We continue our discussion of the Small Business Administration’s (SBA) recent final rule on various small business programs. We previously discussed SBA’s changes to the effect of recertifications under multiple award contracts, new protest and size determination grounds related to such recertifications, and changes to SBA’s mentor-protégé and joint venture regulations, but much remains from this far-reaching rule. Today, we focus on amendments to the regulations governing the 8(a) business development program for small business owners who are socially and economically disadvantaged.
Ownership Requirements
The new rule eases restrictions on investment by non-disadvantaged parties in 8(a) participants. SBA’s regulations have restricted the amount of investments in 8(a) participants by non-disadvantaged individuals and non-disadvantaged entities that own minority stakes in other 8(a) participants, as well as non-disadvantaged entities that are in the same or similar line of business as the participant. Investments by these parties are more limited during the participant’s developmental stage—the first four years of 8(a) participation—than the transitional stage—the last five years of participation. Previously, such investors could only hold a 10 percent share or interest of an 8(a) participant in the developmental stage of the program and a 20 percent interest during the transitional stage. Now, following the revision, such investors may hold a 20 percent interest during the developmental stage and a 30 percent interest during the transitional stage. The revision does not change the allowable ownership interest for parties to an SBA-approved mentor-protégé joint venture; the mentor may own up to 40 percent of its 8(a)-participant protégé.
The revision also modifies the situations in which an 8(a) participant may change its ownership structure without prior SBA approval (which, given the amount of time it often takes to get such approval, is a significant benefit). The general rule is that participants must seek and receive SBA approval before changes of ownership, but there are several exceptions. Now, prior approval is not required when all non-disadvantaged individuals or entities involved in the change of ownership own no more than a 30 percent interest in the participant before and after the transaction. Keep in mind this is not 30 percent in any given transaction, but a total of 30 percent in non-disadvantaged ownership. Previously, the exception only applied if all non-disadvantaged individuals involved in the change of ownership owned no more than 20 percent of the 8(a) participant. In addition, the revision added an exception to SBA approval for change of control where the participant has never received an 8(a) contract and the individual or entity upon whom eligibility was based continues to own more than 50 percent of the participant.
Continuing an ease on restrictions for 8(a) participants, SBA’s new rule also now allows non-disadvantaged individuals and entities to retain a right of first refusal for the purchase of ownership interests in 8(a) participants. This abrogates existing caselaw from the SBA’s Office of Hearings and Appeals, which previously held that the 8(a) unconditional ownership regulations did not allow non-disadvantaged individuals or entities to have a right of first refusal. The new provision includes the limitation that the terms of the right of first refusal “must follow normal commercial practices.” If such rights are exercised, then the 8(a) participant must notify the SBA.
Potential for Success
Applicants to the 8(a) program will also now face a reduced burden to demonstrate their potential for success if their experience in an industry is too recent to appear on their tax returns under the final rule. Previously, applicants had to submit income tax returns for the preceding two tax years, and each return had to report operating revenues “in the primary industry in which the applicant is seeking 8(a) [business development] certification.” Now, the requirement has been reduced to say only that an applicant’s tax returns from the past two years must show operating revenues. The SBA targeted this change at companies whose tax returns might not represent their primary line of business. SBA explained that a firm that has performed work in its projected primary industry, but whose work may not have been properly captured on its tax return, should not be precluded from entry to the 8(a) program.
Alignment Between 8(a) and Other Historically Disadvantaged Programs
SBA’s new rule also aligns several provisions in the regulations for the 8(a), woman-owned small business, and VetCert programs, which should simplify requirements for entities that participate in more than one program. Most notably, as we previously discussed, SBA will expressly permit the same six minority controls (including a catchall provision that aligns with existing OHA precedent) that will be permitted across all programs without finding affiliation based on negative control. The new rule also amended 8(a) regulations on the distribution of profits to match the other two programs. Similarly, a provision was removed from the 8(a) regulations that required the SBA to consider community property laws (when an owner resided in a community property state) in determining ownership interests, which brought 8(a) into alignment with the other programs. All three programs were amended to share identical language regarding the involvement of non-disadvantaged individuals in program participants. This standardization is designed to resolve doubts about whether former differences in the regulations for each program meant that the SBA intended different rules for each program. Finally, the revision requires that the highest-paid director, officer, or employee in a certified woman-owned small business be a woman, finally bringing that program into alignment with 8(a) and VetCert in this regard.
Takeaways
Increased ownership of 8(a) participants by non-disadvantaged individuals and entities should allow for more investment in program participants. In addition, the greater alignment between 8(a), woman-owned small business, and VetCert rules could reduce compliance costs. Overall, this rule change should strengthen the 8(a) program and the other SBA programs that help develop businesses from historically disadvantaged groups.
Ethan Sterenfeld, a law clerk in our Washington, D.C. office, contributed to the writing of this article.
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