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Proposed Rule

Small Business Investment Companies

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Information about this document as published in the Federal Register.

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Small Business Administration (SBA).


Proposed rule.


This proposed rule would allow 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.


Comments must be received on or before June 17, 2002.


Written comments should be sent to Leonard W. Fagan, Investment Division, U.S. Small Business Administration, 409 3rd Street, SW., Washington, DC 20416.

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Harry Haskins, Deputy Associate Administrator, Investment Division, 202-205-6734.

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The Small Business Investment Corrections Act of 2000, Public Law 106-554, Title IV, section 402, amended section 103(5)(A)(i) of the Small Business Investment Act (Act) to clarify that a small business concern controlled by venture capital firms, including licensed small business investment companies (SBICs), does not for that reason cease to qualify as independently owned and operated. The statute reads, “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 U.S.C. 662(5)(A)(i)).

This proposed rule simplifies SBA's present regulation governing control of a small business and brings it into conformity with the Act, as amended in 2000. It also removes 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 rule is to implement a statutory change designed to allow SBICs the freedom to operate in the fashion of modern venture capital investors. SBA intends through this rule to permit the type of control that a modern venture fund would exercise while developing an investment, yet avoid the control typical of a holding company operating a firm as a subsidiary and deriving profits through earnings and cash flow.

The legislative history indicates that Congress envisioned only the kind of control that a modern venture capital fund focusing on capital gains would exercise. The legislative history (H.Rpt. 106-520) states that Congress did not intend for SBICs to exercise the control typical of a holding company or a continuing business operation conducted through a subsidiary for the purpose of accruing earnings on an annualized or cash flow basis.

Proposed § 107.865(a) is a statement of general policy. It differs from the present regulation 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 proposed rule also changes the definition of the “Investor Group”, those entities whose ownership interests are aggregated for the purpose of determining whether control exists. Under the current regulation, the Investor Group consists of all SBICs that invest in a portfolio company, even if there is no affiliation among them, and all of the SBICs' Associates as defined in § 107.50. The proposed rule defines the Investor Group as an SBIC and its Associates, but does not aggregate the interests of two or more unrelated SBICs. SBA believes that unrelated SBICs should have as much freedom to co-invest with one another as they do to co-invest with venture funds that are not SBICs.

The only restriction in proposed § 107.865(a) is a five-year limit on SBIC control. This will be measured from the initial assumption of control, regardless of interruptions in control. SBA considers five years 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. It should also suffice for the reversal of the declining fortunes of an operating business. Moreover, the vast majority of SBICs are organized as limited partnerships with a life span not much in excess of ten years.

The proposed rule retains § 107.865(b) with one clarification in the introductory text. Section 107.865(b) outlines the circumstances under which SBA will presume control over a small business for the purpose of determining when control begins or ends. The proposed language clarifies that this paragraph relates only to control based on ownership of voting securities. Control through other means, as specified in § 107.865(a), may still exist even if the conditions in paragraph (b) are not met.

The proposed rule retains § 107.865 (c), which sets forth rebuttals to the presumption of control based on ownership of voting securities.

Proposed § 107.865(d) allows extension of control over portfolio Start Printed Page 35056concerns 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. It also allows for SBA, in its discretion, to extend the period of control if necessary to protect the financial stability of the portfolio concern.

SBA believes that an investment for venture capital purposes is based primarily on an expectation of capital gains resulting from the divestiture of equity investments or conversion of warrants. SBA does not believe that conducting the ongoing operations of a portfolio concern for the purpose of receiving regular income is consistent with venture capital investing.

As stated above, SBA believes five years is generally sufficient time for profitable and effective venture capital investing. Consequently, SBA will not allow control beyond five years, except in limited circumstances.

Proposed § 107.865(d) makes clear that an SBIC may provide additional financing to a concern it controls regardless of the provisions of § 107.730(a)(1).

The rule would remove § 107.865 (e) and (f) as unnecessary and would redesignate § 107.865(g) as § 107.865(e).

Section 107.885(b) 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. SBA believes control of such situations is best left to negotiations between the SBIC and the small business. Consequently, SBA proposes to remove § 107.885(b).

Compliance With Executive Orders 12866, 12988, and 13132, the Regulatory Flexibility Act, and the Paperwork Reduction Act

The Office of Management and Budget (OMB) did not review this proposed rule as a “significant” regulatory action under Executive Order 12866. The proposed rule implements technical corrections to the SBIC program. This proposed rule will not have an annual effect on the economy of $100 million or more, adversely affect the economy in a material way, create a serious inconsistency or otherwise interfere with an action taken or planned by another agency, materially alter the budgetary impact of loan programs or other government programs, or raise novel legal or policy issues arising out of legal mandates or the President's priorities.

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

This regulation will not have substantial direct effects on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government. Therefore, under Executive Order 13132, the SBA determines that this proposed rule does not have sufficient federalism implications warranting the preparation of a Federalism Assessment.

This proposed rule does not impose any new information collection requirements from SBA which require approval by OMB under the Paperwork Reduction Act, 44 U.S.C. Ch.35.

When an agency issues a rulemaking proposal, the Regulatory Flexibility Act (RFA) requires the agency to “prepare and make available for public comment an initial regulatory flexibility analysis” which will “describe the impact of the proposed rule on small entities.” (5 U.S.C. § 603(a)) Section 605 of the RFA allows an agency to certify a rule, in lieu of preparing an analysis, if the proposed rulemaking is not expected to have a significant economic impact on a substantial number of small entities.

This proposed rule directly affects all SBICs, of which there are currently 432. SBA estimates that approximately 75 percent of these SBICs are small entities. Therefore, SBA has determined that this proposed rule will have an impact on a substantial number of small entities.

However, SBA has determined that the impact on entities affected by the proposed rule will not be significant. The effect of the proposed rule will be to allow SBICs the flexibility to choose the optimal structure for their investments without having to notify or seek approval from SBA. SBA expects the impact of the proposed rule will be a reduction in the paperwork burden for SBICs. SBA asserts that the economic impact of the reduction in paperwork, if any, will be minimal and entirely beneficial to small SBICs. Accordingly, the Administrator of the SBA hereby certifies that this rule will not have a significant economic impact on a substantial number of small entities. SBA invites comment from members of the public who believe there will be a significant impact either on SBICs, or on companies that receive funding from SBICs.

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List of Subjects in 13 CFR Part 107

  • Investment companies
  • Loan programs—business
  • Reporting and recordkeeping requirements
  • Small businesses
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For the reasons stated in the preamble, the Small Business Administration proposes to amend 13 CFR part 107 as follows:

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1. The authority citation for part 107 continues to read as follows:

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Authority: 15 USC 681 et seq., 683, 687(c), 687b, 687d, 687g, and 687m.

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2. In § 107.865, revise the section heading and paragraphs (a), (b) and (d) to read as follows:

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.

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(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.

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[Removed and Redesignated]

3. Remove the existing § 107.865(e) and (f) and redesignate § 107.865(g) as § 107.865(e).

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4. Amend 107.885 by removing paragraph (b) and removing the paragraph designation “(a)”.

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Dated: May 13, 2002.

Hector V. Barreto,


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[FR Doc. 02-12466 Filed 5-16-02; 8:45 am]