licensee which granted such option or a wholly owned subsidiary thereof, or a successor licensee or a wholly owned subsidiary thereof;

(ii) The aggregate number of shares of any class of stock which may be issued under options pursuant to the terms of the plan shall not exceed 72 percent of the total number of outstanding shares of such class (less shares reacquired and held in the treasury) at the time the plan is adopted;

(iii) The individuals who are officers or employees of the licensee or of a wholly owned subsidiary thereof at the time the plan is adopted may not receive options to acquire more than an aggregate of 66% percent of the total number of shares of each class of stock which may be issued under options pursuant to the terms of the plan; and

(iv) No individual may receive an option or options to purchase more than 35 percent of the aggregate number of shares of each class which may be issued under options pursuant to the terms of the plan.

(2) Stock options not deemed compensation. Stock options issued by any licensee, including a 1940 act company, which comply with the requirements of foregoing subparagraph (1) of this paragraph shall be deemed not to constitute "compensation" for purposes of any requirement of prior written consent of SBA with respect to increases of salaries or other compensation beyond amounts approved by SBA. [Amdt. 10, 37 F.R. 15145, July 28, 1972] § 107.806

ments.

the

Retention of loans and invest

A Licensee may retain its investment in a concern which qualified as a small business concern at the time of Licensee's initial financing but which subsequently became large. Securities of a large business received by a Licensee in connection with the merger, consolidation, or affiliation of a portfolio concern with such large business may be retained as long as continued ownership does not interfere with the Licensee's ability to maintain on hand funds in adequate supply for the financing of small business concerns. The Licensee may, however, in any event retain such securities until it has fully recovered the amount of its original investment plus a reasonable return thereon. Additional financing may be provided only to the extent necessary (a) to honor a commitment made while the

concern still qualified as a small business concern or (b) to protect Licensee's original investment.

§ 107.807

Purchases of securities from another Licensee.

A Licensee may exchange with or purchase for cash from another Licensee portfolio securities (or any interest therein) acquired from small business concerns by such Licensee or any other Licensee (a) without recourse against the seller (except for such liability as may result from the falsity of representations or warranties as to matters of fact) or (b) in the case of portfolio securities consisting of evidence of indebtedness issued by an obligor small business concern (§ 107.302(b) (2) or 107.401), with recourse against the seller not to exceed 90 percent of the amount of the debt outstanding at the time of default by such concern (and with full recourse against the seller for such liability as may result from the falsity of its representations or warranties as to matters of fact) Provided, however, That (1) a Licensee shall not have invested at any one time more than one-third of its total assets in securities of small business concerns acquired through such exchanges or purchases, and (2) the outstanding amount for which the selling Licensee may be liable due to recourse against default, pursuant to this paragraph (b), shall be included in its 20 percent limit applicable to investments in a single concern under § 107.301(c).

[Rev. 4, Amdt. 2, 33 F.R. 20035, Dec. 31, 1968] § 107.808 Idle funds.

Idle funds of a Licensee not employed in current financing of small business concerns and not invested in accordance with the last sentence of section 308(b) of the Act shall, without delay, be placed on demand deposit, or in Time Certificates of Deposit maturing not later than 1 year after issuance, in any bank or banks which are members of the Federal Deposit Insurance Corporation: Provided, however, That a Licensee may maintain an imprest petty cash fund in an amount not to exceed $500 at any one time.

§ 107.809 Investment adviser.

(a) General. A Licensee may contract in writing with an individual or nonLicensee concern to serve on a continuing basis as its investment adviser. Services performed shall be advisory only

and shall not include the actual performance of management or operating activities of the Licensee. The Licensee shall, on or before the effective date thereof, furnish SBA with a copy of such contract. Where the Licensee is indebted to SBA, SBA reserves the right to approve the compensation of the investment adviser.

(b) Common investment adviser. Two or more Licensees may, with prior SBA approval, contract in writing with án individual or non-Licensee concern to serve on a continuing basis as their common investment adviser.

(c) Exempt contracts. Contracts for appraisal, custodial, collection, bookkeeping, accounting, and legal services shall not be considered advisory services for the purposes of this section.

§ 107.810 Assets acquired in liquidation.

Where property is acquired by a Licensee in full or partial satisfaction of an obligation of a portfolio concern, Licensee may incur reasonably necessary expenditures for the care and preservation of such property: Provided, however, That except as specifically permitted in writing by SBA, such expenditures (other than ordinary and necessary expenses for the maintenance of such assets) plus Licensee's funds attributable to such assets in liquidation shall not exceed an amount equivalent to Licensee's investment limit under 8 107.301(c). Licensee shall take steps to dispose of assets in liquidation within a reasonable period of time.

§ 107.811 Additional investment by bank.

A bank which on January 9, 1968, holds fifty (50%) percent or more of any class of equity securities issued by a Licensee and having actual or potential voting rights, may, pursuant to section 302(b) of the Act, make further investments in such Licensee only if such investments would not increase its percentage holdings of such securities. Such capital increases shall be subject to SBA postapproval under § 107.1105.

existence of the small business concern, or will contribute to a well-balanced national economy by facilitate ownership of small business concerns by persons whose participation in the free enterprise system is hampered because of social and economic disadvantages. The relevant particulars bringing such financing within the purview of this section shall be reported to SBA within ten (10) business days of such financing.

[Amdt. 3, 34 F.R. 1234, Jan. 25, 1969] § 107.813 Financing disadvantaged concerns through a MESBIC wholly or commonly owned by licensee companies.

(a) General. Sections 304(d) and 305(b) of the Act authorize Licensees to finance small concerns in cooperation with each other and/or other lenders and investors, incorporated or unincorporated, through participation agreements. This section enables Licensee companies and non-Licensee investors to participate in financing disadvantaged small concerns, subject to the conditions hereinafter set forth, through the medium of a wholly or commonly owned MESBIC.

(b) Conditions. A MESBIC may, with SBA's prior written approval, be wholly or commonly owned by a Licensee or Licensee companies ("participant Licensee"), with or without non-Licensees, subject to the following conditions:

(1) In reviewing an application by a participant Licensee, SBA will consider the effect of its investment in the MESBIC on the financial structure and operations of each participant Licensee and of the MESBIC: Provided, however, That no participant Licensee may use funds borrowed from or guaranteed by SBA for the capitalization of the MESBIC.

(2) Each participant Licensee shall own at least 20 percent of the voting securities of the MESBIC, equity ownership in such amount constituting a presumption of active participation. Licensees proposing to own less than 20 percent of the voting securities will be accorded an opportunity to demonstrate to SBA's satisfaction that they will be active participants.

(3) Within the percentage and dollar limits prescribed by section 303(b) of the Act, MESBIC debentures shall be eligible for SBA purchase or guarantee to the extent that:

(i) MESBIC capitalization is derived from non-Licensee investors; or

(ii) A participant Licensee has unused eligibility under section 303(b) of the Act which is transferred to its capital investment in the MESBIC (the participant Licensee's eligibility being reduced accordingly), but not to exceed the matching ratio under section 303(b) applicable to such investment.c

(4) MESBIC capitalization attributable to the contribution of a participant Licensee without unused eligibility, or unwilling to have its eligibility reduced in accordance with subparagraph (3) (ii) of this paragraph, will not be eligible for leveraging by SBA.

(5) For a definition of Associate of participant Licensees and their wholly commonly owned MESBICS,

or

§ 107.3(h).

[Amdt. 6, 35 F.R. 11463, July 17, 1970]

RESTRICTED ACTIVITIES

see

§ 107.901 Control of small business con

cern.

(a) General: The Act does not contemplate that Licensees shall operate business enterprises or function as holding companies exercising control over such enterprises. Accordingly, neither a Licensee, nor a Licensee and its Associates, nor two or more Licensees may, except as hereinafter set forth, assume control over a small business concern pursuant to management agreements, voting trusts, majority representation on the board of directors, or otherwise.

(b) Presumption of control: Control over a small business concern will be presumed to exist whenever a Licensee, or a Licensee and its Associates or two or more Licensees acting in concert, own, hold, or control, directly or indirectly, voting securities equivalent to (1) more than 50 percent of the outstanding voting securities, if the voting securities of such concern are held by less than 50 shareholders; or (2) more than 25 percent of the outstanding voting securities or a block of 20 or more percent of the outstanding voting securities which is as large as or larger than the largest other outstanding block of such securities, if the voting securities of such concern are held by 50 or more shareholders. This presumption may be rebutted by the submission of appropriate evidence satisfactory to SBA.

(c) Temporary control permitted: A Licensee may acquire temporary control over a small business concern in connection with financing supplied to it

only where assumption of control is reasonably necessary for the protection of Licensee's investment.

(d) Plan to relinquish or divest control: A Licensee shall not assume control over a small business concern pursuant to paragraph (c) of this section unless it has negotiated and has entered into a fair and reasonable written plan at the time of financing, as a contractual obligation on its part enforceable by the small concern or its shareholders providing for relinquishment of control within a reasonable period of time not exceeding 7 years. Such plan shall contain provisions expressly stating that it is subject to SBA approval under this section and that the parties consider the plan to be fair and reasonable. The plan shall be filed with SBA not later than thirty (30) days after acquisition of control and shall be subject to SBA's postapproval as a condition for the continuance of the License. The plan shall be deemed approved unless Licensee is notified to the contrary by SBA within ninety (90) days after its receipt by SBA. Where the plan appears inadequate or unreasonable, SBA may notify and afford the Licensee and other parties concerned an opportunity to submit evidence as to whether renegotiation of the divestiture plan should be required. SBA approval shall be contingent upon full disclosure of all relevant facts and shall be subject to such conditions as SBA may determine are appropriate.

(e) The Licensee shall furnish to SBA with its annual Financial Report, SBA Form 468, a statement (in triplicate) setting forth current prospects for the implementation of the divestiture plan, and additional factors, if any, affecting the status or feasibility of relinquishing control.

(f) Subsequent events affecting plan: Where changed circumstances indicate that a workable arrangement no longer exists, SBA may, on its own initiative or upon application by the Licensee or other interested person, notify and afford the Licensee and other parties concerned an opportunity to submit evidence as to whether renegotiation of the divestiture plan should be required.

(g) Enforcement actions: (1) Divestiture plans entered into pursuant to this section shall not adversely affect or interfere with enforcement by the Licensee of its legal rights against a concern which has defaulted on its obligations to the

Licensee and shall no longer continue in effect as a binding obligation on Licensee's part in the event of such enforcement action. (2) If the Licensee acquires control of the small business concern as the result of enforcement action taken, the Licensee shall immediately notify SBA and shall take steps to divest itself of control within a reasonable period of time pursuant to a plan approved in writing by SBA. In connection therewith, the Licensee shall be free to negotiate with any appropriate person or entity necessary to accomplish relinquishment of control.

(h) Licensees with existing plans: Licensees which have control of a small business concern on the effective date of this section, shall bring their plans for divestiture of control into compliance with this section not later than March 31, 1968: Provided, however, That the plan shall provide for relinquishment of such control within a reasonable period of time, but in no event later than March 31, 1975. Such plans shall be filed with SBA not later than April 30, 1968, and will be subject to SBA approval in accordance with the provisions of this section.

(i) Additional financing: Whenever a Licensee assumes control of a small concern, and later provides additional financing to it, the Licensee shall within thirty (30) days resubmit its divestiture plan (amended if necessary or appropriate) for SBA review and approval in accordance with the provisions of this section.

[Rev. 4, 33 F.R. 326, Jan. 9, 1968, as amended by Amdt. 2, 33 F.R. 20036, Dec. 31, 1968; Amdt. 5, 35 FR. 4596, Mar. 14, 1970] § 107.902 Voluntary capital decrease.

A Licensee shall not voluntarily reduce its paid-in capital and paid-in surplus without prior written SBA approval. A Licensee may not purchase and hold more than 2 percent of any class of its stock without prior written SBA approval. § 107.903 Mergers, consolidations, and reorganizations.

Subject to the prior written approval of SBA, a Licensee may participate as a party to a statutory or other type of merger, consolidation, or reorganization with another Licensee or non-Licensee company where the resultant company will qualify as a Licensee. SBA's approval may be conditioned on such reasonable terms and conditions as it determines appropriate.

PROHIBITIONS

§ 107.1001 Prohibited uses of funds. No funds may be provided by a licensee for:

(a) Relending, reinvesting, etc. Relending or reinvesting by the small business concern, nor may funds be provided to a small business concern if the business activity of such concern involves directly or indirectly the investing, lending, or other providing of funds to others in exchange for an equity interest or monetary obligation, purchase or discounting of debt obligations, factoring, or long-term leasing of equipment with no provision for maintenance or repair: Provided, however, That, except for commercial banks, savings banks, agricultural credit companies, and savings and loan associations not insured by the Federal Savings and Loan Insurance Corporation, the foregoing prohibition shall not apply to Venture Capital financings (as defined in § 107.3) made to any small business concern, organized less than five (5) years before the date of financing, which is owned, or will be owned in accordance with § 107.812, by individuals whose participation in the free enterprise system is hampered by social or economic disadvantages: And provided, further, That, notwithstanding any other provision of these regulations, a licensee's outstanding financings to such small business concern(s) pursuant to the authorization of the foregoing proviso may not, without prior SBA approval in writing, exceed its private paid capital and paid-in surplus as of the close of any full fiscal year.1 (b) Financing Licensees. Use, directly or indirectly, to purchase stock in or otherwise to provide capital for a Licensee, or to repay an indebtedness to accomplish such purpose.

(c) Investments in unimproved real estate. The acquisition, or payment of obligations relating to the prior acquisition, by a small business concern of land or improved real estate to be held, without prompt and substantial improvement or development, for resale or leasing to others. Improvement or development shall, for the purposes of this paragraph, be deemed prompt and substantial if (1) an amount equivalent to 50 or more per

11940 act companies are reminded that subsections 12(d) (2) and (3) of that act impose additional restrictions on certain investments otherwise permitted by this § 107.1001 (a).

cent of the financing supplied or committed by Licensee is used for land improvement, new construction, renovation, or other types of improvement or development, and (2) such improvement or development is undertaken within one (1) year from date of acquisition or date of Licensee's financing, whichever is later.

(d) Purposes contrary to the public interest. Purposes contrary to the public interest, including but not limited to gambling enterprises and activities, and any purpose which would encourage monopoly or be inconsistent with accepted standards of free competitive enterprise.

(e) Foreign investment. Use outside the United States: Provided, however, That a Licensee may provide funds to a small business concern which is subject to state or federal jurisdiction, (1) for use in the domestic production of products for distribution abroad, or to acquire abroad materials for such operation or (2) for use in its branch operations abroad or for transfer to its controlled foreign subsidiary; so long as the major portion of the assets and activities of such concern, after funds are so employed, remains within the territorial jurisdiction of the States.

(f) Passive businesses. Any person that is not engaged in a business operation conducted as a regular and continuous activity.

(g) Licensee associated supplier. A small business concern which purchases goods or services from a supplier; which supplier is an Associate of the Licensee, if 50 percent or more of the funds (or funds of the small business concern released by such financing) are used by the concern to purchase goods or services from such supplier: Provided, however, That in the case of a MESBIC such limit shall be 75 percent.

(h) Real estate. A small business concern which is classified under Major Group 65 (Real Estate) of the Standard Industrial Classification Manual issued by the Bureau of the Budget except for (1) subdividers and developers (other than cemetery subdividers and developers), (2) operative builders, (3) title abstract companies, and (4) agents, brokers and managers: Provided, however, That a Licensee may retain any such investment in its portfolio on the effective date of this paragraph (not consummated in violation of provisions in effect when made).

i

(1) Agriculture. Concerns engaged solely or primarily in the production of agricultural commodities.

[Rev. 4, 33 F.R. 326, Jan. 9, 1968, as amended by Amdt. 1, 33 F.R. 11147, Aug. 7, 1968; Amdt. 3, 34 F.R. 1234, Jan. 25, 1969; Amdt. 7, 36 F.R. 18859, Sept. 23, 1971; Amdt. 11, 37 F.R. 16789, Aug. 19, 1972]

§ 107.1002 Capital impairment.

(a) Each Licensee shall maintain at all times an unimpaired capital. An impairment shall be deemed to exist when the retained earnings deficit exceeds fifty (50%) percent of the private paid-in capital and paid-in surplus. Treasury stock shall not be considered as part of private paid-in capital and paid-in surplus.

(b) A debtor Licensee shall promptly inform SBA when its retained earnings deficit exceeds thirty-five (35) percent of its combined paid-in capital and paidin surplus.

(c) For capital impairment purposes, gains may be recognized by SBA only to the extent permitted in Addendum II (Realization and Use of Income and Gains) to SBA's Audit and Examination Guide for Small Business Investment Companies printed in Appendix 1 as part of the regulations of this part.

(d) In the case of a MESBIC an impairment of capital shall be deemed to exist when the retained earnings deficit equals or exceeds private paid-in capital and paid-in surplus. Except with prior SBA written approval, no debtor MESBIC shall pledge, assign, hypothecate, or otherwise encumber any of its portfolio securities or other assets, or create or allow to be created any mortgage, lien, or other encumbrance thereon, while it has a retained earnings deficit of fifty percent (50%) or more of its private paid-in capital and paid-in surplus. A debtor MESBIC with a retained earnings deficit of fifty percent (50%) of its private paidin capital and paid-in surplus shall immediately notify SBA and shall be deemed to have authorized SBA to take such measures as may be appropriate to perfect a security interest in favor of SBA in its assets. SBA may direct the MESBIC to take such actions as SBA considers necessary to perfect such a security interest.

[Rev. 4, 33 F.R. 326, Jan. 9, 1968, as amended by Amdt. 5, 35 F.R. 4596, Mar. 14, 1970; Amdt. 7, 36 F.R. 18859, Sept. 23, 1971]