On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Our separate post outlines the Paycheck Protection Program (“PPP”), which is administered by the U.S. Small Business Administration (SBA), and is a distinct component of the Act. Inherent to the PPP (and other SBA loans modified by the Act), is the question of “affiliation” as it pertains to businesses, their owners, and their parent and subsidiary entities and affiliations. Importantly, the SBA’s size and affiliation rules are broader than most common understandings of the affiliation concept in other aspects of the law and will play a pivotal role in determining whether or not a particular business may be eligible for a PPP (or other SBA) loan under the CARES Act.
This post provides an overview of the SBA’s size and affiliation rules with respect to the PPP Loan program.
Size Matters When Determining Eligibility for a PPP Loan
As has been well publicized, the CARES Act expanded the scope of businesses otherwise eligible for SBA loans, including the new PPP loan. In addition to “small business concerns” already covered by the Small Business Act, the following are eligible for PPP loans:
- sole proprietors, independent contractors, or eligible self-employed individuals
- businesses, nonprofit organizations, and veterans’ organizations that employ no more than the greater of either:
- 500 employees, or
- the number of employees designated in the applicable NAICS code size standard.
The 500 Employee Rule
For many businesses, eligibility for a PPP loan will ultimately hinge on the “500 Employee Rule.” To determine whether an applicant meets the 500 employee size limit, the applicant must count its own employees (which the CARES Act defines as any individual employed on a full-time, part-time or other basis) as well as the employees of its “affiliates,” unless the applicant fits within one of the following categories:
- businesses with 500 or fewer employees and that are assigned a North American Industry Classification (NAICS) code starting with 72;
- any business that is operating as a franchise that is assigned a franchise identifier code by the SBA; or
- any business that receives financial assistance from a small business investment company licensed under section 301 of the Small Business Investment Act of 1958.
In other words, any applicant that falls within one of the aforementioned categories can be eligible for a PPP loan even if they are “affiliated” with another company (or companies) that, when taken in combination with the applicant, would total more than 500 employees. Further, a business in the accommodations and food service industry (NAICS code starting with 72) with 500 or fewer employees per physical location is also eligible for a PPP loan.
SBA Affiliation Rules
With the exception of the three business categories noted above, the SBA affiliation rules will determine whether the number of employees of other entities need to be added to an applicant’s employee count for PPP eligibility purposes. If an “affiliate” relationship exists, the applicant must aggregate the total number of its employees and the total number of any affiliate’s employees in determining its eligibility for a PPP loan. As noted above, the SBA’s conceptions of “affiliation” are more expansive than they are in the corporate context and in other legal regimes.
The SBA generally considers entities to be “affiliates” of one another when one entity controls or has the power to control the other, or a third-party controls or has the power to control both.
There are several ways that entities can be affiliated.[1] As a basic rule, ownership of 50% or more of a business’ voting equity will constitute control based on ownership alone and thus establish an “affiliation” between the business and its majority owner. The control rights of minority owners may also result in affiliation. For example, if company A owns 50 percent or more of each of company B and C’s voting equity, and company C is determining the number of its employees for purposes of the PPP loan, company C must include the number of employees of B, C, and A as part of the calculation.
Additionally, a minority owner will be deemed to be affiliated with the company if it has the ability to prevent a quorum or otherwise block board or shareholder actions. Similar “negative control” issues can arise where a minority stakeholder (such as an investor) is given the sole authority to approve or veto certain business decisions, such as determining employee compensation or incurring debt.
Affiliation may also exist based on common management or identity of interest between companies. For example, if one or more officers, directors, managing members, or general partners of a business control the board and/or management of another business, the SBA may consider those companies to be affiliated with each other based on common management.
In determining whether an affiliation exists, the SBA may also look at the totality of the circumstances, considering factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships. Stated differently, affiliation may be found on a case-by-case basis even if no single factor standing alone would be sufficient.
Applying Affiliation to PPP Loan Eligibility
Before applying for a PPP loan, companies and their counsel should review their capitalization tables, shareholder agreements, and other governing documents to identify any potential affiliates and evaluate whether provisions in those documents give minority owners either affirmative or negative control. Each prospective loan applicant will be required to identify affiliates and may be required to make certain eligibility certifications in its loan application. Ultimately, each applicant’s eligibility will turn on its own unique circumstances, and eligibility determinations should therefore be made carefully and thoughtfully.
[1] For a complete list of the SBA’s affiliation rules for its loan programs, see 13 CFR 121.301(f).
Disclaimer: The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls, letters and electronic mail.
