SBA recently issued a final rule redefining the rules of affiliation for firms applying to SBA’s business loan programs. The final rule separates and distinguishes the loan program affiliation rules from SBA’s government contracting and business development programs. Moreover, the final rule simplifies the guidelines for determining affiliation for small business eligibility as it relates to the loan programs. Case in point—the minority shareholder rule.
Under the new minority shareholder rule, when no single owner (individual or entity) holds more than 50 percent of a business concern’s voting equity, SBA will deem the Board of Directors, President, Chief Executive Officer, or other officers, managing members, or partners who control the management of the concern, to be in control. While a minority shareholder can still be found in control, that individual or entity must have the ability, under the concern’s governing documents, i.e., charter, bylaws, or shareholder’s agreement, to prevent a quorum or otherwise block action.
The rationale behind the new rule is SBA’s belief – at least, for loan program purposes – that a minority shareholder’s interest is so diffused that control would always rest with the small business concern’s Board of Directors or management since it is that unit of the organization that is truly running the business. This makes sense and the new minority shareholder rule should be a welcomed change for loan program applicants. Still, one has to question why SBA would choose not to apply the new rule across the board and, instead, continue to subject firms participating in SBA’s government contracting and business development programs, i.e., the 8(a) Business Development Program, to a minority shareholder rule that defies business reality.
The minority shareholder rule, as applied to those firms, provides that when a concern is owned by multiple owners with equal minority interests, all of those owners are presumed to control the concern. While the presumption is rebuttable, it requires a showing that such control does not in fact exist. And, long-standing OHA precedent makes clear that the presumption will not be rebutted unless the concern can demonstrate that the minority owner at issue is a true “passive investor” with no involvement in the concern’s business operations. This is by no means an easy feat. In fact, one seat on a Board of (countless) Directors or even a clear administrative-type role (e.g., Tax Matters Member) all but guarantees a finding of active investment.
In closing, the new, simplified version of the minority shareholder rule shows that SBA is aware of how businesses actually operate on a daily basis. However, the minority shareholder rule – and affiliation based on stock ownership, in general – is relevant to all of the small business programs and, for this reason, SBA should consider making a similar revision to its government contracting and business development programs’ regulations on affiliation.
About the author: Peter Ford is an associate with PilieroMazza in the Government Contracts Group. He may be reached at [email protected].