Pass Through Businesses – What Are They? & Are they Legit?

— BY Kelly Jeffcote AND Fred McKinney, PH.D

Ever since public and private programs were created in the late 1960s to increase the utilization of diverse businesses, there have been “entrepreneurs” who have taken advantage of the programs by creating businesses that appear to be eligible for the benefits of these programs but are not. The most common offenders of these programs are companies that put eligible persons in charge of businesses, but are owned, managed, and controlled by persons who would not be eligible if they were listed as the owners. Third-party certification was designed to address this problem of what are known as “fronts”.

Certification has effectively dealt with ethnic minority front companies, although “entrepreneurs” continue to attempt to circumvent the rules. I recall a case in Connecticut in 2014 when I received a call from the Department of Justice about Manafort Brothers, a Connecticut based construction firm that set up a minority front company to as a subcontractor on a Department of Transportation contract. Manafort Brothers was fined $2.4 million and suspended from further DOT contracts.

A problem that still exist when it comes to legitimacy has to do with M/WBE companies that claim to function like brokers but do significantly less. These companies “buy” products from non-M/WBE firms and sell to corporations and public sector entities without adding value to the product. The buying organization claims the spending as minority spend and the M/WBE and their non-M/WBE “supplier” distribute the proceeds. There is a fine line that separates legitimate brokering businesses from questionable pass-through businesses. Brokers provide value to customers in markets – passthrough businesses do not.

The key distinction between brokers and pass-throughs is control. Brokers provide value to customers because they have the independence to direct their clients to products and companies that best meet their clients’ needs. Passthroughs are “captured” by their primary supplier and are often restricted to selling the goods and services of a single supplier. This distinction is the tell-tale sign of whether your company is buying from a legitimate M/WBE broker or whether it is buying from a pass-through. Pass-through companies lack control over their product offerings and the companies they represent.

The passthrough is little more than a glorified salesperson. I have seen examples of passthrough companies where the M/WBE is physically located within their supplier’s facilities. While it might be an efficient way for the M/WBE passthrough to organize its activities, this makes the business un-certifiable. But even if the pass-through has its own location, if it is only selling one company’s product, it fails to offer the independent advice and direction that is essence of the value provided by brokers.

Some industries are more likely to have pass-through companies posing as M/WBEs. These are often low-margin products, often in technology where there is high industry concentration. These industries often have high barriers to entry, and the only way for M/WBEs to participate is through partnerships. It would be incorrect to conclude that all M/WBEs in these industries are pass-throughs. Some M/WBEs in these spaces have developed not only strong downstream relationships with multiple companies, they also have strong relationships with clients based on their industry and product knowledge.

Buying organizations can test whether they are dealing with a M/WBE passthrough by asking the business for products from multiple and competing companies that they want to consider. If the potential seller has only one company’s product, or that company’s product is always less expensive than their supplier’s competitor companies, then chances are you are dealing with a passthrough.

If nobody was harmed bypass-throughs, there would be little to complain about. After all, the passthrough business is employing minority and women who can be generating significant income for themselves, their families, and their communities. But there is harm if the pass-through and their non-minority supplier are blocking the success of M/WBE firms that compete with the non-minority supplier for the same or similar lines of business. In these situations, or even where there is no significant M/WBE, the pass-through and their supplier are discouraging legitimate M/WBE business development in these industries because buying firms already have a “minority” incumbent.

I have heard from some MBEs during the study I am conducting that they have been solicited by corporations to serve as passthroughs even though the MBE has a legitimate book of business. The attraction of additional income for both parties is powerful, but fortunately, this particular MBE declined to participate for fear of ruining their reputation.

What should buying organizations do when they realize they are dealing with a passthrough? My suggestion is for the buying organization to identify a legitimate M/WBE supplier and discontinue the relationship with the passthrough and their non-minority supplier. What should M/WBEs do who are operating as pass-throughs? They should start operating as legitimate brokers or be put out of business and at the very least lose the ability to become certified.

The opinions expressed in this article is solely those of the author and not necessarily those of DiversityPlus Magazine.