Wall Street and big businesses are lobbying to gain access to rescue loans intended to help mom and pop businesses maintain payroll through the crisis. The coronavirus stimulus package, known as the CARES Act, established a new type of loan program known as the Paycheck Protection Program within the U.S. Small Business Administration’s (SBA’s) main lending program. According to the Financial Times, private equity firms are pushing to loosen the standards the Small Business Administration uses to determine which firms qualify for loans, so that “small businesses” owned by private equity firms will qualify, even though, in contrast to truly independent small firms, private equity has billions of dollars of cash on hand to shore up the balance sheets of the companies they own.
The problem for private equity is that, under the SBA’s “affiliation rule,” SBA loans can only be approved for small businesses that are independently owned. Unlike, say, venture capital, which invests in startups and takes a small stake in each one, private equity tends to buy entire mature companies. Because private equity firms own more than 50 percent of the equity in their portfolio companies, the SBA considers the subsidiary firm to be an affiliate of its private equity parent and ineligible for small business loans. Giving small business loans to private equity portfolio companies would be a subsidy to Wall Street.
This most recent instance of big corporations attempting to elbow their way into the SBA’s honey pot is not the first. In fact, large corporations have lobbied to access SBA loans since the program was instituted in the 1950s. Many big corporations in the auto, oil, fast food, and hotel industries already benefit from SBA financing, having waged their own lobbying efforts decades ago, and will continue to do so through the crisis.
When Congress took up the creation of the Small Business Administration in 1952, the House Select Committee on Small Business declared that the purpose of the new agency was to fight the formation of monopolies, mitigate the concentration of economic power, and preserve the “integrity of the independent enterprise.” Accordingly, when it passed the Small business Act of 1953, Congress specified that the universe of small businesses aided by the new bureau would include only “independently owned and operated” small firms.
The first corporations to try to loosen the affiliation rules were auto manufacturers, oil companies, fast food chains, and hotel brands. These corporations all relied on a franchising business model in which, rather than own and operate retail outlets themselves, they outsourced to smaller firms that they minutely controlled through restrictive contracts, dictating products, hours of operation, and many other business decisions. The SBA at the time refused to approve loans to franchisees. As SBA Administrator Eugene P. Foley testified to a Congressional committee in 1965, “the major decision for the Small Business Administration is this: Are we financing the distribution outlets of large businesses, or are we financing independent small businesses as the Congress intended us to?”[1] To Foley, and others at the SBA at the time, because franchisors dominated the operational decisions of franchisees, “independent” distributors and franchisees were not independent businesses at all, but were “affiliated” with their parent companies and should not be eligible for SBA loans intended to support independent small businesses.
The SBA’s skepticism of franchising echoed that of many others in the Federal Trade Commission, Department of Justice, and Congress at the time. In a hearing concerning “problems affecting small business” in 1965, Chief Counsel to the Senate Antitrust Committee Jerry S. Cohen noted that “there is a certain emotional aura which seems to exist that the franchise system is all for the advantage of the small businessman. But one cannot help but notice that it is mostly the very large corporate giants that are … involved.” He wondered at what point “a so-called independent businessman is no longer an independent businessman, but is so tied down that he is merely an employee.”[1]
The franchisors’ main lobby group, the International Franchise Association (IFA), sprung into action in the mid-1960s to loosen the affiliation standards and gain access to the SBA’s lending program. The IFA’s efforts were successful, and the SBA changed its affiliation rules to allow franchisors to tap the SBA loan program in 1966, despite franchisees’ lack of independence in making operating decisions. Henceforth the level of franchisor control of franchisees would no longer be a factor in judging the independence of franchisees. (The SBA’s general counsel who conducted the hearings, Philip Zeidman, would go on to serve as the IFA’s Washington Counsel from 1969 to 2016). The rule change opened up an important new source of financing to franchisors that remains important to this day: in 2014, forty-three percent of first-time franchisees obtained financing from SBA loans. The SBA now actually gives special preference to franchisee borrowers independently operated businesses, maintaining a “franchise registry” of franchise chains eligible for fast-tracked loan approvals
Almost overnight, the SBA shifted is attitude from skepticism of big business controlling small business through franchising to the advocate for franchising that it remains to this day. There were dissenting voices at the time, however, whose voices seem prescient in the current moment. Worth Rowley, a former Antitrust Division attorney, complained to the SBA that with the rule change “SBA is likely to be financing big business in a big way. … [W]ith limited funds available for small business beneficiation, SBA should be careful to guard against the diversion of those funds in aid of the growth of monopoly power.”[1] In a warning that the SBA might do well to heed today, in 1981 the General Accounting Office complained that large automobile, gasoline, and fast food corporations had been absorbing an overgenerous share of SBA loans. It recommended that the SBA stop approving loans to franchisees unless the franchisor was truly unable to guarantee the loans itself or provide its own financial assistance to franchisees. Similarly, private equity firms, with billions of dollars of cash on hand, can surely support their portfolio companies without relying on SBA funds.
[1] Letter from Worth Rowley to SBA General Counsel Philip Zeidman, September 23, 1966. Small Business Administration Archives, National Archives. Record Group 309, Box No. 288.
[1] Ibid, pp. 92-93
[1] Distribution Problems Affecting Small Business. Subcommittee on Antitrust and Monopoly, Senate, Washington DC, Thursday, March 4, 1965, p. 19.
Brian Callaci 