The Paycheck Protection Program established under the CARES Act provides eligible businesses — including for-profit business concerns, 501(c)(3) nonprofits, 5019(c)(19) veterans organizations and Tribal concerns (collectively referred to here as organizations or concerns), as well as self-employed individuals, sole proprietorships and independent contractors (collectively referred to here as individual applicants) — with loans to pay up to eight weeks of payroll costs (including benefits) and certain other overhead costs. The Paycheck Protection Program will use the existing Small Business Administration 7(a) loan program, but with key differences intended to expedite the intended relief from the economic impact of the COVID-19 pandemic.
Small business concerns that previously qualified for SBA 7(a) loans are also qualified for Paycheck Protection Program loans. But eligibility for Paycheck Protection Program loans has been expanded to include organizations that employ not more than the greater of (1) 500 employees or (2) if applicable, the size standard in number of employees established by the SBA based upon the six-digit North American Industrial Classification System (NAICS) code of any applicant organization.
This alert addresses the applicant’s determination of its eligibility for Paycheck Protection Program loans with respect to the 500-employee test regarding for-profit businesses. Eligible nonprofits are also subject to the affiliation rule, other than a religious freedom exemption described in the interim final rules for affiliation published on the Treasury.
Department website on April 3, 2020, but application of affiliation rules to nonprofits and the related religious exception is not included in the scope of this communication.
In general, to be considered “small” from the perspective of the SBA, and therefore eligible for support under various SBA programs, organizations must be no larger than the prescribed size standard that corresponds to a six-digit North American Industrial Classification System (NAICS) code. In most cases, the SBA size standard is expressed either (a) as a maximum number of employees, or (b) in dollars, which refers to the receipts of the organization. Under the Paycheck Protection Program, organizations with an NAICS code sized by a threshold other than total number of employees cannot rely on that alternative sizing parameter to determine eligibility for a Paycheck Protection Program loan.
In addition to considering the NAICS code of an individual organization, under its affiliation rules, the SBA also considers whether the organization should be combined with other affiliated individuals, organizations or other entities in order to determine its size. Affiliation can occur among individuals as well as with other organizations.
New affiliation rule guidance published on the Treasury Department website on or about April 3, 2020, specifies the following circumstances as sufficient to establish affiliation for applicants for the Paycheck Protection Program.
- Affiliation based on ownership.
- Majority Ownership. A concern is an affiliate of an individual, concern or entity that owns more than 50 percent of the concern’s voting equity.
- Power to Control. A concern is an affiliate of an individual, concern or entity that has the power to control more than 50 percent of the concern’s voting equity.
- Deemed Management Control. If no individual, concern or entity is found to control, SBA will deem the Board of Directors or president or chief executive officer (CEO) (or other officers, managing members or partners who control the management of the concern) to be in control of the concern.
- Minority Investor Negative Control. SBA will deem a minority shareholder to be in control of a concern if that individual or entity 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.
- Affiliation arising under stock options, convertible securities and agreements to merge.
- Options Deemed Exercised. In determining size, 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. SBA treats such options, convertible securities and agreements as though the rights granted have been exercised.
- Speculative Options Excluded. Options, convertible securities and agreements that are subject to conditions precedent that are incapable of fulfillment, speculative, conjectural or unenforceable under state or federal law, or where the probability of the transaction (or exercise of the rights) occurring is shown to be extremely remote, are not given present effect.
- Letters of Intent, etc. Agreements to open or continue negotiations toward the possibility of a merger or a sale of stock at some later date are not considered “agreements in principle” and are thus not given present effect.
- Appearance of Termination of Control. An individual, concern or other entity that controls one or more other concerns cannot use options, convertible securities or agreements to appear to terminate such control before actually doing so. SBA will not give present effect to individuals’, concerns’ or other entities’ ability to divest all or part of their ownership interest to avoid a finding of affiliation.
- Affiliation based on shared management or management agreement.
- Shared Management. Affiliation arises where the CEO or president of the applicant concern (or other officers, managing members or partners who control the management of the concern) also controls the management of one or more other concerns.
- Board Control. Affiliation arises where a single individual, concern or entity that controls the Board of Directors or management of one concern also controls the Board of Directors or management of one or more other concerns.
- Management Agreement. Affiliation arises where a single individual, concern or entity controls the management of the applicant concern through a management agreement.
- Affiliation based on identity of interest. Affiliation arises when there is an identity of interest between close relatives, as defined in 13 CFR 120.10, with identical or substantially identical business or economic interests (such as where the close relatives operate concerns in the same or similar industry in the same geographic area). Where SBA determines that 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.
Impact of Affiliation for Paycheck Protection Program
Determination of whether an applicant meets the maximum size criteria to qualify for a Paycheck Protection Program loan, meaning no more than 500 employees (or, if the applicant’s NAICS code provides for an employee count of more than 500 under the SBA Size Standards Table, more than that higher number of employees specified in the table), must include (a) all of the employees of the applicant (whether or not those employees are eligible to be included in the calculation of payroll costs) and (b) all employees of all its affiliates as determined under the affiliation rules described above. Additional guidance is needed to determine whether NAICS code sizes based on a metric other than number of employees (such as annual dollar amount of receipts) could be substituted for the size determination for an applicant with such a NAICS code.
Waiver of Affiliation Rules for Paycheck Protection Program
Under the Paycheck Protection Program, there are three exceptions to the application of the affiliation rules:
Hotels and Food Services. Business concerns with an NAICS code starting with 72.
Franchisees. Business concerns operating as a franchisee of a franchise assigned a franchise identifier code by the SBA. For information, see the SBA franchise directory.
SBIC-Supported Companies. Business concerns that receive “financial assistance” from an SBIC (a company licensed under Section 301 of the Small Business Investment Act). For information, see the SBA’s SBIC directory.
Any company that falls within one of the three categories listed above does not have to consider affiliation rules when determining whether it meets the maximum size standards for a Paycheck Protection Program loan.
Business Concerns With More Than One Location
In addition to being exempt from the affiliation rules, any business concern with an NAICS code starting with 72 that also has more than one physical location is eligible for Paycheck Protection Program loans if it employs not more than 500 employees per physical location, regardless of how many physical locations it may have. Further SBA guidance is needed (i) as to whether such loans are to be obtained as a single loan subject to the aggregate $10 million cap on Paycheck Protection Program loans or if each location can apply individually without having to aggregate all Paycheck Protection Program loans for purposes of the cap, and (ii) for businesses that operate as employee managers on behalf of third parties, which is a common structure for the hospitality sector.
Business Concerns Receiving SBIC Financial Assistance
A business concern receiving “financial assistance” from an SBIC is exempt from application of the affiliation rules. In the Small Business Investment Act, the term “financial assistance” is used to broadly refer to the long-term debt and equity investment programs available thereunder.
How Does the SBA Count Employees?
The SBA counts all individuals employed on a full-time, part-time or other basis. This includes employees obtained from a temporary employee agency, professional employee organization or leasing concern. For purposes of the Paycheck Protection Program, employees who do not reside in the United States are not counted for the determination of loan size, but are included for the determination of whether the organization satisfies the maximum employee test.
The first interim final rule with respect to the Paycheck Protection Program also clarified that independent contractors should not be counted as employees of an eligible business for purposes of the Paycheck Protection Program because independent contractors can separately apply for a loan under the program.
Who Determines Affiliation?
For purposes of a Paycheck Protection Program loan, the borrower is responsible for analyzing the impact of the affiliation rules, determining whether it is eligible under the 500-employee test after including whether any affiliate should be included, and certifying on the borrower application form whether it is “eligible to receive a loan under the rules in effect at the time this application is submitted that have been issued by the Small Business Administration (SBA) implementing the Paycheck Protection Program under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).”