One area in the review of a potential SBA 504 loan that is sometimes difficult to wrap your arms around deals with possible affiliated businesses to our borrower. Determining if there are any affiliated businesses to our borrower is important for several reasons. This week’s blog focuses on what impact affiliation might have and how the SBA determines affiliation.
Why is affiliation important and how can it affect an SBA 504 loan request? Three areas of eligibility are impacted by affiliation. The first is the SBA size standards. An eligible small business must have a net worth less than $15 million and net income averaged over the past two years of less than $5 million. These numbers also include any affiliated businesses. So while our specific borrower might fall under those financial benchmarks, if there are multiple affiliates, the totals of each of the affiliates plus our borrower might add up to be greater than the maximum limits allowed, thus making our borrower ineligible for 504 financing.
Another area involves maximum SBA exposure. The maximum amount of SBA exposure (7a guarantied portion and 504 balances) to any one borrower including affiliates is $5 million. If an entity is determined to be an affiliate of our borrower and that entity currently has a 7a or 504 loan, then that could limit the amount of SBA funds that would be available for our borrower. Exceptions to this rule include manufacturers and projects involving eligible Energy Public Policy Goals.
Finally, affiliation can have an impact on whether a franchise is deemed eligible. If our borrower will be entering into a franchise agreement, the SBA must review the agreement to determine whether an affiliation with the franchisor exists. In the case of franchises, an affiliation can exist through common ownership, common management, excessive restrictions upon the sale/transfer of the franchise interest, or control by a franchisor either directly or through an affiliated entity or agent such that the franchisee does not have right to profit from its efforts and bear the risk of loss commensurate with ownership. The restraints imposed on a franchisee by its franchise agreement relating to standardized quality, advertising, accounting format and other similar provisions, generally will not be considered in determining whether the franchisor is affiliated.
Now that the importance of affiliation has been explained, how exactly is affiliation determined? That is a very good question and one that the SBA has been looking into simplifying and clarifying since there are sometimes gray areas that can be left up to interpretation or argument.
According to the SBA’s Standard Operating Procedures, 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. SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships, in determining whether affiliation exists.
Control may be affirmative or negative. Negative control includes, but is not limited to, instances where a minority shareholder has the ability, under the concern's charter, by-laws, or shareholder's agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders. Affiliation may be found where an individual, concern, or entity exercises control indirectly through a third party. In determining whether affiliation exists, SBA will consider the totality of the circumstances, and may find affiliation even though no single factor is sufficient to constitute affiliation.
If two or more persons (including any individual, concern or other entity) each owns, controls, or has the power to control less than 50 percent of a concern's voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, SBA presumes that each such person controls or has the power to control the concern whose size is at issue. This presumption may be rebutted by a showing that such control or power to control does not in fact exist.
If a concern's voting stock is widely held and no single block of stock is large as compared with all other stock holdings, the concern's Board of Directors and CEO or President will be deemed to have the power to control the concern in the absence of evidence to the contrary.
For common management, affiliation arises where one or more officers, directors, managing members, or partners who control the board of directors and/or management of one concern also control the board of directors or management of one or more other concerns.
Affiliation may arise among two or more persons with an identity of interest. Individuals or firms that have identical or substantially identical business or economic interests (such as family members, individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships) may be treated as one party with such interests aggregated. Where SBA determines that such interests should be aggregated, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one are in fact separate.
Since affiliation is important in determining the eligibility of a potential SBA 504 loan, we typically ask early on in the process for information about any other ownership or management interests, no matter how small, of every owner of our borrower. If there are any, then we conduct a review of those entities to determine whether any affiliation might exist.