When SBA updated its service-disabled veteran-owned small business eligibility requirements earlier this year, it included a welcome change: now, service-disabled veteran owners can meet the unconditional ownership requirement even if a non-SDVO holds a right of first refusal over the SDVO’s ownership interest.
But not every socioeconomic program benefits from this new provision. Small businesses should be aware of the distinction between SBA’s socioeconomic program regulations to avoid jeopardizing their eligibility.
To qualify as an SDVOSB, SBA’s regulations require that the business be at least 51% owned and controlled by a service-disabled veteran. This ownership must be unconditional. In the not-too-distant past, the requirement for unconditional ownership meant that an SDVO could not grant a right of first refusal to a non-veteran.
This restriction always struck me as goofy. A right of first refusal is (in my anecdotal experience) a fairly common request by a minority owner. It protects a minority owner’s investment by allowing that person the chance to purchase the majority owner’s interest in lieu of it being sold to another; by refusing to allow for such a provision, the regulations threatened an SDVOSB’s ability to attract investment. And I’ve always viewed this type of provision as a reflection of unconditional ownership, not a restriction against it—because the veteran owner chose to grant a minority owner a right of first refusal, so how can that choice be viewed as surrendering an interest?
Thankfully, SBA’s updated regulations change course, and allow an SDVO the ability to grant a reasonable right of first refusal over her interests:
A right of first refusal granting the non-qualifying-veteran the contractual right to purchase the ownership interests of the qualifying veteran does not affect the unconditional nature of ownership, if the terms follow normal commercial practices. If those rights are exercised by the non-qualifying-veteran, a Participant must notify SBA[.] If the exercise of those rights results in the qualifying veteran(s) owning less than 51% of the concern, SBA will initiate decertification pursuant to 128.310.
Progress!
Kind of . . . .
To be sure, this update is a beneficial change. But the new regulation leaves a few questions unanswered. What are the “normal commercial practices” the right of first refusal must follow? And does SBA strictly mean only rights of first refusal are acceptable, or will drag-along/tag-alongs (or other options) be considered okay? The regulations don’t say—leaving the bounds of the new provision up to SBA Office of Hearings and Appeals’ interpretation.
More problematic, though, is that the SDVOSB ownership requirements now differ significantly from those in the 8(a) and WOSB programs. Like the SDVOSB program, the latter programs also require unconditional ownership; but unlike the SDVOSB program, the 8(a) and WOSB regulations have not been updated to allow for rights of first refusal. Companies seeking certification as an SDVOSB and an 8(a) or WOSB should be aware of this difference—at least as of right now, covering an ownership interest with a right of first refusal may jeopardize 8(a) or WOSB status, even though it’s allowed under the SDVOSB program.
In his latest post, Ian Patterson offered suggestions for a small business’s annual compliance check-up. To his, I’ll add another: small businesses should take efforts to understand SBA’s different socioeconomic program regulations to ensure compliance with them. As the latest regulatory change shows, compliance can be a moving target.
If you have any questions about SDVOSB eligibility—or eligibility under SBA’s other socioeconomic programs—give us a call.