You might already know that 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.

You may not know that the SBA’s affiliation rules found at 13 CFR § 121.103 play a part in determining size for the purposes of participating in such programs and being awarded certifications. Affiliation refers to the ability of one entity to control another. It does not matter if the entity with the power of control actually exercises that control—once the relationship exists, it is enough to be an affiliation under the SBA rules. Affiliation can also exist where control can be exerted through a third party. If your company is deemed to be affiliated with another, the revenue of the two companies will be added together for size determination purposes.

In this blog, we’ll look at one way that the SBA can determine affiliation—stock ownership. There are three ways that affiliation can be based on stock ownership according to 13 CFR § 121.103(c):

1. A person, entity, or concern is an affiliate if they own or have the power to control 50% or more of your business’s voting stock. Affiliation may also exist where a minority stock owner owns or controls a large block of voting stock compared to others. For example, if one entity owns over 50% of your stock, the SBA will aggregate employees of both your business and that entity to evaluate size.
2. If two or more persons, entities, or concerns each owns or controls less than 50% but still a significant percentage of the voting stock, and the sum of their holdings are equal to or more compared to others, the SBA assumes that each individual has the ability to exert control over your business and affect its size determination. The rationale is that larger minority shareholders can exert more power over a business than smaller minority shareholders. For example, large minority shareholders might be able to prevent a quorum or block actions by the Board of Directors or other shareholders. This is called negative control because it potentially restricts action. You can rebut this by showing that such control does not exist.
3. If the voting stock is widely owned such that there isn’t a majority shareholder or bloc of shareholders, your business’s Board of Directors and CEO or President will be deemed to have the power to control. If any of these individuals own or control another entity, then this would make that entity an affiliate.

Consider this example of a telecom company whose affiliation to another company which was majority owned by a large Dutch cooperative association was deemed “other than small” due to the Cooperative’s passive ability to control. Size Appeal of: Clarity Commc’ns Grp., LLC. Appellant, SBA No. SIZ-6011, 2019 (June 17, 2019). Even though the Cooperative was far removed from the daily operations of the telecom company, its majority ownership of the company that controlled all the telecom company’s shares gave it power of control (albeit unexercised) and factored into the ultimate size determination.

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