- A Present from Congress: Significant Changes for SBICs
- December 21, 2015 | Authors: Steven B. Boehm; Terri G. Jordan; Cynthia M. Krus; Lisa A. Morgan; Harry S. Pangas
- Law Firm: Sutherland Asbill & Brennan LLP - Washington Office
Late on December 15, Congress unveiled a tax extenders bill and omnibus bill that are expected to be merged into a single bill to be signed into law. The House and Senate are both expected to pass this legislation before the end of this week, and the President has indicated that he will sign this legislation into law. The long-awaited “family of funds” limit increase is included in this pending legislation. Together with other recent developments affecting small business investment companies (SBICs), this could make for a happy holiday for fund managers focused on lending to the lower middle market.
Family of Funds Limit Increased to $350 Million
Included in the tax extenders bill are several important SBIC-related provisions. First and foremost is the so-called “family of funds” limit increase, which would permit affiliated SBICs to borrow up to $350 million under the Small Business Administration (SBA) SBIC program, a significant increase from the current limit of $225 million. This initiative has been proposed and moved through various stages of the legislative process for the last several years without culminating in successful passage. We believe this will be significant for the SBIC industry, and will encourage even more fund managers to pursue SBIC licensing. In addition, the bill includes a tax provision that would make permanent the 100% capital gains exclusion for investments in SBICs.
SBIC Advisers Relief Act Reduces Burden on Advisers
On December 4, 2015, the provisions of the SBIC Advisers Relief Act were passed by Congress and signed into law as part of the Fixing America’s Surface Transportation (FAST) Act.
Certain provisions of the Investment Advisers Act of 1940 (Advisers Act) applicable to advisers of SBICs were amended to provide for federal preemption of state registration requirements. Advisers whose only clients are SBICs will no longer be subject to state level registration requirements, and will no longer need to rely on state level exempt reporting adviser exemptions.
In addition, the SBIC Advisers Relief Act provides relief to investment advisers that advise both SBIC clients and venture capital fund clients, by providing that an SBIC will be considered to qualify as a venture capital fund, as defined in the Advisers Act under Rule 203(l)-1, for purposes of the venture fund adviser exemption, thereby allowing these advisers to rely on that exemption. Previously, advisers whose only clients were venture capital funds were able to rely on an exemption from registration at the federal level, as were advisers whose only clients were SBICs. However, if an adviser advised both venture capital funds and SBICs, no such exemption was available. Advisers should note that in order to claim the venture capital fund exemption, the adviser must register with the U.S. Securities and Exchange Commission (SEC) as an exempt reporting adviser.
Finally, advisers managing SBICs together with other non-SBIC private funds may be able to avail themselves of the private fund adviser exemption. The private fund adviser exemption has historically allowed an adviser whose only clients were private funds and that had less than $150 million in regulatory assets under management from having to register with the SEC. This $150 million calculation included the gross asset value of all assets, plus any uncalled limited partner commitments. Under the SBIC Advisers Relief Act provisions, the SBIC capital, including both equity and debt borrowed from the SBA, is no longer required to be included in the $150 million calculation for the private fund adviser exemption. As a result, many existing SBIC managers may qualify for the “exempt reporting adviser” standard, or even avoid SEC adviser registration altogether.
Changes to Permitted Use of Passive Entities
In early October, the SBA proposed revisions to the Passive Business Rule aimed at expanding the permitted use of passive businesses and certain holding company structures by SBICs, including those controlled by business development companies (BDCs).
Sutherland submitted a comment letter in response to these proposed revisions that generally supported the new rule as drafted, which would eliminate the prior approval requirement for the use of a tax blocker structure, permit the use of blockers to prevent effectively connected income (ECI) taxation, and provide clarity that SBICs may organize and capitalize these passive entities.
Sutherland also suggested that the rule should be further revised to permit the use of tax blockers by SBICs controlled by BDCs, so as to manage non-qualified regulated investment company income that can be generated by equity investments made within SBIC subsidiaries.