Using an SBIC to De-Affiliate Portfolio Companies

Potential PPP loan Relief

Available to Private Equity Portfolio Companies


This note will explain how private equity sponsors, SBICs, BDCs and their portfolio companies may benefit from the new unsecured and potentially fully forgivable SBA Paycheck Protection Program (PPP) loans under the pending Coronavirus Aid, Relief, and Economic Security Act, or “CARES Act.”[1]  Some initial commentary from leading industry commentators noted that such loans would not be generally available to PE portfolio companies.  While generally true, that analysis omits an important exception that should allow PE sponsors to obtain PPP loans for some of their portfolio companies.

Under the size standards applicable to the traditional SBA 7(a) loan program, controlled portfolio companies of PE funds are treated as affiliates and thus aggregated to determine eligibility under the SBA size standards.  Two controlled portfolio companies of the same PE sponsor that each have 300 employees would thus be aggregated and each would fail a size standard set at 500 employees, assuming the sponsor “controls” both companies.  Thus, neither one could get a traditional SBA 7(a) loan.

While that same concept generally applies to the new PPP loans, the act exempts from all of those affiliation rules, any business that receives “financial assistance” from an SBIC. This means that either of the sponsor-controlled companies above who would NOT have qualified for SBA loans due to the current affiliation rules now would qualify for a new PPP loan if that portfolio company currently has a loan[2] from an SBIC or obtains an SBIC loan prior to the time that it applies for the PPP loan.

In short, PE portfolio companies that are each individually small businesses may qualify for unsecured, forgivable loans, if they are able to first obtain an SBIC loan or possibly have an SBIC purchase all or part of an existing loan.

As drafted, it appears that even portfolio companies that do not currently have SBIC loans outstanding can go get such a loan, and thus qualify for a PPP loan, if they meet the SBA size standards on a stand-alone basis.  We expect that this will create significant demand for new SBIC loan origination (and possibly secondary loan transfers), especially for BDCs who have affiliated SBICs. 


The CARES Act amends the Small Business Act (“SBA”) to add a “Paycheck Protection Program” under which some small businesses and other eligible recipients may qualify for unsecured and forgivable SBA loans as they fight the potential consequences of the COVID-19 pandemic.  These loans generally contain borrower-favorable terms, including:

  • Principal Amount: Up to the lesser of $10 million or 2.5x average monthly payroll expenses (excluding certain compensation for employees making more than $100,000 per year).
  • Interest:  PIK only for 6-12 months at a rate not to exceed 4% per annum.
  • Maturity: Up to 10 years for any amounts not forgiven.
  • Collateral:  Unsecured; guaranteed by the SBA.
  • Forgiveness:  The principal amount of loans (but not interest) will be forgiven to the extent of the borrower’s documented expenses for payroll, interest on certain preexisting (as of Feb. 15, 2020) mortgage debt, rent and utilities payments, in each case incurred during the 8-week period from the loan origination.
  • Details:  A number of other terms and conditions apply.  For further information, see our Q&A on the PPP loans here and a more detailed description here.


The PPP loans are an outgrowth of the SBA 7(a) loan program, so in order to qualify for a PPP loan, the borrower has to either qualify under the traditional SBA 7(a) size standards or meet certain relaxed standards created by the CARES Act to expand the pool of “eligible recipients.”  Thus, the PPP loans are available to borrowers who:

  • Would otherwise qualify as a small business concern and thus be eligible for an SBA 7(a) loan, under the applicable SBA size standard[3] based on the borrower’s industry NAICS code, as listed here, which are based either on:
    • annual receipts (averaged over 3-5 years) or
    • number of employees;
  • Fail to meet the above industry-based size standard, but employ fewer than 500 employees (i.e., for industries subject to an employee size test, the limit is the greater of 500 or the applicable industry standard); or
  • Operate in NAICS Code 72 and employ not more than 500 employees per physical location of the business.


A key impediment for private equity sponsors, however is that the SBA 7(a) size standards apply a fairly broad affiliation concept to potential borrowers, which requires aggregation of employees or annual receipts of all of the sponsor’s “controlled” portfolio companies, thus keeping most sponsors from looking to the SBA loan program generally.  Note that, solely for purposes of the Small Business Investment Company (“SBIC”) investment program, portfolio companies of most PE and VC funds are exempt from these affiliation rules, which has allowed SBICs to support the private equity industry. 

The SBA considers a broad range of factors to determine control and affiliation, of which the following may be most applicable to PE and VC portfolio companies:

  • If a PE sponsor owns a majority of a company’s voting equity or has a right to control the board, that company is deemed an affiliate, and the SBA has the ability to look through to indirect ownership and voting arrangements. 
  • Even if one or more funds do not own a majority of the equity, but their holdings are large compared to others, the large investors may be deemed to control the company.  (The SBA gives the example of an investor owning 40% of the equity, with rest of the ownership being widely dispersed such that the next largest investor owns 2%).
  • Certain equity-linked negative covenants that give an investor an ability to prevent a board quorum or prevent a portfolio company from taking actions could result in the investor controlling the portfolio company and thus affiliation. VC funds should pay particular attention to how typical preferred stock “protective provisions” could trigger a finding of what the SBA refers to as “negative control”.
  • Companies that share common investors, management or directors may be deemed affiliates, even if there is no one controlling owner, which could impact some unfunded sponsors and other fund structures.

While these are the main factors likely to apply to PE, and some VC, portfolio companies, there are a number of other factors that the SBA can use to determine affiliation and which are further explained here.  PE sponsors that use multiple fund entities to invest in their portfolio companies or otherwise have complex investment and capital structures may want to review the affiliation guidelines closely to determine whether the SBA would deem the sponsor to be an affiliate of some or all of those portfolio companies.


Even for sponsors who do control their portfolio companies under the traditional SBA affiliation rules, the CARES Act says that none of those affiliation rules apply to portfolio companies of SBICs or companies that receive “financial assistance” from an SBIC.[4]  This means that PE sponsors seeking PPP loans for their controlled portfolio companies may apply the SBA 7(a) size standards on an individual company-by-company basis for any portfolio company that has a loan from an SBIC.  Thus, SBIC-funded portfolio companies of a sponsor need not aggregate employees or annual receipts with other portfolio companies of the sponsor, which should greatly expand the number of PE portfolio companies that may be eligible for a PPP loan.

We are receiving questions about whether this only applies to portfolio companies with existing SBIC loans. We believe that the CARES Act is not so limited.  While there are other provisions in the CARES Act tied to debt existing as of February 15, 2020, the CARES Act in the affiliation exemption refers only to a business “that receives financial assistance” from an SBIC, without requiring that such assistance (i.e., loan or investment) currently be in place.  Thus, under a plain reading of the CARES Act, it appears that a portfolio company that otherwise would individually be an eligible recipient of a PPP loan, could now borrow from an SBIC and thus qualify for the PPP loan.  We thus expect that many sponsors will look to SBICs to obtain loans to qualify otherwise eligible portfolio companies for PPP loans.  This may be especially beneficial for Business Development Companies (BDCs) and their borrowers, because many BDCs have affiliated SBICs.  Even if its affiliated SBIC does not hold part of a current BDC loan, that BDC may be able to quickly arrange for financing from such SBIC.

We are also receiving many questions about whether an SBIC can simply purchase all or part of an existing loan from an incumbent non-SBIC lender. The answer here is less clear.  The SBA Regulations allow SBICs to purchase securities from such an incumbent lender if such purchase is:

  • “a reasonably necessary part of the overall sound” financing of the business, or
  • “to finance a change of ownership” of a borrower (which would likely be less relevant in the current context, except perhaps as part of an overall restructuring of a borrower).

While it seems tempting to say that a PPP loan is a logical part of a sound financing package for a small business, it is not clear that the SBA would agree that a third party purchase of outstanding debt is “reasonably necessary” in order to allow the borrower to obtain such package.  Because of the short time period during which the PPP loans are available, there is an argument that such a secondary purchase would be “reasonably necessary” to avoid the need for a full negotiation of a new set of loan (and potentially intercreditor and equity) documents with the SBIC. However, there is no assurance that the SBA would agree.  We are continuing to review that aspect on behalf of our clients.

If you have questions or would like further information, please contact Rick Giovannelli, Christine Hoke, Liz Evans any member of our private funds team.

[1] This note refers to the version of the CARES Act passed by the Senate and House, which we understand may be passed by signed by the President as soon as Friday, March 26.

[2] Although we refer to SBIC loans throughout this article, note that the same concept would apply to an equity investment made by an SBIC.  SBICs generally tend to make equity investments in connection with providing a loan rather than on a standalone basis, so we refer only to loans for the sake of simplicity.

[3] For those familiar with the SBIC program, the traditional SBA 7(a) standards are the industry-based standards that can be used for SBIC eligibility if a borrower fails the primary $6.5M and $19.5M SBIC tests.

[4] The affiliation rules are also waived for companies that (a) are franchisees or (b) operate in NAICS code 72, which generally covers food service and hospitality companies, and having no more than 500 employees.  This further expands the universe of PE portfolio companies that may be eligible for PPP loans.