[House Report 106-1]
[From the U.S. Government Publishing Office]
106th Congress Report
1st Session HOUSE OF REPRESENTATIVES 106-1
_______________________________________________________________________
AMENDING SECTION 20 OF THE SMALL BUSINESS ACT AND MAKE TECHNICAL
CORRECTIONS IN TITLE III OF THE SMALL BUSINESS INVESTMENT ACT
_______
January 19, 1999.--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
together with
ADDITIONAL VIEWS
[To accompany H.R. 68]
[Including cost estimate of the Congressional Budget Office]
The Committee on Small Business, to whom was referred the
bill (H.R. 68) to amend section 20 of the Small Business Act
and make technical corrections in Title III of the Small
Business Investment Act, having considered the same, report
favorably thereon without amendment and recommend that the bill
do pass.
Purpose
The purpose of H.R. 68 is to make certain technical
amendments to Title III of the Small Business Investment Act of
1958 and amend Section 20 of the Small Business Act. Title III
authorizes the activities of the Small Business Investment
Company program. Small Business Investment Companies (SBICs)
are venture capital firms licensed by the Small Business
Administration that use SBA guarantees to leverage private
capital for investment in small businesses.
The technical corrections proposed by H.R. 68 will improve
the flexibility of the SBIC program and allow improved access
to this program by small businesses.
Need for Legislation
Congress revamped the SBIC program in the 103d Congress to
provide for a new form of leverage geared specifically towards
equity investment in small businesses. Over the ensuing years,
as the new program has become established, certain deficiencies
have come to light; in addition, certain statutory provisions
have become obsolete.
Moreover, the nature of the SBIC industry has changed. The
result is a participating securities industry made up primarily
of smaller SBICs. The fact that these smaller SBICs are
dominating the program points to shifting dynamics in the SBIC
program. Smaller, start-up investments are more typical and,
therefore, the demand for leverage has shifted to smaller
individual placements.
H.R. 68 seeks to correct these deficiencies, and remove
provisions that may produce confusion due to changes in law and
the character of the SBIC program. First, H.R. 68 will modify
the SBIC program to exclude contingent obligations from the
calculation of interest in loans made by SBICs. These
contingent obligations include financial tools like royalties,
warrants, conversion rights and options. Many small businesses
use these devices to help buy down the interest rates on their
financings. Unfortunately, current law has forced SBA and the
SBICs to try and include these options as part of the interest
applicable for a determination of the maximum applicable
interest rate. These valuations have resulted in confusion and
uncertainty for all concerned and have often resulted in the
loss of financing opportunities for small businesses.
Second, under H.R. 68, a provision in the Small Business
Investment Act that reserves leverage for smaller SBICs will
also be repealed. Changes in SBA policy regarding applications
for leverage, statutory changes in the availability of
commitments for SBICs, and the makeup of the industry present
the possibility that that provision may, in fact, create
conflicts and confusion.
Third, H.R. 68 will increase the authorization levels for
the participating securities segment of the SBIC program. The
authorization levels will rise from $800 million to $1 billion
in fiscal year 1999, and from $900 million to $1.2 billion in
fiscal year 2000. These increases are necessary to meet the
rising demands for this section of the SBIC program.
Fourth, H.R. 68 modifies a test for determining the
eligibility of small businesses for SBIC financing. Current
statutory language does not account for small businesses
organized in pass-through tax structures such as S
corporations, limited liability companies, and certain
partnerships. These organizations do not pay taxes at the
enterprise level, but instead pass through income and the
ensuing tax liabilities to their partners and shareholders.
Consequently, many of these small businesses face difficulties
when the income test is applied to them, and are often declared
ineligible for financing they should receive.
Finally, H.R. 68 will allow the SBA greater flexibility in
issuing trust certificates to finance the SBIC program's
investments in small businesses. Current law allows fundings to
be issued every six months or more frequently. This inhibits
the ability of the SBICs and the SBA to form pools of
certificates that are large enough to generate serious investor
interest. Allowing more time between fundings will permit SBA
and the industry to form larger pools for sale in the market,
thereby increasing investor interest and improving the interest
rates for the small businesses financed.
Committee Action
In the 105th Congress, a hearing was held on May 12, 1998,
to discuss H.R. 3412 a bill substantially similar to H.R. 68.
Mr. Lee Mercer, President of the National Association of Small
Business Investment Companies, testified concerning the
provisions of H.R. 3412. At that hearing, Chairman Talent
questioned Mr. Mercer regarding concerns that repeal of the
provision reserving leverage for smaller SBICs might impair
access to leverage for those firms. Mr. Mercer responded that
his organization, which is composed primarily of smaller SBICs,
endorsed the provision. Further, he informed the Committee
that, based on industry and SBA data, 80 percent of the
participating securities licensees were smaller SBICs. He also
stated that demands for leverage in the participating
securities were generally for small individual placements
rather than any single large investments that would seriously
deplete funding. Ms. Velazquez then questioned Mr. Mercer about
the correction of the after-tax income test, and asked if he
could supply any specific firms who had been denied eligibility
due to the current test. Mr. Mercer stated that he could not
name any specific firms but that he had heard of several such
firms.
Ms. Velazquez, Mr. Davis and Mrs. Kelly then asked Mr.
Mercer several questions concerning the SBIC industry's efforts
to attract more minority and women-owned businesses for
financing assistance. Mr. Mercer described a number of
initiatives that his organization had started to achieve those
ends. Ms. Velazquez also requested that Mr. Mercer and his
organization develop and provide an outreach program for
minority and women-owned businesses.
On Thursday, January 7, 1999, the Committee on Small
Business held a brief hearing to consider the provisions of
H.R. 68. Testifying at the hearing was Mr. Lee Mercer,
President of the National Association of Small Business
Investment Companies. Mr. Mercer reiterated his testimony from
the 105th Congress regarding the beneficial effects that H.R.
68 would have on the SBIC program. He recognized the
improvements in management that have occurred in the program
over recent years and strongly recommended the corrections
contained in H.R. 68. Mr. Mercer explained the five provisions
and the effect they would have in detail. The hearing was in
essence a reprise of the hearing held the previous year to
discuss the provisions of H.R. 3412.
Mr. Hinojosa asked questions concerning the establishment
of the cost of money for the SBIC program through the secondary
market. Mr. Mercer explained that the cost was variable and
fluctuated in correspondence with changes in the 10-year
Treasury rate and the varying spread requirements of
institutional investors. Ms. Napolitano also asked Mr. Mercer
about the various examples of the effect and impact of the SBIC
program. There being no further questions, the hearing was
gaveled to a close and the Committee moved on to consideration
of H.R. 68.
Immediately after the hearing, Chairman Talent called the
Committee to order for the purpose of marking up and reporting
H.R. 68. The bill was introduced, considered as read, and
opened for amendment. No amendments were offered. Mrs. Kelly
then moved to pass H.R. 68 and report it to the House. At 11:05
a.m., by a unanimous voice vote, a quorum being present, the
Committee passed the bill, H.R. 68, and ordered it reported.
Section-by-Section Analysis
Section 1. Short title
Designates the bill as ``The Small Business Investment
Company Technical Corrections Act of 1999''.
Section 2. SBIC program
(1) Paragraph (a) of section 2 modifies section 308(i)(2)
of the Small Business Investment Act of 1958 to exclude
contingent obligations from the calculation used to determine
the maximum allowable interest rate in an SBIC financing.
Contingent obligations include financial tools such as options,
warrants, conversion rights and royalties. Because such devices
are contingent and speculative their correct valuation has been
a problem for small businesses, SBICs and the SBA.
(2) Paragraph (b) changes Section 20 of the Small Business
Act to increase the authorization levels for participating
securities under the SBIC program. The authorizations are
increased from $800 million to $1 billion in fiscal year 1999,
and from $900 million to $1.2 billion in fiscal year 2000.
(3) The first part of paragraph (c) removes subparagraph
(13) of Section 303(g) of the Small Business Investment Act (15
U.S.C. 683(g)). That provision reserves 50% of participating
securities leverage for Small Business Investment Companies
with private capital of less than $20 million until the fourth
fiscal quarter. While the Committee continues to be interested
that all SBICs have access to the funding needed to complete
their investments, we also recognize that this provision is no
longer necessary. Only 12 of the 60 SBICs in the participating
leverage program have more than $20 million in private capital,
and the original concern that a few large SBICs would dominate
the program has proved unfounded. It appears that most SBIC
equity placements are in smaller early-stage businesses, and
consequently most participating securities SBICs are
established as smaller funds.
(4) The second part of paragraph (c) establishes a test for
small businesses formed as tax ``pass-through'' entities such
as S corporations or limited liability companies. Such
businesses will have their small business investment
eligibility determined by multiplying their net income by the
combined federal and state corporate tax rate and then
subtracting the result from their net income. That result will
serve as the small business' estimated ``after-tax income'' for
the purpose of determining eligibility. This removes an
uncertainty in the statute that means a C corporation with as
much as $9 million in pretax income could be a small business
but a pass-through S corporation with $6,000,001 in income was
ineligible.
(5) The final part of paragraph (c) changes Section 320 of
the Small Business Investment Act to allow issuance of Small
Business Administration-backed trust certificates not less than
every twelve months rather than the current standard of every
six months. SBA would retain the discretion to issue guarantees
and trust certificates at shorter intervals if appropriate. The
chance will give SBA increased flexibility in negotiating the
terms and costs associated with the placement of certificates,
either by contract or public offering. This will ultimately
benefit the small business seeking financing since the rates
sought by SBICs are reflected in the rates charged to small
businesses.
Congressional Budget Office Cost Estimate
U.S. Congress,
Congressional Budget Office,
Washington, DC, January 13, 1999.
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. 68, the Small
Business Investment Company Technical Corrections Act of 1999.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Mark Hadley.
Sincerely,
James L. Blum
(For June E. O'Neill, Director).
Enclosure.
H.R. 68--Small Business Investment Company Technical Corrections Act of
1999
Summary: H.R. 68 would make a number of technical
corrections to the Small Business Investment Act of 1958. It
would eliminate a provision in current law that reserves funds
for smaller Small Business Investment Companies (SBICs) until
the last quarter of the fiscal year. The bill also would allow
a more accurate determination of eligibility of small
businesses for SBIC programs by requiring the Small Business
Administration (SBA) to measure a firm's revenues assuming that
it has paid all required income taxes. (Certain corporate
structures, such as ``S'' corporations, pass all income through
to the stockholders. Other firms do not pass through income,
but instead pay taxes at the corporate level). Finally H.R. 68
would give SBA more flexibility in issuing certificates that
help finance SBIC activities by increasing the minimum
placement period for public offerings from 6 months to 12
months.
The bill would increase the authorized level of the SBIC
participating securities program in 1999 and 2000. CBO
estimates that the subsidy costs of guarantees for the
authorized levels would increase by about $10 million over the
1999-2004 period.
H.R. 68 would not affect direct spending or receipts;
therefore, pay-as-you-go procedures do not apply. H.R. 68
contains no intergovernmental or private-sector mandates as
defined in the Unfunded Mandates Reform Act (UMRA) and would
not affect the budgets of state, local, or tribal governments.
Estimated cost to the Federal Government: For purposes of
this estimate, CBO assumes that the bill will be enacted by
March 31, 1999. CBO further assumes appropriation of authorized
amounts, including a supplemental appropriation for increases
of authorized amounts in fiscal year 1999. The estimated
budgetary impact of H.R. 68 is shown in the following table.
The costs of this legislation fall within budget function 370
(commerce and housing credit).
[By fiscal year, in millions of dollars]
----------------------------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 2004
----------------------------------------------------------------------------------------------------------------
Authorizations of Appropriations
SBIC Participating Securities Loans: \1\
Estimated authorization level................... 4 6 0 0 0 0
Estimated outlays............................... 1 6 2 (\2\) 0 0
----------------------------------------------------------------------------------------------------------------
\1\ Implementing H.R. 68 also would increase SBA's costs for administering loans, but CBO estimates that the
changes in administrative expenses would be less than $500,000 a year.
\2\ Less than $500,000.
The Federal Credit Reform Act of 1990 requires
appropriation of the subsidy costs and administrative costs for
credit programs. The subsidy cost is the estimated long-term
cost to the government of a direct loan or loan guarantee,
calculated on a net present-value basis and excluding
administrative costs.
H.R. 68 would increase the authorized program level of the
SBIC participating securities program from $800 million to $1
billion in 1999 and from $900 million to $1.2 billion in 2000.
Based on information from the SBA and on historical data for
this program, CBO estimates that the subsidy costs of
guarantees for the authorized levels would increase by $10
million over the 1999-2004 period. CBO estimates that this
provision would not significantly increase the administrative
costs of the agency.
Pay-as-you-go considerations: None.
Intergovernmental and private-sector impact: H.R. 68
contains no intergovernmental or private-sector mandates as
defined in UMRA and would not affect the budgets of state,
local, or tribal governments.
Estimate prepared by: Mark Hadley.
Estimate approved by: Paul N. Van de Water, Assistant
Director for Budget Analysis.
Committee Estimate of Costs
Pursuant to the Congressional Budget Act of 1974, the
Committee estimates that the amendments to Small Business
Administration authorization levels in H.R. 68 will increase
appropriations by no more than $10 million over the next five
fiscal years, if fully funded. 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. 68 will not significantly increase administrative costs.
This concurs with the estimate of the Congressional Budget
Office.
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 recommendations have been made by the
Committee on Government Reform with respect to the subject
matter contained in H.R. 68.
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. 68 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 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 III--SMALL BUSINESS INVESTMENT COMPANIES
* * * * * * *
Borrowing Power
Sec. 303. (a) * * *
* * * * * * *
(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
``prioritized payments'' 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) * * *
* * * * * * *
[(13) Participating securities for smaller small
business investment companies.--
[(A) In general.--Subject to the provisions
of subparagraph (B), of the amount of the
annual program level of participating
securities approved in appropriations Acts, 50
percent shall be reserved for funding small
business investment companies with private
capital of not more than $20,000,000.
[(B) Exception.--During the last quarter of
each fiscal year, if the Administrator
determines that there is a lack of qualified
applicants with private capital of not more
than $20,000,000, the Administrator may utilize
all or any part of the program level for
securities reserved under subparagraph (A) for
qualified applicants with private capital of
more than $20,000,000.]
* * * * * * *
Miscellaneous
Sec. 308. (a) * * *
* * * * * * *
(i)(1) The purpose of this subsection is to facilitate the
orderly and necessary flow of long-term loans and equity funds
from small business investment companies to small business
concerns.
(2) In the case of a business loan, the small business
investment company making such loan may charge interest on such
loan at a rate which does not exceed the maximum rate
prescribed by regulation by the Administration for loans made
by any licensee (determined without regard to any State rate
incorporated by such regulation). In this paragraph, the term
``interest'' includes only the maximum mandatory sum, expressed
in dollars or as a percentage rate, that is payable with
respect to the business loan amount received by the small
business concern, and does not include the value, if any, of
contingent obligations, including warrants, royalty, or
conversion rights, granting the small business investment
company an ownership interest in the equity or increased future
revenue of the small business concern receiving the business
loan.
* * * * * * *
(j) For the purposes of sections 304 and 305, in any case
in which an incorporated or unincorporated business is not
required by law to pay Federal income taxes at the enterprise
level, but is required to pass income through to its
shareholders or partners, an eligible small business or smaller
enterprise may be determined by computing the after-tax income
of such business by deducting from the net income an amount
equal to the net income multiplied by the combined marginal
Federal and State income tax rate for corporations.
* * * * * * *
Periodic Issuance of Guarantees and Trust Certificates
Sec. 320. The Administration shall issue guarantees under
section 303 and trust certificates under section 319 at
periodic intervals of not less than every [6] 12 months and
shall do so at such shorter intervals as it deems appropriate,
taking into consideration the amount and number of such
guarantees or trust certificates.
* * * * * * *
----------
SECTION 20 OF THE SMALL BUSINESS ACT
Sec. 20. (a) * * *
* * * * * * *
(d) Fiscal Year 1999.--
(1) Program levels.--The following program levels are
authorized for fiscal year 1999:
(A) * * *
* * * * * * *
(C) For the programs authorized by title III
of the Small Business Investment Act of 1958,
the Administration is authorized to make--
(i) [$800,000,000] $1,000,000,000 in
purchases of participating securities;
and
(ii) $700,000,000 in guarantees of
debentures.
* * * * * * *
(e) Fiscal Year 2000.--
(1) Program levels.--The following program levels are
authorized for fiscal year 2000:
(A) * * *
* * * * * * *
(C) For the programs authorized by title III
of the Small Business Investment Act of 1958,
the Administration is authorized to make--
(i) [$900,000,000] $1,200,000,000 in
purchases of participating securities;
and
* * * * * * *
ADDITIONAL VIEWS
As the Ranking Democratic Member of the Small Business
Committee, I want to express my strong support for a piece of
legislation that I am an original cosponsor of--H.R. 68, The
Small Business Investment Company Technical Corrections Act of
1999. This bill will make several key improvements to the Small
Business Investment Company Act and create a more efficient and
effective SBIC program.
The five provisions contained in H.R. 68 include three
passed by the House early last year as H.R. 3412, The Small
Business Investment Company Act of 1998. As a proponent of the
SBIC program, I was a cosponsor of that bill. It successfully
passed the House of Representatives by a unanimous vote last
summer. I was also pleased to work in conjunction with Chairman
Talent to ensure that the SBIC program was fully funded in the
Fiscal Year 1999 Commerce, Justice, State Appropriations. These
efforts were undertaken to make the program more efficient and
responsive to the needs of investors and small entrepreneurs.
There is no question that the value of Small Business
Investment Companies has been felt across the country. SBICs
have invested nearly $15 billion in long-term debt and equity
capital to over 90,000 small businesses. Millions of jobs have
been created and billions of dollars have been added to our
economy. For this reason, I believe that starting the 106th
Congressional Session with an SBIC-focused bill is important.
Building on the success of last year's legislation, there
are five technical improvements included in H.R. 68, The Small
Business Investment Company Technical Corrections Act of 1999.
The first change provides greater flexibility for funding
leverage, permitting the Small Business Administration (SBA) to
explore the broadest range of funding mechanisms that might
reduce the cost of leverage.
The next improvement establishes an assumed tax rate for
small businesses formed as pass-through entities for use in
determining eligibility for SBIC funding. This will increase
the number of small businesses that are eligible for SBIC
funding.
The third change ends the requirement that the SBA reserve
50% of participating security leverage for the first three
fiscal quarters of each year for SBICs with less than $20
million in private capital. This removes an administrative
burden rendered unnecessary by the commitment process.
Additionally, H.R. 68 increases the authorization level for
participating securities from $800 million to $1 billion for
current fiscal year 1999 and $900 million to at least $1.2
billion for fiscal year 2000.
In particular, I would like to clarify the first provision
which excludes royalty agreements from the cost of money
calculations. The manner in which the change is drafted is
meant to give SBA the greatest flexibility possible when they
promulgate regulations. Currently, SBICs may charge one maximum
permissible rate of interest for straight loans--those with no
contingent rights in the small business--or a lower maximum
permissible rate for hybrid loans--those with contingent rights
or other equity features. SBA has long struggled with how to
treat the value, if any, of the contingent equity features that
an SBIC receives in these hybrid loan transactions.
This proposal aims to be a powerful new tool for
underserved areas in their campaign to increase access to
investment capital. However, excluding royalties is not only
important for underserved areas, it is key for any small
businesses trying to attract SBIC financing.
During the past few years, the SBIC program has expanded
into new areas. In 1997 alone, we saw several ground breaking
efforts with the creation of two women owned SBICs, and the
establishment of the first Hispanic owned SBIC. The corrections
envisioned by H.R. 68 are part of an ongoing process that will
enable us to provide more ground breaking efforts to serve
small entrepreneurs.
Nydia M. Velazquez.