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. 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. Employees or annual receipts of domestic and foreign affiliates, in some cases under the CARES Act , may not count when considering whether a business, including portfolio companies owned by private equity funds, satisfies the SBA’s size requirements. Approving or making changes to the company’s budget or approving capital expenditures outside the budget. Making, declaring, or paying distributions or dividends other than tax distributions. Transportation. The SBA rules do not specify all the specific instances in which such minority rights constitute control. Consumer Finance Regulation 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. 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. 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. Applicants should take care that the application and certification are made in good faith after a careful examination of the facts and circumstances specific to the applicant and its investment structure. 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. Regulatory & Government Affairs The regulations are available online at http://www.ecfr.gov. Learn about the four tests for affiliation and how they apply to participants in the Paycheck Protection Program. This was again reaffirmed on April 6, 2020, when the SBA issued a new set of frequently asked questions (FAQs). Corporate & Transactional The advice appropriate for you will be dependent upon the particular facts and circumstances of your situation. Does each company still need to count the employees of its “affiliate” in determining its size? 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. § 121.103. Engaging in any action that could result in a change in the amount or character of a company’s capital contributions. The materials you find on this web site have been prepared by Karr Tuttle Campbell to provide information about the services we offer to our clients and to provide information of general interest about a variety of legal subjects. On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. 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. The CARES Act has not modified the annual receipts threshold. 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). 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. Life Sciences Attorney Advertising © 2020 O'Melveny & Myers LLP. The transmission or receipt of this information does not create an attorney-client relationship. 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. 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 Thank you for your interest. Before you communicate with one of our attorneys, please note: Any comments our attorneys share with you are general information and not legal advice. 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. section 121.103 and section 121.301. 2000bb-1 and bb-3, and SBA regulation at 13 C.F.R. § 121.301(9) and located a… 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. 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. 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. Consumer & Retail Products Technology Incurring or guaranteeing debts or obligations. The SBA also clarified the scope of what are known as “affiliation rules” for borrowers seeking to obtain PPP loans (the Affiliation Rule). Health Care 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. ,” the affiliation rules are critical because only businesses with less than 500 employees can qualify for PPP loans. The CARES Act, moreover, did not repeal the existing exceptions to the affiliation rules, which are referenced at 13 C.F.R. All Rights Reserved. This Client Alert was prepared by Michael Rebagliati and Stephen S. McKay. 13 CFR 121.301 was most recently updated via an interim final rule entitled “Express Loan Programs; Affiliation … Narrow Waiver of Affiliate Rules Under the CARES Act. With respect to the Paycheck Protection Program, the industry’s engagement removed obstacles such as owner guarantees. 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. 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. Sponsor Capital formed three special purpose funds to assemble the equity for each of the portfolio companies (“Fund A”, “Fund B”, and “Fund C”). 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. 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. As discussed in our April 3, 2020 article, “ Can Qualified Small Businesses Get a PPP Loan under the CARES Act? SBA’s rules on affiliation for its programs (except SBIR and STTR) are found 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. 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. However, it is important to remember that no one factor is dispositive. 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. Control Analysis is Fact Specific; Control of Day-to-Day Operations is Important. Professional Services In analyzing this issue, we will focus on how the SBA affiliate rules apply to independent sponsors and their portfolio companies. With respect to the Paycheck Protection Program, the industry’s engagement removed obstacles such as owner guarantees. are a wide swathe of possible minority shareholder (or single director) control rights that may constitute control. To begin, it is important to note that the CARES Act does provide a narrow waiver of the SBA affiliation 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. 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) … 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. You may also contact any of the points of contact at the bottom of this document to receive a copy of the rules. 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 based on size, remain applicable to the Paycheck Protection Program as well as other SBA programs. 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. Let’s assume OpCo’s A, B and C are affiliated, but that they each operate in entirely different industries. The views expressed in this newsletter are the views of the authors except as otherwise noted. Then, they would need to discern which entity accounted for the largest percentage of gross revenue amongst the three. Portions of this communication may contain attorney advertising. A new system—including additional lenders, and new rules and guidance—is being created by the government for Paycheck Protection Program applications. 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. 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. SBA determined that the Religious Freedom Restoration Act (RFRA) requires the SBA to exempt faith-based organizations from affiliation rules when such 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, 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… Placing an encumbrance or lien on all or substantially all of the company’s assets. Real Estate & Homebuilding 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. In addition, affiliation can exist based on the existence of certain stock options, convertible securities, and agreements to merge. 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 Amending the governing documents to materially alter the rights of existing owners. Coronavirus Resource Center SBA Affiliation Rules as They Pertain to the CARES Act. What About a Group of Affiliates Where Each Affiliate Operates in a Different Industry? 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 … Entertainment & Media Under the SBA’s affiliation rules, your employee headcount is required to be combined with the headcount of all of your company’s affiliates. 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. 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. Increasing or decreasing the size of the board. 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. First, it is important to note that affiliate analysis is fundamentally a qualitative “control” analysis. O’Melveny uses cookies to improve functionality and performance, by continuing to this website, you are The rules do provide some direct guidance. Changing the company’s line of business. 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. 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. 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. 113.3-1h, which provides: Entering into contracts or joint ventures. Increasing, decreasing, or reclassifying the authorized capital of the company. For more about the CARES Act, see our overview alert. 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. 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. 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. Energy, Natural Resources & Utilities Hiring and firing officers and executives. 2 E.g. Franchises that are approved on the SBA’s Franchise Directory; and 3. 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 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. SBA Programs Under the CARES Act: ‘Affiliation’ Interim Final Rules and Guidance. KTC’s Business & Finance attorneys are available to assist you with your specific questions. 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 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 … Coronavirus resource hub. The CARES Act states that the SBA’s affiliation rules apply regarding eligibility determinations for Paycheck Protection Loans. Similarly, in evaluating control via a management agreement, the specific management rights matter. Blocking changes in the company’s strategic direction. Fraud and intentional or reckless misstatements may have criminal or civil consequences. 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 … 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. The CARES Act refers to 13 CFR 121.103 whenever it refers to affiliate rules. The SBA always retains the authority to analyze affiliation under a totality of the circumstances approach. Establishing or amending an incentive or employee stock ownership plan. SBA also applies nine affiliation exceptions.3 The CARES Act changes how SBA applies the affiliation rules for the Paycheck Protection Program. Beyond the 50% ownership test, most of the current SBA affiliation rules are fact intensive control analyses. 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. Industrials & Manufacturing Sponsors should speak with SBA lenders to develop practical strategies for determining affiliate group employee counts. Hospitality & Leisure 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. 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. Are OpCo’s A, B, and C affiliates? © 2020 O’Melveny & Myers LLP. Consent right with respect to the sale of all or substantially all of the company’s assets. Except as noted above, the SBA’s affiliation rules will continue to apply to businesses seeking financial assistance under the CARES Act. 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. While the application process is expected to be more streamlined than for traditional SBA 7(a) loans, applicants will, at a minimum, have to self-identify any ‘affiliates’ and make a certification as to eligibility. All Rights Reserved. 04.03.2020 CARES ACT: Will SBA Affiliation Rules Cause Startups and Portfolio Companies to be Ineligible for PPP and EIDL Loans, and is Relief on the Way? two businesses with board overlap that have similar businesses and shared customers. For a VC-backed company, your VC investors could be considered affiliates, which would significantly impact your employee headcount for purposes of the CARES Act programs. Disposing of the goodwill of the company. Sports, Stadiums & Arenas 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. 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