On March 23, 2018, President Trump signed into law the Small Business Credit Availability Act (SBCAA) as part of an omnibus spending bill. The SBCAA will significantly impact the current practices of business development companies (BDCs) by: (1) easing the current asset coverage ratio requirements for BDCs to issue senior securities or pay cash dividends under the Investment Company Act of 1940 (1940 Act), and (2) improving the securities offering process for BDCs under the Securities Act of 1933 (1933 Act) by providing certain benefits that were previously only available to non-BDC issuers. BDCs are significant financing sources for small and middle market companies, and their significance has been increasing in recent periods.
Easing the Asset Coverage Ratio Requirements for BDCs
Under the 1940 Act, BDCs may not issue any class of senior security or pay any cash dividend unless the BDC has asset coverage of at least 200% immediately after the issuance or dividend. The SBCAA amends Section 61(a) of the 1940 Act to reduce the asset coverage ratio requirements applicable to BDCs from 200% to 150%. In other words, the SBCAA allows BDCs to increase their debt-to-equity ratio from 1:1 to 2:1. However, such reduction in the asset coverage ratio requirements must first be approved by either (1) a majority of the shareholders or (2) a majority of the disinterested directors and a majority of directors who have no financial interest in the BDC, and such approval must be publicly disclosed. In addition, a non-listed BDC which obtains such approval must offer to repurchase all of its currently outstanding shares over a 12 month period. By easing this ratio, BDCs can increase their leverage and deploy more capital, thereby potentially increasing overall returns. BDCs considering this change will also need to review debt incurrence and financial ratio covenants set out in existing debt instruments.
Pursuant to the SBCAA, the amendment to Section 61(a) of the 1940 Act became effective on March 23, 2018.
Improving the Securities Offering Process for BDCs
The SBCAA also requires the Securities and Exchange Commission (SEC) to make changes to certain of its rules and forms so that BDCs may utilize a registration and reporting framework which was previously only available to traditional operating companies. The SBCAA refers to this change as “parity” for BDCs and includes the following notable changes:
- A BDC may now qualify as a “well-known seasoned issuer,” or WKSI, and file automatically effective shelf registration statements (i.e., no review by the staff of the SEC), have reduced disclosure requirements in its shelf registration statements, and utilize a “pay as you go” filing fee system. In additions, BDCs which are WKSIs will have the benefit of more liberal communications rules under the 1933 Act.
- BDCs will be permitted to incorporate by reference their periodic reports filed with the SEC pursuant to the Securities Exchange Act of 1934 (1934 Act) into a shelf registration statement on Form N-2. This change permits automatic updating of a BDC’s shelf registration statement for new financial information rather than annual updating through a post-effective amendment or the filing of a new shelf registration statement each year.
These amendments should result in cost savings for BDCs in the offering and registration process, as well as reduce the time requirements of company management. In addition, BDCs should be able to more efficiently access the capital markets and take advantage of offering windows on a timelier basis.
Pursuant to the SBCAA, the SEC is required to make the specified revisions to its rules and forms within one year after the enactment of the SBCAA. If the SEC fails to timely complete the required revisions, during the period beginning the first day after the first anniversary of the enactment of the SBCAA and ending on the date the SEC completes the revisions, BDCs may deem the revisions to have been completed. Summary of the SBCAA Provisions The following chart summarizes the relevant law, rules and forms that the SBCAA impacts and the related change for BDCs.
Summary of the SBCAA Provisions
The following chart summarizes the relevant law, rules and forms that the SBCAA impacts and the related change for BDCs.