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One of the highlights of the recent $2 trillion CARES Act is the Paycheck Protection Program (PPP). The PPP is a loan designed to provide small businesses with the funds necessary to navigate the effects caused by COVID-19. The PPP loans are being administered through the U.S. Small Business Administration (SBA) and in order to qualify, businesses must typically have less than 500 employees.

Do middle-market private equity firms miss out on relief?

Most PE firms focusing on the middle market have less than 500 employees, but under the SBA’s “affiliation” rules, businesses also should add an affiliate’s employees to their total headcount.

The SBA has four control-based affiliation tests that are applicable to companies seeking relief under the PPP.

  1. Affiliation based on ownership.
  2. Affiliation arising under stock options, convertible securities, and agreements to merge.
  3. Affiliation based on management.
  4. Affiliation based on identity of interest.

Through the first two affiliation tests, a company may be deemed as an affiliate and thus included in the PE firm’s total headcount.

Working around the affiliation tests

The SBA is offering a “quick solution” where minority shareholders can irrevocably waive or relinquish existing rights that trigger affiliate status and may qualify for a PPP loan if done before applying.  Another option is to amend governing documents, which may prove tricky considering the need for investor consent.   Ultimately, there appears to be no easy fix for the problem at hand.

Currently, the Association for Corporate Growth (ACG) is tackling the matter directly with the U.S. Secretary of the Treasury and the U.S. SBA Administrator urging immediate resolution on the issue and should be lauded for taking up the charge to allow PE firms to seek relief.  There are currently over 200,000 middle-market companies in the U.S. and approximately 98% of them are privately held.   In 2019 alone, fundraising broke the $130B barrier with an increase in 25% in capital raised.

There is no doubt that the middle market is the backbone of the U.S. economy and the liquidity, strategic management, and value creation that PE firms offer those businesses are a strong force in the overall success of operations.  Changes to the current affiliation rules are necessary so that PE firms are able to seek relief and place their focus back on helping the middle market weather the COVID-19 storm.

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