[Federal Register Volume 67, Number 96 (Friday, May 17, 2002)]
[Proposed Rules]
[Pages 35055-35057]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12466]



13 CFR Part 107

RIN 3245-AE88

Small Business Investment Companies

AGENCY: Small Business Administration (SBA).

ACTION: Proposed rule.


SUMMARY: This proposed rule would allow a Small Business Investment 
Company (SBIC) to assume control over a small business concern, without 
notice to the SBA and to retain such control for a period of up to five 
years, or longer with SBA's approval. The proposed rule would also 
allow an SBIC to sell equity securities in a portfolio concern to a 
competitor of that portfolio concern.

DATES: Comments must be received on or before June 17, 2002.

ADDRESSES: Written comments should be sent to Leonard W. Fagan, 
Investment Division, U.S. Small Business Administration, 409 3rd 
Street, SW., Washington, DC 20416.

FOR FURTHER INFORMATION CONTACT: Harry Haskins, Deputy Associate 
Administrator, Investment Division, 202-205-6734.

SUPPLEMENTARY INFORMATION: The Small Business Investment Corrections 
Act of 2000, Public Law 106-554, Title IV, section 402, amended section 
103(5)(A)(i) of the Small Business Investment Act (Act) to clarify that 
a small business concern controlled by venture capital firms, including 
licensed small business investment companies (SBICs), does not for that 
reason cease to qualify as independently owned and operated. The 
statute reads, ``regardless of the allocation of control during the 
investment period under any investment agreement between the business 
concern and the entity making the investment.'' (15 U.S.C. 
    This proposed rule simplifies SBA's present regulation governing 
control of a small business and brings it into conformity with the Act, 
as amended in 2000. It also removes a regulatory restriction on the 
right of an SBIC to sell securities of a small business to a competitor 
of that business.
    The intent of the rule is to implement a statutory change designed 
to allow SBICs the freedom to operate in the fashion of modern venture 
capital investors. SBA intends through this rule to permit the type of 
control that a modern venture fund would exercise while developing an 
investment, yet avoid the control typical of a holding company 
operating a firm as a subsidiary and deriving profits through earnings 
and cash flow.
    The legislative history indicates that Congress envisioned only the 
kind of control that a modern venture capital fund focusing on capital 
gains would exercise. The legislative history (H.Rpt. 106-520) states 
that Congress did not intend for SBICs to exercise the control typical 
of a holding company or a continuing business operation conducted 
through a subsidiary for the purpose of accruing earnings on an 
annualized or cash flow basis.
    Proposed Sec. 107.865(a) is a statement of general policy. It 
differs from the present regulation by broadly permitting SBICs to 
exercise control over a portfolio concern through ownership of voting 
securities, management agreements, voting trusts, majority 
representation on the board of directors, or any other means. The 
proposed rule also changes the definition of the ``Investor Group'', 
those entities whose ownership interests are aggregated for the purpose 
of determining whether control exists. Under the current regulation, 
the Investor Group consists of all SBICs that invest in a portfolio 
company, even if there is no affiliation among them, and all of the 
SBICs' Associates as defined in Sec. 107.50. The proposed rule defines 
the Investor Group as an SBIC and its Associates, but does not 
aggregate the interests of two or more unrelated SBICs. SBA believes 
that unrelated SBICs should have as much freedom to co-invest with one 
another as they do to co-invest with venture funds that are not SBICs.
    The only restriction in proposed Sec. 107.865(a) is a five-year 
limit on SBIC control. This will be measured from the initial 
assumption of control, regardless of interruptions in control. SBA 
considers five years sufficient time for a viable seed stage company to 
become an operating business, or to generally develop the investment in 
a portfolio concern prior to divestiture for gain. It should also 
suffice for the reversal of the declining fortunes of an operating 
business. Moreover, the vast majority of SBICs are organized as limited 
partnerships with a life span not much in excess of ten years.
    The proposed rule retains Sec. 107.865(b) with one clarification in 
the introductory text. Section 107.865(b) outlines the circumstances 
under which SBA will presume control over a small business for the 
purpose of determining when control begins or ends. The proposed 
language clarifies that this paragraph relates only to control based on 
ownership of voting securities. Control through other means, as 
specified in Sec. 107.865(a), may still exist even if the conditions in 
paragraph (b) are not met.
    The proposed rule retains Sec. 107.865 (c), which sets forth 
rebuttals to the presumption of control based on ownership of voting 
    Proposed Sec. 107.865(d) allows extension of control over portfolio

[[Page 35056]]

concerns if an SBIC has made reasonable efforts to divest itself of 
control within the five-year period, but is unable to complete the 
divestiture in time. It also allows for SBA, in its discretion, to 
extend the period of control if necessary to protect the financial 
stability of the portfolio concern.
    SBA believes that an investment for venture capital purposes is 
based primarily on an expectation of capital gains resulting from the 
divestiture of equity investments or conversion of warrants. SBA does 
not believe that conducting the ongoing operations of a portfolio 
concern for the purpose of receiving regular income is consistent with 
venture capital investing.
    As stated above, SBA believes five years is generally sufficient 
time for profitable and effective venture capital investing. 
Consequently, SBA will not allow control beyond five years, except in 
limited circumstances.
    Proposed Sec. 107.865(d) makes clear that an SBIC may provide 
additional financing to a concern it controls regardless of the 
provisions of Sec. 107.730(a)(1).
    The rule would remove Sec. 107.865 (e) and (f) as unnecessary and 
would redesignate Sec. 107.865(g) as Sec. 107.865(e).
    Section 107.885(b) requires an SBIC that controls a small business 
to obtain SBA's prior approval before selling the small business's 
equity securities to a competitor of the small business. SBA 
anticipates that SBICs may exit from an investment by a sale to a 
strategic investor. SBA believes control of such situations is best 
left to negotiations between the SBIC and the small business. 
Consequently, SBA proposes to remove Sec. 107.885(b).

Compliance With Executive Orders 12866, 12988, and 13132, the 
Regulatory Flexibility Act, and the Paperwork Reduction Act

    The Office of Management and Budget (OMB) did not review this 
proposed rule as a ``significant'' regulatory action under Executive 
Order 12866. The proposed rule implements technical corrections to the 
SBIC program. This proposed rule will not have an annual effect on the 
economy of $100 million or more, adversely affect the economy in a 
material way, create a serious inconsistency or otherwise interfere 
with an action taken or planned by another agency, materially alter the 
budgetary impact of loan programs or other government programs, or 
raise novel legal or policy issues arising out of legal mandates or the 
President's priorities.
    For purposes of Executive Order 12988, the SBA has determined that 
this proposed rule was drafted, to the extent practicable, in 
accordance with the standards set forth in section 3 of that order.
    This regulation will not have substantial direct effects on the 
States, on the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government. Therefore, under Executive Order 13132, 
the SBA determines that this proposed rule does not have sufficient 
federalism implications warranting the preparation of a Federalism 
    This proposed rule does not impose any new information collection 
requirements from SBA which require approval by OMB under the Paperwork 
Reduction Act, 44 U.S.C. Ch.35.
    When an agency issues a rulemaking proposal, the Regulatory 
Flexibility Act (RFA) requires the agency to ``prepare and make 
available for public comment an initial regulatory flexibility 
analysis'' which will ``describe the impact of the proposed rule on 
small entities.'' (5 U.S.C. Sec. 603(a)) Section 605 of the RFA allows 
an agency to certify a rule, in lieu of preparing an analysis, if the 
proposed rulemaking is not expected to have a significant economic 
impact on a substantial number of small entities.
    This proposed rule directly affects all SBICs, of which there are 
currently 432. SBA estimates that approximately 75 percent of these 
SBICs are small entities. Therefore, SBA has determined that this 
proposed rule will have an impact on a substantial number of small 
    However, SBA has determined that the impact on entities affected by 
the proposed rule will not be significant. The effect of the proposed 
rule will be to allow SBICs the flexibility to choose the optimal 
structure for their investments without having to notify or seek 
approval from SBA. SBA expects the impact of the proposed rule will be 
a reduction in the paperwork burden for SBICs. SBA asserts that the 
economic impact of the reduction in paperwork, if any, will be minimal 
and entirely beneficial to small SBICs. Accordingly, the Administrator 
of the SBA hereby certifies that this rule will not have a significant 
economic impact on a substantial number of small entities. SBA invites 
comment from members of the public who believe there will be a 
significant impact either on SBICs, or on companies that receive 
funding from SBICs.

List of Subjects in 13 CFR Part 107

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


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

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

    2. In Sec. 107.865, revise the section heading and paragraphs (a), 
(b) and (d) to read as follows:

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

    (a) In General. You, or you and your Associates, (in the latter 
case, the ``Investor Group'') may exercise Control over a Small 
Business for purposes connected to your investment, through ownership 
of voting securities, management agreements, voting trusts, majority 
representation on the board of directors, or otherwise. The period of 
such Control will be limited to the fifth anniversary of the date on 
which such Control was initially acquired or, any earlier date 
specified by the terms of any investment agreement.
    (b) Presumption of Control. Control over a Small Business based on 
ownership of voting securities will be presumed to exist whenever you 
or the Investor Group own or control, directly or indirectly:
    (1) At least 50 percent of the outstanding voting securities, if 
there are fewer than 50 shareholders; or
    (2) More than 25 percent of the outstanding voting securities, if 
there are 50 or more shareholders; or
    (3) A block of at least 20 percent of the outstanding voting 
securities, if there are 50 or more shareholders and no other party 
holds a larger block.
* * * * *
    (d) Extension of Control. With SBA's prior written approval you, or 
the Investor Group, may retain Control for such additional period as 
may be reasonably necessary to complete divestiture of Control, or to 
ensure the financial stability of the portfolio company.
* * * * *

Sec. 107.865  [Removed and Redesignated]

    3. Remove the existing Sec. 107.865(e) and (f) and redesignate 
Sec. 107.865(g) as Sec. 107.865(e).

[[Page 35057]]

Sec. 107.885  [Amended]

    4. Amend 107.885 by removing paragraph (b) and removing the 
paragraph designation ``(a)''.

    Dated: May 13, 2002.
Hector V. Barreto,
[FR Doc. 02-12466 Filed 5-16-02; 8:45 am]