The US Small Business Administration (SBA) recently issued a proposed rule impacting the ability of small business government contractors to continue performance of set-aside awards following a merger or acquisition. The changes to 13 CFR § 121.404 are of significance to companies such as private equity firms seeking to acquire small business contractors.

In Depth

THE CURRENT RULE

Under the SBA’s current regulations, when a small or disadvantaged contractor merges with or is acquired by a large business resulting in the contractor losing its small or disadvantaged size status, the contractor generally remains eligible to continue performance on any existing government set-aside contracts. In most instances, the contractor may complete option periods on existing set-aside contracts and may be eligible for orders under an existing small business Multiple Award Contract (MAC).

The SBA’s existing rules require contractors to recertify as to size and socioeconomic status within 30 days of a merger, sale, acquisition, or novation, or prior to the end of the fifth year of a long-term contract. However, even if the contractor certifies that it is no longer small or no longer disadvantaged, the government does not automatically terminate the contractor’s set-aside awards. Instead, the awarding agency is simply unable to count any remaining option periods towards the agency’s small business contracting goals.

THE PROPOSED CHANGE

The SBA is now proposing to limit a contractor’s ability to continue performance of certain set-aside awards after a transaction causes the contractor to lose its small or disadvantaged business status. The proposed rule modifies the triggering event for a recertification. The new language provides:

Recertification of size and small business program status (i.e., 8(a), HUBZone, WOSB/EDWOSB, or SDVOSB) is required within 30 calendar days of an approved novation, merger, acquisition, or sale, including agreements in principle, of or by a concern or an affiliate of the concern, which results in a change in controlling interest.

The current rule presently in effect makes no mention of “an agreement in principle,” meaning that if the proposed rule is approved, contractors may need to recertify as to size status even before a transaction is finalized.

In addition, the proposed rule includes three significant changes to long-term contracts and pending proposals that will be of particular interest to companies considering acquiring a small or disadvantaged business:

1. Under the proposed rule, when a contractor recertifies that it is no longer small, it will not be eligible for future task orders under a small business MAC. This is a significant change, as previously contractors that held a small business MAC could continue to be eligible for future task orders even after recertifying as other than small.
2. The proposed rule similarly prevents contractors who recertify as other than small from receiving small business orders under their General Services Administration federal supply schedule contract.
3. Finally, under the proposed rule, if a contractor recertifies as other than small within 180 days of submitting a proposal, but prior to an award, the contractor will be ineligible for an award of a small business contract. Under the current rules, if a small business submits a proposal for a small business contract and only later undergoes a change in its small business status, the contractor remains eligible for the contract award. The proposed change means that small businesses that may be eligible for an award when they bid on a contract could forfeit that eligibility by the time the contract is awarded if they undergo a merger or an acquisition.

THE IMPACT

The proposed rule impacts the attractiveness of small business contractors as acquisition targets. Large companies and private equity firms are used to assuming that a small business will be able to complete any set-aside contract. Companies will now need to reassess the value of small business targets that derive a portion of their revenue from long term set-aside contracts.