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In August, the Small Business Administration ("SBA") issued a proposed rule that included significant and sweeping changes to its regulations, including to its rules on joint ventures, mentor-protégé, HUBZones, and others. Notably, with regard to mergers and acquisitions ("M&A"), SBA proposed to amend its negative control affiliation and recertification rules (discussed here and here). As noted in those articles, SBA's revised M&A provisions (as written) would likely stifle investment and hinder growth opportunities for small business.

On December 17, 2024, SBA published the final rule, which takes effect on January 16, 2025 (with a notable exception discussed below). At a high level, the final rule not only significantly alters the small business regulatory landscape but also shows that the agency heeded industry concerns by introducing a slew of refinements to the proposed text.

Because the final rule is too lengthy to cover in one pass, this article focuses on some of the final rule's M&A-related provisions. As shown below, where M&A is concerned, small businesses will likely view the final rule positively, notwithstanding the massive shift in how recertifications will impact eligibility under multiple award contracts.

Negative Control Affiliation

As proposed, SBA added language to its negative control rule to provide six specific instances in which a minority shareholder's consent (vote) does not create impermissible negative control: (1) add a new equity stakeholder; (2) dissolve the company; (3) sell the company or all assets of the company; (4) merge the company; (5) declare bankruptcy; and (6) amend the company's governance documents to remove the shareholder's authority to block any of (1) through (5). The proposed rule departed from the current landscape because permissible negative control provisions are largely a creature of OHA caselaw.

While well intentioned, our first article noted that SBA's overly-prescriptive proposed rule could upend common practice regarding supermajority provisions in an operating agreement that do not impact the day-to-day control and instead protect the minority shareholder's financial investment. SBA received several comments along those lines. Some urged the agency to include a "catch-all" and another urged the agency to add language that follows OHA caselaw. See Southern Contracting Solutions III, LLC, SBA No. SIZ-5956 (Aug. 30, 2018) (no negative control if the provisions are "crafted to protect the investment of the minority shareholders" and do not impact the majority's ability to control operations or run the company).

SBA heeded those concerns, among others. As finalized, a minority shareholder does not have negative control where its consent (vote) is required to: (1) add a new equity stakeholder or increase the investment amount of an equity stakeholder; (2) dissolve the company; (3) sell the company or all assets of the company; (4) merge the company; (5) declare bankruptcy; (6) amend corporate governance documents to remove the shareholder's authority to block any of (1) through (5); and (7) take any other extraordinary action that is crafted solely to protect the investment of the minority shareholders, and not to impede the majority's ability to control the concern's operations or to conduct the concern's business as it chooses.

SBA's final rule on negative control is good news, as the catch-all provides needed flexibility. Moving forward, small businesses and their minority shareholders (investors) will be able to continue the common practice of drafting governance documents in a way that provides voting rights to minority shareholders for certain issues, so long as the provisions are crafted to protect their investment and are otherwise consistent with longstanding OHA caselaw.

Recertification

SBA's size recertification rules have been the subject of considerable debate, particularly as it relates to small business eligibility following an M&A event. As we noted in the second article, SBA's proposed rule introduced a paradigm shift because it tied recertifications to eligibility instead of goaling credit (for the most part). This was a massive departure from the status quo and one that would have a significant impact on small business M&A activity.

As proposed, SBA created a new rule (13 C.F.R. § 125.12) to simplify and consolidate its patchwork of regulations. Under the proposed scheme, SBA categorized recertifications as qualifying or disqualifying and outlined the impact of a disqualifying recertification on multiple award contracts ("MAC"). In that regard, the proposed rule covered M&A events, contracting officer requests for recertification, long-term contracts, pending proposals, future set-aside or reserve awards, options, and JVs.

While those changes were discussed at length in our prior article, the proposed rule generally stated that if a company has a disqualifying recertification on a set-aside MAC (e.g., M&A activity, including agreements in principle, and contracting officer requests for recertification), the company would not be eligible to submit an offer for a set-aside order thereunder. SBA also clarified that disqualifying recertifications also impact eligibility for orders or agreements under the Federal Supply Schedule.

Turning to the final rule, while SBA did not reverse course on the eligibility issue, SBA heeded industry feedback and injected considerable clarity and flexibility into the final rule, including by adding a delayed effective date. The changes in the final rule are reflected in this document (comparing the proposed rule text to the final rule), some of which are summarized below.

To begin, commenters believed that recertifications should not be required for "agreements in principle" since they "may never be finalized or the ultimate sale or merger may take a long time, conceivably beyond one or more additional fiscal years (upon which size status is based)." SBA agreed and removed that language from the overarching M&A section.

Where pending proposals are concerned, the final rule did not make any major changes. If an M&A event occurs within 180 days after the offer but prior to award, the concern is ineligible for the award. If an M&A event occurs more than 180 days after the offer but prior to award, eligibility hinges on whether the effort is a single award or MAC. For single awards, the award will count as an award to a small business for goaling credit for up to five years from the award unless there is a disqualifying recertification. However, for a small business MAC, the concern would be ineligible for award because the concern would not be eligible for orders thereunder.

Notably, and in response to comments, SBA included a carve-out for M&A involving two small businesses. In that regard, SBA added language that says if a small business has a disqualifying recertification in response to a requirement to recertify size or status following an M&A event with another small business concern, the company will remain eligible for set-aside orders but the procuring agency cannot count the order as an award to a small business (e.g., 8(a), WOSB, SDVOSB, or HUBZone). In other words, while the two small business entities generally would be affiliates (and may not be small for new contracts), the merged concern would remain eligible for orders under MACs and it would be a goaling issue for the agency.

The final rule also includes language regarding natural growth. In that regard, SBA added language providing that where a small business experiences natural growth and is no longer small, the company may continue to qualify as a small business for orders or agreements so long as a contracting officer does not request recertification. This new language is welcome news because SBA addressed natural growth beyond its prefatory comments and included it in the text of the final rule. Left open to interpretation, however, is what happens when two small businesses merge and remain small but then become other than small a couple years later? Would that qualify as natural growth?

Lastly, and perhaps most importantly, SBA also included a delayed effectiveness date in response to concerns regarding how disqualifying recertifications would alter existing work or opportunities. Indeed, several commenters advised that SBA adopt a "phased or delayed implementation of these provisions to allow time to adapt." SBA agreed and pushed out the effective date for one year. Thus, where a concern has a disqualifying recertification and that recertification occurs before January 17, 2026, the company would be eligible for orders issued under an underlying set-aside MAC. This delay is great news as it provides small business with time to adjust to the rule and to ensure that pending or planned M&A transactions are not disrupted.

Takeaway

As shown above, SBA made significant revisions to its proposed negative control and recertification rules. For its negative control affiliation rule, SBA injected clarity and flexibility into the final rule. With the addition of a catch-all to the listed items, minority control provisions will still be subject to OHA caselaw, which reflects the current landscape. And, while SBA did not shelve the recertification-eligibility issue, SBA heeded industry input and made several important changes. SBA's clarifying language coupled with a delayed effective date regarding disqualifying recertifications and the "all small" M&A provision is indeed welcome news as the final rule gives small businesses time to plan for how M&A activity could impact their business.

Notably, the inclusion of a delayed effective date likely will drive a number of M&A transactions prior to 2026 where a large buyer is involved. As SBA noted in its prefatory comments, small businesses that make disqualifying recertifications before January 17, 2026 "will continue to be eligible to receive orders and options after the effective date of this [final] rule.” In other words, the status quo remains during the delay window – small businesses can undergo an M&A event with a large business will still be eligible for orders after that one-year mark (unless there is a post-2026 disqualifying recertification).

On the other hand, small businesses that do not close an M&A deal prior to that date may see valuations decline. To avoid plummeting transaction values, it is possible that industry will see a rise in carve-out M&A deals – e.g., a firm's assets relating to MACs are separated into a division (or subsidiary) and sold to another small business, while the remainder of the company is sold to a large entity. Thus, while the "all small" M&A provision may result in a rise in traditional M&A between small businesses – which may further bolster the growing mid-tier market – the new provision also may be the means by which small businesses seek to offset plummeting transaction values in M&A deals where a large entity is involved.

Finally, the final rule also demonstrates what can happen when industry provides robust feedback during the comment period. As SBA's prefatory comments and final text show, SBA heeded industry input and made several tailored refinements to address those issues. Small businesses should keep this in mind, and be prepared to submit comments, the next time SBA (or any other agency) issues a proposed rule that impacts your business.