On Friday, August 23, the Small Business Administration issued a proposed rule that would significantly change the SBA’s HUBZone small business contracting program and other small business programs, including the 8(a) Program and the All Small Mentor-Protégé Program.

Comments are due by October 7, 2024. They should reference Docket No. SBA-2024-0007 or RIN 3245-AH68, and may be submitted through http://www.regulations.gov/.

Below is the first in a series that will address the proposed changes in detail. We will first discuss the proposed changes to affiliation and negative control.

To determine whether one concern is affiliated with another for size purposes, the SBA considers whether “negative control” exists. Under 13 CFR 121.103(a)(3), the SBA may find negative control where a minority shareholder has the ability to prevent a quorum or otherwise block action by the board of directors or shareholders. Such action would qualify the concern to be regarded as controlled by, and therefore affiliated with, the minority shareholder. The current rule does not include any specific exceptions, though some have developed through case law at SBA’s Office of Hearings and Appeals. See, e.g., Southern Contracting Solutions III, LLC, SBA No. SIZ-5956 (Au. 30, 2018).

The proposed rule would explicitly identify the following actions that a minority shareholder can veto without risk of establishing “negative control” for purposes of affiliation:

(1) adding a new equity stakeholder

(2) dissolution of the company

(3) sale of the company or all its assets

(4) merger of the company

(5) the company declares bankruptcy

(6) amendment of the company’s governance documents to remove the shareholder’s authority to block any of (1) through (5)

The SBA proposes to add these explicit exceptions because they are currently contained in the VetCert rules, and the SBA seeks to promote consistency with other contracting programs.

The SBA is also seeking comments about whether additional explicit exceptions are appropriate:

Through this proposed rule, SBA would add explicit exceptions to the negative-control provision for all programs for which control is an eligibility element. This would permit all small businesses to seek equity funding without becoming affiliated with the investors solely because of a broad interpretation of the negative control rule. SBA specifically requests comments as to whether the six identified exceptions are sufficient or whether one or more additional exceptions should also be included in the regulations. (emphasis added).

For 8(a) companies that have minority partners, or seek to solicit investment from a minority partner, ensuring that the corporate governance structure in their operating agreements does not run afoul of “negative control” and its potential for affiliation can be a difficult issue to resolve. Minority investors often look for corporate governance protections that are inconsistent with the SBA’s current affiliation rules. As such, 8(a) companies may want to consider whether additional clarification or limits on the SBA’s ability to find negative control are warranted.

This article summarizes aspects of the law and does not constitute legal advice. For legal advice with regard to your situation, you should contact an attorney.