/>iMergers and acquisitions (M&A) involving government contractors present unique challenges and considerations that require meticulous due diligence. Unlike purely commercial deals, government contracts introduce layers of regulatory compliance, security requirements, and approval processes that can significantly affect deal structure, valuation, and risk. This blog post outlines some of the basic best practices for due diligence when acquiring or selling a business that performs U.S. government contracts.
Assess Government Contracting Status Early
Early in the due diligence process, buyers should determine whether the target is a prime contractor, subcontractor, or both, and identify all relevant contracts, subcontracts, and task orders. It is important to understand the customer base — whether it’s DoD, civilian agencies, or state/local governments — as each target presents different risks and obligations.
Review Contract Performance and Compliance History
Key questions to answer during due diligence include:
- Has the contractor met performance milestones and delivery requirements?
- Are there any pending or past disputes, cure notices, terminations for default, or performance issues?
- Are there any audit findings or noncompliance issues reported by the Defense Contract Audit Agency (DCAA) or inspector general?
Moreover, understanding the target’s history with compliance — including adherence to the Federal Acquisition Regulation (FAR), Cost Accounting Standards (CAS), and agency supplements (like DFARS) — is essential.
Analyze Past Performance
The target company’s past performance record is a key asset in government contracting. However, an acquiring company must ensure that this past performance will be recognized in future bids. The FAR allows agencies discretion in considering the past performance of predecessor companies (FAR 15.305(a)(2)(iii)).
Evaluate Representations, Certifications, and Registrations
Ensure that all representations and certifications made in the System for Award Management (SAM) and on contract solicitations are accurate and current. Check for proper registrations, including:
- SAM.gov
- NAICS code alignment
- Small business or socioeconomic certifications (e.g., 8(a), HUBZone, SDVOSB, WOSB, etc.)
Misrepresentations can lead to False Claims Act liability and/or suspension or debarment.
Identify Organizational Conflicts of Interest (OCI)
Conduct a thorough analysis of potential OCIs that could impair objectivity or create unfair competitive advantages post-closing. This is especially important if the buyer already holds government contracts that could overlap with the target’s portfolio.
Understand Novation Requirements
Government contracts are not automatically assignable. If the transaction constitutes a change of ownership requiring a novation agreement under FAR 42.1204, the buyer must:
- Notify the relevant contracting officer(s)
- Prepare a novation package, including the purchase agreement and corporate documentation
- Be aware that novation approval is discretionary and can delay closing or transition
Some buyers structure transactions to avoid novation altogether, such as through equity purchases.
Review Security Clearances and Facility Requirements
If the target holds facility security clearances (FCLs) or performs classified work, due diligence must verify:
- That the clearances are active and match the scope of work
- Personnel clearances (PCLs) and any foreign ownership, control, or influence (FOCI) mitigation plans
- Compliance with the National Industrial Security Program Operating Manual (NISPOM)
Post-closing, the Defense Counterintelligence and Security Agency (DCSA) will review the transaction to ensure continued eligibility for classified contracts.
Scrutinize Pricing and Cost Accounting Practices
For cost-reimbursable and time-and-materials contracts, buyers must understand the target’s accounting systems, indirect cost rates, and billing practices. Ensure systems are compliant with government standards and validated by relevant audits.
Additionally, evaluate potential exposure to cost disallowances, overbillings, or defective pricing under the Truthful Cost or Pricing Data statute (formerly TINA).
Analyze Paycheck Protection Program (PPP) Loans
PPP loans, forgiveness applications, and supporting documentation should also be analyzed.
Analyze Subcontracting Plans and Flowdowns
Examine the target’s subcontracting compliance, especially for large businesses with small business subcontracting plans. Confirm that required FAR clauses have been flowed down to subcontractors and that appropriate monitoring systems are in place.
Assess Export Control and ITAR Compliance
If the target deals with defense articles or technical data, review its compliance with:
- International Traffic in Arms Regulations (ITAR)
- Export Administration Regulations (EAR)
- Export licenses and technology control plans
Violations may not only carry penalties but also restrict post-acquisition operations.
Assess False Claims Act and Compliance Risks
M&A due diligence for government contractors should include a rigorous review of compliance with the False Claims Act (FCA) (31 U.S.C. §§ 3729–3733), the Procurement Integrity Act, and other federal statutes. Undisclosed compliance violations or internal investigations can result in successor liability or post-closing enforcement actions.
Tailor the Purchase Agreement to Government Contract Risks
The purchase agreement should include:
- Robust representations and warranties regarding government contracts
- Indemnities for known risks (e.g., outstanding investigations, pending audits)
- Covenants related to novation, change-of-control notifications, and post-closing cooperation
Conclusion
Government contractor M&A requires far more than standard commercial diligence. By proactively identifying regulatory risks, understanding contract transfer limitations, and ensuring compliance, parties can better structure the transaction, protect value, and avoid costly surprises. Buyers and sellers alike should involve counsel with deep experience in government contracts early in the process to guide these critical due diligence steps.
