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On April 24, 2020, the U.S. Small Business Association (SBA) clarified that hedge funds and private equity firms are not eligible for the Paycheck Protection Plan (PPP) loans, as their primary business is to engage in investments or speculation. The SBA is of the belief that Congress did not intend for these types of businesses to be eligible for 7(a) loans under the SBA programs. 

The SBA further clarified that portfolio companies of private equity funds would be eligible for the PPP, unless otherwise expressly excluded, similar to any other business, as long as they meet the definition of small business including SBA’s affiliation rules. Private equity funds that are SBA-licensed Small Business Investment Companies have been exceptioned from the 500-employee count. In addition, all applicants and borrowers must certify that they have been negatively impacted by the economic uncertainty created by the COVID-19 pandemic that makes the loan request necessary for its operations. Any borrower that obtained a PPP loan prior to issuance of this guidance and repays the loan by May 7, 2020, will be deemed to have met the requirement of certification in good faith. 

In general, to qualify for PPP an applicant cannot have more than 500 employees unless they meet SBA size standards. Under SBA’s affiliate rules, the employee count of a business is determined by adding the applicant’s and its affiliates’ employees. SBA size standards follow North American Industry Classification System (NAICS) Codes. Under NAICS, the size standards are based on the average annual receipts (gross income) or the average number of employees. If the applicant’s NAICS Code follows receipts, then the applicant and its affiliates’ total employee count cannot exceed 500. But if it follows the employee count that exceeds 500 under the NAICS Code, then the excess count is also allowed under PPP. 

SBA looks at affiliations from various angles. Here are some of the affiliation rules, which are expanded on below:

  • One business controls or has power to control another 
  • A third party (or parties) controls or has power to control
  • Negative control of minority owner
  • Negative controls by a group of minority owners
  • Widely held voting stocks
  • Stock options, convertible securities and agreements to merge
  • Common management
  • Identity of interest 
  • Totality of circumstances

When one business controls or has power to control another, the businesses are considered affiliates. Control is based on 50 percent or more voting stocks, and for the single largest stock owner. 

When a third party controls ownership or has the power to control multiple businesses, e.g., a private equity fund that controls several portfolio companies, they are deemed to be affiliates. Again, control is based on 50 percent or more voting stocks and being the single largest stock owner. 

Negative controls of a minority owner, where the owner can prevent a quorum or block an action by the board of directors or shareholders, are deemed to have control. If a minority owner has Bad Veto Rights as outlined by the SBA’s Office of Hearing and Appeals, they are deemed to be the controlling interest. Examples of the Bad Veto Rights are vetoes over dividend distribution, employee compensation or hire and fire of executives. Such minority controlling interests are deemed to be affiliates.

When a minority owner is part of a group of minority owners that has negative controls, and the group vote can block a board resolution, then the minority owner can be deemed to have control. Such minority controlling interests are deemed to be affiliates.

When an entity has widely held stock where no single or block of ownership is large enough as compared to others, the concern’s board of directors (BOD) and chief executive officer or president (together CEO) are deemed to have control. Thus, all entities similarly controlled by such BOD and CEO are deemed to be affiliates. 

Granted stock options, convertible securities and executed agreements to merge or sell stocks are treated as if exercised in determining power to control and are deemed to be affiliates. 

When entities have one or more of the same officers, directors, managing members or general partners controlling the BOD and/or the management they are deemed to be affiliates. 

Individuals, firms and family businesses that have identical business, common economic interest, joint ventures, contractual relationships or economic dependencies may be deemed to be affiliates. 

When there is no independent basis of affiliation, but totality of circumstances suggests that businesses are heavily reliant on each other, the businesses also may be deemed to be affiliates. 

Those businesses that do not qualify for PPP loans or large investment-grade corporation credit facilities should know that on April 30, 2020, the Federal Reserve announced the expansion of the scope and eligibility for the Main Street Lending Program. The Fed released the term sheets for three facilities: the Main Street New Loan Facility, the Main Street Priority Loan Facility and the Main Street Expanded Loan Facility (together, the Facilities). The Facilities would be funded with $75 billion from the United States Department of the Treasury along with leverage from Federal Reserve to form a total lending capacity of $600 billion. Depending on eligibility for the program, U.S. businesses may be eligible to borrow under the Facilities if they employ up to 15,000 employees or have revenue of up to $5 billion. There is no discussion of affiliate rules or common control as these facilities are not under SBA rules. 

As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication.

If you have further questions, contact Partner Sal Shah by email or at 646.253.5193 or use the Contact Us form below.

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