[Federal Register Volume 83, Number 112 (Monday, June 11, 2018)]
[Proposed Rules]
[Pages 26875-26877]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-12030]



13 CFR Part 107

RIN 3245-AG68

Small Business Investment Companies (SBIC); Early Stage 

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule; withdrawal.


SUMMARY: The Small Business Administration (SBA) is withdrawing its 
proposed rule published on September 19, 2016. SBA proposed making 
changes to its Early Stage Small Business Investment Company (SBIC) 
initiative, which was launched in 2012. SBA is withdrawing the proposed 
rule because very few qualified funds applied to the Early Stage SBIC 
initiative, the costs were not commensurate with the results and the 
comments to the proposed rule did not demonstrate broad support for a 
permanent Early Stage SBIC program.

DATES: SBA is withdrawing the proposed rule published on September 19, 
2016 (81 FR 64075) as of June 11, 2018.

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


I. 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

[[Page 26876]]

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) up to a maximum amount of $150 million per SBIC based on 
the amount of the SBIC's qualifying private capital, defined in SBA 
regulations as 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). SBA 
will typically provide an SBIC with up to two ``tiers'' of leverage (a 
two-to-one match between leverage and Regulatory Capital).
    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 traditional bank funding face difficult challenges accessing 
capital. As a result of this capital gap, 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 in an amount 
equal to each Early Stage SBIC's Regulatory Capital (one tier of 
leverage, rather than the two tiers typically available to traditional 
SBICs), up to a maximum of $50 million. SBA targeted an allocation of 
$200 million per year ($1 billion total) of its SBIC Debenture 
authorization over these years to this effort.
    In order to determine potential changes needed to attract 
sufficient interest from qualified early stage fund managers to apply 
for the Early Stage SBIC program, SBA sought input from the public 
through an Advance Notice of Proposed Rulemaking (ANPRM) on March 18, 
2015 (80 FR 14034). Based on comments on the ANPRM and additional 
discussions SBA held with industry participants, SBA published a 
proposed rule (81 FR 64075) on September 19, 2016, to make changes to 
make the Early Stage SBIC program more attractive and make the program 
a permanent part of the SBIC program. These changes included: (1) 
Extending the program past FY 2016; (2) modifying Early Stage licensing 
procedures to be more consistent with other SBICs by allowing Early 
Stage SBIC applicants to apply at any time and allowing existing Early 
Stage SBICs to apply for a subsequent license; (3) allowing Early Stage 
SBICs to use a line of credit without SBA's prior approval; and (4) 
increasing the maximum leverage from $50 million to $75 million.

II. Reason for Withdrawal

    In determining whether to publish a final rule, SBA evaluated the 
results of the Early Stage SBIC Initiative, the costs of the initiative 
and the comments received on the proposed rule.
    Between 2012 and June 2016, SBA received 62 applications to the 
Early Stage SBIC program, but licensed only 5 Early Stage SBICs. Those 
applicants that were not licensed failed to meet SBA's licensing 
criteria. Many of the applicants had management teams with limited 
track records and few positive realizations. Although SBA sought to 
increase the number of applicants to the Early Stage SBIC initiative, 
at the end of FY 2016, none of the SBIC applicants utilizing an early 
stage investment strategy in SBA's licensing pipeline sought to issue 
SBA-guaranteed Debentures or to be licensed as an Early Stage SBIC. SBA 
has and will continue to license qualifying early stage venture funds 
that do not intend to issue SBA-guaranteed Debentures. Although venture 
capital funds pursuing an early stage investment strategy are not 
prohibited from applying to the program as a leveraged SBIC, SBIC 
guaranteed Debentures are not well-suited to an early stage investing 
strategy since many early stage investments do not provide ongoing cash 
flows needed to pay the current interest and annual charges associated 
with SBA guaranteed debentures. Based on its evaluation of the Early 
Stage initiative, SBA concluded that there are insufficient qualified 
early stage fund management teams that are interested in using SBA-
guaranteed leverage under the terms needed to make the Early Stage SBIC 
initiative a permanent part of the SBIC program.
    SBA also considered costs in determining whether to withdraw the 
proposed rule. As noted in the April 27, 2012, final rule, due to the 
risk associated with this class of SBICs, SBA increased the annual 
charge for all SBICs issuing Debenture leverage in order to implement 
the Early Stage SBIC initiative. The September 2016 Early Stage SBIC 
proposed rule stated that because Early Stage SBICs invest in early 
stage investments with higher risk, the rule would continue to apply a 
higher annual charge payable by all SBICs issuing SBA-guaranteed 
Debentures. SBA expected to allocate no more than approximately $200 
million in leverage commitments to Early Stage SBICs each year after FY 
2017, which allocation was expected to increase the cost to all SBICs 
issuing SBA-guaranteed debentures by increasing the annual fee payable 
by all such SBICs by approximately 14 basis points. For an SBIC issuing 
$100 million in SBA-guaranteed Debentures, 14 basis points would equate 
to $140,000 per year. SBICs typically issue Debenture leverage over 4 
to 6 years (using multiple commitments) and begin paying back leverage 
as the fund harvests its investments after that period. Based on 
Debenture pools since 1992 that have been fully repaid, the average 
hold period is approximately 6 years. Therefore the 14 basis points 
addition for an SBIC issuing $100 million in SBA-guaranteed Debentures 
would equate to $840,000. If the SBIC held the leverage for the full 
10-year term, this would equate to $1,400,000 for a single SBIC over 
that timeframe. Between FYs 2012 and 2017, SBA approved on average 
$2.28 billion aggregate debenture commitments per year. If an 
additional 14 basis point charge were in effect, SBICs would incur over 
$3.2 million per year in additional fees, or approximately $19 million 
over the average 6 year holding period for SBIC-guaranteed Debentures. 
This is capital that SBICs could otherwise deploy to small businesses. 
Additionally, SBA must expend additional administrative costs to 
oversee these SBICs and to maintain subsidy formulation and re-estimate 
models. SBA received four comment letters on the proposed rule. Among 
other things, these comments requested changes to the payment structure 
of the Early Stage debenture--partial, as opposed to full prepayments--
which structure SBA has determined is not workable. Another comment 
suggested that the amount of leverage SBA intended to allocate to Early 
Stage SBICs on an annual basis was perceived as a limit which placed 
unacceptable risk to management teams that would otherwise be 
interested in applying to the program. As discussed above, in order to 
determine the annual charge as required by the Act, if the proposed 
rule became final, SBA would be required to

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allocate an amount of leverage to Early Stage SBICs on an annual basis. 
Other comments suggested concerns or requested clarifications. It was 
not evident to SBA from these comments that the proposed rule was 
broadly supported by SBIC program stakeholders.
    The withdrawal of the proposed rule does not impact the Early Stage 
regulations contained in 13 CFR part 107 or the five currently licensed 
Early Stage SBICs. Such Early Stage SBICs remain subject to the Act, 
applicable regulations at 13 CFR part 107 and SBA policies.

Executive Order 13771

    The withdrawal of the proposed rule qualifies as a deregulatory 
action under Executive Order 13771. See OMB's Memorandum titled 
``Guidance Implementing Executive Order 13771, Titled `Reducing 
Regulation and Controlling Regulatory Costs''' (April 5, 2017).
    Accordingly, for the reasons stated in the preamble, the proposed 
rule published at 81 FR 64075 on September 16, 2016 is withdrawn.

    Authority:  15 U.S.C. 634(b)(6).

    Dated: May 12, 2018.
Linda E. McMahon,
[FR Doc. 2018-12030 Filed 6-8-18; 8:45 am]