SBA Size Standards: Affiliation Considerations Arising under Stock Options, Convertible Securities, and Agreements to Merge

As discussed in our prior blog, 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.

In determining whether your business meets the requirements to be a small business, the SBA looks at whether your business is affiliated with another.  

There are a variety of ways that the SBA looks at affiliation.  Once such way is stock ownership. According to SBA affiliation rules, stock ownership may create a power of control that deems your business linked to another individual, business or entity such that your revenue is aggregated in determining size. Under 13 CFR 121.103(d) stock options, convertible securities, and agreements to merge are similarly treated as power to control that has already been granted and exercised. They are regarded as having a present effect. This will be so, unless there is some showing that the agreements involved are subject to conditions that are highly unlikely to be fulfilled.

The SBA Office of Hearings and Appeals (OHA) has explained that under the present effect rule, “a merger or acquisition is effective as of the date that an ‘agreement in principle’ is reached, even though the merger or acquisition itself is not yet consummated.” Size Appeal of Heard Constr., Inc. Appellant, SBA No. SIZ-5461, 2013 (April 3, 2013). This means that even if a merger itself is effective on a certain date, the SBA will consider the date on which the agreement to merge was formed as the beginning of the affiliation relationship. Such agreements should be fully formalized, and two entities will not be considered affiliated based simply on ongoing discussions or an informal agreement. 

Consider this case where an overzealous website designer listed a small business as a branch location of a larger company before a formal agreement had been reached. Size Appeal of: Crop Jet Aviation, LLC. Appellant, SBA No. SIZ-5933, 2018 (June 8, 2018). The SBA determined that the listing on the website was not enough to show affiliation. Entities must move past the negotiating phase and have binding documentation showing intent to find such affiliation.

On the other hand, the SBA does not view agreements to terminate stock options or other equity rights as exercised until the date such agreements are actually executed. Therefore, affiliation status will remain in effect until the termination date itself and not the date of the agreement to terminate. 

SMGG thanks summer associate Krystel G. Becker for her assistance with writing this blog.