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Barry McVay's FEDERAL CONTRACTS DISPATCH

DATE: November 17, 2000

FROM: Barry McVay, CPCM

SUBJECT: Small Business Administration (SBA); Small Business Investment Companies

SOURCE: Federal Register, November 17, 2000, Vol. 65, No. 223, page 69431

AGENCIES: Small Business Administration (SBA)

ACTION: Final Rule

SYNOPSIS: SBA is amending its regulations to implement a provision of the Small Business Investment Improvement Act of 1999 (Public Law 106-9) that excludes certain types of consideration paid to a small business investment company (SBIC) by a small business from "cost of money" limitations.

EDITOR'S NOTE: The SBA's regulations being amended are in Title 13 of the Code of Federal Regulations (CFR), Business and Credit Administration; Chapter 1, Small Business Administration; Part 107, Small Business Investment Companies.

For more on the proposed rule, see the June 20, 2000, FEDERAL CONTRACTS DISPATCH "Small Business Administration; Small Business Investment Companies."

EFFECTIVE DATE: December 18, 2000.

FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division, 202-205-7583.

SUPPLEMENTAL INFORMATION: Public Law 106-9, enacted April 5, 1999, amended Section 308(i)(2) of the Small Business Investment Act of 1958 to provide 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 SBA -- specifically, any consideration consisting of "contingent obligations" which grant the SBIC an interest in the "equity or increased future revenue" of the small business.

On June 20, 2000, SBA published a proposed rule that would implement this change by revising Section 107.855, Interest Rate Ceiling and Limitations on Fees Charged to Small Businesses ("Cost of Money"). No comments were received, so the proposed rule is finalized without change.

This final rule revises Section 107.855 as follows:

• Paragraph (g) covers "Charges Excluded from the Cost of Money." Paragraph (g)(12) had excluded "royalty payments received under any LMI [low and moderate income] investment if the royalty is based on improvement in the performance of the small business after the date of the financing." This rule deletes the words "received under any LMI investment if the royalty is" so that it now reads "royalty payments based on improvement in the performance of the small business after the date of the financing."
  
  In conjunction with the change to paragraph (g)(12), the definition of a "debt security" in paragraph (a) of Section 107.815, Financings in the Form of Debt Securities, is revised to add "...or a loan with a right to receive royalties that are excluded from the cost of money pursuant to Sec. 107.855(g)(12)" (the term was defined as "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"). This change applies to the Section 107.855(g)(12) loans the lower cost of money ceiling applicable to debt securities rather than the higher ceiling applicable to loans with no upside potential.
  
  
• Paragraph (g)(13) is added, and it excludes "gains realized on the disposition of equity securities issued by the small business." SBA states in its introduction to the final rule that "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."
  
  
• Paragraph (i) is removed. Paragraph (i) had excluded one-time "bonuses" at the end of the loan term from the cost of money. The revision to paragraph (g)(12) provides a broader exclusion of contingent payments from the cost of money, so paragraph (i) is now redundant.

FOR FURTHER INFORMATION CONTACT: Barry McVay at 703-451-5953 or by e-mail to BarryMcVay@FedGovContracts.com.

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