When it comes to new business opportunities for small businesses, there are two potentially lucrative markets that are sometimes overlooked: the state and local governments. In fact, the Commonwealth of Virginia spent nearly $9.8 billion in fiscal year 2018. Given the large dollars involved and diverse opportunities, government contractors, and small businesses eager to break into the government contracting industry, may find it advantageous to look beyond the federal government for contracts.
Start with SWaM?
For a small business eager to do business with the Commonwealth of Virginia, a major part in winning these opportunities depends on a company’s ability to receive SWaM certification. The SWaM certification program is a state program administered by the Virginia Department of Small Business & Supplier Diversity (SBSD). “SWaM” stands for small, women-owned and minority-owned business, which are the applicable designations that an applicant may receive. In addition to the small, women-owned and minority-owned business designations, a company may also apply for a micro certification. Unlike some of the similar federal programs (e.g., women-owned small business), a company eager to obtain a SWaM certification cannot merely self-certify, but instead must apply for certification.
This post describes the various categories of SWaM certification and summarizes hurdles in the certification process.
Which SWaM certification applies to your business?
Generally, the first step in obtaining SWaM certification is to determine which certification applies to your business and whether your business satisfies the requirements for such certification. For the socio-economic certifications, such as minority-owned and women-owned, the minority or woman must own and control the business, which must be sufficiently evidenced in the submitted legal documents. Although this may sound simple, there are common pitfalls related to the organizational documents that give the SBSD grounds for denying certification, and, in such case, a denied applicant must wait one year to re-apply.
Several key categories include:
Small. To be classified as a “small business,” the business must be “at least 51 percent independently owned and controlled by one or more individuals who are U.S. citizens or legal resident aliens and, together with affiliates, ha[ve] 250 or fewer employees or average annual gross receipts of $10 million or less averaged over the previous three years.” Notably, the number of employees and average gross receipts are calculated by looking at the business applying for certification as well as all affiliates.
Whether a company is an affiliate of the applicant will be discussed in a subsequent blog post, but for right now just think of subsidiary companies and those under common ownership or control.
Micro. A business may be certified as a micro business if it may certify as a small business (above) and has 25 or fewer employees and average annual gross receipts of $3 million or less averaged over the previous three years. Again, the calculation of gross receipts and employees takes into account the receipts and employees of the applicant’s affiliates.
Women-Owned. To qualify as a “women-owned” business, the business must be at least 51% owned by women who are U.S. citizens or legal resident aliens. Both the management and daily business operations must be controlled by one or more women. As explained in further detail below, evidencing the requisite level of control tends to be difficult for many applicants.
Minority-Owned. Generally, a business may be certified as a minority-owned business if: (1) it meets the definition of minority-owned business under the statute or (2) the minority owner is regarded as such by the community of which the person claims to be a part.
To qualify as a “minority-owned” business, the business must be at least 51% owned by minority individuals who are U.S. citizens or legal resident aliens, and both the management and daily business operations must be controlled by one or more minority owners. Generally, the statute defines “minority individual” to include African Americans, Asian Americans, Hispanic Americans and Native Americans.
In making the determination whether a person is a minority individual, the department may be required to determine whether the person is regarded as a minority individual by the community in which he or she claims to be a part. In determining whether a person is regarded as a minority by the community of which he or she claims to be a part, the SBSD may consider whether:
The person regularly describes himself, in printed materials and orally, as a member of the community.
Whether the person historically has held himself out as a member of the community.
Whether the individual is a member of and actively participates in business, educational, charitable, civic, or community organizations, or activities made up of or traditionally identified with or attended by members of the community.
Whether other members of the community describe the person as a fellow member of the community.
Certification hurdles: ownership and control
As described above, there are a variety of hurdles to obtaining the applicable certifications, but perhaps the biggest problem is demonstrating the requisite level of ownership and control. In order to verify the legal ownership and control of the business, the SBSD requires the applicant to submit certain organizational documents. The required organizational documents depend on the type of entity involved but generally include, for an LLC, the articles of organization, operating agreement, and record of ownership interests, and for a corporation, the articles of incorporation, bylaws, shareholders’ agreement and stock certificates.
The broadest ownership policy is that the ownership of the business by women, minority or individual owners (in the case of a small business) must be real, substantial and continuing beyond the pro forma ownership of the business. In fact, the SBSD will look at the applicant’s organizational documents to verify the necessary ownership and that the individuals in question share in “all risks and profits in proportion to their ownership interests.”
To further complicate matters, the SBSD looks at an individual’s level and sufficiency of contribution of capital or expertise. For instance, for an applicant seeking the women-owned certification, the SBSD would look to determine whether the woman-owner contributed sufficient capital for her interest (e.g., did she pay a real and substantial amount for her stock?), and whether she has sufficient expertise to run the business (e.g., does she have the necessary training and experience?). In evaluating the sufficiency of a contribution, the SBSD finds “promises to contribute capital or expertise in the future; a note or notes payable to the business or its owners who are not themselves women, minority, or individual owners; or the mere participation as an employee” as insufficient contributions. These tend to be payments or contributions that are due in the future. Interestingly, we have even seen situations in which the SBSD has denied certification to an applicant based on the husband and wife owning the joint bank account that was drawn upon to purchase the wife’s stock in a corporation seeking certification as a women-owned small business.
As to whether the owner has sufficient expertise, the SBSD will review the prior work and educational experience of the applicant as set forth in the applicant’s resume. This may cause issues in a joint ownership situation, in which the woman or minority owner does not have the background and experience compared to the other owner.
Perhaps the most difficult hurdle is to “show evidence that the women, minority, or individual owners have control of the business.” In determining whether such control is sufficiently evidenced, the SBSD evaluates:
the broad governance authority
control of the day-to-day operations
the level of independence
The SBSD determines whether these factors are sufficiently present by reviewing the applicant’s organizational documents.
The organizational documents of the applicant must not contain any provision that may be read to restrict the ability of the women, minority or individual owners to exercise managerial control and operational authority of the business. One way the SBSD evaluates this requirement is by looking at the composition and powers of the Board of Directors. The SBSD requires that the board of directors (or other management committee) be composed in such a manner as to allow the women, minority, or individual owners to act in their sole and unfettered discretion. One common ground for denying certification based on this requirement occurs when the board includes more than one director or manager. In fact, if the board is comprised of two or more members, then the woman or minority member would depend on the other members to be present to create a quorum (be present to hold a meeting) and to affirmatively vote with the woman or minority owner. If the SBSD can conceive a situation in which a quorum would not be present, or the other members would not be required to vote with the woman or minority owner, the application will likely be denied based upon a lack of control.
Furthermore, applicants claiming women-owned or minority-owned status must have a woman or minority owner holding the highest executive officer position in the company. The best practice is for him or her to be the highest paid employee.
Operation and management
The women, minority or individual owners “must possess the power to direct or cause the direction of the management and policies of the business and to make the day-to-day decisions as well as major decisions on matters of management, policy, and operations.” On an operational level, such owners must actually operate the day-to-day business, which depends on the peculiarities of the industry of the applicant. In order to determine whether operational control exists, the SBSD looks at the experience of the owner by looking at the level of relevant educational and work experience and whether the necessary certifications are held. Further, the owner must demonstrate his or her role in making the day-to-day decisions and must also have the technical competence necessary to critically evaluate the work of the subordinates.
Managerial control, on the other hand, requires that the owner demonstrate that he or she guides the “future and destiny of the business.” In particular, the organizational documents and the record must demonstrate that the owner has the ability to control the basic business functions, such as executing contracts, hiring and authorizing payroll.
To satisfy the independence factor, the applicant must demonstrate that the “woman, minority, or individual owner’s expertise must be indispensable to the business’s potential success.” Moreover, such owner must be able to run the business without substantial reliance on the finances or resources of persons that are not eligible for certification. For instance, the SBSD will look at how the applicant obtains its employees, office space, equipment and other necessary items to see if there is undue reliance on another entity (or whether common ownership or control exists). An example of this is a construction company that is unable to obtain the necessary bonding and that unduly relies upon another entity for such bonding.
Given the tremendous value in obtaining a SWaM certification, the intricacies and hurdles in obtaining certification, and the one year waiting period after denial, applicants should ensure they have their house in order before applying for SWaM certification. One way to avoid these hurdles is to make sure the organizational documents satisfy complicated ownership and control requirements.