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###### Small Business Administration

          - 13 CFR Part 107 

# AGENCY:

Small Business Administration. 

# ACTION:

Final rule. 

# SUMMARY:

This final rule implements a provision of Public Law 106-9, enacted April 5, 1999, under which certain types of consideration paid to a small business investment company (SBIC) by a small business are excluded from “cost of money” limitations. 

# DATES:

This final rule is effective December 18, 2000. 

# FOR FURTHER INFORMATION CONTACT:

Leonard W. Fagan, Investment Division, at (202) 205-7583. 

# SUPPLEMENTARY INFORMATION:

On June 20, 2000, SBA published a proposed rule to implement a provision of Public Law 106-9, enacted April 5, 1999, that amended section 308(i)(2) of the Small Business Investment Act of 1958. See 65 FR 38223. This amendment provided that certain types of consideration paid to an SBIC by a small business are excluded from the regulatory limitations on “Cost of Money” established by the Small Business Administration (SBA). The amendment excluded from these Cost of Money limits any consideration consisting of “contingent obligations” granting the SBIC an interest in the “equity or increased future revenue” of the small business. 

SBA received no comments on the proposed rule during the 30-day public comment period and is finalizing the proposed rule without change. The final rule contains the following provisions: 

                    Revised § 107.855(g)(12) allows the exclusion of royalty payments for all SBIC financings. Previously, this exclusion applied only to “LMI Investments” as defined in § 107.50. To qualify for the exclusion, the royalty must be based on improvement in the performance of the small business after the date of the financing. The royalty could be expressed, for example, as a percentage of any increase in an underlying unit of measurement (                    *e.g.,*                     revenues or sales) after the date of the financing. The royalty can be based on an increase in more than one unit of measurement; for example, a royalty could provide for payment to the SBIC if either the revenue or the profits of the small business increased.                 

If an SBIC makes an investment through a holding company or an investment vehicle, as permitted under § 107.720(b), SBA will evaluate performance improvements by looking through the holding company or investment vehicle to the performance of the operating business itself. 

Also with respect to royalty payments, the definition of a Debt Security in § 107.815(a) is revised to include a loan with a right to receive royalties that are excluded from the Cost of Money. As a result, a financing of this type will be subject to the lower Cost of Money ceiling applicable to Debt Securities, rather than the higher ceiling applicable to Loans with no upside potential. 

This rule also adds § 107.855(g)(13), which excludes from Cost of Money any gains realized by an SBIC from the disposition of Equity Securities issued by a small business. This provision has been added as a clarification, since SBA's longstanding practice has been to exclude such gains from the Cost of Money limits. For example, if an SBIC receives warrants that qualify as Equity Securities, or converts debt to an Equity Security, any gains realized on the disposition of these interests do not count against the Cost of Money ceiling. 

Finally, § 107.855(i) has been removed. This paragraph allowed an SBIC that was lending to a small business to receive a one-time “bonus” at the end of the loan term, contingent upon one or more factors reflecting the performance of the business during the loan period. Such bonus payments were excluded from the Cost of Money. The revision of § 107.855(g)(12), which provides a broader exclusion of contingent payments from the Cost of Money, renders the bonus provision redundant. 

## Compliance With Executive Orders, 12866, 12988, and 13132, the Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the Paperwork Reduction Act (44 U.S.C. Ch. 35). 

This final rule does not constitute a “significant” regulatory action within the meaning of section 3(f) of Executive Order 12866 and thus, was not reviewed by the Office of Management and Budget (OMB). 

                    Under the Regulatory Flexibility Act, 5 U.S.C. 601,                     *et seq.*, SBA has determined that this final rule will not have a significant economic impact on a substantial number of small entities. The purpose of the final rule is to implement a provision of Public Law 106-9 allowing small business investment companies (SBICs) to realize contingent payments, such as royalties, from small businesses without being subject to regulatory limits on the amount of consideration received. Interest and other non-contingent payments made to SBICs by small businesses will continue to be subject to the existing Cost of Money regulations. This provision is expected to be attractive primarily to SBICs considering investments in small businesses that are seeking to grow, but whose owners do not want to give substantial equity interests to outside investors. In such cases, the SBIC can participate in the growth of the business by collecting a royalty rather than through an ownership interest.                 

                    Based on recent statistics for the SBIC program, the circumstances that this final rule addresses do not appear to apply to most small businesses currently receiving SBIC financing. In fiscal year 1999, SBICs provided financing to 1,983 different small businesses. In approximately two-thirds of all the financings closed during that year, the SBIC obtained an actual or potential equity interest in the small business; even if the proposed rule had been in place, it is unlikely that these transactions would have included royalty provisions. The remaining one-third of SBIC financings typically consist of loans to very small businesses with low growth potential, which are unlikely to have the ability to make royalty payments under any circumstances. Thus, it is unlikely that this final rule will affect a substantial number of small entities. The final rule is expected to expand financing                           ( print page 69432)                        opportunities for certain small businesses wishing to grow while remaining closely held, rather than make SBIC financing more expensive for small businesses currently being served by the program.                 

For purposes of Executive Order 12988, SBA has determined that this final rule is drafted, to the extent practicable, in accordance with the standards set forth in section 3 of that Order. 

For purposes of Executive Order 13132, SBA has determined that this final rule has no federalism implications. 

For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA certifies that this final rule contains no new reporting or recordkeeping requirements. 

# List of Subjects in 13 CFR Part 107

      - Investment companies
      - Loan programs-business
      - Reporting and recordkeeping requirements
      - Small businesses

For the reasons set forth above, SBA is amending 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 U.S.C. 681*et seq.*, 683, 687(c), 687b, 687d, 687g and 687m.                         

2. In § 107.815, revise the first sentence of paragraph (a) to read as follows: 

§ 107.815 

* * * * *

                            (a)                             *Definitions.*                             Debt Securities are instruments evidencing a loan with an option or any other right to acquire Equity Securities in a Small Business or its Affiliates, or a loan which by its terms is convertible into an equity position, or a loan with a right to receive royalties that are excluded from the Cost of Money pursuant to § 107.855(g)(12).* * *                         

* * * * *

3. In § 107.855, revise paragraph (g)(12), add paragraph (g)(13) and remove paragraph (i) to read as follows: 

§ 107.855 

* * * * *

(g) * * * 

(12) Royalty payments based on improvement in the performance of the Small Business after the date of the Financing. 

(13) Gains realized on the disposition of Equity Securities issued by the Small Business. 

* * * * *

Dated: November 3, 2000. 

Aida Alvarez, 

Administrator. 

[FR Doc. 00-29522 Filed 11-16-00; 8:45 am] 

BILLING CODE 8025-01-P