SBA Affiliation Rules and Control: The Minority Owner Trap

Does a person who owns a minority share of a company “control” the company under the SBA affiliation rules?  Yes, if the company has no majority owner and the minority share owned by the individual in question is the largest, or is similar in size to, the largest other minority shares.

Get all that?  An example may help.  The decision of the SBA Office of Hearings and Appeals in Size Appeal of Advent Environmental, Inc., SBA No. SIZ-5325 (2012), demonstrates how this rule can be a trap for the unwary.

In the Advent Environmental size appeal, the question was whether Advent Environmental, Inc. was affiliated with a company called International Wholesale Tile.  Anthony Otten, who controlled Advent, owned a 25% interest in IWT.  Three other people also owned 25% interests in IWT.

According to Advent, Mr. Otten’s role in IWT was primarily as a passive investor, not a day-to-day corporate decision-maker.  The company’s operating agreement indicated that Mr. Otten, as a 25% owner, could not unilaterally make decisions for the company.

Nevertheless, the SBA Area Office held that Mr. Otten controlled IWT by virtue of a special SBA affiliation rule, which creates a legal presumption that a minority owner controls a company when the company has no majority owner, and the minority owner in question owns a share that is equal or approximately equal in size to the next largest shares.  Because Mr. Otten’s share was equal in size to those of his co-owners, the SBA found that Mr. Otten controlled IWT.  Because he also controlled Advent, the SBA found the companies affiliated.

On appeal, SBA OHA agreed with the SBA Area Office.  SBA OHA recognized that Mr. Otten could not unilaterally make decisions for the company, but wrote that “OHA has long held that the mere fact that a minority shareholder cannot individually control a concern is not sufficient to overcome the presumption” that the rule applies.  Because of the affiliation, Advent Environmental was found ineligible for a small business set-aside contract it thought it had won.

The SBA’s “minority shareholder” affiliation rule may seem counterintuitive—after all, an individual like Anthony Otten cannot unilaterally make decisions for the company, so how can he control it?  But the rule stems from the SBA’s conclusion that, for affiliation purposes, every company must be controlled by someone, even if that someone is a minority owner.  In the case of Mr. Otten and Advent, the minority shareholder rule proved very costly indeed.

Full disclosure: In this size appeal, I represented a competitor of Advent, making the argument that the minority shareholder rule should apply. 

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