As discussed previously in this blog series, the Small Business Administration (SBA) promulgates rules on the size standards under which businesses may qualify as “small.” Your business must meet the relevant size standards (i.e., according to the NAICS code for your industry) if you’d like to qualify for certain business development programs or certifications such as DBE, WOSB, EDWOSB, VOSB, SDVOSB or other SBA programs.

So far, we have explained SBA Affiliation arising from:

• • • Stock ownership;
    • Stock Options, Convertible Securities, and Agreements to Merge; and
    • Common management
    • Identity of Interest

Affiliation may also arise under 13 CFR 121.103(g), the SBA’s “newly organized concern” rule. “The purpose of the “newly organized concern” rule is to prevent circumvention of the size standards by the creation of “spin-off” firms that appear to be small, independent firms but are, in actuality, affiliates or extensions of large firms.” Size Appeal of: Coastal Management Solutions, Inc., SBA No. SIZ-5281, at 3 (September 2, 2011). Affiliation under the “newly organized concern” rule occurs when four elements are present: 

(1) former or current officers, directors, principal stockholders, managing members or key employees from one business create a new business; (2) the new business is in the same or a related industry; (3) the persons who organized the new business serve as its officers, directors, principal stockholders, managing members, or key employees; and (4) the first business will give assistance to the new business in the form of contracts, financial support, technical know-how, indemnification, or facilities.

If these elements are met, the SBA is likely to find the businesses affiliated for the purposes of size determination. Despite the implication by the rule name that it applies only to “new” businesses, the OHA has found that mere passage of time does not necessarily bar application of the “newly organized concern” rule. Id., at 5. Consider this case where a company in existence for six years was still considered a nascent concern because despite its incorporation date, it had been inactive for its first four years. Size Appeal of Taylor Consultants, Inc., SBA No. SIZ-4775, (April 7, 2006)

A business may rebut presumed affiliation under the “newly organized concern” rule by showing a clear line of fracture—operating in different industries, no sharing of resources, an absence of contracts between the concerns, etc. However, it must be noted that showing a lack of economic dependence between two concerns is insufficient evidence of a clear line of fracture. The fourth element of the rule does not apply only where the assistance involved would produce economic dependence. Rather, this fourth element is about the existence of a continuing relationship between concerns.