The Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) authorizes $349 billion in forgivable Section 7(a) Small Business Administration (“SBA”) loans under the Paycheck Protection Program, to be issued by qualified SBA lenders, as described further in our client alert. Prior to the passage of the CARES Act, Disaster Declarations also made available separate small business loans through the SBA Economic Injury Disaster Loan Program (“EIDL”). To be eligible for an SBA loan under either of these programs, an applicant must be considered “small” and fit within applicable employee or revenue thresholds. However, the SBA reviews not only the applicant but also the applicant’s affiliates to fit within the applicable threshold altogether, including affiliated entities that are non-profit and foreign. Therefore, businesses that are affiliated with other entities may no longer be eligible for an SBA loan under either program due to the aggregated employee count or revenue. Also, EIDL applicants must abide by additional size guidelines thereunder.
Overall, the SBA affiliation rules are broader than typical affiliation rules. In general, SBA affiliation exists when one business controls or has the power to control another business, or is based on common control; for example, private equity or VC-backed companies may be ineligible for SBA loans because of the affiliation rules, even though the portfolio companies are generally unrelated. Control may arise through ownership, management, or other relationships or interactions between the parties. Furthermore, control may be affirmative or negative, such as a minority owner who has the ability to prevent a quorum or block action. However, the SBA determines affiliation by reviewing the “totality of the circumstances” on a case-by-case basis even where no single factor alone is sufficient to constitute affiliation; therefore, it is important to consider all the facts for each entity. A complete affiliation analysis is important because the SBA loan application process requires the applicant to certify, under penalty of perjury, that the applicant is in fact eligible for the program, including under the affiliation rules.
Standards for which affiliation may exist for a Section 7(a) loan under 13 CFR § 121.301(f):
- Majority Ownership – Control exists by ownership of more than 50% of the voting equity.
- Convertible notes, options, warrants, etc. are generally deemed exercised.
- Minority Ownership – Control is defined in the negative, through the right to “block action” by the board of directors or shareholders due to rights in articles of incorporation or agreements among shareholders.
- VC and PE investors may be considered affiliates under this test.
- Management –
- A CEO or president serves in the same capacity for multiple companies.
- A single individual or entity controls the board of directors of multiple entities.
- Control may exist through a management agreement.
- Substantially Identical Business or Economic Interests –
- Close relatives, if the relatives have substantially identical business interests (e.g. same or similar industry in same geographic area)
- Common investments, with shared resources, equipment, locations, employees, or financial support
- Economic dependence, in which a concern derives more than 85% of receipts over prior 3 years from another concern, with exceptions
- Newly Organized Concern – Concern is in business for less than two years and is an affiliate of another entity if the newly organized concern was formed by the officers, directors, 20% owners, or other managers of a prior concern with direct monetary benefits flowing from the new concern to the original concern.
Exceptions to affiliation coverage:
- Concern has received investment from an investment company licensed under the Small Business Investment Act
- Business concerns owned by Indian Tribes, Community Development Corporations
- SBA-approved pool of concerns for a joint program of R&D for defense production
- SBA-approved mentor-protégé agreement
- Member shareholders of a small agricultural cooperative
If you have any questions regarding whether entities are considered affiliates under the SBA regulations, please let us know. The relevant SBA affiliate regulations may be accessed here.
