Edwards Wildman Client Advisory: SBA Issues Proposed Rule Permitting SBICs to Invest in Double Holding Companies

    On December 23, 2013, the U.S. Small Business Administration (“SBA”) issued a proposed rule to revise the Small Business Investment Company (“SBIC”) regulations regarding investments in passive businesses and the use of double holding companies in structuring SBIC investments.

    Currently, SBIC investments in passive businesses (those that are not operating companies) are generally prohibited. The SBIC regulations include limited exceptions to this general prohibition, including an exception for situations where the passive small business passes through the investment proceeds to one or more non-passive small business subsidiaries or uses the investment process for the purpose of acquiring a majority ownership interest in a non-passive business.

    The proposed rule expands this exception to permit SBICs to structure investments using two holding companies, as opposed to only a single holding company as permitted by the current rule. In such a circumstance, the passive business that is the direct recipient of the SBIC investment must indirectly, through the second passive business, own at least 50% of the non-passive small business. The proposed rule does not allow more than two holding companies.

    This modification has been proposed to give SBICs greater flexibility in structuring investments and to help SBICs take advantage of a double holding company structure that is frequently utilized by non-SBICs in the venture capital and private equity sectors. Double holding company structures can address a number of concerns, including (1) simplifying the process of allocating income to different classes of investors in a syndicated transaction involving a number of participants, (2) accommodating investors’ needs for a mix of taxable and non-taxable entities, and (3) taking advantage of favorable tax treatment under Internal Revenue Code section 338(h)(10) in transactions involving the purchase of s corporation stock.

    Comments on the proposed rule must be received by January 22, 2014.

    If you have questions regarding the proposed rule on double holding companies or the SBIC program in general, please contact any of the attorneys listed on this page.

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