SEC Broadens Opportunities For Small Business Financing

by Mike Godfrey, for LawAndTax-News.com, Washington

20 May 2008

The US Securities and Exchange Commission (SEC) on Thursday announced it has broadened small business financing opportunities by adopting a rule amendment under the Investment Company Act to increase the availability of capital to certain smaller companies that may not have ready access to the public capital markets or other forms of conventional financing.

"Small businesses are the backbone of the US economy," commented SEC Chairman Christopher Cox, adding that:

"Today's action will help retail investors broaden their participation in small business financing. That will improve opportunities for investors and small businesses alike, and contribute directly to the health of our nation's capital markets."

Congress in 1980 established business development companies (BDCs), a type of publicly traded investment company, to help make capital more readily available to small, developing, and financially troubled businesses.

To accomplish this purpose, the Investment Company Act generally prohibits a BDC from making any investment unless, at the time of the investment, at least 70% of its total assets are invested in securities of certain specific types of companies, including "eligible portfolio companies.

The Commission has amended Rule 2a-46 to expand the definition of eligible portfolio company to include any domestic operating company with securities listed on a national securities exchange, if the company has a market capitalization of less than USD250mn.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board.

In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a 46 to include in the definition of eligible portfolio company all private companies and public companies whose securities are not listed on a national securities exchange.

This is the rule that the Commission has amended.

The Commission in 2006 also adopted Rule 55a-1 to conditionally permit a BDC to include in its 70% basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

The amendment to Rule 2a-46 will become effective in July 2008, 60 days after its publication in the Federal Register.

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