[Federal Register Volume 78, Number 246 (Monday, December 23, 2013)]
[Proposed Rules]
[Pages 77377-77380]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-30504]



[[Page 77377]]

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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG57


Small Business Investment Companies--Investments in Passive 
Businesses

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: The U.S. Small Business Administration (SBA) proposes to 
revise the regulations for the Small Business Investment Company (SBIC) 
program concerning investments in passive businesses. SBICs are 
generally prohibited from investing in passive businesses under the 
Small Business Investment Act of 1958, as amended, as well as under 
SBIC program regulations. Currently these program regulations provide 
for exceptions that allow an SBIC to structure an investment utilizing 
a passive small business as a pass-through under certain limited 
circumstances. One such exception provides that an SBIC may make an 
investment in a passive small business that passes through the 
investment proceeds to one or more subsidiaries, each of which must be 
a non-passive small business. The proposed rule would modify this 
exception to allow an SBIC to structure an investment utilizing two 
passive small businesses as pass-through entities. This modification 
would place SBICs on an equal footing with their non-SBIC counterparts 
in the venture capital and private equity sectors, in which investments 
structured with two passive levels, are not uncommon.
    This proposed rule also includes several technical corrections. 
Specifically, the proposed rule would update the regulations by 
replacing obsolete Standard Industrial Classification (SIC) codes with 
their equivalents under the North American Industrial Classification 
System (NAICS); correct erroneous paragraph cross-references; and 
modernize the options for meeting the record preservation requirements 
by removing the reference to ``microfilm.''

DATES: Comments on the proposed rule must be received on or before 
January 22, 2014.

ADDRESSES: You may submit comments, identified by RIN 3245-AG57, by any 
of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail, Hand Delivery/Courier: Pravina Raghavan, Deputy 
Associate Administrator for Investment, U.S. Small Business 
Administration, 409 Third Street SW., Washington, DC 20416.
SBA will post comments 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, Office of Investment 
and Innovation, (202) 205-7559 or [email protected].

SUPPLEMENTARY INFORMATION:

A. Passive Businesses

Section 107.720--Small Businesses That May Be Ineligible for Financing

    The Small Business Investment Act of 1958, as amended, prohibits an 
SBIC from making passive investments. Accordingly, SBA promulgated 13 
CFR 107.720(b), which states as a general rule that an SBIC is not 
permitted to finance a passive business. The regulation defines a 
business as passive if: (1) It is not engaged in a regular and 
continuous business operation; (2) its employees do not carry on the 
majority of day-to-day operations, and the company does not exercise 
day-to-day control and supervision over contract workers; or (3) the 
business passes through substantially all financing proceeds to another 
entity.
    The current regulation provides exceptions to the general 
prohibition that allow SBICs to employ certain structures in which the 
direct recipient of financing is a passive business, but the end 
recipient is an active business. SBA is proposing to expand the 
exception set out in Sec.  107.720(b)(2), which permits an SBIC to 
finance a passive Small Business (as defined in 13 CFR 107.50) if it 
passes through substantially all the proceeds to one or more 
``subsidiary companies, each of which is an eligible Small Business 
that is not passive.'' A subsidiary company is currently defined as one 
in which the financed passive business owns at least 50 percent of the 
outstanding voting securities. This exception allows, for example, an 
SBIC to provide financing to ABC Holdings, a passive Small Business, as 
long as the proceeds are passed through to and used by its subsidiary, 
ABC Manufacturing, a non-passive Small Business. SBA also interprets 
Sec.  107.720(b)(2) to permit a financing to ABC Holdings that is used 
to acquire an ownership interest in ABC Manufacturing, which post-
acquisition would be a subsidiary of ABC Holdings.
    To summarize, current Sec.  107.720(b)(2) allows an SBIC to finance 
a passive Small Business only if it passes the proceeds directly to one 
or more non-passive Small Business subsidiaries (or uses the proceeds 
to acquire one or more non-passive Small Businesses that will become 
its directly-owned subsidiaries). The proposed rule would modify the 
definition of a subsidiary company to allow financing proceeds to pass 
through a second passive business before reaching a non-passive 
subsidiary. Under proposed Sec.  107.720(b)(2), a ``subsidiary 
company'' would be defined as one in which the passive business that 
receives financing from an SBIC owns at least 50 percent of the 
outstanding voting securities, either (1) as the direct owner of the 
subsidiary company, or (2) as the direct owner of a second passive 
Small Business, which in turn is the direct owner of the voting 
securities of the subsidiary. This revised definition would not change 
the requirement that a passive recipient of SBIC financing own at least 
50% of the active business that ultimately receives the proceeds (or 
that the proceeds are used to acquire); rather it would allow for 
indirect ownership through a second passive Small Business.
    Following is an example of a transaction structure that the 
proposed revision of Sec.  107.720(b)(2) would permit: An SBIC proposes 
to provide financing to Newco, a newly-formed passive holding company, 
to help acquire an active Small Business, ABC Manufacturing Company 
(``ABC Mfg''). Newco will participate in the acquisition with other 
investors. The investor group forms passive ABC Acquisition Company 
(``ABC Acquisition''), with 50 percent of its voting securities being 
owned by Newco. ABC Acquisition acquires 100 percent of the voting 
securities of ABC Mfg. Post-acquisition, Newco owns 50 percent of the 
outstanding voting securities of ABC Mfg indirectly through its 
ownership of ABC Acquisition. Therefore, ABC Mfg qualifies as a 
subsidiary of Newco, and the proposed financing is permitted.
    The proposed rule would allow SBICs to have greater flexibility in 
structuring transactions. Private equity and venture capital firms that 
are not SBICs may structure investments with two passive

[[Page 77378]]

levels for a number of reasons. For example:
    1. In syndicated transactions involving a number of participants, a 
multi-level structure may make it easier to allocate income to 
different classes of investors.
    2. Some transactions are structured with a mix of taxable and non-
taxable entities to accommodate investors' varying needs.
    3. Certain transactions involving the purchase of the stock of an S 
Corporation generally must be structured with two levels of passive 
entities in order to take advantage of favorable tax treatment under 
section 338(h)(10) of the Internal Revenue Code.
    By putting SBICs on an equal footing with their non-SBIC 
counterparts in the venture capital and private equity sectors, the 
proposed rule may help to expand the resources available to Small 
Businesses through the SBIC program by attracting additional capital 
and qualified fund managers. At the same time, the proposed rule would 
continue to limit the complexity of transactions permitted by Sec.  
107.720(b)(2) by allowing no more than two passive levels. SBA notes 
that while a number of SBICs have voiced support for an expansion of 
the exception in current Sec.  107.720(b)(2), none has indicated a need 
to structure transactions with more than two levels of passive holding 
companies.

B. Technical Changes to Regulations

Section 107.600--General Requirement of Licensee To Maintain and 
Preserve Records

    The record-keeping requirements applicable to SBICs are found 
primarily in Sec.  107.600. This section enumerates various types of 
records and the periods for which they must be preserved. The final 
paragraph of the section, Sec.  107.600(c)(4), allows an SBIC to 
substitute ``a microfilm or computer-scanned or generated copy'' for 
any original paper record. The proposed rule would modernize this 
provision by deleting the reference to ``microfilm'' as a preservation 
medium.

Section 107.720--Small Businesses That May Be Ineligible for Financing

    Real Estate Businesses. Under current Sec.  107.720(c), an SBIC is 
not permitted to finance ``any business classified under Major Group 65 
(Real Estate) or Industry No. 1531 (Operative Builders) of the SIC 
Manual'' with exceptions provided for certain business that provide 
services within the real estate industry (such as title abstract 
companies). The ``SIC Manual'' refers to the Standard Industrial 
Classification system formerly used by Federal statistical agencies in 
classifying business establishments for the purpose of collecting, 
analyzing, and publishing statistical data related to the U.S. business 
economy. In 1997, the Federal government replaced the SIC codes with 
the North American Industrial Classification System (NAICS).
    The proposed rule would update 13 CFR 107.720(c) by replacing SIC 
codes with their 2012 NAICS equivalents. SBA's intention is to 
duplicate the existing general prohibitions and permitted exceptions as 
closely as possible. The following tables show each of the SIC codes 
referenced in the current regulation and the NAICS code that SBA 
proposes to replace it with.

                 Crosswalk From SIC Codes to NAICS Codes
------------------------------------------------------------------------
                SIC Code                            NAICS Code
------------------------------------------------------------------------
                         Prohibited Investments
------------------------------------------------------------------------
6512 Operators of nonresidential         531120 Lessors of
 buildings.                               nonresidential buildings
                                          (except miniwarehouses)
6513 Operators of apartment buildings..  531110 Lessors of residential
                                          buildings and dwellings
6514 Operators of dwellings other than
 apartment buildings.
6515 Operators of residential mobile     531190 Lessors of other real
 home sites.                              estate property
6517 Lessors of railroad property......
6519 Lessors of real property, not
 elsewhere classified.
6552 Land subdividers and developer,     237210 Land subdivision
 except cemeteries.
1531 Operative builders................  236117 New housing for-sale
                                          builders
                                         236118 Residential remodelers
                                          \1\
                                         236210 Industrial building
                                          construction\1\
                                         236220 Commercial and
                                          institutional building
                                          construction \1\
------------------------------------------------------------------------
\1\ An SBIC may not finance a Small Business classified under this code
  if such business is primarily engaged in construction or renovation of
  properties on its own account rather than as a hired contractor.


------------------------------------------------------------------------
                SIC Code                            NAICS Code
------------------------------------------------------------------------
                         Restricted Investments
------------------------------------------------------------------------
6531 Real estate agents and managers     531210 Offices of real estate
 (establishments primarily engaged in     agents and brokers
 renting, buying, selling, managing,
 and appraising real estate for others).
                                         531311 Residential property
                                          managers
                                         531312 Nonresidential property
                                          managers
                                         531320 Offices of real estate
                                          appraisers
                                         531390 Other activities related
                                          to real estate
Permitted only if business derives at    Permitted only if business
 least 80% of its revenue from non-       derives at least 80% of its
 Affiliate sources.                       revenue from non-Affiliate
                                          sources.
------------------------------------------------------------------------


------------------------------------------------------------------------
                SIC Code                            NAICS Code
------------------------------------------------------------------------
                          Permitted Investments
------------------------------------------------------------------------
6541 Title abstract offices............  541191 Title abstract and
                                          settlement offices
------------------------------------------------------------------------


[[Page 77379]]

    The only SIC code in the current regulation that does not 
correspond directly to one or more NAICS codes is 1531, ``Operative 
builders.'' The SIC Manual described this industry as consisting of 
establishments primarily engaged in the construction (including 
renovation) of single-family houses and other buildings for sale on 
their own account rather than as contractors. The industry included 
speculative builders and condominium developers. The 2012 NAICS codes 
primarily use the term ``for-sale builder'' to describe businesses 
engaged in construction or renovation of buildings on their own 
account. However, except for those engaged in new housing construction 
(NAICS code 236117), for-sale builders are combined with contractors in 
three different NAICS codes, depending on whether they are engaged in 
residential remodeling (NAICS code 236118), manufacturing/industrial 
building construction (NAICS code 236210), or commercial/institutional 
building construction (NAICS code 236220). The proposed rule would 
prohibit an SBIC from providing financing to a Small Business 
classified under any of these three NAICS codes only if the company 
were primarily engaged in construction or renovation of buildings as a 
for-sale builder. Guidance provided by the United States Census Bureau 
indicates that the key distinction is whether a firm is engaged in 
construction on its own account, as opposed to having been hired as a 
contractor. For example, an SBIC would be permitted to provide 
financing to a firm that primarily renovates or builds additions to 
homes if the homeowners have contracted for the firm's services. 
However, a firm that primarily acquires homes to renovate and re-sell 
at its own risk is a for-sale remodeler that would not be eligible for 
financing by an SBIC.

Section 107.1150--Maximum Amount of Leverage for a Section 301(c) 
Licensee

    Current Sec.  107.1150(e), which sets forth leverage eligibility 
provisions for SBICs that make Energy Saving Qualified Investments (as 
defined in 13 CFR 107.50), erroneously refers to ``paragraph (d)'' 
instead of ``paragraph (e). The proposed rule would correct these 
references.

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 not a ``significant'' regulatory action under Executive Order 12866. 
This is also not a ``major'' rule under the Congressional Review Act, 5 
U.S.C. 801, et seq.

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 13132

    The proposed rule would not have substantial direct effects on the 
States, or the distribution of power and responsibilities among the 
various levels of government. Therefore, for the purposes of Executive 
Order 13132, Federalism, SBA determines that this proposed rule has no 
federalism implications warranting the preparation of a federalism 
assessment.

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

    For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA 
has determined that this rule would not impose any new reporting or 
recordkeeping requirements.

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

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601, requires 
administrative agencies to consider the effect of their actions on 
small entities, small non-profit businesses, and small local 
governments. Pursuant to the RFA, when an agency issues a rule, the 
agency must prepare an Initial Regulatory Flexibility Act (IRFA) 
analysis which describes whether the impact of the rule will have a 
significant economic impact on a substantial number of small entities. 
However, Sec.  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 would affect all SBICs, of which there are currently 
close to 300. SBA estimates that approximately 75% of these SBICs are 
small entities. Therefore, SBA has determined that this proposed rule 
would have an impact on a substantial number of small entities. 
However, SBA has determined that the impact on entities affected by the 
rule would not be significant. The passive business provision would 
provide SBICs with additional flexibility to employ a transaction 
structure commonly used by private equity or venture capital funds that 
are not SBICs.
    SBA asserts that the economic impact of the rule, if any, would be 
minimal and entirely beneficial to small SBICs. Accordingly, the 
Administrator of the SBA certifies that this rule would not have a 
significant impact on a substantial number of small entities.

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

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

0
1. The authority citation for part 107 continues to read as follows:

    Authority:  15 USC 681 et seq., 683, 687(c), 687b, 687d, 687g, 
687m, Pub. L. 106-554, 114 Stat. 2763; and Pub. L.111-5, 123 Stat. 
115.


Sec.  107.50  [Amended]

0
2. Amend Sec.  107.50 by removing the definition of ``SIC Manual''.
0
3. Revise Sec.  107.600(c)(4) to read as follows:


Sec.  107.600  General requirement for Licensee to maintain and 
preserve records.

* * * * *
    (c) * * *
    (4) You may substitute a computer-scanned or generated copy for the 
original of any record covered by this paragraph (c).
0
4. Amend Sec.  107.720 by revising paragraphs (b)(2) and (c)(1), and 
the introductory text of paragraph (c)(2) to read as follows:


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

* * * * *
    (b) * * *
    (2) Exception for pass-through of proceeds to subsidiary. You may 
finance a passive business if it is a Small Business and it passes 
substantially all the proceeds through to one or more subsidiary 
companies, each of which is an eligible Small Business that is not 
passive. For the purpose of this paragraph (b)(2), ``subsidiary 
company'' means a company in which the Financed passive business 
either:
    (i) Directly owns at least 50 percent of the outstanding voting 
securities, or
    (ii) Indirectly owns at least 50 percent of the outstanding voting 
securities (by directly owning at least 50% of the

[[Page 77380]]

outstanding voting securities of another passive Small Business that is 
the direct owner of at least 50% of the outstanding voting securities 
of the subsidiary company).
* * * * *
    (c) Real Estate Businesses. (1) You are not permitted to finance 
any business classified under North American Industry Classification 
System (NAICS) codes 531110 (lessors of nonresidential buildings except 
miniwarehouses), 531120 (lessors of residential buildings and 
dwellings), 531190 (lessors of other real estate property), 237210 
(land subdivision), or 236117 (new housing for-sale builders). You are 
not permitted to finance any business classified under NAICS codes 
236118 (residential remodelers), 236210 (industrial building 
construction), or 236220 (commercial and institutional building 
construction), if such business is primarily engaged in construction or 
renovation of properties on its own account rather than as a hired 
contractor. You are permitted to finance a business classified under 
NAICS codes 531210 (offices of real estate agents and brokers), 531311 
(residential property managers), 531312 (nonresidential property 
managers), 531320 (offices of real estate appraisers), or 531390 (other 
activities related to real estate), only if such business derives at 
least 80 percent of its revenue from non-Affiliate sources.
    (2) You are not permitted to finance a Small Business, regardless 
of NAICS classification, if the Financing is to be used to acquire or 
refinance real property, unless the Small Business:
* * * * *
0
5. Amend Sec.  107.1150 by revising paragraphs (e)(1), (e)(2)(iii), and 
(e)(2)(iv) to read as follows:


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

* * * * *
    (e) Additional Leverage based on Energy Saving Qualified 
Investments in Smaller Enterprises. (1) Subject to SBA's credit 
policies, if you were licensed on or after October 1, 2008, you may 
have outstanding Leverage in excess of the amounts permitted by 
paragraphs (a) and (b) of this section in accordance with this 
paragraph (e). Any investment that you use as a basis to seek 
additional Leverage under this paragraph (e) cannot also be used to 
seek additional Leverage under paragraph (c) of this section.
* * * * *
    (2) * * *
    (iii) Subtract from your outstanding Leverage the lesser of 
(e)(2)(i) or (e)(2)(ii).
    (iv) If the amount calculated in paragraph (e)(2)(iii) is less than 
the maximum Leverage determined under paragraph (a) of this section, 
the difference between the two amounts equals your additional Leverage 
availability.

    Dated: November 14, 2013.
Jeanne Hulit,
Acting Administrator.
[FR Doc. 2013-30504 Filed 12-20-13; 8:45 am]
BILLING CODE 8025-01-P