For small businesses, understanding the Small Business Administration’s rules concerning affiliation is vital for establishing and maintaining a certain size threshold. Relationships that are deemed too close by the SBA can lead to a finding of affiliation and, ultimately, the loss of the ability to chase set-aside work.
The rules of affiliation are notoriously ambiguous. While general guidelines exist, there are no absolutes. The SBA will look to the “totality of the circumstances,” so each relationship must be carefully examined.
Today, we are looking the concept of “economic dependence.” In a nut shell, economic dependence occurs when a small business is dependent on another company for a disproportionate amount of its revenue. In other words, without a steady flow of business from its counterpart, the small business would be unable to survive (let alone thrive). When one business is economically dependent on another, there is a presumption of affiliation.
The SBA provides some guidance when it comes to the concept of economic dependence. The magic number is 70% — if a small business derives 70% or more of its revenue from the other business, there is a presumption of dependence (and, therefore, affiliation). Caution: there are rarely hard and fast rules when it comes to the SBA and affiliation. Economic dependence can still be found at less than 70% if other factors are present.
The concept of dependence is also vital to small businesses participating (or that want to participate) in the SBA’s 8(a) program. There, economic dependence is viewed in a big picture way. Dependence is present when the small business is so reliant on its counterpart that it cannot exercise independent business judgment without great economic risk.
Again, concepts like independent business judgment and economic risk can be difficult to quantify or nail down. When it comes to the SBA and affiliation, it always makes sense to come back to control. The hallmark of affiliation is one business’s ability to control another. So, if you are concerned that your small business is too economically dependent on another business, ask yourself what drives your business decisions. Is it your business’s best interests – or the interests of another company?
If you had to think about it . . . its time to have a conversation about affiliation and how to diversify.
If you are interested in recent decisions concerning the SBA’s take on affiliation and economic dependence, check out the recent decision in The DESA Group, Inc., where the U.S. District Court for the District of Columbia remanded to the SBA for further investigation into a finding of economic dependence.