It’s a delicate dance for the SBA to ensure that the participants in its socioeconomic programs get the most out of them without allowing outsiders to pull the strings.
Limits must be placed to prevent program exploitation without stifling participation. Striking the correct balance has long been a challenge for the SBA. Recent rule changes may suggest a paradigm shift in how the SBA does this dance.
The SBA’s status based socioeconomic preference programs (e.g., 8(a), SDVOSB, WOSB) each provide significant benefits for participants, including access to set-aside contracts and joint venture opportunities. Given the advantages, it is important to set clear expectations for participation. Requirements for these programs focus on the status of the majority owner and that individual’s ability to exercise managerial and ownership control over the entity.
Historically, the 8(a), SDVOSB, and WOSB, programs required unconditional control and ownership to be exercised by the individual qualifying the business for the program. To ensure the unconditionality, the regulations for these programs either barred participation of non-qualifying individuals in certain corporate activities or presumed lack of control when non-qualifying individuals performed certain tasks for the entities.
These rules have succeeded in drawing clear limits on control and ownership for participants in its small business programs. Unfortunately, they also proved challenging at times because these strictures at times failed to reflect commercial realities. For example, raising capital through investors has often proved challenging. Commercial minority investors often expect unanimous consent for certain activities to protect the integrity of their investment but SBA’s regulations prohibited exactly this type of negative control.
Recent changes to the SBA’s regulation appear to recognize these challenges and strike a new balance. For example, the SBA’s joint venture regulations were updated in 2020. Prior to the update, the managing venturer was required to exercise absolute control over the operations of the joint venture entity. The revised regulations, however, soften this stance. “The managing venturer is responsible for controlling the day-to-day management and administration of the contractual performance of the joint venture, but other partners to the joint venture may participate in all corporate governance activities and decisions of the joint venture as is commercially customary.” This is a far more accommodating requirement.
Similar changes have also been made to the SDVOSB program. Prior to this year, the SDVOSB program specified various ways that non-veteran involvement in business activities would trigger non-compliance presumptions. Changes to the SDVOSB regulations effective this year have reduced the number of non-compliance presumptions, as well as provided greater flexibility to participants. This reflects commercial realities facing SDVOSB entities.
While recent changes recognize commercial realities require greater flexibility, the revised regulations pose a new challenge with respect to boundaries. Commercial customs vary greatly. This poses a significant issue for compliance. What two companies may believe are commercially customary, may or may not be what the SBA believes is compliant. Thus, while the revisions better reflect commercial realities, they also provide more opportunities for disagreements about reasonableness. It will take time for the SBA and the industry to achieve a new status quo regarding expectations for commercial reasonableness.
Ultimately, the SBA’s recent regulatory changes open some opportunities for common commercial arrangements to exist that previously would have been compliance issues. The extent of these flexibilities, however, remain the SBA’s to judge. Thus, program participants are wise to not see this as a sea change, but instead as an opportunity to make incremental changes that reflect common commercial practices. Compliance is in the eye of the beholder. In this case, it’s the SBA.