Disabled Veteran Business Enterprise Program Review

analysis full AN LAO REPORT Disabled Veteran Business Enterprise Program Review GABRIEL PETEK | LEGISLATIVE ANALYST | DECEMBER 2025 SUMMARY As required by Chapter 80 of 2020 (SB 588, Archuleta), this brief reviews California’s Disabled Veteran Business Enterprise (DVBE) program, which is designed to support DVBEs by ensuring they receive a portion of state government purchasing contracts. The law requires state entities to set a goal of awarding at least 3 percent of their annual contract value to DVBEs. State law also establishes the Office of Small Business and Disabled Veteran Business Enterprise Services (OSDS) as the DVBE program administrator, directs it to implement policies to ensure that only eligible businesses participate, and requires it to track and investigate cases of program abuse and noncompliance. DVBE Program Implementing Recent Changes, But Key Challenges Remain. Overall, the state has implemented some recent statutory changes successfully (such as the substitution process described below), but the program is in transition as it is still implementing other changes. One current limitation is inconsistent data and uneven adherence across state entities. For example, while the state as a whole met the 3 percent participation goal in nine of the past ten years, only 57 percent of state entities required to report to OSDS met the target individually in 2023-24. Continued monitoring and improved reporting would enable a clearer evaluation of the program’s effectiveness and help inform decisions about future modifications. Brief Provides Key Metrics Required by SB 588. Pursuant to the direction in SB 588, we reviewed the available data on the following program characteristics: • Noncompliance and Program Abuse. Over roughly four years, OSDS investigated 230 cases of potential noncompliance. Underutilization—the failure of prime contractors (who are the entities directly awarded contracts) to provide the level of work committed to DVBE subcontractors—was the most commonly investigated violation. After OSDS investigations, roughly two-thirds of all closed cases resulted in no violation; about one-third resulted in sanctions, ranging from warnings to the loss of ability to do business with the state. • Withholding Payments. Senate Bill 588 requires state entities to withhold up to $10,000 from final payment owed if prime contractors fail to certify certain DVBE participation information. Lack of data prevents us from determining the effects of the policy on prime contractors’ compliance with DVBE program rules. Additionally, stakeholders have raised concerns about the $10,000 withholding amount—arguing it may be too small to influence behavior on large contracts and too large for small businesses to manage—though current evidence is inconclusive. • Substitutions. The state DVBE substitution process allows prime contractors to replace listed DVBE subcontractors with other DVBEs in certain cases. At least 50 prime contractors received approval for substitutions between 2021 and 2025. • Notifications. A generally accepted best practice is for program administrators to notify a DVBE subcontractor when they are named on a prime contractor’s bid. For state entities using the Financial Information System for California (FI$Cal), such notifications occur automatically, with 3,070 issued in 2024. It is unclear how consistently state entities not using FI$CAL are issuing notifications. www.lao.ca.gov 1 analysis full AN LAO REPORT Issues for Legislative Consideration. Going forward, we identify a few issues for the Legislature to consider: • To the extent the Legislature wants more definitive conclusions on the program’s outcomes, it could request an audit focused on state entities’ compliance with DVBE policies, the effects of recent changes, and measures to improve data quality and consistency. • If the Legislature wants to address stakeholder concerns about the $10,000 withholding, it could consider creating a sliding scale (with costlier penalties for larger contracts) or excluding small businesses from the policy. Alternatively, it could wait until more data has been collected showing the need for change. • If the Legislature is concerned about state entities not achieving the 3 percent goal, it could request OSDS to provide information on which entities meet the goal (and why) and which struggle (and why) to inform potential program changes. 2 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT INTRODUCTION Established in 1989, California’s Disabled This brief is provided in response to provisions Veteran Business Enterprise (DVBE) program of SB 588 that direct our office to review the DVBE is designed to support service-disabled, program. Specifically, SB 588 directs our office to veteran-owned businesses by ensuring they receive provide information on: a portion of state government purchasing contracts. • Noncompliance Reporting. Reports of However, two California State Auditor reports from noncompliance with the requirements of the 2014 and 2019 identified significant DVBE program DVBE program. deficiencies and recommended a list of reforms. • Complaint Tracking. Whether DGS is These reforms included changes to data collection tracking complaints of abuse of the program, and reporting and the transfer of program oversight and information about those complaints, from the California Department of Veterans Affairs if available, including the type of abuse, (CalVet) to the Department of General Services how it was reported or discovered, dates (DGS). In the years since the Auditor’s reports that specific actions were taken on the were released, state entities implemented the case, and preventive measures taken by recommended changes to administrative practices awarding departments. while the Legislature made various statutory • Notifications to DVBE Subcontractors. changes to the DVBE program. These include: Whether the awarding departments notified • Chapter 676 of 2019 (AB 230, Brough)— DVBE subcontractors when they were named which, among other things, requires prime on an awarded contract. contractors (the entities directly awarded a • Approval of DVBE Subcontractor contract) to use the DVBE subcontractors Substitutions. Whether prime contractors named in their original bids unless they receive received approval by DGS to replace DVBE approval from the state to substitute them. subcontractors identified by the prime It also requires prime contractors to certify, contractors in their bids or offers. at contract completion, (1) the percentage • Withheld Payments. Whether withholding of work the prime contractor committed to payments has deterred prime contractors from provide to a DVBE subcontractor, and (2) that failing to provide accurate certifications. the DVBE subcontractor has been paid for that work. Our review of the DVBE program relies on data • Chapter 80 of 2020 (SB 588, Archuleta)— and information provided by DGS program staff, which, among other things, directs state as well as discussions with various stakeholders entities to withhold up to $10,000 from the and CalVet. final payment otherwise due to a prime contractor if that prime contractor does not certify various pieces of DVBE-related information. This information includes the amount and percentage of work the prime contractor committed to provide initially and the actual amount paid to a DVBE subcontractor (as required by Chapter 676 and other provisions of existing law). www.lao.ca.gov 3 analysis full AN LAO REPORT BACKGROUND California’s Program Structured to veteran-owned businesses. This is commonly known as the “3 percent participation goal.” Support Service-Disabled Veteran State law also establishes the Office of Small Businesses Business and Disabled Veteran Business Enterprise California Has a Significant Number of Services (OSDS)—located within DGS—as the Disabled Veterans. Over 1.2 million veterans— administrator of the DVBE program. Other states about 8 percent of the total U.S. veteran and the federal government also have programs population—call California home. Approximately designed to support DVBE firms. (For more 380,000 California veterans (about 30 percent) have information on these other programs, see the a service-connected disability, which is defined nearby box.) as a disability that was caused (or made worse) by What Does OSDS Do in Support of the DVBE military service. Of California’s service-disabled Program? Among other things, OSDS certifies veterans, nearly half (approximately 174,000) have DVBE vendor eligibility; manages and responds to disability ratings exceeding 70 percent. (Higher complaints of program noncompliance, fraud, and disability ratings imply greater impacts on overall abuse; provides education, training, and support health and ability to function.) to DVBEs; and provides guidance to state entities The State’s DVBE Program Encourages to help them meet their 3 percent participation State Entities to Purchase Goods and Services goals. Since the passage of Chapter 730 of 2022 from Disabled-Veteran Owned Businesses. (AB 2019, Brough), OSDS must establish and take The purpose of California’s DVBE program, as remedial actions when state entities have failed outlined in state law, is to “address the special to meet their DVBE participation goals in three of needs of disabled veterans seeking rehabilitation five prior years. (Such remedial actions include and training through entrepreneurship and to removing purchasing authority; however, the list of recognize the sacrifices of Californians disabled proposed remedial actions was still under review during military service.” The law requires state in October 2025.) Additionally, OSDS prepares entities to set a goal of awarding at least 3 percent and publishes various reports on DVBEs and the of their annual contract value to service-disabled state program. Disabled Veteran Business Enterprise Contracting Goals in Selected Other States and the Federal Government • Illinois—State agencies and universities are encouraged to spend at least 3 percent of their procurement budgets with certified veteran-owned businesses. • Michigan—Michigan’s goal is to award at least 5 percent of total state expenditures for goods, services, and construction to qualified service-disabled veteran-owned companies. • New York—The Service-Disabled Veteran-Owned Business program participation goal in New York is set at 6 percent. • Washington—In Washington, state agencies have been charged with meeting a 5 percent veteran-owned business participation goal overall. However, individual agencies receive a customized target goal that may be more or less than this amount. • Federal—Between 1999 and 2024, the federal governments maintained an enterprise-wide goal of awarding not less than 3 percent of the total value of all contracts (prime and subcontract) to certified Service-Disabled Veteran-Owned Small Businesses. In 2024, federal policymakers increased this percentage by two points, to 5 percent. 4 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT How Does a Business Qualify as a DVBE? criteria). For example, in contracts awarded For the purposes of the state DVBE program, based on the lowest price, a bidder’s “price” a “disabled veteran” is defined as a veteran of can be adjusted downward for the purpose the U.S. military, naval, or air service, who has of awarding the contract. (The actual price a service-connected disability rating of at least charged to the state if the contract is awarded 10 percent, and resides in California. Vendors does not change.) Similarly, in contracts wishing to qualify as a DVBE apply for state awarded based on highest score, a bidder certification. Among other criteria, vendors must can receive additional points based on demonstrate that their businesses are: DVBE participation. • Majority owned (by at least 51 percent) • Reciprocity Partners—These cities, counties, by one or more disabled veterans; or, in a special districts, and other public entities business whose stock is publicly held, at least agree to accept and recognize the state 51 percent or more of the stockholders are DVBE certification as a valid credential, which disabled veterans; confers benefits similar to those above on DVBEs in their procurement processes. Key • Managed and controlled by one or more reciprocity partners include the City and disabled veterans; and, County of Los Angeles and many California • Located in the United States (and not a branch utility companies. or subsidiary of a non-U.S. business). • Certified DVBEs must reapply for certification How Many DVBEs Are There in California? every two years. As of June 2025, California had 2,118 certified DVBEs. By comparison, the average number of What Are the Business Advantages of DVBE certified DVBEs between the 2017-18 and 2023-24 Certification? DVBE-certified vendors receive the fiscal years was 1,774—ranging from a low of following financial and competitive advantages in 1,623 in 2018-19 to a peak of 2,070 in 2020-21. the state procurement process: The number of certified DVBEs with active state • DVBE Option—The DVBE option is a contracts is somewhat unclear. This is because procurement process that, under specified only state entities that use the Financial Information conditions, allows state entities to contract System for California (FI$Cal) are able to easily directly with a certified DVBE for goods and identify the number of unique DVBEs they contract services without going through the typical with. In 2023-24, 369 unique DVBEs were doing competitive bidding process. To qualify, the business as a prime contractor, and 220 were doing contract award must be either: (1) between business as subcontractors, with state entities that $5,000 and $250,000; or (2) for public works use FI$Cal. However, the actual number of unique contracts, an amount as otherwise provided DVBEs with active state contracts may be higher by the Director of Finance. State purchasers because some departments that make significant must receive price quotes from at least two use of DVBEs—such as the California Department certified DVBEs. This is intended to simplify of Transportation (CalTrans) and the California the contracting process both for the state Department of Corrections and Rehabilitation entity and the DVBE. (CDCR)—do not use FI$Cal. • DVBE Incentive—The DVBE incentive, How Much State Funding Goes to DVBEs? The on the other hand, provides a competitive state awarded $743 million across 20,838 contracts advantage to bidders who include a certified to DVBEs in 2023-24—or 4.6 percent of the DVBE subcontractor in their proposals. The $16 billion total reported contract dollars in incentive applies to most competitive state that year. This amount includes $626 million solicitations. Advantages to the bidder include from 150 state entities that must report DVBE bid price adjustments (in the case of lowest participation under state law (such as state price contracts) or point increases (in the government departments and agencies, which case of contracts awarded based on scoring OSDS refers to as “mandatory reporters”), and www.lao.ca.gov 5 analysis full AN LAO REPORT $117 million from 31 state entities that report Ensuring Only Eligible Vendors voluntarily (such as universities, departments Participate Has Been a Focus headed by constitutional officers and other Ensuring That Only Eligible Vendors independent state entities). As shown in Figure 1, Participate Has Been an Historical Challenge reported state contract dollars received by DVBEs With Violations Ranging From Inadvertent generally increased between 2018-19 and 2022-23. to Fraudulent. One historical challenge for Notably, reported state contract dollars—both programs like the state’s DVBE program, which going to DVBEs and overall—reversed this general directs procurement contracts to certain types trend and decreased between 2022-23 and of vendors, is preventing ineligible vendors from 2023-24. OSDS largely attributes this year-over-year participating. Ineligible participation can range from decrease to a statewide expenditure reduction the inadvertent failure to comply with state law and directive issued by the Department of Finance in policy (such as failing to submit correct paperwork), December 2023 that was intended to help address to program abuse (such as substituting a DVBE the fiscal difficulties facing the state. subcontractor without approval), to outright fraud Is the State Meeting the 3 Percent (such as falsely claiming to be a disabled veteran). Participation Goal? According to information These categories are not exclusive and can overlap. provided by OSDS, in the aggregate across all More Serious Instances of Program Abuse reported contracts for mandatory reporters, Have Typically Occurred in One of Two Ways. the state met the 3 percent participation goal in There are two primary means by which vendors nine of ten years between 2013-14 and 2023-24. may engage in program abuse or fraud. The first However, although the state as a whole generally occurs when the business itself claims to be a met the 3 percent participation goal, state entities DVBE when it is not. In such cases, the vendor are encouraged to achieve the goal individually represents their business as both owned and and many do not. In 2023-24, for example, 85 of operated by one or more service-disabled veterans 150 mandatory reporters (57 percent) met the DVBE when both conditions have not actually been met. participation goal while 58 (39 percent) did not. The second occurs when prime contractors claim (Seven, or 5 percent, made no reportable awards.) to be doing a stated amount of subcontracting with a DVBE when they are not. This could be done a number of Figure 1 ways, including: State Contract Dollars to DVBEs • A prime contractor names Generally Increased Between 2017-18 and 2023-24 a DVBE subcontractor as (In Millions) a project partner in order to win a bid, but that DVBE $1,200 subcontractor may not know they were included in 1,000 974 the application. 800 723 743 • A prime contractor 636 substitutes an original 600 545 461 434 DVBE subcontractor with a 400 different subcontractor after winning the bid (without 200 state approval). • A DVBE subcontractor serves 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 as a pass-through entity to create the appearance of DVBE = Disabled Veterans Business Enterprise. participation but the DVBE 6 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT does not (in actuality) provide goods and and helps catch vendors that may be services or perform the work as stipulated. misrepresenting their status. (In other words, the DVBE must actually • Notification Practices are designed to perform work and cannot simply lend its ensure that the state alerts DVBEs when certification to another business to help win they have been named as part of a bid. This a bid.) This is called a “commercially useful helps the state catch vendors who might be function” or “CUF” violation. misleading state procurement officials into • A prime contractor commits a certain thinking a DVBE subcontractor is involved in portion of the work to a DVBE subcontractor the bid when the DVBE is unaware they have as part of a bid, but then does not fully been named. meet that commitment. This is known • Substitution Limitations seek to prevent as “underutilization.” prime contractors from replacing a DVBE subcontractor named in a bid with a different Certain DVBE Program Elements and vendor after winning the contract. Policies Have Been Designed to Address Noncompliance and Program Abuse. Such • Withholding Payment thwarts underutilization elements and policies include: and CUF violations by allowing state contract managers to withhold a portion of a prime • Certification Compliance Review is a contractor’s final payment until that contractor process by which program staff look carefully certifies under penalty of perjury that the at a vendor’s file to ensure all supporting named DVBE subcontractor did the work and documentation is present and accurate. was paid as per the provisions in the bid. This helps identify inadvertent noncompliance REPORTS OF PROGRAM ABUSE AND NONCOMPLIANCE Senate Bill 588 directs our office to review certifications each month and recertify the eligibility noncompliance reporting and complaint tracking. of all DVBE firms every two years. Referrals and Below, we provide data on the number of cases of complaints of alleged DVBE program abuse can potential noncompliance and program abuse, the come from the public, state entities (including most common type of alleged abuse, how OSDS awarding departments), or OSDS program staff. responds to these cases, and whether state entities Most commonly, reports of alleged DVBE program take additional measures to prevent it. As described abuse come through state entity referrals. Prior more fully below, OSDS has investigated over to referring an allegation to OSDS, the awarding 200 cases of potential noncompliance and program entity must investigate the alleged violation and abuse. The most commonly reported type of prepare written findings. These findings are then alleged program abuse was underutilization. submitted to OSDS. OSDS reviews the findings and Most cases resulted in a finding of no violation, but determines an appropriate response, which could about one third resulted in a penalty or sanction of include, among other possibilities, a warning letter some kind. to the prime contractor, or referral to the Attorney OSDS Has Investigated 230 Cases of General (for the most serious allegations). Of the Potential Noncompliance and Program Abuse. 230 investigations initiated between January 2021 Cases of potential noncompliance and program and April 2025, 163 were certification compliance abuse may be identified through certification reviews designed to ensure vendor certification files compliance reviews, complaints, or referrals. were current, complete, and in compliance; and Certification compliance reviews generally start with 67 involved cases of alleged program abuse. OSDS program staff, who randomly audit DVBE www.lao.ca.gov 7 analysis full AN LAO REPORT Underutilization Is the Most Common Type Unclear If State Entities Take Additional of Alleged Program Abuse Referred to OSDS. Preventative Measures in Response to Case OSDS recognizes five categories of alleged Data. Senate Bill 588 requires our office to program abuse violations: underutilization, illegal review whether OSDS is tracking preventative substitution, cases where both underutilization and measures taken by state entities in response to illegal substitution occur, CUF, and certification cases of program abuse and noncompliance, if fraud. As shown in Figure 2, of the 67 investigations available. Noncompliance and program abuse into reported program abuse that were initiated case data provided by OSDS does not link specific between January 2021 and April 2025, the majority preventative measures taken by state awarding (34) were for underutilization. entities on a case-by-case basis with specific OSDS Responded in Various Ways to instances of confirmed program abuse. However, Program Noncompliance and Abuse with the primary means by which state entities prevent Severe Penalties Being Rare. As shown in DVBE program abuse is through their overall Figure 3, nearly two-thirds (64 percent) of the compliance with statewide DVBE contracting closed certification compliance reviews and policies and best practices, such as the withholding program abuse investigations resulted in a finding payments, substitution, and notification practices. of “no violation.” About a third (33 percent) resulted Further, OSDS has various general mechanisms to in a sanction of some kind—that is, the vendor’s capture feedback on state entity performance (such certification was discontinued, they received a as surveys and reporting) and to improve state warning letter, or (in the most egregious cases) a entity compliance (such as training in best practices vendor’s executives were suspended from doing and improvement plans). Therefore, while program business with the state. A total of 3 percent of abuse case data do not link changes in department closed cases resulted in a mixed outcome—which policy or contracting rules on a case-by-case basis means the firm lost one certification but kept in response to specific instances of program abuse others. As of December 2024, two DVBE firms or noncompliance, these activities are occurring were included on OSDS’ publicly available list of on a statewide level. (Below we provide more suspended firms. information about the implementation of some of these statewide preventative measures.) Figure 2 Underutilization Was the Most Common Type of Alleged Violation January 2021 to April 2025 Number of Cases Alleged Violation Definition Reported Underutilization Occurs when a prime contractor does not use a Disabled Veteran Business 34 Enterprise (DVBE) subcontractor to the extent listed in the initial bid without a justified reason, such as a change in the scope of work. Illegal Substitution Occurs when a listed DVBE subcontractor is replaced by another DVBE 8 subcontractor without state approval. Underutilization and Combination of these categories. 11 Illegal Substitution Commercially Useful Occurs when a prime contractor lists a DVBE on the contract to give the 7 Function appearance of participation, but the DVBE does not (in actuality) provide goods and services or perform the work as stipulated. Certification Fraud Occurs when a DVBE willingly obtains or maintains a certification despite knowing 7 they do not meet certification requirements. 8 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT Figure 3 Most Investigations Found No Violation, About One-Third Resulted in a Sanction 230 Total Investigations = 211 (Closed), 15 (Open), 4 (Closed Due to Delay) All Cases Sanctions Certification Discontinued No Violation Sanctions 76 50 Warning Letter 135 17 Mixed Outcome 7 Closed (Delay) Open 4 Suspended 15 2 Mixed Outcome = Vendor had one or more certifications and lost one (or more) but not all of them. Closed (Delay) = Case dismissed due to an unreasonable delay in bringing the claim. Suspended = Ability to do business with the state suspended. POLICIES FOR ENSURING ELIGIBLE VENDORS PARTICIPATE Senate Bill 588 directs our office to report on accordance with state law. This data serves withheld payments, substitutions, and notifications. as the basis for our analysis (as follows in this Overall, we found that a lack of consistently reliable section) of the effects of the withholding payments data made it difficult to determine the programmatic policy. However, as we reviewed the data, we effects of the withheld payments policy. We also found several errors. We worked with OSDS on a found that the state has a process for substituting case-by-case basis to correct these errors, but it DVBE subcontractors; and—at least for state is not clear how pervasive these problems are or if entities that use FI$Cal—a system to automatically this data is reliable. Although we present the data notify DVBEs when they are included in a bid. in this section in an effort to be responsive to our The following sections describe these findings statutory reporting requirements, we encourage more fully. readers to be mindful of the potential limitations of this information. In addition, OSDS reports that it Withholding Payments took a few years to fully stand-up the withholding Data Quantity and Quality Problems Prevent policy and ensure that awarding entities were Us From Drawing Clear Conclusions About correctly withholding payments as required. Policy Effects. In response to our request for As a result, only one year of data that is roughly information, OSDS provided data on deductions comprehensive—encompassing the 2023-24 fiscal made from final payments owed to state contractors year—was available for our review. who had failed to certify the participation of their DVBE subcontractors at project completion in www.lao.ca.gov 9 analysis full AN LAO REPORT State Law Directs State Entities to Withhold contractors. About half of prime contractors appear Up to $10,000 from the Final Payment Due to have cured, but we could not establish a causal to Prime Contractors Working with DVBE link between the withheld payment and decision Subcontractors. As previously noted, Senate to cure based on the data provided. For example, Bill 588 directs state entities to withhold up to prime contractors may have submitted certifications $10,000 from the final payment otherwise due to in direct response to the withheld payment—which a prime contractor if that prime contractor fails suggests that the withheld payment deterred them to certify, under penalty of perjury, the identities from failing to certify. Or they may have just been of the DVBE subcontractors who participated in slow to report or failed to understand reporting the performance of a state contract, the amount instructions. With respect to the accuracy of the of work those subcontractors were supposed certifications submitted by prime contractors, our to do (and did), and payments made for that findings are also indeterminate. Although we found work. This certification is due upon completion instances of inaccurate reporting in the data, we of the contract, no later than final invoice. If the could not determine if the inaccuracy stemmed certification is not received when due, state entities from the prime contractor, the awarding state entity, must withhold up to $10,000 of the final payment. or both. The withhold is temporary at this stage and the Fixed $10,000 Withholding Limit May Have prime contractor can still receive these funds if Limited Effect for Large Contracts… Senate Bill they submit their certifications (called “curing”) 588 established a $10,000 limit on state withholding within 30 days after notice. The withhold becomes authority, regardless of the size of the contract. permanent—and the prime contractor forfeits the For high dollar value contracts—often reaching withheld amount—if they fail to cure. $1 million or more—this amount of withholding With Limited Data Available, About Half could provide limited financial incentive to complete of Withholds Are Cured. In 2023-24, state the certification process. For example, in such entities reported a total of 98 contracts with initial cases, it might be more cost-effective for prime withholds, 11 of which became permanent. Of the contractors to simply forego the $10,000 rather remaining 87—that is, those withholds that had than utilize and pay for the full value of a DVBE not (or not yet) become permanent—45 were subcontractor’s work. While such behavior seems cases where the prime contractor had met their plausible in theory, our review of the 2023-24 data commitment to their DVBE subcontractor, but there found no clear pattern of permanently withheld was a delay in the state’s receipt of this information. payments being disproportionately associated with Based on the data provided, it appears these cases high dollar value contracts. were cured (or should have been). The outcome in …But May Be Challenging for Small the remaining 42 withholds was indeterminate for a Contracts. The $10,000 withhold could be a variety of reasons, including a lack of data, change potential obstacle to partnerships between prime in the scope of work, or the state entity was still contractors and DVBEs on smaller contracts. waiting for certification. A total of 13 contracts— (Smaller contracts, as used here, are those including 5 where the withhold had become transactions worth less than $10,000.) Data permanent and 8 where the outcome was still provided by OSDS shows a precipitous reduction indeterminate—were referred to compliance. in the number of smaller contracts with DVBE Unclear if Withholding Policy Has Deterred subcontractors in the years after the withholding Prime Contractors From Failing to Provide policy was adopted—dropping from 742 such Accurate Certifications. As noted above, the transactions in 2020-21 to 348 in 2023-24 2023-24 withheld payments dataset contains many (53 percent). OSDS theorizes that this change may instances of prime contractors who failed to provide be driven by a drop in the number of partnerships certification at contract completion as required. between small business prime contractors and In response to this failure, state agencies withheld DVBEs. (Small businesses may not be able to up to $10,000 of the final payment due to those pay their DVBE subcontractors in full at contract 10 LEGISLATIVE ANALYST’S OFFICE analysis full AN LAO REPORT completion without full and final payment from the The substituting DVBE vendor must perform state, particularly in cases where total contract work stated in the original bid and cannot start value is below the $10,000 threshold.) However, the work until OSDS has issued an approval in writing. data provided by OSDS were preliminary and do not In general, the process for making such changes conclusively demonstrate a uniquely negative effect includes notifying the listed DVBE subcontractor, on small businesses. Instead, the data also show a the proposed replacement subcontractor (which drop of equal magnitude in the number of smaller must also be a DVBE), and the awarding state contracts involving DVBE subcontractors that are entity. The listed, original DVBE can oppose the partnered with larger businesses. Unfortunately, request to substitute. The request to substitute is OSDS did not provide more comprehensive data reviewed by the awarding entity, and if tentatively that could be used to verify or fully assess these approved, sent to OSDS for final review and trends, such as annual data going back several decision. Substitutions occurred at least 50 times years before the policy was implemented. Further— between January 2021 and April 2025. even with a decline in small contracts—the payment Notifications withholding policy might not be the main reason for this change. One or more other factors—such FI$Cal Automatically Sends Notifications to as the change in state purchasing as a result of DVBEs When They Are Named on a Contract. the COVID-19 pandemic or changing economic Notifying subcontractors when they are named on conditions affecting businesses that compete for a bid is a best practice, not a requirement. For state small contracts—might also be at play. As a result, entities that use FI$Cal, DVBE notification occurs the effect of the payment withhold policy on small when the contract or purchase order is approved. firms or small contracts more generally to date is FI$Cal automatically generates and sends letters not clear. to the DVBE subcontractors named on awarded contracts. In 2024, the FI$CAL system issued Substitutions 3,070 such notifications. At Least 50 Prime Contractors Received Unclear if State Entities That Do Not Use Approval for a DVBE Subcontractor FI$CAL Are Notifying DVBEs as Consistently. Replacement via the State Substitution State entities that do not use FI$Cal process Process. Under the state DVBE substitution DVBE notifications manually. As a result, we were process, a prime contractor may replace the not able to determine how many such entities listed DVBE subcontractor with another certified have adopted notification as a practice or how DVBE subcontractor under certain conditions. consistently it occurs. We asked two non-FI$Cal Specifically, regulations authorize a substitution if agencies that tend to work consistently with the originally named DVBE subcontractor: DVBEs—CalTrans and CDCR—for the number • Fails or refuses to execute the contract. of such notices they sent in the past five years. CalTrans reported that they had sent none, but • Goes bankrupt or becomes insolvent. noted that they post awarded construction contract • Fails or refuses to perform the work. information (including DVBE subcontractors) to their • Refuses or fails to meet bond requirements. website. CDCR indicated that they notify DVBE • Was listed as a result of inadvertent subcontractors routinely, but that they could not clerical error. easily track a total number of such notifications • Is not licensed. sent. CDCR estimated, based on the number of • Has performed work that the awarding entity contracts awarded that included a commitment to a determines unsatisfactory. DVBE subcontractor, that they sent 18 notifications in calendar year 2024 and 20 in 2023. • Is ineligible to work on a public works contract, or • Has been determined to be irresponsible by the awarding entity. www.lao.ca.gov 11 analysis full AN LAO REPORT ISSUES FOR LEGISLATIVE CONSIDERATION DVBE Program Changes Implemented for large contracts. Similarly, with minimal data Relatively Recently, May Benefit From provided, there may be some indication that Additional Assessment in the Future. The the $10,000 limit might be too high for small Legislature made several changes to the DVBE contracts. If the Legislature wanted to address program in recent years. The program also received these concerns its options could include a sliding additional funding and staff in 2023-24 to enable scale (with costlier penalties for larger contracts) it to undertake these additional authorities and or excluding state-certified small businesses from responsibilities. As many of these policy changes the withheld payments policy all together. However, were still in progress or had only recently reached the data supporting the need for such changes is full implementation at the time this brief was being comparatively weak. Accordingly, the Legislature written, our findings reflect only a limited time could wait to make further changes to the withheld under the new structure. Also, we identified several payment policy until OSDS has had time to collect a errors in some of the reported data on withheld larger and better dataset on withheld payments. payments. Previous reports from the State Auditor Number of State Entities Not Meeting the raised related concerns about state entity reporting. 3 Percent Participation Goal is a Concern… Accordingly, to the extent the Legislature wants Still Unknown if Recent Policy Changes Will more definitive conclusions on the implementation Help. As noted above, 39 percent of mandatory of the withholding payment policy by state entities reporter state entities did not meet the program’s or its effects on prime contractors who partner 3 percent participation goals in 2023-24. Policy with DVBE subcontractors, it may wish to consider changes made in recent years—such as those requesting a follow-up audit focused on how well requiring state entities to make continuous efforts state awarding entities are complying with state to expand the pool of DVBE bidders and giving DVBE policy overall, the effects of recent policy OSDS the authority to establish remedial actions changes, and measures to improve the quality and against state entities that fail to meet the 3 percent consistency of data reported by awarding entities participation goal—may help but it is too early to to OSDS (including withheld payments data and know. The Legislature could benefit from additional number of unique DVBEs with state contracts). The information focused on which state entities have State Auditor is well positioned for this task given its consistently succeeded in reaching their 3 percent previous experience auditing the program. goals (and why) and on which state entities Various Options Available to Address consistently struggle (and why). Accordingly, the Stakeholder Concerns About $10,000 Withheld Legislature could direct OSDS to compile and Payment Limit. Although the preliminary data report on this information to better understand on the effects of the $10,000 withheld payment opportunities and challenges in state DVBE policy was inconclusive, stakeholders consistently contracting, which could, in turn, inform potential reported that the $10,000 limit may be too low modifications to the program. LAO PUBLICATIONS This report was prepared by Heather Gonzalez, and reviewed by Drew Soderborg and Ross Brown. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, California 95814. 12 LEGISLATIVE ANALYST’S OFFICE