One of the things the Small Business Administration may be best known for is its small business loan programs, such as the section 7(a) and 504 Loan Programs. These programs have been a staple of the small business landscape for quite some time. Unsurprisingly though, there are multiple rules associated with them. Among these myriad rules and requirements, is the determination as to whether a loan applicant is a small business. One of the things that can affect whether a business is small is affiliation with other businesses push that company over the size limit. In a new proposed rule, it appears the SBA plans to dramatically scale back the ways that a business may be seen as affiliated, by practically getting rid of affiliation through “control”–only for for loan purposes, not procurement purposes. As this presents quite a shift in operations, all of us here at SmallGovCon wanted to make sure we have provided you, our readers, a breakdown of these proposed changes to a cornerstone of the SBA.
First, it may be good to think about how the SBA got to this point. As you may recall, during the early periods of the COVID-19 Pandemic, the SBA launched the Paycheck Protection Program. That loan program was geared towards helping small businesses through the COVID-19 Pandemic, and eventually the SBA granted ways for businesses to request forgiveness of those PPP loans. As was noted in a previous blog post, here at SmallGovCon, SBA’s affiliation rules related to loan programs, were applied to the PPP and generally were found to be a point of confusion for many working through that program. Well, through a proposed rule, published by the SBA on October 26, 2022, the SBA admits that based on its experiences with the PPP and over time with their other loan programs, SBA may gain some efficiencies by streamlining its process related to loan approval and affiliation rules.
Before getting into the meat of the loan program rules related to affiliation, it is important to note that any changes to affiliation regulations for SBA loans DO NOT change affiliation rules related to procurements. For information about that form of affiliation, check out our two part series on affiliation here, and here. Now, let’s get back to our chat about the SBA’s new proposed changes to its loan programs’ affiliation rules.
SBA’s loan programs look at affiliation based on 13 C.F.R. § 121.301, to determine if a business is “small” for 7(a) and 504 loans (as well as other loans such as PPP). These rules historically would determine if there were shared ownership, or “control” between businesses (such as shared management). If there was shared ownership or control, meeting the standards of 13 C.F.R. § 121.301, the applicant business would be combined in SBA’s eyes with the affiliate business as one business, and SBA’s determination of whether the business was “small” would be based on the combined receipts or employees of the businesses. Well, with the newly published proposed rule, the SBA is stating that they plan to basically do away with “control” between two businesses as an affiliation factor, seemingly focusing on ownership as the determining factor.
SBA states in its proposed rule that determining affiliation based on “control” was burdensome for applicants as well as lenders to understand the requirements, and focusing on affiliation, based mainly on ownership, pretty much captures the aim of the “control” component of affiliation. So, separate “control” factors are no longer necessary. In order to achieve this aim, the SBA is revising multiple sections of 13 C.F.R. § 121.301.
13 C.F.R. 121.301 currently states that a “small business” is one that is independently owned and operated, which is not dominant in its field of operating. As alluded to earlier, when determining if a business fits this definition, any “affiliate” of the company is included with the applicant business to determine the size of the applicant company. So, how affiliation is determined may truly mean the difference between a business being seen as small and receiving a loan, or not.
The proposed rule would update the definition of “ownership” in the regulations to remove the principle of control of one entity over another. Additionally, the SBA would clarify in the rules that certain affiliation by ownership will only arise if the applicant business and another business are operating in the same 3-digit NAICS subsector. SBA hopes that this will restrict affiliates to businesses in the same field. Finally, the SBA wants to further update the ownership definition to state that businesses in which the applicant business (or its owners) is a majority owner, are affiliates of the applicant business. If the other business does not have any majority owner (i.e. 51% owner), then SBA will review to see if the applicant business (or its owners) has 20% ownership in a business within the same 3-digit NAICS. If SBA finds this, then ownership affiliation would likely be found between the applicant business and the other business.
Additionally, SBA wanted to make it clear, that with its focus on ownership going forward, if there are family members with ownership in companies, the ownership interests of spouses, and minor children will all be combined with the the applicant to determine ownership affiliation.
For the SBA loan program affiliation regulations related to Stock Options, Securities and Merger Agreements, SBA states they will be examining businesses with those categories for current effects on ownership, but not control. Also, the affiliation determination based on management will be removed from the regulations, as the SBA believes the decision to hire a management company is a decision best left to the business itself.
Additionally, SBA proposes to remove affiliation based on identity of interest, because the SBA states “it is inherently unfair and impractical to require close relatives to provide multiple years’ worth of financial statements for review by a lender and by the SBA when the close relative is not a principal of the applicant business.” Of note, this does not affect the requirement to combine ownership interests of spouses and minor children when determining ownership affiliation.
Finally, SBA has stated that they propose to remove affiliation based on franchise and license agreements and will no longer publish the SBA’s Franchise Directory. However, SBA will still request the franchise identifier number and other items from applicants that have franchise and license agreements, when applying for loans under the SBA. Also, the SBA will still look into franchised businesses for affiliation based on ownership like any other applicant.
The SBA states in this proposed rule that they hope these changes will help lenders utilize technology and lessen the burden on applicants. It is also important to point out that these affiliation rule changes are not the only things SBA is proposing to change related to its loan programs. For example, the proposed rule also contains a myriad of other changes, including but not limited to, possibly eliminating hazard insurance requirements for 7(a) and 504 loans under $150,000, and allowing the Director, Office of Financial Assistance, to delegate reconsideration requests to a designee. So, even if you are not interested in the changes to the affiliation rules related SBA’s loan programs, it may be worth your time to give this proposed rule a read over your lunch or morning coffee. The SBA is requesting comments by December 27, 2022, regarding this rule, and a link to submitting comments can be found on the Federal Register page for this proposed rule.
So, while that may have felt like a whirlwind of information, legalese, and changes, it does truly represent quite a change in how the SBA may look at businesses’ sizes when applying for loans. That being said, this is only a proposed rule at this time, and has quite the way to go through the rule-making process still. So, until the rule is finalized, affiliation based on “control” is still present when applying for loans through the SBA and should be kept in mind when applying for any SBA loan at this time. Here at SmallGovCon, we will of course keep you updated on any other changes proposed by the SBA, as well as other Federal Government Contracting news, and we encourage you to check our blog regularly.
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