Morgan Lewis

With the targeted relief for small businesses from the Coronavirus Aid, Relief, and Economic Security (CARES) Act come questions about whether certain entities are eligible for relief under the act’s Paycheck Protection Program. For private equity and venture capital portfolio companies, additional analysis is required to determine whether they can obtain CARES Act aid. This LawFlash analyzes such companies’ ability to successfully apply for and receive relief.

US President Donald Trump signed the CARES Act into law on March 27. The act, among other economic stimulus measures, provides targeted relief to small businesses through its Paycheck Protection Program (PPP). Read our March 27 LawFlash on the PPP.

These relief measures include emergency grants and certain “paycheck protection” loans under Section 7(a) of the Small Business Act for companies (generally including affiliates) that meet any of the following criteria:

  • 500 or fewer employees
  • More than 500 employees but fewer than the number of employees specified as the threshold for the borrower’s North American Industry Classification System (NAICS) code
  • Deemed small under preexisting Small Business Administration (SBA) size rules where size is based on annual receipts, even if the company has more than 500 employees
  • $15 million or less tangible net worth, and $5 million or less average net income after federal income taxes (excluding any carryover losses) for the two full fiscal years before the date of the application, under SBA’s temporary alternative size standard [1]

For an ostensibly “small” private equity or venture capital (PE/VC) portfolio company, however, the assessment of whether the company qualifies for this assistance requires analysis.

Depending on the circumstances, the calculation of the totals above may need to incorporate the applicable numbers from an affiliated PE/VC firm or other portfolio companies in which that firm has invested.

SBA Affiliation Rules

As a Section 7(a) assistance loan program, the CARES Act’s PPP is subject to the SBA’s affiliation rules in 13 CFR § 121.301. Pursuant to those rules, SBA takes into account the number of employees or annual receipts (or net worth/net income under the alternative size standard) belonging to the business at issue (i.e., the portfolio company), as well as those of any “affiliated” businesses, in determining eligibility under the applicable size standard. Businesses and entities are considered to be affiliates of one another when one controls or has the power to control the other, or a third party or parties controls or has the power to control both (e.g., controlled by the same PE/VC fund).[2] It does not matter whether control is actually exercised so long as the power to control exists.[3]

What Constitutes “Control”?

One of the most common ways that SBA finds control (and hence, affiliation) is where an individual or another business concern owns more than 50% of the voting equity of the business concern seeking financial assistance.[4] However, even a minority investor may be found to control a business concern where it has the power to exercise “negative control.” This includes the ability under a business concern’s charter, by-laws, shareholders agreement, or similar governing document to block actions related to the daily operations of the business concern (e.g., hiring or firing officers, borrowing money, or paying dividends).[5]

Control can also arise through contractual or other economic dependence, including when a business concern derived more than 85% of its receipts over the previous three fiscal years from a contractual relationship with another concern, unless certain facts refuting dependence are present.

Further, effective March 11, SBA reinstated a “totality of the circumstances” affiliation test under which SBA may consider all connections between the borrower and a possible affiliate and, if no single factor is sufficient to constitute affiliation, SBA may determine on a case-by-case basis that affiliation exists when there is “clear and convincing evidence” based on the totality of the circumstances.

As a result, even if a PE/VC firm has made a minority investment in a portfolio company, if it also can block actions by the board or shareholders relative to the daily operations of that company through certain protective provisions, the company will likely be deemed affiliated with that PE/VC firm.

Finally, note that if the same individuals or entities control two or more funds, these funds, and the related portfolio companies themselves in which these funds have invested, may also be affiliated. In this regard, for example, two funds owned by the same unrelated individuals or firms may be affiliated under the “identity of interest” test even though the largest number of shares in each of the two funds, respectively, is not held by the same member of the group. SBA finds such an “identity of interest” where two or more individuals or firms have identical or substantially identical business or economic interests, such as common investments. Such individuals or firms may be treated as one party with such interests aggregated, subject to rebuttal with evidence showing that the interests deemed to be one are in fact separate.

Other Criteria Beyond Control/Affiliation

Once affiliation with a PE/VC investor is found, SBA aggregates the number of employees or annual receipts (or net worth/net income under the alternative size standard) of that business concern with the number of employees or annual receipts of the business concern at issue, in order to assess whether the business concern exceeds the size standard for loan eligibility.[6] All foreign and domestic affiliates are considered, regardless of whether the affiliates are organized for profit (meaning that non-profit business concerns are not exempt from being found affiliated, and from including their employees in the total calculation).

SBA also considers whether a PE/VC investor has its own affiliates that must be included in the calculation such as other portfolio companies the PE/VC investor also has the power to control. In most cases where affiliation with a PE/VC investor is found, the resulting total employee count will exceed the applicable threshold, and the business will be excluded from the provisions for relief in the CARES Act. If it does not, of course, the business generally still qualifies.

Exceptions to Affiliation Rules

SBA applies certain exceptions to the above-described general principles of affiliation. For example, businesses owned by licensed investment companies or qualified development companies under the Small Business Investment Act of 1958 (SBIA) are not considered affiliates of such investment companies or development companies.[7]

While other investors—including venture capital operating companies and registered investment companies—are specifically called out in another of these exceptions, that carve-out is expressly limited to situations in which the business is applying for financial, management, or technical assistance under the SBIA. This exception, on its face, is therefore inapplicable to PPP loans under the CARES Act, which modifies Section 7(a) of the separate Small Business Act.[8]

The CARES Act explicitly waives the SBA affiliation rules for the following small businesses seeking relief under the CARES Act’s PPP provisions:

  • Any business with 500 or fewer employees at a single physical location that operates under an NAICS code beginning with 72, namely, businesses in the accommodation and food service industries (view the SBA’s full table of NAICS codes and related size thresholds)[9]
  • Any business operating as a franchise that is assigned a franchise identifier code by the SBA (view the SBA database of franchises that have received a franchise identifier code)
  • Any business that receives financial assistance from a small business investment company licensed under the SBIA. Note that the language of this CARES Act exception differs from the language of the more restrictive, preexisting SBIC exception, which simply provides that businesses owned in whole or substantial part by investment companies licensed, or development companies qualifying, under the SBIA are not considered affiliates of such investment companies or development companies

As a result, PE/VC-owned businesses that are franchises, recipients of SBIC financial assistance, or that operate in a single location of 500 employees or fewer that operate in the hospitality or food service industries likely do not have to perform the affiliation analysis and are therefore more likely to be eligible to receive an assistance loan pursuant to CARES.

Final Thoughts

As with any time funding is available from the federal government, it is important to consider the risk of civil and criminal liability under the False Claims Act (FCA), which penalizes false or fraudulent statements or claims of entitlement to the government in connection with a request for payment or approval. Civil FCA penalties can be substantial, including the potential for treble damages. As a result, companies should ensure that they meet the size requirements, including applicable affiliated investors, or an applicable waiver, before applying for financial relief under the CARES small business provisions. For more on this read our March 27 LawFlash, CARES Act’s Substantial Relief Funds Create Fraud Risk.


For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold.


[1]15 USC 632(a)(5)(B); see also SBA Information Notice 5000-1175.

[2] § 121.301(f).

[4] § 121.301(f)(1).

[5] §121.301(f)(1)&(f)(6).

[6] §121.301(f)(8).

[7] See §121.103(b)(1); see also § 121.301(f)(9).

[8] §121.103(b)(5).

[9] 13 CFR 121.20