To qualify for the 8(a) Program, a firm must be a small business that is unconditionally owned and controlled by one or more socially- and economically-disadvantaged individuals who are of good character and citizens of the United States and that demonstrates a potential for success.
What does this really mean? Here are five things you should know about 8(a) Program eligibility.
- Is your business small enough to become an 8(a) Participant?
The 8(a) Program is only open to businesses that are small under the size standard corresponding to their primary NAICS codes. And remember: SBA will not only consider your company’s size, but will also add to it the size of any affiliates. If there’s a question as to your business’s size, SBA may go so far as to request a formal size determination.
What is your primary NAICS code? While businesses have some leeway to select the code that fits best, the SBA may push back if the NAICS code you choose doesn’t seem to be the one in which your company does the most work. Before applying, it may be useful to review the SBA’s definition of “primary industry” at 13 C.F.R. 121.107.
One final note: some IRS tax returns already provide a spot for a primary NAICS code. For example, Form 1065, which is completed by many LLCs, asks for a primary NAICS in box A, “principal business activity.” Oftentimes, our clients are surprised to notice that an accountant or bookkeeper has identified a primary NAICS code on a tax return. Be aware that the SBA will ask for an explanation if that primary NAICS code isn’t the one the company has selected for 8(a) purposes.
- What is “social” disadvantage?
It’s not enough to be a small business to qualify for the 8(a) Program. The business’s owner also must demonstrate suffering from social disadvantage—or, as SBA defines it, “racial or ethnic prejudice or cultural bias within American society because of their identities as members of groups and without regard to their individual qualities.”
Members of certain racial or ethnic groups are presumed by SBA to have suffered social disadvantage, including Black Americans, Hispanic Americans, Native Americans, and some Asian Americans. This presumption is not absolute (as it may be rebutted by credible evidence demonstrating the lack of social disadvantage) or controversy (as its constitutionality has been challenged, but recently upheld). For a full list of groups presumed socially disadvantaged, take a look at 13 C.F.R. 124.103(b).
But participation in the 8(a) Program isn’t limited to only the groups listed in the regulations. Any individual can try to establish social disadvantage by presenting evidence showing chronic disadvantage based on a characteristic or circumstance beyond that person’s control, which has impacted that person’s education, employment, or business histories. For example (and not by way of limitation), our firm has assisted companies owned by Caucasian women and disabled veterans in obtaining 8(a) certification.
- What is “economic” disadvantage?
In addition to social disadvantage, you still must show economic disadvantage to be eligible for the 8(a) Program. An economically-disadvantaged individual is one whose ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to other non-socially disadvantaged persons (in the same or similar line of business).
SBA will take a detailed look at an individual’s financial history to determine his or her economic disadvantage. Though there are caveats and exceptions to these requirements, here are a few numbers to keep in mind:
Net worth: For initial eligibility, the adjusted net worth of the person claiming economic disadvantage must be less than $250,000. The adjustment typically excludes: (1) funds invested in an IRA, 401(k), or other official retirement account; (2) income received from an S corporation, LLC or partnership, if that income was reinvested in the company or used to pay company taxes, (3) the equity interest in the applicant company, and (4) equity in the individual’s primary residence.
Fair market value of all assets: Notwithstanding a person’s net worth or personal income, an individual will not be considered economically-disadvantaged if the fair market value of his/her assets (including the value of the applicant company and the person’s primary residence) exceeds $4 million. But even this calculation excludes funds in traditional retirement accounts.
Personal income: If an individual’s adjusted gross income for the three years prior to the 8(a) application exceeds $250,000, there is a rebuttable presumption the individual isn’t economically disadvantaged. Income from an S Corporation or LLC will be excluded when the funds were reinvested in the company or used to pay company taxes.
Are there any other requirements?
Yes. Again, socially- and economically-disadvantaged individuals have to unconditionally own and control the company. This means disadvantaged individuals must directly own at least 51% of the company and oversee its strategic policy and day-to-day management and administration. Additionally, the individual must manage the company on a full-time basis while holding its highest officer position.
The company must also demonstrate potential for success. This assessment generally requires a holistic view of the company: not only must it have been generating revenues in its primary industry for at least two years, but SBA will also consider every aspect of its business operations (including access to capital and financing, technical and managerial experience of the company’s managers, its past performance, and licensing requirements) to determine if the company is likely to succeed in the 8(a) Program.
The company and its principals must have good character. For example, if the business owner has recently been convicted of a felony or any crime involving business integrity, the SBA may decline the application. The SBA will also examine federal financial obligations: unpaid back taxes and defaults on SBA business loans, for example, may lead to a rejection.
It’s important to note that while these are some of the most important requirements, it’s not an exhaustive list. 8(a) Program eligibility is rather complex.
- Do you have to maintain compliance with these eligibility requirements throughout your participation in the 8(a) Program?
Yes. Demonstrating eligibility isn’t a one-time thing; once a company is admitted to the 8(a) Program, SBA will review its eligibility compliance on an annual basis.
Some of the initial eligibility requirements are modified for continuing eligibility. For example, once admitted to the 8(a) Program, caps on net worth and personal income are raised (but not eliminated). But tread lightly: SBA imposes additional requirements on 8(a) Participants to remain eligible, such as limiting the number of withdrawals an individual can take from a Participant and restricting the number of 8(a) awards a Participant may receive.
If these eligibility requirements sound a bit ominous, it’s for good reason: they can be. But that’s not to scare you away from considering the 8(a) Program—as I mentioned in my initial post, the benefits to participating can be tremendous.
If you have questions about your company’s 8(a) Program eligibility, or would like help applying for the Program, please call us at 785-200-8919.