[Federal Register Volume 63, Number 24 (Thursday, February 5, 1998)]
[Rules and Regulations]
[Pages 5859-5873]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-2556]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107


Small Business Investment Companies

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: The Small Business Programs Improvement Act of 1996 made a 
number of changes to the Small Business Investment Act of 1958, as 
amended. For the Small Business

[[Page 5860]]

Investment Company program, these changes include provisions affecting 
capital requirements, Leverage eligibility and fees, and the status of 
Section 301(d) Licensees. This final rule implements the statutory 
provisions; in addition, it makes various technical corrections and 
clarifications, as well as other changes to provide greater fairness 
and flexibility in such areas as portfolio diversification 
requirements, Cost of Money and distributions by SBICs that have issued 
Participating Securities.

DATES: This final rule is effective February 5, 1998.

FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division, 
at (202) 205-7583.

SUPPLEMENTARY INFORMATION: On October 14, 1997, SBA published a 
proposed rule to implement the provisions of Title II of Public Law 
104-208 (September 30, 1996), entitled ``The Small Business Programs 
Improvement Act of 1996,'' which relate to small business investment 
companies (SBICs). See 62 FR 53253. The proposed rule also included 
certain other substantive changes, clarifications and technical 
corrections to the regulations governing SBICs, including those 
concerning portfolio diversification, Cost of Money, and the 
computation of distributions to be made by SBICs that have issued 
Participating Securities.
    SBA received 10 comment letters on the proposed rule during the 30-
day public comment period. This final rule includes changes based on 
some of the comments received. In addition, the final rule incorporates 
certain provisions of Public Law 105-135, which was enacted December 2, 
1997.

Section 301(d) Licensees

    Prior to October 1, 1996, an SBIC program applicant could be 
licensed under either section 301(c) or section 301(d) of the Small 
Business Investment Act of 1958, as amended (Act). A Section 301(d) 
Licensee, also known as a ``specialized SBIC'' or ``SSBIC'', agreed to 
invest only in businesses owned and controlled by socially or 
economically disadvantaged individuals. In return, a Section 301(d) 
Licensee received certain benefits not available to other SBICs, such 
as eligibility for certain types of subsidized Leverage (as defined in 
Sec. 107.50).
    Effective October 1, 1996, section 208(b)(3) of Public Law 104-208 
repealed section 301(d) of the Act. However, the repeal provision was 
accompanied by the following language: ``The repeal * * * shall not be 
construed to require the Administrator to cancel, revoke, withdraw, or 
modify any license issued under section 301(d) of the Small Business 
Investment Act of 1958 before the date of enactment of this Act.''
    At the same time, section 208(d) of Public Law 104-208 amended the 
Act to eliminate subsidized SBA Leverage. Such Leverage was previously 
available to SSBICs in the form of Debentures with an interest rate 
subsidy or Preferred Securities with a 4 percent dividend. Although 
subsidized Leverage can no longer be issued, the Act does not require 
SSBICs to prepay or redeem such Leverage prior to its scheduled 
maturity. In addition, an SSBIC may apply for any type of non-
subsidized Leverage (Debentures or Participating Securities) for which 
it is eligible.
    To implement these statutory changes, SBA proposed revisions to the 
definitions of ``Section 301(d) Licensee'' and ``Preferred Securities'' 
found in Sec. 107.50, as well as to Secs. 107.120, 107.230(d)(4), 
107.1100, 107.1160, 107.1400, 107.1420 and 107.1430; Secs. 107.110 and 
107.1110 were proposed to be removed. These sections are finalized with 
one modification, as discussed hereafter.
    SBA received one comment concerning proposed Sec. 107.120. The 
proposed rule would have allowed an existing SSBIC which was licensed 
as a subsidiary of another Licensee or group of Licensees to continue 
its operations under the same conditions as before; however, an 
existing SSBIC that was not already a subsidiary would not have been 
permitted to become one. The commenter suggested that Section 301(d) 
Licensees should continue to have access to this option. Although the 
current provision has rarely been used, SBA has no objection to its 
continued availability and has revised the final rule accordingly.

Common Control

    SBA proposed to broaden a portion of the defined term ``Common 
Control'' in Sec. 107.50. The purpose of the change was to reflect the 
way the term is actually used in the regulations. The definition is 
adopted as proposed.

Management and Ownership Diversity

    Proposed Sec. 107.150 is adopted without change. SBA received one 
comment on this section expressing support for the general requirement 
that a Licensee which plans to obtain SBA Leverage must have diversity 
between management and ownership. Under the revised regulation, the 
investors relied upon to satisfy the diversity requirement cannot be 
Affiliates of one another. In addition, SBA has discretion to reject 
for diversity purposes an investor whose ownership interest is not 
significant, either in terms of absolute dollars or percentage of 
ownership.
    These changes reflect policies which SBA has been developing in its 
review of license applications. SBA is continuing to refine these 
guidelines and expects to incorporate them into its standard operating 
procedures.

Capital Requirements

    Under the Act as amended by section 208(c) of Public Law 104-208, 
SBICs licensed on or after October 1, 1996 must meet increased minimum 
capital requirements. These requirements are implemented in 
Sec. 107.210, which is finalized as proposed. Under this section, a 
company that does not wish to be eligible to issue Participating 
Securities must have Regulatory Capital of at least $5,000,000. As an 
exception to this general rule, the regulation provides that SBA can 
license an applicant with Regulatory Capital of at least $3,000,000, 
but only if the applicant meets certain conditions. As mandated by the 
Act, this exception is limited to those instances where ``special 
circumstances and good cause'' can be shown.
    A company that wishes to be eligible to apply for Participating 
Securities must have Regulatory Capital of at least $10,000,000, with a 
permitted exception for an applicant which demonstrates to SBA's 
satisfaction that it can be financially viable over the long term with 
a lower amount (but under no circumstances less than $5,000,000). The 
regulation does not permit prospective Participating Securities issuers 
to be licensed pursuant to the exception available to other applicants, 
under which a license may be granted with Regulatory Capital as low as 
$3,000,000. For applicants planning to issue Participating Securities, 
SBA believes that the ability to meet the standard minimum capital 
requirement is an important indicator of the credibility of management. 
SBA also doubts that any such applicant can demonstrate financial 
viability with Regulatory Capital of only $3,000,000, even on a 
temporary basis.
    In addition to the Regulatory Capital requirements described above, 
Sec. 107.210(a) also requires any company licensed on or after October 
1, 1996, to have Leverageable Capital of at least $2,500,000. 
Leverageable Capital is a subset of Regulatory Capital; while both 
include capital actually contributed to a Licensee by its private 
investors, the major difference between them is that Regulatory Capital 
also includes the Licensee's unfunded binding

[[Page 5861]]

commitments from Institutional Investors.
    SBICs licensed before October 1, 1996, are not required to increase 
their capital. Under Sec. 107.210(b), such companies must continue to 
meet the applicable minimum capital requirements under the regulations 
in effect on September 30, 1996 (see Secs. 107.210 and 107.220 as in 
effect on that date). These requirements vary depending upon the date a 
company was licensed and the type of SBA Leverage it has issued or 
wants to issue.
    See also the section of this preamble entitled ``Eligibility for 
Leverage and Leverage Commitments''.

Valuations

    Section 208(f)(2) of Public Law 104-208 included one provision 
related to the valuation of portfolio securities held by Licensees 
which was not already reflected in the regulations. Under this 
provision, as part of the annual audit of a Licensee's financial 
statements, the independent auditor must provide to SBA a statement 
that the Licensee's valuations were performed in accordance with its 
SBA-approved valuation policy, as required by section 310(d)(2) of the 
Act. SBA included this requirement in proposed Sec. 107.503(e), which 
is finalized without change.

Reports To Be Filed With SBA

    SBA received one comment on proposed Sec. 107.660(d), which would 
have required a Licensee to notify SBA if an officer, director, general 
partner or other Control Person is charged with or convicted of any 
criminal offense other than a misdemeanor involving a minor motor 
vehicle violation. The purpose of the proposed rule was to give SBA a 
mechanism for updating information typically provided at the time of 
licensing by key personnel associated with a license applicant. The 
commenter pointed out that the broad regulatory definition of ``Control 
Person'' may cause the notification requirement to apply to persons who 
were not required to provide personal history statements to SBA as part 
of the licensing process and who have no direct role in the management 
of the SBIC.
    SBA agrees that the proposed regulation may, under certain 
circumstances, unnecessarily include persons who are not involved in 
the operations of a Licensee. The final rule is modified accordingly, 
so that the notification requirement applies to any officer, director 
or general partner of a Licensee, and any other person who was required 
to provide a personal history statement to SBA in connection with the 
SBIC's license (either at the time of licensing or subsequently, as in 
the case of a new investor who acquires a significant interest in an 
existing SBIC).

Financing of Smaller Enterprises

    Proposed Sec. 107.710 is adopted without change. This section 
includes a provision applicable to SBICs licensed on or before 
September 30, 1996, which issue Leverage after that date and which do 
not meet the current minimum capital requirement (Regulatory Capital of 
at least $5,000,000 for Debentures or at least $10,000,000 for 
Participating Securities). For such Licensees, at least 50 percent of 
the aggregate dollar amount of their Financings extended after 
September 30, 1996 must be invested in Smaller Enterprises.
    Under Sec. 107.710(e), a Licensee which has not achieved the 
required percentage of investments in Smaller Enterprises is allowed 
one additional year to bring its portfolio into compliance. However, 
such a Licensee is not eligible for additional Leverage until it 
reaches the required percentage. See also the section of this preamble 
entitled ``Eligibility for Leverage and Leverage Commitments''.

Passive Businesses

    SBA received five comments on proposed Sec. 107.720(b), which dealt 
with the financing of passive businesses. SBICs are generally 
prohibited from investing in passive businesses, but an exception is 
provided for holding companies which pass through substantially all of 
the financing proceeds to an active subsidiary. The proposed rule would 
have modified the existing exception by allowing a holding company to 
pass through proceeds to more than one operating company, rather than a 
single company, provided that each operating company qualified as a 
``subsidiary'' of the holding company. A subsidiary company was defined 
as one in which the financed passive business owns at least 50 percent 
of the voting securities.
    All of the commenters supported the provision allowing proceeds to 
be passed through a holding company to more than one operating company. 
However, four of the commenters were concerned that the proposed 50 
percent ownership requirement would foreclose another type of 
investment structure which may be important to certain Licensees 
organized as limited partnerships. Specifically, for a partnership with 
tax exempt investors (such as pension funds), direct investment in an 
unincorporated business is considered highly undesirable because of the 
possibility that the tax exempt investors will be deemed to have 
``unrelated business taxable income'' under section 511 of the Internal 
Revenue Code of 1986, as amended. The common solution to this problem 
is for the partnership to form a wholly-owned corporate subsidiary 
which receives funds from its parent and in turn reinvests these funds 
in one or more unincorporated operating companies. If an SBIC creates a 
passive corporation for this purpose, it is likely that the corporation 
would own less than 50 percent of the voting securities of the financed 
Small Business. Therefore, the investment would not qualify for the 
exception in proposed Sec. 107.720(b)(2).
    SBA does not wish to prevent partnership Licensees from investing 
in unincorporated Small Businesses, but it has a number of concerns. 
First, SBA believes that when a Licensee makes an investment in a 
holding company which is unrelated to the Licensee and is, in fact, a 
portfolio company, the requirement that proceeds be passed through only 
to 50 percent-owned subsidiaries should remain. This provision ensures 
that there is a significant relationship between the financed passive 
business and the active businesses which ultimately receive the 
proceeds, and that the passive business is not functioning simply as a 
reinvestor.
    Second, SBA believes that there may be significant credit risks 
associated with the formation of corporate subsidiaries by SBICs. For 
example, Licensees are prohibited by law from filing for bankruptcy 
protection, providing SBA with an important safeguard in its effort to 
manage the government's financial risk. However, when a Licensee holds 
assets through a subsidiary, the possibility arises that these assets 
can be shielded through a bankruptcy filing by the subsidiary.
    To accommodate the Agency's concerns as well as those of certain 
Licensees, SBA is finalizing Sec. 107.720 as follows: The exception in 
proposed Sec. 107.720(b)(2) is adopted without change, and a further 
exception is added in a new paragraph (b)(3). Under this new provision, 
a partnership Licensee may form one or more wholly-owned corporations 
with SBA's prior written approval. Such corporations must be formed for 
the sole purpose of providing Financing to one or more eligible, 
unincorporated Small Businesses. The formation of such corporations is 
limited to situations in which a direct investment in the Small 
Business would cause one or more of the Licensee's investors to have 
unrelated business taxable income. The regulation resolves

[[Page 5862]]

potential contradictions within part 107 by specifying that ownership 
of such a corporation does not violate the limitations on Control in 
Sec. 107.865(a) or the conflict of interest prohibitions in 
Sec. 107.730(a).
    SBA wishes to emphasize that the requirement for prior written 
approval to form a subsidiary is consistent with longstanding practice 
within the SBIC program. SBA's concern in this regard relates not only 
to credit risks associated with the shift of assets from a Licensee to 
its subsidiaries, but also to the purpose for which a subsidiary is 
formed and whether its proposed function is consistent with the purpose 
of an SBIC as set forth in the Act.

Co-Investment With Associates

    SBA received two comments in support of proposed 
Sec. 107.730(d)(3)(iv), which is finalized without change. Under this 
provision, co-investments by a non-leveraged SBIC and its non-SBIC 
Associate are presumed to be fair and equitable to the SBIC, so that no 
specific demonstration of equity is required.

Portfolio Diversification Requirements (``Overline'' Limit)

    SBA received four comments on proposed Sec. 107.740, under which a 
leveraged SBIC may not have more than 20 percent of its Regulatory 
Capital invested in or committed to a single Small Business or group of 
related businesses, unless SBA gives its prior written approval (for 
SSBICs, the limit is 30 percent of Regulatory Capital). The proposed 
rule was intended to address a problem faced by an SBIC which reduces 
its Regulatory Capital in a manner permitted by the regulations (such 
as when a Participating Securities issuer returns capital to its 
investors), and then finds that one or more of its existing investments 
now exceed its reduced overline limitation. SBA's proposed solution was 
to base a Licensee's maximum permitted investment in or commitment to a 
Small Business on its Regulatory Capital at the time the investment or 
commitment is made.
    All of the commenters supported this change, but suggested that SBA 
go further. One commenter felt that an SBIC should have the ability to 
make follow-on investments in a Small Business based on the Licensee's 
Regulatory Capital at the time the initial investment was made. The 
other commenters argued more broadly that an SBIC, particularly a 
limited life partnership which expects to return capital to investors 
as investments are harvested, should be permitted to base its overline 
limit on its initial Regulatory Capital (assuming no further 
increases), with no reduction for any subsequent decreases in 
Regulatory Capital. The commenters all suggested that an SBIC should 
not be forced to reduce the intended investment size reflected in its 
business plan because of an early return of capital; one commenter 
pointed out that this imposes a penalty which is particularly 
unjustified in the case of an SBIC which makes a distribution resulting 
from a profitable realization of a portfolio company investment.
    SBA understands these concerns, particularly with respect to an 
SBIC organized as a limited life partnership which does not reinvest 
capital. However, SBA believes that the suggested changes are 
prohibited by section 306(a) of the Act. Therefore, the proposed rule 
is finalized without change.

Cost of Money

    SBA proposed three revisions to Sec. 107.855, which sets forth 
limits on interest rates and other charges that SBICs may impose on 
Small Businesses, generally referred to as ``Cost of Money''. These 
provisions are finalized as proposed. Two of the changes dealt with the 
computation of the Cost of Money ceiling, mainly the circumstances 
under which Licensees may include in the computation the 1 percent 
additional charge on Leverage which is payable to SBA. The other change 
involved the treatment of detachable stock purchase warrants.
    The four comments received on this section all strongly supported 
proposed Sec. 107.855(g)(1), which contained an exclusion from Cost of 
Money for a discount on the loan portion of a Debt Security, if the 
discount results solely from the allocation of fair value to detachable 
stock purchase warrants as required by generally accepted accounting 
principles. One commenter suggested that the exclusion be extended to 
any discount resulting from the allocation of fair value to an equity 
feature of a Debt Security, without regard to whether the equity 
feature was in the form of a warrant, common stock or other equity 
equivalent. SBA did not expand the proposed language because it has not 
encountered this type of Cost of Money issue with equity features other 
than warrants; if such an issue arises in the future, the Agency will 
consider whether further change is desirable.

Control

    Proposed Sec. 107.865 contained two clarifications to the existing 
regulation concerning Control of a Small Business by an SBIC, which are 
finalized without change. SBA received one comment concerning proposed 
Sec. 107.865(c), which set forth the circumstances under which a 
Licensee can rebut a presumption of Control. The comment did not 
specifically relate to the proposed change, which was merely an 
editorial clarification. It concerned the interpretation of the 
rebuttal condition in Sec. 107.865(c)(2) which states, in part, that 
``[m]anagement of the Small Business can elect at least 40 percent 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.''
    The commenter provided the following scenario: There are five seats 
on the Small Business's board of directors, three to be filled by 
management and two by the Investor Group. One of the seats controlled 
by management is vacant, so the actual board composition represents a 
50-50 split between management and the Investor Group. The commenter 
suggested that these circumstances satisfy the rebuttal condition in 
Sec. 107.865(c)(2) because management can fill three of the five board 
seats (60 percent), while the Investor Group can fill the remaining two 
(40 percent). The vacant seat should not affect the rebuttal, because 
the management of the Small Business can exercise its right to fill the 
seat and assert control of the board at any time. As long as there are 
no restrictions on management's ability to do so, SBA agrees with this 
interpretation of the regulation and does not believe that any further 
clarification is needed.

Eligibility for Leverage and Leverage Commitments

    Section 208 of Public Law 104-208 established certain requirements 
which an SBIC must satisfy in order to obtain SBA Leverage. These 
requirements are implemented by Sec. 107.1120 (c) and (d), which are 
adopted without change from the proposed rule. Under these provisions, 
an SBIC licensed after September 30, 1996, with Regulatory Capital of 
less than $5,000,000 is ineligible for Leverage until it reaches the 
$5,000,000 level. An SBIC licensed on or before September 30, 1996, is 
not required to increase its capital in order to obtain additional 
Leverage; however, if its Regulatory Capital is less than $5,000,000 
($10,000,000 for a company seeking to issue Participating Securities), 
it must certify in writing that at least 50 percent of the aggregate 
dollar amount of its Financings

[[Page 5863]]

extended after September 30, 1996 will be provided to Smaller 
Enterprises (see also Sec. 107.710(c)). Finally, any Licensee seeking 
Leverage must certify in writing that it is in compliance with the 
general requirement to provide 20 percent of its total Financings to 
Smaller Enterprises under Sec. 107.710(b).
    SBA is also finalizing without change the revisions proposed in 
Secs. 107.1200, 107.1230 and 107.1240 to eliminate unnecessary 
limitations on the amounts of Leverage commitments and draws and to 
facilitate the interim Leverage funding mechanism which SBA is now 
developing.

Leverage Fees

    SBA proposed changes in Secs. 107.1130 and 107.1210 to implement 
provisions of section 208(d)(6) of Public Law 104-208 which affect the 
fees SBICs must pay in order to obtain SBA Leverage. Proposed 
Sec. 107.1130 is adopted without change; however, Sec. 107.1210 has 
been revised as a result of legislation enacted after publication of 
the proposed rule.
    Under Sec. 107.1130(a), a Licensee must pay a nonrefundable 
``leverage fee'' to SBA when Debentures or Participating Securities are 
issued. The fee is 3 percent of the face amount of the Leverage issued, 
replacing the 2 percent user fee and the 1 percent commitment fee 
previously in effect. Section 107.1130(d) requires a Licensee to pay to 
SBA an additional ``Charge'' on Debentures and Participating Securities 
(see also Sec. 107.50 for the definition of this new term). For both 
types of Leverage, the Charge is 1 percent per annum. The Charge is 
payable under the same terms and conditions as the interest on 
Debentures or the Prioritized Payments on Participating Securities, as 
applicable. Thus, a Debenture issuer would pay the Charge in two semi-
annual installments together with its interest payments. In contrast, a 
Participating Securities issuer would pay the Charge only when it had 
profits and was distributing Prioritized Payments under Sec. 107.1540. 
The Charge does not apply to Leverage drawn down against a commitment 
obtained from SBA on or before September 30, 1996.
    Under proposed Sec. 107.1210(a), if a Licensee received a Leverage 
commitment from SBA, it would have been required to prepay the 3 
percent leverage fee at the time it received the commitment. However, 
section 215(d) of Public Law 105-135, enacted December 2, 1997, 
dividend payment of the leverage fee into two stages for Licensees 
which receive a Leverage commitment: A nonrefundable fee equal to 1 
percent of the committed amount must be paid when the commitment is 
received, and 2 percent of the amount of each draw must be paid when 
funds are drawn down. To implement this statutory mandate, the final 
rule is modified accordingly.

Participating Securities--General

    Proposed Sec. 107.1500 is adopted without change. This section 
contains clarifications and minor revisions concerning the redemption 
and priority in liquidation of Participating Securities, and eliminates 
the requirement for a Licensee to maintain a specified level of Equity 
Capital Investments.

Liquidity Requirements for Participating Securities

    The proposed rule included two minor changes to the liquidity 
requirements in Sec. 107.1505. The section is finalized as proposed. 
SBA received two comments in support of the revised computation of the 
liquidity ratio in Sec. 107.1505(b). Both commenters stated that the 
change in the weighting of publicly traded securities will simplify the 
computation and also will eliminate the ``double discounting'' of such 
securities.

Earmarked Profit (Loss)

    Section 107.1510 is adopted as proposed. This section contains 
minor technical revisions intended to simplify the computation of 
Earmarked Profit (Loss) by Participating Securities issuers.

Prioritized Payments

    Section 107.1520 tells a Licensee how to compute Prioritized 
Payments and how to determine whether it has profits which will cause 
Prioritized Payments to become ``earned'' and therefore payable to SBA. 
Four revisions to this section were proposed and are adopted without 
change.
    First, the regulation implements a provision of Public Law 104-208 
by including ``Charges'' (the 1 percent annual fee discussed in this 
preamble under the heading ``Leverage Fees'') on outstanding 
Participating Securities in the required computations. Although Charges 
are not part of Prioritized Payments, they are payable under the same 
terms and conditions.
    Second, Sec. 107.1520(a) incorporates a technical change intended 
to facilitate the interim Leverage funding mechanism currently under 
consideration by SBA.
    Third, the computation of profit for the purposes of Sec. 107.1520 
is revised under Sec. 107.1520(d). Under the previous regulation, a 
Licensee's ``profit'' was its cumulative Earmarked Profit minus its 
cumulative Earned Prioritized Payments from prior periods. This 
computation ignored the fact that some or all of the profit computed in 
this manner may have already been distributed under other sections of 
the regulations, either to SBA as Profit Participation or to the 
Licensee's private investors. The revised rule takes prior profit 
distributions into account in determining whether a Licensee has 
profits which can be used to pay Prioritized Payments. SBA received two 
comments in support of this change.
    Finally, Sec. 107.1520(f) provides additional detail concerning the 
computation of Adjustments, a type of compounding of unpaid Prioritized 
Payments.

Profit Participation

    Section 107.1530 is adopted as proposed. SBA received two comments 
in support of the proposed regulation. The section contains several 
changes affecting the computation of Profit Participation, which must 
be allocated to SBA by a Participating Securities issuer when it has 
earned profits over and above the amount necessary to pay its 
Prioritized Payments in full. Profit Participation is determined by 
computing a ``Base'' and a ``Profit Participation Rate'', and 
multiplying the Base by the Rate. The rule revises the computation of 
the Base with respect to certain losses incurred by a Licensee in prior 
periods and provides a simpler method of computing the ``PLC ratio'', 
which is one of the variables in the Profit Participation Rate formula. 
The rationale for these changes is discussed in detail in the preamble 
to the proposed rule.

Tax Distributions

    Proposed Sec. 107.1550, which dealt with tax distributions by 
Participating Securities issuers organized as limited partnerships or 
similar flow-through entities, is adopted as final with one 
modification. The proposed changes consisted of clarifications and a 
minor technical revision, as discussed in the preamble to the proposed 
rule. In the final rule, SBA is incorporating one additional change to 
correct an error in Sec. 107.1550(c)(3). The previous regulation stated 
that SBA would apply its share of any tax distribution to the Profit 
Participation owed by a Licensee under Sec. 107.1530. However, there 
are certain circumstances under which SBA's share of a tax distribution 
may exceed the Profit Participation owed. In such cases, SBA will apply 
its share first to any Profit Participation, and then generally as a 
redemption of Participating Securities in order of issue

[[Page 5864]]

(in rare cases, a Licensee may owe other amounts which will be 
considered in the application of the distribution). The final rule 
incorporates this correction by indicating that SBA will apply its 
share of tax distributions in the same order specified for other 
profit-based distributions in Sec. 107.1560(g).

Distributions Based on ``Retained Earnings Available for 
Distribution''

    SBA proposed minor revisions in Sec. 107.1560(a)(1), (a)(4), (b) 
and (e) which are finalized without change. These provisions clarify 
various aspects of the calculation of distributions by Participating 
Securities issuers who have Retained Earnings Available for 
Distribution remaining after paying Prioritized Payments and tax 
distributions.

Optional Distributions Not Based on READ

    Proposed Sec. 107.1570(b) is adopted without change. SBA received 
two comments in support of the proposed section, which dealt with 
conditions under which a Licensee which has no Retained Earnings 
Available for Distribution can make optional distributions to its 
private investors and SBA. Both commenters agreed with SBA that the 
change in Sec. 107.1570(b)(1)(ii) removes an unintended limitation on 
Licensees' ability to make such distributions.

Notice of Participating Securities Distributions

    The proposed rule included a prior notice requirement for all 
distributions by SBICs which have issued Participating Securities. SBA 
is finalizing as proposed the language establishing this requirement in 
Secs. 107.1540 through 107.1570, which govern the various types of 
distributions. A Licensee must notify SBA 10 business days before any 
planned distribution, unless the Agency permits otherwise. SBA received 
one comment agreeing that such notification is appropriate given the 
complexity of the distribution rules. The commenter did not believe 
that the requirement would unreasonably constrain a Licensee's freedom 
of action.

Timing of Participating Securities Distributions

    Section 107.1575 is adopted as proposed. SBA received three 
comments on the proposed rule, all of which supported the additional 
flexibility given to Participating Securities issuers wishing to make 
distributions on dates other than the established quarterly ``Payment 
Dates'' (February 1, May 1, August 1 and November 1 of each year).
    All of the commenters raised one issue which may arise when a 
Licensee makes a distribution to SBA which includes a redemption of 
Participating Securities. The proposed rule specified that in such 
cases, the effective date of the redemption would be the next Payment 
Date following the distribution date; therefore, a Licensee would be 
responsible for Prioritized Payments through the next Payment Date on 
the amount of Participating Securities to be redeemed. SBA felt this 
provision was necessary because Participating Securities are funded 
through the purchase by investors of Trust Certificates, under which 
principal can be returned only on Payment Dates.
    The commenters understood why SBA must continue to ``charge'' the 
Prioritized Payment on Participating Securities up to the next Payment 
Date, but asked whether SBA could provide a mechanism (such as an 
escrow provision) which would allow a Licensee to earn interest on any 
redemption payment that it distributes to SBA, from the date of 
distribution until the next Payment Date. SBA is sympathetic to this 
request and believes that the result would be fair both to Licensees 
and to the Agency. To facilitate such an arrangement, SBA is exploring 
the possibility of allowing SBICs to establish individual escrow 
accounts at a designated financial institution to hold the proceeds of 
distributions made on dates other than Payment Dates. The accounts 
would be for the benefit of SBA, but any interest income would inure to 
the benefit of the Licensee. Each SBIC would be responsible for any 
expenses incurred in establishing and maintaining its account. The use 
of an escrow account would be an option available to SBICs, but would 
not be required. SBA does not believe that such an arrangement requires 
a change in the regulations. SBA will provide further information to 
Licensees as soon as possible.

In-Kind Distributions by Licensees

    SBA received three comments on proposed Sec. 107.1580. The section 
sets forth the conditions under which a Participating Securities issuer 
can make distributions in the form of securities rather than cash. All 
of the commenters supported the proposed revision permitting a Licensee 
to pay Prioritized Payments under Sec. 107.1540 via an in-kind 
distribution. Two of the commenters suggested that SBA also consider 
allowing SBICs to make tax distributions under Sec. 107.1550 in the 
form of securities. SBA feels strongly that tax distributions should be 
made on a cash-only basis. As stated in the preamble to the proposed 
rule, the intent of such distributions is to provide investors in flow-
through entities with sufficient cash to pay their anticipated tax 
liabilities, and an in-kind distribution does not satisfy this purpose. 
Therefore, the proposed rule is finalized without change.

Exchange of Debentures for Participating Securities

    Proposed Secs. 107.1585 and 107.1590 are finalized without change. 
In these sections, references to the retirement of Debentures through 
the issuance of Preferred Securities are eliminated, and provisions 
governing the retirement of Debentures through the issuance of 
Participating Securities are reorganized and reworded without 
substantive change.

Characteristics of SBA's Leverage Guarantee

    Section 107.1720 is adopted as proposed. The section restores 
language setting forth the unconditional nature and other 
characteristics of SBA's guarantee which was inadvertently dropped in a 
previous regulatory revision.

Capital Impairment

    Proposed Sec. 107.1830(a) is finalized without change. The 
provision clarifies that SBA Leverage is subject to the Capital 
Impairment regulations in effect on the date the Leverage is issued. In 
addition, it requires a Licensee to comply with any specific conditions 
to which it has agreed by contract with SBA.

Miscellaneous Corrections and Editorial Changes

    The proposed definition of ``Commitment'' in Sec. 107.50 is 
finalized without change. The definition is reworded in the third 
person (i.e., to refer to ``a Licensee'' instead of ``you'') to conform 
to the style in which the other definitions are written.
    The proposed correction of the SIC code for Operative Builders in 
Sec. 107.720(c) is adopted as final.
    Proposed Sec. 107.1600(a) is adopted as final. Under this 
provision, references to section 321 of the Act are changed to section 
319, reflecting the amendment of the Act by Public Law 104-208. In 
addition, to implement section 215(e) of Public Law 105-135, 
Sec. 107.1600(b) is revised to state that SBA will issue guarantees of 
Leverage and of Trust Certificates at intervals of not more than six 
months, rather than three months.

[[Page 5865]]

    The proposed definition of Trust Certificate Rate is adopted as 
final. The definition incorporates certain technical changes to 
facilitate the interim funding mechanism currently under consideration 
by SBA.

Limited Liability Companies

    Section 208(b)(1) of Public Law 104-208 amended the Act to permit 
SBICs to organize as limited liability companies (LLCs). SBA is 
studying the legal and administrative issues which may arise in 
connection with LLCs, and will publish a proposed rule to implement 
this form of organization by SBICs at a later date.
    Although SBA regulations do not yet provide for LLC Licensees, SBA 
has the statutory authority to license such companies. SBA's current 
policy is to accept a license application from an LLC only if the LLC 
is organized under Delaware's Limited Liability Company Act and does 
not intend to issue Participating Securities, which SBA has not yet 
developed in a form suitable for use by an LLC. SBA may reconsider 
these limitations as SBA acquires greater familiarity with the LLC form 
of organization and as a body of case law is created under the various 
state LLC laws. The adoption of a Uniform LLC Act by a significant 
number of states also would induce SBA to reexamine its current 
preference for Delaware law.
    Until SBA regulations are revised to accommodate LLC Licensees, 
such Licensees should understand that SBA regards the members of the 
LLC to be equivalent to the general partners in a partnership Licensee 
unless the LLC's operating agreement clearly indicates otherwise. Thus, 
all members of an LLC Licensee will automatically be considered Control 
Persons and Associates of the Licensee unless the LLC's operating 
agreement vests management authority only in certain members of the 
company.

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 final rule will not be a significant 
regulatory action for purposes of Executive Order 12866 because it will 
not have an annual effect on the economy of more than $100 million, and 
that it will 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 purpose of the rule is to 
implement provisions of Public Law 104-208 which relate to small 
business investment companies, and to make certain other changes, 
primarily technical corrections and clarifications, to the regulations 
governing SBICs.
    For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA 
certifies that this final rule will contain no new reporting or 
recordkeeping requirements.
    For purposes of Executive Order 12612, SBA certifies that this 
final rule will not have any federalism implications warranting the 
preparation of a Federalism Assessment.
    For purposes of Executive Order 12778, SBA certifies that this 
final rule is drafted, to the extent practicable, in accordance with 
the standards set forth in Section 2 of that Order.

List of Subjects in 13 CFR Part 107

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

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

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

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

    Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g 
and 687m.

    2. Section 107.50 is amended by revising the definitions for 
Commitment, Common Control, Preferred Securities, Section 301(d) 
Licensee, and Trust Certificate Rate, and adding in alphabetical order 
a definition of Charge, to read as follows:


Sec. 107.50  Definitions of terms.

* * * * *
    Charge means an annual fee on Leverage issued on or after October 
1, 1996 (except for Leverage issued pursuant to a commitment made by 
SBA before October 1, 1996), which is payable to SBA by Licensees, 
subject to the terms and conditions set forth in Sec. 107.1130(d).
* * * * *
    Commitment means a written agreement between a Licensee and an 
eligible Small Business that obligates the Licensee 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. The agreement may 
include reasonable conditions precedent to the Licensee's obligation to 
fund the commitment, but these conditions must be outside the 
Licensee's control.
    Common Control means a condition where two or more Persons, 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.
* * * * *
    Preferred Securities means nonvoting preferred stock or nonvoting 
limited partnership interests issued to SBA prior to October 1, 1996, 
by a Section 301(d) Licensee. Such securities were issued at par value 
in the case of preferred stock, or at face value in the case of 
preferred limited partnership interests.
* * * * *
    Section 301(d) Licensee means a company licensed prior to October 
1, 1996 under section 301(d) of the Act as in effect on the date of 
licensing, that may provide Assistance only to Disadvantaged 
Businesses. A Section 301(d) Licensee may be organized as a for-profit 
corporation, as a non-profit corporation, or as a limited partnership.
* * * * *
    Trust Certificate Rate means a fixed rate determined by the 
Secretary of the Treasury at the time Participating Securities or 
Debentures are pooled, 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.
* * * * *


Sec. 107.110  [Removed]

    3. Section 107.110 is removed.
    4. Section 107.120 is revised to read as follows:


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

    With SBA's prior written approval, a Section 301(d) Licensee may 
operate as the subsidiary of one or more Licensees (participant 
Licensees), subject to the following:

[[Page 5866]]

    (a) Each participant Licensee must own at least 20 percent of the 
voting securities of the Section 301(d) Licensee.
    (b) A participant Licensee must treat its entire capital 
contribution to the subsidiary as a reduction of its Leverageable 
Capital. The participant Licensee's remaining Leverageable Capital must 
be sufficient to support its outstanding Leverage.
    (c) A participant Licensee may not transfer its Leverage to a 
subsidiary Section 301(d) Licensee.
    5. In Sec. 107.150, the introductory text of paragraph (a)(1) is 
revised to read as follows:


Sec. 107.150  Management and ownership diversity requirement.

* * * * *
    (a) Requirement one. * * *
    (1) At least 30 percent of your Regulatory Capital and Leverageable 
Capital must be owned by Persons unrelated to management. To satisfy 
this requirement, such Persons must not be your Associates (except for 
their status as your shareholders or limited partners) and must not 
Control, be Controlled by, or be under Common Control with any of your 
Associates. You must have as investors at least three such Persons who 
are not Affiliates of one another and whose investments are significant 
in both dollar and percentage terms, as determined by SBA. As an 
alternative, you may substitute one investor who is an acceptable 
Institutional Investor for the three investors who are otherwise 
required. For purposes of this paragraph (a)(1), the following 
Institutional Investors are acceptable:
* * * * *
    6. Section 107.210 is revised to read as follows:


Sec. 107.210  Minimum capital requirements for Licensees.

    (a) Companies licensed on or after October 1, 1996. A company 
licensed on or after October 1, 1996 must have Leverageable Capital of 
at least $2,500,000 and must meet the applicable minimum Regulatory 
Capital requirement:
    (1) Licensees other than Participating Securities issuers. A 
Licensee that does not wish to be eligible to apply for Participating 
Securities must have Regulatory Capital of at least $5,000,000. As an 
exception to this general rule, SBA in its sole discretion and based on 
a showing of special circumstances and good cause may license an 
applicant with Regulatory Capital of at least $3,000,000, but only if 
the applicant:
    (i) Has satisfied all licensing standards and requirements except 
the minimum capital requirement, as determined solely by SBA;
    (ii) Has a viable business plan reasonably projecting profitable 
operations; and
    (iii) Has a reasonable timetable for achieving Regulatory Capital 
of at least $5,000,000.
    (2) Participating Securities issuers. A Licensee that wishes to be 
eligible to apply for Participating Securities must have Regulatory 
Capital of at least $10,000,000, unless it demonstrates to SBA's 
satisfaction that it can be financially viable over the long term with 
a lower amount. Under no circumstances can the Licensee have Regulatory 
Capital of less than $5,000,000.
    (b) Companies licensed before October 1, 1996. A company licensed 
before October 1, 1996 must meet the minimum capital requirements 
applicable to such company, as required by the regulations in effect on 
September 30, 1996. See Sec. 107.1120(c)(2) for Leverage eligibility 
requirements.


Sec. 107.220  [Removed]

    7. Section 107.220 is removed.
    8. Section 107.230 is amended by revising the introductory text of 
paragraph (d)(4) to read as follows:


Sec. 107.230  Permitted sources of Private Capital for Licensees.

* * * * *
    (d) Qualified Non-private Funds. * * *
    (4) Funds invested in or committed in writing to any Section 301(d) 
Licensee prior to October 1, 1996, from the following sources:
* * * * *
    9. In Sec. 107.503, paragraphs (a), (b) and (e), and the heading 
and first sentence of paragraph (c), are revised to read as follows:


Sec. 107.503  Licensee's adoption of an approved valuation policy.

    (a) Valuation guidelines. You must prepare, document and report the 
valuations of your Loans and Investments in accordance with the 
Valuation Guidelines for SBICs issued by SBA. These guidelines may be 
obtained from SBA's Investment Division.
    (b) SBA approval of valuation policy. You must have a written 
valuation policy approved by SBA for use in determining the value of 
your Loans and Investments. You must either:
    (1) Adopt without change the model valuation policy set forth in 
section III of the Valuation Guidelines for SBICs; or
    (2) Obtain SBA's prior written approval of an alternative valuation 
policy.
    (c) Responsibility for valuations. Your board of directors or 
general partner(s) 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. * * *
* * * * *
    (e) Review of valuations by independent public accountant. (1) For 
valuations performed as of the end of your fiscal year, your 
independent public accountant must review your valuation procedures and 
the implementation of such procedures, including adequacy of 
documentation.
    (2) The independent public accountant's report on your audited 
annual financial statements (SBA Form 468) must include a statement 
that your valuations were prepared in accordance with your approved 
valuation policy established in accordance with section 310(d)(2) of 
the Act.
    10. Section 107.660 is amended by redesignating paragraph (d) as 
paragraph (e) and by adding a new paragraph (d) to read as follows:


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

* * * * *
    (d) Notification of criminal charges. If any officer, director, or 
general partner of the Licensee, or any other person who was required 
by SBA to complete a personal history statement in connection with your 
license, is charged with or convicted of any criminal offense other 
than a misdemeanor involving a minor motor vehicle violation, you must 
report the incident to SBA within 5 calendar days. Such report must 
fully describe the facts which pertain to the incident.
* * * * *
    11. Section 107.710 is amended by adding a sentence at the end of 
paragraph (e) and by revising paragraphs (b) and (c) to read as 
follows:


Sec. 107.710  Requirement to Finance Smaller Enterprises.

* * * * *
    (b) Smaller Enterprise Financings.--(1) General rule. At the close 
of each of your 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 Enterprises. If you were licensed after April 
25, 1994, the 20 percent requirement applies to the total dollar amount 
of the Financings you

[[Page 5867]]

extended since you were licensed plus any pre-licensing investments 
approved by SBA for inclusion in your Regulatory Capital.
    (2) Phase-in for new Licensees. At the close of your first full 
fiscal year after licensing, at least 10 percent of the total dollar 
amount of the Financings you extended, including any pre-licensing 
investments approved by SBA for inclusion in your Regulatory Capital, 
must have been invested in Smaller Enterprises. At the close of each 
fiscal year thereafter, you must meet the requirement in paragraph 
(b)(1) of this section.
    (c) Special requirement for certain leveraged Licensees.--(1) This 
paragraph (c) applies if you were licensed on or before September 30, 
1996, and you issued Leverage after that date, and you have Regulatory 
Capital of:
    (i) Less than $10,000,000 if such Leverage was Participating 
Securities; or
    (ii) Less than $5,000,000 if such Leverage was Debentures.
    (2) At the close of each of your fiscal years, at least 50 percent 
of the total dollar amount of the Financings you extended after 
September 30, 1996 must have been invested in Smaller Enterprises.
* * * * *
    (e) Non-compliance with this section. * * * However, you will not 
be eligible for additional Leverage until you reach the required 
percentage (see Sec. 107.1120(c) and (d)).
    12. In Sec. 107.720, paragraph (b)(2) is revised, paragraph (b)(3) 
is added, and the introductory text of paragraph (c)(1) is revised to 
read as follows:


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

* * * * *
    (b) Passive Businesses. * * *
    (2) Exception for pass-through of proceeds to subsidiary. You may 
finance a passive business if it is a Small Business and it passes 
substantially all the proceeds through to one or more subsidiary 
companies, each of which is an eligible Small Business that is not 
passive. For the purpose of this paragraph (b)(2), ``subsidiary 
company'' means a company in which at least 50 percent of the 
outstanding voting securities are owned by the Financed passive 
business.
    (3) Exception for certain Partnership Licensees. With the prior 
written approval of SBA, if you are a Partnership Licensee, you may 
form one or more wholly-owned corporations in accordance with this 
paragraph (b)(3). The sole purpose of such corporation(s) must be to 
provide Financing to one or more eligible, unincorporated Small 
Businesses. You may form such corporation(s) only if a direct Financing 
to such Small Businesses would cause any of your investors to incur 
unrelated business taxable income under section 511 of the Internal 
Revenue Code of 1986, as amended (26 U.S.C. 511). Your ownership of 
such corporation(s) will not constitute a violation of Sec. 107.865(a) 
and your investment of funds in such corporation(s) will not constitute 
a violation of Sec. 107.730(a).
    (c) Real Estate Businesses. (1) You are not permitted to finance 
any business classified under Major Group 65 (Real Estate) or Industry 
No. 1531 (Operative Builders) of the SIC Manual, with the following 
exceptions:
* * * * *
    13. In Sec. 107.730, paragraph (d)(3)(iv) is revised to read as 
follows:


Sec. 107.730  Financings which constitute conflicts of interest.

* * * * *
    (d) Financings with Associates. * * *
    (3) Exceptions to paragraphs (d)(1) and (d)(2) of this section. * * 
*
    (iv) Both you and your Associate are non-leveraged Licensees, or 
you are a non-leveraged Licensee and your Associate is not a Licensee.
* * * * *
    14. In Sec. 107.740, paragraph (a) is revised to read as follows:


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, you may provide Financing or a Commitment to a Small 
Business only if the resulting amount of your aggregate outstanding 
Financings and Commitments to such Small Business and its Affiliates 
does not exceed:
    (1) 20 percent of your Regulatory Capital as of the date of the 
Financing or Commitment if you are a Section 301(c) Licensee; or
    (2) 30 percent of your Regulatory Capital as of the date of the 
Financing or Commitment if you are a Section 301(d) Licensee.
* * * * *
    15. Section 107.855 is amended by revising paragraphs (c)(1), 
(c)(4)(i) and (d)(4), redesignating paragraphs (g)(1) through (g)(10) 
as paragraphs (g)(2) through (g)(11), and adding a new paragraph (g)(1) 
to read as follows:


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

* * * * *
    (c) How to determine the Cost of Money ceiling for a Financing. * * 
*
    (1) Choose a base rate for your Cost of Money computation. The base 
rate may be either the Debenture Rate currently in effect plus the 
applicable Charge determined under Sec. 107.1130(d)(1), or your own 
``Cost of Capital'' as determined under paragraph (d) of this section.
* * * * *
    (4) * * *
    (i) The current Debenture Rate plus the applicable Charge 
determined under Sec. 107.1130(d)(1);
* * * * *
    (d) How to determine your Cost of Capital. * * *
    (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. 
For the purposes of this paragraph (d)(4):
    (i) Interest expense on Debentures includes the 1 percent Charge 
paid by a Licensee under Sec. 107.1130(d)(1); and
    (ii) Section 301(d) Licensees with outstanding subsidized 
Debentures are presumed to have paid interest at the rate stated on the 
face of such Debentures, without regard to any subsidy paid by SBA.
* * * * *
    (g) Charges excluded from the Cost of Money. * * *
    (1) Discount on the loan portion of a Debt Security, if such 
discount exists solely as the result of the allocation of value to 
detachable stock purchase warrants in accordance with generally 
accepted accounting principles.
* * * * *
    16. In Sec. 107.865, the first sentence of paragraph (c)(2) and 
paragraph (d)(1) are revised to read as follows:


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

* * * * *
    (c) Rebuttals to presumption of Control. * * *
    (2) The management of the Small Business can elect at least 40 
percent 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. 
* * *
* * * * *
    (d) Temporary Control permitted. * * *
    (1) Where reasonably necessary for the protection of your existing 
investment;
* * * * *

[[Page 5868]]

    17. Section 107.1100 is revised to read as follows:


Sec. 107.1100  Types of Leverage and application forms.

    (a) Types of Leverageable available. 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) Application forms. Use SBA Form 1022 to apply for Debentures 
and SBA Form 1022B to apply for Participating Securities.
    (c) Where to send your application. Send all Leverage applications 
to SBA, Investment Division, 409 Third Street, S.W., Washington, DC 
20416.


Sec. 107.1110  [Removed]

    18. Section 107.1110 is removed.
    19. Section 107.1120 is amended by revising paragraph (c), 
redesignating paragraphs (d) through (f) as paragraphs (e) through (g), 
and adding a new paragraph (d) to read as follows:


Sec. 107.1120  General eligibility requirements for Leverage.

* * * * *
    (c) Meet the minimum capital requirements of Sec. 107.210, subject 
to the following additional conditions:
    (1) If you were licensed after September 30, 1996 under the 
exception in Sec. 107.210(a)(1), you will not be eligible for Leverage 
until you have Regulatory Capital of at least $5,000,000.
    (2) If you were licensed on or before September 30, 1996, and have 
Regulatory Capital of less than $5,000,000 (less than $10,000,000 if 
you wish to issue Participating Securities):
    (i) You must certify in writing that at least 50 percent of the 
aggregate dollar amount of your Financings extended after September 30, 
1996 will be provided to Smaller Enterprises (as defined in 
Sec. 107.710(a)); and
    (ii) You must demonstrate to SBA's satisfaction that the approval 
of Leverage will not create or contribute to an unreasonable risk of 
default or loss to the United States government, based on such 
measurements of profitability and financial viability as SBA deems 
appropriate.
    (d) Certify in writing that you are in compliance with the 
requirement to finance Smaller Enterprises in Sec. 107.710(b).
* * * * *
    20. Section 107.1130 is amended by revising the section heading and 
paragraphs (a) through (c), redesignating paragraph (d) as paragraph 
(e), and adding a new paragraph (d) to read as follows:


Sec. 107.1130  Leverage fees and additional charges payable by 
Licensee.

    (a) Leverage fee. You must pay a leverage fee to SBA for each 
issuance of a Debenture or Participating Security. The fee is 3 percent 
of the face amount of the Leverage issued.
    (b) Payment of leverage fee. (1) If you issue a Debenture or 
Participating Security to repay or redeem existing Leverage, you must 
pay the leverage fee before SBA will guarantee or purchase the new 
Leverage security.
    (2) If you issue a Debenture or Participating Security that is not 
used to repay or redeem existing Leverage, SBA will deduct the leverage 
fee from the proceeds remitted to you, unless you prepaid the fee under 
Sec. 107.1210.
    (c) Refundability. The leverage fee is not refundable under any 
circumstances.
    (d) Additional charge for Leverage.--(1) Debentures. You must pay 
to SBA a Charge of 1 percent per annum on the outstanding amount of 
your Debentures issued on or after October 1, 1996, payable under the 
same terms and conditions as the interest on the Debentures. This 
Charge does not apply to Debentures issued pursuant to a Leverage 
commitment obtained from SBA on or before September 30, 1996.
    (2) Participating Securities. You must pay to SBA a Charge of 1 
percent per annum on the outstanding amount of your Participating 
Securities issued on or after October 1, 1996, payable under the same 
terms and conditions as the Prioritized Payments on the Participating 
Securities. This Charge does not apply to Participating Securities 
issued pursuant to a Leverage commitment obtained from SBA on or before 
September 30, 1996.
* * * * *
    21. Section 107.1160 is amended by adding introductory text to read 
as follows:


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

    This section applies to Leverage issued by a Section 301(d) 
Licensee on or before September 30, 1996. Effective October 1, 1996, a 
Section 301(d) Licensee may apply to issue new Leverage, or refinance 
existing Leverage, only on the same terms permitted under 
Sec. 107.1150.
* * * * *
    22. Section 107.1200 is amended by revising paragraphs (c) and (d) 
to read as follows:


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

* * * * *
    (c) Limitations on the amount of a Leverage commitment. The amount 
of a Leverage commitment must be a multiple of $5,000.
    (d) Term of Leverage commitment. SBA's Leverage commitment will 
automatically lapse on the expiration date stated in the commitment 
letter issued to you by SBA.
    23. Section 107.1210 is revised to read as follows:


Sec. 107.1210  Payment of leverage fee upon receipt of commitment.

    (a) Partial prepayment of leverage fee. As a condition of SBA's 
Leverage commitment, and before you draw any Leverage under such 
commitment, you must pay to SBA a non-refundable fee equal to 1 percent 
of the face amount of the Debentures or Participating Securities 
reserved under the commitment. This amount represents a partial 
prepayment of the 3 percent leverage fee established under 
Sec. 107.1130(a).
    (b) Automatic cancellation of commitment. Unless you pay the fee 
required under paragraph (a) of this section 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.
    24. In Sec. 107.1230, paragraphs (a) and (b) are revised to read as 
follows:


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 authorize SBA, or any agent or trustee SBA designates, 
to guarantee your Debenture or Participating Security and to sell it 
with SBA's guarantee.
    (b) Limitations on amount of draw. The amount of a draw must be a 
multiple of $5,000. SBA, in its discretion, may determine a minimum 
dollar amount for draws against SBA's Leverage commitments. Any such 
minimum amounts will be published in Notices in the Federal Register 
from time to time.
* * * * *
    25. Section 107.1240 is amended by revising paragraphs (a)(1), (b), 
(c) and (d) to read as follows:


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. * * *

[[Page 5869]]

    (1) The sale of your Debenture or Participating Security to a 
short-term investor at a rate that may be different from the Trust 
Certificate Rate which will be established at the time of the pooling 
of your security;
* * * * *
    (b) Sale of Debentures to a short-term investor. If SBA sells your 
Debenture to a short-term investor:
    (1) The sale price will be the face amount.
    (2) At the next scheduled date for the sale of Debenture Trust 
Certificates, whether or not the sale actually occurs, you must pay 
interest to the short-term investor for the short-term period. If the 
actual sale of Trust Certificates takes place after the scheduled date, 
you must pay the short-term investor interest from the scheduled sale 
date to the actual sale date. This additional interest is due on the 
actual sale date.
    (3) Failure to pay the interest constitutes noncompliance with the 
terms of your Leverage (see Sec. 107.1810).
    (c) Sale of Participating Securities to a short-term investor. If 
SBA sells your Participating Security to a short-term investor, the 
sale price will be the face amount.
    (d) Licensee's right to repurchase its Debentures before pooling. 
You may repurchase your Debentures 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 Debenture is to be included; and
    (2) Pay the face amount of the Debenture, plus interest, to the 
short-term investor.


Sec. 107.1350  [Redesignated as Sec. 107.1585]

    26. Subpart I of Part 107 is amended by removing the undesignated 
center heading ``Exchange of Outstanding Debentures for Participating 
or Preferred Securities--Section 301(d) Licensees'' preceding 
Sec. 107.1350, by redesignating Sec. 107.1350 as Sec. 107.1585 and 
revising it to read as follows:


Sec. 107.1585  Exchange of Debentures for Participating Securities.

    You may, in SBA's discretion, retire a Debenture through the 
issuance of Participating Securities. To do so, you must:
    (a) Obtain SBA's approval to issue Participating Securities;
    (b) Pay all unpaid accrued interest on the Debenture, plus any 
applicable prepayment penalties, fees, and other charges;
    (c) Have outstanding Equity Capital Investments (at cost) equal to 
the amount of the Debenture being refinanced; and
    (d) Classify all your existing Loans and Investments as Earmarked 
Assets.
    27. In Sec. 107.1400, the section heading and introductory text are 
revised to read as follows:


Sec. 107.1400  Dividends or partnership distributions on 4 percent 
Preferred Securities.

    If you issued Preferred Securities to SBA on or after November 21, 
1989, you must pay SBA a dividend or partnership distribution of 4 
percent per year, from the date you issued Preferred Securities to the 
date you repay them, both inclusive. The dividend or partnership 
distribution is:
* * * * *
    28. Section 107.1420 is revised to read as follows:


Sec. 107.1420  Articles requirements for 4 percent Preferred 
Securities.

    If you have outstanding 4 percent Preferred Securities, your 
Articles must contain all the provisions in Secs. 107.1400 and 
107.1410.


Sec. 107.1430  [Amended]

    29. Section Sec. 107.1430 is amended by removing the last sentence.
    30. In Sec. 107.1500, paragraphs (b)(1) and (b)(4), the last 
sentence of paragraph (e), and paragraph (f)(2) are revised to read as 
follows:


Sec. 107.1500  General description of Participating Securities.

* * * * *
    (b) Special eligibility requirements for Participating Securities. 
* * *
    (1) Minimum capital (see Sec. 107.210).
* * * * *
    (4) Equity investing, as set forth in this paragraph (b)(4). If you 
issue Participating Securities, you must invest an amount equal to the 
Original Issue Price of such securities solely in Equity Capital 
Investments, as defined in Sec. 107.50.
* * * * *
    (e) Mandatory redemption of Participating Securities. * * * You 
must pay the Redemption Price plus any unpaid Earned Prioritized 
Payments and any earned Adjustments and earned Charges (see 
Sec. 107.1520).
    (f) Priority of Participating Securities in liquidation of 
Licensee. * * *
    (2) Any Earned Prioritized Payments and any earned Adjustments and 
earned Charges (see Sec. 107.1520); and
* * * * *
    31. In Sec. 107.1505, paragraphs (a)(1) through (a)(3) are added 
and the last sentence of paragraph (a) introductory text and paragraph 
(b) are revised to read as follows:


Sec. 107.1505  Liquidity requirements for Licensees issuing 
Participating Securities.

* * * * *
    (a) Definition of Liquidity Impairment. * * * You are responsible 
for calculating whether you have a condition of Liquidity Impairment:
    (1) As of the close of your fiscal year;
    (2) At the time you apply for Leverage, unless SBA permits 
otherwise; and
    (3) At such time as you contemplate making any Distribution.
    (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                                    
                        Financial account                          reported  on       Weight         Weighted   
                                                                   SBA form 468                       amount    
----------------------------------------------------------------------------------------------------------------
(1) Cash and invested idle funds................................  ..............          x 1.00  ..............
(2) Commitments from investors..................................  ..............          x 1.00  ..............
(3) Current maturities..........................................  ..............          x 0.50  ..............
(4) Other current assets........................................  ..............          x 1.00  ..............
(5) Publicly Traded and Marketable Securities...................  ..............          x 1.00  ..............
(6) Anticipated operating revenue for next 12 months............             (1)          x 1.00  ..............
(7) Total Current Funds Available...............................  ..............  ..............               A
(8) Current liabilities.........................................  ..............          x 1.00  ..............
(9) Commitments to Small Businesses.............................  ..............          x 0.75  ..............
(10) Anticipated operating expense for next 12 months...........             (1)          x 1.00  ..............

[[Page 5870]]

                                                                                                                
(11) Anticipated interest expense for next 12 months............             (1)          x 1.00  ..............
(12) Contingent liabilities (guarantees)........................  ..............          x 0.25  ..............
(13) Total Current Funds Required...............................  ..............  ..............               B
----------------------------------------------------------------------------------------------------------------
\1\ As determined by Licensee's management under its business plan.                                             

    32. In Sec. 107.1510, the introductory text, the last sentence of 
paragraph (c) introductory text, the formula in paragraph (c), and 
paragraph (d)(1)(ii) are revised to read as follows:


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, Adjustments 
and Charges under Sec. 107.1520 and Profit Participation under 
Sec. 107.1530.
* * * * *
    (c) How to compute your Earmarked Asset Ratio. * * * Otherwise, 
compute your Earmarked Asset Ratio using the following formula:

EAR = (EA  LI)  x  100

where:

    EAR = Earmarked Asset Ratio.
    EA = Average Earmarked Assets (at cost) for the fiscal year or 
interim period.
    LI = 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) * * *
    (ii) For the purpose of determining Net Income (Loss), leverage 
fees paid to SBA and partnership syndication costs that you incur must 
be capitalized and amortized on a straight-line basis over not less 
than five years.
* * * * *
    33. Section 107.1520 is revised to read as follows:


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

    This section tells you how to compute Prioritized Payments, 
Adjustments and Charges on Participating Securities and determine the 
amounts you must pay. To distribute these amounts, see Sec. 107.1540.
    (a) How to compute Prioritized Payments and Adjustments--(1) 
Prioritized Payments. For a full fiscal year, the Prioritized Payment 
on an outstanding Participating Security equals the Redemption Price 
times the related Trust Certificate Rate. For an interim period, you 
must prorate the annual Prioritized Payment. If your Participating 
Security was sold to a short-term investor in accordance with 
Sec. 107.1240, the Prioritized Payment for the short-term period equals 
the Redemption Price times the short-term rate.
    (2) Adjustments. Compute Adjustments using paragraph (f) of this 
section.
    (3) Charges. Compute Charges in accordance with 
Sec. 107.1130(d)(2).
    (b) Licensee's obligation to pay Prioritized Payments, Adjustments 
and Charges. You are obligated to pay Prioritized Payments, Adjustments 
and Charges only if you have profit as determined in 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 have not become payable because you 
lack sufficient profit are ``Accumulated Prioritized Payments''. Treat 
all Prioritized Payments as ``Accumulated'' until they become 
``Earned'' under this section.
    (3) Adjustments (computed under paragraph (f) of this section) and 
Charges (computed under Sec. 107.1130(d)(2)) 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, 
unearned Adjustments and unearned Charges.
    (2) Distribution Account. The Distribution Account is a liability 
account. Its balance represents your unpaid Earned Prioritized 
Payments, earned Adjustments and earned Charges.
    (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, earned Adjustments and earned Charges.
    (d) How to determine your profit for Prioritized Payment purposes. 
As of the end of each fiscal year and any interim period for which you 
want to make a Distribution:
    (1) Bring the Accumulation Account up to date by adding to it all 
Prioritized Payments and Charges through the end of the appropriate 
fiscal period.
    (2) Determine whether you have profit for the purposes of this 
section by doing the following computation:
    (i) Cumulative Earmarked Profit (Loss) under Sec. 107.1510(f); 
minus
    (ii) The Earned Payments Account balance; minus
    (iii) All Distributions previously made under Secs. 107.1550, 
107.1560 and 107.1570(a); minus
    (iv) Any Profit Participation previously allocated to SBA under 
Sec. 107.1530, but not yet distributed.
    (3) The amount computed in paragraph (d)(2) of this section, if 
greater than zero, is your profit. If the amount is zero or less, you 
have no profit.
    (4) 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 and the 
Earned Payments Account.
    (f) How to compute Adjustments. You must compute Adjustments as of 
the end of each fiscal year if you have a balance greater than zero in 
either your Accumulation Account or your Distribution Account, after 
giving effect to any Distribution that will be made no

[[Page 5871]]

later than the second Payment Date following the fiscal year end.
    (1) Determine the combined average Accumulation Account and 
Distribution Account balances for the fiscal year, assuming that 
Prioritized Payments accumulate on a daily basis without compounding.
    (2) Multiply the average balance computed in paragraph (f)(1) of 
this section by the average of the Trust Certificate Rates for all the 
Participating Securities poolings during the fiscal year.
    (3) Add the amounts computed in this paragraph (f) to your 
Accumulation Account.
    (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 section 
as of the end of each fiscal quarter and prior to making any 
Distribution. You must distribute any Earned Prioritized Payments, 
earned Adjustments and earned Charges 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, 
unearned Adjustments and unearned Charges will be extinguished.
    34. Section 107.1530 is amended by removing paragraphs (e)(3) and 
(e)(4) and revising paragraphs (c), (e)(2) and (h) to read as follows:


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

* * * * *
    (c) How to compute the Base. As of the end of each fiscal year and 
any year-to-date interim period 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 for the period from Sec. 107.1520(a)(1), 
Adjustments (if applicable) from Sec. 107.1520(f), and Charges (if 
applicable) from Sec. 107.1130(d)(2).
    UL = ``Unused Loss'' from prior periods as determined in this 
paragraph (c).

    (1) If the Base computed as of the end of your previous fiscal year 
(your ``Previous Base'') was less than zero, your Unused Loss equals 
your Previous Base.
    (2) If your Previous Base was zero or greater, your Unused Loss 
equals zero, with the following exception: If you made an interim 
Distribution of Profit Participation during your previous fiscal year, 
and your Previous Base was lower than the interim Base on which your 
Distribution was computed, then your Unused Loss equals the difference 
between the interim Base and the Previous Base. For example, assume you 
are computing your Base as of December 31, 1997, your fiscal year end. 
Your Previous Base, computed as of December 31, 1996, was $3,000,000. 
During 1996, you made an interim Distribution which was computed on a 
Base of $3,500,000 as of June 30, 1996. The $500,000 difference between 
the 1996 interim and year-end Bases would be carried forward as Unused 
Loss in the computation of your Base as of December 31, 1997.
    (3) If you had no Participating Securities outstanding as of the 
end of your last fiscal year, you may request SBA's approval to treat 
your Undistributed Net Realized Loss, as reported on SBA Form 468 for 
that year, as Unused Loss. If you did not file SBA Form 468 because you 
were not yet licensed as of the end of your last fiscal year, you may 
request SBA's approval to treat pre-licensing losses as Unused Loss.
* * * * *
    (e) Compute the ``PLC ratio''. * * *
    (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. In 
addition, the increase must have been expressly provided for in a plan 
of operations submitted to and approved by SBA in writing, or must be 
the result of the takedown of commitments or the conversion of non-cash 
assets that were included in your Private Capital. If these conditions 
are satisfied, compute your reduced PLC ratio as follows:
    (i) Divide the highest dollar amount of Participating Securities 
you have ever had outstanding by your increased Leverageable Capital.
    (ii) If the result in paragraph (e)(2)(i) of this section is lower 
than your PLC ratio currently in effect, such result will become your 
new PLC ratio.
* * * * *
    (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 from paragraph (c) of this section by the 
Profit Participation Rate from paragraph (g) of this section.
    (2) If your last Profit Participation computation was for an 
interim period during the same fiscal year and used a higher Profit 
Participation Rate than the Rate you just used in paragraph (h)(1) of 
this section, you must adjust the amount computed in paragraph (h)(1) 
of this section as follows:
    (i) Determine the difference between the Profit Participation Rate 
you just used in paragraph (h)(1) of this section and the Rate used in 
your previous computation;
    (ii) Multiply the difference by the Base from your last Profit 
Participation computation; and
    (iii) Add the result to the amount you computed in paragraph (h)(1) 
of this section.
    (3) Reduce the Profit Participation computed in paragraphs (h)(1) 
and (h)(2) 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(s) during the fiscal 
year. The result is SBA's Profit Participation (unless it is less than 
zero, in which case SBA's Profit Participation is zero).
* * * * *
    35. Section 107.1540 is amended by adding a sentence at the end of 
the introductory text to read as follows:


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

    * * * You must notify SBA of any planned distribution under this 
section 10 business days before the distribution date, unless SBA 
permits otherwise.
* * * * *
    36. Section 107.1550 is amended by adding a sentence at the end of 
the introductory text and by revising paragraphs (a)(1), (b) and (c)(3) 
to read as follows:


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

    * * * You must notify SBA of any planned distribution under this 
section 10 business days before the distribution date, unless SBA 
permits otherwise.
    (a) Conditions for making a tax Distribution. * * *
    (1) You have paid all your Prioritized Payments, Adjustments, and 
Charges, so that the balance in both your Distribution Account and your

[[Page 5872]]

Accumulation Account is zero (see Sec. 107.1520).
* * * * *
    (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=Net ordinary income allocated to your partners or other owners 
for Federal income tax purposes for the fiscal year immediately 
preceding the Distribution, excluding Prioritized Payments allocated to 
SBA.
    HRO=The highest combined marginal Federal and State income tax rate 
for corporations or individuals on ordinary income, determined in 
accordance with paragraphs (b)(2) through (b)(4) of this section.
    TCG=Net capital gains allocated to your partners or other owners 
for Federal income tax purposes for the fiscal year immediately 
preceding the Distribution, excluding Prioritized Payments allocated to 
SBA.
    HRC=The highest combined marginal Federal and State income tax rate 
for corporations or individuals on capital gains, determined in 
accordance with paragraphs (b)(2) through (b)(4) of this section.

    (2) You may compute the highest combined marginal Federal and State 
income tax rate on ordinary income and capital gains using either 
individual or corporate rates. However, you must apply the same type of 
rate, either individual or corporate, to both ordinary income and 
capital gains.
    (3) In determining the combined Federal and State income tax rate, 
you must assume that State income taxes are deductible from Federal 
income taxes. For example, if the Federal tax rate was 35 percent and 
the State tax rate was 5 percent, the combined tax rate would be [35% 
x  (1-.05)] + 5% = 38.25%.
    (4) For purposes of this paragraph (b), the ``State income tax'' is 
that of the State where your principal place of business is located, 
and does not include any local income taxes.
    (c) SBA's share of the tax Distribution.
* * * * *
    (3) SBA will apply its share of the tax Distribution in the order 
set forth in Sec. 107.1560(g).
* * * * *
    37. In Sec. 107.1560, in the first column of the table in paragraph 
(e), the column heading is revised to read ``If your ratio of Leverage 
to Leverageable Capital as of the fiscal period end is:'', a sentence 
is added at the end of the introductory text, and paragraphs (a)(1), 
(a)(4) and (b) are revised to read as follows:


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

    * * * You must notify SBA of any planned distribution under this 
section 10 business days before the distribution date, unless SBA 
permits otherwise.
    (a) Conditions for making Distributions.
* * * * *
    (1) You must have paid all Prioritized Payments, Adjustments and 
Charges, so that the balance in both your Distribution Account and your 
Accumulation Account is zero (see Secs. 107.1520 and 107.1540).
* * * * *
    (4) The amount you distribute under this section must not exceed 
your remaining 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, after giving effect to any Distribution under 
Secs. 107.1540 and 107.1550; minus
    (2) All previous Distributions under this section and 
Sec. 107.1570(a) 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.
* * * * *
    38. Section 107.1570 is amended by adding a sentence at the end of 
the introductory text and by revising the heading of paragraph (b)(1) 
and paragraphs (b)(1)(i) and (b)(1)(ii) to read as follows:


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

    * * * You must notify SBA of any planned distribution under this 
section 10 business days before the distribution date, unless SBA 
permits otherwise.
* * * * *
    (b) Other optional Distributions. * * *
    (1) Conditions for making a Distribution. * * *
    (i) You have distributed all Earned Prioritized Payments, earned 
Adjustments, and earned Charges, 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 which you are required to distribute under Sec. 107.1560 
or permitted to distribute under paragraph (a) of this section, as 
appropriate, and you have made all required Distributions under 
Sec. 107.1560.
* * * * *
    39. Section 107.1575 is added to subpart I to read as follows:


Sec. 107.1575  Distributions on other than Payment Dates.

    (a) Permitted Distributions on other than Payment Dates. 
Notwithstanding any provisions to the contrary in Secs. 107.1540 
through 107.1570, you may make Distributions on dates other than 
Payment Dates as follows:
    (1) Required annual Distributions under Secs. 107.1540(a)(1), and 
any Distributions under Secs. 107.1550 and 107.1560, must be made no 
later than the second Payment Date following the end of your fiscal 
year;
    (2) Required Distributions under Sec. 107.1540(b) must be made no 
later than the first Payment Date following the end of the applicable 
fiscal quarter;
    (3) Optional Distributions under Sec. 107.1540(a)(2) and 
Sec. 107.1570 may be made on any date.
    (b) Conditions for making Distribution. All Distributions under 
this section are subject to the following conditions:
    (1) You must obtain SBA's written approval before the distribution 
date;
    (2) You must use the distribution date as the ending date of the 
period for which you compute your Earmarked Profits, Prioritized 
Payments, Adjustments, Charges, Profit Participation, Retained Earnings 
Available for Distribution, liquidity ratio, Capital Impairment, and 
any other applicable computations required under Secs. 107.1500 through 
107.1570;
    (3) If your Distribution includes an amount which SBA will apply as 
a redemption of Participating Securities, the effective date of such 
redemption, for all purposes including future computations of 
Prioritized Payments, will be the next Payment Date following the 
distribution date.
    40. In Sec. 107.1580, the heading and introductory text of 
paragraph (a) are revised to read as follows:


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

    (a) In-Kind Distributions. A Distribution under Secs. 107.1540, 
107.1560 or 107.1570 may consist of securities (an ``In-Kind 
Distribution'').

[[Page 5873]]

Such a Distribution must satisfy the conditions in this paragraph (a).
* * * * *
    41. Section 107.1590 is amended by removing paragraph (c), 
redesignating paragraph (d) as paragraph (c), and revising paragraph 
(a)(1) to read as follows:


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

* * * * *
    (a) Election to exclude pre-existing portfolio. * * *
    (1) The proceeds of your first issuance of Participating Securities 
are not used to refinance outstanding Debentures (see 
Sec. 107.1585(a)). 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.
* * * * *
    42. In Sec. 107.1600, the first sentence of paragraph (a) and 
paragraph (b) are revised to read as follows:


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

    (a) Authorization. Sections 319(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. * * *
    (b) Periodic exercise of authority. SBA will issue guarantees of 
Debentures and Participating Securities under section 303 and of TCs 
under section 319 of the Act at six month intervals, or at shorter 
intervals, taking into account the amount and number of such guarantees 
or TCs.
* * * * *
    43. Section 107.1720 is added to subpart I to read as follows:


Sec. 107.1720  Characteristics of SBA's guarantee.

    If SBA agrees to guarantee a Licensee's 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.
    44. In Sec. 107.1820, paragraph (e)(9) is revised to read as 
follows:


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

* * * * *
    (e) Restricted Operations Conditions. * * *
    (9) Failure to meet investment requirements. You fail to make the 
amount of Equity Capital Investments required for Participating 
Securities (Sec. 107.1500(b)(4)), if applicable to you; or you fail to 
maintain as of the end of each fiscal year the investment ratios or 
amounts required for 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. In determining whether you have met the maintenance requirements 
in Sec. 107.1160(c) or (d), SBA will disregard any prepayment, sale, or 
disposition of Venture Capital Financings, any increase in Leverageable 
Capital, and any receipt of additional Leverage, within 120 days prior 
to the end of your fiscal year.
* * * * *
    45. In Sec. 107.1830, paragraph (a) is revised to read as follows:


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

    (a) Applicability of this section. This section applies to Leverage 
issued on or after April 25, 1994. For Leverage issued before April 25, 
1994, you must comply with paragraphs (e) and (f) of this section and 
the Capital Impairment regulations in this part in effect when you 
issued your Leverage. For all Leverage issued, you must also comply 
with any contractual provisions to which you have agreed.
* * * * *
    Dated: January 28, 1998.
Aida Alvarez,
Administrator.
[FR Doc. 98-2556 Filed 2-4-98; 8:45 am]
BILLING CODE 8025-01-P