Do Your Company's Legal Documents Support Your Special Status?

Have you set up your company to qualify for a special status, such as a women-, veteran-, or minority-owned business? If so, do your corporate legal documents support that status?

Many small business owners believe their business qualifies if the owner who has special status owns 51% or more of the company. That is true, but other factors also must be met that often are overlooked or misunderstood.

The legal documents must show that the company is owned, operated, and controlled by the individual with the special status. Small businesses often satisfy the "owned by" factor, but their legal documents contain provisions that negate the "operated by" and "controlled by" factors. If the legal documents leave the door open for a non-qualified owner, officer, or director to gain the ultimate authority to operate or control the company, even if that hasn't yet happened in reality, then the company will not qualify for or lose its special status. Many times, this issue is not discovered until the certifying agency or organization reviews the company's legal documents.

This problem might arise for a number of reasons. If you set up your company without the help of a lawyer, you might use form documents that don't take into account your intention to qualify the company for a special status. Even if you engage a lawyer to help you, if he is unaware of your intentions, then he probably will use his own form documents that don't contain provisions supporting the special status.

Another common problem I see arises when non-qualified individuals are elected to a company's board of directors or board of managers. If the board consists of an equal number of qualified individuals and non-qualified individuals, then the qualified individuals no longer control the company because the non-qualified individuals can veto the qualified individuals' decisions (called "negative control"). The non-qualified individuals possession of negative control (even if they don't actually exercise it) destroys the qualified individuals' control of the company, which means the company won't qualify for its special status.

Or, the ownership structure of your company might change over time so that legal documents that worked when you set up the company may no longer support the special status after ownership changes. For example, if the qualified individual owned 100% of the company at startup, but subsequently gave equity in the company to a non-qualified individual, such as a key employee, the legal documents might inadvertently open up the possibility that the non-qualified individual could negatively control the company.

These are just a few examples I've seen.

Losing special status is a big deal if your company relies on that status to win and keep key contracts. If you own a company with special status, I recommend you review your legal documents to determine whether they support the special status. You should also review them each time you make an ownership change to confirm they will continue to support the special status after the change. If the legal documents don't support the special status, then you should amend them so they do so.