Smith, Gambrell & Russell, LLP

Qualifying as a Minority Business Enterprise

According to the U.S. Census Bureau's 2005 American Community Survey, more than 73 million Americans, or 25 percent of the U.S. population, are members of ethnic minorities. However, such individuals have been and continue to be underrepresented in the business-ownership population. In 2002, the last year for which the U.S. Department of Commerce figures are available, minority-owned businesses represented only 18 percent of all U.S. businesses by number -- less than their pro rata share of the population. Additionally, minority-owned businesses typically are smaller and have fewer employees than non-minority-owned businesses. Average gross receipts of minority-owned businesses are about one third of their non-minority counterparts.

But by another measure, minority business enterprises are doing well. Between 1997 and 2002, the number of minorityowned businesses in the United States increased by 35 percent, while the number of non-minority businesses increased by only 6 percent. The growth of minority business enterprises is in large measure due to the availability of a number of programs on the federal, state, county and city levels designed to support and foster minority business enterprises. Some large corporations also provide programs similar to those offered by the government. These programs provide, among other benefits, support for government contractors, access to capital, and management, technical and export assistance. Qualifying for any one of these programs can provide immeasurable benefits to a minority-owned business seeking to grow and expand.

Some of the more common assistance programs and their names and abbreviations are:

Federal Programs

  • Small Business Administration: 8(a) BD, Small Disadvantaged Business (SDB) and HUBZone
  • U.S. Department of Transportation: Disadvantaged Business Enterprise (DBE)

State, County, City & Corporate Programs (where available)

  • Minority Business Enterprise (MBE)
  • Disadvantaged Business Enterprise (DBE)
  • Small Business Enterprise (SBE) -- typically race neutral

This article focuses on the requirements of the Section 8(a) BD Program, administered by the Small Business Administration (SBA). The SBA also oversees the Small Disadvantaged Business (SDB) Certification Program. While the 8(a) BD Program offers a broad scope of assistance to socially and economically disadvantaged firms, SDB certification pertains strictly to benefits in federal procurement. Section 8(a) BD firms automatically qualify for SDB certification. To remain compatible with federal programs, many state and local programs mirror the requirements of the federal programs.

The 8(a) BD Program

The purpose of the 8(a) BD Program is to help eligible small, disadvantaged businesses compete in the American economy through business development. An application for 8(a) BD program admission must be filed with the SBA Division of Program Certification and Eligibility (DPCE) field office serving the territory in which the principal place of business of the applicant is located.

Generally, an applicant meets the basic requirements for admission to the 8(a) BD Program if it is (1) a small business that is (2) unconditionally owned and (3) controlled by (4) one or more socially and economically disadvantaged individuals who are (5) of good character and (6) citizens of the United States, and that (7) demonstrates potential for success.

Small Business

An applicant for 8(a) BD status must qualify as a "small business" concern. The Small Business Act provides that a small business is "one that is independently owned and operated and which is not dominant in its field of operation." The law also states that in determining what constitutes a small business, the definition will vary from industry to industry to reflect industry differences accurately. The SBA's Small Business Size Regulations in turn implement the Small Business Act. The SBA has established a table of size standards for small businesses, matched to the North American Industry Classification System (NAICS). The table may be found at sba.gov/size/sizetable2002.html.

Socially and Economically Disadvantaged Individuals

Socially disadvantaged individuals are those who have been subjected to racial or ethnic prejudice or cultural bias within American society because of their identities as members of certain groups. The social disadvantage must stem from circumstances beyond their control. There is a rebuttable presumption that members of certain ethnic groups, including African-Americans, Hispanic Americans, Native Americans and certain groups of Asian-Americans are socially disadvantaged.

Economically disadvantaged individuals are socially disadvantaged individuals whose ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to others in the same or similar line of business who are not economically disadvantaged.

Unconditional Ownership

An applicant for 8(a) BD status must be at least 51 percent unconditionally and directly owned by one or more socially and economically disadvantaged individuals. "Unconditional ownership" means ownership 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, non-disadvantaged person. 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.

The growth of minority business enterprises is in large measure due to the availability of a number of programs on the federal, state, county and city levels designed to support and foster minority business enterprises.

(a) Ownership must be direct. Ownership by one or more disadvantaged individuals must be direct. An applicant owned principally by another business entity or by a trust (including employee stock ownership trusts) that is in turn owned and controlled by one or more disadvantaged individuals does not meet this requirement. However, ownership by a trust, such as a living trust, may be treated as the functional equivalent of ownership by a disadvantaged individual where the trust is revocable and the disadvantaged individual is the grantor, a trustee or the sole current beneficiary of the trust.

(b) Ownership of a partnership. In the case of an entity organized as a partnership, at least 51 percent of every class of partnership interest must be unconditionally owned by one or more individuals determined by the SBA to be socially and economically disadvantaged. The ownership must be reflected in the partnership agreement.

(c) Ownership of a limited liability company. In the case of a limited liability company, at least 51 percent of each class of member interest must be unconditionally owned by one or more individuals determined by the SBA to be socially and economically disadvantaged.

(d) Ownership of a corporation. In the case of an entity organized as a corporation, at least 51 percent of each class of voting stock outstanding and 51 percent of the aggregate of all stock outstanding must be unconditionally owned by one or more individuals determined by the SBA to be socially and economically disadvantaged.

(e) E ffect of stock options on ownership. In determining unconditional ownership, the SBA will disregard any unexercised stock options or similar agreements held by disadvantaged individuals. However, any unexercised stock options or similar agreements (including rights to convert non-voting stock or debentures into voting stock) held by non-disadvantaged individuals will be treated as exercised.

(f ) Dividends and distributions. One or more disadvantaged individuals must be entitled to receive:
(i) At least 51 percent of the annual distribution of dividends paid on the stock of a corporate applicant;
(ii) 100 percent of the value of each share of stock owned by them in the event that the stock is sold; and
(iii) At least 51 percent of the retained earnings of the entity and 100 percent of the unencumbered value of each share of stock owned in the event of dissolution of the corporation.

Management and Control

Disadvantaged individuals managing the entity must have managerial experience of the extent and complexity needed to run the business. A disadvantaged individual need not have the technical expertise or possess a required license to be found to control an applicant if he or she can demonstrate ultimate managerial and supervisory control over those who possess the required licenses or technical expertise. However, where a critical license is held by a non-disadvantaged individual having an equity interest in the applicant, the non-disadvantaged individual may be found to control the firm. A number of specific requirements exist in order to satisfy the "control" element of
8(a) BD eligibility:

(a) An applicant must be managed on a full-time basis by one or more disadvantaged individuals who possess requisite management capabilities.

(b) A disadvantaged full-time manager must hold the highest officer position (usually president or chief executive officer) in the applicant.

(c) One or more disadvantaged individuals who manage the applicant must devote their full-time efforts to the business during the normal working hours of firms in the same or similar line of business. Work in a wholly owned subsidiary of the applicant may be considered to meet the requirement of full-time devotion (this condition refers only to a subsidiary owned by the 8(a) BD enterprise, and not to businesses in which the disadvantaged individual has an ownership interest).

(d) Any disadvantaged manager who wishes to engage in outside employment must notify the SBA of the nature and anticipated duration of the outside employment and obtain the prior written approval of the SBA. The SBA will deny a request for outside employment that could conflict with the management of the firm or hinder it in achieving the objectives of its business development plan.

(e) A disadvantaged owner's unexercised right to cause a change in the control or management of the applicant concern does not in itself constitute disadvantaged control and management, regardless of how quickly or easily the right could be exercised.

(f ) In the case of a partnership, one or more disadvantaged individuals must serve as general partners, with control over all partnership decisions. A partnership in which no disadvantaged individual is a general partner will be ineligible for participation.

(g) In the case of a limited liability company, one or more disadvantaged individuals must serve as management members with control over all decisions of the company.

(h) One or more disadvantaged individuals must control the board of directors of a corporate applicant or participant. The SBA will deem disadvantaged individuals to control the board of directors where:
(i) a single disadvantaged individual owns 100 percent of all voting stock of the entity;
(ii) a single disadvantaged individual owns at least 51 percent of all voting stock of the entity, the individual is on the board of directors and no super-majority voting requirements exist for shareholders to approve corporation actions. Where super-majority voting requirements are provided for in the entity's articles of incorporation, its by-laws or by state law, the disadvantaged individual must own at least the percent of the voting stock needed to overcome the super-majority voting requirements; or
(iii) more than one disadvantaged shareholder seeks to qualify the entity (i.e., no one individual owns 51 percent), each such individual is on the board of directors, together they own at least 51 percent of all voting stock, no super-majority voting requirements exist, and the disadvantaged shareholders can demonstrate that they have made enforceable arrangements to permit one of them to vote the stock of all as a block without a shareholder meeting. Where the entity has super-majority voting requirements, the disadvantaged shareholders must own at least that percentage of voting stock needed to overcome any such super-majority ownership requirements.

Where an applicant does not meet the "control" requirements, the disadvantaged individual(s) upon whom eligibility is based must control the board of directors through actual numbers of voting directors or, where permitted by state law, through weighted voting (e.g., in a concern having a two-person board of directors where one individual on the board is disadvantaged and one is not, the disadvantaged vote must be weighted -- that is, worth more than one vote -- in order for the business to be eligible for 8(a) BD participation).

Reasonable Prospects for Success

The applicant must possess reasonable prospects for success in competing in the private sector to be admitted to the 8(a) BD program. To do so, it must have been in business in its primary industry classification for at least two full years immediately prior to the date of its 8(a) BD application, unless the SBA grants a waiver for this requirement.

Conclusion

If you are a small business, you may be able to take advantage of the various federal, state and local programs designed to assist minority business enterprises. Which program a minority business should look to depends on the goals of the business, its geographic location and the requirements of the available programs. The 8(a) BD program described in this article provides a good starting point. In addition, the following Web sites:
- Small Business Administration: sba.gov/8abd/
- Minority Business Development Agency: mbda.gov/
are good resources for small businesses seeking minority certification.

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