Affiliation is quite possibly one of the scariest words to small business government contractors. And it is easily one of the most misunderstood concepts in SBA’s small business regulations. Perhaps the widespread fear and misunderstanding are due to the fact that there are so many potential bases for affiliation listed in SBA’s rules–or the fact that you can be found affiliated with another company even if SBA finds that none of the listed bases for affiliation are met. Or maybe its the fact that, while affiliation isn’t always a bad thing, it can lead to severe consequences, like preventing an otherwise responsible and eligible business from competing under set-asides contracts.
Either way, this “Back to Basics” blog will be the first of two blogs that will “unpack” this concept for you, hopefully, removing some of the mystery. This first blog will provide a general overview of affiliation and what it means for government contractors, while the second blog will focus on the different types of affiliation.
What is affiliation?
Affiliation is, at its most basic, a determination that one business can control another, or that a third party controls both. According to SBA’s rules, policies, and case law, one thing is very clear: control is the most important concept in the field of affiliation. But it is not just “actual control” that can raise control concerns in an affiliation analysis. As SBA’s rules state:
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, so long as the power to control exists.
It is often this concept of the “power to control,” which includes what we like to call “negative control,” that seems to trip people up. In contrast, if one business is controlling the day-to-day and long-term operations of another business, a finding of affiliation isn’t going to shock anyone.
But situations where one business has a right to control certain aspects of another business, even if that control is never in fact exercised, can be just as problematic. For example, sometimes you will see a situation where one business (or an individual principal of that business) has a right to block a voting quorum of the shareholders or board of another business, or to veto certain decisions (sometimes as a part of financing or equity purchase agreements). We won’t get too far in the weeds on this one. The takeaway here is that even just the “power to control” is enough to find affiliation.
The SBA may consider all aspects of the parties’ relationship (the totality of the circumstances, in legal-speak) to determine whether this control–or ability to control–exists. Though the second blog on this topic will go into more detail on the various basis for affiliation (including the totality of the circumstances term mentioned above), some of the most common reasons for finding affiliation are when firms share common ownership or management, one entity is basically a spin-off or is economically dependent on another, or a company is unusually reliant on another as its ostensible subcontractor.
But, so what? Who cares if you have an affiliate? Let’s look at why it may (or may not) matter to you.
How can affiliation make a small business large?
To qualify as a small business for purposes of a government contract, a business has to be small under the size standard associated with the North American Industry Classification System (NAICS) code assigned to the solicitation. In addition to considering the firm’s own revenues or employee count, the SBA will add the size of any affiliates. So if your business’s size, together with that of any affiliates, exceeds the applicable size standard, your business won’t be eligible for the award. And unfortunately, this won’t only prevent your business from bidding on small business set-asides, but also on any 8(a) Program, WOSB/EDWOSB, SDVOSB/VOSB, and HUBZone set-asides for which your size, plus your affiliate(s), would be considered large.
So your next question may logically be: “How does the SBA find out whether or not you have affiliates?” Well there are a few ways, which often begin with the award of a small business (or other set-aside) contract. We will talk about some of those now.
Who can challenge an awardee’s size?
The SBA may determine affiliation in a variety of contexts. But an affiliation analysis often arises due to a formal size protest. After your business is named the awardee under a set-aside solicitation, another bidder (or even the contracting officer themselves) may file a protest questioning your company’s size. If so, and if the protest satisfies certain jurisdictional prerequisites, it will be up to you to show that affiliation doesn’t exist (if it truly doesn’t). This is typically done by providing SBA with the requested organizational documents and information, information on owners and managers, financials, agreements, etc., as well as by arguing your case to the SBA that the affiliation factors and/or the required control are not present in your case.
If your business’s size is successfully protested in connection with a set-aside solicitation, you won’t be eligible to receive the award. If the contract has already been awarded, it will likely be rescinded or terminated. Additionally, if you are found “generally affiliated” with your affiliate (we will discuss this in the next blog), you could be ineligible for all other set-aside work under the same (or a lower) size standard unless and until such affiliation is severed.
Affiliation should therefore be taken very seriously.
But the good news is, as I hint at above, affiliation does not have to be permanent.
Can affiliation be fractured (or mitigated)?
Indeed, affiliation should be a serious concern for every small government contractor. If you’re concerned that your small business might be affiliated with another company, there are steps you can take to try to fracture that affiliation before you submit an offer on a small business solicitation. Doing so could help save a contract.
Even if you are found generally affiliated with another business in a formal size investigation, while you are almost certainly out of luck for that contract, you can also take steps to “sever” the affiliation for future work. Affiliation is a fluid concept. If SBA finds you affiliated with another business based on common management, for example, and you reorganize your company to remove the common manager’s title, role, and ability to exercise any control, you at least have a solid argument that the affiliation has been severed (though, it is obviously up to SBA in the end).
Well, that sums up affiliation, very generally. But you might be wondering, are there exceptions to it/protections from it? And the answer is, yes. There are some limited exceptions /protections out there for certain types of affiliation, for example, for companies in mentor-protégé relationships, under some ANC and NHO rules, and (perhaps the most common) for joint ventures.
Do joint ventures enjoy some protection from affiliation?
Yes, but it is limited. Many of the small business owners I speak with operate under the belief that their business will be exempt from affiliation with its joint venture partner. This isn’t true—the members of a joint venture enjoy some special affiliation benefits, but not blanket immunity. Don’t let this same mistaken assumption jeopardize an award to your joint venture.
Affiliation can make your small business large and, in doing so, jeopardize an award. If you have concerns and would like legal assistance about affiliation, please give us a call at 785-200-8919.
Questions about this post? Or need help with a government contracting legal issue? Email us.
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