[Federal Register Volume 81, Number 181 (Monday, September 19, 2016)]
[Proposed Rules]
[Pages 64075-64080]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-21509]


 ========================================================================
 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
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  Federal Register / Vol. 81, No. 181 / Monday, September 19, 2016 / 
Proposed Rules  

[[Page 64075]]



SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG68


Small Business Investment Companies (SBIC); Early Stage 
Initiative

AGENCY: U.S. Small Business Administration.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: In this proposed rule, SBA is making changes to its Early 
Stage Small Business Investment Company (SBIC) initiative, which was 
launched in 2012 as a 5-year effort as part of President Obama's 
Startup America Initiative. The intent of the initiative was to license 
and provide SBA-guaranteed leverage to Early Stage SBICs that would 
focus on making investments in early stage small businesses. Although 
62 investment funds applied to the program, few satisfied SBA's 
licensing criteria. To date, SBA has only licensed five Early Stage 
SBICs. In an attempt to attract more qualified early stage fund 
managers, this rule proposes changes to the initiative with respect to 
licensing, non-SBA borrowing, and leverage eligibility. These proposed 
changes are based in part on feedback SBA received on an Advance Notice 
of Proposed Rulemaking (ANPRM) that was published in March 2015. In 
addition, this rule reflects SBA's intention to continue licensing and 
providing SBA-guaranteed leverage to Early Stage SBICs beyond the 5-
year term of the initiative, and proposes certain technical changes to 
SBA's Early Stage regulations.

DATES: Comments on the proposed rule must be received on or before 
October 19, 2016.

ADDRESSES: You may submit comments, identified by RIN 3245-AG68, by any 
of the following methods:
    Federal eRulemaking Portal: http://www.regulations.gov. Follow the 
instructions for submitting comments.
    Mail, Hand Delivery/Courier: Mark Walsh, Associate Administrator 
for the Office of Investment and Innovation, 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 Theresa Jamerson, Office of Investment and Innovation, 
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 or not it will 
publish the information.

FOR FURTHER INFORMATION CONTACT: Theresa Jamerson, Office of Investment 
and Innovation, (202) 205-7563.

SUPPLEMENTARY INFORMATION: 

I. Public Participation

    SBA invites comments, data, and information from all interested 
parties, including but not limited to investors, small businesses, 
advocacy groups, nongovernmental organizations, and legal 
representatives with relevant expertise on any and all aspects of this 
proposed rule. Comments that will provide the most assistance to SBA in 
developing these procedures will reference a specific portion of the 
proposed rule, explain the reason for any recommended change, and 
include data, information, or authorities that support such recommended 
change. SBA is generally seeking comments on:
    A. Proposed licensing requirements for Early Stage SBICs;
    B. Proposed evaluation of Early Stage SBICs by SBA;
    C. Proposed treatment of third-party debt of Early Stage SBICs;
    D. Proposed maximum amount of leverage for Early Stage SBICs, both 
individually and annually in aggregate;
    E. Constraints of equity versus debenture financing as articulated 
in the proposed rule;
    F. Treatment of interest reserve, capital impairment, and cost of 
money in the proposed rule;
    G. Alternative financing terms compared with those in the proposed 
rule, such as discounted debentures and longer-maturity debentures;
    H. Access by non-leveraged SBICs to Early Stage SBIC leverage under 
the proposed rule;
    I. Alignment of the proposed rule with early stage investment 
strategies, including the relatively long time horizons of early-stage 
investors in capital-intensive technologies; and
    J. Other suggested changes that SBA has not included in this 
proposal.
    SBA also invites comments on the economic and financial analyses 
supporting this rule.

II. Background Information

    In the Small Business Investment Act of 1958 (Act), Congress 
created the Small Business Investment Company (SBIC) program 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 . . . 
.'' 15 U.S.C. 661. Congress intended that the program ``be carried out 
in such manner as to insure the maximum participation of private 
financing sources.'' Id. In accordance with that policy, the U.S. Small 
Business Administration (SBA) does not invest directly in small 
businesses. Rather, through the SBIC program, SBA licenses and provides 
debenture leverage to SBICs. SBICs are privately-owned and 
professionally managed for-profit investment funds that make loans to, 
and investments in, qualified small businesses using a combination of 
privately raised capital and debenture leverage guaranteed by SBA. SBA 
will guarantee the repayment of debentures issued by an SBIC 
(Debentures) based on the amount of qualifying private capital raised 
by an SBIC up to a maximum amount of $150 million.
    The standard Debenture requires semi-annual interest payments. 
Consequently, most SBICs finance later stage small businesses with 
positive operating cash flow, and most structure their investments as 
loans or mezzanine debt in an amount that is at least sufficient to 
cover the SBIC's Debenture interest payments. Early stage companies 
typically do not have positive operating cash flow and therefore cannot 
make current interest or dividend payments. As a result, investments in 
early stage companies do not fit naturally with the structure of 
debenture leverage.
    Early stage businesses without the necessary assets or cash flow 
for

[[Page 64076]]

traditional bank funding face difficult challenges accessing capital. 
As a result of this capital gap, and as part of President Obama's 
Startup America Initiative, on April 27, 2012, SBA published a final 
rule (77 FR 25042) to define a new sub-category of SBICs. SBA's intent 
was to license over a 5-year period (fiscal years 2012 through 2016) 
venture funds focused on early stage businesses. Because Early Stage 
SBICs present a higher credit risk than traditional SBICs, that rule 
authorized SBA to guarantee Debentures only in an amount equal to each 
Early Stage SBIC's 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), up 
to a maximum guarantee amount of $50 million. SBA allocated $200 
million per year ($1 billion total) of its SBIC Debenture authorization 
over these years to this effort.
    Since 2012, SBA has received 62 applications to the Early Stage 
SBIC program, but licensed only five Early Stage SBICs. Those 
applicants that were not licensed failed to meet SBA's licensing 
criteria. Many of these applicants had management teams with limited 
track records and few positive realizations. In order to determine the 
market need for SBA to continue licensing Early Stage SBICs past fiscal 
year 2016, SBA sought input from the public through an Advance Notice 
of Proposed Rule Making (ANPRM) on March 18, 2015 (80 FR 14034). In the 
ANPRM, SBA also sought input regarding what changes should be made to 
the program to attract qualified early stage fund managers.
    Comments on the ANPRM and additional discussions SBA held with 
industry participants indicated that the program should be continued 
because funding gaps, especially in certain geographic areas and 
industries, continue to pose challenges for early stage businesses. 
Based on SBA's analysis of the financing data available on the 
PricewaterhouseCoopers' Moneytree Web site (www.pwcmoneytree.com), 
although the venture capital industry provided over $81 billion in 
financings to U.S. businesses between January 2014 and June 2015, less 
than a third went to early stage or start-up businesses. Additionally, 
venture capital financings were geographically focused, with over three 
quarters of venture capital dollars going to three states: California, 
New York, and Massachusetts.
    In comparison, based on financing data Early Stage SBICs reported 
in SBA Form 1031 (Portfolio Financing Report), Early Stage SBICs 
reported that over 69% of their financing dollars through September 
2015 were invested in states other than California, New York, or 
Massachusetts. Also, Early Stage SBICs reported that investments they 
have made in early stage small businesses have resulted in net job 
growth. SBA compared job data submitted by the existing Early Stage 
SBICs on SBA Form 1031 at the time of first financing to that submitted 
on SBA Form 468 (Annual Financial Report) for the reporting period as 
of December 31, 2014. This data indicated that Early Stage SBIC 
portfolio companies increased job growth on a net basis by 48% from the 
date of initial Early Stage SBIC investment through the reporting 
period.
    SBA received suggestions for program improvement both through the 
ANPRM and discussions with industry. This proposed rule incorporates 
some of those suggested changes.

III. Section by Section Analysis

Section 107.310--When and How To Apply for Licensing as an Early Stage 
SBIC

    The proposed rule would remove Sec.  107.310 in its entirety. The 
current regulation sets forth two restrictions specific to the 
licensing of Early Stage SBICs. First, Early Stage SBIC applications 
may be submitted only during a limited timeframe identified in a Notice 
published in the Federal Register (which SBA has published on an annual 
basis since 2012). This restriction was put in place to enable SBA to 
manage the flow of applicants and properly allocate the $200 million 
annual Early Stage leverage among all successful applicants. Since the 
demand for Early Stage licenses from qualified fund managers has been 
well below capacity, the proposed rule would allow Early Stage 
applicants to apply at any time, similar to other SBIC applicants. SBA 
believes that if the demand for Early Stage licenses increases to such 
an extent that SBA becomes concerned about leverage availability, SBA 
will be able to manage the flow of applicants and leverage issued 
through Sec.  107.320, an existing regulation that gives SBA the right 
to maintain diversification of Early Stage SBICs with respect to the 
year in which Early Stage SBICs commence operations.
    The second restriction set forth in current Sec.  107.310 states 
that SBA will not consider an application from an applicant under 
Common Control with an existing Early Stage SBIC that has outstanding 
Debentures or Debenture commitments. This requirement was put in place 
to promote fund manager diversification and because the short term 
duration of the original initiative would not have given existing Early 
Stage SBICs time to realize investments sufficiently to qualify for a 
subsequent fund. Since the proposed rule would make the initiative an 
ongoing part of the SBIC program, SBA is proposing to remove this 
restriction. SBA would review requests for subsequent Early Stage 
licenses similar to other SBIC subsequent license requests, by 
considering such factors as the existing SBIC's investment cycle, 
operating and regulatory history of the existing SBIC, anticipated co-
investment between the proposed and existing SBIC, realizations since 
the existing SBIC was licensed, forecasted realizations and repayment 
of leverage, and consistency of management teams and limited partners 
between the existing SBIC and applicant.
    One of SBA's strategic goals, as set forth in the FY2014-2018 
Strategic Plan, is to ensure inclusive entrepreneurship by expanding 
access and opportunity to small businesses and entrepreneurs, including 
women, minorities, veterans and other entrepreneurs, in communities 
where market gaps remain. SBA encourages fund managers with early stage 
investment strategies that focus on these diverse communities to apply 
for licensing as an Early Stage SBIC.

Section 107.320--Evaluation of Early Stage SBICs

    Current Sec.  107.320 gives SBA 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. 
The proposed rule would clarify that diversification by geographic 
location would be with regard to where the fund would be investing 
rather than where the fund is located. Although SBA believes that Early 
Stage investors typically invest close to where they are located since 
they are often actively involved with their portfolio companies, this 
proposed change would clarify SBA's original intent.

Section 107.565--Restrictions on Third-Party Debt of Early Stage SBICs

    Although current regulations allow standard SBICs to incur 
unsecured third party debt without SBA approval, current Sec.  107.565 
requires Early Stage SBICs to obtain prior SBA approval in order to 
have, incur or refinance any third party debt, whether secured or 
unsecured. This restriction was created because of the high risk 
profile of Early Stage SBICs. Even debt that is

[[Page 64077]]

unsecured increases SBA's credit risk because SBA leverage is never 
senior to the claims of other unsecured creditors: Under Sec.  107.560, 
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. Nonetheless, SBA recognizes that it is 
typical practice for investment funds, including those pursuing venture 
capital strategies, to use a line of credit to help bridge capital 
needs for financings--investment funds use lines of credit to fund 
financings and operations between capital calls, and can generally draw 
on a line of credit more quickly than investors pay in capital when 
called. To provide Early Stage SBICs access to this industry-standard 
tool while minimizing the credit risk to SBA, this proposed rule would 
allow current and future Early Stage SBICs to obtain an unsecured line 
of credit without SBA approval under the following conditions:
    (1) The line of credit is limited to the lesser of 20% of 
Regulatory Capital or total unfunded binding commitments from 
Institutional Investors minus any such commitments included in the 
Interest Reserve under Sec.  107.1181. Since the line of credit will be 
used to bridge private capital calls to enable an Early Stage SBIC to 
finance a small business, SBA believes that the line of credit should 
not exceed the maximum amount that may be invested into a single 
portfolio company. Existing Sec.  107.740 calculates the maximum amount 
an SBIC may invest in a single portfolio company based on certain 
changes to an SBIC's Regulatory Capital, but this amount is generally 
20% of Regulatory Capital. For simplicity, the proposed rule would set 
the borrowing limit to be no greater than 20% of Regulatory Capital as 
determined by the Capital Certificates submitted from time to time by 
the SBIC. Additionally, the line of credit should be no greater than 
the amount of capital available for call from investors. Early Stage 
SBICs use unfunded binding commitments from investors for three primary 
purposes: (1) To call capital to finance small businesses, (2) to call 
capital to fund operations, and (3) to fund the Interest Reserve 
required under Sec.  107.1181. Since Early Stage SBICs cannot call 
unfunded commitments associated with the Interest Reserve (unless they 
are using that capital to pay interest on SBA-guaranteed leverage or 
SBA annual charges), the line of credit should be no greater than 
unfunded binding commitments from Institutional Investors minus any 
commitments associated with the Interest Reserve.
    (2) The term of the line of credit does not exceed 24 months. Based 
on feedback from industry, SBA understands that most lines of credit 
are renewed on an annual basis. In this rule, SBA is proposing a 24 
month limitation on the duration of the line of credit, which SBA 
believes should be sufficiently long so as to not impact the standard 
maturity dates in typical line of credit documentation. An Early Stage 
SBIC may renew the line of credit during its lifecycle as long as each 
renewal is no longer than 24 months and the Early Stage SBIC is in 
compliance with the requirements of this section.
    (3) The line of credit is held by a federally regulated financial 
institution. SBA proposes this requirement, that the lender be 
regulated by a federal financial institutions regulator (e.g., the 
FDIC, OCC, or NCUA) to ensure that the lender is creditworthy, that the 
credit terms are reasonable and customary, and that the lender will not 
seek unusual remedies in the event of a default.
    (4) All borrowings under the line of credit: (i) Are not secured 
third-party debt, as that term is defined under Sec.  107.550(a); (ii) 
Are for the purpose of maintaining the Early Stage SBIC's operating 
liquidity or providing funds for a particular Financing of a Small 
Business; (iii) Must be fully repaid within 90 days after the date they 
are drawn; and (iv) Must be fully paid off for at least 30 consecutive 
days during the Early Stage SBIC's fiscal year. SBA proposes these 
requirements to ensure that such debt is unsecured, since secured third 
party debt presents a higher credit risk to SBA and must be approved by 
SBA under Sec.  107.550. Further, the third party debt must be solely 
for the purpose of maintaining the SBIC's operating liquidity or 
providing funds for a particular financing of a small business. 
Finally, since such borrowings are temporary in nature, the line of 
credit should be repaid quickly and not continuously refinanced. SBA 
believes these requirements are typical for a line of credit and would 
provide Early Stage SBICs with access to a standard industry tool while 
minimizing SBA's credit risk.

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

    Current Sec.  107.1150(c) limits Early Stage SBICs to SBA-
guaranteed leverage and leverage commitments of 100 percent of 
Regulatory Capital or $50 million, whichever is less. Originally, the 
$50 million maximum was set in order to provide increased diversity to 
the Early Stage SBIC portfolio. Comments to the Early Stage ANPRM 
indicated that a higher maximum would be more attractive to experienced 
early stage fund managers and suggested either $75 million or $100 
million as a maximum leverage ceiling. Given that SBA's goal is still 
to keep the overall amount of Early Stage leverage to $200 million in 
any given year, SBA believes that $75 million is responsive to the 
feedback SBA has received and is a more appropriate amount than $100 
million to help achieve diversification within the Early Stage program. 
This proposed maximum would be available to future Early Stage SBICs as 
well as existing Early Stage SBICs.
    The proposed rule would change the references to $50 million in 
both Sec.  107.1150(c)(1) and Sec.  107.1150(c)(3)(iii) to $75 million 
to reflect the increase in SBA-guaranteed leverage.
    It should be noted that SBA's approval of leverage commitments to, 
and draws by, Early Stage SBIC applicants would remain subject to SBA 
credit policies and SBA's overall SBIC Debenture leverage 
authorization. Also, as discussed above, under existing Sec.  107.320, 
SBA will also continue to maintain the right to require diversification 
among Early Stage SBICs by year and geography as part of the evaluation 
of Early Stage SBICs in the licensing process.

Compliance With Executive Orders 12866, 12988, 13132, 13563, 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
    As discussed above, early stage financing gaps remain, and SBA's 
Early Stage SBICs are financing these gaps and creating jobs. This 
proposed rule reflects SBA's intention to continue licensing and 
providing SBA-guaranteed leverage to Early Stage SBICs, and implements 
changes to improve the program and attract more qualified fund managers 
to continue to finance those gaps. Based on industry feedback, SBA 
believes that minor changes could improve the program without 
increasing credit risk to SBA. For example, removing the call process 
and accepting Early Stage SBIC applications on a rolling basis would 
allow fund managers to organize funds on their own timeline and allow 
fund managers

[[Page 64078]]

to apply in a manner more conducive to their fundraising process. In 
addition, increasing the maximum leverage to $75 million would be more 
attractive to qualified managers that are able to raise higher amounts 
of capital and are seeking more capital to round out their fundraising. 
At the same time, maintaining a maximum one to one ratio of leverage to 
private capital would permit this increase to maximum leverage without 
increasing the risk to SBA. Moreover, allowing fund managers of 
existing Early Stage SBICs to apply for a subsequent license would help 
successful fund managers continue to fund early stage small businesses. 
Finally, allowing Early Stage SBICs to access a line of credit, similar 
to other venture funds and standard SBICs, would streamline Early Stage 
SBIC cash management and operations.
2. Alternative Approaches to Regulation
    SBA considered making no changes to the Early Stage regulations and 
not issuing any further calls for Early Stage SBICs. However, based on 
industry feedback received through the ANPRM process, which is 
supported by industry statistics, gaps in the market place still remain 
for early stage financings. Because Early Stage SBICs are financing 
that gap and creating jobs, SBA decided to make the Early Stage program 
an ongoing part of the SBIC program and propose as part of this rule 
those changes suggested by industry that would not increase risk but 
would help to improve the program.
    As part of the ANPRM process and discussions with industry, SBA 
received several suggested changes that the Agency either could not 
implement or chose not to implement primarily due to cost and risk. 
These include the following:
     Implementing a true equity program. Although SBA agrees 
that an early stage investment strategy would be more ideally funded 
with equity capital than the currently structured Debenture, SBA is not 
authorized by the Act to take equity positions in SBICs or make direct 
equity investments in small businesses. SBA has tried to provide for a 
leverage structure that balances risk/cost and usability by venture 
investors.
     Lowering or removing the Interest Reserve. Early Stage 
SBICs currently have access to a Debenture that requires quarterly 
interest payments throughout its term. Current Sec.  107.1181 requires 
that for each Debenture that requires periodic interest payments to SBA 
during the first five years of its term, an Early Stage SBIC must 
maintain a reserve (consisting of either unfunded commitments from 
Institutional Investors or restricted cash in a segregated account) 
sufficient to pay the interest and annual charge on such Debenture for 
the first 21 payment dates following the date of issuance. SBA modeled 
both lowering the number of years required for the Interest Reserve and 
removing the Interest Reserve completely to identify the impact to the 
annual charge. The annual charge is an amount that SBA formulates each 
year and is paid by SBICs with outstanding leverage to offset projected 
SBIC Debenture losses and keep the Debenture program at zero subsidy 
cost. The Interest Reserve decreases SBA's credit risk for Early Stage 
SBICs; therefore, making the proposed changes to the Interest Reserve 
would have required all SBICs to pay a higher annual charge. SBA 
received input on these impacts from three of its five Early Stage 
SBICs, all of which preferred a lower annual charge rather than changes 
to the Interest Reserve. SBA therefore decided not to pursue this 
option.
     Implementing an accruing Debenture with longer maturity. 
In addition to the Debenture discussed above, Early Stage SBICs have 
access to a Debenture that is issued at a discount and does not require 
interest payments during the first five years of its term. In response 
to industry suggestions to modify the Debenture to align better with 
early stage cash flows, SBA considered creating a Debenture that would 
not be issued at a discount and would not require interest payments 
over a 10 or even 15 year period, but would accrue interest that would 
be payable at maturity. Evaluation of this instrument must take into 
account the fact that SBA's guarantee includes both the leverage 
principal and accrued interest. Using such a non-discounted accruing 
Debenture, if an Early Stage SBIC with $75 million in Regulatory 
Capital were to issue $75 million in Debentures, the $75 million in 
Debenture proceeds plus the accrued interest would exceed both the 1 
tier of leverage maximum and $75 million maximum leverage guarantee 
amount for the Early Stage SBIC. If an SBIC issued Debentures at the 
full face amount of $75 million with interest accruing at a 5% rate and 
an annual charge of 1%, this would accrue in 5 years to over $100 
million, in 10 years to over $134 million, and in 15 years to over $179 
million. At the 15 year point, the maximum leverage guarantee would 
exceed the maximum leverage allowed by statute. In this scenario, the 
Debentures must be issued at a discount, and extending the 5-year 
discount to a 10 or 15 year timeframe would decrease the amount of 
proceeds the Early Stage SBIC would receive at time of issuance. For 
example, a Debenture that would accrue in five years to $1 million may 
provide an Early Stage SBIC with only $750,000 in proceeds, based on a 
4% interest rate and a 1% annual charge. Increasing the accrual period 
to 10 years would reduce those proceeds to less than $600,000. At a 
higher interest rate, these Debenture proceeds would be reduced even 
further. SBA believes this would make the instrument less attractive.
     Providing more flexibility with regard to capital 
impairment. One of the ANPRM comments indicated that Early Stage SBICs 
should be provided with more flexibility in regard to capital 
impairment, the primary financial metric SBA uses to evaluate SBIC 
financial performance. Most Early Stage SBICs have a 70% maximum 
allowable capital impairment percentage (CIP). CIP measures the amount 
of operating and investment losses against an SBIC's Regulatory 
Capital. If an Early Stage SBIC exceeds its maximum CIP, after 
notifying the SBIC and giving the SBIC a cure period of at least 15 
days, SBA may invoke the remedies identified in Sec.  107.1810(g), 
which include, among other things, declaring the Debentures and any 
accrued interest immediately due and payable. SBA has decided not to 
modify the maximum allowable CIP for Early Stage SBICs because SBA 
generally experiences leverage losses with SBICs whose CIPs are in 
excess of 70%.
    Furthermore, the existing Early Stage regulations already include 
adequate flexibility for Early Stage SBICs with respect to CIP. SBA 
previously operated a program that focused on equity investment called 
the Participating Securities program. That program generally allowed 
SBICs to have up to 85% maximum CIP in the first five years following 
the first issuance of leverage. In originally developing the Early 
Stage rule, SBA noted that SBA incurred leverage losses for most 
Participating Securities SBICs when the SBIC's CIP went over 85%. For 
the few Participating Securities SBICs that did fully repay SBA 
leverage, higher CIPs were often the result of the loss of ``Class 2 
Appreciation'' on the SBIC's investments. Class 2 Appreciation, defined 
in Sec.  107.1840(d)(3), relates to unrealized appreciation on 
securities that are non-public securities of a small business based on 
a new round of outside financing within the last 24 months. After 24 
months, an SBIC's Class 2 Appreciation could ``time out'' and the SBIC 
would no longer receive credit for it in the CIP calculation.

[[Page 64079]]

Current Sec.  107.1845 allows Early Stage SBICs to request approval to 
extend the validity of Class 2 Appreciation beyond 24 months based on 
relevant information, including a third party valuation. SBA believes 
this provision provides sufficient flexibility for Early Stage SBICs 
with respect to CIP while properly limiting SBA's credit risk.
     Change cost of money rules for Early Stage SBICs. Current 
Sec.  107.855 generally limits the interest an SBIC may charge a small 
business on Debt Securities to 14 percent and Loans to 19 percent. SBA 
received comments that Early Stage SBICs should be allowed greater 
flexibility with cost of money provisions. SBA does not believe that 
such changes would significantly help Early Stage SBICs, which are 
primarily making equity investments that are not subject to the cost of 
money limitations.
     Non-leveraged SBIC access to Early Stage leverage. SBA 
received comments in response to the ANPRM stating that SBA should 
allow non-leveraged SBICs that have an early stage strategy to access 
Early Stage leverage. In the licensing process for non-leveraged 
applicants, SBA does not perform the same level of financial review 
that it does for applicants that intend to use leverage. A request of 
this type would require SBA to undertake a substantive review of the 
non-leveraged SBIC's qualifications that would, in many ways, be 
equivalent to a new license application. Moreover, nothing in SBA's 
regulations prevents a non-leveraged SBIC with an early stage focus 
from applying for the Early Stage SBIC program if that SBIC wishes to 
access Early Stage leverage. Therefore, SBA does not propose to 
implement this suggestion.
     Increase the maximum leverage to $100 million. Although 
SBA received comments that indicated the maximum leverage for Early 
Stage SBICs should be increased to $100 million, SBA was concerned 
that, based on its expected $200 million annual allocation of Early 
Stage leverage, this could concentrate the limited Early Stage 
allocation to only two funds per year. SBA therefore chose to propose a 
maximum leverage ceiling of only $75 million per year. SBA also 
considered only approving a higher maximum for new Early Stage SBIC 
applicants, but believes that existing Early Stage SBICs should be able 
to benefit from this increase.
3. Potential Benefits and Costs
    The proposed rule reflects SBA's intent to continue licensing and 
providing SBA-guaranteed leverage to Early Stage SBICs, and would make 
material improvements to the program. Even though currently licensed 
Early Stage SBICs are eligible for almost $220 million in commitments, 
Early Stage SBICs have requested and been approved for less than $113 
million in leverage commitments and have issued less than $44 million 
in Debentures through September 2015. Most venture funds have a 5-year 
investment period with follow-on financings in later years, so it is 
not unusual that these funds have not applied for or drawn all 
available leverage. SBA expects Early Stage SBICs to draw additional 
capital and leverage over a 5 to 7 year period to support financings 
and operational expenses, commensurate with this investment cycle. 
Despite the relatively small amount of leverage drawn, Early Stage 
SBICs have made over $94 million in financings to 46 small businesses 
through September 2015, with over half of the financing dollars 
reported in FY 2015. Since most Early Stage SBICs did not start 
reporting financings until 2014, and venture funds typically have a 5 
year investment period, SBA expects funds to continue to make $50 to 
$75 million in financings per year for the next 2 to 3 years and then 
decline, unless new Early Stage SBICs are licensed.
    As previously noted, the Early Stage program finances geographic 
funding gaps and creates jobs. Over 69% of Early Stage SBIC financing 
dollars went to states not in the traditional geographic hubs for 
venture capital financing. In addition, Early Stage SBIC financial 
reports filed with SBA for Early Stage SBICs' fiscal year 2014 showed a 
net gain in jobs of 48% in the small businesses Early Stage SBICs had 
invested in during 2014.
    In terms of cost, since fiscal year 2012, the SBIC Debenture 
subsidy formulation model has taken into account Early Stage SBICs. 
Early Stage SBICs have a higher expected loss rate than standard SBICs, 
so the more leverage SBA allocates to Early Stage SBICs results in a 
proportionally higher annual charge. As noted in the April 27, 2012 
final rule that established Early Stage SBICs (77 FR 25042), SBA 
allocated $150 million in leverage commitments (i.e., 7% of SBA's total 
leverage authorization) to Early Stage SBICs for FY 2012. This 
allocation increased the FY 2012 annual charge for all SBICs by 13.7 
basis points. For FY 2017, based on current demand, SBA has budgeted 
$100 million in Early Stage commitments (i.e., 4% of SBA's total 
leverage authorization). SBA expects this allocation to increase the 
annual charge paid by all SBICs by less than 7 basis points, which is 
smaller than the increase to the annual charge related to the $200 
million allocation for each of FYs 2012-2016. After FY 2017, SBA 
expects to allocate no more than approximately $200 million in leverage 
commitments to Early Stage SBICs in any year, which would keep the 
increase in cost related to the Early Stage program to no more than 
approximately 14 basis points. Depending on demand, Early Stage SBIC 
performance, and other factors, SBA may modify this targeted 
allocation. SBA believes that none of the changes proposed in this rule 
would alter the risk profile of the Early Stage SBICs or increase the 
annual charge paid by SBICs. The program will remain a zero subsidy 
program.
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 rule will 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.
Executive Order 13563
    This proposed rule was developed based on comments received on the 
ANPRM SBA issued in March 2015 (80 FR 14034) and several discussions 
with Early Stage participants and others in the industry. SBA issued 
the ANPRM to solicit comments and ideas on the Early Stage SBIC program 
and considered each comment it received. The proposed changes are a 
result of those comments.
Paperwork Reduction Act, 44 U.S.C. Ch. 35
    SBA has determined that this rule proposes no additional reporting 
or recordkeeping requirements as defined by the Paperwork Reduction 
Act.
Regulatory Flexibility Act, 5 U.S.C. 601-612
    When an agency promulgates a rule, the Regulatory Flexibility Act 
requires the agency to prepare an initial regulatory flexibility 
analysis (IRFA), which describes the potential economic impact of the 
rule on small entities and alternatives that may minimize that impact. 
Section 605 of the RFA allows

[[Page 64080]]

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 the existing five Early Stage 
SBICs, as well as all potential applicants, all of which are small 
entities. Although SBA is seeking to expand the number of participants, 
because of the limited amount of available leverage, even with future 
growth, the number of affected small entities will still be relatively 
low. SBA has determined that the impact on entities affected by the 
rule will not be significant. Because SBA's subsidy model already takes 
into account Early Stage SBICs and the proposed rule does not impact 
the current annual fee needed to keep the Debenture program at a zero 
subsidy cost, no cost impacts are expected.

List of Subjects in 13 CFR Part 107

    Examination fees, Investment companies, Loan programs-business, 
Licensing fees, 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

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

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


Sec.  107.310  [Removed and Reserved]

0
2. Remove and reserve Sec.  107.310.
0
3. Revise Sec.  107.320(b) to read as follows:


Sec.  107.320  Evaluation of Early Stage SBICs.

* * * * *
    (b) The geographic location of projected investments based on the 
applicant's business plan.
0
4. Revise Sec.  107.565 to read as follows:


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

    (a) General. 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, unless 
such debt satisfies the conditions in paragraph (b) of this section.
    (b) Qualified line of credit. Without obtaining SBA's prior written 
approval, an Early Stage SBICs may have, incur, or refinance third 
party debt that meets all of the following conditions:
    (1) The third party debt is a line of credit with maximum 
availability limited to the lesser of:
    (i) 20% of Regulatory Capital; or
    (ii) Total unfunded binding commitments from Institutional 
Investors minus any such commitments used to fund the Interest Reserve 
under Sec.  107.1181.
    (2) The term of the line of credit does not exceed 24 months, but 
may be renewable, provided that each renewal does not exceed 24 months 
and you are in compliance with the conditions of this paragraph (b).
    (3) The line of credit is held by a federally regulated financial 
institution.
    (4) All borrowings under the line of credit:
    (i) Are not secured third-party debt, as that term is defined in 
Sec.  107.550(a);
    (ii) Are for the purpose of maintaining your operating liquidity or 
providing funds for a particular Financing of a Small Business;
    (iii) Must be fully repaid within 90 days after the date they are 
drawn; and
    (iv) Must be fully paid off for at least 30 consecutive days during 
your fiscal year.
0
5. Amend Sec.  107.1150 by revising paragraphs (c)(1) and (c)(3)(ii), 
to read as follows:


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

* * * * *
    (c) * * *
    (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 $75 million, whichever is less;
* * * * *
    (3) * * *
    (ii) $75 million.
* * * * *

    Dated: August 26, 2016.
Maria Contreras-Sweet,
Administrator.
[FR Doc. 2016-21509 Filed 9-16-16; 8:45 am]
BILLING CODE 8025-01-P