On December 17, the Small Business Administration (SBA) published its final rule detailing new recertification requirements following mergers and acquisitions (M&A), new language around negative control for affiliation purposes, and changes to 8(a) ownership percentages, among other changes. We discussed the new recertification requirements and their potential impact on GovCon M&A in a previous blog post that can be found here. Below we discuss the new negative control rule and the 8(a) ownership changes.

Clarifying Negative Control Rule

SBA’s interpretation of the extent to which minority investors in small businesses can possess “negative controls” without triggering affiliation has long been a point of debate. Affiliation is triggered when minority investors in small businesses control the day-to-day operations and therefore have the power to “control” the small business. However, case law from the SBA’s Office of Hearings and Appeals (OHA) began poking holes in what was understood as a hard and fast rule creating exceptions where “extraordinary” events are present. Then in 2018, an SBA final rule delineated five explicit circumstances where minority investors could hold super majority voting rights in small businesses without triggering affiliation.

The December 17 final rule applies the negative control requirements to all socioeconomic categories of small business concerns (Service-Disabled Veteran-Owned Small Business (SDVOSB), 8(a), HUBZone, and Women-Owned Small Business programs) and explicitly details six types of negative controls that minority investors may hold without risking affiliation. Those controls include:

  1. Adding a new equity stakeholder or increasing the investment amount of an equity stakeholder.
  2. Dissolving the company.
  3. Selling the company or all its assets.
  4. Merging the company.
  5. Declaring bankruptcy.
  6. Amending corporate governance documents to remove the shareholder’s authority to block any of (1) through (5).
  7. Taking 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.

The final rule adds a “catch-all” provision providing increased flexibility and allowing small businesses and their minority shareholders to continue drafting governance documents in a way that provides voting rights to minority shareholders for certain issues.

8(a) Minority Investment Percentage Increase

The SBA final rule also makes two noteworthy changes to the ownership requirements for 8(a) firms. First, the rule hikes the percentage non-disadvantaged individuals can own in an 8(a) small business without SBA approval or triggering affiliation due to control. While potential non-disadvantaged owners who own at least 10% in another 8(a) firm or are in a similar line of business were previously limited to owning 10% in the developmental stage of the 8(a) program and 20% in the transitional stage, they may now own 20% in the developmental stage and 30% in the transitional stage. The limit for SBA-approved mentors remains at 40%.

Second, the final rule adds another circumstance for when an 8(a) firm is excepted from obtaining SBA approval for changes of ownership where the interest of qualified owners is not impacted. Currently, there are three exceptions to the rule:

  1. When all disadvantaged owners remain below 20% interest in the concern
  2. When the change in ownership arises due to the death or incapacitation of a disadvantaged owner due to a severe, prolonged illness or injury.
  3. The disadvantaged controlling owner of the 8(a) firm expands their ownership interest.

The final rule adds a fourth exception: SBA approval is not required when the 8(a) firm has not received an 8(a) contract and the owner(s) who qualifies the firm as 8(a) continues to own over 50% of the concern. Also, important to note, that while approval may not be required, concerns must still notify SBA of these types of changes within 60 days or before it bids on an 8(a) contract, whichever occurs first.

The final rule went into effect on January 16.

Going Forward

The negative control rule and increase in minority investment percentages are good news for many small business concerns as they provide needed clarity and flexibility. The update to the negative control rule will comport with OHA case law on the topic, while the increase in the ownership percentage non-disadvantaged individuals can have in 8(a) concerns will allow these businesses to more easily access capital and attract partners, bolstering prospects for future growth.

If you have any questions regarding the final SBA rule or how it may impact your business, please contact the author.