[Federal Register Volume 67, Number 96 (Friday, May 17, 2002)]
[Proposed Rules]
[Pages 35055-35057]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12466]
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SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
RIN 3245-AE88
Small Business Investment Companies
AGENCY: Small Business Administration (SBA).
ACTION: Proposed rule.
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SUMMARY: This proposed rule would allow a Small Business Investment
Company (SBIC) to assume control over a small business concern, without
notice to the SBA and to retain such control for a period of up to five
years, or longer with SBA's approval. The proposed rule would also
allow an SBIC to sell equity securities in a portfolio concern to a
competitor of that portfolio concern.
DATES: Comments must be received on or before June 17, 2002.
ADDRESSES: Written comments should be sent to Leonard W. Fagan,
Investment Division, U.S. Small Business Administration, 409 3rd
Street, SW., Washington, DC 20416.
FOR FURTHER INFORMATION CONTACT: Harry Haskins, Deputy Associate
Administrator, Investment Division, 202-205-6734.
SUPPLEMENTARY INFORMATION: The Small Business Investment Corrections
Act of 2000, Public Law 106-554, Title IV, section 402, amended section
103(5)(A)(i) of the Small Business Investment Act (Act) to clarify that
a small business concern controlled by venture capital firms, including
licensed small business investment companies (SBICs), does not for that
reason cease to qualify as independently owned and operated. The
statute reads, ``regardless of the allocation of control during the
investment period under any investment agreement between the business
concern and the entity making the investment.'' (15 U.S.C.
662(5)(A)(i)).
This proposed rule simplifies SBA's present regulation governing
control of a small business and brings it into conformity with the Act,
as amended in 2000. It also removes a regulatory restriction on the
right of an SBIC to sell securities of a small business to a competitor
of that business.
The intent of the rule is to implement a statutory change designed
to allow SBICs the freedom to operate in the fashion of modern venture
capital investors. SBA intends through this rule to permit the type of
control that a modern venture fund would exercise while developing an
investment, yet avoid the control typical of a holding company
operating a firm as a subsidiary and deriving profits through earnings
and cash flow.
The legislative history indicates that Congress envisioned only the
kind of control that a modern venture capital fund focusing on capital
gains would exercise. The legislative history (H.Rpt. 106-520) states
that Congress did not intend for SBICs to exercise the control typical
of a holding company or a continuing business operation conducted
through a subsidiary for the purpose of accruing earnings on an
annualized or cash flow basis.
Proposed Sec. 107.865(a) is a statement of general policy. It
differs from the present regulation by broadly permitting SBICs to
exercise control over a portfolio concern through ownership of voting
securities, management agreements, voting trusts, majority
representation on the board of directors, or any other means. The
proposed rule also changes the definition of the ``Investor Group'',
those entities whose ownership interests are aggregated for the purpose
of determining whether control exists. Under the current regulation,
the Investor Group consists of all SBICs that invest in a portfolio
company, even if there is no affiliation among them, and all of the
SBICs' Associates as defined in Sec. 107.50. The proposed rule defines
the Investor Group as an SBIC and its Associates, but does not
aggregate the interests of two or more unrelated SBICs. SBA believes
that unrelated SBICs should have as much freedom to co-invest with one
another as they do to co-invest with venture funds that are not SBICs.
The only restriction in proposed Sec. 107.865(a) is a five-year
limit on SBIC control. This will be measured from the initial
assumption of control, regardless of interruptions in control. SBA
considers five years sufficient time for a viable seed stage company to
become an operating business, or to generally develop the investment in
a portfolio concern prior to divestiture for gain. It should also
suffice for the reversal of the declining fortunes of an operating
business. Moreover, the vast majority of SBICs are organized as limited
partnerships with a life span not much in excess of ten years.
The proposed rule retains Sec. 107.865(b) with one clarification in
the introductory text. Section 107.865(b) outlines the circumstances
under which SBA will presume control over a small business for the
purpose of determining when control begins or ends. The proposed
language clarifies that this paragraph relates only to control based on
ownership of voting securities. Control through other means, as
specified in Sec. 107.865(a), may still exist even if the conditions in
paragraph (b) are not met.
The proposed rule retains Sec. 107.865 (c), which sets forth
rebuttals to the presumption of control based on ownership of voting
securities.
Proposed Sec. 107.865(d) allows extension of control over portfolio
[[Page 35056]]
concerns if an SBIC has made reasonable efforts to divest itself of
control within the five-year period, but is unable to complete the
divestiture in time. It also allows for SBA, in its discretion, to
extend the period of control if necessary to protect the financial
stability of the portfolio concern.
SBA believes that an investment for venture capital purposes is
based primarily on an expectation of capital gains resulting from the
divestiture of equity investments or conversion of warrants. SBA does
not believe that conducting the ongoing operations of a portfolio
concern for the purpose of receiving regular income is consistent with
venture capital investing.
As stated above, SBA believes five years is generally sufficient
time for profitable and effective venture capital investing.
Consequently, SBA will not allow control beyond five years, except in
limited circumstances.
Proposed Sec. 107.865(d) makes clear that an SBIC may provide
additional financing to a concern it controls regardless of the
provisions of Sec. 107.730(a)(1).
The rule would remove Sec. 107.865 (e) and (f) as unnecessary and
would redesignate Sec. 107.865(g) as Sec. 107.865(e).
Section 107.885(b) requires an SBIC that controls a small business
to obtain SBA's prior approval before selling the small business's
equity securities to a competitor of the small business. SBA
anticipates that SBICs may exit from an investment by a sale to a
strategic investor. SBA believes control of such situations is best
left to negotiations between the SBIC and the small business.
Consequently, SBA proposes to remove Sec. 107.885(b).
Compliance With Executive Orders 12866, 12988, and 13132, the
Regulatory Flexibility Act, and the Paperwork Reduction Act
The Office of Management and Budget (OMB) did not review this
proposed rule as a ``significant'' regulatory action under Executive
Order 12866. The proposed rule implements technical corrections to the
SBIC program. This proposed rule will not have an annual effect on the
economy of $100 million or more, adversely affect the economy in a
material way, create a serious inconsistency or otherwise interfere
with an action taken or planned by another agency, materially alter the
budgetary impact of loan programs or other government programs, or
raise novel legal or policy issues arising out of legal mandates or the
President's priorities.
For purposes of Executive Order 12988, the SBA has determined that
this proposed rule was drafted, to the extent practicable, in
accordance with the standards set forth in section 3 of that order.
This regulation will not have substantial direct effects on the
States, on the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government. Therefore, under Executive Order 13132,
the SBA determines that this proposed rule does not have sufficient
federalism implications warranting the preparation of a Federalism
Assessment.
This proposed rule does not impose any new information collection
requirements from SBA which require approval by OMB under the Paperwork
Reduction Act, 44 U.S.C. Ch.35.
When an agency issues a rulemaking proposal, the Regulatory
Flexibility Act (RFA) requires the agency to ``prepare and make
available for public comment an initial regulatory flexibility
analysis'' which will ``describe the impact of the proposed rule on
small entities.'' (5 U.S.C. Sec. 603(a)) Section 605 of the RFA allows
an agency to certify a rule, in lieu of preparing an analysis, if the
proposed rulemaking is not expected to have a significant economic
impact on a substantial number of small entities.
This proposed rule directly affects all SBICs, of which there are
currently 432. SBA estimates that approximately 75 percent of these
SBICs 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 proposed rule will not be significant. The effect of the proposed
rule will be to allow SBICs the flexibility to choose the optimal
structure for their investments without having to notify or seek
approval from SBA. SBA expects the impact of the proposed rule will be
a reduction in the paperwork burden for SBICs. SBA asserts that the
economic impact of the reduction in paperwork, if any, will be minimal
and entirely beneficial to small SBICs. Accordingly, the Administrator
of the SBA hereby certifies that this rule will not have a significant
economic impact on a substantial number of small entities. SBA invites
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, the Small Business
Administration proposes to amend 13 CFR part 107 as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for part 107 continues to read as
follows:
Authority: 15 USC 681 et seq., 683, 687(c), 687b, 687d, 687g,
and 687m.
2. In Sec. 107.865, revise the section heading and paragraphs (a),
(b) and (d) to read as follows:
Sec. 107.865 Control of a Small Business by a Licensee.
(a) In General. You, or you and your Associates, (in the latter
case, the ``Investor Group'') may exercise Control over a Small
Business for purposes connected to your investment, through ownership
of voting securities, management agreements, voting trusts, majority
representation on the board of directors, or otherwise. The period of
such Control will be limited to the fifth anniversary of the date on
which such Control was initially acquired or, any earlier date
specified by the terms of any investment agreement.
(b) Presumption of Control. Control over a Small Business based on
ownership of voting securities will be presumed to exist whenever you
or the Investor Group own or control, directly or indirectly:
(1) At least 50 percent of the outstanding voting securities, if
there are fewer than 50 shareholders; or
(2) More than 25 percent of the outstanding voting securities, if
there are 50 or more shareholders; or
(3) A block of at least 20 percent of the outstanding voting
securities, if there are 50 or more shareholders and no other party
holds a larger block.
* * * * *
(d) Extension of Control. With SBA's prior written approval you, or
the Investor Group, may retain Control for such additional period as
may be reasonably necessary to complete divestiture of Control, or to
ensure the financial stability of the portfolio company.
* * * * *
Sec. 107.865 [Removed and Redesignated]
3. Remove the existing Sec. 107.865(e) and (f) and redesignate
Sec. 107.865(g) as Sec. 107.865(e).
[[Page 35057]]
Sec. 107.885 [Amended]
4. Amend 107.885 by removing paragraph (b) and removing the
paragraph designation ``(a)''.
Dated: May 13, 2002.
Hector V. Barreto,
Administrator.
[FR Doc. 02-12466 Filed 5-16-02; 8:45 am]
BILLING CODE 8025-01-P