SBA Proposes Consolidated SDVOSB Eligibility Rules

The SBA has released its proposed consolidated rule for SDVOSB eligibility, which was published in the Federal Register today.  Once the rule becomes final, it will apply government-wide, to both VA and non-VA SDVOSB contracts.

For SDVOSBs, a uniform set of rules is a very good thing.  There has been far too much chaos and confusion under the current system, in which the SBA and VA have different SDVOSB eligibility requirements.  But how about the substance of the proposal itself?  Well, there are certainly some things to like–and some areas that could use improvement.

As SmallGovCon readers will recall, the 2017 National Defense Authorization Act directed the SBA and VA to work together on a consolidated SDVOSB eligibility rule, with the SBA taking the lead in the effort.  As a result, the SBA’s proposal incorporates some pieces of the existing VA SDVOSB ownership and control rules.  The SBA also includes some entirely new provisions, such as an exception to the ordinary control requirements in a handful of “extraordinary” circumstances.

Here are some of the highlights (and a few lowlights) of the proposal.

Unconditional Ownership

The proposed rule would update 13 C.F.R. 125.12 to provide additional guidance about how an SDVOSB must be owned.  Unsurprisingly, the rule retains the general requirement that an SDVOSB be “unconditionally and directly owned by one or more service-disabled veterans.”

The proposed rule provides an exception for surviving spouses, but only in very limited circumstances: for a surviving spouse to qualify as an SDVOSB owner, the veteran must have either had a 100 percent service-connected disability, or have died as a result of the service-connected disability.

The proposed rule also includes an exception for employee stock ownership plans, or ESOPs.  Unfortunately, however, the proposed exception is essentially worthless: it says that “[i]n the case of a publicly traded business,” stock owned by an ESOP need not be 51% owned by veterans.  But when was the last time you saw a publicly traded SDVOSB?  The next time I run across one of those will be the first.  For everyone else, there’s still no exception for ESOPs, which is unfortunate.  In my view, service-disabled veterans ought to have the flexibility to offer ordinary ESOPs to their employees.

The proposed rule adds a requirement that service-disabled veterans receive at least 51 percent of the profits of a corporation, partnership, or LLC.  Additionally, a service-disabled veteran’s ability to share in the profits “must be commensurate with the extent of his/her ownership interest in that concern.”  For example, if a service-disabled veteran owns 75% of an SDVOSB, he or she must receive 75% of the profits.  These profit-sharing requirements aren’t part of the SBA’s current SDVOSB rules, but have been incorporated essentially word-for-word from the VA’s regulations.

The proposed rule also provides that service-disabled veterans must receive “100 percent of the value of each share of stock owned by them in the event that the stock or member interest is sold,” and “[a]t least 51 percent of the retained earnings of the concern and 100 percent of the unencumbered value of each share of stock or member interest owned in the event of dissolution of the corporation, partnership, or limited liability company.”  Again, these requirements aren’t found in the current SBA SDVOSB regulations, but have long been a part of the VA’s rules.

Unconditional Control

The proposed rule retains the requirement in 13 C.F.R. 125.13 that, for a company to qualify as an SDVOSB, “the management and daily business operations of the concern must be controlled by one or more service-disabled veterans.”  However, “in the case of a veteran with a permanent and severe disability, the spouse or permanent caregiver of such veteran” may control the company.

I’m not a fan of the “spouse or permanent caregiver” provision.  No, not because I don’t think that veterans with permanent and severe disabilities ought to be able to delegate day-to-day control–to me, that’s fair.  My concern is that the SBA’s rule would continue to provide that the caregiver must “have managerial experience of the extent and complexity needed to run the concern.”

Now how likely is it that the typical spouse or appointed permanent caregiver has that experience–much less the time and interest, when the caregiver is busy providing for the needs of a severely disabled veteran?  I’ll let Mr. Jerry Seinfeld answer that one.  In my view, it would be better to allow the veteran to designate a experienced non-caregiver manager, provided that the designated person satisfied certain reasonable criteria (e.g., no conflicts of interest).  This would ensure that the company is run by someone who knows what he or she is doing, and allow the caregiver to devote full attention to the disabled veteran, instead of spending his or her time trying to run a business.

Unlike the current rule, the proposed rule would define “daily business operations.”  The proposed definition states that those operations “include, but are not limited to, the marketing, production, sales, and administrative functions of the firm, as well as the supervision of the executive team, the implementation of policies and the setting of the strategic direction of the firm.”  This one’s slightly odd: I think of “setting the strategic direction of the firm” as big-picture management, not a day-to-day operation.  Regardless, though, the added definition should provide some additional insight as to what the SBA wants to see when it comes to control.

The SBA has provided some additional guidance about when service-disabled veterans will be deemed to control a company’s Board of Directors.  This language is largely borrowed from the 8(a) and VA regulations, and I don’t have any particular concerns about it.

The proposed regulation includes another odd provision regarding super majority voting: it states that “[o]ne or more service-disabled veterans must meet all super majority voting requirements.”  That’s not the odd part, although it seems inconsistent with the limited “extraordinary decisions” language I’ll discuss momentarily.  The odd part is the requirement that “an applicant must inform the Department of Veterans Affairs, when applicable, of any super majority voting requirements provided for” in its governing documents.

As I read it, this means that VA CVE applicants would have to highlight super majority voting requirements in their governing documents.  Does this mean that the SBA doesn’t trust the VA to find these during its document review?  And why should the veterans have to identify any requirements that they satisfy?  For instance, if a veteran owns 75% of a company, then a 66% super majority voting requirement shouldn’t be problematic, should it?

The SBA’s proposed rule adopts some current VA regulations regarding situations where non-veterans may be found to control a company.  For instance, the SBA adopts the VA’s position that the service-disabled veteran generally must be the highest-compensated in the company.  But the SBA proposal provides additional examples of things that may constitute impermissible control.  SBA’s proposal says, for example, that impermissible control may exist “[i]in circumstances where the concern is co-located with another firm in the same or similar line of business, and that firm or an owner, director, officer, or manager, or a direct relative of an owner, director, officer or manager of that firm owns an equity interest in the firm.”

The SBA also proposes to adopt a “rebuttable presumption that a service-disabled veteran does not control the firm when the service-disabled veteran is not able to work for the firm during the normal working hours that firms in that industry normally work.”  In its comments, SBA says that “[t]his is not a full time devotion requirement” and that a veteran can rebut the presumption by “providing evidence of control.”  The SBA doesn’t explain what sort of evidence it will accept, however.

The SBA also proposes a problematic new “close proximity” requirement.  This one says:

There is rebuttable presumption that a service-disabled veteran does not control the firm if that individual is not located within a reasonable commute to firm’s headquarters and/or job-site locations, regardless of the firm’s industry. The service-disabled veteran’s ability to answer emails, communicate by telephone, or to communicate at a distance by other technological means, while delegating the responsibility of managing the concern to others is not by itself a reasonable rebuttal.

I don’t like this one.  Granted, it’s just a rebuttable presumption–not conclusive ineligibility–but as the world moves more and more in the direction of telecommuting, it’s unfortunate that the SBA views physical location as so important, “regardless of industry.”  Also, the “and/or” in the proposed language doesn’t make any sense.  Does the veteran have to be close to headquarters, job sites, or both?  If both, how is that possible for a company that bids regionally or nationally, and has job sites spread across the country?

Finally, the SBA says that it won’t find a lack of control “where a service-disabled veteran does not have the unilateral power and authority to make decisions in ‘extraordinary circumstances.'”  But only five actions would count as extraordinary: (1) adding a new equity stakeholder; (2) dissolution of the company; (3) sale of the company; (4) merger of the company; or (5) declaring bankruptcy.  Non-veteran owners could have veto power over these five actions, but nothing more.

I’m glad that the SBA is recognizing that complete, unfettered unconditional control actually harms service-disabled veterans by scaring away potential investors.  But I think this list is too narrow, and misses some fundamental items that the SBA Office of Hearings and Appeals has identified in its size and affiliation cases.  These include such things as issuing new shares of stock (which could dilute the interests of minority members, even without adding a new owner), selling all the firms assets, increasing or decreasing the size of the Board of Directors, and selling or disposing of all of the firm’s assets.  I hope the SBA will look at broadening this list to better enable service-disabled veterans to attract qualified investors.

Next Steps

Keep in mind that for now, this is just a proposal, not a law.  The SBA is accepting public comments on the proposal on or before March 30, 2018.  To comment, go to the Federal Register and follow the instructions.