It seems the business world is abuzz with information, and misinformation, about the Small Business Administration’s (the “SBA”) Paycheck Protection Program (the “PPP”) and its loan forgiveness provisions. Although lenders are now accepting applications, many businesses have been met with confusion and uncertainty in navigating the application process. One area that many assume should be straightforward is surprisingly unclear, that is, determining the number of employees of the small business. Since most businesses employing more than 500 employees are ineligible for the PPP, determining a business’ number of employees is of utmost importance. To make this determination, the SBA requires the inclusion of the employees of affiliated entities, with only a few specific exceptions,[1]  but the definition of affiliate for these purposes has remained elusive for some. In fact, as a result of this confusion, the SBA released a clarification ruling on April 3, 2020 as an attempt to bring clarity to this topic.

The SBA’s method to determine a business’s status as an affiliate is more expansive than the definition found in other areas of law, including in much of corporate law. Consequently, in many situations many business owners may believe their interests in other businesses does not render those businesses affiliates, whereas the SBA may classify them as such. For example, an entity owning 30% of a business interest might not be considered an affiliate in other areas of law, but in many circumstances may be considered an affiliate under the SBA’s definitions.

There is no bright line test to determine whether affiliation exists between entities; instead, the SBA reviews the totality of the circumstances on a case by case basis when making its determination. Nevertheless, the SBA provides some general concepts it uses when making its analysis. One important, and often definitional factor centers around control. Entities are affiliates when one controls or has the power to control the other, or when a third-party controls or has the power to control both. But even this seemingly clear factor requires specific knowledge of SBA regulation because, unlike in other areas of law, the SBA’s definition of control can apply to more than one entity, for example, where multiple entities control another. Many businesses may find the below non-exhaustive list of factors, based on SBA guidance, useful when evaluating their individual circumstances.

  • Ownership, management, previous relationships or ties to other entities and contractual or personal relationships between the entities or directors and managers
  • People or entities with the ability to prevent a quorum or otherwise block action by the board of directors or other shareholders
  • Indirect control via a third party
  • Control, or the power to control, fifty percent of the voting stock
  • Stock options, convertible securities and merger agreements that may result in changes of control

[1] The exceptions explicitly mentioned in the CARES Act are: (i) businesses having a North American Industry Classification System code beginning with 72, (ii) businesses operating as franchises that are assigned a franchise identifier code by the SBA, and (iii) businesses that receive financial assistance from a company licensed under Section 301 of the Small Business Investment Act of 1958. Furthermore, the SBA acknowledged that other legislation either mandates or authorizes exemption from the affiliation rules for faith-based organizations whose religious exercise will be substantially burdened by the application of the affiliation. Such organizations are therefore exempted from the affiliation rules.