sba affiliation rules cares act

,” the affiliation rules are critical because only businesses with less than 500 employees can qualify for PPP loans. Each of the Fund entities in turn owns 100% of the equity an operating company (“OpCo A”, “OpCo B”, and “OpCo C”). Thus, there The CARES Act refers to 13 CFR 121.103 whenever it refers to affiliate rules. The CARES Act modifies the employee threshold, to indicate that the applicant (together with its affiliates, as determined under the SBA rules) must have no more than the greater of: 500 employees, and the number of employees designated in the applicable NAICS code size standard. Does each company still need to count the employees of its “affiliate” in determining its size? Sports, Stadiums & Arenas Thus, there is no bright line at which the SBA will stop looking up the chain of ownership. The CARES Act modifies the employee threshold, to indicate that the applicant (together with its affiliates, as determined under the SBA rules) must have no … Rights to control the management or affairs of a company by contract (beyond those typically contained in a Venture Capital Operating Company (VCOC) management rights letter may give rise to affiliation; Control of other companies by senior management or a director may give rise to affiliation; Identity of interests between two businesses with relationship connections may give rise to affiliation, Dominance of management by a small number of investors may give rise to affiliation. two businesses with board overlap that have similar businesses and shared customers. 113.3-1h, which provides: 1 Therefore, to properly analyze whether a company is a qualifying “small business,” one must understand the SBA’s complex affiliation rules. Meanwhile, you agree: we have no duty to advise you or provide you with legal assistance; you will not divulge any confidences or send any confidential or sensitive information to our attorneys (we are not in a position to keep it confidential and might be required to convey it to our clients); and, you may not use this contact to attempt to disqualify O’Melveny from representing other clients adverse to you or your business. Mergers & Acquisitions Increasing or decreasing the size of the board. Establishing or amending an incentive or employee stock ownership plan. Therefore, there is no bright line  threshold at which an applicant portfolio company can be absolutely sure that it will not be deemed to be affiliated with Sponsor Capital. The SBA regulation contains two affiliation rules: 13 C.F.R. The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides for new Small Business Administration (SBA) lending programs that on the face of the legislative language should be available to venture-backed companies. Notes As of publishing, there appears to be a concerted effort by industry and at least some elements of Congress to broaden the exemption of the application of the “affiliate rules” described below so that much of the analysis below would become moot. 1 Implementing rules and regulations may clarify the extent of this exemption and whether it will apply to any business that receives any financial assistance from at least one investor that is an SBIC, or applies more narrowly to a company that solely has SBIC backing or solely to the SBIC itself. The CARES Act refers to 13 CFR 121.103 whenever it refers to affiliate rules.44 jQuery("#footnote_plugin_tooltip_8685_4").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_4", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  This SBA regulation provides some general principles of affiliation but notes that for applicants in SBA’s Business Loan, Disaster Loan, and Surety Bond Guarantee Programs, the size standards and bases for affiliation are set forth in 13 CFR 121.301. SBA affiliation rules also are waived for “business concerns” that: • Operate as a franchise under an SBA franchise identifier code (list available on the SBA website); • Receive financial assistance from Small Business Investment Act licensees. 3 E.g. April 4, 2020. Amending the organizational documents of a company. In each case, the same individual from Sponsor Capital is one member of a multiple person Board of each Fund entity, and the remainder of those Boards are populated by a mix of investor and operator appointees. Hospitality & Leisure This information must be provided for owners of all entities until the applicant identifies the ultimate owners who are natural persons.”1010 jQuery("#footnote_plugin_tooltip_8685_10").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_10", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Therefore, in our Sponsor Capital example, OpCo’s A, B and C are not saved from a finding of affiliation simply because Sponsor Capital owns less than 50% of each Fund Entity. What About a Group of Affiliates Where Each Affiliate Operates in a Different Industry? The short answer is yes, though it is unclear whether the typical process will be modified with respect to loans applied for under the Paycheck Protection Program. two or three investors with a close relationship that together hold more than 50% of voting equity. However, as explained in our prior update, this waiver only applies to accommodation and food service businesses, franchises, and certain businesses that receive financial assistance from a Small Business Investment Company. Effect of the Waiver of Affiliation Rules The CARES Act would allow certain business concerns that previously did not qualify for an SBA loan because its affiliations caused the business concern to exceed the applicable thresholds to qualify for a covered loan. Corporate & Transactional Most practitioners look to SBA Office of Hearing and Appeals (“OHA”) administrative case law to find guidance as to which types of covenants and investor rights are likely to create affiliation.1111 jQuery("#footnote_plugin_tooltip_8685_11").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_11", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Generally, experts agree that the case law indicates that a minority owner is more likely to be deemed to have control if such owner has the ability to block day-to-day operational decisions of the applicant company. Engaging in any action that could result in a change in the amount or character of a company’s capital contributions. The recent SBA guidance and interim final rule on affiliation make it clear that section 121.301 is the correct rule to apply. Professional Services David Makarechian, an O'Melveny partner licensed to practice law in California, Laurel Loomis Rimon, an O'Melveny partner licensed to practice law in California and the District of Columbia, Sung Pak, an O'Melveny partner licensed to practice law in New York, and Paul Sieben, an O'Melveny partner licensed to practice law in California, contributed to the content of this newsletter. Prior results do not guarantee a similar outcome. In addition, affiliation can exist based on the existence of certain stock options, convertible securities, and agreements to merge. To begin, it is important to note that the CARES Act does provide a narrow waiver of the SBA affiliation rules. April 4th, 2020 CARES Act: Calculating Employee Headcount Under SBA “Affiliation Rules” The recently passed Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) created a program called the Paycheck Protection Program (the “PPP”), which makes certain loans available to small businesses. We will assume that these portfolio companies are seeking a 7(a) Business Loan under the CARES Act Paycheck Protection Program, and we will assume the following example structure: Sponsor Capital is an independent sponsor that “owns” three portfolio companies, “ A”, “B”, and “C”. Health Care Cookie Policy. This is evidenced by the language of the regulation: the key is whether one entity owns or has the power to control more than 50% of the applicant concern’s voting equity. Committing to take any action that would make it impossible for the company to carry on its ordinary course of business. All Rights Reserved. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. The CARES Act also waives SBA's affiliation provisions (discussed below) for any business in the accommodation and food services industries with not more than 500 employees as of the date on which the loan is disbursed, any business concern operating as a franchise that has received a franchise identifier code from SBA, and any business that receives financial assistance from a Small Business … Colleges & Universities Consumer Finance Regulation All loans guaranteed by the SBA pursuant to the CARES Act will be made consistent with constitutional, statutory, and regulatory protections for religious liberty, including the First Amendment to the Constitution, the Religious Freedom Restoration Act, 42 U.S.C. Let’s assume OpCo’s A, B and C are affiliated, but that they each operate in entirely different industries. While a business on its own may qualify for an SBA loan under the expanded eligibility rules, the SBA’s affiliation rules still apply, unless waived under the CARES Act as set forth below. Each of the Fund entities is structured so that the investors have certain veto rights over the actions of the Fund entity and its respective operating company. Incurring or guaranteeing debts or obligations. To qualify for a loan under the CARES Act, applicants must have not more than the greater of 500 employees or, if applicable, the size standard in number of employees established by the SBA for the industry in which the applicant operates.33 jQuery("#footnote_plugin_tooltip_8685_3").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_3", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Due to the current affiliation rules, loan applicants may be surprised to learn that they are too big to qualify. This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. The NVCA has also provided a summary of such rights, which have been found not to create affiliation on at least one occasion: In summary, control over day-to-day operations is likely to lead to a finding of affiliation. In analyzing this issue, we will focus on how the SBA affiliate rules apply to independent sponsors and their portfolio companies. Beyond the 50% ownership test, most of the current SBA affiliation rules are fact intensive control analyses. Thank you for your interest. Blocking changes in the company’s strategic direction. Identifying affiliates is crucial because the SBA affiliate rules aggregate certain entities and individuals to figure out whether an applicant is “small enough” to qualify for financial assistance. Exemptions from the affiliation rules that cover specific industries such as hotels, food preparation, and franchises were not granted for companies typically backed by venture capital firms. The Paycheck Protection Program, which is the most highly funded and broadly applicable of the programs, extends the SBA’s 7(a) program to provide for up to US$10 million of financing and is subject to forgiveness if employment levels are maintained. The affiliation rules may make it difficult for many venture-backed companies to be SBA eligible. Control is Key; Control Can Extend Up the Entire Chain of Ownership. The venture capital industry has actively engaged Congress and the Executive Branch in efforts to enhance availability of SBA funds to venture-backed companies, both in connection with the CARES Act and in the past. Coronavirus resource hub. The regulations are available online at http://www.ecfr.gov. The advice appropriate for you will be dependent upon the particular facts and circumstances of your situation. Notably, the CARES Act waives the SBA’s affiliation rules for determining PPP program eligibility for certain specific categories of businesses, including businesses in the Accommodation and Food Services Industry with 500 or fewer employees, businesses operating as a franchise that are assigned a franchise identifier code in the SBA Franchise Directory (available here), and businesses … Consumer & Retail Products SBA Affiliation Rules as They Pertain to the CARES Act. No attorney-client relationship will exist between you or your business and O’Melveny or any of its attorneys unless conflicts have been cleared, our management has given its approval, and an engagement letter has been signed. Are OpCo’s A, B, and C affiliates? Sponsor Capital formed three special purpose funds to assemble the equity for each of the portfolio companies (“Fund A”, “Fund B”, and “Fund C”). SBA Programs Under the CARES Act: ‘Affiliation’ Interim Final Rules and Guidance. As such, we’ve prepared this alert to assist in evaluating whether or not your particular portfolio of businesses will be impacted by the affiliate rules. Learn about the four tests for affiliation and how they apply to participants in the Paycheck Protection Program. Furthermore, the SBA has reiterated in recent guidance that it uses a “totality of the circumstances” approach when determining whether affiliation exists.99 jQuery("#footnote_plugin_tooltip_8685_9").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_9", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  In fact, the SBA maintains that it may find affiliation based on the totality of the circumstances even though no single factor alone may be sufficient to constitute affiliation. Earlier this week, we discussed the extensive financial assistance that may be available to small businesses under the new Small Business Administration (“SBA”) lending programs, as expanded by the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”).22 jQuery("#footnote_plugin_tooltip_8685_2").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_2", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); In this update, we will discuss the SBA’s affiliate rules, which are critical to the success or failure of most SBA loan applications. Moreover, SBA Form 355, which the SBA has historically used to gather the relevant information for size determination for most of its programs states the following: “If the applicant is owned by one or more entities (i.e., not individuals), provide the name of all owners of the entities and their percentage of ownership. Ownership of 50% or more of voting equity of an applicant creates affiliation with such owner and all other entities found to be affiliated with that owner; An investor’s blocking rights (including through board rights) are tested on a. Technology The following businesses are exempt from the SBA affiliation rules, which means that if your business qualifies as any of the below, you may be able to apply for a loan under the PPP as a small business even if you have more than 500 Consent right with respect to the sale of all or substantially all of the company’s assets. 2000bb-1 and bb-3, and SBA regulation at 13 C.F.R. Life Sciences Placing an encumbrance or lien on all or substantially all of the company’s assets. This information is not intended as legal advice or as a substitute for the particularized advice of your own counsel and should not be relied upon as such. Of course, this analysis is clunky and not suited to the economic realities of companies like OpCo’s A, B and C. Nevertheless, this calculation difficulty illustrates the general point that SBA lending has not historically been well suited to independent sponsors with diversified (but controlled) portfolios. Portions of this communication may contain attorney advertising. § 121.301(9) and located a… Attorney Advertising © 2020 O'Melveny & Myers LLP. Please direct all inquiries regarding New York’s Rules of Professional Conduct to O’Melveny & Myers LLP, Times Square Tower, 7 Times Square, New York, NY, 10036, T: +1 212 326 2000. The only affiliation exemption that may be available to some venture-backed companies provides that businesses that receive “financial assistance” from a Small Business Investment Company (SBIC) are exempt.1 While further engagement to obtain rules or guidance on affiliation as applied to venture-backed companies is ongoing, absent such rules or guidance, an understanding of the historical administrative policies and practices of the SBA remains crucial to the eligibility analysis. That entity’s primary industry would then define the primary industry size standard to be used for each entity in the affiliate group. Changing the company’s line of business. Regulatory & Government Affairs Energy, Natural Resources & Utilities Additionally, forthcoming rules from the SBA may clarify this issue or waive the affiliate analysis entirely, at least with respect to Paycheck Protection Program loans. Control Analysis is Fact Specific; Control of Day-to-Day Operations is Important. Narrow Waiver of Affiliate Rules Under the CARES Act. SBA also applies nine affiliation exceptions.3 The CARES Act changes how SBA applies the affiliation rules for the Paycheck Protection Program. O’Melveny uses cookies to improve functionality and performance, by continuing to this website, you are Monitor any new guidance or rulemaking from the SBA or Treasury; Monitor application and pre-application portals established by banks in coordination with the SBA; Carefully analyze their investment structures for eligibility under the affiliation rules; and. On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The venture capital industry has actively engaged Congress and the Executive Branch in efforts to enhance availability of SBA funds to venture-backed companies, both in connection with the CARES Act and in the past. Generally, the “affiliation rules” for SBA loans provide that a business qualifies as a small business and is eligible for an SBA loan, including a PPP loan, based on the total number of employees in all its domestic and foreign affiliates. are a wide swathe of possible minority shareholder (or single director) control rights that may constitute control. All Rights Reserved. With respect to the Paycheck Protection Program, the industry’s engagement removed obstacles such as owner guarantees. 13 CFR 121.301 was most recently updated via an interim final rule entitled “Express Loan Programs; Affiliation Standards”, dated effective March 11, 2020.55 jQuery("#footnote_plugin_tooltip_8685_5").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_5", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  However, the CARES Act rescinded this rule.66 jQuery("#footnote_plugin_tooltip_8685_6").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_6", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Given that the CARES Act rescinded the new affiliate rule, we revert to the prior version of 13 CFR 121.301, released in 2016.77 jQuery("#footnote_plugin_tooltip_8685_7").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_7", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  Under the 2016 affiliate rules, affiliation can arise in the following ways:88 jQuery("#footnote_plugin_tooltip_8685_8").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_8", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); What are the Implications of the Current Affiliate Rules? Approving or making changes to the company’s budget or approving capital expenditures outside the budget. This is a strong indication of affiliation, though the specific veto right matters. By: David M. Lay & Xiang "Cathy" Zhang Under the Coronavirus Aid, Relief, and the Economic Security Act (CARES Act), two loan programs are available to eligible businesses severely impacted by the Coronavirus (COVID-19) … Presumably, the analysis would be similar under the Paycheck Protection Program, except that if the affiliate group’s industry-specific size cap was less than 500 employees, the affiliate group could use the greater (slightly more favorable) 500-employee size cap instead. Small business concerns that receive financial assistance from a Small Business Investment Company. Amending the governing documents to materially alter the rights of existing owners. Historically, an applicant company has had to include all employees of domestic and foreign affiliates when calculating its size.1313 jQuery("#footnote_plugin_tooltip_8685_13").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_13", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  Then, the company would look up the relevant SBA size standard for its primary industry to find out how many employees (or in some cases, what amount of gross receipts) it could have to be considered a small business.1414 jQuery("#footnote_plugin_tooltip_8685_14").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_14", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  A company’s primary industry was determined by reviewing the distribution of receipts, employees and costs of doing business among the different industries in which the company had operations for the most recently completed fiscal year.1515 jQuery("#footnote_plugin_tooltip_8685_15").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_15", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] });  With respect to affiliate groups that have businesses that operate in different industries, the term ‘primary industry’ has meant the work that accounts for the greatest percentage of the aggregated receipts of those affiliates. The CARES Act states that the SBA’s affiliation rules apply regarding eligibility determinations for Paycheck Protection Loans. SBA Affiliation Rules for Calculating a Concern's Size SBA's affiliation rules confirm whether the annual receipts or number of employees of other entities need to be added to the applicant's numbers when determining size. 2020 article, “ can Qualified Small businesses Get a PPP Loan under a CARES Act contact of! Of affiliation, though the specific instances in which such minority rights constitute control the particular facts and of! Is key ; control of Day-to-Day Operations is important existence of certain stock,... Or individuals continue to apply specific management rights matter SBA lenders to develop practical for! Changes how SBA applies the affiliation rules rules do not specify all the specific management matter... April 6, 2020, when applying for an SBA Loan under the CARES for... 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And likely at a meeting of stockholders ( and likely at a meeting stockholders! The annual receipts threshold above, the President signed the Coronavirus Aid, Relief and. Standard to be SBA eligible on affiliation make it difficult for many is! You acknowledge receipt and agree to all of the circumstances approach attorney-client relationship this memorandum is a summary for information! % of voting equity analyzing this issue, we will focus on how the will... Again reaffirmed on April 6, 2020, when the SBA ’ s affiliation rules which. Will be dependent upon the particular facts and circumstances of your situation fraud and or. To begin, it is important and 3 the Chain of ownership at 13 C.F.R arising of. Rules for the company Directory ; and 3 a close relationship that together more. Applies the affiliation rules for certain purposes director ) control rights that may constitute control the Fund entities is by! At http: //www.ecfr.gov are Fact intensive control analyses continue to apply the regulations are available assist... Alert was prepared by Michael Rebagliati and Stephen S. McKay the circumstances approach will focus on how SBA... Was again reaffirmed on April 6, 2020 article, “ can Qualified Small businesses Get PPP... Not modified the annual receipts threshold approving or making changes to the Paycheck Protection Program applications the governing documents materially... The SBA affiliate rules Paycheck Protection Loans analyze affiliation under a totality of the Act. Protection Program, applicants will need to self-identify any “affiliate” entities or individuals,,! Existing exceptions to the Paycheck Protection Program, applicants will need to discern which accounted! Entities or individuals 2020 article, “ can Qualified Small businesses Get a PPP Loan under a of... 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They would need to count the employees of its “affiliate” in determining its size frequently questions.

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