Strings Attached? Don’t Put Conditions on SDVOSB Ownership, Cautions OHA

Ownership of a Service-Disabled Veteran-Owned Business has to be unconditional. As the owner of an SDVOSB recently found out, unconditional ownership generally means there can be no restrictions on the service-disabled veteran owner’s ability to sell the ownership interest. Let’s explore the details.

The Small Business Administration’s Office of Hearings and Appeals decision was ALOG Corp., SBA No. VET-285 (July 21, 2020). OHA considered an protest of ALOG’s status after winning an Air Force procurement that was an SDVOSB set-aside.

As a reminder, SBA requires that an SDVOSB must be “at least 51% unconditionally and directly owned by one or more service-disabled veterans.” 13 C.F.R. § 125.12. Unconditional ownership, in turn, means:

[O]wnership that is not subject to conditions precedent, conditions subsequent, executory agreements, voting trusts, restrictions on or assignments of voting rights, or other arrangements causing or potentially causing ownership benefits to go to another (other than after death or incapacity). The pledge or encumbrance of stock or other ownership interest as collateral, including seller-financed transactions, does not affect the unconditional nature of ownership if the terms follow normal commercial practices and the owner retains control absent violations of the terms.

13 C.F.R. § 125.11.

So, ownership of an SDVOSB “must be unlimited, with no restrictions whatsoever on their ownership, or their ability to dispose of their shares in any way they choose. The exceptions are agreements dealing with the death or incapacity of a shareholder, and the pledge of stock as collateral if the terms follow normal commercial practices.” In addition, a “concern may change its ownership or business structure so long as one or more service-disabled veterans own and control it after the change.” 13 C.F.R. § 125.12(f).

Basically, the veteran has to be the supreme commander.

So, how does this jibe with ALOG’s situation?

ALOG was majority owned by two service-disabled veterans, Paul Smith and Stephen Smith. Stephen Smith and other non-veteran owners had purchased ALOG shares from Paul Smith via a Stock Purchase Agreement (I’ll call it the Agreement) and a loan and note. Paul Smith would continue to own part of ALOG and be an employee for four years after the sale.

The Agreement stated that the stock could not be sold unless the shares were first offered for sale to the company, stating that, before sale, the owners “shall first offer the Offered Shares for sale to the Corporation”. In other words, ALOG retained a right of first refusal before any shareholder, including service-disabled veterans, could sell their shares.

Additionally, the Agreement contained a specific restriction on the shares owned by service-disabled veteran Paul Smith. With respect to his shares, if four years after the sale he was still a shareholder, he had to sell his shares back to ALOG, and ALOG had to buy them. Finally, shareholders could only sell their shares to employees of ALOG.

Because this was an Air Force procurement, the SBA has a two-step protest process. In contrast, Department of Veterans Affairs procurements have a separate protest process. In the first step of this protest, SBA determined that Paul Smith, one of the two service-disabled veteran owners, did not own his shares unconditionally.

There were a few restrictions on ownership. For one, Paul Smith would be required to sell his shares to ALOG if he still owned them on December 31, 2021. Second, he could only sell his shares to employees of ALOG.

ALOG appealed this decision to SBA’s Office of Hearings and Appeals, arguing that the restrictions in the Agreement were merely part of a long-term plan for a change in ownership from one service-disabled veteran to another. ALOG based this on 13 C.F.R § 125.12(f), which allows for a change in ownership or business structure so long as service-disabled veterans own and control the firm after the change.

Unfortunately for ALOG, OHA didn’t buy this argument. OHA determined that there were multiple restrictions on Paul Smith’s ownership of ALOG.

  1. Paul Smith had to sell his shares to ALOG if he still owned them after the four-year period listed in the Agreement.
  2. ALOG had a first right of refusal.
  3. Shareholders, including service-disabled veterans, could not transfer stock to a person who is not an employee of ALOG.

These restrictions meant the service-disabled veteran’s ownership was not unconditional.

This case is a good reminder that ownership of an SDVOSB by a service-disabled veteran must be without restrictions, other than a few limited exceptions for death or incapacity of a shareholder or a stock pledge for collateral in connection with a standard commercial practices. Check and make sure your ownership documents follow these rules.

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