Treasury Clarifies “Affiliation” Rules For SBA Section 7(a) Loans

Gene Naumovsky

Due to misreadings and distinguishably different wordings, startups and VCs are left in confusion over loan eligibility.

In a recent article, Forbes answered questions regarding venture capital-backed startups and their eligibility for SBA Section 7(a) loans under the Paycheck Protection Program. When it comes to affiliation rules, Section 301(f) determines the analysis of SBA section 7(a), meaning that a good amount of startups would not be “affiliates” of their VC. By avoiding affiliate status, startups are able to apply for loans as their employee count would not factor in all VC branches. The Treasury’s clarification of an original misreading communicated clearly to industry professionals what loans they are eligible for. In terms of protective provisions, the Affiliate Rules also state that a VC’s degree of significant protective provision control needs to be reported, as that degree shapes who truly operates the startup. Affiliation determined by protective provisions is covered under Sections 103 and 103(f), but the two hold key differences. The wording of the two sections allows cases examining “Negative Controls” or “Protective Provisions” to be interpreted differently. For example, Section 103 “provides for a minority shareholder to share “control” with one or more other minority shareholder(s), while Section 301(f)(1) ONLY finds percentage ownership control when the holder exceeds 50% of the voting equity.” Section 103 is also more detailed and in-depth regarding “Negative Controls,” stating that different situations, listed and not listed, can influence “Negative Controls.” Unlike Section 301, Section 301(f) allows SBA to “find affiliation where multiple VCs each own sizable chunks of a startup’s stock and together “control” that startup, even if none of them owns a majority.” Section 301 relies on the “totality of circumstances” for approaches to distinguish control.

Section 301(f) makes a clear point that a single equity holder, in control of protective provisions or vetos, is able to remove him or herself from that position to conform to loan policies. In order for such a step to be effective, the move should be enforceable by law, not revocable by the investor, in writing, effective at the time of application, and in good faith. When applying for loans it is important for startups and VCs to carefully assess their positions and plan of actions. Signing the application’s certification is a consequential decision, and a company needs to thoroughly examine their eligibility, status, and legality.

Read the full story here.

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