[Federal Register Volume 65, Number 119 (Tuesday, June 20, 2000)]
[Proposed Rules]
[Pages 38223-38224]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-15421]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107


Small Business Investment Companies

AGENCY: Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: This proposed rule would implement a provision of Public Law 
106-9, enacted April 5, 1999, under which certain types of 
consideration paid to a small business investment company (SBIC) by a 
small business are excluded from ``cost of money'' limitations.

DATES: Submit comments on or before July 20, 2000.

ADDRESSES: Address comments to Don A. Christensen, Associate 
Administrator for Investment, U.S. Small Business Administration, 409 
3rd Street, SW, Suite 6300, Washington, DC 20416.

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

SUPPLEMENTARY INFORMATION: This proposed rule would implement a 
provision of Public Law 106-9, enacted April 5, 1999, that amended 
section 308(i)(2) of the Small Business Investment Act of 1958. The 
amendment provided that certain types of consideration paid to an SBIC 
by a small business are excluded from the regulatory limitations on 
``Cost of Money'' established by the Small Business Administration 
(SBA). The amendment excluded from these Cost of Money limits any 
consideration consisting of ``contingent obligations'' granting the 
SBIC an interest in the ``equity or increased future revenue'' of the 
small business.
    To implement this change, SBA is proposing to broaden one of the 
exclusions from Cost of Money in Sec. 107.855(g) and to add another. 
First, Sec. 107.855(g)(12) would be revised to allow the exclusion of 
royalty payments for all SBIC financings. Currently, this exclusion 
applies only to ``LMI Investments'' as defined in Sec. 107.50. To 
qualify for the exclusion, the royalty must be based on improvement in 
the performance of the small business after the date of the financing. 
The royalty could be expressed, for example, as a percentage of any 
increase in an underlying unit of measurement (e.g., revenues or sales) 
after the date of the financing. As discussed in the preamble to the 
final rule establishing the original provision for LMI Investments (64 
FR 52641), the royalty can be based on an increase in more than one 
unit of measurement. For example, a royalty could provide for payment 
to the SBIC if either the revenue or the profits of the small business 
increased.
    If an SBIC makes an investment through a holding company or an 
investment vehicle, as permitted under Sec. 107.720(b), performance 
improvements will be evaluated in the same manner already established 
for LMI Investments. In determining whether a business's performance 
has improved, SBA will look through any holding company or investment 
vehicle to the performance of the operating business itself.
    SBA is proposing one additional change with respect to royalty 
payments. In Sec. 107.815(a), the definition of a Debt Security would 
be revised to include a loan with a right to receive royalties that are 
excluded from the Cost of Money. The effect of this change is that a 
financing of this type will be subject to the lower Cost of Money 
ceiling applicable to Debt Securities, rather than the higher ceiling 
applicable to Loans with no upside potential.
    SBA also proposes to add Sec. 107.855(g)(13), which would exclude 
from Cost of Money any gains realized by an SBIC from the disposition 
of Equity Securities issued by a small business. This provision has 
been added as a clarification, since SBA's longstanding practice has 
been to exclude such gains from the Cost of Money limits. For example, 
if an SBIC receives warrants that qualify as Equity Securities, or 
converts debt to an Equity Security, any gains realized on the 
disposition of these interests do not count against the Cost of Money 
ceiling.
    Finally, SBA proposes to remove paragraph Sec. 107.855(i). This 
paragraph allows an SBIC that is lending to a small business to receive 
a one-time ``bonus'' at the end of the loan term, contingent upon one 
or more factors reflecting the performance of the business during the 
loan period. Such bonus payments are excluded from the Cost of Money. 
The proposed revision of Sec. 107.855(g)(12), which would provide a 
broader exclusion of contingent payments from the Cost of Money, 
renders the bonus provision redundant.

Compliance With Executive Orders, 12866, 12988, and 13132, the 
Regulatory Flexibility Act (5 U.S.C. 601, et seq., and the 
Paperwork Reduction Act (44 U.S.C. Ch. 35)

    SBA has determined that this proposed rule does not constitute a 
significant rule within the meaning of section 3(f) of Executive Order 
12866.
    Under the Regulatory Flexibility Act, 5 U.S.C. 601, et seq., SBA 
has determined that this proposed rule will not have a significant 
economic impact on a substantial number of small entities. The purpose 
of the proposed rule is to implement a provision of Public Law 106-9 
allowing small business investment companies (SBICs) to realize 
contingent payments, such as royalties, from small businesses without 
being subject to regulatory limits on the amount of consideration 
received. Interest and other non-contingent payments made to SBICs by 
small businesses would continue to be subject to the existing Cost of 
Money regulations. This provision is expected to be attractive 
primarily to SBICs considering investments in small businesses that are 
seeking to grow, but whose owners do not want to give substantial 
equity interests to outside investors. In such cases, the SBIC can

[[Page 38224]]

participate in the growth of the business by collecting a royalty 
rather than through an ownership interest.
    Based on recent statistics for the SBIC program, the circumstances 
that this proposed rule would address do not appear to apply to most 
small businesses currently receiving SBIC financing. In fiscal year 
1999, SBICs provided financing to 1,983 different small businesses. In 
approximately two-thirds of all the financings closed during that year, 
the SBIC obtained an actual or potential equity interest in the small 
business; even if the proposed rule had been in place, it is unlikely 
that these transactions would have included royalty provisions. The 
remaining one-third of SBIC financings typically consist of loans to 
very small businesses with low growth potential, which are unlikely to 
have the ability to make royalty payments under any circumstances. 
Thus, it is unlikely that this proposed rule would affect a substantial 
number of small entities. The proposed rule is expected to expand 
financing opportunities for certain small businesses wishing to grow 
while remaining closely held, rather than make SBIC financing more 
expensive for small businesses currently being served by the program.
    For purposes of Executive Order 12988, SBA has determined that this 
proposed rule is drafted, to the extent practicable, in accordance with 
the standards set forth in Section 3 of that Order.
    For purposes of Executive Order 13132, SBA has determined that this 
proposed rule has no federalism implications.
    For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA 
certifies that this proposed rule contains no new reporting or 
recordkeeping requirements.

List of Subjects in 13 CFR Part 107

    Investment companies, Loan programs-business, Reporting and 
recordkeeping requirements, Small businesses.
    For the reasons set forth in the preamble, SBA proposes to amend 13 
CFR part 107 as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

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

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

    2. In Sec. 107.815, revise the first sentence of paragraph (a) to 
read as follows:


Sec. 107.815  Financings in the form of Debt Securities.

* * * * *
    (a) Definitions. Debt Securities are instruments evidencing a loan 
with an option or any other right to acquire Equity Securities in a 
Small Business or its Affiliates, or a loan which by its terms is 
convertible into an equity position, or a loan with a right to receive 
royalties that are excluded from the Cost of Money pursuant to 
Sec. 107.855(g)(12).
* * * * *
    3. In Sec. 107.855, revise paragraph (g)(12), add paragraph 
(g)(13), and remove paragraph (i) to read as follows:


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

* * * * *
    (g) * * *
    (12) Royalty payments based on improvement in the performance of 
the Small Business after the date of the Financing.
    (13) Gains realized on the disposition of Equity Securities issued 
by the Small Business.
* * * * *

    Dated: June 8, 2000.
Aida Alvarez,
Administrator.
[FR Doc. 00-15421 Filed 6-19-00; 8:45 am]
BILLING CODE 8025-01-U