Purchasing Selected Assets of Another Firm May Result in “Affiliation”

If you are a small business considering the acquisition of another company, one of the first things that should come to mind is your continued eligibility as a “small” business after the acquisition. It is clear under SBA regulations that the acquisition of all of the assets of another business results in affiliation between the buyer and the seller and requires the combination of the revenues of both companies over the previous three years. However, when some lesser portion of a company’s assets is purchased, the result is not so clear and will depend on the facts of the particular case. A closer review of the applicable regulations and case law provides guidance to purchasers faced with these circumstances.

In general, SBA regulations provide that the size of a business concern is determined by calculating the average annual receipts or employees of the concern and its affiliates for the previous three years. Therefore, if a concern acquires an affiliate during the applicable three-year period, then the receipts or employees of that affiliate are included for the entire period of measurement. Accordingly, a firm acquiring another firm must include the seller’s historical data regarding receipts or employees throughout the applicable three-year period. See 13 C.F.R. 121.104(d) and 121.106(b).

Where a small business purchases only certain assets of another company, SBA provide that the two firms nonetheless may be “affiliates” for size purposes. Specifically, SBA regulations provide that a firm will not be treated as a separate business concern (but rather as an affiliate) if “a substantial portion of its assets and/or liabilities are the same as those of a predecessor entity.” 13 C.F.R. 121.105(c). The central issue, therefore, is what constitutes a “substantial portion.”

The SBA’s Office of Hearings and Appeals (“OHA”) has issued several decisions addressing the issue of whether a predecessor entity that sells a portion of its assets is considered to be an “affiliate” of the buyer for size purposes. Although those decisions provide guidance, they unfortunately lack detail and in some cases, are not entirely consistent. The following is a quick summary of some of the OHA decisions on the subject:

1. The purchase of certain assets from one of a company’s three locations, including most furniture and equipment, office lease, telephone number, and existing contracts, resulted in affiliation. Size Appeal of Ace Federal Reporters, Inc., SBA No. 2814 (1988).
2. The purchase of most of the assets, including contracts, of an operating division of the seller, and the hiring of a substantial number of employees of that division, resulted in affiliation between the buyer and that division of the seller, thereby requiring inclusion of the division’s receipts and employees in calculating size. Size Appeal of Atmel Corporation, SBA No. 3286 (1990).
3. The purchase of “primary assets” of a company, including equipment, goodwill, going concern value, customer lists, and existing contracts resulted in affiliation between the buyer and the seller. Size Appeal of Andrews Moving and Storage, SBA No. 4070 (1995).
4. The purchase of all assets and ongoing contracts of a company’s operating division, the right to use the name, and assumption of employees and liabilities of that division, resulted in affiliation between the buyer and that division of the seller, thereby requiring inclusion of the division’s receipts and employees in calculating size. Size Appeal of Xeno Technix, Inc., SBA No. 4242 (1997).
5. The purchase of the name of another firm and less than one-third of its equipment only (i.e., not the firm’s goodwill, existing contracts, customer lists, accounts receivable, cash, employees or assumption of liabilities) did not result in affiliation. Size Appeal of Midwest Ambucare, Inc., SBA No. 4339 (1999).

Several of the challenged firms in the above cases argued against a finding of affiliation by citing to a 1977 decision, Size Appeal of Glenn Berry Manufacturing, Inc., SBA No. 1056 (1977). In that case, a new firm purchased the entire manufacturing facility of a large business four days before bid opening in a small business set-aside procurement. OHA found that there was no affiliation, noting that there was no evidence that it was not a “good faith” transaction or that the buyer was controlled by the seller. OHA, however, has rejected arguments in subsequent cases that have sought to rely on Glenn Berry. Therefore, that case appears to have been, at least practically speaking, superseded by more recent decisions.

In should also be noted that, in the event of a size inquiry, the SBA has the right to request copies of all relevant documents from the firm whose size is in question (e.g., purchase agreement), and to draw adverse inferences if that information is not provided. See Size Appeal of Donovan Travel, Inc., SBA No. 4260 (1997).

In summary, OHA decisions have given considerable weight to the acquisition of contracts and employees, as well as the assumption of liabilities, in finding affiliation. This is most likely because these components involve, to a large extent, a “substantial” acquisition of the goodwill of a predecessor firm. Although the acquisition of a single contract (including assumption of its employees and liabilities) would likely not be considered “substantial assets” (depending of course on the relation of that contract and those employees to the company as a whole), the acquisition of more than one contract of another firm (including assumption of employees and liabilities under those contracts) would likely create a significant risk of affiliation.

However, if a seller has defined “divisions,” there is precedent under the Xeno andAtmel decisions mentioned above, that although affiliation may be found if the assets and liabilities within that division are sold, the affiliation would only involve that division, such that only the receipts and employees of that division would be included for size purposes.