On July 6, 2022, the Small Business Administration (SBA) changed its rules for calculating size based on the number of employees from a 12-month calculation period to 24 months (87 Fed. Reg. 34094 (the Final Rule)). Government contractors should review the Final Rule and the revised 13 C.F.R. § 121.106 to determine any impact that these recent changes will have on their size status for government contracts and subcontracts. 

Regulatory Background For Recent Changes To SBA’s Size Standards

A business concern may self-certify as small for a federal government contract if it meets the applicable size standard associated with the NAICS Code that is assigned to that contract. The NAICS Codes and associated size standards are found at 13 C.F.R. § 121.201. Each size standard is determined by either: (1) the average number of employees employed by the concern, or (2) the concern’s average annual receipts. 

On December 17, 2018, President Trump signed into law the Small Business Runway Extension Act of 2018 (Runway Extension Act), which increased the measurement period for calculating average annual receipts for small business size purposes from three years to five years. The Runway Extension Act did not impact employee-based size standards. We addressed that change in previous alerts, which can be found here. The general purpose of the Runway Extension Act was to allow businesses with increasing revenues to have more time under the five-year calculation to remain small before being excluded from competition for SBA set-aside contracts. 
 
While the Runway Extension Act was enacted into law on December 17, 2018, the SBA did not implement the changes into its regulations until January 6, 2020 (84 Fed. Reg. 66561) and even then included a phase-in period allowing contractors to elect between a 3-year or a 5-year period for average annual receipts until January 6, 2022. The option to elect either the 3-year or 5-year period for average annual receipts ended on January 6, 2022, except for SBA’s Business Loan and Disaster Loan Programs. While the Final Rule expanded this election option to additional SBA financial assistance programs (i.e., Business Loans, Disaster Loans, SBG, and SBIC Programs), the SBA confirmed that it will not renew or allow an election for the government contracting programs because government contracts involve competition and every competitor should be required to follow the same time period for calculation when competing for a government contract. The regulations governing the calculation of average annual receipts can be found at 13 C.F.R. § 121.104.

Consistent with the changes made to the annual receipts calculation under the Runway Extension Act, on January 1, 2021, Congress also directed changes to the employee-based size standards through language included in Section 863 of the Fiscal Year 2021 National Defense Authorization Act (FY2021 NDAA). Specifically, through the passage of the FY2021 NDAA, Congress directed the SBA to change the 12-month calculation period for average number of employees to 24 months. This extended period of time for calculating size under an employee-based size standard will allow businesses to remain eligible for SBA’s programs for a longer period and will better reflect a concern’s true size. 

Impact Of SBA’s Final Rule Changing Employee-Based Size Standards

Employee-based size standards primarily apply to manufacturers, but firms in certain environmental remediation, insurance, mining, publishing, research and development, telecommunications, transportation, and utilities industries also determine size based on the number of employees. Therefore, the Final Rule will not impact all small business concerns, but will change how size is calculated for firms who determine size based on the number of employees.

Unlike the phased changes that were made to annual receipts calculations as a result of the Runway Extension Act, the Final Rule does not include any transition period for the 24-month employee calculation to take effect. Beginning on July 6, 2022, concerns determining their size based on the average number of employees must use the 24-month period.  

However, similar to the purpose of the Runway Extension Act, the Final Rule will allow concerns using employee-based size standards a longer runway to determine eligibility for SBA’s programs. For example, a business that may have had a significant increase in hiring because of supply shortages occurring in the past year will now have a 24-month period to determine size, which will cause temporary employment spikes to have less impact.  Concerns that may have recently lost their eligibility based on the 12-month calculation because of significant increases in hiring during the past year now can recertify as a small business if the 24-month period causes them to be below the relevant size standard. The SBA expects that the Final Rule will result in a net gain of approximately $158 million in federal small business contract dollars as more firms will be eligible for these contracts because of the longer period to calculate size. 

Conclusion

Contractors using employee-based size standards should closely review the requirements of 13 C.F.R. § 121.106, which now includes the 24-month calculation period, to determine how these changes impact their size.