This is the stickiest point in the CARES Act for many Burkland clients. The SBA determines affiliation for the purposes of the under-500 employee eligibility requirements.
Control of a business may be established by, among other things:
- Ownership or control of, or the power to control, 50% or more of voting stock,
- A block of voting stock that is large compared to all other outstanding blocks of voting stock.
- The ability, under the company’s charter/by-laws/shareholder’s agreement, to prevent a quorum or otherwise block action by the BOD or shareholders.
In the case of affiliation, the company’s employees are counted alongside those of all the controlling entity’s other holdings. For example:
A company with 150 employees received financing through a venture capital round dominated by one investor, and that fund was granted preference/control rights. By the SBA’s existing rules, the business concern is deemed an affiliate of the fund and of any other portfolio company controlled by the fund, and to have all the employees of the venture fund and the fund’s other portfolio companies.
Exceptions
The CARES Act provides that this regulation is waived with respect to businesses with <500 employees:
- With NAICS codes beginning with 72 (hotels, restaurants, etc.)
- Businesses operating as franchises
- Businesses receiving financial assistance from a firm licensed to operate as a small business investment company (SBIC) under Sec. 301/Small Business Investment Act of 1958
The apparent exclusion of most venture- and private-equity backed companies from the CARES Act has come under intense scrutiny since passage of the bill on March 27. Even prior to the COVID-19 crisis, affiliation determinations were complex and often on a case-by-case basis. We expect clarifying language/guidance from the Congress and/or SBA as soon as possible and will updated information as soon as we have the information.
NVCA’s Interpretation
The National Venture Capital Association’s interpretation can be found here.
Resources Regarding CARES Act Exceptions
NVCA – Legislative Update
Choate – Client Alert on Eligibility
SBA – Affiliation Overview