Earlier this week, on January 29, 2018, the U.S. Small Business Administration (SBA) published a Proposed Rule addressing ownership and control of Service-Disabled Veteran-Owned Businesses (SDVOSB’s). The Proposed Rule follows through on changes to the ownership requirements under the Department of Veterans Affairs (VA’s) programs that were anticipated by the SBA in its last semiannual Regulatory Agenda and that are mandated by NDAA 2017. As we explained in our prior Bulletin covering the semiannual Regulatory Agenda (here), NDAA 2017 vested the SBA with responsibility for formulating one uniform definition of a “small business concern owned and controlled by service-disabled veterans” to be used for SDVOSB procurements by both the VA and by non-VA agencies. NDAA 2017 also indicated that the definition should encompass certain categories of small businesses owned and controlled by service-disabled veterans (SDV’s).
The Proposed Rule implements several of the NDAA 2017 requirements on ownership of an SDVOSB by making changes to the SBA regulation under 13 CFR 125.11, which sets out important definitions.
U.S. Small Businesses
As an initial matter, as amended by the Proposed Rule, 13 CFR 125.11 requires a “small business concern owned and controlled by service-disabled veterans” to be a “small business concern,” and now defines “small business concern” to be a “concern” that, with its affiliates, meets the applicable NAICS code size standard for its primary industry under part 121 of the SBA regulations. As the SBA stated in the preamble to the Proposed Rule, small businesses, therefore, must meet all of the requirements under part 121, including the requirement under 13 CFR 121.105(a)(1) that the firm be “for profit,” with a place of business located in the United States, and which operates primarily within the United States or which makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials or labor.
Owned By SDV and Managed By SDV or Spouse (if SDV Permanently and Severely Disabled)
As required by NDAA 2017, the Proposed Rule’s definition of “small business concern owned and controlled by service-disabled veterans” retains, with one modification discussed below, the following category of small business concerns under the current rule: small business concerns (i) that are not less than 51% owned by one or more SDV's or, in the case of any publicly-owned business, that not less than 51% of the stock of which is owned by one or more SDV's; and (ii) the management and daily business operations of which are controlled by one or more SDV's or, in the case of a veteran with permanent and severe disability, the spouse or permanent caregiver of such veteran.
In the case of publicly-owned businesses, however, the Proposed Rule now excludes stock owned by an ESOP, which is also now a defined term. The Proposed Rule now also includes a definition for "daily business operations."
Owned By SDV Who Is Rated By The VA Permanently and Totally Disabled
As required by NDAA 2017, the Proposed Rule’s definition for “small business concern owned and controlled by service-disabled veterans” includes a new category for small business concerns that are at least 51% owned by one or more SDV's that have a disability rated by the VA as a permanent and total disability and who are unable to manage the daily operations of the business. Alternatively, in the case of a publicly-owned business, ownership must be of not less than 51% of the company's stock (not including stock owned by an ESOP).
Unconditionally and Directly Owned
The Proposed Rule makes several changes impacting the rule under 13 CFR 125.12 for determining when a small business concern is at least 51% unconditionally and directly owned by one or more SDV.
In the case of a partnership, the current rule requires unconditional ownership of at least 51% of "every class of partnership interest." Where a partnership includes general and limited partners, therefore, SDV’s currently are required to be both general and limited partners. The Proposed Rule, however, requires one or more SDV’s to unconditionally own at least 51% of the “aggregate voting interest” of the partnership rather than of every class of partnership interest.
In the case of corporations that are publicly owned, the Proposed Rule excludes stock owned by an ESOP.
The Proposed Rule also includes minimum dividend and distribution requirements that are intended to ensure SDV owners actually receive the benefits and value that typically accompany majority equity ownership. As amended by the Proposed Rule, 13 CFR 125.12 requires SDV owners of partnerships, corporations and limited liability companies to receive at least 51% of the annual distribution of profits, 100% of the value of any stock or member interest that is sold, and at least 51% of retained earnings and 100% of unencumbered value of stock or member interest in the event of dissolution.
Lastly, in addition to requiring ownership to be subject to community property laws, the Proposed Rule opens up ownership to a third category of owners – namely surviving spouses. Specifically, 13 CFR 125.12 adds a provision stating that a small business concern owned and controlled by an SDV continues to qualify as such a concern upon the death of an SDV as long as (i) the surviving spouse of the deceased veteran acquires such veteran's ownership interest in such concern; (ii) the veteran had a service-connected disability rated as 100 percent disabling by the VA or such veteran died as a result of a service-connected disability; and (iii) immediately prior to the death of such veteran and during the period it is otherwise an SDVOSB the small business concern is included in the VA’s VetBiz database.
A surviving spouse can continue to operate the SDVOSB until the tenth anniversary of the veteran’s death, the date he or she remarries, or the date he or she relinquishes ownership, whichever comes first.
In addition to amending ownership rules, the Proposed Rule amends the SBA rules under 13 CFR 125.13 concerning control over an SDVOSB. The changes are intended, in part, to clarify the role that non-SDV owners can take without diluting SDV control.
The Proposed Rule adds new provisions relating to control over the Board of Directors of a corporation. For example, in instances in which a super majority voting requirement exists for shareholders to approve corporation actions, the SDV or SDV’s must own at least the percent of voting stock necessary to overcome the super majority requirement.
The Proposed Rule also states that unexercised rights to change control or management of a business do not, in themselves, constitute control and management regardless of how quickly or easily the rights can be exercised.
The Proposed Rule also adds rebuttable presumptions on the control of a business with regard to business hours worked and proximity to the business locations. Specifically, the Proposed Rule states that there is a rebuttable presumption that an SDV does not control a business if he or she is not able to work for the firm during normal business hours. In addition, there is a rebuttable presumption that an SDV does not control a business if he or she is not located within a reasonable commute to a firm’s headquarters or job locations. An SDV’s ability to communicate by phone, e-mail, or other technological means while delegating responsibility for managing the business to others will not in itself constitute a reasonable rebuttal.