[House Report 106-520]
[From the U.S. Government Publishing Office]
106th Congress Report
HOUSE OF REPRESENTATIVES
2d Session 106-520
=======================================================================
SMALL BUSINESS INVESTMENT CORRECTIONS ACT OF 2000
_______
March 14, 2000.--Committed to the Committee of the Whole House on the
State of the Union and ordered to be printed
_______
Mr. Talent, from the Committee on Small Business, submitted the
following
R E P O R T
[To accompany H.R. 3845]
[Including cost estimate of the Congressional Budget Office]
The Committee on Small Business, to whom was referred the
bill (H.R. 3845) to make corrections to the Small Business
Investment Act of 1958, and for other purposes, having
considered the same, report favorably thereon without amendment
and recommend that the bill do pass.
Purpose
The purpose of H.R. 3845 is to amend the Small Business
Investment Act (the Act) to make changes in the Small Business
Investment Company (SBIC) program at the Small Business
Administration (SBA), commonly known as the SBIC program. H.R.
3845 contains four technical changes to improve the program and
correct problems brought to the Committee's attention through
the oversight process.
H.R. 3845 modifies the definition of control for SBIC
investment in small businesses, eliminating a cumbersome five
prong test and setting a clear statutory standard. H.R. 3845
will also modify the definition of long term investment under
the Act, changing it from five years to one year, in order to
harmonize that definition with accepted business practice and
the tax and banking laws. Third, the bill allows the
Administration to adjust the subsidy fee for the SBIC program
to maintain the subsidy rate of the program at zero. Finally,
the bill makes a change to the distribution language in the
Act, allowing SBICs more flexibility in making distributions to
their investors and will simplify the accounting and tax
procedures at SBICs.
Need for Legislation
Definition of small business concern
SBA regulations currently prohibit an SBIC from owning a
controlling interest in the voting stock of a small business or
otherwise exercising control to the small business.
These regulations were put in place to ensure that SBICs
did not become holding companies and to protect small business
from over aggressive investments. During the life of the
program several exceptions have been put in place recognizing
the reality of equity investment. These include control for a
start-up company, when a major investment is undertaken, for a
troubled company, breach of agreement, and most recently for
those businesses that are located in low and moderate income
area (LMIs). Through the administering and oversight of these
regulations the Committee believes the result has been to
create a complicated and sometimes burdensome process for both
SBA and SBICs.
While the intent of the regulation was the protection of
small business it has resulted in keeping parties to an SBIC
investment from structuring the investment in ways that may be
most reasonable and acceptable from both operating and market
perspective. The Committee made these changes recognizing the
reality of venture capital investment, however the amendment is
not intended to foster SBICs becoming holding companies for
operating small business concerns. In today's venture capital
world venture funds may act as incubators of business ideas by
creating and capitalizing small businesses to nurture
technology in the early stages of its development. In such
cases SBICs may need to create, capitalize and operate small
business concerns in the early years.
Furthermore, the Gramm-Leach-Bliley Bank Modernization
Act--which grants banks authority to conduct venture capital
operations without an SBIC license--does not prohibit control.
To the contrary, it explicitly permits control during the
investment period. The proposed amendment would make the Small
Business Investment Act consistent with the new banking law and
would serve as an incentive for banks to retain their SBIC
operations--to the benefit of U.S. small businesses.
Definition of long term
The term ``long-term'' as found in Section 102 of the Act
has been interpreted to mean a period of time equal to a
minimum of five years for all SBIC investments other than those
made in ``Disadvantaged Businesses.'' For the latter, the
minimum period is four years.
This interpretation does not allow SBICs and small
businesses to fashion investment agreements that are flexible
enough to meet the needs of both parties in accordance with the
dictates of the commercial marketplace.
This interpretation has no counterpart in any other area of
business commerce. To the contrary, Generally Accepted
Accounting Principles (GAAP) define ``long-term'' as any period
of time greater than one year in duration. Likewise, tax law
defines ``long-term'' for capital gains purposes as a period
greater than one year. The proposed amendment would make SBIC
law consistent with GAAP and tax law and apply the same
standard for all SBIC investments.
The Gramm-Leach-Bliley Bank Modernization Act--which gives
banks authority to conduct venture capital operations without
an SBIC license--places no restrictions on the period of time
for investments. The proposed amendment will be consistent with
the new bank law and would serve as an important incentive for
banks to retain their SBIC operations--to the benefit of U.S.
small businesses seeking financing. Without the amendment, many
banks may choose to operate all their venture capital
operations outside the SBIC program--to the detriment of small
businesses served by the SBIC program.
Subsidy fees
An additional 1 percent interest obligation was imposed on
SBICs in 1996 in order to reduce the Small Business
Administration's appropriated cost, as determined by the
Administration's subsidy model, for supporting the SBIC
program. Since then changes in the program coupled with a
stricter examination and licensing program at SBA have
significantly reduced the subsidy cost of both the Debenture
and Participating Securities programs. At least part of the 1
percent in additional interest is no longer required in the
Debenture program to keep the subsidy rate at zero. The same
may soon be true for the Participating Securities program as
well. In fact, current estimates show that the 1 percent fee is
overcharging the SBICs (and their small business clients),
resulting in a hidden tax on the program.
Changing the law as proposed would allow the Administration
to adjust the additional interest and prioritized payment rates
annually based on annual subsidy rate calculations. A similar
approach is already in place for the SBA's 504 loan program
which operates at no cost to the taxpayer and has consistently
reduced its fees.
Distribution
Under current law, SBICs may make prioritized payment
distributions, profit distributions, and other optional
distributions (e.g., distributions of capital on any date with
prior SBA approval). Tax distributions, however, may only be
made at the end of calendar year quarters.
The practical impact of this restriction is that SBICs are
forced to either delay otherwise permitted interim
distributions (that would include tax distributions) to the end
of a quarter or split their distributions into two
distributions--tax distributions (made at the end of a quarter)
and all other distributions (made at any time during a
quarter).
Postponing an entire distribution to the end of a quarter
has negative cash flow and internal rate of return (IRR)
implications for SBICs. Consequently, most SBICs will opt to
split their distributions. Splitting distributions requires the
preparation, submission, and SBA review of two sets of
documents when one would otherwise suffice. This results in
inefficient use of both SBA and SBIC time and resources.
The proposed amendment is technical in nature and will have
no substantive impact on the SBIC program. However, it will
save time and expense for both SBA and SBICs by eliminating
duplicative filings and inefficient use of SBA resources.
Committee Action
Hearing on the SBA budget and legislative proposals
On March 1, 2000, at 10:00 a.m., the Committee on Small
Business convened a hearing to discuss the Administration's
budget proposal for the SBA for fiscal year 2001 and
legislative proposals. The Committee received testimony from
five witnesses: Hon. Aida Alvarez, Administrator of the Small
Business Administration; Mr. Anthony Wilkinson, President of
the National Association of Government Guaranteed Lenders; Mr.
Lee Mercer, President of the National Association of Small
Business Investment Companies; Mr. Woody McCutchen, Executive
Director of the Association of Small business Development
Centers; Ms. Caroline Hayashi, representing the Association for
Enterprise Opportunity; and Mr. John Geigel, Vice President for
Government Relations of the National Association of Development
Companies.
During his testimony Mr. Mercer discussed the changes
included in H.R. 3845 and asked that the Committee consider
legislation addressing these concerns.
Consideration of H.R. 3845
At 10 a.m. on March 9, 2000, the Committee on Small
Business met to consider and report H.R. 3843 and H.R. 3845.
After consideration of H.R. 3843, Chairman Talent asked
unanimous consent that H.R. 3845 be considered as read and open
for amendment at any point. No amendments were offered to H.R.
3845. The Chairman then moved the bill be reported, and at
10:16 a.m., by a voice vote, a quorum being present, the
Committee passed H.R. 3845 and ordered it reported.
Section-by-Section Analysis
Section 1. Short title
Section 2. Definitions
(a) Small Business Concern.--Inserts the following language
in section 103(5)(A)(i) of the Small Business Investment Act--
``regardless of the allocation of control during the investment
period under any investment agreement between the business
concern and the entity making the investment''. This phrase
clarifies that a venture capital investment agreement from an
SBIC may cause a change in control of a small business, but
that such a change will not affect the eligibility of the small
business concern. The Committee does not intend that SBICs
become holding companies hence the language references the
period of the investment agreement. Further, the Committee
retains the authority for SBIC examinations to inquire into
``illegal control'' by SBICs, though the committee expects such
control to be that exercised outside an investment agreement.
(b) Long term.--Inserts the following paragraph in section
103 of the Small Business Investment Act:
``(17) the term long term, when used in connection
with equity capital or loan funds invested in any small
business concern or smaller enterprise, means any
period of time not less than 1 year.''
The language changes the definition of a long term
investment to harmonize it with the tax and banking laws.
Section 3. Subsidy fees
This provision amends sections 303(b) and 303(g)(2) of the
Small Business Investment Act to allow the Administration to
adjust the fee assessed on debentures and participating
securities up to a maximum of one percent. The fee will be
adjusted to keep the subsidy cost of the programs at zero or as
close as possible to zero.
Section 4. Distributions
This section amends section 303(g)(8) of the Small Business
Investment Act in order to allow SBICs to make distributions at
any time during a calendar quarter based on the maximum
estimated tax liability.
Section 5. Conforming amendment
CBO Estimate
U.S. Congress,
Congressional Budget Office,
Washington, DC, March 14, 2000.
Hon. James M. Talent,
Chairman, Committee on Small Business,
House of Representatives, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for H.R. 3845, the Small
Business Investment Corrections Act of 2000.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Mark Hadley.
Sincerely,
Barry B. Anderson
(For Dan L. Crippen, Director).
Enclosure.
CBO estimates that enactment of H.R. 3845 would cost about
$50 million in 2000 because it could end the collection of fees
currently charged by the Small business Administration (SBA)
for loan guarantees made to private venture capital firms. The
bill could reduce offsetting receipts (a form of direct
spending); therefore, pay-as-you-go procedures would apply.
H.R. 3845 contains no intergovernmental or private-sector
mandates as defined in the Unfunded Mandates Reform Act and
would impose no costs on state, local, or tribal governments.
Through two Small Business Investment Company (SBIC)
programs, SBA guarantees 10-year loans made to venture capital
firms. To offset the subsidy cost of these guarantees, SBA
charges venture capital firms that participate in the program a
fee of 1 percent of the loan amount each year. Based on
information from SBA and the Office of Management and Budget,
CBO estimates that there will be about $6 billion of guaranteed
loan balances at the end of 2000, resulting in the collection
of about 460 million in fees in 2000.
H.R. 3845 would require SBA to reduce the 1 percent fee if
the subsidy cost of these programs would otherwise be less than
zero. The subsidy cost of a loan guarantee is the estimated
long-term cost to the government, calculated on a net present
value basis and excludes administrative costs. For fiscal year
2000, the estimated subsidy rate is 1.8 percent for one of the
SBIC programs and zero for the other. If SBA reestimates the
subsidy cost of these loan guarantees to be less than zero
(that is, a ``negative subsidy''), H.R. 3845 would require the
agency to reduce the fees by reducing the possibility of
recognizing any negative subsidies. Based on the likelihood
that the subsidy rate for these programs could be less than
zero, CBO estimates that enacting this provision would reduce
future offsetting receipts. The estimated cost of $50 million
represents the present value of fees that could be eliminated
by the bill. Such fees would otherwise be collected annually
over the remaining term of the $6 billion in loan guarantees.
The CBO staff contact is Mark Hadley. The estimate was
approved by Peter H. Fontaine, Deputy Assistant Director for
Budget Analysis.
Committee Estimate of Costs
Pursuant to the Congressional Budget Act of 1974, the
Committee estimates that the amendments to the Small Business
Investment Act contained in H.R. 3845 will not increase
discretionary spending over the next five fiscal years. The
Committee also estimates that H.R. 3845 will increase direct
spending by $50 million, as currently drafted, when applied to
previous cohorts of SBIC loans. This estimate concurs with
Congressional Budget Office (CBO) estimates.
Furthermore, pursuant to clause 3(d)(2)(A) of rule XIII of
the Rules of the House of Representatives, the Committee
estimates that implementation of H.R. 3845 will not
significantly increase other administrative costs.
Oversight Findings
In accordance with clause 4(c)(2) of rule X of the Rules of
the House of Representatives, the Committee states that no
oversight findings or recommendation have been made by the
Committee on Government Reform with respect to the subject
matter contained in H.R. 3845.
In accordance with clause (2)(b)(1) of rule x of the Rules
of the House of Representatives, the oversight findings and
recommendations of the Committee on Small Business with respect
to the subject matter contained in H.R. 3845 are incorporated
into the descriptive portions of this report.
Statement of Constitutional Authority
Pursuant to clause 3(d)(1) of rule XIII of the Rules of the
House of Representatives, the Committee finds the authority for
this legislation in Article I, Section 8, clause 18, of the
Constitution of the United States.
Changes in Existing Law Made by the Bill, as Reported
In compliance with clause 3(e) of rule XIII of the Rules of
the House of Representatives, changes in existing law made by
the bill, as reported, are shown as follows (existing law
proposed to be omitted is enclosed in black brackets, new
matter is printed in italic, existing law in which no change is
proposed is shown in roman):
SMALL BUSINESS INVESTMENT ACT OF 1958
* * * * * * *
TITLE I--SHORT TITLE, STATEMENT OF POLICY, AND DEFINITIONS
* * * * * * *
definitions
Sec. 103. As used in this Act--
(1) * * *
* * * * * * *
(5) the term ``small-business concern'' shall have
the same meaning as in the Small Business Act, except
that, for purposes of this Act--
(A) an investment by a venture capital firm,
investment company (including a small business
investment company) employee welfare benefit
plan or pension plan, or trust, foundation, or
endowment that is exempt from Federal income
taxation--
(i) shall not cause a business
concern to be deemed not independently
owned and operated 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) the term ``member'' means, with respect to a
licensee that is a limited liability company, a holder
of an ownership interest or a person otherwise admitted
to membership in the limited liability company; [and]
(16) the term ``limited liability company'' means a
business entity that is organized and operating in
accordance with a State limited liability company
statute approved by the Administration[.]; and
(17) the term ``long term'', when used in connection
with equity capital or loan funds invested in any small
business concern or smaller enterprise, means any
period of time not less than 1 year.
* * * * * * *
TITLE III--SMALL BUSINESS INVESTMENT COMPANIES
* * * * * * *
borrowing power
Sec. 303. (a) * * *
(b) To encourage the formation and growth of small business
investment companies the Administration is authorized when
authorized in appropriation Acts, to purchase, or to guarantee
the timely payment of all principal and interest as scheduled
on, debentures or participating securities issued by such
companies. Such purchases or guarantees may be made by the
Administration on such terms and conditions as it deems
appropriate, pursuant to regulations issued by the
Administration. The full faith and credit of the United States
is pledged to the payment of all amounts which may be required
to be paid under any guarantee under this subsection.
Debentures purchased or guaranteed by the Administration under
this subsection shall be subordinate to any other debenture
bonds, promissory notes, or other debts and obligations of such
companies, unless the Administration in its exercise of
reasonable investment prudence and in considering the financial
soundness of such company determines otherwise. Such debentures
may be issued for a term of not to exceed fifteen years and
shall bear interest at a rate not less than a rate determined
by the Secretary of the Treasury taking into consideration the
current average market yield on outstanding marketable
obligations of the United States with remaining periods to
maturity comparable to the average maturities on such
debentures, adjusted to the nearest one-eighth of 1 per centum,
[plus an additional charge of 1 percent per annum which shall
be paid to and retained by the Administration] plus an
additional charge, in an amount established annually by the
Administration, of not more than 1 percent per year as
necessary to reduce to zero the cost (as defined in section 502
of the Federal Credit Reform Act of 1990 (2 U.S.C. 661a)) to
the Administration of purchasing and guaranteeing debentures
under this Act, which shall be paid to and retained by the
Administration. The debentures or participating securities
shall also contain such other terms as the Administration may
fix, and shall be subject to the following restrictions and
limitations:
(1) * * *
* * * * * * *
(g) In order to encourage small business investment companies
to provide equity capital to small businesses, the
Administration is authorized to guarantee the payment of the
redemption price and prioritized payments on participating
securities issued by such companies which are licensed pursuant
to section 301(c) of this Act, and a trust or a pool acting on
behalf of the Administration is authorized to purchase such
securities. Such guarantees and purchases shall be made on such
terms and conditions as the Administration shall establish by
regulation. For purposes of this section, (A) the term
``participating securities'' includes preferred stock, a
preferred limited partnership interest or a similar instrument,
including debentures under the terms of which interest is
payable only to the extent of earnings and (B) the term
``prioritizedpayments'' includes dividends on stock, interest
on qualifying debentures, or priority returns on preferred limited
partnership interests which are paid only to the extent of earnings.
Participating securities guaranteed under this subsection shall be
subject to the following restrictions and limitations, in addition to
such other restrictions and limitations as the Administration may
determine:
(1) * * *
(2) Prioritized payments on participating securities
shall be preferred and cumulative and payable out of
the retained earnings available for distribution, as
defined by the Administration, of the issuing company
at a rate determined by the Secretary of the Treasury
taking into consideration the current average market
yield on outstanding marketable obligations of the
United States with remaining periods to maturity
comparable to the average maturities on such
securities, adjusted to the nearest one-eighth of 1
percent, [plus an additional charge of 1 percent per
annum which shall be paid to and retained by the
Administration] plus an additional charge, in an amount
established annually by the Administration, of not more
than 1 percent per year as necessary to reduce to zero
the cost (as defined in section 502 of the Federal
Credit Reform Act of 1990 (2 U.S.C. 661a)) to the
Administration of purchasing and guaranteeing
participating securities under this Act, which shall be
paid to and retained by the Administration.
* * * * * * *
(8) Notwithstanding paragraph (9), if a company is
operating as a limited partnership or as a subchapter
[s] S corporation or an equivalent pass-through entity
for tax purposes and if there are no accumulated and
unpaid prioritized payments, the company may make
annual distributions to the partners, shareholders, or
members in amounts not greater than each partner's,
shareholder's, or member's maximum tax liability. For
purposes of this paragraph, the term ``maximum tax
liability'' means the amount of income allocated to
each partner, shareholder, or member (including an
allocation to the Administration as if it were a
taxpayer) for Federal income tax purposes in the income
tax return filed or to be filed by the company with
respect to the fiscal year of the company immediately
preceding such distribution, multiplied by the highest
combined marginal Federal and State income tax rates
for corporations or individuals, whichever is higher,
on each type of income included in such return. For
purposes of this paragraph, the term ``State income
tax'' means the income tax of the State where the
company's principal place of business is located. A
company may also elect to make a distribution under
this paragraph at [the end of any calendar quarter
based on a quarterly] any time during any calendar
quarter based on an estimate of the maximum tax
liability. If a company makes 1 or more [quarterly
distributions for a calendar year,] interim
distributions for a calendar year, and the aggregate
amount of those distributions exceeds the maximum
amount that the company could have distributed based on
a single annual computation, any subsequent
distribution by the company under this paragraph shall
be reduced by an amount equal to the excess amount
distributed.
* * * * * * *
examinations and investigations
Sec. 310. (a) * * *
* * * * * * *
(c) Each small business investment company shall be examined
at least every two years in such detail so as to determine
whether or not--
(1) * * *
* * * * * * *
(4) it has made investments in small businesses for
not less than [five years] 1 year;
* * * * * * *