SBA's New Rule Clarifies Role of Minority Equity Holders in Small Businesses and 8(a) Concerns

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

Uniformity of Minority Owner Controls Across SBA's Socioeconomic Programs

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

SBA's Final Rule now provides uniform negative controls that may be held by minority owners of all types of small business concerns, including concerns across SBA's socioeconomic programs (i.e., 8(a) Business Development, SDVOSB, HUBZone and Women-Owned Small Business (WOSB)/Economically Disadvantaged Women-Owned Small Business (EDWOSB) programs). The Final Rule sets forth a consolidated list of six minority controls – with a seventh "catch-all" provision – that are allowed without a finding of affiliation across all SBA programs. The allowable, extraordinary actions are:

1. adding a new equity stakeholder or increasing the investment amount of an equity stakeholder
2. dissolution of the company
3. sale of the company or all assets of the company
4. merger of the company
5. company declares bankruptcy
6. amendment of the company's corporate governance documents to remove the shareholder's authority to block any of the actions above that constitute allowable minority control
7. any other extraordinary action 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 significant expansion of permitted minority controls for minority owners of SDVOSB concerns, the seventh "catch-all" provision appears intended to encompass all of the negative controls that OHA found to be "extraordinary" in Southern Contracting Solutions III LLC. In its commentary, SBA explained its addition of the "catch-all" provision in terms that spoke favorably of OHA's 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 crafted 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 should be permitted. See Size Appeal of S. Contracting Sols. III, LLC, SBA No. SIZ-5956 (2018) (citing Size Appeal of EA Eng'g., Sci. & Tech., Inc., SBA No. SIZ-4973 (2008), Size Appeal of Carntribe-Clement 8AJV #1, LLC, SBA No. SIZ-5357 (2012)). SBA agrees and has adopted this catch all language in this final rule.

This likely means that bylaws and operating agreements for SDVOSB concerns can be revised without triggering affiliation or disqualification under the SDVOSB program to expand minority ownership rights beyond the five extraordinary controls previous laid out in SBA's SDVOSB regulations to include the minority controls summarized in Southern Contracting Solutions III LLC.

Increases in the 8(a) Minority Investment Percentage Without Prior SBA Approval

SBA's Final Rule makes a notable (and positive) change in easing restrictions for non-disadvantaged investors to own a larger percentage of an 8(a) small business firm without SBA approval (or a finding of affiliation based on control).

Specifically, the Final Rule increases the allowable ownership percentages without SBA prior approval for non-disadvantaged individuals and business concerns (those owning at least 10 percent in other 8(a) participant and those in the same or similar line of business) from 10 percent to 20 percent in the developmental stage of program participation and from 20 percent to 30 percent in the transitional stage of program participation.¹ Additionally, the Final Rule allows 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 whom initial eligibility was based continues to own more than 50 percent of the concern.

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

These higher non-disadvantaged ownership caps open up more opportunities for minority investors to participate in the 8(a) program while still maintaining the core requirement that the 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 opportunity for growth and development.

Conclusion

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

Note

¹ SBA's 8(a) Program allows participation for a maximum of nine years. The first four years are considered a development stage, and the last five years are considered a transitional stage. Continuation in the program is dependent on staying in compliance with program requirements.