[Federal Register Volume 65, Number 223 (Friday, November 17, 2000)]
[Rules and Regulations]
[Pages 69431-69432]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-29522]



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Rules and Regulations
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Federal Register / Vol. 65, No. 223 / Friday, November 17, 2000 / 
Rules and Regulations

[[Page 69431]]



SMALL BUSINESS ADMINISTRATION

13 CFR Part 107


Small Business Investment Companies

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 Sec. 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 Sec. 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 Sec. 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 Sec. 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 Sec. 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, Sec. 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 Sec. 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

[[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 Sec. 107.815, revise the first sentence of paragraph (a) to 
read as follows:


Sec. 107.815  Financings in the form of Debt Securities.

* * * * *
    (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 
Sec. 107.855(g)(12).* *  *
* * * * *

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


Sec. 107.855  Interest rate ceiling and limitations on fees charged to 
Small Businesses (``Cost of Money'').

* * * * *
    (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