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85th oa) COMMITTEE PRINT
2d Session
HOW TO OBTAIN FINANCING UNDER THE SMALL BUSINESS INVEST- MENT ACT OF 1958
QUESTIONS AND ANSWERS IN SIMPLE TERMS
AUGUST 21, 1958
Printed for the use of the Select Committee on Small Business of the House of Representatives, Eighty-fifth Congress, Second Session
UNITED STATES GOVERNMENT PRINTING OFFICE WASHINGTON : 1958
SELECT COMMITTEE ON SMALL BUSINESS WRIGHT PATMAN, Texas, Chairman
»CE L. EVINS, Tennessee WILLIAM §. HILL, Colorado
ABRAHAM J. MULTER, New York R. WALTER RIEHLMAN, New York SIDNEY R. YATES, Dlinois HORACE SEELY-BROWN, Jr., Connecticut TOM STEED, Oklahoma WILLIAM M. McCULLOCH, Ohio
JAMES ROOBEVELT, Oalifornia TIMOTHY P. SHEEHAN, Dlinois OHARLES H. BROWN, Missouri ARCH A. MOORE, Jr., West Virginia
Bryan H. Jacques, Staff Director EVERETTE MACINTYRE, General Counsel Wx. SumMMERS JOHNSON, Chief Economist
CONTENTS
How the Johnson-Patman Act came to be enacted-__-__-_--_-- How a small-business investment company may be formed under the 006: «660 cnuwsnivéscmnwneses auewseeee How a small-business investment company may be financed _- How a small-business concern may obtain equity capital under How a small-business concern may obtain long-term loans from small-business investment companies___..-.-.-.---------- How a State development company may obtain unsecured loans wndet GRO G06. . 2... 226 ccccunminss anita oom How small-business concerns may obtain secured loans through State and local development companies---_------...------ How the tax benefits provided by the Technical Amendments Act of 1958 apply to small business and small-business invest- ment companies... ii... sidsddbdein ddan cae beta eS How small-business investment companies may obtain exemp- tions from the Securities Act of 1933, the Trust Indenture Act of 1939, and the Investment Company Act of 1940__-_-_-_-- How universities, colleges, and research groups may obtain grants for small-business research How ‘‘small-business” is defined
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HOW TO OBTAIN FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT OF 1958
HOW THE JOHNSON-PATMAN ACT CAME TO BE ENACTED
The Johnson-Patman Act ! is a new approach to helping small busi- ness find a solution to one of its most pressing problems—the problem of obtaining adequate financing. In enacting this legislation in 1958, Congress has provided a new system whereby small-business concerns will have better access to equity capital and to long-term loans.
The purpose of this report is to describe in everyday language how the new system works. Simple questions and answers are supplied for this purpose.
This new system is not just another Government “loan’’ program. It is a way to help private enterprise help itself. Furthermore, the purpose is to help small-business firms obtain the kind of financial assistance which they have not generally been able to obtain, either through any Government lending authority or through private finan- cial institutions.
For many years there has been a growing public concern over the handicaps which face small and medium-size firms in our business system. One handicap which has long been of major concern in Con- gress is small firms’ relative inability to obtain financing—particularly equity and long-term debt financing—such as the major corporations obtain with relative ease. The problem arises—and this now seems well established—from the fact that there is no financial machinery, certainly no adequate financial machinery, which serves the function of gathering together investment capital and making such capital available at places and at costs which make it practical for small firms to bid for its use. The problem has been growing more acute. While the great majority of small firms are limited in their capital by the amount of personal savings their family and friends may have, the amount of capital equipment needed to operate an efficient firm, either large or small, has been increasing.
During the past 25 years this problem has been met with a variety of Federal loan programs. But while these programs have been most helpful to small business—and financially successful for the Government—none has offered help of the kind that is most needed, which is help in obtaining equity and long-term debt capital.
In the 85th Congress, small-business financing problems were the subjects of intensive investigations and studies by both the Small Business Committees and the Committees on Banking and Currency of both the Senate and the House, as well as by the Federal Reserve Board. These studies have pinpointed the problem and brought about a wider understanding of its exact nature. The picture which has emerged shows the problem to be not so much in the field of commercial credit, nor even in the availability of well-secured loans
1 The act (Public Law 699, 85th Cong,, 2d sess,) became effective on August 21, 1958. 1
2 FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT
of short and intermediate maturities. Rather, the principal short- comings are in the fields of capital—risk capital and long-term debt capital. Bigger corporations obtain “outside” capital from the cen- tralized stock and bond markets, such as those centered on Wall Street, but no such organized market or financing machinery is avail- able to smaller companies.
The new act provides a number of ways by which small-business concerns will be given better access to both equity capital and long- term debt capital. In this, the act provides considerable flexibility. It also provides for a minimum of redtape and Government regulation. For the most part, investment decisions will be made solely by paren owned and operated small-business investment companies.
he SBA has certain duties for issuing general regulations under the act, but as a general rule small-business concerns will have no dealings with the SBA, directly or otherwise.
The principal method of the new program is to encourage the establishment of local, small-business investment companies which will be voluntarily formed, and may be formed by any 10 or more stock- holders. These privately owned and operated companies will decide which small-business concerns they will invest in, or make loans to, and in these loans and investments they will risk a substantial portion of their own money. It is this feature of the program which permits a minimum of Government regulation and permits investments and loans of a risk nature.
The spirit of the new legislation is perhaps best described by its principal authors. Senator Lyndon Johnson, majority leader of the Senate, who introduced the bill (S. 3651) in the Senate, told the Senate during debate on the bill that the purpose was to set up a program—
* * * that does no violence to free enterprise, that does not raise the specter of Federal control of, and competition with, private business * * * Eventual private ownership is what is proposed here for the small-business investment companies * * *
Representative Wright Patman, chairman of the House Small Business Committee, who introduced the bill (H. R. 12064) in the House of Representatives told the House that the legislation has two goals:
First, the individual investment decisions should be made not by a bureau in Washington, but by local businessmen who will be backing their decisions with substantial amounts of their own money.
The second goal of the system is that it should provide for private capital to come in and take over complete ownership and operation of the system.
Senator Sparkman, chairman of the Senate Small Business Com- mittee, and a cosponsor of the Senate bill, told the Senate that the legislation is similar to bills which he introduced in the 82d, 83d, 84th oe ee Congresses, and that it has the same purpose and objective of his bills—
* * *
namely, to establish privately owned and operated investment companies which would provide long-term loans and equity capital to small-business concerns. * * * The
FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT 3
time is long overdue for such legislation, and the needs of small business have never been more pressing.
Representative James Roosevelt told the House that the legislation had not lost sight of the principles and guidelines established in earlier bills which he had coauthored with Representative Patman, which were to—
assist free enterprise to do the small-business financing job; not merely to set up or expand a governmental bureau. * * * Local investors will undoubtedly cooperate, and cooperate enthusiastically, if SBA provides prompt and dynamic leader- ship. I hope SBA will provide that leadership. * * * It holds a large part of America’s future in its hand.
Senator Fulbright, chairman of the Committee on Banking and Currency of the Senate, said the legislation—
offers a way to help small-business concerns to remain inde- pendent and to maintain the free economy so essential to our democratic Nation.
Representative Brent Spence, chairman of the Committee on Bank- ing and Currency of the House, told the House that:
if you want to open the door of opportunity to all who are willing to knock at it and to profit by it, you must preserve small business * * *.
The big institution that is nationally known, that has a financial status, that attracts the investing public to buy its debentures and obligations, has no trouble in acquiring this character of capital and reserves. The small-business man cannot get that support.
The new program is not intended to replace the Small Business Administration’s regular loan program. On the contrary, the 85th Congress enacted several important small-business measures, one of which was to make the SBA a permanent agency of the Federal Gov- ernment. The SBA legislation also raised the maximum loan which the SBA can make from $250,000 to $350,000. It is recognized that there will be a continuing need for SBA lending of the type previously available, to supplement the services which the private banks and other lending institutions supply in extending low-risk credit for short and intermediate periods.
Nor is it intended that the new financing programs will compete with private commercial banks. Commercial banks can, and do, make loans to small firms. But such loans are necessarily for short and intermediate terms—usually for periods of less than 10 years. And commercial bank loans must also involve very little risk. Com- mercial banks must necessarily limit their lending, for the most part, to loans of short terms and high security. Funds on which the banks operate are only a small percentage paid-in capital, and a very large percentage demand deposits. To obtain a sizable commercial bank loan, to run for a period of several years, a small firm must usually pledge tangible assets which would bring an amount more than adequate to cover the loan in a distress sale.
4 FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT
In the hearings of the Select Committee on Small Business of the House, the witness who appeared on behalf of the American Bankers Association said:
The banks, as this committee knows, are not set up, they are not capitalized, they are not organized for the purpose of providing equity capital, and they are certainly not organ- ized for the purpose of providing long-term loans.
The Johnson-Patman Act also authorizes SBA to make loans to State development companies. And it authorizes SBA to make loans under more restrictive terms and conditions to both State and local development companies.
The act authorizes $250 million to be appropriated for the entire new financing program, which amount is to be operated as a revolving fund. In addition, the act makes available to SBA $27.5 million for use in making grants to States, State agencies, colleges and universities for research and counseling relating to small-business concerns.
As the legislation was originally introduced, it contained amend- ments to the Internal Revenue Code intended to encourage the new small-business investment companies to invest in the stocks of small- business concerns, and to encourage private investors to invest in these investment companies. Before passage, however, these tax provisions were transferred to another bill (H. R. 8381) which created the Technical Amendments Act of 1958. This latter act, another important small-business measure passed by Congress in 1958, contains tax benefits for small business generally—not just for the new small-business investment companies.
The 10 chapters which follow explain the ways by which small firms may participate in the new financing program. ‘These chapters explain the ways in which new small-business investment companies may be formed, and how they will operate. They also explain how State and local development companies may obtain loans to assist in financing small-business concerns. They explain certain exemp- tions from the Securities and Exchange Commission regulations which may be obtained by the small-business investment companies. Funds available to SBA for making grants to State agencies, colleges, and universities for research and counseling on small-business problems are also described.
Finally, since the success of the new small-business financing pro- gram depends in large part on necessary amendments to the Federal tax laws, there is a separate chapter on the tax benefits for small business, and for the new small-business investment companies, pro- vided by the Technical Amendments Act of 1958.
I. HOW A SMALL-BUSINESS INVESTMENT COMPANY MAY BE FORMED UNDER THE ACT
To form an SBI company under the act, there are only five general requirements which must be met.2, The SBI company must: (1) Be formed to carry out the purpose of the act, which is to finance small-business concerns. (2) Have at least 10 members, or stockholders. (3) Have $300,000 of paid-in capital and surplus, half of which may be obtained from the Small Business Administration. (4) Obtain a charter—or articles of incorporation—for the purpose of operating under the act. (5) Obtain the approval of the Small Business Administration. ‘ hese requirements will be explained in the questions and answers below:
1. Q. What is the purpose of an SBI company? A. To help small-business concerns raise capital.
2. Q. How will it do this?
A. By making loans directly, or by purchasing the debentures of the small-business concern.
3. Q. Will an SBI company be owned by the Government? A. No. It will be owned and operated entirely by private citizens.
4. Q. Will SBI companies be ‘“‘nonprofit”’ enterprises?
A. No. It is hoped that they will be profitable. There are special tax provisions to encourage profitmaking.
5. Q. Who may form an SBI company?
A. Any 10 or more people who can invest, altogether, $150,000 in the company.
6. Q. Will an SBI company be limited to 10 stockholders?
A. No. The act places no top limit on the number. There may be more at the beginning; and more may be added later.
7. Q. Must the 10 people who form an SBI company all live in the community where it will operate?
A. No. The act says nothing about this. However, the spirit of the act intends that the stockholders will usually live in the com- munity. This is because local citizens are likely to be in the best position to judge the character and needs of the small-business concerns in their community.
2 These organizational requirements are not strictly mandatory for State-chartered companies. How- ever, it is expected that in approving State-chartered companies SBA will, but for exceptional circum- stances, adhere to these requirements which Congress specified as appropriate for federally chartered companies.
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8. Q. When 10 people form an SBI company, may some of these be blood relatives or man and wife?
A. Yes. The act places no restriction on this.
9. Q. May two or more of the stockholders in an SBI company be in the same line of business?
A. Yes. The act places no limit on this.
10. Q. Must the stockholders all be in business?
A. No. The act places no restriction on this. It is hoped that, for the most part, the stockholders will be small-business people. Professional people, retired people and even people who are active in big business may also be stockholders.
11. Q. May an SBI company invest in or make loans to small business concerns outside the local community?
A. The act places no restriction on this. The answer will depend upon how the charter of the SBI company is written. State laws may sometimes place restrictions.
12. Q. Must an SBI company be incorporated? A. Yes.
13. Q. Where may an SBI company obtain a charter?
A. Normally, from officials of the State where the principal office of the SBI company is to be located. In some cases, however, 'the Small Business Administration may grant a charter.
14. Q. Under what circumstances may SBA grant a charter?
A. If an investment company cannot be chartered under the laws of the State, to operate in accordance with the purposes of the act, SBA may grant a charter. However, SBA’s authority to issue charters expires on June 30, 1961.
15. Q. Does a State charter automatically entitle an SBI company to operate under the act?
A. No. The SBI company will have to obtain the approval of SBA.
16. Q. What must be done to receive SBA’s approval to operate under the act?
A. The articles of incorporation must be sent to the Small Business Administration in Washington.
17. Q. What must the articles of incorporation contain?
A. They must give the name of the company, the location of its principal office, the area or areas where it will operate, the amount and classes of its shares of capital stock, and, in general terms, the objects for which the company is formed.
FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT 7
18. Q. May the articles of incorporation contain other provisions?
A. Yes. They may contain any other provisions which the com- pany may see fit to adopt for the regulation of its business and the conduct of its affairs, as long as these are not inconsistent with the provisions of the act.
19. Q. May an SBI company’s articles of incorporation be amended at a future time?
A. Yes, subject to the approval of the Small Business Administra- tion.
20. Q. What else is required to obtain SBA’s approval to operate an SBI company under the act?
A. SBA must review to see that the articles of incorporation are in order. In deciding whether to give its approval, SBA must consider the need for the financing of small business concerns in the area, the general character of the proposed management of the SBI company, and the number and volume of the operations of such companies previously organized.
21. Q. When SBA grants a charter, for how long is the charter good?
A. Thirty years. The act provides for SBA to renew the charter for additional 30-year periods.
22. Q. In what States can SBA issue charters?
A. This is not yet known. The SBA Administrator will have to make a determination. So if you are interested in forming an SBI company you should write to the SBA Administrator in Washington, or consult a local lawyer, or both.
23. Q. Can a State-chartered company which was already in exist- ence before the act was passed operate under the act?
A. Yes; if the stockholders vote to convert to an SBI company meeting the requirements of the act, SBA may approve it.
Il. HOW A SMALL-BUSINESS INVESTMENT COMPANY MAY BE FINANCED
The act requires an SBI company, to begin operations, to have at least $300,000 of paid-in capital; under the act the SBI company may receive funds in four ways, as follows:
(1) As part of its permanent capital, the SBI company may obtain $150,000 of Federal funds—no more and no less—by turning over subordinated debentures in that amount to SBA. Such $150,000 will be part of the SBI company’s paid-in capital.
(2) The SBI company may, in addition, obtain loans from SBA—at the beginning of operations or later. The amount of such loans outstanding cannot exceed 50 percent of the SBI company’s total paid-in capital and surplus.
(3) At least $150,000 of paid-in capital must be obtained from private sources before the SBI company can be approved. The act places no limit on the amount of additional paid-in capital which the SBI company may raise from private sources.
(4) The act places no limit of the amount of loans the SBI company may obtain from private sources.
The following questions and answers will help in understanding these methods of doundions
1. Q. How much money must an SBI company have to begin operations under the act?
A. $300,000 of ‘‘paid-in” capital.
2. Q. What is meant by “paid-in” capital?
A. “Paid-in” capital is the “risk” capital invested in the company.
3. Q. How much of the SBI company’s paid-in capital must come from private sources?
A. At least $150,000. “ a Q. How much paid-in capital may an SBI company obtain from SBA?
A. $150,000.
5. Q. Is the SBI company permitted to obtain more than $150,000 of paid-in capital from private sources?
A. Yes. The act places no maximum on the amount of capital that may be raised from private sources.
6. Q. May an SBI company obtain more than $150,000 of paid-in capital from SBA?
A. No. The act provides only for $150,000—no more and no less. However, an SBI company may obtain certain loans from SBA in addition to the $150,000 of paid-in capital obtained from SBA.
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7. How does an SBI company obtain paid-in capital from SBA?
A. By issuing “subordinated debenture bonds’’ to SBA in the amount of $150,000.
8. Q. How does an SBI company obtain paid-in capital from private sources?
A. By issuing common stock in the SBI company.
9. Q. How is common stock in an SBI company defined?
A. Just as common stock in any other company. A share of com- mon stock is an ownership share in the company.
10. Q. Will the SBI company pay interest on its common stock?
A. No. A share of common stock entitles the owner to a share of the company’s profits, if any.
11. Q. Will the capital received from SBA in exchange for sub- ordinated debentures have to be repaid by any specified date?
A. No. Funds received from these debentures are part of the paid-in capital of the SBI company.
12. Q. Will subordinated debentures issued to SBA be secured by any specific assets of the SBI company?
A. No. They will have a claim on the SBI company’s general earning ability. But they will not contain a pledge of the tangible properties of the SBI company.
13. Q. Will the SBI company have to pay SBA interest on capital received in exchange for its subordinated debentures?
A. Yes. These debentures will specify the rate of interest and the dates when interest payments are to be made.
14. Q. What rate of interest will be paid on the subordinated debentures issued to SBA?
A. SBA must issue regulations fixing the rate of interest and the interest payment dates.
15. Q. Can the SBI company buy back its subordinated debentures from SBA?
A. Yes. It has the right to buy back these debentures at any time—by paying back the amount of capital received plus the accrued interest.
16. Q. Why are the debenture bonds issued to SBA called subordi- nated debentures?
A. Because in case an SBI company is liquidated, these debentures have a lower claim on the assets of the SBI company than the claims of some of the company’s other obligations.
FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT |]
17. Q. What claim do the subordinated debentures have on the assets of the SBI company?
A. In case an SBI company is liquidated, the subordinated deben- tures have a claim which comes just ahead of the claim of the common stock. Borrowed money, promissory notes, and other obligations and liabilities of the SBI company, including any outstanding loans from
SBA, will have a higher claim on the company’s assets than the subordinated debentures have.
18. Q. Is SBA permitted to sell the subordinated debentures of an SBI company to a third party?
A. Yes. These debentures are negotiable, which means they may
be sold and resold. The purchaser, or holder in due course, will have all the rights SBA had.
19. Q. May other institutions purchase stock issued by an SBI company?
A. Yes. The act does not exclude any institution or person. And to make it easier for the SBI companies to raise capital from private sources, the act authorizes the national banks to purchase such stocks. In addition, the act authorizes purchase of such stock by State member banks of the Federal Reserve System and by FDIC-insured State banks where such purchases are not contrary to State law.
20. Q. To what extent may a bank invest in the stock of SBI companies?
A. The authority provided in the act limits the investment by a bank in such stocks to no more than 1 percent of the bank’s capital and surplus.
21. Q. May the SBI company obtain loans from SBA, in addition to the paid-in capital obtained from SBA?
A. Yes. The Johnson-Patman Act authorizes funds from which SBA may make loans to SBI companies. SBA may also use these funds to purchase the obligations, such as debenture bonds and promissory notes, of SBI companies.
22. Q. Under what terms and conditions may SBA make loans to an SBI company?
A. The act authorizes SBA to fix the terms on which it will lend money and purchase obligations of SBI companies. The only limit is that at any one time, the borrowed capital from SBA cannot amount
to more than 50 percent of the SBI company’s paid-in capital and surplus.
23. Q. What interest rate must an SBI company pay on a loan from SBA?
A. The act calls for SBA to issue regulations fixing the rate.
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24. Q. In case SBA makes a loan to the SBI company, would such a loan have a higher claim on the assets of the company than other obligations or liabilities of the SBI company?
A. This will depend entirely upon the terms of the contract entered into with SBA at the time the loan is made. 25. Q. May the SBI company borrow money from private sources?
A. Yes. It may receive loans, issue promissory notes or debt obli- gations. The conditions, limitations and terms may be fixed by regulations to be issued by the SBA.
26. Q. If an SBI company raises $150,000 of capital from private sources, what is the maximum amount it may obtain from SBA?
A. $300,000. SBA may purchase $150,000 in subordinated de- bentures; and $150,000 may be made up of loans or purchases of other obligations of the SBI company.
lil. HOW A SMALL-BUSINESS CONCERN MAY OBTAIN EQUITY CAPITAL UNDER THE ACT
Equity capital may be obtained, under the act, only through an SBI company. The main points are:
(1) The SBI company must first purchase “convertible” de- bentures of the small-business concern. The SBI company may then exchange such convertible debentures for common stock of the small-business concern, at an exchange ratio based on the sound book value of the stock as determined at the time the convertible debentures are issued.
(2) When the small-business concern obtains capital through sale of convertible debentures to the SBI company, the small- business concern must at the same time purchase stock in the SBI company, amounting to between 2 percent and 5 percent of the capital which the small-business concern receives from the sale of its convertible debentures. The Small Business Admin- istration will issue regulations fixing the exact rate between 2 percent and 5 percent.
(3) The amount of the SBI company’s total investment (equity capital plus outstanding loans) in a single small-business concern must not be more than 20 percent of the SBI company’s paid-in capital and surplus.
The following questions and answers will help to make clear the act’s provisions on this subject:
1. Q. What is equity capital?
A. Capital obtained by a business concern from the sale of its common stock.
2. Q. Why is it called “equity capital’’?
A. Because the owner of the stock has an equity, or ownership share, in the business concern.
3. Q. Does the business firm have to repay the capital which it receives from the buyers of its common stock?
A. No. Buying common stock gives the purchaser an ownership claim on the assets of the business.
4. Q. What responsibilities does the business concern have to its stockholders?
A. It has only a general obligation to try to make profits, in which
case the stockholders share proportionately in the company’s divi- dends.
5. Q. Can the business concern buy back the stock it has issued? A. No, except in rare circumstances.
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6. Q. Does common stock pay the owner a specified rate of interest?
A. No. Common stock does not call for the payment of interest; it calls for the owner to receive a certain share of whatever dividends the company may declare.
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7. Q. To obtain equity capital under the Johnson-Patman Act, must a small-business concern be incorporated?
A. Yes. (But unincorporated small-business concerns may obtain loans under the act. See chs. IV, V and VI.)
8. Q. How may a small-business concern obtain equity capital under the act?
A. Only from an SBI company.
9. Q. May an SBI company invest in a small-business concern simply by purchasing the concern’s stock?
A. No. To invest in a small-business concern’s common stock, the SBI company must first purchase ‘“‘convertible’’ debentures of the small-business concern; after this it may exchange the convertible debentures for common stock.
10. Q. What is a convertible debenture?
A. In the act, these are called ‘debenture bonds.’”’ This means that they must carry a specified rate of interest and have a specified maturity date.
11. Q. What makes them “convertible?”
A. “Convertible’’? means that before the bonds mature, the bond-
holder may choose to exchange his debentures for common stock in the company.
12. Q. Who decides whether or not an SBI company may purchase convertible debextures in any particular small-business concern?
A. The SBI company alone decides this. The Small Business Ad- ministration will issue general regulations concerning the operations of the SBI companies, but SBA has no authority to interfere in the individual invest:rent decisions of the SBI company.
13. Q. When must the debenture bonds be paid off? A. The act places no maximum time for these bonds. It does,
however, require that the SBI company obtain SBA’s approval of its debenture bo.id prozram.
14. Q. What interest rate will the small-business concern have to pay on its debenture bonds?
A. The act places no limitation on this, except here again this is one of the items in the SBI company’s program for which it must obtain the general approval of SBA.
15. Q. May the debenture bonds be paid off before they are due?
A. Yes. The small-business concern has a right, upon 3 months’ notice, to repay any or all of its bonds on any interest payment date.
FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT 15
16. Who decides whether or not convertible debentures will be exchanged for common stock in the small-business concern?
A. Under the act, the SBI company has the option. The small- business concern has no such option.
17. Q. Under the act, may the SBI company and the small-business concern have an understanding or a contract, at the time convertible
debentures are issued, calling for these debentures to be converted into common stock?
A. Yes. There is nothing in the act which prohibits such an agreement being made at any time.
18. Q. Must the debenture bonds be converted into common stock?
A. No. The SBI company, or the holder in due course, has the option.
19. Q. What is meant by the “holder in due course’?
A. This is a person who has purchased the debenture bonds, or otherwise acquired them in a legal way. The SBI company has the right to sell these bonds; and the purchasers may in turn resell them.
20. Q. How many shares of common stock of the small-business
concern can be exchanged for the small-business concern’s convertible debentures?
A. The exchange rate will be fixed at the time the convertible debentures are issued. This will be based on the “‘sound book value’’
of the small-business concern’s stock as determined at the time the debentures are issued.
21. Q. May a small-business concern which already has debts or obligations outstanding obtain equity capital from an SBI company?
A. Yes. But the SBI company may require such a concern first to refinance any or all of its indebtedness, so that all of the concern’s debt is held by the SBI company.
22. Q. May a small-business concern obtain other loans or issue other obligations after it obtains equity capital from an SBI company?
A. The small-business concern must agree that it will not incur any future debt without the approval of the SBI company, which must be given the first opportunity to finance such new debt. SBA may provide for certain minor exceptions.
IV. HOW A SMALL-BUSINESS CONCERN MAY OBTAIN LONG-
TERM LOANS FROM SMALL-BUSINESS INVESTMENT COMPANIES
The act authorizes SBI companies to make loans to both incorpo- rated and unincorporated small-business concerns. The main points are:
(1) Such loans must be of ‘‘such sound value, or so secured, as reasonably to assure repayment.”
(2) Such loans may be made for terms up to 20 years, and the SBI company may extend the term up to another 10 years if such extension will aid in orderly liquidation of the loan.
(3) Such loans may be made either directly by the SBI com- pany, or in participation with other lending institutions.
(4) The amount which an SBI company may have outstand- ing to a single small-business concern may not be more than 20 percent of the SBI company’s paid-in capital and surplus— except with the approval of SBA. (Amount outstanding in- cludes both loans and stock investments. )
The following questions and answers will give more details:
1. Q. What is a small-business concern?
A. The Johnson-Patman Act specifies that the same definitions which SBA makes for its regular loan pone under the authority of the Small Business Act will also apply to the new act.
2. Q. May partnership firms and single-proprietorship firms obtain loans from an SBI company?
A. Yes, and small corporations may also obtain such loans.
3. Q. Must a small-business concern put up security to obtain a loan from an SBI company?
A. Not necessarily. The loan must be ‘‘of such sound value, or so secured, as reasonably to assure repayment.’ This means that if the small-business concern has good management and good earning prospects, the SBI company need not require security.
4. Q. For what purposes may an SBI company make loans to small-business concerns?
A. Any good business purpose. The act states “to provide such concerns with funds needed for sound financing, growth, moderniza- tion, and expansion.”
5. Q. Can loan funds obtained from an SBI company be used for working capital?
A. This depends upon the agreement reached between the small- business concern and the SBI company. The act permits it.
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6. Q. May an SBI company make a loan in participation with other lending institutions?
A. Yes. The SBI company may make a loan where it puts up part of the money and one or more banks or other lending institutions put up the other part. This may be done on either an “immediate’”’ or a ‘“‘deferred”’ basis.
7. Q. What is meant by “immediate” participation?
A. This is where the SBI company puts up its part of the money at the time the loan is made.
8. Q. What is meant by “deferred” participation?
A. This is where the other lending institution puts up all of the money, but the SBI company agrees it will put up some specified part at a later time—if called upon to do so.
9. Q. May an SBI company “guarantee” 100 percent of a deferred participation loan?
A. No. The act says an SBI company cannot agree to put up more than 90 percent of a loan made on a deferred participation basis.
10. Q. What is the maximum loan that an SBI company can make to a single small-business concern?
A. There is no special maximum for loans by themselves. But an SBI company cannot tie up more than 20 percent of its own paid-in capital and surplus in any single small-business concern without SBA’s consent.
11. Q. Exactly what is included in this maximum amount?
A. This amount must include loans, convertible debentures, stock acquired through convertible debentures, and all other obligations of the small-business concern held by the SBI company.
12. Q. May SBI companies make loans to new small-business con- a cerns?
A. Yes. New concerns may be formed with the help of SBI loans.
13. Q. What interest rate will small-business concerns pay on loans from SBI companies?
A. The act does not specify, but it does require SBA to set the maximum rate. Where SBI companies make loans in participation with other institutions, this maximum will apply only to the SBI company’s share of the loan.
V. HOW A STATE DEVELOPMENT COMPANY MAY OBTAIN UNSECURED LOANS UNDER THE ACT
The act (sec. 501) authorizes SBA to make loans to State develop- ment companies to “assist in carrying out the purposes of the act.” State development companies are those which have been chartered by a number of the States to foster industrial development. State development companies chartered after passage of the act will also be eligible. The main features of the authority are:
(1) Any funds SBA advances to a State development company must be in exchange for obligations of the company, contaiming an interest rate and such other terms as SBA may fix.
(2) The funds need not be secured by anything more than the general obligation of the State development company.
(3) The total amount of obligations which SBA may hold at any one time may not exceed the total amount of funds borrowed by the State development company from all other sources.
The following questions and answers will give more details:
ae or W hat purpose may SBA make loans to State development c wmsnaiaeh
A. Such loans must be for the purpose of financing small-business concerns.
2. Q. Can SBA make loans to a State development company if that company engages also in other activities besides financing small- business concerns?
A. Yes. SBA may make such loans without regard to the kind of use or investment which the State development company makes of funds which it obtains from other sources.
3. Q. What security must a State development company offer in order to obtain a loan from SBA?
A. It need not offer any security more than its general obligation to repay.
4. Q. What claim on the assets of a State development company may SBA accept as security?
A. The act requires that funds lent by SBA have as high a priority as funds obtained by the State development company from any source after date of enactment of this act. (This does not apply to
funds borrowed by the State development company before the act was passed.)
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20 FINANCING UNDER THE SMALL BUSINESS INVESTMENT ACT
5. Q. What is the maximum loan SBA can make to a State develop- ment company?
A. There is no limit, except that a State development company cannot have outstanding from SBA an amount greater than the amount which that State development company has borrowed from all other sources combined.
6. Q. Does the amount of paid-in capital in a State development
company determine the maximum loan which the company may obtain from SBA?
A. No. The limitation in the act refers to the amount which the State development company has ‘‘borrowed”’ from all other sources.
7. Q. What is the maximum term of a loan which SBA may make to a State development company?
A. The act specifies no maximum number of years.
8. Q. What is the maximum interest rate which a State development company will have to pay on an SBA loan?
A. SBA will determine; the act states no maximum.
VI. HOW SMALL-BUSINESS CONCERNS MAY OBTAIN
SECURED LOANS THROUGH STATE AND LOCAL DEVELOP- MENT COMPANIES
The act (sec. 502) authorizes SBA to make secured loans to both State and local development companies where the proceeds of the loan are to be used solely to assist one or more identifiable s 1all- business concerns