing to a Small Business to discharge an 
obligation to your Associate or free other funds to pay such 
obligation. This paragraph (a)(4) does not apply if the obligation is 
to an Associate Lending Institution and is a line of credit or other 
obligation incurred in the normal course of business.
    (5) Provide Financing to a Small Business for the purpose of 
purchasing property from your Associate, except as permitted under 
Sec. 107.720(h).
    (b) Rules applicable to Associates. Without SBA's prior written 
approval, your Associates must not, directly or indirectly:
    (1) Borrow money from any Person described in paragraph (a)(3) of 
this section.
    (2) Receive from a Small Business any compensation in connection 
with Assistance you provide (except as permitted under Secs. 107.828(c) 
and 107.900), or anything of value for procuring, attempting to 
procure, or influencing your action with respect to such Assistance.
    (c) Applicability of other laws. You are also bound by any 
restrictions in Federal or State laws governing conflicts of interest 
and fiduciary obligations.
    (d) Financings with Associates--(1) Financings with Associates 
requiring prior approval. Without SBA's prior written approval, you may 
not Finance any business in which your Associate has either a voting 
equity interest, or total equity interests (including potential 
interests), of at least five percent.
    (2) Other Financings with Associates. If you and an Associate 
provide Financing to the same Small Business, either at the same time 
or at different times, you must be able to demonstrate to SBA's 
satisfaction that the terms and conditions are (or were) fair and 
equitable to you, taking into account any differences in the timing of 
each party's financing transactions.
    (3) Exceptions to paragraphs (d)(1) and (d)(2) of this section. A 
Financing that falls into one of the following categories is exempt 
from the prior approval requirement in paragraph (d)(1) of this section 
or is presumed to be fair and equitable to you for the purposes of 
paragraph (d)(2) of this section, as appropriate:
    (i) Your Associate is a Lending Institution that is providing 
financing under a credit facility in order to meet the operational 
needs of the Small Business, and the terms of such financing are usual 
and customary.
    (ii) Your Associate invests in the Small Business on the same terms 
and conditions and at the same time as you.
    (iii) Both you and your Associate are leveraged Licensees, and both 
have outstanding Participating Securities or neither has outstanding 
Participating Securities.
    (iv) Both you and your Associate are non-leveraged Licensees.
    (e) Use of Associates to manage Portfolio Concerns. To protect your 
investment, you may designate an Associate to serve as an officer, 
director, or other participant in the management of a Small Business. 
You must identify any such Associate in your records available for 
SBA's review under Sec. 107.600. Without SBA's prior written approval, 
the Associate must not:
    (1) Have any other direct or indirect financial interest in the 
Portfolio Concern that exceeds, or has the potential to exceed, 3 
percent of the Portfolio Concern's equity.
    (2) Have served for more than 30 days as an officer, director or 
other participant in the management of the Portfolio Concern before you 
provided Financing.
    (3) Receive any income or anything of value from the Portfolio 
Concern unless it is for your benefit, with the exception of director's 
fees, expenses, and distributions based upon the Associate's ownership 
interest in the Concern.
    (f) 1940 and 1980 Act Companies: SEC exemptions. If you are a 1940 
or 1980 Act Company and you receive an exemption from the Securities 
and Exchange Commission for a transaction described in this 
Sec. 107.730, you need not obtain SBA's approval of the transaction. 
However, you must promptly notify SBA of the transaction and satisfy 
the public notice requirements in paragraph (g) of this section.
    (g) Public notice. Before SBA grants an exemption under this 
Sec. 107.730, you must publish notice of the transaction in a newspaper 
of general circulation in the locality most directly affected by the 
transaction, and furnish a certified copy to SBA within 10 days of 
publication. SBA will publish a similar notice in the Federal Register.


Sec. 107.740  Portfolio diversification (``overline'' limitation).

    (a) General rule. This Sec. 107.740 applies if you have outstanding 
Leverage or want to be eligible for Leverage. Without SBA's prior 
written approval, your aggregate outstanding Financings and Commitments 
to a Small Business (including its Affiliates) must not exceed:
    (1) 20 percent of Regulatory Capital for a Section 301(c) Licensee; 
or
    (2) 30 percent of Regulatory Capital for a Section 301(d) Licensee.
    (b) Outstanding Financings. For the purposes of paragraph (a) of 
this section, you must measure each outstanding Financing at its 
current cost plus any amount of the Financing that was previously 
written off.
    (c) Adjustment to Regulatory Capital. For the purposes of paragraph 
(a) of this section, you may compute a higher maximum permitted 
investment in a Small Business (an ``increased limit'') by adding ``net 
unrealized gains'' on Publicly Traded and Marketable securities to your 
Regulatory Capital, subject to the following conditions: 

[[Page 58557]]

    (1) Net unrealized gains on Publicly Traded and Marketable 
securities means unrealized gains on Publicly Traded and Marketable 
securities minus unrealized losses on all Loans and Investments.
    (2) You must value your Publicly Traded and Marketable securities 
in accordance with your SBA-approved valuation policy.
    (3) You must have positive Retained Earnings Available for 
Distribution at the time you compute an increased limit under this 
paragraph (c).
    (4) At the time you first compute an increased limit, and as of the 
first business day of each calendar quarter that the increased limit is 
in effect, you must keep copies in your files of the NASDAQ listings 
(or the Wall Street Journal) or written quotations from the market 
makers quoting the Publicly Traded and Marketable securities which 
support the adjustment.
    (5) If your net unrealized gains on Publicly Traded and Marketable 
securities are more than 30 percent below their original level on the 
first business day of any calendar quarter, and remain so for the next 
30 days, you agree to do one of the following to remain in compliance 
with the terms of your Leverage:
    (i) By the first day of the next calendar quarter, increase your 
Regulatory Capital sufficiently to restore support for the increased 
limit; or
    (ii) Lower the increased limit to reflect the decrease in net 
unrealized gains on Publicly Traded and Marketable securities, and 
reduce any Financings that exceed the lower limit.

    Example to paragraph (c) of this section. Your Regulatory 
Capital is $2,500,000 and your overline limit is $500,000 (20 
percent of $2,500,000). On January 15, 1995, you document net 
unrealized gains on Publicly Traded and Marketable securities of 
$200,000 and compute an increased limit of $540,000 (20 percent of 
$2,700,000). You now make an investment of $540,000 in a Small 
Business. Nothing changes until the first business day of April, 
1996, when you document net unrealized gains on Publicly Traded and 
Marketable securities of only $120,000, a reduction of more than 30 
percent. Your net unrealized gains remain at this level for the next 
30 days. Your increased limit is now only $524,000 (20 percent of 
$2,620,000). By July 1, 1996, you must either increase Regulatory 
Capital by $80,000 to restore your increased limit to $540,000, or 
reduce your portfolio investment from $540,000 to $524,000.

Sec. 107.750  Conditions for financing a change of ownership of a Small 
Business.

    You may finance a change of ownership of a Small Business only 
under the conditions set forth in this section.
    (a) The Financing must:
    (1) Promote the sound development or preserve the existence of the 
Small Business;
    (2) Help create a Small Business as a result of a corporate 
divestiture; or
    (3) Facilitate ownership in a Disadvantaged Business.
    (b) The Resulting Concern (as defined in paragraph (c) of this 
section) must:
    (1) Be a Small Business under Sec. 107.700;
    (2) Have 500 or fewer full-time equivalent employees; or meet one 
of the appropriate debt/equity ratio tests:
    (i) If you have outstanding Leverage, the Resulting Concern's ratio 
of debt to equity must be no more than 5 to 1; or
    (ii) If you have no outstanding Leverage, the Resulting Concern's 
ratio of debt to equity must be no more than 8 to 1.
    (c) Definitions. (1) The ``Resulting Concern'' is determined by 
viewing the business as though the change of ownership had already 
occurred, giving effect to all contemplated financing, mergers, and 
acquisitions.
    (2) For purposes of this section, ``debt'' means long-term debt, 
including contingent liabilities, but excluding accounts payable, 
operating leases, letters of credit, subordinated notes payable to the 
seller, any other liabilities approved for exclusion by SBA and short-
term working capital loans (so long as the loans carry a zero balance 
for 30 consecutive days during the concern's fiscal year).
    (3) For purposes of this section, ``equity'' means common and 
preferred stock (corporation), contributed capital (partnership), or 
membership interests (limited liability company).


Sec. 107.760  How a change in size or activity of a Portfolio Concern 
affects the Licensee and the Portfolio Concern.

    (a) Effect on Licensee of a change in size of a Portfolio Concern. 
If a Portfolio Concern no longer qualifies as a Small Business you may 
keep your investment in the concern and:
    (1) Subject to the overline limitations of Sec. 107.740, you may 
provide additional Financing to the concern up to the time it makes a 
public offering of its securities.
    (2) Even after the concern makes a public offering, you may 
exercise any stock options, warrants, or other rights to purchase 
Equity Securities which you acquired before the public offering.
    (b) Effect of a change in business activity occurring within one 
year of Licensee's initial Financing--(1) Retention of Investment. 
Unless you receive SBA's written approval, you may not keep your 
investment in a Portfolio Concern, small or otherwise, which becomes 
ineligible by reason of a change in its business activity within one 
year of your initial investment.
    (2) Presumption against Portfolio Concern--Default. If such a 
change occurs within one year, there is a presumption that the change 
was within the contemplation of the Portfolio Concern at the time of 
your initial Financing. Unless this presumption is rebutted, this 
change constitutes a default or breach of the terms of your initial 
Financing and a violation of this part.
    (3) Licensee's rights upon default of Portfolio Concern. If the 
Portfolio Concern is in breach or default, you have the right to demand 
immediate repayment of all indebtedness owed by the Portfolio Concern 
to you, or redemption of all of your equity investments in the 
Portfolio Concern.
    (4) Request for SBA's approval to retain investment. If you request 
that SBA approve the retention of your investment, your request must 
include sufficient evidence to rebut the presumption in paragraph 
(b)(2) of this section by a showing that the change in business 
activity was caused by an unforeseen change in circumstances.
    (5) Additional Financing. If SBA approves your request to retain an 
investment under paragraph (b)(4) of this section, you may provide 
additional Financing to the Portfolio Concern to the extent necessary 
to protect against the loss of the amount of your original investment, 
subject to the overline limitations of Sec. 107.740.
    (c) Effect of a change in business activity occurring more than one 
year after the initial Financing. If a Portfolio Concern becomes 
ineligible because of a change in business activity more than one year 
after your initial Financing you may:
    (1) Retain your investment; and
    (2) You may provide additional Financing to the Portfolio Concern 
to the extent necessary to protect against the loss of the amount of 
your original investment, subject to the overline limitations of 
Sec. 107.740.

Structuring Licensee's Financing of Eligible Small Businesses: 
Types of Financing


Sec. 107.800  Financings in the form of Equity Securities.

    (a) You may purchase the Equity Securities of a Small Business. You 
may not, inadvertently or otherwise:
    (1) Become a general partner in any unincorporated business; or
    (2) Become jointly or severally liable for any obligations of an 
unincorporated business. 

[[Page 58558]]

    (b) Definition. Equity Securities means stock of any class in a 
corporation, limited partnership interests in a limited partnership, 
membership interests in a limited liability company, or joint venture 
interests. If the Financing agreement contains covenants or compliance 
provisions with debt-type remedies (as determined by SBA), or includes 
redemption provisions other than those permitted under Sec. 107.850, 
the security will be considered a Debt Security for all regulatory 
purposes.


Sec. 107.810   Financings in the form of Loans.

    You may make Loans to Small Businesses. A Loan means a transaction 
evidenced by a debt instrument with no provision for you to acquire 
Equity Securities.


Sec. 107.815   Financings in the form of Debt Securities.

    You may purchase Debt Securities from Small Businesses.
    (a) Definition. Debt Securities are instruments evidencing a loan 
with an option or any other right to acquire Equity Securities in a 
Small Business or its Affiliates, or a loan which by its terms is 
convertible into an equity position. Consideration must be paid for all 
options that you acquire.
    (b) Restriction on options obtained by Licensee's management and 
employees. Your employees, officers, directors or general partners, or 
the general partners of the management company that is providing 
services to you or to your general partner, may obtain options in a 
Financed Small Business only if:
    (1) They participate in the Financing on a pari passu basis with 
you; or
    (2) SBA gives its prior written approval.


Sec. 107.820   Financings in the form of guarantees.

    At the request of a Small Business or where necessary to protect 
your existing investment, you may guarantee the monetary obligation of 
a Small Business to any non-Associate creditor.
    (a) You may not issue a guaranty if:
    (1) You would become subject to State regulation as an insurance, 
guaranty or surety business;
    (2) The amount of the guaranty plus any direct Financings to the 
Small Business exceed the overline limitations of Sec. 107.740, except 
that a pledge of the Equity Securities of the issuer or a subordination 
of your lien or creditor position does not count toward your overline; 
or
    (3) The total financing cost to the Small Business exceeds the cost 
of money limits of Sec. 107.855.
    (b) Pledge of Licensee's assets as guaranty. For purposes of this 
section, a guaranty with recourse only to specific asset(s) you have 
pledged is equal to the fair market value of such asset(s) or the 
amount of the debt guaranteed, whichever is less.


Sec. 107.825  Commitments to Small Businesses.

    You may enter into a written Commitment to provide Financing to a 
Small Business. A Commitment is a written agreement between you and an 
eligible Small Business that obligates you to provide Financing (except 
a guarantee) to that Small Business 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. You may include in the agreement 
reasonable conditions precedent to your obligation to fund the 
commitment but these conditions must be outside your control.


Sec. 107.828   Purchasing securities from an underwriter or other third 
party.

    (a) Securities purchased through or from an underwriter. You may 
purchase the securities of a Small Business through or from an 
underwriter if:
    (1) You purchase such securities within 90 days of the date the 
public offering is first made;
    (2) Your purchase price is no more than the original public 
offering price; and
    (3) The amount paid by you for the securities (less ordinary and 
reasonable underwriting charges and commissions) has been, or will be, 
paid to the Small Business.
    (b) Recordkeeping requirements. In addition to the recordkeeping 
requirements of Sec. 107.600, you must keep records available for SBA's 
inspection which show the relevant details of the transaction, 
including, but not limited to, date, price, commissions, and the 
underwriter's certifications required under paragraph (c) of this 
section.
    (c) Underwriter's requirements. The underwriter must certify in 
writing that the requirement in paragraph (a)(3) of this section has 
been met. The underwriter also must certify whether it is your 
Associate. Any such Associate underwriter may keep fees or charges 
related to the portion of the offering purchased by you only if such 
fees and charges do not exceed the total of the application and closing 
fees and reimbursable expenses permitted by Sec. 107.860.
    (d) Securities purchased from another Licensee or from SBA. You may 
purchase from, or exchange with, another Licensee, Portfolio securities 
(or any interest therein). Such purchase or exchange may only be made 
on a non-recourse basis. You may not have more than one-third of your 
total assets(valued at cost) invested in such securities. If you have 
previously sold Portfolio Securities (or any interest therein) on a 
recourse basis, you shall include the amount for which you may be 
contingently liable in your overline computation.
    (e) Purchases of securities from other non-issuers. You may 
purchase securities of a Small Business from a non-issuer not 
previously described in this Sec. 107.828 if:
    (1) Such acquisition is a reasonably necessary part of the overall 
sound Financing of the Small Business under the Act; or
    (2) The securities are acquired to finance a change of ownership 
under Sec. 107.750.

Structuring Licensee's Financing of an Eligible Small Business: Terms 
and Conditions of Financing


Sec. 107.830  Minimum duration/term of financing.

    (a) General rule for Section 301(c) Licensees. If you are a Section 
301(c) Licensee, the duration/term of all your Financings must be for a 
minimum period of five years. Exception: You may finance a 
Disadvantaged Business for a minimum term of four years.
    (b) General rule for Section 301(d) Licensees. The duration/term of 
your Financings may be for a minimum period of four years.
    (c) Restrictions on mandatory redemption of Equity Securities. If 
you have acquired Equity Securities, options or warrants on terms that 
include redemption by the Small Business, you must not require 
redemption by the Small Business within the first five years of your 
acquisition except as permitted in Sec. 107.850.
    (d) Special rules for Loans and Debt Securities--(1) Term. The 
minimum term for Loans and Debt Securities starts with the first 
disbursement of the Financing.
    (2) Prepayment before five years. You must permit voluntary 
prepayment by the Small Business at any time during the initial five 
year term. You must obtain SBA's prior written approval of any 
restrictions on the ability of the Small Business to prepay other than 
the imposition of a reasonable prepayment penalty under paragraph 
(d)(3) of this section.
    (3) Prepayment penalties. You may charge a reasonable prepayment 
penalty 

[[Page 58559]]
which must be agreed upon at the time of the Financing. If SBA 
determines that a prepayment penalty is unreasonable, you must refund 
the entire penalty to the Small Business. 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, is considered reasonable.


Sec. 107.835  Exceptions to minimum duration/term of Financing.

    You may make a Short-term Financing for a term less than five years 
if the Financing is:
    (a) An interim financing (for a period not to exceed one year) in 
contemplation of long-term Financing. The contemplated long-term 
Financing must be in an amount at least equal to the short-term 
Financing, and must be made by you alone or in participation with other 
investors; or
    (b) For protection of your prior investment(s); or
    (c) For the purpose of Financing a change of ownership under 
Sec. 107.750. The total amount of such Financings may not exceed 20 
percent of your Loans and Investments (at cost) at the end of any 
fiscal year; or
    (d) For the purpose of aiding a Small Business in performing a 
contract awarded under a Federal, State, or local government set-aside 
program for ``minority'' or ``disadvantaged'' contractors.


Sec. 107.840  Maximum term of Financing.

    The maximum term of any Financing must be no longer than 20 years.


Sec. 107.845  Maximum rate of amortization on Loans and Debt 
Securities.

    The principal of any Loan (or the loan portion of a Debt Security) 
with a term of five years or less cannot be amortized faster than 
straight line. If the term is greater than five years, the principal 
cannot be amortized faster than straight line for the first five years.


Sec. 107.850  Restrictions on redemption of Equity Securities.

    (a) A Portfolio Concern cannot be required to redeem Equity 
Securities earlier than five years from the date of the first closing 
unless:
    (1) The concern makes a public offering, or has a change of 
management or control, or files for protection under the provisions of 
the Bankruptcy Code, or materially breaches your Financing agreement; 
or
    (2) You make a follow-on investment, in which case the new 
securities may be redeemed in less than five years, but no earlier than 
the redemption date associated with your earliest Financing of the 
concern.
    (b) The redemption price must be either:
    (1) A fixed amount that is no higher than the price you paid for 
the securities; or
    (2) An amount that cannot be fixed or determined before the time of 
redemption. In this case, the redemption price must be based on:
    (i) A reasonable formula that reflects the performance of the 
concern (such as one based on earnings); or
    (ii) The fair market value of the concern at the time of 
redemption, as determined by a professional appraisal performed under 
an agreement acceptable to both parties.
    (c) Any method for determining the redemption price must be agreed 
upon no later than the date of the first (or only) closing of the 
Financing.


Sec. 107.855  Interest rate ceiling and limitations on fees charged to 
Small Businesses (``Cost of Money'').

    ``Cost of Money'' means the interest and other consideration that 
you receive from a Small Business. The Cost of Money to the Small 
Business may not exceed the ceiling determined under this section.
    (a) Financings to which the Cost of Money rules apply. This section 
applies to all Loans and Debt Securities. As required by 
Sec. 107.800(b), you must include as Debt Securities any equity 
interests with redemption provisions that do not meet the restrictions 
in Sec. 107.850.
    (b) When to determine the Cost of Money ceiling for a Financing. 
Your Cost of Money ceiling for a particular Financing is determined as 
of the date of the first closing of the Financing and remains fixed for 
the duration of the Financing.
    (c) How to determine the Cost of Money ceiling for a Financing. At 
a minimum, you may use a Cost of Money ceiling of 19 percent for a Loan 
and 14 percent for a Debt Security. To determine whether you may charge 
more, do the following:
    (1) Choose a base rate for your Cost of Money computation. The base 
rate may be either the Debenture Rate currently in effect or your own 
``Cost of Capital'' as determined under paragraph (d) of this section.
    (2) For a Loan, add 11 percentage points to the base rate; for a 
Debt Security, add 6 percentage points. In either case, round the sum 
down to the nearest eighth of one percent.
    (3) If the result is more than 19 percent (for a Loan) or 14 
percent (for a Debt Security), you may use it as your Cost of Money 
ceiling.
    (4) If two or more Licensees participate in the same Financing of a 
Small Business, the base rate used in this paragraph (c) is the highest 
of the following:
    (i) The current Debenture rate;
    (ii) The Cost of Capital of the lead Licensee; or
    (iii) The weighted average of the Cost of Capital for all Licensees 
participating in the Financing.
    (d) How to determine your Cost of Capital. ``Cost of Capital'' is 
an optional computation of the weighted average interest rate you pay 
on your ``qualified borrowings''. ``Qualified borrowings'' means your 
Debentures together with your borrowings at or below the usual interest 
rate charged by banks in your locality on the date your loan was made.
    (1) For any fiscal year, you may compute your Cost of Capital:
    (i) As of the first day of your fiscal year, to remain in effect 
for the entire year; or
    (ii) As of the first day of every fiscal quarter during the fiscal 
year, to remain in effect for the duration of the quarter.
    (2) For each qualified borrowing outstanding at your last fiscal 
year or fiscal quarter end, multiply the ending principal balance (net 
of related unamortized fees) by the number of days during the past four 
fiscal quarters that the borrowing was outstanding, and divide the 
result by 365.
    (3) Add together the amounts computed for all borrowings under 
paragraph (d)(2) of this section. The result is your weighted average 
borrowings.
    (4) For all qualified borrowings outstanding at your last fiscal 
year or fiscal quarter end, determine the aggregate interest expense 
for the past four fiscal quarters (excluding amortization of loan 
fees).
    (5) Divide the interest expense from paragraph (d)(4) of this 
section by the weighted average borrowings from paragraph (d)(3) of 
this section, and multiply by 100. The result is your Cost of Capital, 
which you may use to compute a Cost of Money ceiling under paragraph 
(c) of this section.
    (e) SBA review of Cost of Capital computation. You must keep your 
Cost of Capital computations in a separate file available for SBA's 
review.
    (1) A computation that is kept in such a file and is audited by 
your independent public accountant is considered correct unless SBA 
demonstrates otherwise.
    (2) If a computation is not kept in such a file or is unaudited, 
you must prove its accuracy to SBA's satisfaction.
    (f) Charges included in the Cost of Money. The Cost of Money 
includes all 

[[Page 58560]]
interest, points, discounts, fees, royalties, profit participation, and 
any other consideration you receive from a Small Business, except for 
the specific exclusions in paragraph (g) of this section. For equity 
interests subject to the Cost of Money rules (see paragraph (a) of this 
section), you must include:
    (1) The portion of the fixed redemption price that exceeds your 
original cost.
    (2) Any amount of a redemption that is paid out of accounts other 
than the Small Business's capital accounts (capital, paid-in surplus, 
or retained earnings of a corporation; or partners' capital of a 
partnership).
    (g) Charges excluded from the Cost of Money. You may exclude from 
the Cost of Money:
    (1) Closing fees, application fees, and expense reimbursements, 
each as permitted under Sec. 107.860.
    (2) Reasonable prepayment penalties permitted under 
Sec. 107.830(d)(3).
    (3) Out-of-pocket conveyance and/or recordation fees and taxes.
    (4) Reasonable closing costs.
    (5) Fees for management services as permitted under Sec. 107.900.
    (6) Reasonable and necessary out-of-pocket expenses you incur to 
monitor the Financing.
    (7) Board of director fees not in excess of those paid to other 
outside directors, if your board representation meets the requirements 
of Sec. 107.730(e).
    (8) A reasonable fee for arranging financing for a Small Business 
from a source that is neither a Licensee nor an Associate of yours. The 
Small Business must agree in writing to pay such a fee before you 
arrange the financing.
    (9) A one-time ``bonus'' that satisfies the requirements in 
paragraph (i) of this section.
    (10) The difference between the contractual interest rate of the 
Financing and a default rate of interest permitted as follows:
    (i) If a Small Business is in default, you may charge a default 
rate of interest as much as 7 percentage points higher than the 
contractual rate until the default is cured.
    (ii) For this purpose, ``default'' means either failure to pay an 
amount when due or failure to provide information required under the 
Financing documents or SBA regulations.
    (h) How to evaluate compliance with the Cost of Money ceiling. You 
must determine whether a Financing is within the Cost of Money ceiling 
based on its discounted cash flows, as follows:
    (1) Beginning with the date of the first disbursement (``period 
zero''), identify your cash inflows and cash outflows for each period 
of the Financing. The appropriate period to use (such as years, 
quarters, or months) depends on how you have structured the 
disbursements and payments.
    (2) Discount the cash flows back to the first disbursement date 
using the Cost of Money ceiling from paragraph (d) of this section as 
the discount rate.
    (3) If the result is zero or less, the Financing is within the Cost 
of Money ceiling; if it is greater than zero, the Financing exceeds the 
Cost of Money ceiling.
    (i) ``Bonus'' paid by a Small Business. You may provide Financing 
to a Small Business that includes both a loan and a one-time ``bonus'' 
determined at the end of the loan term. For Cost of Money purposes, you 
must treat such a Financing as a Debt Security. You may exclude a bonus 
from the Cost of Money only if it is:
    (1) Computed on or after the date that the Financing is repaid in 
full;
    (2) Not fixed or determinable before the computation date; and
    (3) Fully contingent upon factor(s) that reflect the performance of 
the Small Business. The period for which such performance is measured 
must not extend beyond the Small Business's fiscal year end immediately 
following repayment of the Financing. You must demonstrate to SBA's 
satisfaction that the factor(s) used are appropriate indicators of 
performance. Examples of generally acceptable factors include net 
income and operating cash flow; examples of generally unacceptable 
factors include gross revenues or gross profit.


Sec. 107.860  Financing fees and expense reimbursements a Licensee may 
receive from a Small Business.

    You may collect Financing fees and receive expense reimbursements 
from a Small Business only as permitted under this Sec. 107.860.
    (a) Application Fee. You may collect a nonrefundable application 
fee from a Small Business to review its Financing application if:
    (1) The fee is no more than 1 percent of the amount of Financing 
requested (or, if two or more Licensees participate in the Financing, 
their combined application fees are no more than 1 percent of the total 
Financing requested); and
    (2) The Financing applicant signs a letter agreeing to pay the fee.
    (b) SBA review of application fees. For any fiscal year, if the 
number of application fees you collect is more than twice the number of 
Financings closed, SBA in its sole discretion may determine that you 
are engaged in activities not contemplated by the Act, in violation of 
Sec. 107.115.
    (c) Closing fee--Loans. You may charge a closing fee on a Loan if:
    (1) The fee is no more than 2 percent of the Financing amount (or, 
if two or more Licensees participate in the Financing, their combined 
closing fees are no more than 2 percent of the total Financing amount); 
and
    (2) You charge the fee no earlier than the date of the first 
disbursement.
    (d) Closing fee--Debt or Equity Financings. You may charge a 
Closing Fee on a Debt Security or Equity Security Financing if:
    (1) The fee is no more than 4 percent of the Financing amount (or, 
if two or more Licensees participate in the Financing, their combined 
closing fees are no more than 4 percent of the total Financing amount); 
and
    (2) You charge the fee no earlier than the date of the first 
disbursement.
    (e) Limitation on dual fees. If another Licensee or an Associate of 
yours collects a transaction fee under Sec. 107.900(e) in connection 
with your Financing of a Small Business, the sum of the transaction fee 
and your application and closing fees cannot exceed the maximum 
application and closing fees permitted under this Sec. 107.860.
    (f) Expense reimbursements. You may charge a Small Business for the 
reasonable out-of-pocket expenses, other than Management Expenses, that 
you incur to process its Financing application. If SBA determines that 
any of your reimbursed expenses are unreasonable or are Management 
Expenses, SBA will require you to include such amounts in the Cost of 
Money or refund them to the Small Business.


Sec. 107.865  Restrictions on Control of a Small Business by a 
Licensee.

    (a) General. You must not operate a business enterprise or function 
as a holding company exercising Control over a business enterprise. 
Neither you, nor you and your Associates, nor you and other Licensee(s) 
(in the latter two cases, the ``Investor Group'') may, except as set 
forth in this section, assume Control over a Small Business through 
management agreements, voting trusts, majority representation on the 
board of directors, or otherwise.
    (b) Presumption of Control. Control over a Small Business will be 
presumed to exist whenever you or the Investor Group own or control, 
directly or indirectly:
    (1) At least 50 percent of the outstanding voting securities, if 
there are fewer than 50 shareholders; or 

[[Page 58561]]

    (2) More than 25 percent of the outstanding voting securities, if 
there are 50 or more shareholders; or
    (3) A block of at least 20 percent of the outstanding voting 
securities, if there are 50 or more shareholders and no other party 
holds a larger block.
    (c) Rebuttals to presumption of Control. A presumption of Control 
under paragraph (b) of this section is rebutted if:
    (1) The management of the Small Business owns at least a 25 percent 
interest in the voting securities of the business; and
    (2) The management of the Small Business can elect at least 40 
percent (rounded down) of the board members of a corporation, general 
partners of a limited partnership, or managers of a limited liability 
company, as appropriate, and the Investor Group can elect no more than 
40 percent (rounded up). The balance of such officials may be elected 
through mutual agreement by management and the Investor Group.
    (d) Temporary Control permitted. You may acquire temporary Control:
    (1) Where reasonably necessary for the protection of your 
investment under circumstances where a Small Business is threatened 
with insolvency or closure;
    (2) If there has been a material breach of the Financing agreement 
by the Small Business;
    (3) If there has been a substantial change in the Small Business's 
operations or products during the past 2 years, or such a change is the 
intended result of the Financing, and the Investor Group's original 
Financing constitutes the Small Business's major source of capital; or
    (4) In the case of a Start-up Financing, if you or the Investor 
Group constitute the Small Business's major source of capital.
    (e) Control certification. If you take temporary Control of a Small 
Business under paragraph (d) of this section, you must file a Control 
certification with SBA within 30 days. The certification must state:
    (1) The date on which you took Control;
    (2) The basis for taking Control; and
    (3) Your agreement to relinquish Control within five years 
(although you may, under extraordinary circumstances, request SBA's 
approval of an extension beyond five years).
    (f) Control acquired through enforcement actions. If you retain or 
acquire Control through enforcement action, you must notify SBA 
immediately and submit a Control certification within 30 days.
    (g) Additional Financing for businesses under Licensee's Control. 
If you assume Control of a Small Business, you may later provide 
additional Financing, without an exemption under Sec. 107.730(a)(1).


Sec. 107.880  Assets acquired in liquidation of Portfolio securities.

    You may acquire assets in full or partial liquidation of a Small 
Business's obligation to you under the conditions permitted by this 
Sec. 107.880. The assets may be acquired from the Small Business, a 
guarantor of its obligation, or another party.
    (a) Timely disposition of assets. You must dispose of assets 
acquired in liquidation of a Portfolio security within a reasonable 
period of time.
    (b) Permitted expenditures to preserve assets. (1) You may incur 
reasonably necessary expenditures to maintain and preserve assets 
acquired.
    (2) You may incur reasonably necessary expenditures for 
improvements to render such assets saleable.
    (3) You may make payments of mortgage principal and interest 
(including amounts in arrears when you acquired the asset), pay taxes 
when due, and pay for necessary insurance coverage.
    (c) SBA approval of expenditures. This paragraph (c) applies if you 
have outstanding Leverage or are applying for Leverage. Any application 
for SBA approval under this paragraph must specify all expenses 
estimated to be necessary pending disposal of the assets. Without SBA's 
prior written approval:
    (1) Your total expenditures under paragraphs (b)(1) and (b)(2) of 
this section plus your total Financing(s) to the Small Business must 
not exceed your overline limit under Sec. 107.740; and
    (2) Your total expenditures under paragraph (b) of this section 
plus your total Financing(s) to the Small Business must not exceed 35 
percent of your Regulatory Capital.
Limitations on Disposition of Assets
Sec. 107.885  Disposition of assets to Licensee's Associates or to 
competitors of Portfolio Concern.

    (a) Sale of assets to Associate. Except with SBA's prior written 
approval, you are not permitted to dispose of assets (including assets 
acquired in liquidation) to any Associate if you have outstanding 
Leverage or Earmarked Assets. As a prerequisite to such approval, you 
must demonstrate that the proposed terms of disposal are at least as 
favorable to you as the terms obtainable elsewhere.
    (b) Sale of assets to competitor of Small Business. Except with the 
prior written approval of the Portfolio Concern (if it is not under 
your Control) or of SBA, you are not permitted to dispose of Portfolio 
securities to a competitor of such concern. If SBA's prior approval is 
not required, you must promptly notify SBA of any such disposal.

Management Services and Fees


Sec. 107.900  Management fees for services provided to a Small Business 
by Licensee or its Associate.

    This Sec. 107.900 applies to management services that you or your 
Associate provide to a Small Business during the term of a Financing or 
prior to Financing. It does not apply to management services that you 
or your Associate provide to a Small Business that you do not finance. 
Fees permitted under this section are not included in the Cost of Money 
(see Sec. 107.855).
    (a) Permitted management fees. You or your Associate may provide 
management services to a Small Business financed by you if:
    (1) You or your Associate have entered into a written contract with 
the Small Business;
    (2) Services are provided only on an hourly fee basis;
    (3) The fees charged are for services actually performed; and
    (4) The hourly rate does not exceed the prevailing rate charged for 
comparable services by other organizations in your geographic area.
    (b) Fees for service as a board member. You or your Associate may 
receive fees for services provided as members of the board of directors 
of a Small Businesses Financed by you. The fees must not exceed those 
paid to other outside board members.
    (c) SBA approval required. You must obtain SBA's prior written 
approval of any management contract that does not satisfy paragraphs 
(a) or (b) of this section.
    (d) Record keeping requirements. You must keep a record of hours 
spent and amounts charged to the Small Business, including expenses 
charged.
    (e) Transaction fees. (1) You may charge reasonable transaction 
fees for work you or your Associate perform to prepare a client for a 
public offering, private offering, or sale of all or part of the 
business, and for assisting with the transaction. Compensation may be 
in the form of cash, notes, stock, and/or options.
    (2) Your Associate may charge market rate investment banking fees 
to a Small Business on that portion of a Financing that you do not 
provide. However, at 

[[Page 58562]]
least 95 percent of the Associate's revenues must derive from sources 
unrelated to Financings by you. If the Associate does not meet this 
test, its fee must not exceed the sum of the application and closing 
fees permitted under Sec. 107.860.

Subpart H--Non-leveraged Licensees--Exceptions to Regulations


Sec. 107.1000  Licensees without Leverage--exceptions to the 
regulations.

    The regulatory exceptions in this section apply to Licensees with 
no outstanding Leverage or Earmarked Assets.
    (a) You are exempt from the following provisions (but you must come 
into compliance with them to become eligible for Leverage):
    (1) The overline limitation in Sec. 107.740.
    (2) The restrictions in Sec. 107.530 on investments of idle funds, 
provided you do not engage in activities not contemplated by the Act.
    (3) The restrictions in Sec. 107.550 on third-party debt.
    (4) The restrictions in Sec. 107.880 on expenses incurred to 
maintain or improve assets acquired in liquidation of Portfolio 
securities.
    (b) You are exempt from the requirements to obtain SBA's prior 
approval for:
    (1) A decrease in your Regulatory Capital of more than two percent 
under Sec. 107.585 (but not below the minimum required under the Act or 
these regulations). You must report the reduction to SBA within 30 
days.
    (2) Disposition of any asset to your Associate under Sec. 107.885.
    (3) A contract to employ an Investment Adviser/Manager under 
Sec. 107.510. However, you must notify SBA of the Management Expenses 
to be incurred under such contract, or of any subsequent material 
changes in such Management Expenses, within 30 days of execution. In 
order to become eligible for Leverage, you must have the contract 
approved by SBA.

Subpart I--SBA Financial Assistance for Licensees (Leverage)

General Information About Obtaining Leverage


Sec. 107.1100  Types of Leverage available.

    (a) Types of Leverage available for Section 301(c) Licensees. If 
you are a Section 301(c) Licensee, you may apply for Leverage from SBA 
in one or both of the following forms:
    (1) The purchase or guarantee of your Debentures.
    (2) The purchase or guarantee of your Participating Securities.
    (b) Types of Leverage available for Section 301(d) Licensees. If 
you are a Section 301(d) Licensee, you may apply for Leverage from SBA 
in one or more of the following forms:
    (1) The purchase or guarantee of your Debentures.
    (2) The purchase or guarantee of your Participating Securities.
    (3) The purchase of your Preferred Securities.
    (c) Subsidized and non-subsidized Debentures available to 
Licensees. If you are a Section 301(d) Licensee, you may issue both 
subsidized and non-subsidized Debentures. If you are a Section 301(c) 
Licensee, you may issue only non-subsidized Debentures.
    (1) Non-subsidized Debentures. SBA may purchase or guarantee non-
subsidized Debentures under section 303(b) of the Act. You pay interest 
on a non-subsidized Debenture at the rate stated on its face.
    (2) Subsidized Debentures. SBA may purchase or guarantee subsidized 
Debentures under section 303(c) of the Act. On a guaranteed Debenture, 
during the first 5 years of the term, you pay an interest rate that is 
300 basis points below the rate stated on the face of the Debenture. On 
a Debenture that SBA purchases, you pay a reduced interest rate 
determined under section 317 of the Act.


Sec. 107.1110  How to apply for Leverage.

    (a) Application forms. Select the appropriate form from the 
following table:

------------------------------------------------------------------------
 Type of leverage you are applying for          Application form        
------------------------------------------------------------------------
Debentures (any type).................  SBA Form 1022.                  
Participating Securities..............  SBA Form 1022A.                 
4% Preferred Securities...............  SBA Form 1022B.                 
------------------------------------------------------------------------

    (b) Where to send your application. Send all Leverage applications 
to SBA, Investment Division, 409 Third Street, S.W., Washington, D.C. 
20416.


Sec. 107.1120  General eligibility requirements for Leverage.

    To be eligible for Leverage, you must:
    (a) Demonstrate a need for Leverage, evidenced by your investment 
activity and a lack of sufficient funds for investment. For your first 
issuance of Leverage, if you have invested at least 50 percent of your 
Leverageable Capital, you are presumed to lack sufficient funds for 
investment.
    (b) Have adequate Private Capital to satisfy the requirements for 
financial viability under Sec. 107.200.
    (c) Meet the minimum capital requirements of Sec. 107.210 or 
Sec. 107.220, as appropriate.
    (d) Show, to the satisfaction of SBA, that your management is 
qualified and has the knowledge, experience, and capability necessary 
for investing in the types of businesses contemplated by the Act, these 
regulations and your business plan.
    (e) Be in compliance with the regulations in this Part.
    (f) If required by SBA, have your Control Person(s) assume, in 
writing, personal responsibility for your Leverage, effective only if 
such Control Person(s) participate (directly or indirectly) in a 
transfer of Control not approved by SBA.


Sec. 107.1130  Leverage fees payable by Licensee.

    (a) User fee for Debentures and Participating Securities. You must 
pay a user fee to SBA for each issuance of a Debenture or Participating 
Security. The fee is 2 percent of the face amount of the Leverage 
issued.
    (b) Payment of user fee. If you issue a Debenture or Participating 
Security:
    (1) To repay or redeem existing Leverage, you must pay the user fee 
before SBA will guarantee or purchase the new Debenture or 
Participating Security.
    (2) That is not used to repay or redeem existing Leverage, SBA will 
deduct the user fee from the proceeds remitted to you, unless you 
prepaid the fee under Sec. 107.1210.
    (c) Refundability. The user fee is not refundable under any 
circumstances.
    (d) Other Leverage fees. SBA may establish a fee structure for 
services performed by the CRA. SBA will not collect any fee for its 
guarantee of TCs.


Sec. 107.1140  Licensee's acceptance of SBA remedies under 
Secs. 107.1800 through 107.1820.

    If you issue Leverage after April 25, 1994, you automatically agree 
to the terms and conditions in Secs. 107.1800 through 107.1820 as they 
exist at the time of issuance. The effect of these terms and conditions 
is the same as if they were fully incorporated in the terms of your 
Leverage.

Maximum Amount of Leverage for Which a Licensee is Eligible


Sec. 107.1150  Maximum amount of Leverage for a Section 301(c) 
Licensee.

    (a) Maximum amount of Leverage. If you are a Section 301(c) 
Licensee, use the following table to determine the maximum amount of 
Leverage you may have outstanding at any time:

                                                                        

[[Page 58563]]
------------------------------------------------------------------------
                                             Then your maximum leverage 
      If your leverageable capital is                    is:            
------------------------------------------------------------------------
Not over $15,000,000......................  300% of Leverageable        
                                             Capital.                   
Over $15,000,000 but not over $30,000,000.  $45,000,000 + [200% of      
                                             (Leverageable Capital -    
                                             $15,000,000)].             
Over $30,000,000 but not over $45,000,000.  $75,000,000 + [100% of      
                                             (Leverageable Capital -    
                                             $30,000,000)].             
Over $45,000,000..........................  $90,000,000.                
------------------------------------------------------------------------



    (b) Exceptions to maximum Leverage provisions--(1) Licensees under 
Common Control. Two or more Licensees under Common Control may have 
aggregate outstanding Leverage over $90,000,000 only if SBA gives them 
permission to do so. SBA may grant such permission on a case-by-case 
basis only. SBA may impose any terms and conditions SBA considers 
appropriate to minimize its risk of loss in the event of default.
    (2) Licensees with excess Leverage issued before March 31, 1993. If 
you had outstanding Debentures on March 31, 1993 that exceeded 300 
percent of your Leverageable Capital:
    (i) You do not have to prepay the excess amount.
    (ii) You may apply for an additional Debenture guarantee or 
Participating Security guarantee if you use the proceeds solely to pay 
the amount due at maturity on a Debenture issued before March 31, 1993. 
The new Debenture or Participating Security must mature on or before 
September 30, 2002.
    (iii) You must maintain at least 65 percent of your ``Total Funds 
Available for Investment'' in ``Venture Capital Financings'' (as 
defined in Sec. 107.1160(e) and (f), respectively) until your 
outstanding Debentures no longer exceed 300 percent of your 
Leverageable Capital.
    (3) Maximum amount of Participating Securities. See Sec. 107.1170.


Sec. 107.1160  Maximum amount of Leverage for a Section 301(d) 
Licensee.

    (a) Maximum amount of subsidized Leverage. (1) ``Subsidized 
Leverage'' means Debentures with a reduced interest rate and Preferred 
Securities. If you are a Section 301(d) Licensee:
    (i) The maximum amount of subsidized Leverage you may have 
outstanding at any time is the lesser of 400 percent of your 
Leverageable Capital, or $35,000,000. The same limit applies to a group 
of Section 301(d) Licensees under Common Control.
    (ii) The maximum amount of Preferred Securities you may have 
outstanding at any time is 200 percent of your Leverageable Capital.
    (2) Certain types and amounts of subsidized Leverage have special 
eligibility requirements (see paragraphs (c) and (d) of this section).
    (b) Maximum amount of total Leverage. Use Sec. 107.1150(a) and 
(b)(1) to determine your maximum amount of Leverage as if you were a 
Section 301(c) Licensee. If the result is more than your maximum 
subsidized Leverage, then this is your maximum total (subsidized plus 
non-subsidized) Leverage. Otherwise, your maximum total Leverage is the 
same as your maximum subsidized Leverage. For Participating Securities, 
see Sec. 107.1170.
    (c) Special eligibility requirements for fourth tier of Leverage. A 
``fourth tier of Leverage'' is any amount of outstanding Leverage in 
excess of 300 percent of your Leverageable Capital.
    (1) To qualify for a fourth tier of Leverage, you must have 
invested (or have Commitments to invest) at least 30 percent of your 
``Total Funds Available for Investment'' in ``Venture Capital 
Financings'' (see the definitions in paragraphs (e) and (f) of this 
section).
    (2) While you have a fourth tier of Leverage, you must maintain 
Venture Capital Financings (at cost) that equal at least 30 percent of 
your Total Funds Available for Investment.
    (d) Special eligibility requirements for second tier of Preferred 
Securities. A ``second tier of Preferred Securities'' is any amount of 
outstanding Preferred Securities in excess of 100 percent of your 
Leverageable Capital.
    (1) To qualify for a second tier of Preferred Securities:
    (i) If your license was issued after October 13, 1971, you must 
have at least $500,000 of Leverageable Capital.
    (ii) You must have invested (or have Commitments to invest) at 
least the same dollar amount in Venture Capital Financings.
    (2) While you have a second tier of Preferred Securities, you must 
maintain at least the same dollar amount of Venture Capital Financings 
(at cost).
    (e) Definition of ``Total Funds Available for Investment''. Total 
Funds Available for Investment means the result obtained from the 
following formula:

T = .90 x (CA + LI)

Where:

T = Total funds available for investment
CA = Total current assets
LI = Total Loans and Investment at cost (as reported on SBA Form 468), 
net of current maturities

    (f) Definition of ``Venture Capital Financing''. Venture Capital 
Financing means an investment represented by common or preferred stock, 
a limited partnership interest, or a similar ownership interest; or by 
an unsecured debt instrument that is subordinated by its terms to all 
other borrowings of the issuer.
    (1) A debt secured by any agreement with a third party is not a 
Venture Capital Financing, whether or not you have a security interest 
in any asset of the third party or have recourse against the third 
party.
    (2) A Financing that originally qualified as a Venture Capital 
Financing will continue to qualify (at its original cost), even if you 
later must report it on SBA Form 468 under either Assets Acquired in 
Liquidation of Portfolio Securities or Operating Concerns Acquired.


Sec. 107.1170  Maximum amount of Participating Securities for any 
Licensee.

    The maximum amount of Participating Securities you may have 
outstanding at any time is 200 percent of your Leverageable Capital. If 
you are a Section 301(d) Licensee, the maximum combined amount of 
Participating Securities and Preferred Securities you may have 
outstanding at any time is 200 percent of your Leverageable Capital.

Conditional Commitments by SBA to Reserve Leverage for a Licensee


Sec. 107.1200  SBA's Leverage commitment to a Licensee--application 
procedure, amount, and term.

    (a) General. Under the provisions in Secs. 107.1200 through 
107.1240, you may apply for SBA's conditional commitment to reserve a 
specific amount and type of Leverage for your future use. You may then 
apply to draw down Leverage against the commitment.
    (b) Applying for a Leverage commitment. SBA will notify you when it 
is accepting requests for Leverage commitments. Upon receipt of your 
request, SBA will send you a complete application package.
    (c) Limitations on the amount of a Leverage commitment. The amount 
of any Leverage commitment must be at least $500,000. It must not 
exceed 100 percent of your Regulatory Capital or your remaining 
Leverage eligibility, whichever is less.
    (d) Term of Leverage commitment. SBA's Leverage commitment will 
automatically lapse at 5:00 P.M. Eastern Time on August 1 of the next 
full Federal fiscal year following issuance of the commitment. 

[[Page 58564]]



Sec. 107.1210  Commitment fees payable by Licensee.

    (a) Commitment fees. As a condition of SBA's Leverage commitment, 
and before you may draw any Leverage, you must pay SBA a non-refundable 
fee of:
    (1) 3 percent of the face amount of the Debentures or Participating 
Securities reserved under the commitment; or
    (2) 1 percent of the issue price of Preferred Securities reserved 
under the commitment.
    (b) Credit for user fee. The 3 percent commitment fee paid by 
issuers of Debentures or Participating Securities under paragraph 
(a)(1) of this section includes the 2 percent user fee required under 
Sec. 107.1130. If you pay the commitment fee, you do not have to pay 
the user fee separately.
    (c) Automatic cancellation of commitment. Unless you pay the full 
amount of the commitment fee by 5:00 P.M. Eastern Time on the 30th 
calendar day following the issuance of SBA's Leverage commitment, the 
commitment will be automatically canceled.


Sec. 107.1220  Requirement for Licensee to file quarterly financial 
statements.

    As long as any part of SBA's Leverage commitment is outstanding, 
you must give SBA a Financial Statement on SBA Form 468 (Short Form) as 
of the close of each quarter of your fiscal year. You must file this 
form within 30 days after the close of the quarter, or with any request 
for a draw that you make within such 30-day period. You will not be 
eligible for a draw if you are not in compliance with this 
Sec. 107.1220.


Sec. 107.1230  Draw-downs by Licensee under SBA's Leverage commitment.

    (a) Licensee's authorization of SBA to purchase or guarantee 
securities. By submitting a request for a draw against SBA's Leverage 
commitment, you:
    (1) Authorize SBA to purchase your Preferred Security; or
    (2) Authorize SBA, or any agent or trustee SBA designates, to 
guaranty your Debenture or Participating Security and to sell it with 
SBA's guarantee.
    (b) Limitations on amount of draw. For Debentures or Participating 
Securities, any draw against SBA's Leverage commitment must be at least 
$500,000; amounts above $500,000 must be in multiples of $100,000. You 
may issue Preferred Securities in any amount.
    (c) Effect of regulatory violations on Licensee's eligibility for 
draws--(1) General rule. You are eligible to make a draw against SBA's 
Leverage commitment only if you are in compliance with all applicable 
provisions of the Act and SBA regulations (i.e., no unresolved 
statutory or regulatory violations).
    (2) Exception to general rule. If you are not in compliance, you 
may still be eligible for draws if:
    (i) SBA determines that your outstanding violations are of non-
substantive provisions of the Act or regulations and that you have not 
repeatedly violated any non-substantive provisions; or
    (ii) You have agreed with SBA on a course of action to resolve your 
violations and such agreement does not prevent you from issuing 
Leverage.
    (d) Procedures for funding draws. You may request a draw at any 
time during the term of the commitment. With each request, submit the 
following documentation:
    (1) If your request is submitted within 30 days following the close 
of your fiscal quarter, a Financial Statement on SBA Form 468 (Short 
Form) prepared as of the close of that fiscal quarter; otherwise, a 
statement certifying that there has been no material adverse change in 
your financial condition since your last filing of SBA Form 468 (Long 
or Short Form).
    (2) A statement certifying that to the best of your knowledge and 
belief, you are in compliance with all provisions of the Act and SBA 
regulations (i.e., no unresolved regulatory or statutory violations), 
or a statement listing any specific violations you are aware of. Either 
statement must be executed by one of the following:
    (i) An officer of the Licensee;
    (ii) An officer of a corporate general partner of the Licensee; or
    (iii) An individual who is authorized to act as or for a general 
partner of the Licensee.
    (3) A statement that the proceeds are needed to fund one or more 
particular Small Businesses, including the name and address of each 
Small Business, and the amount and anticipated closing date of each 
proposed Financing.
    (e) Reporting requirements after drawing funds. (1) Within 30 
calendar days after the actual closing date of each Financing funded 
with the proceeds of your draw, you must file an SBA Form 1031 
confirming the closing of the transaction.
    (2) Within 60 calendar days after the anticipated closing date, if 
a planned Financing has not closed, you must give SBA a written 
explanation of the failure to close.
    (3) If you do not comply with this paragraph (e), you will not be 
eligible for additional draws. SBA may also determine that you are not 
in compliance with the terms of your Leverage under Secs. 107.1810 or 
107.1820.


Sec. 107.1240  Funding of Licensee's draw request through sale to 
short-term investor.

    (a) Licensee's authorization of SBA to arrange sale of securities 
to short-term investor. By submitting a request for a draw of Debenture 
or Participating Security Leverage, you authorize SBA, or any agent or 
trustee SBA designates, to enter into any agreements (and to bind you 
to such agreements) necessary to accomplish:
    (1) The sale of your Debenture or Participating Security to a 
short-term investor;
    (2) The purchase of your security from the short-term investor, 
either by you or on your behalf; and
    (3) The pooling of your security with other securities with the 
same maturity date.
    (b) Sale of Debentures to a short-term investor. If SBA sells your 
Debenture to a short-term investor:
    (1) The sale will be at a discount based on an interest rate 
determined under section 303(b) of the Act (without any interest rate 
subsidy), as if the maturity date of the Debenture were the next 
scheduled date for the sale of Debenture Trust Certificates.
    (2) If the actual sale of Trust Certificates takes place after the 
scheduled date, you must pay the short-term investor daily interest on 
the Debenture, at the same rate, from the scheduled sale date to the 
actual sale date. This additional interest is due on the actual sale 
date. Failure to pay the interest constitutes noncompliance with the 
terms of your Leverage (see Secs. 107.1810 and 107.1820).
    (c) Sale of Participating Securities to a short-term investor. If 
SBA sells your Participating Security to a short-term investor:
    (1) The sale price will be the face amount.
    (2) At the closing of the next scheduled sale of Participating 
Security Trust Certificates, you (or SBA, as guarantor) must pay the 
short-term investor Earned Prioritized Payments at a rate determined 
under section 303(b) of the Act, as if the maturity date of the 
Participating Security were the next scheduled date for the sale of 
Trust Certificates.
    (d) Licensee's right to repurchase its securities before pooling. 
You may repurchase your securities from the short-term investor before 
they are pooled. To do so, you must:
    (1) Give SBA written notice at least 10 days before the cut-off 
date for the pool in which your security is to be included; and

[[Page 58565]]

    (2) Pay the face amount of the Debenture, or the face amount of the 
Participating Security plus Earned Prioritized Payments, to the short-
term investor.

Exchange of Outstanding Debentures for Participating or Preferred 
Securities--Section 301(d) Licensees


Sec. 107.1350  Exchange by Section 301(d) Licensee of Debentures for 
Preferred or Participating Securities.

    (a) Conditions for exchange of Debentures. A Section 301(d) 
Licensee may, in SBA's discretion, retire an eligible Debenture through 
the issuance of Preferred or Participating Securities. To do so, you 
must:
    (1) Pay all unpaid accrued interest on the Debenture, plus any 
applicable prepayment penalties, fees, and other charges.
    (2) Comply with all conditions that apply to the issuance of 
Preferred or Participating Securities.
    (b) Debentures not eligible for exchange. You may not retire a 
Debenture by issuing Preferred or Participating Securities if SBA 
guaranteed or purchased it on the basis of funds not included in your 
Leverageable Capital. You must repay such a Debenture at its maturity 
date, unless SBA extends it. SBA has discretion to extend the maturity 
to a date not more than 15 years from the date of issuance if SBA 
believes the extension is necessary for orderly liquidation of the 
indebtedness.

Preferred Securities Leverage--Section 301(d) Licensees


Sec. 107.1400  Stock dividends or partnership distributions on 4 
percent Preferred Securities.

    Preferred Securities that SBA purchases from a Section 301(d) 
Licensee may be in the form of either preferred stock issued at par 
value or a preferred limited partnership interest issued at face value. 
When you issue Preferred Securities, you agree to pay SBA a dividend or 
partnership distribution of 4 percent per year, from the date you issue 
Preferred Securities to the date you repay them, both inclusive. The 
dividend or partnership distribution is:
    (a) Computed on the par value of the outstanding stock or the face 
value of the outstanding limited partnership interest.
    (b) Cumulative. This means that if you do not pay the entire 
dividend or partnership distribution for a given fiscal year, the 
unpaid balance accumulates as a distribution in arrears. You do not 
have to pay interest on distributions in arrears.
    (c) Preferred. This means that you must pay SBA in full (including 
distributions in arrears) before setting aside or paying any amount to 
any other equity holder.
    (d) Payable at the discretion of your Board of Directors or General 
Partner(s), except that all distributions in arrears must be paid in 
full when you redeem the Preferred Securities.


Sec. 107.1410  Requirement to redeem 4 percent Preferred Securities.

    You must redeem 4 percent Preferred Securities not later than 15 
years from the date of issuance. At the redemption date, you must pay 
to SBA:
    (a) The par value (of preferred stock) or face value (of a 
preferred limited partnership interest); plus
    (b) Any unpaid dividends or partnership distributions accrued to 
the redemption date.


Sec. 107.1420  Articles requirements for 4 percent Preferred Securities 
issuers.

    You may issue 4 percent Preferred Securities only if your Articles 
contain all the provisions in Secs. 107.1400 and 107.1410.


Sec. 107.1430  Redeeming 4 percent Preferred Securities with proceeds 
of non-subsidized Debentures.

    If SBA approves, a Section 301(d) Licensee may use the proceeds of 
a Debenture to redeem Preferred Securities at their mandatory 
redemption date, including any accrued unpaid dividends or partnership 
distributions. For this purpose, you may issue only a non-subsidized 
Debenture (see Sec. 107.1100(c)).


Sec. 107.1440  Three percent preferred stock issued before November 21, 
1989.

    Before November 21, 1989, Preferred Securities were available only 
in the form of preferred stock and had a preferred and cumulative 
dividend of 3 percent. If you have such preferred stock outstanding, 
you must follow Sec. 107.1400 (except for Sec. 107.1400(d)), 
substituting ``3 percent'' for ``4 percent'' throughout.) Dividends on 
3 percent preferred stock are payable at the discretion of your Board 
of Directors or General Partner(s), except that all dividends in 
arrears must be paid in full before any non-SBA investor receives any 
distribution. Upon your liquidation, SBA is entitled to payment of all 
dividends in arrears even if you have no Retained Earnings Available 
for Distribution at such time.


Sec. 107.1450  Optional redemption of Preferred Securities.

    (a) Redemption at par or face value. A Section 301(d) Licensee may 
redeem Preferred Securities at any time, provided you give SBA at least 
30 days written notice. You may redeem all or only part of your 
Preferred Securities, but the par value or face value of the securities 
being redeemed must be at least $50,000. At the redemption date, you 
must pay to SBA:
    (1) The par value (of preferred stock) or face value (of a 
preferred limited partnership interest); plus
    (2) Any unpaid dividends or partnership distributions accrued to 
the redemption date.
    (b) Repurchase of 3 percent preferred stock for less than par 
value. If you issued 3 percent preferred stock to SBA, you may ask SBA 
to sell it back to you at a price less than its par value. The terms 
and conditions of any such transaction will be as set forth in the 
Notice published in the Federal Register on April 1, 1994 (Copies of 
this notice are available from SBA, 409 3rd Street, S.W., Washington, 
D.C., 20416). SBA has sole discretion to:
    (1) Approve or disapprove the sale.
    (2) Determine the sale price after considering any factors SBA 
considers appropriate.
    (3) Determine the form of payment SBA will accept. SBA is not 
authorized to accept the proceeds of a subsidized Debenture as payment.

Participating Securities Leverage


Sec. 107.1500  General description of Participating Securities.

    (a) Types of Participating Securities. Participating Securities are 
redeemable, preferred, equity-type securities. SBA may purchase or 
guarantee Participating Securities issued by Licensees in the form of 
limited partnership interests, preferred stock, or debentures with 
interest payable only to the extent of earnings. The structure, terms 
and conditions of Participating Securities are set forth in detail in 
Secs. 107.1500 through 107.1590.
    (b) Special eligibility requirements for Participating Securities. 
In addition to the general eligibility requirements for Leverage under 
Sec. 107.1120, Participating Securities issuers must also comply with 
special rules on:
    (1) Minimum capital (see Sec. 107.220).
    (2) Liquidity (see Sec. 107.1505).
    (3) Non-SBA borrowing (see Sec. 107.570).
    (4) Making Equity Capital Investments in Small Businesses, as 
follows:
    (i) General rule. If you issue Participating Securities, you must 
invest an amount equal to the Original Issue Price of such securities 
solely in Equity Capital Investments.
    (ii) Continuing requirement to maintain Equity Capital Investments. 


[[Page 58566]]
Unless SBA permits otherwise, once you have met the initial investment 
requirement of this paragraph (b)(4), you must maintain Equity Capital 
Investments with an original cost equal to or greater than the 
outstanding balance of Participating Securities in your portfolio, 
measured as of the end of each fiscal year.
    (c) Special features of Participating Securities--Prioritized 
Payments, Adjustments, and Profit Participation. When you issue 
Participating Securities, you agree to make the following payments:
    (1) Prioritized Payments. Depending upon the type of Participating 
Security you issue, Prioritized Payments may be preferred partnership 
distributions, preferred dividends, or interest. Your obligation to pay 
Prioritized Payments is contingent upon your profits as determined 
under Sec. 107.1520.
    (2) Adjustments to Prioritized Payments. If you have unpaid 
Prioritized Payments, you must compute Adjustments, which are 
additional contingent obligations determined under Sec. 107.1520. The 
conditions for paying Adjustments are the same as for Prioritized 
Payments.
    (3) SBA Profit Participation. Profit Participation is an amount 
payable to SBA under Sec. 107.1530 in consideration for SBA's guarantee 
of your Participating Securities.
    (d) Distributions by Licensees issuing Participating Securities. 
Sections 107.1540 through 107.1580 govern both required and optional 
Distributions by Participating Securities issuers. Distributions 
include both profit distributions and returns of capital, paid either 
to SBA or to your non-SBA investors.
    (e) Mandatory redemption of Participating Securities. You must 
redeem Participating Securities at the redemption date, which is the 
same as the maturity date of the Trust Certificates for the Trust 
containing such securities. The redemption date can never be later than 
15 years after the issue date. You must pay the Redemption Price plus 
any unpaid Earned Prioritized Payments and any earned Adjustments due 
under Sec. 107.1520.
    (f) Priority of Participating Securities in liquidation of 
Licensee. In the event of your liquidation, the following are senior in 
priority, for all purposes, to all other equity interests you have 
issued at any time:
    (1) The Redemption Price of Participating Securities;
    (2) Any Prioritized Payments and earned Adjustments; and
    (3) Any Profit Participation allocated to SBA under Sec. 107.1530.


Sec. 107.1505  Liquidity requirements for Licensees issuing 
Participating Securities.

    If you have outstanding Participating Securities, you must maintain 
sufficient liquidity to avoid a condition of Liquidity Impairment. Such 
a condition will constitute noncompliance with the terms of your 
Leverage under Sec. 107.1820(e).
    (a) Definition of Liquidity Impairment. A condition of Liquidity 
Impairment exists when your Liquidity Ratio, as determined in paragraph 
(b) of this section, is less than 1.20. You are responsible for 
calculating whether you have a condition of Liquidity Impairment as of 
the close of your fiscal year, at the time of application for Leverage, 
or at such time as you contemplate making any Distribution. However, 
SBA has the right to make the final determination of Liquidity 
Impairment.
    (b) Computation of Liquidity Ratio. Your Liquidity Ratio equals 
your Total Current Funds Available (A) divided by your Total Current 
Funds Required (B), as determined in the following table:

                     Calculation of Liquidity Ratio                     
------------------------------------------------------------------------
                                   Amount                               
                                reported on                    Weighted 
       Financial account          SBA form       Weight         amount  
                                    468                                 
------------------------------------------------------------------------
      Total Current Funds                                               
         Available(A)                                                   
Cash and invested idle funds..  ...........   x 1.00                    
Commitments from investors....  ...........   x 1.00                    
Current maturities............  ...........   x 0.50                    
Other current assets..........  ...........   x 1.00                    
Publicly Traded and Marketable  ...........   x 0.65                    
 Securities.                                                            
Anticipated operating revenue         (\1\)   x 1.00                    
 for next 12 months.                                                    
      Total Current Funds                                               
          Required(B)                                                   
Current liabilities...........  ...........   x 1.00                    
Commitments to Small            ...........   x 0.75                    
 Businesses.                                                            
Anticipated operating expense         (\1\)   x 1.00                    
 for next 12 months.                                                    
Anticipated interest expense          (\1\)   x 1.00                    
 for next 12 months.                                                    
Contingent liabilities          ...........   x 0.25                    
 (guarantees).                                                          
------------------------------------------------------------------------
\1\ As determined by Licensee's management under its business plan.     

Sec. 107.1510  How a Licensee computes Earmarked Profit (Loss).

    Computing your Earmarked Profit (Loss) is the first step in 
determining your obligations to pay Prioritized Payments and 
Adjustments under Sec. 107.1520 and Profit Participation under 
Sec. 107.1530.
    (a) Requirement to compute your Earmarked Profit (Loss). While you 
have Participating Securities outstanding or have Earmarked Assets (as 
defined in paragraph (b) of this section), you must compute your 
Earmarked Profit (Loss) for:
    (1) Each full fiscal year.
    (2) Any interim period (consisting of one or more fiscal quarters) 
for which you want to make a Distribution.
    (b) How to determine your Earmarked Assets. ``Earmarked Assets'' 
means all the Loans and Investments that you have when you issue 
Participating Securities or that you acquire while you have 
Participating Securities outstanding, and any non-cash assets that you 
receive in exchange for such Loans and Investments.
    (1) An Earmarked Asset remains earmarked until you dispose of it, 
even if you no longer have any outstanding Participating Securities.
    (2) Investments you make after redeeming all your Participating 
Securities are not Earmarked Assets. However, if you issue new 
Participating Securities, all of your Loans and Investments again 
become Earmarked Assets. 

[[Page 58567]]

    (3) If you were licensed before March 31, 1993, you may be 
permitted to exclude Loans and Investments held at that date from 
Earmarked Assets under Sec. 107.1590.
    (c) How to compute your Earmarked Asset Ratio. You must determine 
your Earmarked Asset Ratio each time you compute Earmarked Profit 
(Loss). If all your Loans and Investments are Earmarked Assets, your 
Earmarked Asset Ratio equals 100 percent. Otherwise, compute your 
Earmarked Asset Ratio using the following formula:

EAR = [(EA + P) / (LI + P)]  x  100

Where:

EAR = Earmarked Asset Ratio
EA = Weighted average Earmarked Assets (at cost) for the fiscal year or 
interim period
P = Weighted average uninvested proceeds of Participating Securities 
for the fiscal year or interim period
LI = Weighted average Loans and Investments (at cost) for the fiscal 
year or interim period

    (d) How to compute your Earmarked Profit (Loss) if Earmarked Asset 
Ratio is 100 percent. (1) If your Earmarked Asset Ratio from paragraph 
(b) of this section is 100 percent, use the following formula to 
compute your Earmarked Profit (Loss):

EP = NI + IK + EME

Where:

EP = Earmarked Profit (Loss)
NI = Net Income (Loss), as reported on SBA Form 468
IK = Unrealized Appreciation (Depreciation) on Earmarked Assets that 
you are distributing as an In-Kind Distribution under Sec. 107.1580
EME = Excess Management Expenses

    (2) ``Excess Management Expenses'' are those that exceed the 
following limit:
    (i) For a full fiscal year, the limit is the lower of:
    (A) 2.5 percent of your weighted average Combined Capital for the 
year, plus $125,000 if Combined Capital is below $20,000,000; or
    (B) Your Management Expenses approved by SBA.
    (ii) For less than a full fiscal year, you must prorate the annual 
amounts in paragraph (d)(2)(i) of this section to determine the limit.
    (e) How to compute your Earmarked Profit (Loss) if Earmarked Asset 
Ratio is less than 100 percent. If your Earmarked Asset Ratio is less 
than 100 percent, compute your Earmarked Profit (Loss) as follows:
    (1) Do the Earmarked Profit (Loss) computation in paragraph (d) of 
this section.
    (2) Subtract your net realized gain (loss) (as reported on SBA Form 
468) on Loans and Investments that are not Earmarked Assets.
    (3) Separate the result from paragraph (e)(2) of this section into:
    (i) Net realized gain (loss) (as reported on SBA Form 468) on 
Earmarked Assets (``EGL''); and
    (ii) The remainder (``R'').
    (4) Your Earmarked Profit (Loss) equals:

EGL + (R  x  Earmarked Asset Ratio)

    (f) How to compute your cumulative Earmarked Profit (Loss). Sum 
your Earmarked Profit (Loss) for all fiscal years and for any interim 
period following the end of your last fiscal year. The total is your 
cumulative Earmarked Profit (Loss), which you must use in the 
Prioritized Payment computations under Sec. 107.1520.


Sec. 107.1520  How a Licensee computes and allocates Prioritized 
Payments to SBA.

    This section tells you how to compute Prioritized Payments and 
Adjustments and determine the amounts you must pay. To distribute 
Prioritized Payments, see Sec. 107.1540.
    (a) How to compute Prioritized Payments and Adjustments--(1) 
Prioritized Payments. For a full fiscal year, the Prioritized Payment 
on a Participating Security equals the Redemption Price times the Trust 
Certificate Rate. For a shorter period (one or more fiscal quarters), 
you must prorate the annual Prioritized Payment.
    (2) Adjustments. Compute Adjustments using paragraph (f) of this 
section.
    (b) Licensee's obligation to pay Prioritized Payments and 
Adjustments. You are obligated to pay Prioritized Payments and 
Adjustments only if you have profit as determined under paragraph (d) 
of this section.
    (1) Prioritized Payments that you must pay (or have already paid) 
because you have sufficient profit are ``Earned Prioritized Payments''.
    (2) Prioritized Payments that are not payable because you lack 
sufficient profit are ``Accumulated Prioritized Payments''. Treat all 
Prioritized Payment as ``Accumulated'' until they become ``Earned'' 
under this section.
    (3) Adjustments are computed under paragraph (f) of this section 
and are ``earned'' according to the same criteria applied to 
Prioritized Payments.
    (c) How to keep track of Prioritized Payments. You must establish 
three accounts to record your Accumulated and Earned Prioritized 
Payments.
    (1) Accumulation Account. The Accumulation Account is a memorandum 
account. Its balance represents your Accumulated Prioritized Payments 
and unearned Adjustments.
    (2) Distribution Account. The Distribution Account is a liability 
account. Its balance represents your unpaid Earned Prioritized Payments 
and earned Adjustments.
    (3) Earned Payments Account. The Earned Payments Account is a 
memorandum account. Each time you add to the Distribution Account 
balance, add the same amount to the Earned Payments Account. Its 
balance represents your total (paid and unpaid) Earned Prioritized 
Payments and earned Adjustments.
    (d) How to determine your profit for Prioritized Payment purposes. 
As of the end of each fiscal year and any interim period (one or more 
fiscal quarters) for which you want to make a Distribution:
    (1) Bring the Accumulation Account up to date by adding to it all 
Prioritized Payments through the end of the fiscal period.
    (2) Determine your cumulative Earmarked Profit (Loss) under 
Sec. 107.1510(e) and subtract your Earned Payments Account balance from 
it. The result (if greater than zero) is your profit for the purposes 
of this section; if zero or less, you have no profit.
    (3) If you have a profit, continue with paragraph (e) of this 
section. Otherwise, continue with paragraph (f) of this section.
    (e) Allocating Prioritized Payments to the Distribution Account. 
(1) If you have a profit under paragraph (d) of this section, determine 
the lesser of:
    (i) Your profit; or
    (ii) The balance in your Accumulation Account.
    (2) Subtract the result in paragraph (e)(1) of this section from 
the Accumulation Account and add it to the Distribution Account.
    (f) How to compute Adjustments. You must compute your Adjustments 
as of the end of each fiscal year.
    (1) Adjustments based on Accumulation Account balance. If you have 
any balance in your Accumulation Account, determine your average 
Accumulation Account balance for the fiscal year and multiply it by the 
average of the Trust Certificate Rates for all the Participating 
Securities poolings during such year.
    (2) Adjustments based on Distribution Account balance. If you have 
any balance in your Distribution Account after giving effect to any 
Distribution that will be made on the first or second Payment Date 
following your fiscal year end, do the computations in paragraph (f)(1) 
of this section, substituting 

[[Page 58568]]
``Distribution Account'' for ``Accumulation Account''.
    (3) Add the amounts computed in this paragraph (f) to your 
Accumulation Account balance.
    (g) Licensee's obligation to pay Prioritized Payments after 
redeeming Participating Securities. This paragraph (g) applies if you 
have redeemed all your Participating Securities, but you still hold 
Earmarked Assets and still have a balance in your Accumulation Account.
    (1) You must continue to perform all the procedures in this 
Sec. 107.1520 as of the end of each fiscal quarter. You must distribute 
any Earned Prioritized Payments and earned Adjustments in accordance 
with Sec. 107.1540.
    (2) After you dispose of all your Earmarked Assets and make any 
required Distributions in accordance with Sec. 107.1540, your 
obligation to pay any remaining Accumulated Prioritized Payments and 
unearned Adjustments will be extinguished.


Sec. 107.1530  How a Licensee computes SBA's Profit Participation.

    This section tells you how to compute SBA's Profit Participation. 
Profit Participation is included in the Distributions you make to SBA 
under Secs. 107.1550 and 107.1560.
    (a) How to compute Profit Participation. Profit Participation 
equals your ``Base'' times your ``Profit Participation Rate'' (if the 
Base is zero or less, you do not owe SBA Profit Participation). Compute 
the Base using paragraph (c) of this section and the Profit 
Participation Rate using paragraphs (d) through (g) of this section. 
You must compute your Earmarked Profit (Loss) under Sec. 107.1510 and 
your Prioritized Payments and Adjustments under Sec. 107.1520 before 
you can compute Profit Participation.
    (b) How to keep track of Profit Participation. You must establish a 
Profit Participation Account to record your computations under this 
section and payments under Secs. 107.1550 and 107.1560. Its balance 
represents your unpaid Profit Participation.
    (c) How to compute the Base. As of the end of each fiscal year and 
any year-to-date interim period (one or more fiscal quarters) for which 
you want to make a Distribution, compute your Base using the following 
formula:

B = EP - PPA - UL

Where:

B = Base
EP = Earmarked Profit (Loss) for the period from Sec. 107.1510
PPA = Prioritized Payments from Sec. 107.1520(a)(1) and Adjustments (if 
applicable) from Sec. 107.1520(f)
UL = ``Unused Loss'' as determined in this paragraph (c).

    (1) If you have never computed a Base before, or if the Base as of 
the end of your last fiscal year (your ``Previous Base'') was zero or 
greater, your Unused Loss is zero.
    (2) If your Previous Base was less than zero, your Unused Loss 
equals your Previous Base.
    (d) How to compute the Profit Participation Rate. You must 
determine your Profit Participation Rate each time you compute a Base 
that is greater than zero. Compute the Rate by following the steps in 
paragraphs (e) through (g) of this section.
    (e) Compute the ``PLC ratio''--(1) General rule. The ``PLC ratio'' 
is the highest ratio of outstanding Participating Securities to 
Leverageable Capital that you have ever attained.
    (2) Exception. You may reduce the ratio computed under paragraph 
(e)(1) of this section if you have increased your Leverageable Capital 
above its highest previous level. The increase must have taken place at 
least 120 days before the date as of which your Base is computed and 
must have been expressly provided for in a plan of operations submitted 
to and approved by SBA in writing. To reduce your PLC ratio:
    (i) Determine the increase in your Leverageable Capital over its 
highest previous level.
    (ii) Find your highest previous ratio of Participating Securities 
to Leverageable Capital. If you have attained your highest ratio more 
than once, with different numerators and denominators, choose the ratio 
with the highest numerator.
    (iii) Add the increase in Leverageable Capital to the denominator 
of the ratio chosen in paragraph (e)(2)(ii) of this section, and divide 
the numerator by the revised denominator. The result is your new PLC 
ratio.
    (3) Once you compute a PLC ratio under either paragraph (e)(1) or 
(e)(2) of this section, do not recompute it unless there has been a 
change in your outstanding Participating Securities or your 
Leverageable Capital.
    (4) Example.

----------------------------------------------------------------------------------------------------------------
                                                           Participating                                        
                                                             securities   Leverageable      A/B       PLC ratio 
                                                                (A)        capital (B)                          
----------------------------------------------------------------------------------------------------------------
End of period 1..........................................         1,000          1,000         1.00         1.00
End of period 2..........................................         1,500          1,000         1.50         1.50
End of period 3..........................................         1,200            900         1.33         1.50
End of period 4..........................................           750            500         1.50         1.50
End of period 5..........................................           750          1,500         0.50         1.00
----------------------------------------------------------------------------------------------------------------
Explanation of PLC Ratio calculation following increase in Leverageable Capital:                                
Step 1: Increase in Leverageable Capital over highest previous level = 1,500-1,000=500.                         
Step 2: Highest previous ratio of Participating Securities to Leverageable Capital = 1.50 (attained two times,  
  at end of periods 2 and 4).                                                                                   
Step 3: Highest numerator associated with highest ratio = 1,500 (at end of period 2); associated denominator =  
  1,000.                                                                                                        
Step 4: Add the increase in Leverageable Capital (from step 1) to the denominator (from step 3):                
  500+1,000=1,500.                                                                                              
Step 5: Divide the numerator (from step 3) by the revised denominator (from step 4): 1,500/1,500=1.00.          

    (f) Compute the Profit Participation Rate (before indexing). 
Compute the Profit Participation Rate (before indexing) using the table 
in this paragraph (f). Then go to paragraph (g) of this section to 
determine whether to index the Profit Participation Rate.

------------------------------------------------------------------------
                                                  Then your profit      
           If your PLC ratio is                 participation rate is   
------------------------------------------------------------------------
1 or less.................................  9%  x  PLC Ratio.           
More than 1...............................  9%+[3% x (PLC ratio-1)].    
------------------------------------------------------------------------

    (g) Indexing the Profit Participation Rate. The Profit 
Participation Rate is indexed, up or down, to the yield-to-maturity on 
Treasury bonds with a remaining term of ten (10) years (the ``Treasury 
Rate''). You must perform the indexing procedures in this paragraph (g) 
unless the Treasury Rate was exactly 8 percent on every date that you 
issued Participating Securities.
    (1) Licensees that have issued Participating Securities on only one 
occasion. Determine the Treasury Rate for the date you issued your 

[[Page 58569]]
Participating Security. Adjust the Profit Participation Rate from 
paragraph (f) of this section by the percentage difference between the 
Treasury Rate and 8 percent. For example, assume that you issued 
Participating Securities when the Treasury Rate was 10 percent. The 
percentage difference between 10 percent and 8 percent is 25 percent. 
If you had a PLC ratio of 1, the Profit Participation Rate before 
indexing would be 9 percent. You would increase this rate by 25 
percent, giving you a Profit Participation Rate of 11.25 percent.
    (2) Licensees that have issued Participating Securities on more 
than one occasion. Determine the Treasury Rate for each of the dates 
you issued Participating Securities.
    (i) Compute an average of all such Treasury Rates, weighted to 
reflect the dollar amount of each issuance (ignoring any redemptions) 
and the number of days from the date of each issuance to the date as of 
which you are computing the Profit Participation Rate.

    Example to paragraph (g)(2)(i) of this section. If you issued 
$10 million of Participating Securities on the 60th day of Fiscal 
Year 1 when the Treasury Rate was 8 percent, and another $15 million 
on the 100th day of Fiscal Year 3 when the Treasury Rate was 10 
percent, then the weighted average Treasury Rate computed as of the 
end of Fiscal Year 3 would be 8.55 percent. [Days elapsed since 
first issuance of Participating Securities = 1,035; days elapsed 
since second issuance of Participating Securities = 265; weighted 
amount of first issuance = $10,000,000 x 1,035/1,035=$10,000,000; 
weighted amount of second issuance = $15,000,000 x 265/
1035=$3,840,579; weighted average amount of Participating Securities 
issued = $10,000,000+$3,840,579=$13,840,579; weighted average 
Treasury Rate = {(.08 x $10,000,000)+(.10 x $3,840,579)}/
$13,840,579=8.55%].

    (ii) Adjust the Profit Participation Rate from paragraph (f) of 
this section by the percentage difference between the weighted average 
Treasury Rate and 8 percent. In the example given in paragraph 
(g)(2)(i) of this section, if the PLC ratio were equal to 2, the Profit 
Participation Rate for the fiscal year would be 12.83 percent. 
[{((.0855-.08)/
.08)+1} x .12 x 100=12.83%].
    (h) Computing SBA's Profit Participation. If the Base from 
paragraph (c) of this section is greater than zero, you must compute 
SBA's Profit Participation as follows:
    (1) Multiply the Base by the Profit Participation Rate to determine 
the Profit Participation for the fiscal year or year-to-date interim 
period.
    (2) Reduce the Profit Participation from paragraph (h)(1) of this 
section by any amounts of Profit Participation that you distributed or 
reserved for distribution to SBA, or its designated agent or Trustee, 
for any previous interim period during the fiscal year.
    (3) If you computed Profit Participation for any previous interim 
period during the fiscal year, you must adjust it to account for any 
increase in the Profit Participation Rate.
    (i) Allocation of Profit Participation. Before any Distribution and 
in any case within 120 days following the end of your fiscal year, you 
must add the amount of Profit Participation computed under this 
Sec. 107.1530 to the Profit Participation Account. You must reserve 
funds equal to this amount for distribution to SBA, or its designated 
agent or Trustee; you may not reinvest these funds or use them for any 
other purpose.


Sec. 107.1540  Distributions by Licensee--Prioritized Payments and 
Adjustments.

    After you compute Prioritized Payments and Adjustments under 
Sec. 107.1520, you must distribute them in accordance with this 
Sec. 107.1540.
    (a) Requirement to distribute Prioritized Payments and Adjustments. 
This paragraph (a) applies only if you satisfy the liquidity 
requirement in Sec. 107.1505. All Distributions under this paragraph 
(a) go to SBA or its designated agent or trustee.
    (1) You must distribute the balance in your Distribution Account 
from Sec. 107.1520 annually on the first or second Payment Date 
following your fiscal year end, and on any Payment Date when you are 
making any other Distribution.
    (2) You may distribute all or part of the balance in your 
Distribution Account on any Payment Date regardless of whether you are 
making any other Distribution on that date.
    (b) Additional requirement for Licensees with undistributed 
Prioritized Payments. This paragraph (b) applies if you do not 
distribute the full amount in your Distribution Account by the second 
Payment Date following the end of your fiscal year. At the end of each 
fiscal quarter, until you reduce the balance in your Distribution 
Account to zero, you must:
    (1) Do all the steps in Sec. 107.1520; and
    (2) Distribute the balance in your Distribution Account on the next 
Payment Date following the end of your fiscal quarter, provided you 
satisfy the liquidity requirement in Sec. 107.1505.
    (c) Order of Prioritized Payment Distributions. If you have issued 
Participating Securities on more than one occasion, you must pay 
Prioritized Payments on them in the order of their issue date.


Sec. 107.1550  Distributions by Licensee--permitted ``tax 
Distributions'' to private investors and SBA.

    If you have outstanding Participating Securities or Earmarked 
Assets, and you are a limited partnership, ``S Corporation'', or 
equivalent pass-through entity for tax purposes, you may make an annual 
``tax Distribution'' to your investors, whether or not they have an 
actual tax liability. SBA receives a share of any tax Distribution you 
make. This section tells you when you may make a ``tax Distribution'' 
and how to compute it.
    (a) Conditions for making a tax Distribution. You may make a tax 
Distribution only if:
    (1) You have paid all your Prioritized Payments and Adjustments, so 
that the balance in both your Distribution Account and your 
Accumulation Account is zero (see Sec. 107.1520).
    (2) You satisfy the liquidity requirement in Sec. 107.1505.
    (3) The tax Distribution does not exceed your Retained Earnings 
Available for Distribution.
    (4) The tax Distribution does not exceed the Maximum Tax Liability 
from paragraph (b) of this section.
    (b) How to compute the Maximum Tax Liability. (1) Compute your 
Maximum Tax Liability for a full fiscal year only. Use the following 
formula:
M = (TOI  x  HRO) + (TCG  x  HRC)

Where:

M = Maximum Tax Liability.
TOI = Total ordinary income allocated to your partners or shareholders 
for Federal income tax purposes.
HRO = The highest combined marginal Federal and State income tax rates 
for corporations or individuals (whichever is higher), on ordinary 
income.
TCG = Total capital gains allocated to your partners or shareholders 
for Federal income tax purposes.
HRC = The highest combined marginal Federal and State income tax rates 
for corporations or individuals (whichever is higher), on capital 
gains.

    (2) For purposes of this paragraph (b), the ``State income tax'' is 
that of the State where your principal place of business is located.
    (c) SBA's share of the tax Distribution. (1) SBA's percentage share 
of the tax Distribution is equal to the Profit Participation Rate 
computed under Sec. 107.1530.
    (2) SBA may direct you to pay its share of the tax Distribution to 
its designated agent or Trustee. 

[[Page 58570]]

    (3) SBA will apply its share of the tax Distribution to the Profit 
Participation you owe SBA under Sec. 107.1530.
    (d) Paying a tax Distribution. You may make a tax Distribution only 
on the first or second Payment Date following the end of your fiscal 
year.


Sec. 107.1560  Distributions by Licensee--required Distributions to 
private investors and SBA.

    You must make Distributions under this Sec. 107.1560 if you have 
outstanding Participating Securities or Earmarked Assets and you 
satisfy the conditions in paragraph (a) of this section. Distributions 
under this section are determined as of the end of each fiscal year.
    (a) Conditions for making Distributions. Distributions under this 
section are subject to the following conditions:
    (1) You must have paid all your Prioritized Payments and 
Adjustments, so that the balance in both your Distribution Account and 
your Accumulation Account is zero (see Secs. 107.1520 and 107.1540).
    (2) You must have made any permitted tax Distribution that you 
choose to make under Sec. 107.1550.
    (3) You must satisfy the liquidity requirement in Sec. 107.1505.
    (4) The amount you distribute under this section must not exceed 
your Retained Earnings Available for Distribution.
    (b) Total amount you must distribute. Unless SBA permits otherwise, 
the total amount you must distribute equals the result (if greater than 
zero) of the following computation:
    (1) Your Retained Earnings Available for Distribution as of the end 
of your fiscal year; minus
    (2) All previous Distributions under this Sec. 107.1560 that were 
applied as redemptions or repayments of Leverage; plus
    (3) All previous Distributions under Sec. 107.1570(b) that reduced 
your Retained Earnings Available for Distribution.
    (c) When you must make Distributions. You must make the required 
Distributions on either the first or second Payment Date following the 
end of your fiscal year.
    (d) Effect of Distributions on Retained Earnings Available for 
Distribution. Distributions under this Sec. 107.1560 have the following 
effect on your Retained Earnings Available for Distribution:
    (1) All Distributions to private investors reduce Retained Earnings 
Available for Distribution.
    (2) Distributions to SBA, or its designated agent or Trustee, 
reduce Retained Earnings Available for Distribution if they are applied 
as payments of Profit Participation or distributions on Preferred 
Securities (see paragraph (g) of this section).
    (3) Distributions to SBA, or its designated agent or Trustee, do 
not reduce Retained Earnings Available for Distribution if they are 
applied as a repayment or redemption of Leverage (see paragraph (g) of 
this section).
    (e) SBA's share of the total Distribution. Use the following table 
to determine the percentage share of the total Distribution (from 
paragraph (b) of this section) that goes to SBA (or its designated 
agent or Trustee):

              SBA's Percentage Share of Total Distribution              
------------------------------------------------------------------------
 If your ratio of leverage to leverageable   Then SBA's percentage share
   capital as of the fiscal year end is        of the distribution is   
------------------------------------------------------------------------
Over 200%.................................  [Leverage / (Leverage +     
                                             Leverageable Capital)] x   
                                             100.                       
Over 100% but not over 200%...............  50%.                        
100% or less..............................  Profit Participation Rate   
                                             from Sec.  107.1530.       
------------------------------------------------------------------------

    (f) Exceptions to the Distribution requirement. (1) With SBA's 
prior written approval, you may withhold from distribution reasonable 
reserves necessary to protect your investments or relative position in 
Loans and Investments and to meet contingent liabilities.
    (i) If you submit a written request for SBA approval, you may 
consider it approved unless SBA notifies you otherwise within 30 days 
from receipt.
    (ii) Reserves that you withhold from distribution may not be used 
to make investments in additional portfolio companies.
    (iii) Withholding of reserves under this paragraph (f)(1) is not a 
``payment failure'' in violation of Sec. 107.1820(e)(6).
    (2) SBA may restrict Distributions under this Sec. 107.1560 if SBA 
determines that the value of your assets is materially overstated. SBA 
must give you notice of such a determination in advance of your 
proposed Distribution.
    (g) How SBA will apply your Distributions. Your Distributions to 
SBA (or its designated agent or Trustee) under this Sec. 107.1560 will 
be applied in the following order:
    (1) First, to Profit Participation;
    (2) Second, to the extent there remain any Retained Earnings 
Available for Distribution, to distributions on Preferred Securities;
    (3) Third, as a redemption of Participating Securities in order of 
issue;
    (4) Fourth, as a redemption of Preferred Securities; and
    (5) Fifth, as the repayment of principal of any outstanding 
Debentures, with such repayment to be made into escrow on terms and 
conditions SBA determines.


Sec. 107.1570  Distributions by Licensee--optional Distribution to 
private investors and SBA.

    If you have outstanding Participating Securities or Earmarked 
Assets, you may make two types of optional Distributions under this 
Sec. 107.1570: quarterly Distributions determined the same way as the 
required annual Distributions in Sec. 107.1560, and Distributions 
allocated between SBA and your private investors in proportion to the 
capital contributions of each.
    (a) Quarterly Distributions subject to conditions in Sec. 107.1560. 
(1) You may make Distributions under this paragraph (a) as of the end 
of any fiscal quarter, giving SBA (or its designated agent or Trustee) 
a percentage share determined under Sec. 107.1560(e).
    (2) Such Distributions are subject to all the provisions in 
Sec. 107.1560(a)(1), (a)(3), (a)(4), (d), (f)(2), and (g).
    (3) You may make such Distributions only on the next Payment Date 
following the end of your fiscal quarter.
    (4) The total amount of such Distributions may not exceed the 
result of the following computation:
    (i) Your Retained Earnings Available for Distribution as of the end 
of your fiscal quarter; minus
    (ii) All previous Distributions under this paragraph (a) or 
Sec. 107.1560 that were applied as redemptions or repayments of 
Leverage; plus
    (iii) All previous Distributions under paragraph (b) of this 
section that reduced your Retained Earnings Available for Distribution.
    (b) Other optional Distributions. On any Payment Date, you may make 
additional Distributions to your private investors and to SBA (or its 
designated agent or Trustee) under this paragraph (b).
    (1) Conditions for making Distribution. You may make a Distribution 
under this paragraph (b) only if:
    (i) You have distributed all Earned Prioritized Payments and earned 
Adjustments, so that the balance in your Distribution Account is zero 
(see Sec. 107.1520).
    (ii) You have distributed all Profit Participation computed under 
Sec. 107.1530 and made all required Distributions under Sec. 107.1560. 

[[Page 58571]]

    (iii) You satisfy the liquidity requirement in Sec. 107.1505 or 
obtain SBA's prior written approval of the Distribution.
    (iv) You do not have a condition of Capital Impairment.
    (v) The Distribution does not reduce your Regulatory Capital 
(excluding commitments from Institutional Investors) below the minimum 
required under Sec. 107.210, unless SBA approves the reduction as part 
of a plan of liquidation.
    (vi) The Distribution does not cause you to have excess Leverage 
contrary to section 303 of the Act.
    (2) SBA's share of Distribution. (i) If your Capital Impairment 
Percentage under Sec. 107.1840 is zero, SBA's percentage share of any 
Distribution under this paragraph (b) equals:

    [Leverage/(Leverage+Leverageable Capital)] x 100
    In this formula, use Leverage and Leverageable Capital as of the 
date of the Distribution, after giving effect to any Distribution 
under Sec. 107.1560 and paragraph (a) of this section.

    (ii) If your Capital Impairment Percentage under Sec. 107.1840 is 
greater than zero, you must modify the formula in paragraph (b)(2)(i) 
of this section by replacing Leverageable Capital with:

    Leverageable Capital x (100%-CIP)
    where ``CIP'' is your Capital Impairment Percentage or 100 
percent, whichever is less.

    (3) How SBA will apply Distributions. Any amounts you distribute to 
SBA, or its designated agent or Trustee, under this paragraph (b) will 
be applied as a repayment or redemption of Leverage in the order set 
forth in Sec. 107.1560(g)(3) through (g)(5).
    (4) Effect of Distributions on Retained Earnings Available for 
Distribution. Any amounts you distribute to non-SBA investors under 
this paragraph (b) must reduce your Retained Earnings Available for 
Distribution to zero before reducing your Private Capital.
    (5) Permitted exception to Sec. 107.585. You may make any 
Distribution permitted by this paragraph (b), even if the result is a 
reduction in your Regulatory Capital that would otherwise be prohibited 
under Sec. 107.585.


Sec. 107.1580  Special rules for In-Kind Distributions by Licensees.

    (a) In-Kind Distributions while Licensee has outstanding 
Participating Securities. A Distribution under Secs. 107.1560 or 
107.1570 may consist of securities (an ``In-Kind Distribution''). Such 
a Distribution must satisfy the conditions in this paragraph (a).
    (1) You may distribute only securities that are Publicly Traded and 
Marketable at the time of the Distribution.
    (2) You must distribute each security pro-rata to all investors and 
to SBA or its designated agent or Trustee, based on the amounts that 
each party would receive if the Distribution were in cash.
    (3) You must impute a gain (loss) on each security being 
distributed as if it were being sold, using the value of the security 
as of the declaration date of the Distribution (if you are a Corporate 
Licensee) or the distribution date (if you are a Partnership Licensee).
    (4) You must deposit SBA's share of the securities being 
distributed with the CRA, who will select a Disposition Agent (a person 
who is knowledgeable about and proficient in the marketing of thinly 
traded securities). As an alternative, if you agree, SBA may direct you 
to dispose of its share. In this case, you must promptly remit the 
proceeds to SBA.
    (b) In-Kind Distributions after Licensee has redeemed all 
Participating Securities. This paragraph (b) applies from the time you 
redeem all your Participating Securities until you dispose of all your 
Earmarked Assets.
    (1) You may make an In-Kind Distribution of an Earmarked Asset only 
if you pay SBA the lower of:
    (i) An amount equal to the Unrealized Appreciation on the asset; or
    (ii) The full amount of your Accumulated Prioritized Payments and 
unpaid Adjustments.
    (2) You must obtain SBA's prior written approval of any In-Kind 
Distribution of an Earmarked Asset that is not Publicly Traded and 
Marketable, specifically including approval of the valuation of the 
asset.


Sec. 107.1590  Special rules for companies licensed on or before March 
31, 1993.

    This section applies to companies licensed on or before March 31, 
1993 that apply to issue Participating Securities.
    (a) Election to exclude pre-existing portfolio. You may choose to 
exclude all (but not a portion) of your Loans and Investments as of 
March 31, 1993, from classification as Earmarked Assets if:
    (1) The proceeds of your first issuance of Participating Securities 
are not used to refinance outstanding Debentures (see paragraph (c) of 
this section). SBA will consider payment or prepayment of any 
outstanding Debenture to be a refinancing unless you demonstrate to 
SBA's satisfaction that you can pay the Debenture principal without 
relying on the proceeds of the Participating Securities.
    (2) SBA, in its sole discretion, approves the exclusion.
    (b) Treatment of pre-existing portfolio if not excluded. If you do 
not choose to exclude your Loans and Investments as of March 31, 1993, 
they will be Earmarked Assets for all purposes.
    (c) Refinancing Debentures with Participating Securities. SBA may 
permit you to use the proceeds of a Participating Security to pay the 
principal amount due on an outstanding Debenture if:
    (1) You have outstanding Equity Capital Investments (at cost) equal 
to the amount of the Debentures being refinanced.
    (2) You have not elected to exclude Loans and Investments from 
Earmarked Assets under paragraph (a) of this section.
    (d) Requirements for Licensee's first issuance of Participating 
Securities. When you apply for your first issuance of Participating 
Securities, you must comply with the following:
    (1) For each of your Loans and Investments, you must submit:
    (i) The most recent annual report (or fiscal year-end financial 
statements) and the most recent interim financial statements of the 
Small Business; and
    (ii) Your valuation reports on the Small Business, prepared as of 
the end of each of your last three fiscal years. If you have applied 
for Participating Securities on the basis of interim financial 
statements, you must also submit a valuation report as of your interim 
financial statement date.
    (2) If you have negative Undistributed Net Realized Earnings and/or 
a net Unrealized Loss on Securities Held, SBA may require you to 
undergo a quasi-reorganization in accordance with generally accepted 
accounting principles.
    (3) If your financial statements accompanying the Participating 
Securities application are for an interim period, you must have your 
SBA-approved independent public accountant perform a limited-scope 
audit of the statements. For purposes of this paragraph (d)(3), 
``limited scope audit'' means auditing procedures sufficient to enable 
the independent public accountant to express an opinion on the 
Statement of Financial Position and the accompanying Schedule of Loans 
and Investments.

Funding Leverage by Use of SBA-Guaranteed Trust Certificates (``TCs'')


Sec. 107.1600  SBA authority to issue and guarantee Trust Certificates.

    (a) Full Faith and Credit. Sections 321 (a) and (b) of the Act 
authorize SBA or its CRA to issue TCs, and SBA to guarantee the timely 
payment of the principal and interest thereon. Any guarantee by SBA of 
such TC is limited 

[[Page 58572]]
to the principal and interest due on the Debentures or the Redemption 
Price of and Prioritized Payments on Participating Securities in any 
Trust or Pool backing such TC. The full faith and credit of the United 
States is pledged to the payment of all amounts due under the guarantee 
of any TC.
    (b) Periodic Exercise of Authority. SBA will issue guarantees of 
Debentures and Participating Securities under section 303 and of TCs 
under section 321 of the Act at three month intervals, or at shorter 
intervals, taking into account the amount and number of such guarantees 
or TCs.


Sec. 107.1610  Terms and conditions of Trust Certificates.

    TCs shall provide for a pass-through to their holders of all 
amounts of principal and interest paid on the Debentures, or the 
Redemption Price of and Prioritized Payments on the Participating 
Securities, in the Pool or Trust against which they are issued. SBA 
shall determine the legal and other terms and conditions of TCs in 
conjunction with the Secretary of the Treasury and its own statutory 
authority and such other requirements as may be mandated by law. The 
interest rate on Debentures or the Prioritized Payment rate on the 
Participating Securities in a Trust or Pool shall be determined 
pursuant to section 303 (b) or (g), respectively, of the Act.


Sec. 107.1620  SBA authority to pay subsidy amount on subsidized 
Debentures.

    If SBA guarantees Debentures of a Section 301(d) Licensee, section 
303(d) of the Act requires SBA to make payments to the CRA, or to the 
holder of any such Debenture, sufficient to reduce the effective rate 
of interest to such Licensee during the first five years of the term of 
such Debenture by three percentage points.


Sec. 107.1630  Effect of prepayment or early redemption of Leverage on 
a Trust Certificate.

    (a) The rights, if any, of a Licensee to prepay any Debenture or 
make early redemption of any Participating Security are established by 
the terms of such securities, and no such right is created or denied by 
the regulations in this part.
    (b) SBA's rights to purchase or prepay any Debenture without 
premium are established by the terms of the Guaranty Agreement relating 
to the Debenture. SBA's rights to redeem, at any time, any 
Participating Security without premium are established by the terms of 
the Guaranty Agreement relating to the Participating Security.
    (c) Any prepayment of a Debenture or early redemption of a 
Participating Security pursuant to the terms of the Guaranty Agreement 
relating to such securities, shall reduce the SBA guarantee of timely 
payment of principal and interest on a TC in proportion to the amount 
of principal or Redemption Price that such prepaid Debenture or 
redeemed Participating Security represents in the Trust or Pool backing 
such TC.
    (d) SBA shall be discharged from its guarantee obligation to the 
holder or holders of any TC, or any successor or transferee of such 
holder, to the extent of any such prepayment, whether or not such 
successor or transferee shall have notice of any such prepayment.
    (e) Interest on prepaid Debentures and Prioritized Payments on 
Participating Securities shall accrue only through the date of such 
voluntary prepayment or SBA payment, as the case may be.
    (f) In the event that all Debentures or Participating Securities 
constituting a Trust or Pool are prepaid, the TCs backed by such Trust 
or Pool shall be redeemed by payment of the unpaid principal and 
interest on the TCs; Provided, however, that in the case of the 
prepayment of a Debenture pursuant to the provisions of the Guaranty 
Agreement relating to the Debenture, the CRA shall pass through pro 
rata to the holders of the TCs any such prepayments including any 
prepayment penalty paid by the obligor Licensee pursuant to the terms 
of the Debenture.


Sec. 107.1640  Subrogation of SBA upon payment under Trust Certificate 
Program.

    In the event SBA pays a claim under the guarantee of a TC, SBA's 
claim is subrogated fully to the rights satisfied by such payment. No 
state or Federal law can preclude or limit SBA's exercise of its 
ownership rights acquired by subrogation upon payment under its 
guarantee.


Sec. 107.1650  Formation of a Pool or Trust holding Leverage 
securities.

    SBA shall approve the formation of each Pool or Trust. SBA may, in 
its discretion, establish the size of the Pools and their composition, 
the interest rate on the TCs issued against Trusts or Pools, fees, 
discounts, premiums and other charges made in connection with the 
Pools, Trusts, and TCs, and any other characteristics of a Pool or 
Trust it deems appropriate.


Sec. 107.1660  Functions of agents, including Central Registration 
Agent, Selling Agent and Fiscal Agent.

    (a) Agents. SBA will appoint or cause to be appointed agent(s) to 
perform functions necessary to market and service Debentures, 
Participating Securities, or TCs pursuant to this part.
    (1) Selling Agent. As a condition of guaranteeing a Debenture or 
Participating Security, SBA shall cause each Licensee to appoint a 
Selling Agent to perform functions which include, but are not limited 
to:
    (i) Selecting qualified entities to become pool or Trust assemblers 
(``Poolers''). Such actions shall be subject to SBA prior written 
approval and to the provisions of Sec. 107.1670(b).
    (ii) Receiving guaranteed Debentures and Participating Securities 
as well as negotiating the terms and conditions of periodic offerings 
of Debentures and/or TCs with Poolers on behalf of Licensees.
    (iii) Directing and coordinating periodic sales of Debentures and 
Participating Securities and/or TCs.
    (iv) Arranging for the production of the Offering Circular, 
certificates, and such other documents as may be required from time to 
time.
    (2) Fiscal Agent. SBA shall appoint a Fiscal Agent to:
    (i) Establish performance criteria for Poolers.
    (ii) Monitor and evaluate the financial markets to determine those 
factors that will minimize or reduce the cost of funding Debentures or 
Participating Securities.
    (3) Monitor the performance of the Selling Agent, Poolers, CRA, and 
the Trustee.
    (4) Perform such other functions as SBA, from time to time, may 
prescribe.
    (b) The function of locating purchasers, and negotiating and 
closing the sale of Debentures, Participating Securities and TCs, may 
be performed either by SBA or an agent appointed by SBA. Nothing in the 
regulations in this part shall be interpreted to prevent the CRA from 
acting as SBA's agent for this purpose.
    (c) Pursuant to a contract entered into with SBA, the CRA shall do 
the following as agent of SBA:
    (1) Issuance of the TCs. Upon the formation of any Pool or Trust 
approved by SBA, CRA shall issue TCs, in the form prescribed by SBA, 
upon the primary sale of Debentures or Participating Securities, and 
shall issue or effect the transfer of TCs upon the sale of original 
issue TCs in any secondary market transaction.
    (2) Receipt of amounts due on Debentures and Participating 
Securities. CRA shall receive payments from Licensees of amounts due on 
Debentures and Participating Securities, and amounts paid under 
voluntary prepayments or prepayments by SBA pursuant to the terms of 
the relevant Guaranty Agreements. 

[[Page 58573]]

    (3) Payments of amounts due on TCs. CRA shall make periodic 
payments as scheduled or required by the terms of the TCs, and pay all 
amounts required to be paid upon prepayment of Debentures or redemption 
of Participating Securities.
    (4) Custody of Debentures and Participating Securities and 
Documentation. CRA shall hold and safeguard all Debentures and 
Participating Securities constituting Trusts or Pools and shall 
release, upon instructions of SBA, the Debentures and Participating 
Securities paid in full at maturity or prepaid in full prior to 
maturity. CRA also shall be custodian of such other documentation as 
SBA shall direct by written instructions.
    (5) Registration of Debentures and Participating Securities and 
TCs. CRA shall provide for the registration of all pooled Debentures 
and Participating Securities, all Pools and Trusts, and all TCs. With 
respect to each sale of Debentures or Participating Securities, such 
registration shall include:
    (i) The identification of the selling License;
    (ii) The interest rate to be paid on the Debentures;
    (iii) The Prioritized Payment rate to be paid on the Participating 
Securities;
    (iv) All commissions, fees, and/or discounts paid to brokers and 
dealers in TCs or others;
    (v) Identification of each purchaser and any subsequent purchaser 
of any TC;
    (vi) The interest rate on any TC;
    (vii) The price paid by any purchaser for a TC;
    (viii) The fee of the CRA; and
    (ix) Such other information as SBA may deem appropriate or that may 
be customary in the markets for transactions of similar type.
    (6) Fidelity bond or insurance. CRA shall provide a fidelity bond 
or insurance in such amount as SBA may require to fully protect the 
interest of the government.
    (7) Other necessary functions. CRA shall perform such other 
functions as SBA may deem necessary to implement the provisions of this 
section.


Sec. 107.1670  SBA regulation of Brokers and Dealers and disclosure to 
purchasers of Leverage or Trust Certificates.

    (a) Disclosure to purchasers. Prior to any sale of a Debenture, 
Participating Security, or TC, SBA shall require the seller, or the 
broker or dealer as agent for the seller, to disclose to the purchaser, 
in a form prescribed or approved by SBA, specified information on the 
terms, conditions, and yield of such instrument.
    (b) Brokers and Dealers. Each broker, dealer, and Pool or Trust 
assembler approved by SBA pursuant to these regulations shall either be 
regulated by a Federal financial regulatory agency, or be a member of 
the National Association of Securities Dealers (NASD), and shall be in 
good standing in respect to compliance with the financial, ethical, and 
reporting requirements of such body. They also shall be in good 
standing with SBA as determined by the SBA Associate Administrator for 
Investment (see paragraph (c)(5) of this section) and shall provide a 
fidelity bond or insurance in such amount as SBA may require. Nothing 
in these provisions shall affect the applicability of the securities 
laws, as that term is defined in section 3(a)(47) of the Securities 
Exchange Act of 1934, or any of the rules and regulations thereunder, 
or otherwise supersede or limit the jurisdiction of the Securities and 
Exchange Commission or any authority at any time conferred under the 
securities laws.
    (c) Suspension and/or termination of Broker or Dealer. SBA shall 
exclude from the sale and all other dealings in Debentures, 
Participating Securities or TCs any broker or dealer:
    (1) If such broker's or dealer's authority to engage in the 
securities business has been revoked or suspended by a supervisory 
agency. When such authority has been suspended, such broker or dealer 
will be suspended by SBA for the duration of such suspension by the 
supervisory agency.
    (2) If such broker or dealer has been indicted or otherwise 
formally charged with a misdemeanor or felony bearing on its fitness to 
participate in the market for Debentures, Participating Securities or 
TCs, such broker or dealer may be suspended while the charge is 
pending. Upon conviction, participation may be terminated.
    (3) When such broker or dealer has suffered an adverse final civil 
judgment, holding that such broker or dealer has committed a breach of 
trust or violation of law or regulation protecting the integrity of 
business transactions or relationships, participation in the market for 
Debentures, Participating Securities or TCs may be terminated.
    (4) When such broker or dealer has failed to make full disclosure 
of the information required by paragraph (a) of this section, such 
broker's or dealer's participation in the market for Debentures, 
Participating Securities or TCs may be terminated.
    (5) Proceedings to terminate such broker's or dealer's 
participation in the market for Debentures, Participating Securities or 
TCs shall be conducted in accordance with Part 134 of this Chapter. SBA 
may, for any of the reasons stated above, suspend the privilege of any 
broker or dealer to participate in this market. SBA shall give written 
notice at least ten (10) business days prior to the effective date of 
such suspension. Such notice shall inform the broker or dealer of the 
opportunity for a hearing pursuant to part 134 of this chapter. The 
Assistant Administrator of the Office of Hearings and Appeals or an 
Administrative Law Judge of such office shall be the reviewing official 
for purposes of Secs. 134.32(b)(7) and 134.34 of this chapter.


Sec. 107.1680  SBA access to records of the CRA, Brokers, Dealers and 
Pool or Trust assemblers.

    The CRA and any broker, dealer and Pool or Trust assembler 
operating under the regulations in this part shall make all books, 
records and related materials associated with Debentures, Participating 
Securities and TCs available to SBA for review and copying purposes. 
Such access shall be at such party's primary place of business during 
normal business hours.

Miscellaneous


Sec. 107.1700  Characteristics of SBA's guarantee.

    (a) Unconditional nature of SBA's guarantee. If SBA agrees to 
guarantee your Debentures or Participating Securities, such guarantee 
will be unconditional, irrespective of the validity, regularity or 
enforceability of the Debentures or Participating Securities or any 
other circumstances which might constitute a legal or equitable 
discharge or defense of a guarantor. Pursuant to its guarantee, SBA 
will make timely payments of principal and interest on the Debentures 
or the Redemption Price of and Prioritized Payments on the 
Participating Securities, irrespective of any default by you or 
acceleration of the maturity of the Debentures by SBA, or your 
inability to pay the Redemption Price of or to make the Prioritized 
Payments on the Participating Securities, or any early redemption of 
the Participating Securities by SBA.
    (b) SBA authority to arrange public or private fundings of 
Leverage. SBA in its discretion may arrange for public or private 
financing under its guarantee authority. Such financing arranged by SBA 
may be accomplished by the sale of individual Debentures or 
Participating Securities, aggregations of Debentures or Participating 
Securities, or Pools or Trusts of Debentures or Participating 
Securities issued or sold 

[[Page 58574]]
pursuant to Secs. 107.1600 through 107.1680. Persons interested in 
providing funds to Licensees with SBA's guarantee must notify SBA by 
letter, certifying any direct or indirect beneficial interest, or 
actual or potential voting rights, in any Licensee, or in any person 
directly or indirectly controlling, controlled by or under common 
control with, any Licensee. These reporting requirements are approved 
under OMB No. 3245-0081.
    (c) SBA subrogation rights. In the event SBA pays a claim under its 
guarantee, SBA's claim is subrogated fully to the rights satisfied by 
such payment. No state law or Federal law can preclude or limit SBA's 
exercise of its ownership rights acquired by subrogation upon payment 
under its guarantee.


Sec. 107.1710  Transfer by SBA of its interest in Licensee's Leverage 
security.

    Upon such conditions and for such consideration as it deems 
reasonable, SBA may sell, assign, transfer, or otherwise dispose of any 
Preferred Security, Debenture, Participating Security, or other 
security held by or on behalf of SBA in connection with Leverage. Upon 
notice by SBA, Licensee will make all payments of principal, dividends, 
interest, Prioritized Payments, and redemptions as shall be directed by 
SBA. Licensee will be liable for all damage or loss which SBA may 
sustain by reason of such disposal, up to the amount of Licensee's 
liability under such security, plus court costs and reasonable 
attorney's fees incurred by SBA.


Sec. 107.1720  SBA authority to collect or compromise its claims.

    SBA may, upon such conditions and for such consideration as it 
deems reasonable, collect or compromise all claims relating to 
Preferred or Participating Securities or obligations held or guaranteed 
by SBA, and all legal or equitable rights accruing to SBA.

Subpart J--Licensee's Noncompliance With Terms of Leverage


Sec. 107.1800  Licensee's agreement to terms and conditions in 
Secs. 107.1810 and 107.1820.

    Any Licensee that violates the terms and conditions of its Leverage 
is subject to SBA remedies. The terms, conditions and remedies in 
Sec. 107.1810 apply to outstanding Debentures issued after April 25, 
1994. The terms, conditions and remedies in Sec. 107.1820 apply to 
outstanding Preferred Securities and Participating Securities issued 
after April 25, 1994, or if you have Earmarked Assets in your 
portfolio.


Sec. 107.1810  Events of default and SBA's remedies for Licensee's 
noncompliance with terms of Debentures.

    (a) Applicability of this section. This Sec. 107.1810 applies to 
Debentures issued after April 25, 1994. By issuing such Debentures, you 
automatically agree to the terms, conditions and remedies in this 
section, as in effect at the time of issuance and as if fully set forth 
in the Debentures. Debentures issued before April 25, 1994 continue to 
be governed by the remedies in effect at the time of their issuance.
    (b) Automatic events of default. The occurrence of one or more of 
the events in this paragraph (b) causes the remedies in paragraph (c) 
of this section to take effect immediately.
    (1) Insolvency. You become equitably or legally insolvent.
    (2) Voluntary assignment. You make a voluntary assignment for the 
benefit of creditors without SBA's prior written approval.
    (3) Bankruptcy. You file a petition to begin any bankruptcy or 
reorganization proceeding, receivership, dissolution or other similar 
creditors' rights proceeding, or such action is initiated against you 
and is not dismissed within 60 days.
    (c) SBA remedies for automatic events of default. Upon the 
occurrence of one or more of the events in paragraph (b) of this 
section:
    (1) Without notice, presentation or demand, the entire indebtedness 
evidenced by your Debentures, including accrued interest, and any other 
amounts owed SBA with respect to your Debentures, is immediately due 
and payable; and
    (2) You automatically consent to the appointment of SBA or its 
designee as your receiver under section 311(c) of the Act.
    (d) Events of default with notice. For any occurrence (as 
determined by SBA) of one or more of the events in this paragraph (d), 
SBA may avail itself of one or more of the remedies in paragraph (e) of 
this section.
    (1) Fraud. You commit a fraudulent act which causes detriment to 
SBA's position as a creditor or guarantor.
    (2) Fraudulent transfers. You make any transfer or incur any 
obligation that is fraudulent under the terms of 11 USC 548.
    (3) Willful conflicts of interest. You willfully violate 
Sec. 107.730.
    (4) Willful non-compliance. You willfully violate one or more of 
the substantive provisions of the Act, specifically including but not 
limited to the provisions summarized in section 310(c) of the Act, or 
any substantive regulation promulgated under the Act.
    (5) Repeated Events of Default. At any time after being notified by 
SBA of the occurrence of an event of default under paragraph (f) of 
this section, you engage in similar behavior which results in another 
occurrence of the same event of default.
    (6) Transfer of Control. You violate Sec. 107.475 and/or willfully 
violate Sec. 107.410, and as a result of such violation you undergo a 
transfer of Control.
    (7) Non-cooperation under Sec. 107.1810(h). You fail to take 
appropriate steps, satisfactory to SBA, to accomplish any action SBA 
may have required under paragraph (h) of this section.
    (8) Non-notification of Events of Default. You fail to notify SBA 
as soon as you know or reasonably should have known that any event of 
default exists under this section.
    (9) Non-notification of defaults to others. You fail to notify SBA 
in writing within ten days from the date of a declaration of an event 
of default or nonperformance under any note, debenture or indebtedness 
of yours, issued to or held by anyone other than SBA.
    (e) SBA remedies for events of default with notice. Upon written 
notice to you of the occurrence (as determined by SBA) of one or more 
of the events in paragraph (d) of this section:
    (1) SBA may declare the entire indebtedness evidenced by your 
Debentures, including accrued interest, and/or any other amounts owed 
SBA with respect to your Debentures, immediately due and payable; and
    (2) SBA may avail itself of any remedy available under the Act, 
specifically including institution of proceedings for the appointment 
of SBA or its designee as your receiver under section 311(c) of the 
Act.
    (f) Events of default with opportunity to cure. For any occurrence 
(as determined by SBA) of one or more of the events in this paragraph 
(f), SBA may avail itself of one or more of the remedies in paragraph 
(g) of this section.
    (1) Excessive Management Expenses. Without the prior written 
consent of SBA, you incur Management Expenses in excess of those 
permitted under Sec. 107.520.
    (2) Improper Distributions. You make any Distribution to your 
shareholders or partners, except with the prior written consent of SBA, 
other than:
    (i) Distributions permitted under Sec. 107.585;
    (ii) Payments from Retained Earnings Available for Distribution 
based on either the shareholders' pro-rata 

[[Page 58575]]
interests or the provisions for profit distributions in your 
partnership agreement, as appropriate; and
    (iii) Distributions by Participating Securities issuers as 
permitted under Secs. 107.1540 through 107.1580.
    (3) Failure to make payment. Unless otherwise approved by SBA, you 
fail to make timely payment of any amount due under any security or 
obligation of yours that is issued to, held or guaranteed by SBA.
    (4) Failure to maintain Regulatory Capital. You fail to maintain 
the minimum Regulatory Capital required under these regulations or, 
without the prior written consent of SBA, you reduce your Regulatory 
Capital, except as permitted by Secs. 107.585 and 107.1560 through 
107.1580.
    (5) Capital Impairment. You have a condition of Capital Impairment 
as determined under Sec. 107.1830.
    (6) Cross-default. An obligation of yours that is greater than 
$100,000 becomes due or payable (with or without notice) before its 
stated maturity date, for any reason including your failure to pay any 
amount when due. This provision does not apply if you pay the amount 
due within any applicable grace period or contest the payment of the 
obligation in good faith by appropriate proceedings.
    (7) Nonperformance. You violate or fail to perform one or more of 
the terms and conditions of any security or obligation of yours that is 
issued to, held or guaranteed by SBA, or of any agreement with or 
conditions imposed by SBA in its administration of the Act and the 
regulations promulgated under the Act.
    (8) Noncompliance. Except as otherwise provided in paragraph (d)(5) 
of this section, SBA determines that you have violated one or more of 
the substantive provisions of the Act, specifically including but not 
limited to the provisions summarized in section 310(c) of the Act, or 
any substantive regulation promulgated under the Act.
    (9) Failure to maintain investment ratio. You fail to maintain the 
investment ratio for Leverage in excess of 300 percent of Leverageable 
Capital (see Secs. 107.1150(b)(2) and 107.1160(c)), if applicable to 
you, as of the end of each fiscal year. In determining whether you have 
maintained the ratio, SBA will disregard any prepayment, sale, or 
disposition of Venture Capital Financing, any increase in Leverageable 
Capital, and any receipt of additional Leverage, within 120 days prior 
to the end of your fiscal year.
    (10) Failure to maintain diversity. You fail to maintain diversity 
between management and ownership as required by Sec. 107.150, if 
applicable to you.
    (g) SBA remedies for events of default with opportunity to cure. 
(1) Upon written notice to you of the occurrence (as determined by SBA) 
of one or more of the events of default in paragraph (f) of this 
section, and subject to the conditions in paragraph (g)(2) of this 
section:
    (i) SBA may declare the entire indebtedness evidenced by your 
Debentures, including accrued interest, and/or any other amounts owed 
SBA with respect to your Debentures, immediately due and payable; and
    (ii) SBA may avail itself of any remedy available under the Act, 
specifically including institution of proceedings for the appointment 
of SBA or its designee as your receiver under section 311(c) of the 
Act.
    (2) SBA may invoke the remedies in paragraph (g)(1) of this section 
only if:
    (i) It has given you at least 15 days to cure the default(s); and
    (ii) You fail to cure the default(s) to SBA's satisfaction within 
the allotted time.
    (h) Repeated non-substantive violations. If you repeatedly fail to 
comply with one or more of the non-substantive provisions of the Act or 
any non-substantive regulation promulgated under the Act, SBA, after 
written notification to you and until you cure such condition to SBA's 
satisfaction, may deny you additional Leverage and/or require you to 
take such actions as SBA may determine to be appropriate under the 
circumstances.
    (i) Consent to removal of officers, directors, or general partners 
and/or appointment of receiver. The Articles of any Licensee issuing 
Debentures after April 25, 1994 must include the following provisions 
as a condition to the purchase or guarantee by SBA of such Leverage. 
Upon the occurrence of any of the events specified in paragraphs (d)(1) 
through (d)(6) or (f)(1) through (f)(3) of this section as determined 
by SBA, SBA shall have the right, and you consent to SBA's exercise of 
such right:
    (1) With respect to a Corporate Licensee, upon written notice, to 
require you to replace, with individuals approved by SBA, one or more 
of your officers and/or such number of directors of your board of 
directors as is sufficient to constitute a majority of such board; or
    (2) With respect to a Partnership Licensee, upon written notice, to 
require you to remove the person(s) responsible for such occurrence 
and/or to remove the general partner of Licensee, which general partner 
shall then be replaced in accordance with Licensee's Articles by a new 
general partner approved by SBA; and/or
    (3) With respect to either a Corporate or Partnership Licensee, to 
obtain the appointment of SBA or its designee as your receiver under 
section 311(c) of the Act for the purpose of continuing your 
operations. The appointment of a receiver to liquidate a Licensee is 
not within such consent, but is governed instead by the relevant 
provisions of the Act.


Sec. 107.1820  Conditions affecting issuers of Preferred Securities 
and/or Participating Securities.

    (a) Applicability of this section. This section applies if you have 
Preferred Securities issued after April 25, 1994, or if you issue 
Participating Securities or have Earmarked Assets in your portfolio. 
Your Articles must include the provisions of this Sec. 107.1820 as a 
condition to SBA's purchase of Preferred Securities or guarantee of 
Participating Securities and for as long as you own Earmarked Assets. 
Preferred Securities issued before April 25, 1994 continue to be 
governed by the remedies in effect at the time of their issuance.
    (b) Removal Conditions. Upon the occurrence (as determined by SBA) 
of any of the following conditions (``Removal Conditions''), SBA may 
avail itself of one or more of the remedies in paragraph (d) of this 
section:
    (1) Insolvency or extreme Capital Impairment. You become equitably 
or legally insolvent, or have a Capital Impairment Percentage of 100 
percent or more (``extreme Capital Impairment'') and have not cured 
such Capital Impairment within the time limits set by SBA in writing. 
In this regard:
    (i) You are not considered to have a condition of extreme Capital 
Impairment during the first eight years following your first issuance 
of Participating Securities.
    (ii) This paragraph (b)(1) does not give you an additional 
opportunity to cure if you have already had an opportunity to cure your 
Capital Impairment under paragraph (e)(3) of this section.
    (2) Voluntary assignment. You make a voluntary assignment for the 
benefit of creditors.
    (3) Bankruptcy. You begin any bankruptcy or reorganization 
proceeding, receivership, dissolution or other similar creditors' 
rights proceeding, or such action is initiated against you and is not 
dismissed within 60 days.
    (4) Transfer of Control. You violate Sec. 107.475 and/or willfully 
violate Sec. 107.410, and such violation results in a transfer of 
Control. 

[[Page 58576]]

    (5) Fraud. You commit a fraudulent act which causes serious 
detriment to SBA's position as a guarantor or investor.
    (6) Fraudulent transfers. You make any transfer or incur any 
obligation that is fraudulent under the terms of 11 USC 548.
    (c) Contingent Removal Conditions. Upon the occurrence (as 
determined by SBA) of any of the following conditions (``Contingent 
Removal Conditions''), SBA may avail itself of one or more of the 
remedies in paragraph (d) of this section, but only if you fail to 
remove the person(s) SBA identifies as responsible for such occurrence 
and/or cure such occurrence to SBA's satisfaction within a time period 
determined by SBA (but not less than 15 days):
    (1) Willful conflicts of interest. You willfully violate 
Sec. 107.730.
    (2) Willful or repeated noncompliance. You willfully or repeatedly 
violate one or more of the substantive provisions of the Act, 
specifically including but not limited to the provisions summarized in 
section 310(c) of the Act, or any substantive regulation promulgated 
under the Act.
    (3) Failure to comply with restrictions under paragraph (f) of this 
section. You fail to comply with the restrictions imposed by SBA under 
paragraph (f) of this section.
    (d) SBA remedies for Removal Conditions and Contingent Removal 
Conditions. Upon the occurrence (as determined by SBA) of any Removal 
Condition, or any Contingent Removal Condition accompanied by your 
failure to act as set forth in paragraph (c) of this section, SBA has 
the following rights, and you consent to SBA's exercise of any or all 
of such rights:
    (1) With respect to a Corporate Licensee, upon written notice, to 
require you to replace, with individuals approved by SBA, one or more 
of your officers and/or such number of directors as is sufficient to 
constitute a majority of your board of directors; or
    (2) With respect to a Partnership Licensee, upon written notice, to 
require you to remove the person(s) responsible for such occurrence 
and/or to remove your general partner, who shall then be replaced in 
accordance with your Articles by a new general partner approved by SBA; 
and/or
    (3) With respect to either a Corporate or Partnership Licensee, to 
the appointment of SBA or its designee as your receiver under section 
311(c) of the Act for the purpose of continuing your operations. The 
appointment of a receiver to liquidate a Licensee is not within such 
consent, but is governed instead by the relevant provisions of the Act.
    (e) Restricted Operations Conditions. Upon the occurrence (as 
determined by SBA) of any of the following conditions (``Restricted 
Operations Conditions''), SBA may avail itself of any of the remedies 
in paragraph (f) of this section.
    (1) Removal Conditions or Contingent Removal Conditions. Any 
condition occurs which is listed in paragraphs (b) or (c) of this 
section.
    (2) Failure to maintain Regulatory Capital. You fail to maintain 
the minimum Regulatory Capital required by this part.
    (3) Capital or Liquidity Impairment. You have a condition of 
Capital Impairment as determined under Sec. 107.1830 or, if applicable, 
a condition of Liquidity Impairment as determined under Sec. 107.1505, 
and you fail to cure the impairment within time limits set by SBA in 
writing.
    (4) Improper Distributions. You make any Distribution to your 
shareholders or partners other than those permitted by Secs. 107.585 
and 107.1560 through 107.1580.
    (5) Excessive Management Expenses. Without the prior written 
consent of SBA, you incur Management Expenses in excess of those 
permitted under Sec. 107.520.
    (6) Failure to make payment. You fail to pay any amounts due under 
Preferred Securities or required by Secs. 107.1500 through 107.1590, 
unless otherwise permitted by SBA.
    (7) Noncompliance. Except as otherwise provided for in paragraphs 
(c)(1) and (c)(2) of this section, SBA determines that you have failed 
to comply with one or more of the substantive provisions of the Act, 
specifically including but not limited to the provisions summarized in 
section 310(c) of the Act, or any substantive regulation promulgated 
under the Act.
    (8) Failure to maintain diversity. You fail to maintain diversity 
between management and ownership as required by Sec. 107.150, if 
applicable to you.
    (9) Failure to maintain investment ratios. You fail to maintain the 
investment ratios or amounts required for Participating Securities 
(Sec. 107.1500(b)(4)) or Leverage in excess of 300 percent of 
Leverageable Capital (Sec. 107.1160(c)) or Preferred Securities in 
excess of 100 percent of Leverageable Capital (Sec. 107.1160(d)), if 
applicable to you, as of the end of each fiscal year. In determining 
whether you have maintained the ratios or amounts, SBA will disregard 
any prepayment, sale, or disposition of Equity Capital Investments or 
Venture Capital Financings, as appropriate, any increase in 
Leverageable Capital, and any receipt of additional Leverage, within 
120 days prior to the end of your fiscal year.
    (10) Nonperformance. You violate or fail to perform one or more of 
the terms and conditions of any Participating Security or Preferred 
Security or of any agreement with or condition imposed by SBA in its 
administration of the Act and the regulations promulgated thereunder.
    (11) Noncooperation under paragraph (g) of this section. You fail 
to take appropriate steps, satisfactory to SBA, to accomplish such 
action as SBA may have required under paragraph (g) of this section.
    (f) SBA remedies for Restricted Operations Conditions. Upon the 
occurrence of any Restricted Operations Condition, and until such 
condition(s) are cured to SBA's satisfaction within a time period 
determined by SBA (but not less than 15 days), upon written notice SBA 
shall have the following rights, and you consent to SBA's exercise of 
any or all of such rights:
    (1) To prohibit you from making any additional investments except 
for investments under legally binding commitments you entered into 
before such notice and, subject to SBA's prior written approval, 
investments that are necessary to protect your investments;
    (2) Until all Leverage is redeemed and amounts due are paid, to 
prohibit Distributions by you to any party other than SBA, its agent or 
Trustee;
    (3) To require all your commitments from investors to be funded at 
the earliest time(s) permitted in accordance with your Articles; and
    (4) To review and re-determine your approved Management Expenses.
    (g) Repeated non-substantive violations. If you repeatedly fail to 
comply with one or more of the non-substantive provisions of the Act or 
any non-substantive regulation promulgated thereunder, SBA, after 
written notification to you and until such condition is cured to SBA's 
satisfaction, will deny you additional Leverage and/or require you to 
take such actions as SBA may determine to be appropriate under the 
circumstances.

Computation of Licensee's Capital Impairment


Sec. 107.1830  Licensee's Capital Impairment--definition and general 
requirements.

    (a) Applicability of this section. This Sec. 107.1830 applies to 
you if you have any outstanding Leverage issued on or after April 25, 
1994. If you only have outstanding Leverage issued before April 25, 
1994, you must comply with paragraphs (e) and (f) of this section and 
the Capital Impairment regulations in 

[[Page 58577]]
this part in effect when you issued your Leverage.
    (b) Significance of Capital Impairment condition. If you have a 
condition of Capital Impairment, you are not in compliance with the 
terms of your Leverage. As a result, SBA has the right to impose the 
applicable remedies for noncompliance in Secs. 107.1810(g) and 
107.1820(f).
    (c) Definition of Capital Impairment condition. You have a 
condition of Capital Impairment if your Capital Impairment Percentage, 
as computed in Sec. 107.1840, exceeds:
    (1) For Section 301(d) Licensees, 75 percent.
    (2) For Section 301(c) Licensees, the appropriate percentage from 
the following table:

   Maximum Permitted Capital Impairment Percentages for Section 301(c)  
                                Licensees                               
------------------------------------------------------------------------
                                 And your ratio of                      
 If the percentage of equity   outstanding leverage   Then your maximum 
capital investments (at cost)     to leverageable     permitted capital 
    in your portfolio is:       capital percentage        impairment    
                                        is:             percentage is:  
------------------------------------------------------------------------
67...........................  100 or less.........                   70
  Over 100 but not over 200    60..................                     
  Over 200                     50..................                     
At least 40 but under 67.....  100 or less.........                   55
                               Over 100 but not                       50
                                over 200.                               
  Over 200                     40..................                     
Under 40.....................  100 or less.........                   45
 Over 100 but not over 200     40..................                     
  Over 200                     35..................                     
------------------------------------------------------------------------

    (d) Phase-in of maximum permitted Capital Impairment Percentages 
for Section 301(c) Licensees. If you are a Section 301(c) Licensee, 
regardless of your maximum permitted Capital Impairment Percentage 
under paragraph (c) of this section, you will not have a condition of 
Capital Impairment if:
    (1) Your Capital Impairment Percentage does not exceed 50 percent; 
and
    (2) You have not reached your first fiscal year end occurring after 
April 25, 1995.
    (e) Quarterly computation requirement and procedure. You must 
determine whether you have a condition of Capital Impairment as of the 
end of each fiscal quarter. You must notify SBA promptly if you are 
capitally impaired.
    (f) SBA's right to determine Licensee's Capital Impairment 
condition. SBA may make its own determination of your Capital 
Impairment condition at any time.


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

    (a) General. This section contains the procedures you must use to 
determine your Capital Impairment Percentage if you have outstanding 
Leverage issued after April 25, 1994. You must compare your Capital 
Impairment Percentage to the maximum permitted under Sec. 107.1830(c) 
to determine whether you have a condition of Capital Impairment.
    (b) Preliminary impairment test. If you satisfy the preliminary 
impairment test, your Capital Impairment Percentage is zero and you do 
not have to perform any more procedures in this Sec. 107.1840. 
Otherwise, you must continue with paragraph (c) of this section. You 
satisfy the test if the following amounts are both zero or greater:
    (1) The sum of Undistributed Net Realized Earnings, as reported on 
SBA Form 468, and Includible Non-Cash Gains.
    (2) Unrealized Gain (Loss) on Securities Held.
    (c) How to compute your Capital Impairment Percentage. (1) If you 
have an Unrealized Gain on Securities Held, compute your Adjusted 
Unrealized Gain using paragraph (d) of this section. If you have an 
Unrealized Loss on Securities Held, continue with paragraph (c)(2) of 
this section.
    (2) Add together your Undistributed Net Realized Earnings, your 
Includible Non-cash Gains, and either your Unrealized Loss on 
Securities Held or your Adjusted Unrealized Gain.
    (3) If the sum in paragraph (c)(2) of this section is zero or 
greater, your Capital Impairment Percentage is zero.
    (4) If the sum in paragraph (c)(2) of this section is less than 
zero, drop the negative sign, divide by your Regulatory Capital 
(excluding Treasury Stock), and multiply by 100. The result is your 
Capital Impairment Percentage.
    (d) How to compute your Adjusted Unrealized Gain. (1) Subtract 
Unrealized Depreciation from Unrealized Appreciation. This is your 
``Net Appreciation''.
    (2) Determine your Unrealized Appreciation on Publicly Traded and 
Marketable securities. This is your ``Class 1 Appreciation''.
    (3) Determine your Unrealized Appreciation on securities that are 
not Publicly Traded and Marketable and meet the following criteria, 
which must be substantiated to the satisfaction of SBA (this is your 
``Class 2 Appreciation''):
    (i) The Small Business that issued the security received a 
significant subsequent equity financing by an investor whose objectives 
were not primarily strategic and at a price that conclusively supports 
the Unrealized Appreciation;
    (ii) Such financing represents a substantial investment in the form 
of an arm's length transaction by a sophisticated new investor in the 
issuer's securities; and
    (iii) Such financing occurred within 24 months of the date of the 
Capital Impairment computation, or the Small Business' pre-tax cash 
flow from operations for its most recent fiscal year was at least 10 
percent of the Small Business' average contributed capital for such 
fiscal year.
    (4) Perform the appropriate computation from the following table:

          Adjusted Unrealized Gain Before Estimated Tax Effects         
------------------------------------------------------------------------
                                                                        
------------------------------------------------------------------------
If:.........................  And:................  Then Adjusted       
                                                     Unrealized Gain    
                                                     before Taxes is:   
                                                                        
 
[[Page 58578]]
                                                                        
  Class 1 Appreciation  Net Appreciation.     Appreciation +        Appreciation) +  
                                 Class 2               (50% x Class 2   
                                 Appreciation  Net                            
                                 Appreciation.                          
  Class 1 Appreciation  Net Appreciation.     Appreciation +        Appreciation) +  
                                 Class 2               [(50% x Net      
                                 Appreciation >        Appreciation -   
                                 Net Appreciation.     Class 1          
                                                       Appreciation)].  
  Class 1 Appreciation > Net  ....................    80% x Net         
   Appreciation.                                       Appreciation.    
------------------------------------------------------------------------


    (5) Reduce the gain computed in paragraph (d)(4) of this section by 
your estimate of related future income tax expense. Subject to any 
adjustment required by paragraph (d)(6) of this section, the result is 
your Adjusted Unrealized Gain for use in paragraph (c)(2) of this 
section.
    (6) If any securities that are the source of either Class 1 or 
Class 2 Appreciation are pledged or encumbered in any way, you must 
reduce the Adjusted Unrealized Gain computed in paragraph (d)(5) of 
this section by the amount of the related borrowing or other 
obligation.


Sec. 107.1850  Exceptions to Capital Impairment provisions for 
Licensees with outstanding Participating Securities.

    The provisions in this Sec. 107.1850 apply only if at least two-
thirds of your outstanding Leverage consists of Participating 
Securities, and at least two-thirds of your Loans and Investments (at 
cost) consist of Equity Capital Investments.
    (a) Forbearance period for Participating Securities issuers. During 
the first forty-eight (48) months following your first issuance of 
Participating Securities, you will not have a condition of Capital 
Impairment if your Capital Impairment Percentage is below 85 percent.
    (b) Extended forbearance period for early stage investors. If at 
least two-thirds of your Loans and Investments (at cost) are in Start-
Up Financings, the forbearance period in paragraph (a) of this section 
is extended to 60 months.
    (c) Forbearance based on actions by Licensee. The provisions of 
this paragraph (c) apply only during the fifth and sixth years 
following your first issuance of Participating Securities. If your 
Capital Impairment Percentage, as determined either by you or by SBA, 
exceeds the maximum permitted under Sec. 107.1830(c) but is below 85 
percent, you will not have a condition of Capital Impairment if you do 
either of the following within thirty (30) days of such determination:
    (1) Increase your Regulatory Capital by a cash contribution placed 
in an escrow account or other account satisfactory to SBA, for its 
benefit. The contribution must equal, during the fifth year, 15 percent 
of your outstanding Leverage or, during the sixth year, 30 percent.
    (2) Provide a guarantee, satisfactory to SBA and for its benefit, 
for the amount of the cash contribution required in paragraph (c)(1) of 
this section. SBA will credit any escrowed funds or guarantee received 
in the fifth year toward the requirements for the sixth year.
    (d) Conditions for forbearance under paragraph (c) of this section. 
(1) You cannot count any funds placed in an escrow or other account 
under paragraph (c) of this section as Leverageable Capital.
    (2) Any fee and/or any claim to repayment by the party making the 
capital contribution or by the guarantor must be deferred and 
subordinate to all outstanding Leverage plus any unpaid Earned 
Prioritized Payments and earned Adjustments.
    (3) If there is an acceleration or mandatory redemption under 
Sec. 107.1810 or Sec. 107.1820, any funds in the escrow account and/or 
any guarantee received under paragraph (c) of this section will be 
applied toward repaying any amounts due SBA.
    (4) If you reduce your Capital Impairment Percentage to zero, SBA 
will release and return any escrowed funds and/or any guarantee 
received under paragraph (c) of this section.

Subpart K--Ending Operations as a Licensee


Sec. 107.1900  Surrender of license.

    You may not surrender your license without SBA's prior written 
approval. Your request for approval must be accompanied by an offer of 
immediate repayment of all of your outstanding Leverage (including any 
prepayment penalties thereon), or by a plan satisfactory to SBA for the 
orderly liquidation of the Licensee.

Subpart L--Miscellaneous


Sec. 107.1910  Non-waiver of SBA's rights or terms of Leverage 
security.

    SBA's failure to exercise or delay in exercising any right or 
remedy under the Act or the regulations in this part does not 
constitute a waiver of such right or remedy. SBA's failure to require 
you to perform any term or provision of your Leverage does not affect 
SBA's right to enforce such term or provision. Similarly, SBA's waiver 
of, or failure to enforce, any term or provision of your Leverage or of 
any event or condition set forth in Secs. 107.1810 or 107.1820 does not 
constitute a waiver of any succeeding breach of such term or provision 
or condition.


Sec. 107.1920  Licensee's application for exemption from a regulation 
in Part 107.

    You may file an application in writing with SBA to have a proposed 
action exempted from any procedural or substantive requirement, 
restriction, or prohibition to which it is subject under this part, 
unless the provision is mandated by the Act. SBA may grant an exemption 
for such applicant, conditionally or unconditionally, provided the 
exemption would not be contrary to the purposes of the Act. Your 
application must be accompanied by supporting evidence which 
demonstrates to SBA's satisfaction that:
    (a) The proposed action is fair and equitable; and
    (b) The exemption requested is reasonably calculated to advance the 
best interests of the SBIC program in a manner consonant with the 
policy objectives of the Act and regulations.


Sec. 107.1930  Effect of changes in Part 107 on transactions previously 
consummated.

    The legality of a transaction covered by these regulations is 
governed by the regulations in effect at the time the transaction was 
consummated, regardless of later changes. Nothing in this part bars SBA 
enforcement action with respect to any transaction consummated in 
violation of provisions applicable at the time, but no longer in 
effect.

    Dated: November 11, 1995.
Philip Lader,
Administrator.
[FR Doc. 95-28757 Filed 11-27-95; 8:45 am]
BILLING CODE 8025-18-P