SBA reverses decision on SBIC investments in passive companies

The Small Business Administration (SBA) announced that is withdrawing a December 28, 2016, final rule concerning Small Business Investment Company (SBIC) investments in passive businesses – a small entity that does not engage in regular and continuous business activity. Set to take effect on August 18, the final rule would have placed several restrictions on the eligibility of passive companies to receive SBIC investments. The new decision will maintain the current SBA rule that allows passive companies to remain eligible for SBIC investments. The SBIC, however, must receive SBA written approval before making the investment.

Under SBA guidelines, Eligible Passive Companies (EPCs) typically are structured as real estate holding companies that must use loan proceeds to acquire or lease, and/or improve or renovate real or personal property that it leases to one or more operating companies for conducting the operating company's business. 

After several delays to the December 28 rule, it was withdrawn last month because the SBA contends a change would result in an unacceptable level of risk if SBICs had already structured a significant number of investments through passive companies and blocker companies – a firm that allows tax exempt individuals to protect their investments from taxation when they participate in private equity or with hedge funds. The SBA also contends that the rule would have significantly increased its examination and monitoring requirements, which in turn would increase cost to companies receiving SBIC investments.

Proponents of the decision to withdraw the rule contend that EPCs and other eligible blocking companies stimulate investment in SBIC-backed small businesses and tech startups because they reduce risk for the investors of those companies. This reduced risk is intended to increase the availability of capital for small businesses. Proponents contend this will lead to job creation and innovation.

The rule change was originally proposed due to concerns regarding the ability of SBA to track SBIC investment that passed through EPCs and other blocker companies. The change essentially would have required EPCs and blocker companies to maintain at least 50 percent investment in the operating company as well as other requirements. At the time, the SBA contended that this would have provided investors with protections that stimulated investments, while ensuring that funds were properly being used.

The withdrawal of the December 28 final rule aligns with agenda of President Trump’s administration to reduce regulations across federal agencies, especially rules that were passed under the previous administration.