How Does the SBA Determine Affiliation?

Posted on February 25, 2021

A “small business concern” is eligible for certain Federal programs, including the All Small Mentor-Protégé Program, and for certain Federal contracts and subcontracts.  Often times, the question of whether your business qualifies as small is a straightforward question of your revenue, or how many employees you have.  This article introduces the concept of affiliation, which comes into play when the closeness of your relationships with other companies or individuals puts the small business status of your company at risk.

Small Business Overview

In general, for your business to be considered small, it must meet a particular size standard that corresponds to a six-digit North American Industrial Classification System (“NAICS”) code.  Each size standard is stated in terms of either receipts or employees, and in limited cases a basis other than receipts or employees (e.g., megawatt hours).  For example, in order to qualify as a small business concern for a set-aside, partial set-aside, or reserve the business must meet the size standard that corresponds to the NAICS code assigned to the solicitation, contract or order.  The SBA will consider not just the receipts or employees (or other measure) of an applicant/participant/offeror, but also of its domestic and foreign affiliates, when determining a business concern’s size.
SBA’s size rules apply to small business loan and grant programs as well as the following:

In addition to these SBA-administered programs, other government agencies, e.g., the Department of Veterans Affairs, use SBA affiliation/size rules to run their own small business programs.  Notably, however, that is not the case across the federal government.  For example, the U.S. Food & Drug Administration recently adopted its own rules to govern its small business interactions, e.g., to determine if a new drug manufacturer is a small business and therefore qualifies for reduced application fees.

There is one more critical distinction to point out with regard to size standards in the SBIR and STTR programs.  While these programs of course are reserved for small businesses, the regulations used to determine size and affiliation are different.  For example, for SBIR/STTR’s purposes, a business qualifies as small if it (along with its affiliates) has fewer than 500 employees.

How The SBA Determines Affiliation

Generally, affiliation exists when one business controls, or has the power to control, another business, or when a third-party controls (or has the power to control) both businesses.  This rule exists because the primary purpose behind the substantial benefits that the small business programs offer to small businesses, is to aid their own development.  When someone other than the small business owner is making the decisions, then the development of the small business, i.e., government’s interest in the program, is hindered.  That is why the revenue of the business or individual that controls the small business is then added to the calculation for the purposes of determining the business’s size.

The SBA has issued extensive regulations regarding how it makes affiliation determinations.  Control may arise based on a variety of different relationships that a small business may have with another entity, including ownership, funding, or management arrangements, or other interactions between the parties.  The SBA will consider the totality of the circumstances when determining whether affiliation exists and may find affiliation based on the totality of the circumstances even though no single factor alone may be sufficient to constitute affiliation.

The other entity’s control over the small business may be affirmative or negative. Affirmative controls exist when the other entity has the positive power to direct the small business’s actions, e.g., by having a majority of the board members.  Negative controls, on the other hand, are harder to spot, and include instances where the entity may not have the power to make decisions but does have the power to prevent actions.  For example, a negative control exists when the business’s operating agreement gives a minority shareholder the ability to prevent a quorum, meaning that the minority has the power still to block action by the majority owner of the small business.

The SBA may also find affiliation if your business has an “identity of interest” with another business or individual.  Individuals or firms that have identical (or substantially identical) business or economic interests may be treated as one party unless they can demonstrate otherwise.  The SBA presumes that identical interests exist based on familial relationships, common investments, or economic dependence between firms through contractual (or other) relationships. However, individuals or firms may seek to demonstrate that no affiliation exists by providing evidence establishing that apparently identical interests are, in fact, separate. Patterns of subcontracting, commingling of staff and/or facilities, and other veiled attempts to disguise the true nature of the relationship may evidence an identity of interest. The SBA recently updated its guidance in 2020, which walks through these, and other, examples of relationships that may lead to a finding of affiliation.

Exceptions to Affiliation

The SBA has also recognized several relationships that do not offend the program’s purposes and therefore will not result in a finding of affiliation. The most prominent exception is when a small business forms a joint venture (“JV”) with a large business through the All Small Mentor-Protégé Program.  As we’ve discussed, any joint venture formed between a protégé small business and its SBA-approved mentor receives an exclusion from affiliation, such that the joint venture will qualify as a small business if the protégé individually qualifies as small under the procurement’s NAICS code.  It’s important to remember, however, that these joint ventures are only protected from affiliation insofar as the JV complies with the SBA regulations.  For example, if a JV has already been awarded three contracts in two years—which is the maximum that regulations permit—then the JV partners will be affiliated for any future contracts that the JV bids on.  There are numerous other distinct exceptions (e.g., when two businesses that qualify as small for a solicitation’s NAICS code, form a joint venture for the purposes of bidding on that solicitation) that may be applicable to your business.

Remember, affiliation can matter a great deal if your business plan is dependent on having a small business status.  As we have discussed elsewhere in W&B’s GovCon Resource Library, if your small business is awarded a small business set-aside contract, an unsuccessful offeror may protest the size of your company.  If the SBA determines that affiliation exists in this protest, then the receipts, employees, or other measure of your business’s size must also take into account the receipts, employees, or other measure of size for all of its domestic and foreign affiliates. If you think that affiliation may be a problem for your small business, Ward & Berry can advise you of the risks, help you avoid affiliation now and in the future.
Primary Source: U.S. Small Business Administration, Small Business Compliance Guide: A Guide To The SBA’s Size Program & Affiliation Rules (July 2020)