On March 23, 2018, when the House and Senate passed — and President Trump signed into law — the Consolidated Appropriations Act, 2018, the Small Business Credit Availability Act1 (“SBCAA”) also became law. The SBCAA contains two key provisions affecting Business Development Companies (“BDCs”):
- Increased ability of BDCs to use leverage in the portfolio by modifying the current asset coverage requirements under the Investment Company Act of 1940 (“Company Act”).
- Requirement that the SEC implement regulations allowing publicly traded BDCs to adhere to communications and reporting requirements applicable to a traditional public operating company, including the ability to incorporate information into its prospectus by reference.
BDCs are closed-end investment companies regulated under the Company Act which have elected to be treated as a BDC pursuant to Section 54 thereof. This election exempts BDCs from many of the regulatory constraints of the Company Act, but imposes special "BDC provisions" in Sections 55 through 65 of the Company Act. BDCs are also typically registered under the Securities Act of 1933 (“Securities Act”) and may be publicly traded. BDCs are designed to facilitate capital raising by small, developing and/or financially troubled companies that may lack access to traditional lending or capital markets.
Asset Coverage/Leverage Changes
Under Section 60(a) of the Company Act, BDCs may not issue any “senior security” (typically outstanding borrowing under credit facilities), certain derivatives and other debt instruments which create leverage unless the BDC has asset coverage of at least 200%. In other words, a BDC must hold $2.00 in assets for every $1.00 borrowed.
Under the provisions of Section 2(a)(2) of the SBCAA, a BDC may elect to decrease their asset coverage requirement to 150%, meaning that the BDC must only hold $1.50 in assets for every $1.00 borrowed. The SBCAA provides two potential methods for BDCs to approve and begin operating under the lower asset coverage levels:
- Approval of a majority of the BDC’s directors or general partners, who are not interested persons, to become effective on a date that is one year after the date of approval; or
- Approval of a majority of shareholders or partners at a special or annual meeting at which a quorum is present, to become effective on the first day after the date of approval.
If approval is obtained and the BDC is not publicly traded, the BDC must provide shareholders the opportunity, which may include a tender offer, to sell the securities held as of the applicable approval date. In these circumstances, 25% of the tendered securities must be repurchased in each of the four calendar quarters after the approval date.
In order to avail itself of the lower asset coverage requirement, in addition to approval as discussed above, a BDC must make the following disclosures:
- Initial – No later than five business days after the approval of revised asset coverage requirements, the BDC must disclose the approval and effective date in a Form 8-K and on its website;
- Ongoing – The BDC must disclose in each annual report after adoption:
- The aggregate outstanding principal amount of liquidation preference, as applicable, of the senior securities issued by the BDC and the asset coverage percentage; and
- The effective date and approval of the asset coverage requirements adopted;
- Publicly traded BDCs – The BDC discloses in each annual report after adoption:
- The amount of senior securities, and the associated asset coverage ratios of the BDC; and
- The principal risk factors associated with the issuance of senior securities.
Offering and Proxy Changes
While only applicable to publicly traded BDCs, Section 3 of the SBCAA requires the SEC to make specific revisions, within one year of the passage of the SBCAA, to offering and proxy rules as well as the Form N-2 in order to permit BDCs to operate under the securities offering and proxy rules available to traditional public operating companies. These changes are designed to permit BDCs the same flexibility as public operating companies in communicating with shareholders and prospective investors.
Notably, revisions required under the SBCAA will allow BDCs to “incorporate by reference” the reports and documents filed by the BDC under the Securities Exchange Act of 1934 into the registration statement filed on Form N-2. In addition, the revisions will permit BDC’s to be a “well-known seasoned issuer”2 and to include provisions for a BDC to file automatic shelf offerings on Form N-2. The revisions also make a variety of changes to remove BDC exclusions from certain communications such as those prior to filing a registration statement.
The changes made through the SBCAA are the most substantial regulatory changes to affect BDCs in years and are widely applauded by the industry as a boon to growth and flexibility for shareholders and the companies. Just two weeks after passage of the SBCAA, several BDCs have filed Form 8-Ks and issued press releases regarding their intention to operate at a lower asset coverage ratio, some indicating that the board has already approved the change and noting the 2019 effective date. To many in the industry, the SBCAA’s contents are not much of a surprise as they were considerations that have been discussed and debated at length, but many did not expect to find it attached to an appropriations bill.
How ACA Can Help
ACA’s Investment Company Services Division helps BDCs and their advisers ensure their compliance with regulatory requirements. Our services include compliance program development, customized testing support, compliance program reviews, and customized focused reviews. Our team has the specialized knowledge and skills needed to address BDCs' unique compliance considerations. ACA can help modify your current procedures to comply with these and other regulatory changes or requirements. For more information, please contact Maureen Colligan.
1The full text of Small Business Credit Availability Act is available at https://www.congress.gov/bill/115th-congress/senate-bill/2324/text?q=%7B%22search%22%3A%5B%22Small+Business+Credit+Availability+Act%22%5D%7D&r=2
2A “well-known seasoned issuer” as defined in Rule 405 under the Securities Act is an issuer that meets the registrant requirements Form S-3, and has a worldwide market value of outstanding voting and non-voting common equity held by non-affiliates of $700 million or more; or has issued in the last three years at least $1 Billion aggregate principal amount of non-convertible securities, other than common equity, in prior offerings for cash, not exchange, under the Securities Act.