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[House Report 106-520]
[From the U.S. Government Publishing Office]

106th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 2d Session                                                     106-520

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           SMALL BUSINESS INVESTMENT CORRECTIONS ACT OF 2000

                                _______
                                

 March 14, 2000.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

    Mr. Talent, from the Committee on Small Business, submitted the 
                               following

                              R E P O R T

                        [To accompany H.R. 3845]

      [Including cost estimate of the Congressional Budget Office]

  The Committee on Small Business, to whom was referred the 
bill (H.R. 3845) to make corrections to the Small Business 
Investment Act of 1958, and for other purposes, having 
considered the same, report favorably thereon without amendment 
and recommend that the bill do pass.

                                Purpose

    The purpose of H.R. 3845 is to amend the Small Business 
Investment Act (the Act) to make changes in the Small Business 
Investment Company (SBIC) program at the Small Business 
Administration (SBA), commonly known as the SBIC program. H.R. 
3845 contains four technical changes to improve the program and 
correct problems brought to the Committee's attention through 
the oversight process.
    H.R. 3845 modifies the definition of control for SBIC 
investment in small businesses, eliminating a cumbersome five 
prong test and setting a clear statutory standard. H.R. 3845 
will also modify the definition of long term investment under 
the Act, changing it from five years to one year, in order to 
harmonize that definition with accepted business practice and 
the tax and banking laws. Third, the bill allows the 
Administration to adjust the subsidy fee for the SBIC program 
to maintain the subsidy rate of the program at zero. Finally, 
the bill makes a change to the distribution language in the 
Act, allowing SBICs more flexibility in making distributions to 
their investors and will simplify the accounting and tax 
procedures at SBICs.

                          Need for Legislation

Definition of small business concern

    SBA regulations currently prohibit an SBIC from owning a 
controlling interest in the voting stock of a small business or 
otherwise exercising control to the small business.
    These regulations were put in place to ensure that SBICs 
did not become holding companies and to protect small business 
from over aggressive investments. During the life of the 
program several exceptions have been put in place recognizing 
the reality of equity investment. These include control for a 
start-up company, when a major investment is undertaken, for a 
troubled company, breach of agreement, and most recently for 
those businesses that are located in low and moderate income 
area (LMIs). Through the administering and oversight of these 
regulations the Committee believes the result has been to 
create a complicated and sometimes burdensome process for both 
SBA and SBICs.
    While the intent of the regulation was the protection of 
small business it has resulted in keeping parties to an SBIC 
investment from structuring the investment in ways that may be 
most reasonable and acceptable from both operating and market 
perspective. The Committee made these changes recognizing the 
reality of venture capital investment, however the amendment is 
not intended to foster SBICs becoming holding companies for 
operating small business concerns. In today's venture capital 
world venture funds may act as incubators of business ideas by 
creating and capitalizing small businesses to nurture 
technology in the early stages of its development. In such 
cases SBICs may need to create, capitalize and operate small 
business concerns in the early years.
    Furthermore, the Gramm-Leach-Bliley Bank Modernization 
Act--which grants banks authority to conduct venture capital 
operations without an SBIC license--does not prohibit control. 
To the contrary, it explicitly permits control during the 
investment period. The proposed amendment would make the Small 
Business Investment Act consistent with the new banking law and 
would serve as an incentive for banks to retain their SBIC 
operations--to the benefit of U.S. small businesses.

Definition of long term

    The term ``long-term'' as found in Section 102 of the Act 
has been interpreted to mean a period of time equal to a 
minimum of five years for all SBIC investments other than those 
made in ``Disadvantaged Businesses.'' For the latter, the 
minimum period is four years.
    This interpretation does not allow SBICs and small 
businesses to fashion investment agreements that are flexible 
enough to meet the needs of both parties in accordance with the 
dictates of the commercial marketplace.
    This interpretation has no counterpart in any other area of 
business commerce. To the contrary, Generally Accepted 
Accounting Principles (GAAP) define ``long-term'' as any period 
of time greater than one year in duration. Likewise, tax law 
defines ``long-term'' for capital gains purposes as a period 
greater than one year. The proposed amendment would make SBIC 
law consistent with GAAP and tax law and apply the same 
standard for all SBIC investments.
    The Gramm-Leach-Bliley Bank Modernization Act--which gives 
banks authority to conduct venture capital operations without 
an SBIC license--places no restrictions on the period of time 
for investments. The proposed amendment will be consistent with 
the new bank law and would serve as an important incentive for 
banks to retain their SBIC operations--to the benefit of U.S. 
small businesses seeking financing. Without the amendment, many 
banks may choose to operate all their venture capital 
operations outside the SBIC program--to the detriment of small 
businesses served by the SBIC program.

Subsidy fees

    An additional 1 percent interest obligation was imposed on 
SBICs in 1996 in order to reduce the Small Business 
Administration's appropriated cost, as determined by the 
Administration's subsidy model, for supporting the SBIC 
program. Since then changes in the program coupled with a 
stricter examination and licensing program at SBA have 
significantly reduced the subsidy cost of both the Debenture 
and Participating Securities programs. At least part of the 1 
percent in additional interest is no longer required in the 
Debenture program to keep the subsidy rate at zero. The same 
may soon be true for the Participating Securities program as 
well. In fact, current estimates show that the 1 percent fee is 
overcharging the SBICs (and their small business clients), 
resulting in a hidden tax on the program.
    Changing the law as proposed would allow the Administration 
to adjust the additional interest and prioritized payment rates 
annually based on annual subsidy rate calculations. A similar 
approach is already in place for the SBA's 504 loan program 
which operates at no cost to the taxpayer and has consistently 
reduced its fees.

Distribution

    Under current law, SBICs may make prioritized payment 
distributions, profit distributions, and other optional 
distributions (e.g., distributions of capital on any date with 
prior SBA approval). Tax distributions, however, may only be 
made at the end of calendar year quarters.
    The practical impact of this restriction is that SBICs are 
forced to either delay otherwise permitted interim 
distributions (that would include tax distributions) to the end 
of a quarter or split their distributions into two 
distributions--tax distributions (made at the end of a quarter) 
and all other distributions (made at any time during a 
quarter).
    Postponing an entire distribution to the end of a quarter 
has negative cash flow and internal rate of return (IRR) 
implications for SBICs. Consequently, most SBICs will opt to 
split their distributions. Splitting distributions requires the 
preparation, submission, and SBA review of two sets of 
documents when one would otherwise suffice. This results in 
inefficient use of both SBA and SBIC time and resources.
    The proposed amendment is technical in nature and will have 
no substantive impact on the SBIC program. However, it will 
save time and expense for both SBA and SBICs by eliminating 
duplicative filings and inefficient use of SBA resources.

                            Committee Action

Hearing on the SBA budget and legislative proposals

    On March 1, 2000, at 10:00 a.m., the Committee on Small 
Business convened a hearing to discuss the Administration's 
budget proposal for the SBA for fiscal year 2001 and 
legislative proposals. The Committee received testimony from 
five witnesses: Hon. Aida Alvarez, Administrator of the Small 
Business Administration; Mr. Anthony Wilkinson, President of 
the National Association of Government Guaranteed Lenders; Mr. 
Lee Mercer, President of the National Association of Small 
Business Investment Companies; Mr. Woody McCutchen, Executive 
Director of the Association of Small business Development 
Centers; Ms. Caroline Hayashi, representing the Association for 
Enterprise Opportunity; and Mr. John Geigel, Vice President for 
Government Relations of the National Association of Development 
Companies.
    During his testimony Mr. Mercer discussed the changes 
included in H.R. 3845 and asked that the Committee consider 
legislation addressing these concerns.

Consideration of H.R. 3845

    At 10 a.m. on March 9, 2000, the Committee on Small 
Business met to consider and report H.R. 3843 and H.R. 3845. 
After consideration of H.R. 3843, Chairman Talent asked 
unanimous consent that H.R. 3845 be considered as read and open 
for amendment at any point. No amendments were offered to H.R. 
3845. The Chairman then moved the bill be reported, and at 
10:16 a.m., by a voice vote, a quorum being present, the 
Committee passed H.R. 3845 and ordered it reported.

                      Section-by-Section Analysis

Section 1. Short title

Section 2. Definitions

    (a) Small Business Concern.--Inserts the following language 
in section 103(5)(A)(i) of the Small Business Investment Act--
``regardless of the allocation of control during the investment 
period under any investment agreement between the business 
concern and the entity making the investment''. This phrase 
clarifies that a venture capital investment agreement from an 
SBIC may cause a change in control of a small business, but 
that such a change will not affect the eligibility of the small 
business concern. The Committee does not intend that SBICs 
become holding companies hence the language references the 
period of the investment agreement. Further, the Committee 
retains the authority for SBIC examinations to inquire into 
``illegal control'' by SBICs, though the committee expects such 
control to be that exercised outside an investment agreement.
    (b) Long term.--Inserts the following paragraph in section 
103 of the Small Business Investment Act:
          ``(17) the term long term, when used in connection 
        with equity capital or loan funds invested in any small 
        business concern or smaller enterprise, means any 
        period of time not less than 1 year.''
    The language changes the definition of a long term 
investment to harmonize it with the tax and banking laws.

Section 3. Subsidy fees

    This provision amends sections 303(b) and 303(g)(2) of the 
Small Business Investment Act to allow the Administration to 
adjust the fee assessed on debentures and participating 
securities up to a maximum of one percent. The fee will be 
adjusted to keep the subsidy cost of the programs at zero or as 
close as possible to zero.

Section 4. Distributions

    This section amends section 303(g)(8) of the Small Business 
Investment Act in order to allow SBICs to make distributions at 
any time during a calendar quarter based on the maximum 
estimated tax liability.

Section 5. Conforming amendment

                              CBO Estimate

                                     U.S. Congress,
                               Congressional Budget Office,
                                    Washington, DC, March 14, 2000.
Hon. James M. Talent,
Chairman, Committee on Small Business,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 3845, the Small 
Business Investment Corrections Act of 2000.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Mark Hadley.
            Sincerely,
                                          Barry B. Anderson
                                    (For Dan L. Crippen, Director).
    Enclosure.
    CBO estimates that enactment of H.R. 3845 would cost about 
$50 million in 2000 because it could end the collection of fees 
currently charged by the Small business Administration (SBA) 
for loan guarantees made to private venture capital firms. The 
bill could reduce offsetting receipts (a form of direct 
spending); therefore, pay-as-you-go procedures would apply. 
H.R. 3845 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act and 
would impose no costs on state, local, or tribal governments.
    Through two Small Business Investment Company (SBIC) 
programs, SBA guarantees 10-year loans made to venture capital 
firms. To offset the subsidy cost of these guarantees, SBA 
charges venture capital firms that participate in the program a 
fee of 1 percent of the loan amount each year. Based on 
information from SBA and the Office of Management and Budget, 
CBO estimates that there will be about $6 billion of guaranteed 
loan balances at the end of 2000, resulting in the collection 
of about 460 million in fees in 2000.
    H.R. 3845 would require SBA to reduce the 1 percent fee if 
the subsidy cost of these programs would otherwise be less than 
zero. The subsidy cost of a loan guarantee is the estimated 
long-term cost to the government, calculated on a net present 
value basis and excludes administrative costs. For fiscal year 
2000, the estimated subsidy rate is 1.8 percent for one of the 
SBIC programs and zero for the other. If SBA reestimates the 
subsidy cost of these loan guarantees to be less than zero 
(that is, a ``negative subsidy''), H.R. 3845 would require the 
agency to reduce the fees by reducing the possibility of 
recognizing any negative subsidies. Based on the likelihood 
that the subsidy rate for these programs could be less than 
zero, CBO estimates that enacting this provision would reduce 
future offsetting receipts. The estimated cost of $50 million 
represents the present value of fees that could be eliminated 
by the bill. Such fees would otherwise be collected annually 
over the remaining term of the $6 billion in loan guarantees.
    The CBO staff contact is Mark Hadley. The estimate was 
approved by Peter H. Fontaine, Deputy Assistant Director for 
Budget Analysis.

                      Committee Estimate of Costs

    Pursuant to the Congressional Budget Act of 1974, the 
Committee estimates that the amendments to the Small Business 
Investment Act contained in H.R. 3845 will not increase 
discretionary spending over the next five fiscal years. The 
Committee also estimates that H.R. 3845 will increase direct 
spending by $50 million, as currently drafted, when applied to 
previous cohorts of SBIC loans. This estimate concurs with 
Congressional Budget Office (CBO) estimates.
    Furthermore, pursuant to clause 3(d)(2)(A) of rule XIII of 
the Rules of the House of Representatives, the Committee 
estimates that implementation of H.R. 3845 will not 
significantly increase other administrative costs.

                           Oversight Findings

    In accordance with clause 4(c)(2) of rule X of the Rules of 
the House of Representatives, the Committee states that no 
oversight findings or recommendation have been made by the 
Committee on Government Reform with respect to the subject 
matter contained in H.R. 3845.
    In accordance with clause (2)(b)(1) of rule x of the Rules 
of the House of Representatives, the oversight findings and 
recommendations of the Committee on Small Business with respect 
to the subject matter contained in H.R. 3845 are incorporated 
into the descriptive portions of this report.

                 Statement of Constitutional Authority

    Pursuant to clause 3(d)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee finds the authority for 
this legislation in Article I, Section 8, clause 18, of the 
Constitution of the United States.

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, existing law in which no change is 
proposed is shown in roman):

SMALL BUSINESS INVESTMENT ACT OF 1958

           *       *       *       *       *       *       *

TITLE I--SHORT TITLE, STATEMENT OF POLICY, AND DEFINITIONS

           *       *       *       *       *       *       *

                              definitions

  Sec. 103. As used in this Act--
          (1) * * *

           *       *       *       *       *       *       *

          (5) the term ``small-business concern'' shall have 
        the same meaning as in the Small Business Act, except 
        that, for purposes of this Act--
                  (A) an investment by a venture capital firm, 
                investment company (including a small business 
                investment company) employee welfare benefit 
                plan or pension plan, or trust, foundation, or 
                endowment that is exempt from Federal income 
                taxation--
                          (i) shall not cause a business 
                        concern to be deemed not independently 
                        owned and operated 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) the term ``member'' means, with respect to a 
        licensee that is a limited liability company, a holder 
        of an ownership interest or a person otherwise admitted 
        to membership in the limited liability company; [and]
          (16) the term ``limited liability company'' means a 
        business entity that is organized and operating in 
        accordance with a State limited liability company 
        statute approved by the Administration[.]; and
          (17) the term ``long term'', when used in connection 
        with equity capital or loan funds invested in any small 
        business concern or smaller enterprise, means any 
        period of time not less than 1 year.

           *       *       *       *       *       *       *

TITLE III--SMALL BUSINESS INVESTMENT COMPANIES

           *       *       *       *       *       *       *

                            borrowing power

  Sec. 303. (a) * * *
  (b) To encourage the formation and growth of small business 
investment companies the Administration is authorized when 
authorized in appropriation Acts, to purchase, or to guarantee 
the timely payment of all principal and interest as scheduled 
on, debentures or participating securities issued by such 
companies. Such purchases or guarantees may be made by the 
Administration on such terms and conditions as it deems 
appropriate, pursuant to regulations issued by the 
Administration. The full faith and credit of the United States 
is pledged to the payment of all amounts which may be required 
to be paid under any guarantee under this subsection. 
Debentures purchased or guaranteed by the Administration under 
this subsection shall be subordinate to any other debenture 
bonds, promissory notes, or other debts and obligations of such 
companies, unless the Administration in its exercise of 
reasonable investment prudence and in considering the financial 
soundness of such company determines otherwise. Such debentures 
may be issued for a term of not to exceed fifteen years and 
shall bear interest at a rate not less than a rate determined 
by the Secretary of the Treasury taking into consideration the 
current average market yield on outstanding marketable 
obligations of the United States with remaining periods to 
maturity comparable to the average maturities on such 
debentures, adjusted to the nearest one-eighth of 1 per centum, 
[plus an additional charge of 1 percent per annum which shall 
be paid to and retained by the Administration] plus an 
additional charge, in an amount established annually by the 
Administration, of not more than 1 percent per year as 
necessary to reduce to zero the cost (as defined in section 502 
of the Federal Credit Reform Act of 1990 (2 U.S.C. 661a)) to 
the Administration of purchasing and guaranteeing debentures 
under this Act, which shall be paid to and retained by the 
Administration. The debentures or participating securities 
shall also contain such other terms as the Administration may 
fix, and shall be subject to the following restrictions and 
limitations:
          (1) * * *

           *       *       *       *       *       *       *

  (g) In order to encourage small business investment companies 
to provide equity capital to small businesses, the 
Administration is authorized to guarantee the payment of the 
redemption price and prioritized payments on participating 
securities issued by such companies which are licensed pursuant 
to section 301(c) of this Act, and a trust or a pool acting on 
behalf of the Administration is authorized to purchase such 
securities. Such guarantees and purchases shall be made on such 
terms and conditions as the Administration shall establish by 
regulation. For purposes of this section, (A) the term 
``participating securities'' includes preferred stock, a 
preferred limited partnership interest or a similar instrument, 
including debentures under the terms of which interest is 
payable only to the extent of earnings and (B) the term 
``prioritizedpayments'' includes dividends on stock, interest 
on qualifying debentures, or priority returns on preferred limited 
partnership interests which are paid only to the extent of earnings. 
Participating securities guaranteed under this subsection shall be 
subject to the following restrictions and limitations, in addition to 
such other restrictions and limitations as the Administration may 
determine:
          (1) * * *
          (2) Prioritized payments on participating securities 
        shall be preferred and cumulative and payable out of 
        the retained earnings available for distribution, as 
        defined by the Administration, of the issuing company 
        at a rate determined by the Secretary of the Treasury 
        taking into consideration the current average market 
        yield on outstanding marketable obligations of the 
        United States with remaining periods to maturity 
        comparable to the average maturities on such 
        securities, adjusted to the nearest one-eighth of 1 
        percent, [plus an additional charge of 1 percent per 
        annum which shall be paid to and retained by the 
        Administration] plus an additional charge, in an amount 
        established annually by the Administration, of not more 
        than 1 percent per year as necessary to reduce to zero 
        the cost (as defined in section 502 of the Federal 
        Credit Reform Act of 1990 (2 U.S.C. 661a)) to the 
        Administration of purchasing and guaranteeing 
        participating securities under this Act, which shall be 
        paid to and retained by the Administration.

           *       *       *       *       *       *       *

          (8) Notwithstanding paragraph (9), if a company is 
        operating as a limited partnership or as a subchapter 
        [s] S corporation or an equivalent pass-through entity 
        for tax purposes and if there are no accumulated and 
        unpaid prioritized payments, the company may make 
        annual distributions to the partners, shareholders, or 
        members in amounts not greater than each partner's, 
        shareholder's, or member's maximum tax liability. For 
        purposes of this paragraph, the term ``maximum tax 
        liability'' means the amount of income allocated to 
        each partner, shareholder, or member (including an 
        allocation to the Administration as if it were a 
        taxpayer) for Federal income tax purposes in the income 
        tax return filed or to be filed by the company with 
        respect to the fiscal year of the company immediately 
        preceding such distribution, multiplied by the highest 
        combined marginal Federal and State income tax rates 
        for corporations or individuals, whichever is higher, 
        on each type of income included in such return. For 
        purposes of this paragraph, the term ``State income 
        tax'' means the income tax of the State where the 
        company's principal place of business is located. A 
        company may also elect to make a distribution under 
        this paragraph at [the end of any calendar quarter 
        based on a quarterly] any time during any calendar 
        quarter based on an estimate of the maximum tax 
        liability. If a company makes 1 or more [quarterly 
        distributions for a calendar year,] interim 
        distributions for a calendar year, and the aggregate 
        amount of those distributions exceeds the maximum 
        amount that the company could have distributed based on 
        a single annual computation, any subsequent 
        distribution by the company under this paragraph shall 
        be reduced by an amount equal to the excess amount 
        distributed.

           *       *       *       *       *       *       *

                    examinations and investigations

  Sec. 310. (a) * * *

           *       *       *       *       *       *       *

  (c) Each small business investment company shall be examined 
at least every two years in such detail so as to determine 
whether or not--
          (1) * * *

           *       *       *       *       *       *       *

          (4) it has made investments in small businesses for 
        not less than [five years] 1 year;

           *       *       *       *       *       *       *

                                

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