The situation. Maria applied for an SBA loan to purchase a building for her business in Kansas. She had leased the building for several years and decided it was time to buy the building and build some real equity in her business. The estimated monthly debt service was less than Maria’s rent, the business had been profitable the last three years, and her credit was strong. In short, it was a “Dream Loan” – the kind every lender wants to see. Jim, her loan officer, anticipated an easy approval and a quick close.
Not so fast. Maria’s tax returns indicated that she had a 50% interest in another business that was located in Nebraska. Jim was familiar with SBA’s affiliation requirements, but wanted to be sure he was doing his affiliation analysis correctly. So he gave us call.
Q: Richard, I know affiliation has to do with control. In one of your eBulletins, you recommended getting the organizational documents on businesses that might be affiliates to determine control. I have the organizational documents on Maria’s other business. Turns out that Maria is a member of the Nebraska LLC, but her partner, Wanda, is the managing member. Looks to me like Wanda has control, but could you take a look at the org docs to make sure I’m not missing something?
A: I have a low entertainment threshold, so I assured Jim I’d be happy to review the Articles of Organization and Operating Agreement and asked him to send them to me. Everything looked as Jim had represented: Wanda was the Managing Member and Maria was just a member. But before I called Jim with the good news, I read Paragraph 58 of the Operating Agreement. Turns out a 2/3 vote of the members is required to approve of all business actions.
Two-thirds, but there are only two members! That meant both Maria and Wanda had to agree before the Nebraska business could do anything. So Maria could block any action of the Nebraska business. This gave Maria what SBA deems as “negative control” of the business. And since “control” can be negative as well as positive, the Nebraska business was an affiliate of Maria’s business in Kansas.
How did this happen? While a business owner often gets an attorney to form an entity, Operating Agreements are easily found online. When Wanda and Maria needed an Operating Agreement for the Nebraska business, Wanda just Googled one and downloaded it. Maybe she saved a bunch of money, but she didn’t read the document all the way through – and the Nebraska business turned out to be an affiliate of the Kansas business.
Although I couldn’t give Jim the answer he wanted, he was glad he asked. “Negative control,” he said. “I would never have looked for that.” I know, Jim. That’s why you have my email address.
I love challenges like this. You have my email address too!
Associate CDC/504 Programs