[Federal Register Volume 67, Number 204 (Tuesday, October 22, 2002)]
[Rules and Regulations]
[Pages 64789-64791]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26546]

Rules and Regulations
                                                Federal Register

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Federal Register / Vol. 67, No. 204 / Tuesday, October 22, 2002 / 
Rules and Regulations

[[Page 64789]]


13 CFR Part 107

RIN 3245-AE88

Small Business Investment Companies

AGENCY: U.S. Small Business Administration (SBA).

ACTION: Final rule.


SUMMARY: This final rule allows 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 seven 
years, or longer with SBA approval. The final rule also allows an SBIC 
to sell equity securities in a portfolio concern to a competitor of 
that portfolio concern.

DATES: This rule is effective on November 21, 2002.

FOR FURTHER INFORMATION CONTACT: Carol Fendler, Director, Office of 
Licensing and Program Standards, Investment Division, Office of Capital 
Access, (202) 205-7559 or carol.fendler@sba.gov.


I. Background

    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. Under the statute, a 
business would be considered a small business concern ``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. 662(5)(A)(i)).
    On May 17, 2002, SBA published in the Federal Register a proposed 
rule (67 FR 35055) to simplify its regulation governing control of a 
small business and bring it into conformity with the Act, as amended in 
2000. The proposed rule also removed a regulatory restriction on the 
right of an SBIC to sell securities of a small business to a competitor 
of that business.
    SBA received six comments on the proposed rule. These are discussed 
in the following section-by-section analysis.

II. Section-by-Section Analysis

    SBA amends Sec.  107.865 by revising the heading. This change 
recognizes that SBICs are now allowed to exercise control over a Small 
    SBA amends paragraph (a) of Sec.  107.865 to allow an SBIC to 
exercise control over a Small Business. The period of control is 
limited to the seventh anniversary of the date on which control was 
initially acquired. This is a change from the proposed rule, which 
would have permitted control for up to five years.
    SBA received six comments on the proposed rule. Four of those 
submitted comments supported the proposed rule as drafted. The other 
two that commented supported the concept that SBICs should be permitted 
to take control of portfolio companies but indicated that the proposed 
five year period of control was insufficient. One proposed that a seven 
year time frame would be more appropriate, particularly where 
investments are in seed stage companies. This commenter indicated that 
such investments typically have a 4-7 year investment horizon. SBA 
recognizes that some investments, particularly earlier stage 
investments, may require additional time for the investment to mature. 
Recent historical experience indicates that the percentage of SBIC 
investments in start-up businesses has ranged from approximately 30 
percent to 45 percent. By including add-on investments in companies 
that were originally financed as start-ups by SBICs, the percentage 
increases to over 50 percent. In view of this investing pattern and the 
potential need to grow and support start-up businesses, SBA has 
modified the rule to allow for control to be exercised for a period of 
seven years.
    The final commenter stated that a ten year period would be more 
appropriate than the proposed five year term, for a number of reasons. 
First, the commenter pointed out that market conditions may require 
SBICs to seek extensions of the control period beyond five years. The 
commenter expected that SBA would likely grant these extension 
requests, but suggested that SBA would be spared the expenditure of 
scarce resources needed to address such requests by adopting the ten 
year period at the outset. SBA believes that extension requests will be 
considerably less frequent with the change to a seven-year control 
period, and believes that it has the resources to respond to those 
requests that will be received.
    The commenter also noted that a ten-year term would be consistent 
with the regulations promulgated by the Board of Governors of the 
Federal Reserve System and the Department of Treasury in implementing 
the Gramm-Leach-Bliley Act (GLB), Public Law 106-102. The commenter 
suggested that a differing time period for the exercise of control 
between SBA's regulations and those implementing GLB may result in the 
SBIC program being less attractive to banks and may limit their 
participation in the program.
    SBA believes that the SBIC program will continue to be an 
attractive option for banks interested in making equity investments. 
Although the regulations promulgated under GLB do permit control for a 
period of up to ten years, the restrictions on the exercise and scope 
of that control are greater than in the SBIC program. For example, 
banks taking controlling positions in a portfolio company under GLB are 
prohibited from managing or operating that portfolio company. SBICs, 
however, are not subject to that same type of restriction.
    SBA also believes that banks will remain interested in the SBIC 
program for reasons other than the ability to take controlling 
positions in their investments. Many banks find the SBIC program to be 
an attractive option since investment in an SBIC by a bank is presumed 
to meet the standards for a qualified investment for purposes of 
investment performance under the Community Reinvestment Act 
regulations. Furthermore, many banks continue to invest in SBICs that 

[[Page 64790]]

financial assistance from SBA at favorable rates.
    In adopting seven years as the allowable control period, SBA also 
considered the structure of the SBIC program and SBICs. For most SBICs, 
the projected investment cycle is a 3-5 year investing program with 
exits anticipated after a 3-5 year holding period. Since SBICs 
typically do not expect to hold investments for ten years, a control 
period of that length should not generally be necessary. Although SBA 
recognizes that company and market conditions may impact the ability to 
exit an investment, SBA believes that a seven year control period 
should be sufficient.
    SBA amends Sec.  107.865(b) to clarify that this paragraph, which 
sets forth conditions that create a presumption of control over a small 
business concern, relates only to control based on ownership of voting 
securities. Control may still exist by other means as outlined in Sec.  
107.865 (a). No comments were received on this change.
    SBA amends Sec.  107.865(d) to allow for extension of the control 
period in certain circumstances, with SBA's approval. One commenter 
indicated that the reasons for granting an extension should be expanded 
to allow for consideration of the financial stability of the SBIC in 
addition to the financial stability of the portfolio concern. SBA 
recognizes that relinquishment of control may be difficult to 
accomplish; however, SBA also recognizes that the financial stability 
of the SBIC may have no relationship to its control position in a 
particular portfolio concern and that allowing control to continue may 
be viewed as being adverse to the interests of the portfolio concern. 
SBA will consider the reasons why divestiture cannot be completed 
within seven years when reviewing the request for an extension, and 
will consider the best interests of both the SBIC and the small 
business concern. SBA believes the regulations as promulgated have 
sufficient breadth to allow for a number of considerations. Therefore, 
SBA does not believe that the financial stability of the SBIC should be 
a specifically enunciated consideration.
    SBA amends Sec.  107.865 by deleting paragraphs (e) and (f) and 
redesignating paragraph (g) as (e). The deleted paragraphs are no 
longer necessary.
    SBA amends Sec.  107.885 by removing paragraph (b) and removing the 
designation ``(a)''. This change allows a SBIC to sell its interests in 
a portfolio concern to a competitor of that portfolio concern. This 
change recognizes that in the venture capital industry a likely exit 
for an investment is the sale of an interest in a portfolio concern to 
a competitor of the portfolio concern. Three commenters addressed this 
provision directly, all favorably.

Compliance With Executive Orders 12866, 12988, and 13132, the Paperwork 
Reduction Act (44 U.S.C. Ch. 35), and the Regulatory Flexibility Act (5 
U.S.C. 601-612)

Compliance With Executive Order 12866

    The Office of Management and Budget (OMB) did not review this rule 
as a ``significant'' regulatory action under Executive Order 12866. The 
rule implements technical corrections to the SBIC program. The 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 governmental programs, or raise novel legal or policy issues 
arising out of legal mandates or the President's priorities.

Compliance With Executive Order 12988

    For purposes of Executive Order 12988, the SBA has determined that 
this rule was drafted, to the extent practicable, in accordance with 
the standards set forth in section 3 of that order.

Compliance With Executive Order 13132

    For purposes of Executive Order 13132, SBA has determined that the 
rule 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, SBA has determined 
that the rule does not have sufficient federalism implications 
warranting the preparation of a Federalism Assessment.

Compliance with Paperwork Reduction Act, 44 U.S.C. Ch. 35

    The 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.

Compliance with the Regulatory Flexibility Act, 5 U.S.C. 601-612

    SBA determined that the rule will not have a significant impact on 
a substantial number of small entities. SBA invited comments on this 
determination but received none.

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, amend part 107 of title 13 
of the Code of Federal Regulations as follows:


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

    Authority: 15 U.S.C. 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), remove paragraphs (e) and (f), and redesignate paragraph 
(g) as paragraph (e) 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 seventh 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) At least 20 percent of the outstanding voting securities, if 
there are 50 or more shareholders and no other party holds a larger 
* * * * *
    (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.
* * * * *

[[Page 64791]]

Sec.  107.885  [Amended]

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

    Dated: October 10, 2002.
Hector V. Barreto,
[FR Doc. 02-26546 Filed 10-21-02; 8:45 am]