[Federal Register Volume 76, Number 237 (Friday, December 9, 2011)]
[Proposed Rules]
[Pages 76907-76917]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-31658]



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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG32


Small Business Investment Companies--Early Stage SBICs

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: In this proposed rule, the U.S. Small Business Administration 
(SBA) is defining a new sub-category of small business investment 
companies (SBICs) which will focus on making equity investments in 
early stage small businesses. By licensing and providing SBA leverage 
to these ``Early Stage SBICs,'' SBA seeks to expand entrepreneurs' 
access to capital and encourage innovation as part of President Obama's 
Start-Up America Initiative launched on January 31, 2011. This proposed 
rule also sets forth regulations applicable to Early Stage SBICs with 
respect to licensing, capital requirements, non-SBA borrowing, 
examination fees, leverage eligibility, distributions, and capital 
impairment. In addition, this proposed rule makes certain technical 
changes to SBA regulations.

DATES: Comments must be received on or before February 7, 2012.

ADDRESSES: You may submit comments, identified by RIN 3245-AG32, by any 
of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail, Hand Delivery/Courier: Sean Greene, Associate 
Administrator for Investment, U.S. Small Business Administration, 409 
Third Street SW., Washington, DC 20416.
    SBA will post all comments to this proposed rule without change on 
http://www.regulations.gov. If you wish to submit confidential business 
information (CBI) as defined in the User Notice at http://www.regulations.gov, please submit the information to Carol Fendler, 
Investment Division, 409 Third Street SW., Washington, DC 20416. 
Highlight the information that you consider to be CBI and explain why 
you believe this information should be held confidential. SBA will 
review the information and make the final determination of whether it 
will publish the information or not.

FOR FURTHER INFORMATION CONTACT: Carol Fendler, Investment Division, 
(202) 205-7559 or [email protected].

SUPPLEMENTARY INFORMATION:

I. Background Information

    On January 31, 2011, President Obama announced the ``Start-Up 
America Initiative'' to encourage American innovation and job creation 
by promoting high-growth entrepreneurship across the country with new 
initiatives to help encourage private sector investment in job-creating 
startups and small firms, accelerate research, and address barriers to 
success for entrepreneurs and small businesses. The SBIC program will 
play a key role in accomplishing these goals by expanding access to 
capital for early stage businesses.
    Early stage businesses face difficult challenges accessing capital, 
particularly those without the necessary assets or cash flow for 
traditional bank funding. Although the venture capital industry 
provided over $22 billion in financings to U.S. businesses in calendar 
year 2010, this represented over a 23% decline from 2007. Less than a 
third of these financing dollars went to early stage or start-up 
businesses. Of the financings that went to early stage and start-up, 
over two-thirds went to businesses located in three states: California, 
Massachusetts, and New York. (Source: ThomsonOne VentureXpert) As a 
result, less than 10% of U.S. venture financing dollars went to early 
stage and start-up businesses not in those three states. SBA will seek 
to expand access to capital for early stage small businesses throughout 
the United States by allocating from its current debenture 
authorization up to $200 million per year (up to $1 billion total over 
five years) beginning in FY 2012 to Early Stage SBICs.
    SBA has not typically provided leverage in the form of SBA-
guaranteed debentures to SBICs that plan to provide early stage venture 
capital financing to small businesses. The standard debenture is 
generally appropriate for investments in small businesses that generate 
sufficient cash flow to pay interest and/or dividends, so that SBICs in 
turn can make semi-annual interest payments on their debentures. 
Investments in early stage companies, which typically cannot make 
current interest or dividend payments, do not fit naturally with the 
structure of debenture leverage.
    Furthermore, early stage companies have inherently higher risk; 
although they can offer potentially higher returns than later stage 
equity or mezzanine debt investments, the returns are much more 
volatile. Because the debenture program is required by law to operate 
at zero cost to taxpayers, the Early Stage SBIC initiative contemplates 
a number of strategies to mitigate risk and limit the initiative's 
impact on leverage fees, although fee increases will still be 
necessary. First, SBA intends to limit the amount of debenture leverage 
available to Early Stage SBICs to a small percentage of SBA's overall 
portfolio. Second, SBA is proposing several new regulatory provisions 
to reduce the risk that an Early Stage SBIC will default on its 
leverage and to improve SBA's recovery prospects when a default does 
occur. Third, SBA intends to act immediately to declare an event of 
default when an Early Stage SBIC has a condition of Capital Impairment 
and to exercise all available remedies, including acceleration of the 
Early Stage SBIC's leverage, if the default is not cured within the 
allotted time (see existing Sec. Sec.  107.1830 and Sec.  107.1810(f) 
and (g)). SBA is not proposing to change the current maximum permitted 
Capital Impairment Percentages set forth in Sec.  107.1830 and expects 
that, for most Early Stage SBICs, the applicable percentage would be 70 
percent.
    Once the Early Stage initiative has been implemented, the actual 
performance of Early Stage SBICs would become a factor in the annual 
adjustment of leverage fees to maintain the overall debenture program 
at zero taxpayer cost.
    To provide Early Stage SBICs with added flexibility, SBA expects to 
make two forms of leverage available to them: a debenture that requires 
quarterly interest payments throughout its term, and a debenture that 
is issued at a discount and does not require interest payments during 
the first five years of its term. Both debentures would have a 10-year 
maturity and would be subject to the SBA leverage fee structure 
currently in effect, including a 3 percent origination fee and an 
annual charge that is adjusted at the beginning of each fiscal year and 
applied to new leverage commitments issued in that year.

II. Section by Section Analysis

A. Early Stage Initiative Provisions

    Section 107.50--Definitions. To implement the Early Stage 
initiative, SBA proposes to add the defined term ``Early Stage SBIC'' 
and revise the existing defined term ``Payment Date''.
Early Stage SBIC
    The regulatory definition of Early Stage SBIC has several key 
points. First, an Early Stage SBIC must be organized as a limited 
partnership. Although the current regulations permit other forms of 
organization, the vast majority of existing SBICs are limited 
partnerships. SBA believes that having a degree of

[[Page 76908]]

uniformity in organizational structure will facilitate a more efficient 
licensing process for Early Stage SBICs.
    Second, the definition makes clear that the ``Early Stage SBIC'' 
designation would apply only to SBICs licensed pursuant to the new 
provisions in this rule. The SBIC program currently includes, and SBA 
continues to license, SBICs that make at least some early stage 
investments. With few exceptions, these funds are either: (1) ``Non-
leveraged'' SBICs, which use only private investor capital to make 
investments, (2) older SBICs that used SBA leverage in the form of 
participating securities, which are no longer available, or (3) SBICs 
using debenture leverage that make a few early stage investments as 
part of their portfolio. Such SBICs are excluded from the ``Early Stage 
SBIC'' definition.
    Third, an Early Stage SBIC must invest at least 50 percent of its 
financing dollars in small businesses that are classified as ``early 
stage'' at the time of the SBIC's initial investment. SBA believes that 
the 50 percent threshold indicates a significant focus, while still 
giving SBICs flexibility in developing their portfolios. Since a key 
goal of the Early Stage initiative is to promote the growth of early 
stage businesses, any follow-on investments in a portfolio company that 
was ``early stage'' at the time of the SBIC's initial investment would 
count towards the 50 percent requirement.
    Fourth, a small business would be considered ``early stage'' if it 
has not yet achieved positive cash flow from operations in any full 
fiscal year. A start-up company with no prior operating history may 
qualify under this definition. The venture capital industry employs 
various definitions of ``early stage'', most of which describe a 
business with or without revenues that is not yet profitable or 
generating positive cash flow. SBA chose to define early stage 
companies based on operating cash flow because it is less vulnerable to 
manipulation or distortion than other measures and because the 
availability of adequate cash is crucial to a business's ability to 
survive. Although definitions of ``early stage'' sometimes include the 
number of years the company has been in business, SBA did not include 
age as a factor. Many companies develop slowly over a number of years 
before they are positioned to grow significantly, and SBA believes that 
the definition should not exclude such companies.
Payment Date
    SBA is proposing special distribution rules (see proposed Sec.  
107.1180) for Early Stage SBICs which would require Early Stage SBICs 
to make mandatory prepayments of outstanding debentures at the same 
time they make distributions to their private limited partners. The 
proposed revision of the ``Payment Date'' definition in Sec.  107.50 
would designate March 1, June 1, September 1, and December 1 of each 
year as the dates on which debenture prepayments can be made and 
required interest payments will be due.
    Section 107.210--Minimum capital requirements for Licensees. 
Proposed Sec.  107.210(a)(3) would require an Early Stage SBIC to have 
at least $20 million of Regulatory Capital (consisting of paid-in 
capital contributions from private investors plus binding capital 
commitments from Institutional Investors, as defined in existing Sec.  
107.50). In comparison, the minimum Regulatory Capital is $5 million 
for other debenture SBICs and $10 million for participating securities 
SBICs. SBA considered a number of factors in setting the $20 million 
threshold. First, Early Stage SBICs will have access to at most one 
``tier'' of leverage (a one-to-one match between leverage and private 
capital), while most other SBICs have access to at least two tiers. 
Second, historical data show that SBA has experienced higher loss rates 
on smaller SBICs, with performance statistics improving as private 
capital approaches $20 million. Third, SBA attaches high importance to 
the market validation evidenced by the ability of an Early Stage SBIC's 
management team to raise funds from private investors. Although SBA 
believes the overall $40 million in total capital (private capital plus 
leverage) is appropriate to manage fund risk, SBA requests public input 
on the $20 million private capital minimum.
    The proposed rule does not require an Early Stage SBIC applicant to 
have $20 million of Regulatory Capital at the time of application, only 
at the time of licensing and thereafter. However, the time available 
for additional fundraising after submission of an application may be 
limited, and SBA may require evidence of fundraising progress at the 
time of application. SBA expects to provide further details regarding 
the Early Stage SBIC application process via Federal Register notice 
prior to accepting Early Stage SBIC applications.
    Section 107.300--License application form and fee. This section 
includes a technical correction and clarification, as well as a 
proposed substantive change. The current regulation refers to SBA Form 
415, an old SBIC license application form. This outdated reference 
would be replaced by the correct reference to current SBA Forms 2181 
(the license application) and 2182 (exhibits to the license 
application). The proposed rule would also clarify that the licensing 
fee is non-refundable, consistent with longstanding SBA policy. 
Finally, because Early Stage SBICs would require special processing, 
proposed Sec.  107.300(d) would require such applicants to pay an 
additional licensing fee of $10,000, bringing their total licensing fee 
to $25,000.
    Section 107.305--Evaluation of license applicants. Proposed Sec.  
107.305 discusses the factors used by SBA to evaluate applicants to the 
SBIC program, including applicants for an Early Stage SBIC license, 
which are grouped in four broad categories: Management qualifications, 
performance of managers' prior investments, the applicant's proposed 
investment strategy, and the applicant's proposed organizational 
structure and fund economics. Although this section would be a new 
addition to the regulations, it does not represent a change in SBA's 
licensing criteria. Rather, it would improve public access to useful 
information about the SBIC program by including it in the regulations 
along with the other requirements for obtaining an SBIC license 
(minimum private capital requirements, management-ownership diversity, 
etc.). SBA may still issue further guidance to potential applicants in 
other formats, as needed. SBA requests input from the public on these 
evaluation criteria.
    Section 107.310--When and how to apply for licensing as an Early 
Stage SBIC. Because SBA plans to commit only $200 million of leverage 
per year to Early Stage SBICs, demand may exceed supply. Under proposed 
Sec.  107.310, SBA would not license two Early Stage SBICs under common 
control if both would have SBA leverage or leverage commitments 
outstanding at the same time. For example, the same managers could not 
receive two licenses at the same time or in close proximity, but could 
seek a second license after their first fund had repaid all of its 
leverage and did not intend to seek any more. By limiting the amount of 
leverage in the hands of one owner or management group, this 
restriction would improve diversification of SBA's overall Early Stage 
SBIC portfolio. In addition, the proposed section provides that SBA 
would accept Early Stage SBIC applications only during specified 
periods, which would be announced by Federal Register notice. By 
creating periodic application windows, SBA will be able to gauge the 
overall demand for leverage and allocate the available funds among all 
successful applicants. Up to

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a maximum of $50 million per fund, SBA intends to make one full tier of 
leverage available to each licensed Early Stage SBIC (unless the SBIC 
requests less) and will stop licensing new funds when the aggregate 
private capital of existing licensees is sufficient to utilize all of 
the leverage (up to $1 billion in total) allocated to the Early Stage 
initiative. Depending on demand, SBA may need to commit leverage to 
Early Stage SBICs in tranches spread over several years, rather than 
providing a full one-tier commitment at the time of licensing.
    Section 107.320--Evaluation of Early Stage SBICs. Proposed Sec.  
107.320 states that SBA would evaluate Early State SBIC applicants 
using the same set of factors applicable to SBIC applicants in general, 
as set forth in proposed Sec.  107.305. This does not mean that a 
successful debenture SBIC applicant and a successful Early Stage SBIC 
applicant would look similar. Rather, it means that each applicant's 
investment strategy must be appropriate for the type of SBA leverage it 
intends to use, and each applicant's management team must have a 
successful investment track record that is relevant to its strategy. 
Early Stage applicants will need to demonstrate superior qualifications 
in the key areas identified in the proposed rule. SBA will not relax 
licensing standards to achieve numerical licensing goals or ensure that 
the full amount allocated to the Early Stage initiative is used.
    Proposed Sec.  107.320(a) and (b) would add two selection criteria 
specific to Early Stage SBICs. For risk management purposes, SBA 
considers it important to have adequate diversification of Early Stage 
SBICs with respect to ``vintage year'' (the year in which an investment 
fund draws its initial capital from investors). Because of the cyclical 
nature of venture capital, vintage year has a major impact on the 
return expectations of a fund and excessive concentration in a single 
year could substantially increase program risk. Therefore, SBA will 
reserve the right, when licensing Early Stage SBICs, to maintain 
diversification across vintage years.
    Similarly, SBA will reserve the right to maintain diversification 
of Early Stage SBICs with respect to geographic location. SBA's primary 
concern in terms of geography is to ensure that the Early Stage 
initiative includes assistance to small businesses located in areas 
outside the traditional hubs for venture capital investment.
    SBA expects that the Early Stage licensing process, like the 
standard SBIC licensing process, will have two phases: (1) An initial 
review focused primarily on management qualifications and planned 
investment strategy, for which applicants submit a Management 
Assessment Questionnaire (MAQ); and (2) a licensing phase requiring 
submission of a complete license application, including the licensing 
fee, organizational documents for the proposed SBIC, principals' 
fingerprints and personal history statements that will be used to 
perform criminal history checks, and evidence that the applicant has 
raised sufficient private capital to carry out its business plan. 
Applicants who submit a MAQ in the first phase progress to the second 
phase only if SBA issues a ``green light'' letter inviting them to do 
so. In the standard licensing process, the green light letter is valid 
for 18 months, allowing the applicant time to raise private capital and 
prepare the full application. In the interests of making capital 
available to early stage small businesses as quickly as possible, SBA 
expects to have a more compressed licensing process for Early Stage 
SBICs. Although applicants may be able to continue their fundraising 
activities for a limited time after submitting an application, SBA 
anticipates that they will be required to show substantial progress 
towards their targeted private capital by the application deadline. 
After this rule has been finalized, SBA intends to publish a Federal 
Register notice with further details regarding licensing of Early Stage 
SBICs, including the period during which applications will be accepted.
    Section 107.565--Restrictions on third-party debt of Early Stage 
SBICs. Proposed new Sec.  107.565 would apply to any non-SBA debt of an 
Early Stage SBIC. Current Sec.  107.550 requires an SBIC with 
outstanding leverage to obtain SBA's prior written approval of any 
secured third party debt, but no approval is required for unsecured 
debt. The proposed rule would require an Early Stage SBIC to obtain SBA 
approval to have, incur or refinance any third-party debt, even if it 
is unsecured. SBA believes this is a prudent restriction for Early 
Stage SBICs because of their higher risk profile. Even debt that is 
unsecured increases SBA's credit risk because SBA leverage is never 
senior to the claims of other unsecured creditors: The first $10 
million of SBA leverage is generally subordinated to other unsecured 
debt of an SBIC, and leverage above $10 million is pari passu with 
other unsecured debt.
    Section 107.585--Voluntary decrease in Licensee's Regulatory 
Capital. The current regulation permits an SBIC to reduce its 
Regulatory Capital by as much as two percent in any fiscal year. Any 
reduction in excess of two percent requires SBA's prior written 
approval. A reduction in Regulatory Capital typically occurs when an 
SBIC returns capital to its investors. SBA is proposing special 
distribution rules for Early Stage SBICs to mitigate the additional 
risk associated with early stage investing (see proposed Sec.  
107.1180). To avoid any possible inconsistency between current Sec.  
107.585 and proposed Sec.  107.1180, the proposed rule would require 
any reduction of Regulatory Capital under Sec.  107.585 by an Early 
Stage SBIC to be approved by SBA in writing.
    Section 107.692--Examination fees. SBA intends to closely monitor 
the performance of Early Stage SBICs to help manage the higher risk 
associated with early stage investing. All SBICs undergo periodic 
regulatory compliance examinations, and SBA expects that examinations 
of Early Stage SBICs will include particular attention to the value of 
unrealized investments. Under the proposed amendments to Sec.  107.692, 
SBA would charge Early Stage SBICs an examination fee that is 10 
percent higher than the base fee until all debenture leverage has been 
repaid and no further leverage will be issued. This is the same fee 
structure applied to participants in SBA's Participating Securities 
SBIC program.
    Section 107.1120--General eligibility requirements for Leverage. 
Proposed paragraph (k) of this section would provide for a new 
certification by Early Stage SBICs seeking an SBA leverage commitment 
or draw. The Early Stage SBIC would be required to certify that it will 
provide at least 50 percent of the aggregate dollar amount of its 
financings to ``early stage'' companies, in accordance with the Early 
Stage SBIC definition in Sec.  107.50. SBA seeks input from the public 
on whether 50% minimum is an appropriate level of early stage 
investments. SBA has proposed a prospective certification, rather than 
a certification stating that the Early Stage SBIC currently complies 
with the early stage investment requirement, to provide flexibility for 
a fund to take advantage of good investment opportunities when they 
occur. SBA intends to monitor Early Stage SBICs' performance in making 
early stage investments, and would treat a failure to meet the 50 
percent requirement as an event of default under an Early Stage SBIC's 
leverage (see proposed Sec.  107.1810(f)(11)).
    Section 107.1150--Maximum amount of Leverage for a Section 301(c) 
Licensee. In this section, SBA is proposing special limits on the 
maximum amount of leverage that will be available to an Early Stage 
SBIC.

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First, the maximum amount that SBA would commit to an Early Stage SBIC 
on a lifetime basis would be 100 percent of the SBIC's highest 
Regulatory Capital or $50 million, whichever is less. In addition, the 
maximum leverage that an Early Stage SBIC could have outstanding at any 
time would be limited to 100 percent of its paid-in private capital 
(``Leverageable Capital'') or $50 million, whichever is less. Finally, 
the cumulative amount of leverage drawn by an Early Stage SBIC could 
not exceed the cumulative amount of private capital paid into the fund 
by its investors. The reason for these limits is two-fold. First, early 
stage investing is an inherently high risk activity. Second, SBA plans 
to allocate a relatively small amount of leverage to the Early Stage 
initiative (up to $200 million per year over five years). Under the 
existing rules for leverage eligibility, which permit a single SBIC to 
have outstanding leverage of up to $150 million, the entire allocation 
could be used up by a very small number of SBICs, resulting in 
insufficient portfolio diversification and increased risk to SBA. 
Although a leverage ceiling of less than $50 million per fund would 
improve diversification still further, SBA believes a lower limit could 
make the Early Stage initiative unattractive to many prospective fund 
managers and investors.
    Section 107.1180--Required distributions to SBA by Early Stage 
SBICs. In this section, SBA is proposing to add distribution 
requirements that would apply only to Early Stage SBICs. The current 
regulations generally allow a debenture SBIC to distribute profits to 
its investors, with no obligation to prepay debentures prior to their 
maturity date (although SBICs may prepay debentures in whole at any 
time without penalty). SBA believes that applying these rules to Early 
Stage SBICs would result in an unacceptably high risk of default. 
Compared to most debenture SBICs, the returns realized by Early Stage 
SBICs are expected to be irregular and unpredictable, with a few 
investments producing large profits while many other investments may 
result in complete or partial losses. Depending on when profits are 
realized, the existing distribution rules could result in losses to SBA 
even if an Early Stage SBIC generates positive returns overall. For 
example, an Early Stage SBIC that earned large profits early in its 
life could distribute all of those profits to its private investors, 
assuring them of a net positive return on their investment, and 
thereafter perform poorly and default on its SBA leverage. To reduce 
this type of risk, the proposed rule would require an Early Stage SBIC 
to make a distribution to SBA whenever it makes a distribution to its 
investors. Distributions could be made on any quarterly Payment Date 
(March 1, June 1, September 1, or December 1). SBA would apply any such 
distribution to the repayment of the SBIC's outstanding debentures. 
Proposed Sec.  107.1180(b) states that all distributions to SBA would 
be applied to repayment of outstanding debentures in the same order as 
they were issued. Like other debenture leverage, debentures issued by 
Early Stage SBICs could be prepaid in whole but not in part. Under 
proposed Sec.  107.1180(c), payment of all interest and Charges due and 
payable on outstanding debentures would be required as a condition of 
making a distribution; such interest and Charges could be paid either 
prior to or simultaneously with a distribution.
    Proposed Sec.  107.1180 would apply equally to all distributions, 
including distributions of profits and returns of invested capital. 
However, Early Stage SBICs would still be subject to Sec.  107.585 (as 
revised by this proposed rule), which limits an SBIC's ability to 
reduce its Regulatory Capital. The practical effect of this limitation 
is that an Early Stage SBIC would have to obtain SBA's prior written 
approval for any distribution that is not from profits. For a 
distribution that is from profits, an Early Stage SBIC must notify SBA 
in writing at least 10 business days before the planned distribution 
date.
    SBA's share of a distribution would depend on the Early Stage 
SBIC's ``highest ratio'' of outstanding leverage to Leverageable 
Capital, and its Capital Impairment Percentage (CIP), as determined 
under existing Sec.  107.1840. Under proposed Sec.  107.1180(d)(2)(i), 
if the CIP is less than 50 percent, distributions would be allocated 
pro rata (based on the ``highest ratio'') between SBA (up to the amount 
of the outstanding debenture leverage) and the Early Stage SBIC's 
investors. For example, if an Early Stage SBIC with a CIP of less than 
50 percent has $25 million of contributed capital from its investors 
and has drawn $25 million of leverage from SBA, the distribution would 
be allocated 50% to the investors and 50% to SBA. If the Early Stage 
SBIC has $30 million of contributed capital from its investors and has 
drawn only $20 million of leverage from SBA, the distribution would be 
allocated 60% to the investors and 40% to SBA. An Early Stage SBIC's 
``highest ratio'' of outstanding leverage to Leverageable Capital, 
rather than the ratio at the time of the distribution, will be used to 
determine SBA's share of a distribution. Thus, even if the Early Stage 
SBIC repays SBA leverage or other events occur that cause a reduction 
in the Early Stage SBIC's ratio of outstanding leverage to Leverageable 
Capital, it would continue to base the allocation of future 
distributions on the ``highest ratio'' rather than the current ratio.
    Under proposed Sec.  107.1180(d)(2)(ii), if the CIP reached 50 
percent or more, SBA would receive 100 percent of any distribution 
until all outstanding debentures have been repaid. However, if the 
Early Stage SBIC reduces its CIP below 50 percent, it could resume 
distributions to its investors, as described above. SBA expects that 
all or nearly all Early Stage SBICs will have a maximum allowable CIP 
of 70 percent, as determined under existing Sec.  107.1830, so a 50 
percent CIP would not indicate a condition of Capital Impairment. 
However, SBA believes that its ability to take priority in 
distributions when the CIP reaches 50 percent is an appropriate risk 
reduction measure for the Early Stage initiative, based on historical 
data showing that a high proportion of SBICs that reach a 50 percent 
CIP go on to exceed their maximum allowable CIP.
    Proposed Sec.  107.1180(d)(3) and (d)(4) would provide for a 
``true-up'' of cumulative distributions each time an Early Stage SBIC 
makes a distribution. SBA believes that with the true-up, the proposed 
distribution rules would operate more consistently, with fewer 
distortions created by differences among SBICs in the timing of gains 
and losses.
    Proposed Sec.  107.1180(d)(3) would multiply an Early Stage SBIC's 
total cumulative distributions (including the SBIC's current proposed 
distribution) by SBA's percentage share of cumulative distributions 
calculated under Sec.  107.1180(d)(2). The sum of all prior 
distributions to SBA would then be subtracted from this cumulative 
result to calculate the amount distributable to SBA under proposed 
Sec.  107.1180(d)(4). Under proposed Sec.  107.1180(d)(5), the actual 
dollar amount to be distributed to SBA would be the smallest of three 
figures: The amount calculated under Sec.  107.1180(d)(4); the total 
amount of the SBIC's planned distribution; and the total debenture 
leverage outstanding.
    Following is an example of the distribution mechanics for an Early 
Stage SBIC with a ``highest leverage ratio'' of 1:
    First distribution: SBIC's outstanding leverage and Leverageable 
Capital are both equal to $5 million and its CIP is zero. The SBIC 
wants to distribute profits of $20 million. The SBIC is current on all 
debenture interest and

[[Page 76911]]

fees. On a pro rata basis, SBA and the SBIC's investors would each 
receive 50 percent of the distribution, or $10 million. However, the 
most that SBA can receive is $5 million, the total amount of leverage 
outstanding. Therefore, the SBIC's investors would receive $15 million.
    Second distribution: SBIC's outstanding leverage is $15 million, 
Leverageable Capital is $20 million, and CIP is zero. The SBIC wants to 
distribute profits of $10 million. The SBIC's highest leverage ratio 
remains at 1. Total cumulative distributions (prior and current) equal 
$30 million, of which SBA's share under Sec.  107.1180(d)(3) would 
equal $15 million. Under Sec.  107.1180(d)(4), the $5 million that SBA 
received from the first distribution must then be subtracted from the 
$15 million. The result, $10 million, is the smallest of the three 
amounts under proposed Sec.  107.1180(d)(5), so SBA would receive $10 
million and the SBIC's investors would receive no distribution. On a 
cumulative basis, SBA and the investors would have received $15 million 
each that shows each step of the calculation listed in Table 1, Early 
Stage SBIC Distribution Example:

             Table 1--Early Stage SBIC Distribution Example
                          (Dollars in millions)
------------------------------------------------------------------------
                                       Distribution  1   Distribution  2
------------------------------------------------------------------------
(1) Leverageable capital............              $5.0             $20.0
(2) Outstanding leverage............               5.0              15.0
(3) Cumulative leverage issued......               5.0              20.0
(4) Leverage ratio..................              1.00              0.75
(5) Current proposed distribution...              20.0              10.0
(6) Cumulative distributions........              20.0              30.0
(7) Highest leverage ratio..........              1.00              1.00
(8) Capital impairment percentage...                0%                0%
(9) [Highest Leverage Ratio/(Highest             50.0%             50.0%
 Leverage Ratio + 1)] x 100.........
(10) Line (6) x Line (9)............              10.0              15.0
(11) Prior distributions to SBA.....               0.0               5.0
(12) Line (10) minus Line (11)......              10.0              10.0
(13) Amount of distribution to SBA    ................  ................
 equals least of:...................
    (i) Line (12)...................              10.0              10.0
    (ii) Line (5)...................              20.0              10.0
    (iii) Line (2)..................               5.0              15.0
        SBA's Share of Distribution.               5.0              10.0
        Investors' Share of                       15.0  ................
         distribution...............
Post Distribution: Cumulative                      5.0              15.0
 Distributions to SBA...............
Cumulative Distributions to                       15.0              15.0
 investors..........................
------------------------------------------------------------------------

    Proposed Sec.  107.1180(e) would allow an Early Stage SBIC to 
prepay debenture leverage in order of issue without making any 
distribution to its investors. This type of voluntary prepayment could 
be made on any quarterly Payment Date.
    Section 107.1181--Interest reserve requirements for Early Stage 
SBICs. This section would require an Early Stage SBIC to maintain funds 
in reserve to cover interest and Charges on its outstanding debentures. 
This provision is an important element of risk management for the Early 
Stage initiative because Early Stage SBICs are not expected to generate 
current interest or dividend income, which for most debenture SBICs is 
the primary source of cash used to service their SBA debt.
    SBA expects that some Early Stage SBICs will seek SBA leverage in 
the form of a discounted debenture, which will not require cash 
interest payments during the first five years of its term. Instead, the 
proceeds received by the Early Stage SBIC when the debenture is issued 
will be discounted; over the first five years following issuance, the 
carrying value of the debenture will accrete until it reaches face 
value, and semi-annual interest payments will be required beginning in 
year six. No interest reserve will be required for these discounted 
debentures.
    For standard debentures, an Early Stage SBIC would be required to 
maintain a reserve equal to the total interest and annual Charge that 
will be payable on each such debenture over the first five years of its 
term. The reserve may consist of binding unfunded commitments from the 
Early Stage SBIC's Institutional Investors and/or ``restricted'' cash 
held by the Early Stage SBIC. Neither such unfunded commitments nor 
such restricted cash could be used for any purpose other than payment 
of interest, Charges, and any other amounts due to SBA. Restricted cash 
would be held in a separate bank account and reported separately from 
other cash in the Early Stage SBIC's financial statements. The required 
reserve associated with an individual debenture would be reduced on 
each Payment Date as the Early Stage SBIC made the required payment of 
interest and Charges. Furthermore, if the Early Stage SBIC prepaid a 
debenture, the reserve requirement associated with that debenture would 
be correspondingly eliminated. The interest reserve requirement and the 
associated restrictions on the general partner's ability to call 
capital would have to be included in the Early Stage SBIC's limited 
partnership agreement.
    Section 107.1182--Valuation requirements for Early Stage SBICs 
based on Capital Impairment Percentage. This section would require an 
Early Stage SBIC to notify SBA in writing if it has a Capital 
Impairment Percentage of at least 50 percent, even if its maximum 
allowable CIP is higher. When SBA receives this notification, or makes 
its own determination that the CIP is at least 50 percent, SBA would 
have the right to require the Early Stage SBIC to engage a third party 
valuation expert, acceptable to SBA, to perform valuations of some or 
all of the licensee's investments, as determined by SBA. This provision 
would give SBA an important monitoring tool to guide decision-making 
with respect to Early Stage SBICs that have begun to experience some 
financial difficulty.

[[Page 76912]]

    Section 107.1810--Events of default and SBA's remedies for 
Licensee's noncompliance with terms of Debentures. SBA is proposing 
four changes in this section that would apply only to Early Stage 
SBICs. First, existing Sec.  107.1810(f)(2) provides that an improper 
distribution made by an SBIC is an event of default. Proposed Sec.  
107.1810(f)(2)(iv) would add distributions by Early Stage SBICs, as 
permitted under proposed Sec.  107.1180, to the list of specific 
distributions that would not be considered improper distributions.
    Second, under proposed new Sec.  107.1810(f)(11), it would be an 
event of default if an Early Stage SBIC fails to meet the requirement 
to invest at least 50 percent of its financing dollars in early stage 
companies, as defined under the proposed Early Stage SBIC definition in 
Sec.  107.50. This provision would require an Early Stage SBIC to meet 
the 50 percent requirement as soon as the total dollars invested to 
date are equal to or greater than Regulatory Capital. At that point, a 
typical Early Stage SBIC would have deployed at least half of its total 
funds available for investment and thus would have had ample 
opportunity to seek a variety of investment opportunities. Third, under 
proposed new Sec.  107.1810(f)(12), it would be an event of default if 
an Early Stage SBIC fails to maintain the interest reserve required 
under proposed Sec.  107.1181, as discussed earlier in this preamble.
    The conditions in proposed Sec.  107.1810(f)(11) and (f)(12) would 
both be in the category of events of default with opportunity to cure. 
If the Early Stage SBIC fails to cure to SBA's satisfaction, SBA could 
invoke the remedies in existing Sec.  107.1810(g), which include the 
right to declare outstanding debenture leverage immediately due and 
payable.
    Finally, proposed new Sec.  107.1810(j) would provide SBA with 
additional remedies to help maximize recoveries from Early Stage SBICs 
that have been transferred to a liquidation status. Under this section, 
if SBA must honor its guarantee and pay the principal of an Early Stage 
SBIC's debentures, upon such payment SBA would have the right to 
prohibit the SBIC from making additional investments without SBA 
approval (except for any investments the SBIC had already legally 
committed itself to make); to prohibit Distributions by the SBIC to any 
party other than SBA until all leverage and other amounts due to SBA 
have been repaid; to require all the SBIC's investor commitments to be 
funded at the earliest time(s) permitted under the SBIC's limited 
partnership agreement and other applicable documents; to review and re-
determine the SBIC's approved Management Expenses (as defined in 
existing Sec.  107.520); and to the appointment of SBA or its designee 
as receiver for the SBIC. The receivership would be for the purpose of 
continuing the SBIC's operations; the appointment of a liquidating 
receiver is governed by existing provisions of the Small Business 
Investment Act and is not affected by this proposed rule.

B. Technical Changes to Regulations

    Section 107.130--Requirement for qualified management. SBA is 
proposing one clarification in this section. The current regulation 
provides that an applicant must show ``[w]hen applying for a license'' 
that it has a qualified management team with the knowledge and 
experience to make the type of investments contemplated by the 
applicant's business plan and SBA regulations. SBA has interpreted this 
section as requiring an SBIC to also maintain a qualified management 
team post-licensing, and has taken measures including suspending 
leverage draws when it determines that a qualified management team is 
not present. The proposed rule would make clear that a licensed SBIC 
(including an Early Stage SBIC) must have qualified management as long 
as it has a license.
    Section 107.1130--Leverage fees and additional charges payable by 
Licensee. This section includes two changes to bring the regulation 
into conformity with statutory requirements. Current Sec.  107.1130(d) 
provides for a 1 percent annual fee (``Charge'') that SBICs must pay on 
their outstanding SBA leverage, whether in the form of debentures or 
participating securities. However, section 303(b) of the Act (as 
amended by section 2(a)(1)(B) of P.L. 107-100, December 21, 2001) 
provides for the Charge on debentures to be adjusted annually as 
necessary to keep the debenture program at zero cost to taxpayers, and 
sets a maximum annual Charge of 1.38 percent. Section 303(g)(2) of the 
Act (as amended by section 117 of Pub. L 108-84, September 30, 2003) 
provides for the Charge on participating securities to be similarly 
adjusted and sets a maximum annual Charge of 1.46 percent. Proposed 
Sec.  107.1130(d)(1) and (d)(2) would conform to these two statutory 
provisions and to SBA's actual practice in determining the annual 
Charge to be paid by SBICs.
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)
Executive Order 12866
    The Office of Management and Budget has determined that this rule 
is a ``significant'' regulatory action under Executive Order 12866. The 
Regulatory Impact Analysis is set forth below.
1. Necessity of Regulation
    The Small Business Investment Act of 1958 identifies the SBIC 
program's mission as follows: ``to stimulate and supplement the flow of 
private equity capital and long-term loan funds which small business 
concerns need for the sound financing of their business operations and 
for their growth, expansion, and modernization, and which are not 
available in adequate supply * * *'' Based on venture capital industry 
data (ThomsonOne VentureXpert), SBA believes that early stage 
businesses lack access to needed financing capital. Although the 
venture industry provided over $22 billion in financings to U.S. 
businesses in calendar year 2010, this represented over a 23% decline 
from 2007. Less than a third of these financing dollars went to early 
stage or start-up businesses. Given the decline in venture capital 
financings over the past 3 years, SBA seeks to expand access to early 
stage businesses by implementing an initiative to provide up to $1 
billion in debenture leverage over five years (beginning in FY 2012) to 
a limited number of SBICs focused on early stage investments.
    If SBA debenture leverage is to be used to finance early stage 
small businesses, the high risk associated with such investments 
indicates the need for more protections than those provided by the 
standard SBIC debenture and current regulations to mitigate risk and 
cost to the taxpayer. SBA is proposing regulatory changes to manage the 
risks associated with an early stage portfolio, including: (1) Limiting 
leverage for an individual Early Stage SBIC to 100 percent of 
Regulatory Capital or $50 million, whichever is less; (2) establishing 
special distribution rules to require repayment of leverage whenever an 
Early Stage SBIC makes distributions to its investors; and (3) 
implementing risk monitoring actions appropriate to SBA's leverage 
guarantor/creditor status. Even with these actions, in order to 
maintain an initial subsidy rate of zero for the debenture program 
while limiting the increase in leverage fees, SBA can only issue 
leverage to Early

[[Page 76913]]

Stage SBICs as a very small percentage of its portfolio.
2. Alternative Approaches to Regulation
    SBA considered several alternatives to these proposed regulations. 
The first alternative was for SBA not to pursue the Early Stage 
initiative and continue with its current credit policy of not providing 
debenture leverage to SBICs that focus on early stage equity investing. 
SBA rejected this alternative because of the critical need for early-
stage funding, particularly in the $1 to $5 million range that fits 
well with SBA's small business size standards.
    SBA also considered seeking legislation for a new program 
specifically focused on investing in early stage small businesses. 
Although such an alternative could have provided an opportunity to 
introduce useful risk-management provisions, such as SBA profit 
sharing, SBA chose not to pursue this alternative because of the 
compelling need to begin assisting early stage small businesses as 
quickly as possible. A third alternative was for SBA to modify its 
credit policies to license and approve leverage to qualified early 
stage focused SBICs without changes in program regulations or in the 
terms of debenture leverage. SBA believes that doing so would not be 
financially responsible and would present an excessively high risk of 
losses to the taxpayer. Ultimately, SBA decided that it could 
responsibly license a limited number of early stage SBICs after 
implementing appropriate regulatory changes to manage the associated 
risk.
    In proposing the definition for an Early Stage SBIC, SBA considered 
both the type of investment that should qualify as ``early stage'' and 
whether an Early Stage SBIC's portfolio should be limited to early 
stage investments exclusively. Many small businesses in the earliest 
stages of product development (``seed stage'' companies) could benefit 
from access to additional capital. However, SBA chose not to limit the 
Early Stage initiative to seed stage investments because of their high 
risk and the long holding periods they typically require. Although 
Early Stage SBICs would not be prohibited from investing in seed stage 
companies, to use SBA debenture leverage successfully they will likely 
need to start generating cash returns on investments within 4 to 6 
years after licensing. This timing concern is also why the proposed 
definition requires only 50 percent of an Early Stage SBIC's portfolio 
to be in early stage investments. This standard would allow Early Stage 
SBICs to make some later stage investments that may produce current 
income or have shorter holding periods, thereby reducing the risk of 
default on SBA leverage.
    In determining the maximum amount of leverage for which an Early 
Stage SBIC would be eligible, SBA decided that a one-to-one match 
between leverage and private capital (one ``tier'' of leverage) would 
provide the best balance between program cost and attractiveness to 
fund managers and investors. A second tier of leverage would result in 
a much higher projected loss rate, and a correspondingly greater 
increase in annual leverage fees for all debenture SBICs receiving new 
leverage commitments. SBA also considered a model in which SBA would 
have provided only half a tier of leverage. This lower ratio of 
leverage to private capital would have a much lower impact on leverage 
fees but would be unlikely to attract high quality fund managers and 
investors.
    SBA also considered various dollar limits on the maximum leverage 
available to an Early Stage SBIC, in order to avoid an excessive 
concentration of risk in a small number of funds. A low dollar limit 
could allow more funds to be licensed, but could be unattractive to 
stronger applicants with the ability to raise and deploy larger amounts 
of capital. SBA believes the proposed limit of $50 million is 
sufficient to attract high quality applicants. SBA also believes that 
$50 million of leverage, in combination with at least $50 million of 
private capital, is more than adequate to support a primarily early 
stage portfolio, with most financings expected to be in the $1 to $5 
million range.
3. Potential Benefits and Costs
    SBA anticipates that this proposed rule would provide significant 
benefit to early stage small businesses seeking investments by Early 
Stage SBICs. In estimating the impact, SBA considered that $1 billion 
in anticipated leverage will be matched by a minimum of $1 billion in 
private capital over the next 5 years, beginning in FY 2012. SBA 
expects that Early Stage SBICs will invest over a 5 to 7 year period 
after licensing. Allowing for payment of management expenses and 
interest, SBA estimates that the Early Stage initiative will result in 
approximately $125 million annually in financings to small businesses 
over an 8 to 10 year period.
    The proposed rule would impose additional cost in the form of 
increased annual fees on all debenture SBICs seeking new leverage 
commitments. The estimated cost has been incorporated into the program 
formulation model which determines the annual fee needed to keep the 
debenture program's original subsidy cost at zero, as required by law. 
For FY 2012, SBA has budgeted $150 million in leverage commitments to 
Early Stage SBICs, within the anticipated appropriated SBIC Debenture 
loan levels, representing approximately 7 percent of total expected 
debenture commitments. This 7 percent allocation would increase the 
annual fee on all new debenture commitments by approximately 13.7 basis 
points. This increase reflects the additional risk associated the early 
stage equity investments contemplated by the Early Stage initiative. 
Early stage investing is higher-risk than the typical SBIC portfolio, 
and would have required fees in excess of statutory caps, if operated 
on a stand-alone bases. To align fees and costs to the taxpayers with 
the overall policy goals, the Early Stage initiative incorporates terms 
designed to mitigate risk, and is limited to no more than $200 million 
per fiscal year to keep the annual fees at reasonable levels. The cost 
is expected to vary each year based on the factors and assumptions used 
to develop the annual fee, including the total amount of debenture 
leverage commitments estimated, the amount committed to Early Stage 
SBICs, and interest rates.
Executive Order 12988
    This action meets applicable standards set forth in section 3(a) 
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize 
litigation, eliminate ambiguity, and reduce burden. The action does not 
have retroactive or presumptive effect.
Executive Order 13563
    A description of the need for this regulatory action and benefits 
and costs associated with this action is included above in the 
Regulatory Impact Analysis under Executive Order 12866.
    In connection with the launch of the President's ``Start-Up America 
Initiative'', SBA announced its commitment to making financing 
available to early stage small businesses through the SBIC program. In 
an effort to engage interested parties in this regulatory action, SBA 
has since made presentations at SBIC association meetings, Start-up 
America-related public events, and venture capital industry forums to 
discuss both the market need for new sources of early stage financing 
and key issues associated with the design of the Early Stage 
initiative. Participants were broadly supportive of using the SBIC 
program to expand the financing options available to early stage small

[[Page 76914]]

businesses, while adding key protective provisions to manage program 
risk.
Executive Order 13132
    SBA has determined that this proposed 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, 
for the purposes of Executive Order 13132, Federalism, SBA has 
determined that this proposed rule has no federalism implications 
warranting the preparation of a federalism assessment.
Paperwork Reduction Act, 44 U.S.C. Ch. 35
    SBA has determined that this Early Stage SBIC proposed rule will 
not impose additional reporting or recordkeeping requirements. Early 
Stage SBIC applicants will submit the same license application form as 
other SBIC program applicants (OMB Control Number 3245-0062). Post-
licensing, Early Stage SBICs will have the same recordkeeping and 
reporting requirements as any other licensed SBIC.
Regulatory Flexibility Act, 5 U.S.C. 601-612
    When an agency promulgates a rule, the Regulatory Flexibility Act 
(5 U.S.C. 601-612) requires the agency to prepare an initial regulatory 
flexibility analysis (IRFA) describing the potential economic impact of 
the rule on small entities and alternatives that may minimize that 
impact. Section 605 of the RFA allows an agency to certify a rule, in 
lieu of preparing an IRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This proposed rule affects all SBICs issuing debentures, of which there 
are approximately 160, most of which are small entities. Therefore, SBA 
has determined that this proposed rule will have an impact on a 
substantial number of small entities. However, SBA has determined that 
the impact on entities affected by the rule will not be significant. 
SBA intends to maintain the SBIC program's initial subsidy cost to 
taxpayers at zero by charging up front and annual fees on its leverage. 
SBA calculates the annual fee each year using historical data to assess 
the appropriate fee to offset expected losses. The actual costs for 
SBIC guarantees may be higher or lower, and SBA will monitor program 
performance closely. Because SBA expects Early Stage SBICs to be 
riskier than standard SBICs, the annual fees needed to keep the 
debenture program's original subsidy cost at zero are higher. For FY 
2012, SBA estimates $150 million leverage commitments to Early Stage 
SBICs, which increases the annual fee charged to all SBICs seeking new 
debenture commitments by approximately 13.7 basis points. Since annual 
leverage fees were introduced in FY 1998, the annual fee has ranged 
from a high of 100 basis points (1 percent) to a low of 29 basis 
points, with a 13-year median of 88 basis points. Although the cost 
will vary in the future based on economic factors and assumptions used 
to develop the annual fee, SBA expects the fee to remain under 1 
percent, comparable to historical annual fees and below the statutory 
maximum of 1.38 percent. For debenture leverage committed and drawn by 
SBICs in FY 2012, SBA estimates that the sum of the debenture interest 
rate plus the annual fee will be in the vicinity of 5 percent. 
Debenture SBICs typically use the proceeds of debenture leverage to 
make loans to small businesses at interest rates in the 12 to 16 
percent range, providing them with a significant spread over their cost 
of funds. Accordingly, the Administrator of the SBA hereby certifies 
that this rule will not have a significant impact on a substantial 
number of small entities. SBA welcomes 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, SBA proposes to amend part 
107 of title 13 of the Code of Federal Regulations 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, 687m and Pub. L. 106-554, 114 Stat. 2763; and Pub. L. 111-5, 
123 Stat. 115.

    2. Amend Sec.  107.50 by adding a definition of ``Early Stage 
SBIC'' and revising the definition of ``Payment Date,'' to read as 
follows:


Sec.  107.50  Definitions of terms.

* * * * *
    Early Stage SBIC means a Section 301(c) Partnership Licensee, 
licensed pursuant to Sec.  107.310 of this part, in which at least 50 
percent of all Loans and Investments (in dollars) must be made to Small 
Businesses that are ``early stage'' companies at the time of the 
Licensee's initial Financing. For the purposes of this definition, an 
``early stage'' company is one that has never achieved positive cash 
flow from operations in any fiscal year.
* * * * *
    Payment Date means:
    (1) For a Participating Securities issuer, each February 1, May 1, 
August 1, and November 1 during the term of a Participating Security, 
or
    (2) For an Early Stage SBIC, each March 1, June 1, September 1, and 
December 1 during the term of a Debenture.
* * * * *
    3. Amend Sec.  107.130 by revising the first sentence to read as 
follows:


Sec.  107.130  Requirement for qualified management.

    When applying for a license, and while you have a license, you must 
show, to the satisfaction of SBA, that your current or proposed 
management team is qualified and has the knowledge, experience and 
capability necessary for investing in the types of businesses 
contemplated by the Act, the regulations in this part 107, and your 
business plan. * * *
    4. Amend Sec.  107.210 by revising the paragraph subject heading 
and the first sentence of paragraph (a)(1) introductory text and adding 
paragraph (a)(3) to read as follows:


Sec.  107.210  Minimum capital requirements for Licensees.

    (a) * * *
    (1) Licensees other than Participating Securities issuers and Early 
Stage SBICs. Except for Participating Securities issuers and Early 
Stage SBICs, a Licensee must have Regulatory Capital of at least 
$5,000,000. * * *
* * * * *
    (3) Early Stage SBICs. An Early Stage SBIC must have Regulatory 
Capital of at least $20 million.
* * * * *
    5. Amend Sec.  107.300 by revising the introductory text and adding 
paragraph (d) to read as follows:


Sec.  107.300  License application form and fee.

    The license application must be submitted on SBA Form 2181 together 
with all applicable exhibits on SBA Form 2182 and a non-refundable 
processing fee computed as follows:
* * * * *

[[Page 76915]]

    (d) All applicants seeking to be licensed as Early Stage SBICs will 
pay the fee for a Partnership Licensee plus an additional $10,000 fee, 
for a total of $25,000.
    6. Add Sec.  107.305 to read as follows:


Sec.  107.305  Evaluation of license applicants.

    SBA will evaluate a license applicant based on the submitted 
application materials, any interviews with the applicant's management 
team, and the results of background investigations, public record 
searches, and other due diligence conducted by SBA and other Federal 
agencies. SBA's evaluation will consider factors including the 
following:
    (a) Management qualifications, including demonstrated investment 
skills and experience as a principal investor; business reputation; 
adherence to legal and ethical standards; record of active involvement 
in making and monitoring investments and assisting portfolio companies; 
successful history of working as a team; and experience in developing 
appropriate processes for evaluating investments and implementing best 
practices for investment firms.
    (b) Performance of managers' prior investments, including 
investment returns measured both in percentage terms and in comparison 
to appropriate industry benchmarks; the extent to which investments 
have been realized as a result of sales, repayments, or other exit 
mechanisms; and the contribution of prior investments to the growth of 
portfolio company revenues and number of employees.
    (c) Applicant's proposed investment strategy, including clarity of 
objectives; strength of management's rationale for pursuing the 
selected strategy; compliance with this part 107 and applicable 
provisions of part 121 of this chapter; fit with management's skills 
and experience; and the availability of sufficient resources to carry 
out the proposed strategy.
    (d) Applicant's proposed organizational structure and fund 
economics, including compliance with this part 107; soundness of 
financial projections and underlying assumptions; a compensation plan 
that provides managers with appropriate economic incentives; a 
reasonable basis for allocations of profits and fees to Persons not 
involved in management; and governance procedures that provide 
appropriate checks and balances.
    7. Add Sec.  107.310 to read as follows:


Sec.  107.310  When and how to apply for licensing as an Early Stage 
SBIC.

    From time to time, SBA will publish a Notice in the Federal 
Register, inviting the submission of applications for licensing as an 
Early Stage SBIC. SBA will not consider an application from an Early 
Stage SBIC applicant that is under Common Control with another Early 
Stage SBIC applicant or an existing Early Stage SBIC (unless it has no 
outstanding Leverage or Leverage commitments and will not seek 
additional Leverage in the future). Applicants must comply with both 
the regulations in this part 107 and any requirements specified in the 
Notice, including submission deadlines. The Notice will specify 
procedures for a particular application period.
    8. Add Sec.  107.320 to read as follows:


Sec.  107.320  Evaluation of Early Stage SBICs.

    SBA will evaluate an Early Stage SBIC license applicant based on 
the same factors applicable to other license applicants, as set forth 
in Sec.  107.305, with particular emphasis on managers' skills and 
experience in evaluating and investing in early stage companies. In 
addition, SBA reserves the right to maintain diversification among 
Early Stage SBICs with respect to:
    (a) The year in which they commence operations, and
    (b) Their geographic location.
    9. Add Sec.  107.565 to read as follows:


Sec.  107.565  Restrictions on third-party debt of Early Stage SBICs.

    If you are an Early Stage SBIC and you have outstanding Leverage or 
a Leverage commitment, you must get SBA's prior written approval to 
have, incur, or refinance any third-party debt other than accounts 
payable from routine business operations.
    10. Amend Sec.  107.585 by revising the first sentence to read as 
follows:


Sec.  107.585  Voluntary decrease in Licensee's Regulatory Capital.

    You must obtain SBA's prior written approval to reduce your 
Regulatory Capital by more than two percent in any fiscal year, unless 
otherwise permitted under Sec. Sec.  107.1560 and 107.1570, provided 
however, that if you are an Early Stage SBIC, you must obtain SBA's 
prior written approval for any reduction of your Regulatory Capital, 
including any reduction pursuant to a Distribution under Sec.  107.1180 
of this part. * * *
    11. Amend Sec.  107.692 by redesignating paragraphs (c)(4) and (5) 
as paragraphs (c)(5) and (6), adding a new paragraph (c)(4), and 
revising the table in paragraph (d) to read as follows:


Sec.  107.692  Examination fees.

* * * * *
    (c) * * *
    (4) If you are an Early Stage SBIC with outstanding Leverage or 
Leverage commitments, you will pay an additional charge equal to 10% of 
your base fee;
* * * * *
    (d) * * *

----------------------------------------------------------------------------------------------------------------
                                              Amount of                                            Amount of
                                            discount--% of                                       addition--% of
        Examination fee discounts          base examination      Examination fee additions      base examination
                                                 fee                                                  fee
----------------------------------------------------------------------------------------------------------------
No prior violations.....................                 15  Partnership or limited liability                  5
                                                              company.
Responsiveness..........................                 10  Participating Security Licensee.                 10
                                                             Records/Files at multiple                        10
                                                              locations.
                                                             Early Stage SBIC................                 10
----------------------------------------------------------------------------------------------------------------

* * * * *
    12. Amend Sec.  107.1120 by adding paragraph (k) to read as 
follows:


Sec.  107.1120  General eligibility requirements for Leverage.

* * * * *
    (k) If you are an Early Stage SBIC, certify in writing that at 
least 50 percent of the aggregate dollar amount of your Financings will 
be provided to ``early stage'' companies as defined under the 
definition of Early Stage SBIC in Sec.  107.50 of this part.
    13. Amend Sec.  107.1130 by revising the first sentence of 
paragraph (d)(1) and the first sentence of paragraph (d)(2) to read as 
follows:


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

* * * * *
    (d) * * *
    (1) Debentures. You must pay to SBA a Charge, not to exceed 1.38 
percent per annum, on the outstanding amount of your Debentures issued 
on or after October 1, 1996, payable under the same

[[Page 76916]]

terms and conditions as the interest on the Debentures. * * *
    (2) Participating Securities. You must pay to SBA a Charge, not to 
exceed 1.46 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. * * *
* * * * *
    14. Amend Sec.  107.1150 by revising the first sentence of the 
introductory text and adding paragraph (d) to read as follows:


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

    A Section 301(c) Licensee, other than an Early Stage SBIC, may have 
maximum outstanding Leverage as set forth in paragraphs (a) through (c) 
of this section. An Early Stage SBIC may have maximum outstanding 
Leverage as set forth in paragraph (d) of this section. * * *
* * * * *
    (d) Early Stage SBICs. Subject to SBA's credit policies, if you are 
an Early Stage SBIC:
    (1) The total amount of any and all Leverage commitments you 
receive from SBA shall not exceed 100 percent of your highest 
Regulatory Capital or $50 million, whichever is less;
    (2) On a cumulative basis, the total amount of Leverage you have 
issued shall not exceed the total amount of capital paid in by your 
investors; and
    (3) The maximum amount of Leverage you may have outstanding at any 
time is the lesser of:
    (i) 100 percent of your Leverageable Capital, or
    (ii) $50 million.
    15. Amend Subpart I of Part 107 by adding an undesignated center 
heading and by adding new Sec. Sec.  107.1180, 107.1181, and 107.1182 
to read as follows:

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

* * * * *

Special Rules for Leverage Issued by an Early Stage SBIC


Sec.  107.1180  Required distributions to SBA by Early Stage SBICs.

    (a) Distribution requirement. If you are an Early Stage SBIC with 
outstanding Leverage, you may make Distributions to your investors and 
to SBA only as permitted under this Sec.  107.1180. You may make a 
Distribution on any Payment Date. Unless SBA permits otherwise, you 
must notify SBA in writing of any planned distribution under this 
section, including computations of the amounts distributable to SBA and 
your investors, at least 10 business days before the distribution date.
    (b) How SBA will apply Distributions. Any amounts you distribute to 
SBA, or its designated agent or Trustee, under this Sec.  107.1180 will 
be applied to repayment of principal of outstanding Debentures in order 
of issue. You may prepay any Debenture in whole, but not in part, on 
any Payment Date without penalty.
    (c) Condition for making a Distribution. You may make a 
Distribution under this Sec.  107.1180 only if you have paid all 
interest and Charges on your outstanding Debentures that are due and 
payable, or will pay such interest and Charges simultaneously with your 
Distribution.
    (d) SBA's share of Distribution. For each proposed Distribution, 
determine SBA's share of the Distribution as follows:
    (1) Determine the highest ratio of outstanding Leverage to 
Leverageable Capital that you have ever attained (your ``Highest 
Leverage Ratio''). For the purpose of determining your Highest Leverage 
Ratio, any deferred interest Debentures issued at a discount must be 
included in the computation at their face value.
    (2) Determine SBA's percentage share of cumulative Distributions:
    (i) If your Capital Impairment Percentage under Sec.  107.1840 is 
less than 50 percent as of the Distribution date, SBA's percentage 
share of cumulative Distributions equals:
    [Highest Leverage Ratio/(Highest Leverage Ratio + 1)] x 100
    For example, if your Highest Leverage Ratio equals 1, then SBA's 
share of any distribution you make will be 50 percent.
    (ii) If your Capital Impairment Percentage under Sec.  107.1840 is 
50 percent or greater as of the Distribution date, SBA's percentage 
share of cumulative Distributions equals 100 percent.
    (3) Multiply the sum of all your prior Distributions and your 
current proposed Distribution (including Distributions to SBA, your 
limited partners and your General Partner) by SBA's percentage share of 
cumulative Distributions as determined in paragraph (d)(2) of this 
section.
    (4) From the result in paragraph (d)(3) of this section, subtract 
the sum of all your prior Distributions to SBA under this Sec.  
107.1180.
    (5) The amount of your Distribution to SBA will be the least of:
    (i) The result in paragraph (d)(4) of this section;
    (ii) Your current proposed Distribution; or
    (iii) Your outstanding Leverage.
    (e) Additional Leverage prepayment. On any Payment Date, subject to 
the terms of your Leverage, you may make a payment to SBA to be applied 
to repayment of the principal of one or more outstanding Debentures in 
order of issue, without making any Distribution to your investors.


Sec.  107.1181  Interest reserve requirements for Early Stage SBICs.

    (a) Reserve requirement. If you are an Early Stage SBIC with 
outstanding Leverage, for each Debenture which requires periodic 
interest payments to SBA during the first five years of its term, you 
must maintain a reserve sufficient to pay the interest and Charges on 
such Debenture for the first 21 Payment Dates following the date of 
issuance. This reserve may consist of any combination of the following:
    (1) Binding unfunded commitments from your Institutional Investors 
that cannot be called for any purpose other than the payment of 
interest and Charges to SBA, or the payment of any amounts due to SBA; 
and
    (2) Cash maintained in a separate bank account or separate 
investment account permitted under Sec.  107.530 of this part and 
separately identified in your financial statements as ``restricted 
cash'' available only for the purpose of paying interest and Charges to 
SBA, or for the payment of any amounts due to SBA.
    (b) Your limited partnership agreement must incorporate the reserve 
requirement in paragraph (a) of this section.


Sec.  107.1182  Valuation requirements for Early Stage SBICs based on 
Capital Impairment Percentage.

    (a) If you are an Early Stage SBIC, you must compute your Capital 
Impairment Percentage and determine whether you have a condition of 
Capital Impairment in accordance with Sec. Sec.  107.1830 and 107.1840 
of this part.
    (b) You must promptly notify SBA in writing if your Capital 
Impairment Percentage is at least 50 percent, even if your maximum 
permitted Capital Impairment Percentage is higher.
    (c) Upon receipt of your notification under paragraph (b) of this 
section, or upon making its own determination that your Capital 
Impairment Percentage is at least 50 percent, SBA has the right to 
require you to engage, at your expense, an independent third party, 
acceptable to SBA, to prepare valuations of some or

[[Page 76917]]

all of your Loans and Investments, as designated by SBA.
    16. Amend Sec.  107.1810 by revising paragraphs (f)(2)(ii) and 
(iii) and adding paragraphs (f)(2)(iv), (f)(11), (f)(12), and (j) to 
read as follows:


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

* * * * *
    (f) * * *
    (2) * * *
    (ii) Payments from Retained Earnings Available for Distribution 
based on either the shareholders' prorata interests or the provisions 
for profit distributions in your partnership agreement, as appropriate;
    (iii) Distributions by Participating Securities issuers as 
permitted under Sec. Sec.  107.1540 through 107.1580; and
    (iv) Distributions by Early Stage SBICs as permitted under Sec.  
107.1180.
* * * * *
    (11) Failure by an Early Stage SBIC to meet investment 
requirements. You are an Early Stage SBIC and, beginning on the first 
fiscal quarter end when your cumulative total Financings (in dollars) 
are at least equal to your Regulatory Capital, you have not made at 
least 50 percent of such Financings to Small Businesses that at the 
time of your initial Financing were ``early stage'' companies, as 
defined under the definition of Early Stage SBIC in Sec.  107.50 of 
this part.
    (12) Failure by an Early Stage SBIC to maintain required interest 
reserve. You are an Early Stage SBIC and you fail to maintain a 
sufficient reserve to pay interest and Charges on your Debentures as 
required under Sec.  107.1181 of this part.
* * * * *
    (j) Additional SBA remedies applicable to Debentures issued by 
Early Stage SBICs.
    If you are an Early Stage SBIC, upon SBA's payment pursuant to its 
guarantee of any of your Debentures, SBA shall have the following 
additional rights and you consent to SBA's exercise of any or all of 
such rights:
    (1) To prohibit you from making any additional investments except 
for investments under legally binding commitments you entered into 
before such payment by SBA and, subject to SBA's prior written 
approval, investments that are necessary to protect your investments;
    (2) Until all Leverage is repaid and amounts related thereto are 
paid in full, to prohibit Distributions by you to any party other than 
SBA, its agent or Trustee;
    (3) To require all your commitments from investors to be funded at 
the earliest time(s) permitted in accordance with your Articles;
    (4) To review and re-determine your approved Management Expenses; 
and
    (5) To the appointment of SBA or its designee as your receiver 
under section 311(c) of the Act for the purpose of continuing your 
operations.

    Dated: December 6, 2011.
Karen G. Mills,
Administrator.
[FR Doc. 2011-31658 Filed 12-8-11; 8:45 am]
BILLING CODE 8025-01-P