Evaluating Risks When Losing DBE / Veteran-Owned Business Status

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by a searcher from University of Chicago
in Philadelphia, PA, USA

1yr ago

Evaluating Risks When Losing DBE / Veteran-Owned Business Status

Hi all,

As a fund that is not qualified for any DBE designation, I wanted to see whether any of you have acquired a DBE, lost the designation, and then operated the business as a non-DBE and what the outcome was. I've looked a few sectors and companies where DBE status has been relevant for contract bidding and I have a sense of how I would approach the evaluation. It would be great to get your thoughts on evaluation, whether this is a deal breaker for you, and how this affects your structure and bidding. Also, if there are third-party consultants that support this evaluation, it would be helpful if you could name them in this thread.

The following is from a pre-LOI CIM I wrote earlier this year which laid out my thoughts on evaluating the impact of the lost WBE status if we were to proceed with the acquisition. In this case, the company was a subcontractor to prime contractors, and the prime contractors were responsible for allocating a portion of their work to DBEs to meet state requirements. The company was a WBE, but it only made up very small piece of total contract value and therefore didn't move the needle in terms of helping the prime contractor reach their DBE target. I'm happy to give further context to the deal if it is helpful. Hope this is useful for those of you looking at acquiring DBEs.

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[Company] obtained woman business enterprise (“WBE”) status as a qualifying woman-owned business. The owners of [Company] believe that this status has not made any material impact on the Company’s revenue opportunities. Under the disadvantaged business enterprise (“DBE”) program's requirements, prime contractors are required to allocate a portion of total contract value to DBE-certified businesses. [Company Owner] believes that DBEs need to make up 3-13% of total contract value; however, this is anecdotal and will need to be evaluated further in due diligence. Upon acquisition, [Company] would lose its WBE status, which could present a risk that certain contracts could be lost. However, Carnyx believes this risk is relatively limited:
• DBE standards often apply to large, multimillion dollar projects with many tasks in the project scope. This means that there are many areas where non-DBE subcontractors could be replaced with DBE if a higher percentage of such contracts is required. If [Company]’s loss of the DBE status puts a prime contractor below the DBE requirement, a range of other subcontractors – presumably those with lower work quality and history with the prime contractor – would be at risk of losing their contract.
• [Company's service] generally makes up a small percentage of total contract price (often low six figures or high five figures), so the loss of [Company]’s status may not, in many cases, impact the total contract composition such that incremental DBEs subcontractors need to be hired. Furthermore, larger subcontractors may be more likely to be targeted for replacement given their higher weighting in the total contract value.
• Contracts carrying a DBE goal are required to be awarded to a bidder who has made a good faith effort to meet the contract goal, which includes those that were unable to meet the target. [Company] suggests that under the state's DBE program, if hiring a DBE would cost more money than a non-DBE, prime contractors can hire the less expensive, non-DBE subcontractor.

Given the above points, we believe that there would be limited instances in which [Company] would be at risk of losing a contract. This scenario would involve: i) contracts in which [Company]’s loss of WBE status brings the total project DBE composition below the threshold, ii) [Company] is the weakest non-WBE in the remaining non-DBE contractorsredacted%) and is selected to be replaced, iii) the prime contractor is able to replace [Company] (i.e., does not fail its good faith effort search for an alternative subcontractor). Evaluating this risk will be a critical part of post-LOI due diligence.

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reply by a searcher 1yr ago
from University of Chicago in Philadelphia, PA, USA

Thanks for the all the feedback here. For those of you offering a conversation, this is a small opportunity (~$1mm of revenue) that could be an add-on for something else I'm looking at. I'm going to dig on this status. If it makes sense to reach out, I will - I appreciate your help.

One thing I would add to clarify here is that sometimes the title isn't tied to winning work because a contractor has more than enough qualified subcontractors, but they tick the box anyway, so the loss of status could have no impact, but I don't see a good way to evaluate that.

reply by a searcher 1yr ago
from University of Chicago in Philadelphia, PA, USA

This is awesome - I appreciate the depth here. One thing I would say, seeing as your header says you're exploring a search fund, is that using veteran status could be great for building a holding company for long-term cash flow, but not for search, as you noted.