New SBA Rule Clarifies Role of Minority Equity Owners in Small Businesses and 8(a) Concerns | Insights

The US Small Business Administration’s (SBA) final rule, which takes effect on January 16, 2025, makes a number of substantive changes to the regulatory regime for small business contractors. Holland & Knight previously summarized the key mergers and acquisitions (M&A) impacts related to the recertification changes in the Final Rule. This blog post summarizes the key changes regarding the role that minority investors can play in small business decisions and the share of equity that non-disadvantaged individuals can hold in an 8(a) concern.

Uniformity of minority owner controls in SBA’s socioeconomic programs

Since the major revision of SBA regulations related to the Service-Disabled Veteran-Owned Small Business Program (SDVOSB) in 2018, there has been inconsistency in SBA regulations regarding the extent of adverse controls that an investor pakic can hold in a small business compared to a SDVOSB Concern. Although SBA’s membership regulations have stated that “adverse control” over the day-to-day operations of a concern gives a minority owner the power to control the concern, SBA’s Office of Hearings and Appeals (OHA) had developed the practice jurisprudence providing for a long list of “exceptional” events and circumstances where adverse scrutiny was permissible without triggering affiliation. See, e.g., Southern Contracting Solutions III LLC, SBA No. SIZ-5956 (Aug. 30, 2018) (summarizing exceptional circumstances where minority shareholder approval did not trigger affiliation). However, in 2018, SBA issued regulations specific to the SDVOSB program, specifying only five exceptional circumstances where a minority, non-disabled veteran owner in service of an SDVOSB concern could have supermajority voting rights.

The SBA final rule now provides uniform negative controls that may be held by minority owners of all types of small business concerns, including concerns in all of SBA’s socioeconomic programs (ie, 8(a) Development of Business, SDVOSB, HUBZone and Women-Owned Small Business (WOSB)/Economically Disadvantaged Women-Owned Small Business (EDWOSB) Programs The final defines a consolidated list of six minority controls – with a seventh “catch-all” provision. – which are allowed without a confirmation of affiliation in all SBA programs. Permitted and exceptional actions are:

1. adding a new equity stakeholder or increasing the investment amount of an equity interest group
2. the dissolution of society
3. sale of the company or all assets of the company
4. the union of society
5. the company declares bankruptcy
6. amending the company’s corporate governance documents to remove the shareholder’s authority to block any of the above actions that constitute permissible minority control
7. any other extraordinary action which is designed solely to protect the investment of the minority shareholders and not to impede the ability of the majority to control the operations of the concern or to conduct the business of the concern as it wishes.

In a significant expansion of permitted minority controls for minority owners of SDVOSB concerns, the seventh “catch-all” provision appears intended to include all adverse controls that OHA found to be “”extraordinary”” in Southern Contracting Solutions III LLC.comment, SBA explained its addition of the “catch all” provision in terms that spoke in favor of the OHA case law summarized in Southern Contracting Solutions III LLC:

One commenter recommended that SBA adopt language stated in OHA size appeal cases that supermajority provisions are designed to protect the investment of minority shareholders and not to impede the majority’s ability to control the operations of the concern or to conduct the business of the concern as he chooses. is allowed. See S. Sols Contracting Magnitude Appeal. III, LLCSBA No. SIZ-5956 (2018) (cited Appeal Magnitude of EA Eng’g., Sci. & Tech., Inc.SBA No. SIZ-4973 (2008), Appellate extent of Carntribe-Clement 8AJV #1, LLCSBA No. SIZ-5357 (2012)). SBA agrees with and has adopted this language in this final rule.

This likely means that the bylaws and operating agreements of SDVOSB concerns can be revised without triggering membership or disqualification under the SDVOSB program to expand minority ownership rights beyond the five exceptional controls previously defined in SBA’s SDVOSB regulations. to include minority controls summarized in Southern Contracting Solutions. III Ltd.

Increases to 8(a) minority investment percentage without prior SBA approval

SBA’s final rule makes a significant (and positive) difference in relaxing the restrictions on nondisadvantaged investors to own a larger percentage of an 8(a) small business firm without SBA approval (or a control-based finding of relevance).

Specifically, the Final Rule increases the allowable ownership percentages without prior SBA approval for non-disadvantaged individuals and business concerns (those owning at least 10 percent in other 8(a) participants and those in the same or similar line of business) from 10 percent to 20 percent IN stage of development of participation in the program and from 20 percent to 30 percent IN transitional phase of participation in the program.¹ Additionally, the Final Rule permits a change of ownership without prior SBA approval where the concern has never received an 8(a) contract. and the individual(s) or entity upon which the original eligibility was based continues to own more than 50 percent of the concern.

Importantly, the 8(a) concern is required to notify the SBA within 60 days of the change in ownership or before submitting a bid for an 8(a) contract – whichever occurs first.

These higher non-disadvantaged ownership limits open up more opportunities for minority investors to participate in the 8(a) program, while still maintaining the essential requirement that majority ownership and control remain with socially and economically disadvantaged individuals. It is also a positive step for 8(a) concerns to facilitate access to capital and attract additional partners, which facilitates greater opportunities for growth and development.

CONCLUSION

Whether a small business is affiliated with another company often requires complex navigation through SBA rules and detailed analysis. Although the changes in the Final Rule are helpful in clarifying (and in some ways expanding) the roles of minority shareholders in small businesses, it is important for contractors to ensure compliance with these regulations. For questions about these changes, please contact the authors.

note

¹ The SBA’s 8(a) program allows participation for a maximum of nine years. The first four years are considered a developmental stage, and the last five years are considered a transitional stage. Continuation in the program is contingent upon compliance with program requirements.