In analyzing whether or not to allow businesses to be included in the VA VetBiz Vendor Information Pages (VIP) Verification Program as a service-disabled veteran owned small business (SDVOSB), the Center for Veteran Enterprise (CVE) at the Department of Veteran Affairs applies the provisions of 38 CFR § 74, and essentially looks at two key issues: 1) is the management and daily operations of the business controlled by one or more service-disabled veterans, and 2) is at least 51% of the ownership interests in the business owned unconditionally by one or more service-disabled veterans.

The following is a list of tips you can follow to avoid having your SDVOSB status denied based on your business’s documentation and records. This is of course not an exhaustive list of requirements, but it’s a good checklist to start with. In addition, this list only touches on a few issues related to actual management and operation of the business and also does not get into other issues such as affiliation that SDVOSBs also need to address.

Tip #1

Get rated. This may seem obvious, but make sure your service disabled veteran owners actually have received their disability ratings from the VA. In the past, companies were able to self-certify as SDVOSBs, and some business owners were given poor advice when they started their businesses many years ago that they didn’t need to have a rating, as the program was self-certifying. There is no grandfathering for the SDVOSB program… service-disabled veterans need to have their disability ratings in order to qualify, even if they have been self-certifying their business as a SDVOSB for years.

Tip #2

Watch your payroll. Make sure a service-disabled veteran is the highest paid employee. This issue often comes up in 51/49 owned companies, where two business partners want to be treated as equal is possible. More than one company has slipped up when due to differences in benefits or other income items, the non-service-disabled veteran ended up with a higher W-2 wage amount than the service-disabled veteran even when the partners thought that the service-disabled veteran had a slightly higher salary. Make sure you have enough cushion in your pay packages so that you don’t blow this test.

Tip #3

51% means 51%. Make sure your organizational documents (e.g., Articles, Bylaws, Operating Agreement, Stockholders Agreement, etc.) do not include any super-majority provisions. Organizational documents typically include super-majority provisions, and you need to make sure any form agreement you pull off the Internet, borrow from another company, or receive from an attorney not familiar with the SDVOSB program has these provisions scrubbed out. Look for red flag terms such as “unanimous”, “all” (when referring to owners), “percent” or “%” (when referring to ownership interests, when the number is more than 51), etc. and make sure to remove them.

Tip #4

Count your options. The CVE considers any unexercised stock options or similar agreements (including convertible notes and warrants) held by non-service-disabled veterans to be treated as exercised and will count them against the 51% ownership requirement (and to make things worse, they don’t count the same instruments issued to service-disabled veterans). If your service-disabled veterans own only 51% of the business and wish to put a stock option plan in place or otherwise grant equity (or instruments convertible into equity) to non-service-disabled veterans, they will need to redeem down the non-service-disabled veterans in order to make sure they don’t blow the 51% ownership test.

Tip #5

Avoid negative control. Make sure no non-service disabled veteran has any consent rights (sometimes styled as negative covenants) over the management or daily operations of the business. In addition to super-majority provisions, often times companies give minority owners or outside investors (including debt holders) consent rights over certain actions (such as issuing new stock, making distributions, assuming debt, amending agreements, etc.). These are typical protections that minority owners and investors ask for, but the CVE has found that these sorts of provisions result in the business being subject to the control of a non-service disabled veteran (what is referred to as “negative control”) and thus should be deleted.

Tip #6

Manage your business. If your business is formed as a limited liability company and is defined as being manager-managed rather than member-managed, make sure you have appointed a service-disabled veteran as the manager (or if you have a Board of Managers, make sure service-disabled veterans control the Board). Sometimes owners who form businesses as limited liability companies don’t realize that the business is designated as manager-managed, and instead assume that the members are the ones who control the management and operations of the business, which is not the case. If you don’t appoint the proper managers, the CVE will find that your business is not controlled by service-disabled veterans.

Tip #7

Don’t condition ownership. Make sure the ownership interests of your service-disabled veterans are not subject to any sort of restrictions on withdrawal from the business or sale or other transfer of interests, including rights of first refusal, rights of first offer, etc. The CVE has found that any provision that restricts a service-disabled veteran from disposing of his ownership interest in any way (even if the right is granted to another service-disabled veteran!) is an impermissible condition on ownership. These are pretty typical provisions in organizational documents for businesses, and you need to make sure that they are either deleted completely from your documents, or indicate that they do not apply to the service disabled veterans. Note that these provisions are allowed if they are triggered only upon the death or incapacity of the service-disabled veteran. In addition, pledges of stock for commercial financing arrangements are also allowed.

Tip #8

Be free to amend. Make sure all of your organizational documents include an amendment provision stating that the document (including any provisions restricting the ownership or control of the service-disabled veterans) may be amended by the service-disabled veterans. In this way, even if your organizational document has a provision that the CVE finds objectionable, you can point to the fact that the service-disabled veterans can amend it at any time and thus does not actually impact the ownership or control of the service-disabled veterans.

Tip #9

Make sure to save. Make sure all of your organizational documents includes “savings” provisions… one that states that the document is intended to comply with the requirements of service-disabled veterans regulations, and another that states that in the event of a conflict between the document and the service-disabled veteran regulations, the service-disabled veteran regulations take precedence. I have not yet had to test these provision with the CVE, but if all else fails it is one last arrow in your quiver, and not bad provisions to include.