In a lengthy and complex effort, the U.S. Small Business Administration (SBA) issued a final rule on December 17, 2024, that amended many requirements related to small business contracting. As with most rules, there are some good, some bad and some unknown factors. In this first post on the new regulations, we focus only on the changes with the greatest effects on investments in and M&A transactions of small businesses: (1) updates to permissible minority shareholder controls and (2) a substantial rewrite of post-acquisition recertification rules. We previously discussed the proposed version of this rule. The final rule takes effect on January 16, 2025, although some (but not all) requirements related to recertifications on multiple-award contracts will not take effect until one year later, on January 17, 2026.
Minority Controls
For SBA’s purposes, business size is measured by the aggregate of a business concern and all its affiliates under common control. Such control can be established by affirmative means – by majority ownership or voting interests, for example – or through negative controls exerted by a minority shareholder, which, if one is not careful, can inadvertently jeopardize a company’s small business eligibility. Until now, practitioners have relied on a large body of case law at SBA’s Office of Hearings and Appeals (OHA) to cobble together a generally recognized set of negative controls that are sufficient to create affiliation, and those that are not – lists that varied confusingly between size and socioeconomic programs. With this final rule, SBA will expressly permit the same six minority controls across all programs and include a catchall provision that aligns with existing OHA precedent.
These specific controls allow minority shareholders to block certain “extraordinary” actions by the small business without creating affiliation that could undermine eligibility for small business programs. This welcome change provides much needed certainty for how minority controls will affect affiliation status and further opens the door to minority investors in 8(a), woman-owned, and veteran-owned, and service-disabled veteran-owned small businesses (SDVOSBs).
Five of the six minority controls were already enumerated in the affiliation rule for veteran-owned small businesses and SDVOSBs, and they will now be added to the SBA’s general affiliation rules and affiliation rules for 8(a) and woman-owned small businesses:
- “Adding a new equity stakeholder or increasing the investment amount of an equity stakeholder”;
- “Dissolution of the company”;
- “Sale of the company or all assets of the company”;
- “The merger of the company”; and
- “The company declaring bankruptcy.”
A sixth minority control will be added to the existing allowed minority controls in the veteran-owned small business rule and the newly enumerated minority controls for the general affiliation rule and the affiliation rules for 8(a) and woman-owned small businesses:
- “Amendment of the company’s corporate governance documents to remove the shareholder’s authority to block any of the actions” that constitute allowable minority control.
Previously, the general affiliation rule and affiliation rules for 8(a) and woman-owned small businesses did not include any enumerated exceptions, although precedent from OHA had identified some exceptions.
Finally, a seventh catchall category in all four affiliation rules will allow minority shareholders to block any other “extraordinary action” through a provision that is “crafted solely to protect the investment of the minority shareholders, and not to impede the majority’s ability to control the concern’s operations or to conduct the concern’s business as it chooses.”
In a time when the U.S. government is actively encouraging outside investments in government contractors, these changes are welcome. They will help businesses participating in any of SBA’s programs grow and hopefully make investor negotiations more straightforward. These changes also help meet the goal of simplifying agency regulations and making them more readily understandable outside the legal community. The result of these efforts brings the government market one step closer to the commercial market, although investors should still be careful about using standard forms that do not precisely align with SBA’s guidance, as discussed in our previous blog post.
Recertifications
SBA has also attempted to simplify (or at least reduce the word count) of its recertification rules. This portion of the final rule attempts to provide more consistency in the effect of size recertifications following a merger, acquisition, or other change in control. To accomplish this goal, SBA has substantially rewritten the existing rules and moved them into a single new recertification rule at 13 C.F.R. § 125.12 to be cross-referenced by the regulations for each size and socioeconomic program. As before, recertification of size and status will be required from buyer and seller within 30 days of a merger, acquisition, or other transaction that results in a change of control.[1] However, the effects of that recertification have now changed significantly, at least with respect to eligibility for future task orders on small business multiple-award contracts.
In short, under the new regulations, when a concern represents itself as Other Than Small following a transaction with a large concern, it is:
1. For Single-Award Set-Aside Contracts: Eligible to continue performing, have options exercised, and receive orders.
2. For Multiple-Award Set-Aside Contracts: Not Eligible to bid on future orders or have options exercised.
3. For Pending Proposals:
a. Eligible for award of single-award set-asides if the proposal was submitted at least 180 days prior to the acquisition.
b. Not Eligible for award of pending proposals for single-award set-asides submitted within the last 180 days.
c. Not Eligible for pending multiple-award set-aside contract proposals or task order proposals under multiple-award set-aside contract vehicles, no matter when submitted.
4. For GSA Schedule Contracts: Not Eligible for award of pending or future set-aside orders or blanket purchase agreements (BPAs).
This is a stark departure from the current rule, which, in the interests of competition and consistency, generally permitted former small businesses to continue competing for task orders under multiple-award set-aside contracts and performing through all option periods and permitted contractors to continue bidding as small businesses through their GSA schedule contracts and related BPAs.[2]
SBA takes the express position in its summary of the final rule that these changes will not have a retroactive effect, but that is likely in the eye of the beholder. In any event, SBA has offered some relief to small businesses concerned about the value of their existing contracts: the rules above will not affect (1) eligibility for task order awards (including pending proposals) under multiple-award set-aside contracts if the acquisition occurs prior to January 17, 2026; and (2) eligibility for any options to be exercised prior to January 17, 2026. Note that neither of these exceptions appear to apply to GSA Schedule Contracts. This limited – but significant – one-year grace period before the rule takes effect for options and orders on multiple-award set-aside contracts is likely to drive significant M&A activity in 2025.
New Exception: Small Company Buys Small Company
In a concession to industry and a change from the proposed rule, the final rule includes separate provisions for small companies that become other than small because of a merger with or sale to another small business, when the combined entity is no longer small. In this situation, the surviving entity will remain eligible for set-aside orders and options under existing multiple-award contracts; however, such orders and options will not count toward the procuring agency’s small business contracting goals. In other words, SBA has maintained the current rule for small-small acquisitions, exempting such transactions from the new rules applicable to large-small acquisitions.
Takeaways
In some ways, SBA’s new rules related to investment are more intuitive than the status quo. In particular, the minority shareholder negative control rules will provide real transparency and consistency for small businesses seeking non-control investments (and their investors). However, the recertification changes are likely to have a number of knock-on effects that SBA will have to address including decreasing the value of small businesses with multiple-award contracts, making the transition to a mid-size contractor harder and reducing competition for small business task orders – not to mention likely causing a spike in small business transactions in 2025.
Ethan Sterenfeld, a Law Clerk in our Washington, D.C., office, contributed to the writing of this article.
[1] In a departure from the proposed rule, a mere agreement in principle will not trigger the recertification requirement, and the 30-day window will run instead from the effective date of the transaction.
[2] Buyers should also keep in mind that recertification is required from both the acquired concern and the acquiring concern under the current and new regulations.
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