Our Client Alert addressing enforcement risks and issues arising out of the CARES Act and other economic stimulus provisions is forthcoming. SBA also applies nine affiliation exceptions.3 The CARES Act changes how SBA applies the affiliation rules for the Paycheck Protection Program. April 4, 2020. 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. Increasing or decreasing the size of the board. However, it is important to remember that no one factor is dispositive. 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. 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. 2000bb-1 and bb-3, and SBA regulation at 13 C.F.R. SBA Programs Under the CARES Act: ‘Affiliation’ Interim Final Rules and Guidance. 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. 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. 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. 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. 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. Franchises that are approved on the SBA’s Franchise Directory; and 3. In analyzing this issue, we will focus on how the SBA affiliate rules apply to independent sponsors and their portfolio companies. To begin, it is important to note that the CARES Act does provide a narrow waiver of the SBA affiliation rules. ,” the affiliation rules are critical because only businesses with less than 500 employees can qualify for PPP loans. 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) … This was again reaffirmed on April 6, 2020, when the SBA issued a new set of frequently asked questions (FAQs). The CARES Act has not modified the annual receipts threshold. 13 CFR 121.301 was most recently updated via an interim final rule entitled “Express Loan Programs; Affiliation … 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 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). Portions of this communication may contain attorney advertising. are a wide swathe of possible minority shareholder (or single director) control rights that may constitute control. Consumer Finance Regulation 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. The advice appropriate for you will be dependent upon the particular facts and circumstances of your situation. This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. 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? 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. First, it is important to note that affiliate analysis is fundamentally a qualitative “control” analysis. Beyond the 50% ownership test, most of the current SBA affiliation rules are fact intensive control analyses. Attorney Advertising © 2020 O'Melveny & Myers LLP. Disposing of the goodwill of the company. With respect to the Paycheck Protection Program, the industry’s engagement removed obstacles such as owner guarantees. Thus, there 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. The CARES Act relaxed these rules for certain businesses. Hospitality & Leisure Each of the Fund entities in turn owns 100% of the equity an operating company (“OpCo A”, “OpCo B”, and “OpCo C”). Establishing a quorum at a meeting of stockholders (and likely at a meeting of the board). 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… Except as noted above, the SBA’s affiliation rules will continue to apply to businesses seeking financial assistance under the CARES Act. This is a strong indication of affiliation, though the specific veto right matters. 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. Increasing, decreasing, or reclassifying the authorized capital of the company. section 121.103 and section 121.301. 113.3-1h, which provides: 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. As discussed in our April 3, 2020 article, “ Can Qualified Small Businesses Get a PPP Loan under the CARES Act? two businesses with board overlap that have similar businesses and shared customers. Consent right with respect to the sale of all or substantially all of the company’s assets. § 121.301(9) and located a… 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. Committing to take any action that would make it impossible for the company to carry on its ordinary course of business. The SBA always retains the authority to analyze affiliation under a totality of the circumstances approach. 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. 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. By clicking "accept" you acknowledge receipt and agree to all of the terms of this paragraph and our Disclaimer. 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. 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. The CARES Act refers to 13 CFR 121.103 whenever it refers to affiliate rules. © 2020 O’Melveny & Myers LLP. Amending the governing documents to materially alter the rights of existing owners. 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. 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. O’Melveny uses cookies to improve functionality and performance, by continuing to this website, you are Entering into contracts or joint ventures. Life Sciences A new system—including additional lenders, and new rules and guidance—is being created by the government for Paycheck Protection Program applications. 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. Each of the Fund entities is owned by groups of individual investors. 3 E.g. 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. 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. Regulatory & Government Affairs 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. Cooley Alert. 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. 2 E.g. Corporate & Transactional 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 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 … 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. Cookie Policy. Prior results do not guarantee a similar outcome. 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. The regulations are available online at http://www.ecfr.gov. 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. See O’Melveny’s March 26, 2020 Client Alert for a summary of the Paycheck Protection Program and other lending programs for US businesses. On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Amending the organizational documents of a company. 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. Control Analysis is Fact Specific; Control of Day-to-Day Operations is Important. 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. The views expressed in this newsletter are the views of the authors except as otherwise noted. Let’s assume OpCo’s A, B and C are affiliated, but that they each operate in entirely different industries. 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