DATE: May 17, 2002

SUBJECT: Small Business Administration; Small Business Investment Companies

SOURCE: Federal Register, May 17, 2002, Vol. 67, No. 96, page 35055

AGENCIES: Small Business Administration (SBA)

ACTION: Proposed Rule

SYNOPSIS: The SBA is proposing to amend its regulations to permit 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.

EDITOR'S NOTE: The SBA's regulations that would be amended by this proposed rule are in Title 13 of the Code of Federal Regulations (CFR), Chapter 1, Small Business Administration, Part 107, Small Business Investment Companies, Section 107.865, Restrictions on Control of a Small Business by a Licensee (the proposed rule would change the title to "Control of a Small Business by a Licensee").

DATES: Comments on the proposed rule must be received no later than June 17, 2002.

ADDRESSES: Send comments 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.

SUPPLEMENTAL INFORMATION: The Small Business Investment Corrections Act of 2000 (Public Law 106-554) amended the Small Business Investment Act of 1958 to clarify that a small business concern controlled by venture capital firms, including licensed SBICs, does not cease to qualify as independently owned and operated.

This proposed rule would simplify Section 107.865, which governs control of a small business, and bring it into conformity with the 2000 amendment. Also, the proposed rule would remove 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 proposed rule is to implement the statutory change and allow SBICs the freedom to operate in the manner of modern venture capital investors. This proposed rule would permit the type of control that a modern venture fund would exercise while developing an investment, yet would avoid the control typical of a holding company operating a firm as a subsidiary and deriving profits through earnings and cash flow.

Paragraphs (a), (b), and (d) of Section 107.865 would be revised to read as follows:

     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.

In addition, paragraph (e), which addresses "Control Certifications", and paragraph (f), which addresses "Control Acquired Through Enforcement Actions", would be removed, and current paragraph (g), which addresses "Additional Financing for Businesses Under Licensee's Control", would be redesignated as paragraph (e). Paragraph (c), which addresses "Rebuttals to Presumption of Control", would be unchanged.

The following are the changes that would be made:

  1. Paragraph (a) would be a statement of general policy. It would differ from the present paragraph (a), which prohibits SBICs to operate a business enterprise, 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 only restriction in proposed paragraph (a) would be a five-year limit on SBIC control, which will be measured from the initial assumption of control, regardless of interruptions in control. SBA believes five years is 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. Also, the vast majority of SBICs are organized as limited partnerships with a life span not much in excess of ten years.

  2. Proposed paragraph (b), which outlines the circumstances under which the SBIC is presumed to have control over a small business, would clarify one point: the paragraph only applies to control based on ownership of voting securities. Control through other means, as specified in paragraph (a), may still exist even if the conditions in paragraph (b) are not met.

  3. Proposed paragraph (d) would allows extension of control over portfolio 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. In addition, it would allow SBA, in its discretion, to extend the period of control if necessary to protect the financial stability of the portfolio concern. Also, paragraph (d) would make clear that an SBIC may provide additional financing to a concern it controls.

Finally, paragraph (b) of Section 107.885, Disposition of Assets to Licensee's Associates or to Competitors of Portfolio Concern, currently 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. Since SBA believes control of such situations is best left to negotiations between the SBIC and the small business, SBA proposes to remove paragraph (b).

FOR FURTHER INFORMATION CONTACT: Panoptic Enterprises at 703-451-5953 or by e-mail to Panoptic@FedGovContracts.com.

Copyright 2002 by Panoptic Enterprises. All Rights Reserved.

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