Is Your Business a Small Business for the SBA Economic Injury Disaster Loan Program?– March 24, 2020 by Dave Sobochan

Applicants for the Small Business Association’s (SBA) Economic Injury Disaster Loan Program (7(b)(2)), related to disruptions caused by COVID-19, have to look at certain areas of the business to determine if they are a “small business concern” eligible for this program. Below is an overview and resources to assist.

Determine If the Size of Your Organization Qualifies

First, your entity, including if you are a sole proprietorship, must:

  1. Be organized for profit;
  2. Have a place of business located in the United States; and
  3. Make a significant contribution to the U.S. economy through the payment of taxes or use of American products, materials or labor.

Your business also must meet a particular size standard that corresponds to a six-digit North American Industrial Classification System (NAICS) code. Each size standard is stated in terms of either receipts or employees and, in limited cases, on a basis other than receipts or employees, such as megawatt hours. The SBA will consider your receipts or employees (or other measure) along with all of your domestic and foreign affiliates in determining your business’ size. Below are a few SBA tools and resources to assist you in this determination.

>> View the size standards table
>> Contact the size standards specialist at your nearest SBA Government Contracting Area office
>> Contact the Office of Size Standards by email at sizestandards@sba.gov or by phone at 202.205.6618

Alternate Test
It’s important to note that your business may qualify under either the industry size standards or the alternative size standard. To qualify under the alternative size standard, your business, including your affiliates, must meet the following:

  • The maximum tangible net worth may not exceed $15 million; and
  • Your and your affiliates’ average net income after federal income taxes (excluding any carry-over losses) for the two full fiscal years before the application date may not exceed $5 million.

>> Read Loan Program Now Available to Small Businesses Affected by the Coronavirus

Understand How Affiliated Entities Could Impact Your Eligibility as a Small Business

If you own more than one business, you also will need to understand the affiliation rules and how they can impact your small business status and, therefore, eligibility for this loan program.

Various provisions within Section 121.103 of the Code of Federal Regulations, as outlined below, provide details on how the SBA will determine your affiliation with other entities. There are a number of special situations where other factors could come into play, but the information below focuses on the four most common elements in determining whether entities are affiliated: control, ownership, management and identity of interest.

Control

  • The general principles of affiliation state that concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. It does not matter whether control is exercised, as long as the power to control exists.
  • SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships, in determining whether an affiliation exists.
  • Control may be affirmative or negative. Negative control includes, but is not limited to, instances where a minority shareholder has the ability, under the concern's charter, by-laws or shareholder's agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.
  • There is an exception if the concerns owned in whole or substantial part by investment companies licensed, or development companies qualifying, under the Small Business Investment Act of 1958, as amended, are not considered affiliates of such investment companies or development companies.

Ownership

  • Control of 50% or more of voting stock: A person (including any individual, concern or other entity) that owns, or has the power to control, 50% or more of a concern's voting stock, or a block of voting stock that is large compared to other outstanding blocks of voting stock, controls or has the power to control the concern.
  • Control of less than 50% voting stock, but large compared to others: If two or more persons (including any individual, concern or other entity) each owns, controls or has the power to control less than 50% of a concern's voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, the SBA presumes that each such person controls or has the power to control the concern whose size is at issue. This presumption may be rebutted by a showing that such control or power to control does not in fact exist.
  • Widely held voting stock: When a concern’s voting stock is widely held and no single block of stock is large as compared with all other stock holdings, the business’ Board of Directors and CEO or president are deemed to have the power to control the concern unless evidence is provided to show otherwise.
  • Affiliation arising under stock options, convertible securities and agreements to merge: In determining size, the SBA considers stock options, convertible securities and agreements to merge (including agreements in principle) to have a present effect on the power to control a concern. The SBA treats such options, convertible securities and agreements as though the rights granted have been exercised.

Management

  • Affiliation arises where one or more officers, directors, managing members or partners who control the board of directors and/or management of one concern also control the board of directors or management of one or more other concerns.

Identity of Interest

  • Individuals or firms that have identical or substantially identical business or economic interests, such as family members; individuals or firms with common investments; or firms that are economically dependent through contractual or other relationships may be treated as one party with such interests aggregated. Where the SBA determines that such interests should be aggregated, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one, are in fact separate.
  • Firms owned or controlled by married couples, parties to a civil union, parents, children and siblings are presumed to be affiliated with each other if they conduct business with each other, such as subcontracts or joint ventures or share or provide loans, resources, equipment, locations or employees with one another. This presumption may be overcome by showing a clear line of fracture between the concerns. Other types of familial relationships are not grounds for affiliation on family relationships.

Contractual Relationships

  • A concern that is economically dependent upon another person or concern may be found to be affiliated with that concern. It may also be found affiliated with other concerns controlled by the individual or concern to which it is dependent. It may be found affiliated on the basis of control or power to control, an identity of interest, the newly organized concern rule or a combination of these.

Joint Ventures

  • Parties to a joint venture are affiliates if any one of them seeks SBA financial assistance for use in connection with the joint venture.

>> Read Expansion of SBA 7(a) Loan Program Offers Paycheck Protection for Businesses

Additional Considerations

Anti-Abuse Rule

  • Affiliation may arise where former officers, directors, principal stockholders, managing members or key employees of one concern organize a new concern in the same or related industry or field of operation, and serve as the new concern's officers, directors, principal stockholders, managing members or key employees, and the one concern is furnishing or will furnish the new concern with contracts, financial or technical assistance, indemnification on bid or performance bonds and/or other facilities, whether for a fee or otherwise. A concern may rebut such an affiliation determination by demonstrating a clear line of fracture between the two concerns. A “key employee” is an employee who, because of his/her position in the concern, has a critical influence in or substantive control over the operations or management of the concern.

Exceptions
There are a number of exceptions for other SBA programs. Below are the most relevant to this new program:

  • A business that is wholly owned or substantially owned by investment companies or development companies that are licensed or qualified under the Small Business Investment Act of 1958 (SBIA), are not considered affiliates of those investment companies or development companies.
  • A business that leases employees from a business primarily engaged in leasing employees to other businesses or which enter into a co-employer arrangement with a Professional Employer Organization (PEO) is not affiliated with the leasing company or PEO solely because it leases or co-employs employees.


Work through these rules with your advisors now to ensure there is no delay in the loan processing.

Contact Dave Sobochan at dsobochan@cohencpa.com, Adam Hill at ahill@cohencpa.com or a member of your service team to discuss this topic further.


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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.