SBA Proposes Energy Saving Debenture Rules

January 13, 2011

On Jan. 12, 2011, the U.S. Small Business Administration (SBA) issued a proposed rule implementing certain provisions of the Energy Independence and Security Act of 2007 (Energy Act). The Energy Act, among other things, allows an SBIC making an Energy Saving Qualified Investment (ESQI) to obtain approximately 11% more leverage outstanding than permitted under the standard leverage-qualifying formula via SBA Energy Saving Debentures, provided the criteria described below are met.

Energy Saving Debentures are five- or 10-year debentures issued at a discount so as to be, in effect, “zero coupon” for the first five years. In addition, the annual SBA charge under § 107.1130(d) is deferred for the first five years for Energy Saving Debentures. Assuming the investment qualifies as an ESQI, any SBIC licensed after Sept. 30, 2008, is eligible for Energy Saving Debentures.

Energy Saving Debentures may only be issued if they are used to make an ESQI. An ESQI is an investment made in a small business that is “primarily engaged” in business activities that reduce the use or consumption of non-renewable energy sources (Energy Saving Activities). The ESQI must be an investment in the form of a loan, a debt security that includes an equity feature, or an equity security.

Energy Saving Activities are defined by reference to various other criteria established by federal programs or the Internal Revenue Code. On its Investment Division webpage, SBA intends to provide links to federal government websites that will allow users to determine the likelihood that any given activity is an Energy Saving Activity, including the following sites:

In addition, SBA may consider the merits of certain activities not specifically addressed or defined by other federal programs through an examination of various factors such as patents held by the small business, awards or grants received for the promotion of energy efficiency, and projected energy savings.

A company is presumed to be primarily engaged in Energy Saving Activities if at least 50% of its revenues for the most recently completed fiscal year are derived from such activities. However, SBA may consider the totality of the circumstances to make this determination, examining the distribution of the sources of revenue; the number of employees engaged in Energy Saving Activities; development and current or planned use of intellectual property related to Energy Saving Activities; and Energy Saving Activities contemplated by a formal business plan presented to outside investors.

For SBIC Funds, investment in smaller enterprises is incentivized, as total leverage available will be adjusted by subtracting from the leverage outstanding the cost basis of ESQI made in smaller enterprises. The amount that can be subtracted is limited to 33% of the SBIC’s leverageable capital. Certification must also be obtained from SBA for each investment in a small business that will utilize Energy Saving Debentures. The level of disclosure required for certification varies according to whether (i) the small business is engaged in certain Energy Saving Activities expressly included in the definition of ESQI; and (ii) the small business is primarily engaged in such activities.

For a complete copy of SBA’s Proposed Rule, click here.

McGuireWoods’ Private Equity Practice and Energy Groups are dedicated to keeping clients advised of new legislative and business developments as they occur. If you have any questions regarding these issues, please feel free to contact Mark A. Kromkowski (312.849.8170), Geoffrey C. Cockrell (312.849.8272), your primary attorney at McGuireWoods LLP, or any of the authors.

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