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. The CARES Act, moreover, did not repeal the existing exceptions to the affiliation rules, which are referenced at 13 C.F.R. 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. This Client Alert was prepared by Michael Rebagliati and Stephen S. McKay. 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. Beyond the 50% ownership test, most of the current SBA affiliation rules are fact intensive control analyses. That entity’s primary industry would then define the primary industry size standard to be used for each entity in the affiliate group. 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 … 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. This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. Placing an encumbrance or lien on all or substantially all of the company’s assets. 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) … 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. Similarly, in evaluating control via a management agreement, the specific management rights matter. Does each company still need to count the employees of its “affiliate” in determining its size? Colleges & Universities Our Client Alert addressing enforcement risks and issues arising out of the CARES Act and other economic stimulus provisions is forthcoming. Small business concerns that receive financial assistance from a Small Business Investment Company. As stated in the ACG letter, the application of the SBA’s current affiliation rules would force many smaller companies to aggregate their employees with those of other unrelated companies, merely because they have common equity investors. 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. First, it is important to note that affiliate analysis is fundamentally a qualitative “control” analysis. To begin, it is important to note that the CARES Act does provide a narrow waiver of the SBA affiliation rules. Attorney Advertising © 2020 O'Melveny & Myers LLP. 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. Health Care 4 4 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. two businesses with board overlap that have similar businesses and shared customers. Coronavirus Resource Center On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Generally, the Paycheck Protection Program offers small business loans of up to $ 10 million to cover the recipient's payroll and other specified costs during the loan All Rights Reserved. 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. However, the SBA’s affiliation rules, which aggregate what entities or individuals the SBA considers to be “affiliates” together for purposes of determining SBA eligibility ba… Consumer Finance Regulation A new system—including additional lenders, and new rules and guidance—is being created by the government for Paycheck Protection Program applications. Increasing or decreasing the size of the board. Each of the Fund entities is owned by groups of individual investors. KTC’s Business & Finance attorneys are available to assist you with your specific questions. Coronavirus resource hub. Learn about the four tests for affiliation and how they apply to participants in the Paycheck Protection Program. 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. Yesterday, Speaker Pelosi’s office sent a letter to the Treasury Department urging them to do exactly that in implementing the Paycheck Protection Program.11 jQuery("#footnote_plugin_tooltip_8685_1").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_1", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Nonetheless we’ve received numerous inquiries from our private equity, independent sponsor and venture capital-backed clients concerning the application of existing affiliation rules and how they may or may not prohibit the portfolio companies of those clients from accessing Paycheck Protection Program funds. You may also contact any of the points of contact at the bottom of this document to receive a copy of the rules. Copyright 2011-2019 by Karr Tuttle Campbell, https://www.karrtuttle.com/wp-content/themes/corpus/images/empty/thumbnail.jpg, https://www.speaker.gov/newsroom/33120-0Â, https://www.sba.gov/document/support–table-size-standards, https://www.sba.gov/sites/default/files/2018-07/2018-07-13%20AFFILIATION%20GUIDE_Updated%20%281%29.pdf. Committing to take any action that would make it impossible for the company to carry on its ordinary course of business. 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 SBA regulation contains two affiliation rules: 13 C.F.R. Consumer & Retail Products Engaging in any action that could result in a change in the amount or character of a company’s capital contributions. Thus, if at any point in the chain of ownership there is an entity that has the power to control the applicant concern, then the applicant concern is potentially affiliated with such entity. Professional Services © 2020 O’Melveny & Myers LLP. 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 … April 4, 2020. The views expressed in this newsletter are the views of the authors except as otherwise noted. Regulatory & Government Affairs 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. are a wide swathe of possible minority shareholder (or single director) control rights that may constitute control. 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. Establishing a quorum at a meeting of stockholders (and likely at a meeting of the board). A key feature of the CARES Act $2 trillion relief package is the creation of the … The National Venture Capital Association has published the following summary1212 jQuery("#footnote_plugin_tooltip_8685_12").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_12", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); of current SBA OHA case law, which tends to show that a minority investor’s ability to do or block any of the following company actions (including via a director with a veto right), will create affiliation: By contrast, the SBA sometimes finds that minority investor rights that are tailored towards controlling extraordinary decisions do not create affiliation. 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 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. Portions of this communication may contain attorney advertising. Industrials & Manufacturing SBA Programs Under the CARES Act: ‘Affiliation’ Interim Final Rules and Guidance. 113.3-1h, which provides: 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. Amending the organizational documents of a company. Amending the governing documents to materially alter the rights of existing owners. Making, declaring, or paying distributions or dividends other than tax distributions. Changing the company’s line of business. SBA determined that the Religious Freedom Restoration Act (RFRA) requires the SBA to exempt faith-based organizations from affiliation rules when such affiliation … SBA’s rules on affiliation for its programs (except SBIR and STTR) are found at 13 C.F.R. Corporate & Transactional For example, we know that if Sponsor Capital has a veto right that enables it to block a quorum of the shareholders of Fund A from acting with respect to certain matters, then Sponsor Capital effectively controls OpCo A from acting with respect to those matters. 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. This is a strong indication of affiliation, though the specific veto right matters. As discussed in our April 3, 2020 article, “ Can Qualified Small Businesses Get a PPP Loan under the CARES Act? Cookie Policy. Before you communicate with one of our attorneys, please note: Any comments our attorneys share with you are general information and not legal advice. § 121.103. Incurring or guaranteeing debts or obligations. 13 CFR 121.301 was most recently updated via an interim final rule entitled “Express Loan Programs; Affiliation … Prior results do not guarantee a similar outcome. Mergers & Acquisitions Fraud and intentional or reckless misstatements may have criminal or civil consequences. 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. Energy, Natural Resources & Utilities 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”. 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. Financial Services Regulation, Banking & Financial Services Then, they would need to discern which entity accounted for the largest percentage of gross revenue amongst the three. SBA also applies nine affiliation exceptions.3 The CARES Act changes how SBA applies the affiliation rules for the Paycheck Protection Program. Are OpCo’s A, B, and C affiliates? two or three investors with a close relationship that together hold more than 50% of voting equity. 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 However, it is important to remember that no one factor is dispositive. 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. Cooley Alert. While the affiliation rules are based on the concepts of “control” and “being under common control,” the SBA’s administrative law precedents on affiliation take a broad, “totality-of-the-circumstances” approach to affiliation determinations and generally provide that: As you can see from the above, the SBA’s administrative practices and policies have historically not been friendly as a general matter toward venture-backed companies, particularly in the context of certain of the blocking rights deemed to give rise to affiliation. ,” the affiliation rules are critical because only businesses with less than 500 employees can qualify for PPP loans. See O’Melveny’s March 26, 2020 Client Alert for a summary of the Paycheck Protection Program and other lending programs for US businesses. Sponsors should speak with SBA lenders to develop practical strategies for determining affiliate group employee counts. 3 E.g. 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. Thank you for your interest. 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. The SBA also clarified the scope of what are known as “affiliation rules” for borrowers seeking to obtain PPP loans (the Affiliation Rule). Entertainment & Media Narrow Waiver of Affiliate Rules Under the CARES Act. 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. 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. Under the SBA’s affiliation rules, your employee headcount is required to be combined with the headcount of all of your company’s affiliates. 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. Generally, when applying for an SBA loan under a CARES Act program, applicants will need to self-identify any “affiliate” entities or individuals. To explain the key relief for 501(c)(3)s and small businesses in the recently enacted $2 Trillion CARES Act (complete text), we published our CARES Act Alert #1 (Help for Small Businesses & 501(c)(3)s via the PPP); CARES Act Alert #2 (Get Ready to Apply); CARES Act Alert #3 (PPP vs EIDL), CARES Act Alert #4 (initial Guidance from Treasury), and CARES Act Alert #5 (SBA Issues Interim Final Rule). Control Analysis is Fact Specific; Control of Day-to-Day Operations is Important. For more about the CARES Act, see our overview alert. Thus, there affiliation." The CARES Act provides exceptions to the “affiliation” rules for: 1. Business concerns in the Accommodation and Food Services industries with not more than 500 employees; 2. 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. 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. 1616 jQuery("#footnote_plugin_tooltip_8685_16").tooltip({ tip: "#footnote_plugin_tooltip_text_8685_16", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); Thus, theoretically, OpCo A, B and C would each need to count the others’ employees in their size determinations. 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? In analyzing this issue, we will focus on how the SBA affiliate rules apply to independent sponsors and their portfolio companies. Venture-backed companies interested in SBA funding should: For further updates on the CARES Act and for other legal issues arising out of the COVID-19 pandemic, see O’Melveny’s Coronavirus Resource Center. O’Melveny uses cookies to improve functionality and performance, by continuing to this website, you are Each of the Fund entities in turn owns 100% of the equity an operating company (“OpCo A”, “OpCo B”, and “OpCo C”). 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. Under the affiliation rules, business concerns and other entities or individuals are deemed to be affiliates of each other if (1) one business controls or has the power to control another or (2) a third … Real Estate & Homebuilding The advice appropriate for you will be dependent upon the particular facts and circumstances of your situation. Sports, Stadiums & Arenas To make a good faith self-certification, companies should undertake a careful analysis of the specifics of their investment structure, protective provisions, and venture financing documents, taking available information and precedent into account. Consent right with respect to the sale of all or substantially all of the company’s assets. A key provision in the CARES Act for many companies is a waiver of SBA affiliation rules. Please contact a member of Cooley’s government contracts team shown below, who are available to help companies and investors with questions regarding the act, including the SBA’s affiliation rules. The SBA rules do not specify all the specific instances in which such minority rights constitute control. Transportation. What About a Group of Affiliates Where Each Affiliate Operates in a Different Industry? Blocking rights over day-to-day business operations and decision making, such as the following, have been found in certain cases to give rise to affiliation: Employee compensation and senior management changes, Blocking rights over extraordinary decisions, such as the following, have been found in certain cases, Merger or sale of all or substantially all assets, Changes to amount or character of capital contributions. Control is Key; Control Can Extend Up the Entire Chain of Ownership. The CARES Act refers to 13 CFR 121.103 whenever it refers to affiliate rules. The recent SBA guidance and interim final rule on affiliation make it clear that section 121.301 is the correct rule to apply. 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. Thus, most portfolio companies will still be subject to the 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 … The CARES Act has not modified the annual receipts threshold. 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. Sponsor Capital formed three special purpose funds to assemble the equity for each of the portfolio companies (“Fund A”, “Fund B”, and “Fund C”). The analysis isn’t too difficult for startups without VC-like investors because the SBA’s “affiliation rules” aren’t relevant. The transmission or receipt of this information does not create an attorney-client relationship. The CARES Act relaxed these rules for certain businesses. 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. 1 Therefore, to properly analyze whether a company is a qualifying “small business,” one must understand the SBA’s complex affiliation rules. The SBA always retains the authority to analyze affiliation under a totality of the circumstances approach. 2000bb-1 and bb-3, and SBA regulation at 13 C.F.R. 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