In March 2018, the Office of Inspector General (OIG) released a report detailing $1.8 billion in ineligible loans that the Small Business Administration (SBA) guaranteed for contract poultry growers to build barns. Specifically, the OIG reviewed loans to determine if they were compliant with regulatory, statutory, and SBA requirements for eligibility.

The bottom-line result, as stated in the report, was that the “loans made to growers did not meet regulatory and SBA requirements for eligibility. The large chicken companies (integrators) exercised such comprehensive control over the growers that SBA Office of Inspector General believes the concerns appear affiliative under SBA regulations.”

SBA loans can be made for up to $5 million to fund startup costs, expansion, equipment purchases, and other uses. The SBA guarantees the loans, which means U.S. taxpayers are ensuring that the lenders will have loan repayment. It’s a subsidy by U.S. taxpayers to fund a production model that primarily benefits the integrator by offloading the risky grow out portion of production to the farmer and to the public through the subsidy.

At the heart of this discussion is the determination of affiliation. SBA in it’s public recommendations to update the loan program, is proposing that small businesses must meet an affiliation test. If more than 85% of a small business’ revenue comes from another business, then that small business would be affiliated with the other company and not an independent small business. Note that this has nothing to do with legal structures of the business. Instead, this is assessing the relationship between the contract poultry grower and the integrator.

If you want further reading of the OIG’s report, look up the report titled “Evaluation of SBA 7(A) Loans Made to Poultry Farmers.”

As you might imagine, this affiliation test is deeply opposed by the large chicken companies because funding the grower houses is expensive and high risk (that’s why they need to be guaranteed by the federal government).

APPPA submitted comments in support of the affiliation test being proposed by SBA in the Federal Register on Friday, September 28, 2018. APPPA responded to these parts:

SBA proposes to expand the principle of affiliation arising from “identity of interest” to include common investments and economic dependence through contractual or other relationships between any two or more individuals or businesses, reinstate the “newly organized concern” rule, reinstate the “totality of the circumstances” analysis when determining affiliation between an Applicant for financial assistance and other entities, and clarify affiliation based on a franchise or license agreement.

If a small business Applicant derived more than 85% of its revenue from another business over the previous three fiscal years, SBA would find that the small business Applicant is economically dependent on the other business and, therefore, that the two businesses are affiliated.

Our comments follow.

The American Pastured Poultry Producers Association (APPPA) welcomes the Small Business Administration’s (SBA) attempt to establish and enforce an affiliation test for contract poultry farmers. Recognizing affiliations in the 7(A) loan applications protects the farmers, the public, and a fair marketplace.

APPPA is a non-profit membership-based organization that provides educational resources to pastured poultry farmers who are operating small businesses in rural America. The association represents approximately 1,000 member farms. APPPA was formed in 1997 to support a renewed interest in pastured poultry.

The growing pastured poultry industry does not rely on single grower contracts to produce chicken, eggs, turkey and other poultry; it instead relies on regional, decentralized, and direct-to-consumer markets. The pastured poultry business model stands in stark contrast to the consolidated and disconnected model of the contract poultry farmer.

The Office of Inspector General (OIG) report “Evaluation of SBA7(A) Loans Made to Poultry Farmers” (report number 18-13) from March 6, 2018, is clear in its finding that “7(a) loans made to growers did not meet regulatory and SBA requirements for eligibility” because the poultry integrators exercised complete control over how and when contract growers raised poultry.

The OIG details $1.8 billion in guaranteed funds that were loaned to pay for single use facilities designed for the needs of one “customer.” In a contract poultry environment, the farmer doesn’t even own the birds. The contract grower makes the facility available to house flocks from the integrator through short-term contracts and often with no contractual assurances that the grower will have flocks to pay for the facility in the future. While poultry integrators may be able to find contract growers to hold up as successful examples, the aggregate findings of the OIG paint a bleak economic picture and business model.

Based on the OIG reporting, APPPA has the position that by approving 7(A) loans for contract poultry, SBA is:

1. Allowing the American taxpayers to assume substantial risk and cost to raise the poultry while allowing the poultry integrators to become the primary beneficiary of a tightly integrated business model.
2. Perpetuating a decline in the rural American economy by encouraging high risk business practices through the approval of 7(A) loans for contract poultry growers.
3. Facilitating a competitively disadvantaged marketplace in favor of poultry integrators who can keep costs low by shifting the riskiest part of poultry production onto family farms. Those risks are guaranteed by the public.

Affiliation Rules

Regarding the Summary of Proposed Changes to Affiliation Principles for the Business Loan, Business Disaster Loan, and Surety Bond Guarantee Programs (Section II B), APPPA supports the proposed affiliation principles outlined in Section 121.30.

This is an opportunity to make SBA aware of commercially viable poultry farming businesses that do not follow the contract grower model. Pastured poultry businesses, as a guiding principle, rely on a diverse number of customers to reduce risk from the loss of any single source of revenue. In addition, pastured poultry farms build infrastructure to be as multi-purpose as possible, so that the farm can be responsive to growth opportunities and market changes while proactively leveraging previous investments.

The very nature of the poultry contract model is one of continued consolidation with farms growing larger in terms of animal concentrations and loan requirements (Figure 6: Growth in Annual Average 7(A) Poultry Loan Size, FY 2012-2016 of OIG Report). This consolidation of ineligible loans ultimately reduces the availability of SBA loans to competing businesses, such as pastured poultry farms, thereby enabling an unnatural competitive advantage in favor of the poultry integrators.

Regarding proposed affiliation principles in Section 121.30, APPPA recommends:

1. SBA determine that two businesses are affiliated if one business (e.g., contract poultry grower) receives more than 85% of its revenue from the other business (e.g., poultry integrator).
2. SBA provide clarity to lenders by stating that the relationship between a poultry contract grower and an integrator is an affiliation, and that the poultry contract grower is not acting as an independent small business when applying for loans to build a single purpose facility to receive revenue from one source. According to the OIG’s report, the contract grower’s facility loses between 62% and 94% of its value without a contract from the Integrator (Table 1 from Office of Inspector General (OIG) report “Evaluation of SBA7(A) Loans Made to Poultry Farmers”).

Summary

APPPA encourages the SBA to enact the affiliation thresholds and clearly define the relationship between poultry grower and poultry integrator as a dependent business relationship. In so doing, APPPA believes the SBA will do its part to remove unequitable subsidies that create unfair pricing advantages for the consumer while unburdening the taxpayers from guaranteeing these poultry contract grower loans.