Under the SBA’s small business affiliation regulations, an otherwise small business can be deemed affiliated with a larger business when the firms share “substantially identical business or other interests.” Under this rule, affiliation will be typically be found, as a matter of law, when a small business concern derives 70% or more of its revenue from another firm.

Because most new businesses don’t start up with numerous clients or contracts, a mechanical application of the 70% rule could be disastrous for a new small business faced with an SBA size determination. Thus, the “start-up” exception to the SBA’s affiliation rules—which applies to relatively new businesses whose revenues from its alleged affiliate are insufficient to sustain business operations—can be the saving grace for a small business trying to earn business from the government.

So it was in a recent case decided by the SBA Office of Hearings and Appeals.

OHA’s decision in Size Appeal of Olgoonik Solutions, LLC, SBA No. SIZ-5669 (July 10, 2015) involved the 8(a) Program application of Olgoonik Development, LLC, a subsidiary of a wholly-owned subsidiary of an Alaska Native Corporation.  The SBA Area Office evaluated Olgoonik’s size in connection with the 8(a) Program application.

The SBA Area Office focused on Olgoonik’s relationship with Stanley Convergent Security Solutions, Inc., a large public company part of Stanley Black & Decker, Inc. Olgoonik was organized in 2012 and began operations in July 2013. During the first six months of operations, approximately 85% of Olgoonik’s revenues were derived from its business dealings with Stanley. In 2014 and through the first quarter of 2015, 100% of Olgoonik’s revenue came from Stanley. Because Olgoonik had derived more than 70% of its revenues from Stanley, the SBA Area Office held that the companies were affiliated, rendering Olgoonik ineligible for admission to the 8(a) Program.

Olgoonik filed a size appeal with OHA. Olgoonik relied upon Size Appeal of Argus & Black, Inc., SBA No. SIZ-5204 (2011) to argue that the 70% rule was not applicable given Olgoonik’s status as a start-up. “Nearly every new firm begins with a single source of revenue,” Olgoonik argued. Olgoonik further noted its efforts to generate business with different firms, going so far as to submit a list of 59 new business development meetings it had pursued to generate business. In 2014, moreover, Olgoonik had a net loss of over $500,000; its revenue from Stanley during the same period (about $90,000) was not sufficient to sustain its business operations.

OHA agreed with Olgoonik. OHA faulted the SBA Area Office for misunderstanding Olgoonik’s financial viability absent support from Stanley. Although the revenue Olgoonik received from Stanley was insufficient to sustain Olgoonik’s business operations, it was “able to continue business operations due to the financial support of its parent company, ODL, a wholly-owned subsidiary of an ANC.” (Under the SBA’s size regulations, Olgoonik was exempted from affiliation with its parent company.)

OHA was also impressed with Olgoonik’s “diligent” efforts to pursue business from sources other than Stanley. These efforts, OHA noted, had started to pay off: Olgoonik had earned two subcontracts with firms unrelated to Stanley. Given Olgoonik’s efforts, OHA concluded it would be “unjust” to apply the 70% rule. OHA granted Olgoonik’s size appeal and reversed the size determination.

The “start-up” exception to the 70% rule is a commonsense way in which the SBA can (and should) avoid a mechanical and unjust application of the “economic dependence” affiliation rule. The Olgoonik case is the latest in a growing number of OHA decisions to reaffirm this important exception.