Ownership Control and Independence: Keys to Obtaining DBE Certification

When reviewing your Disadvantaged Business Enterprise (DBE) certification application the certifying agency seeks, at a minimum, to determine whether a socially and economically disadvantaged person (S&ED) owns 51% of the company and whether the S&ED meets the personal net worth requirement of the program. 

 But in order to be certified, the S&ED must also show true ownership of the firm, independence from any other company and the ability to control the firm. If the S&ED owner(s) does not possess the power to direct or cause the direction of the management and policies of the firm, certification can be denied. Similarly, if the disadvantaged business owner’s contribution of capital to acquire her ownership interest in the firm was not real, substantial, and continuing, certification can be denied. Likewise, if the socially and economically disadvantaged person has no experience in the firm’s line of business, certification can be denied.  A review of rules regarding ownership, control and independence follows.

OWNERSHIP

To be an eligible DBE, the rules state in part, that a firm must be at least 51 percent owned by socially and economically disadvantaged individuals.   In the case of a corporation, such individuals must own at least 51 percent of the each class of voting stock outstanding and 51 percent of the aggregate of all stock outstanding.   In the case of a partnership, 51 percent of each class of partnership interest must be owned by socially and economically disadvantaged individuals.  Such ownership must be reflected in the firm’s partnership agreement.  In the case of a limited liability company, at least 51 percent of each class of member interest must be owned by socially and economically disadvantaged individuals.

The rules further state that contributions of capital or expertise by the disadvantaged owner to acquire an ownership interest in the participating DBE business be real and substantial and continuing, going beyond pro forma ownership of the firm as reflected in ownership documents.

Under the rules, contributions of capital or expertise by the socially and economically disadvantaged owners to acquire their ownership interests must be real and substantial. Examples of insufficient contributions include a promise to contribute capital, an unsecured note payable to the firm or an owner who is not a disadvantaged individual, or mere participation in a firm’s activities as an employee.

For purposes of determining ownership, certifying agencies are required to  presume as not being held by a disadvantaged individual, all interests in a business or other assets obtained by the individual as the result of a gift, or transfer without adequate consideration, from any non-disadvantaged individual or non-DBE firm who is (i) involved in the same firm for which the individual is seeking certification, or an affiliate of that firm; (ii) involved in the same or a similar line of business; or (iii) engaged in an ongoing business relationship with the firm, or an affiliate of the firm, for which the individual is seeking certification.

To overcome this presumption and permit the interests or assets to be counted, the rules state that the disadvantaged individual must demonstrate by clear and convincing evidence, that (i) the gift or transfer to the disadvantaged individual was made for reasons other than obtaining certification as a DBE; and (ii) the disadvantaged individual actually controls the management, policy, and operations of the firm, notwithstanding the continuing participation of a non-disadvantaged individual who provided the gift or transfer.

ACTUAL CONTROL

The rules require that the disadvantaged owner possess the power to control day-to-day and major decisions of their firms in critical matters.  Non-disadvantaged persons may be involved in a DBE firm as owners, managers, employees, stockholders, officers, and/or directors. However, non-disadvantaged persons must not possess or exercise the power to control the firm, or be disproportionately responsible for the operation of the firm.

The rules state in part, that a disadvantaged owner may delegate various areas of the management, policy making, or daily operations of the firm to other participants in the firm, regardless of whether these participants are disadvantaged individuals.  Such delegations of authority must be revocable, and the disadvantaged owner must retain the power to hire and fire any person to whom such authority is delegated.  The managerial role of the disadvantaged owner in the firm’s overall affairs must be such that the certifying agency can reasonably conclude that the disadvantaged owner actually exercises control over the firm’s operations, management, and policy.

The rules further require that the disadvantaged owner have the technical competence and experience directly related to the type of business in which the firm is engaged and the firm’s operations. The disadvantaged owner is not required to have experience or expertise in every critical area of the firm’s operations, or to have greater experience or expertise in a given field than managers or key employees. The disadvantaged owners must have the ability to intelligently and critically evaluate information presented by other participants in the firm’s activities and to use this information to make independent decisions concerning the firm’s daily operations, management, and policymaking. Generally, expertise limited to office management, administration, or bookkeeping functions unrelated to the principal business activities of the firm is insufficient to demonstrate control.

Finally, the rules state in part, that a disadvantaged individual may control a firm even though one or more of the individual’s immediate family members (who themselves are not socially and economically disadvantaged individuals) participate in the firm as a manager, employee, owner, or in another capacity.  If the certifying agency cannot determine that the disadvantaged owners — as distinct from the family as a whole — control the firm, then the disadvantaged owners have failed to carry their burden of proof concerning control, even though they may participate significantly in the firm’s activities.

INDEPENDENCE

The rules provide that only an independent business may be certified as a DBE.  An independent business is defined as a company whose viability does not depend on its relationship with another firm or firms.  In determining whether a potential DBE is an independent business, certifying agencies scrutinize relationships with non-DBE firms, in such areas as personnel, facilities, equipment, financial and/or bonding support, and other resources.  They consider whether present or recent employer/employee relationships between the disadvantaged owner(s) of the potential DBE and non-DBE firms or persons associated with non-DBE firms compromise the independence of the potential DBE firm.  They also examine the firm’s relationships with prime contractors to determine whether a pattern of exclusive or primary dealings with a prime contractor compromises the independence of the potential DBE firm. 

TIPS FOR NOT BEING DENIED.

            Based on the above, a company desiring to be certified should ensure that it doesn’t make the following mistakes:

  •  Ensure that any transfer of stocks/shares or ownership does not coincide with the submission of your DBE application. 
  • Avoid transferring stock/shares/ownership as gifts or with no or little exchange of funds. 
  • If the S&ED individual has no experience in line of business ensure that the S&ED obtains formal training and or degrees or certifications in the line of business. 
  • Avoid giving previous employers substantial ownership interests in the DBE business. 
  • An S&ED individual who is still employed by a company in the same line of business as the DBE will be sure to receive extra scutiny. 
  • If ownership of the company goes from a non-disadvantaged to a S&ED it is preferable that the former owners do not remain with the company. 
  • Avoid discrepancies between Operating Agreement and Partnership Agreement, Articles of Incorporation, etc. 
  • When possible, ensure that the S&ED individual lives in the same City as the principal place of business of the DBE company.