[co-author: Michael Calvanico*]
Early last week, the Small Business Administration (SBA) and Department of Veterans Affairs (VA) amended their rules concerning the eligibility of Veteran-Owned Small Businesses (VOSB). Both agencies issued regulations consolidating their previously separated standards, establishing a single rule for ownership and control of VOSBs. While bringing the two divergent standards together may lead to more clarity, it is important for veterans currently engaged in government contracting to understand the changes in order to maintain their firms’ eligibility and ensure current compliance.
One of the more significant changes is the new definition of the “extraordinary circumstances” exception to veteran control of a company. Previously, the regulations and opinions provided latitude to allow non-controlling owners to protect their investments and minority interests via passive control provisions in shareholder or operating agreements.
Now, to satisfy the control requirement, the SBA requires that a veteran have the unilateral power and authority to make decisions except in certain delineated extraordinary circumstances. The new regulations provide an exhaustive list of five actions that do not have to be within the exclusive control of the veteran: 1) Adding a new equity stakeholder; 2) Dissolution of the company; 3) Sale of the company; 4) The merger of the company; and 5) The company declaring bankruptcy.
Principally, these new rules are warier of non-veteran involvement, placing strict restrictions on actions such as supermajority checks over veteran decision making and requiring that veteran owners receive at least 51 percent of the company’s annual distribution of profits, to name a few. Further, the SBA has included numerous rebuttable presumptions that a veteran does not control a firm when certain conditions exist, including: when the veteran does not work at the firm during normal business hours; when the veteran is not located within a reasonable commute from the firm; or when the veteran has received critical financing from another, non-veteran entity, with equity in the business. This list is not exhaustive of the new presumptions but serves to show the SBA takes non-veteran outside involvement quite seriously.
Despite the more stringent treatment of veteran control, some of the requirements regarding veteran ownership of their small business have become more lenient. Notably, the previous restriction on ownership transfers that occur after death has been lifted. Now, when a veteran wishes to leave their interest in an SBA-approved VOSB to their spouse after their death they may no longer risk the firm becoming ineligible. Further, the determination of ownership no longer takes community property into account, meaning spouses may no longer have to disclaim ownership rights in the VOSB.
All of these new requirements clarify standards that had largely been left to interpretation by the office of hearings and appeals until now. The changes listed above are not a comprehensive list of the new requirements imposed by the VA and SBA. Ultimately, entities operating as a VOSB under the current standards, and those that seek new certification, may want to consider examining the new rules and review governing documents to ensure compliance.
Furthermore, the regulations received very few comments or suggestions as to revisions during the drafting phase. Yet, the regulations may have significant impact on the ability of small businesses to obtain investment sources without more protections. As such, companies may want to consider providing comment to draft regulations to ensure that the government is aware of potential impacts on the ability of small businesses to compete for government contracts.
*Michael A. Calvanico graduated from the Sandra Day O'Connor College of Law at Arizona State University in 2018. He is located in the Phoenix office and is not yet licensed to practice.
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