The Wall Just Moved for Some of You

A while back I wrote that the SBA's recertification rule had turned your set-aside status into a wall. Sell to a large prime, I said, and the certification self-destructs at closing. Then I wrote a second piece saying the wall has doors, and walked through the structures that get an owner through it with the certification intact.

At the end of that second piece I put in a caveat. One sentence, near the bottom, where caveats go:

Size status and socioeconomic status are two different tests, and a structure that protects one can quietly break the other.

I meant it as a warning about deal structure. It turns out that sentence is the whole story, and last month it became the most important thing I have written about government contracting.

What happened

On 20 August the SBA proposed the largest expansion of small business size standards in decades. Roughly a thousand existing standards collapse into 338. The methodology behind them drops from seven factors to three. No standard goes down.

The numbers are not just “adjustments”. They are in a different universe. 

Administrative management and general management consulting, which is where a great deal of professional services work sits, moves from $24.5 million to $295 million. Engineering services goes from $25.5 million to $252 million. Computer systems design goes from $34 million to $531 million. Facilities support services goes from $47 million to $156 million.

By SBA's own estimate, 37,002 firms holding roughly $71 billion in federal contracts would regain access to the small business federal market.

Check your own code before you celebrate, because the increases are not uniform even inside a single industry group. All other professional, scientific and technical services, which sits four digits away from management consulting, goes from $19.5 million to $61 million. That is a real increase and it is nothing like twelve times.

Comments close on 21 September. Nothing is final. Until the government has read the comments and issued a final rule, today's standards are the standards.

Why the room is about to tell you this is good news

Because for a great many firms it is. If you have spent three years watching your revenue climb toward a ceiling and doing arithmetic about when you fall off it, that ceiling just moved to a place you will not reach.

And there is a second-order effect that matters more for the subject of this newsletter. Every buyer who could not acquire you without pushing the combined company over the line can now do it and stay under. The pool of people who can buy your firm without breaking it gets dramatically larger.

That is real. It is also not what happens to everyone, and the difference is the sentence I buried.

Two tests, not one

When your company changes hands, the rule requires you to recertify within thirty days. What most owners hear is one event. It is two.

The size test asks a question about arithmetic. Is the combined company, you plus the buyer plus anyone the buyer is affiliated with, over the standard for your industry? That question has nothing to do with who you are. It is a sum.

The status test asks a question about a person. Does the buyer still make the company service-disabled veteran owned, or woman owned, or 8(a) eligible? That question has nothing to do with arithmetic. A buyer who does not carry the qualification fails it at any size.

Raise the ceiling and you have changed the first question completely. You have not touched the second.

So which wall are you standing at

Sort your set-aside revenue into two piles. Most owners have never done this, because until now there was no reason to.

Pile one is size-based. Small business set-asides. Work you win because you are under the ceiling, and for no other reason.

Pile two is status-based. 8(a), service-disabled veteran owned, woman owned, HUBZone. Work you win because of who owns the company or where it operates.

Now put the buyer beside it.

• Sell pile one to a buyer who stays under the new ceiling, and that revenue survives. It survives whether or not the buyer holds any certification at all, because size was the only test it ever had to pass. This is where the proposal does its work, and for a firm whose book is mostly plain small business set-asides, it does a great deal of work.

• Sell pile two to a buyer who does not carry your status, and that revenue is gone, exactly as it was before. Nothing in a size standard reaches it. The wall you were standing at is where you left it.

For most of the firms I talk to in this region, pile two is the larger pile. That is worth knowing before somebody tells you the rules just got easier.

The part nobody is going to mention

There is a way this helps status holders too, and it is indirect enough that I have not seen anyone say it.

The obstacle to selling a certified firm was rarely that no qualified buyer existed. There are plenty of veteran-owned and woman-owned companies with the appetite to buy one. The obstacle was that a qualified buyer large enough to afford you would push the combined company over the ceiling, and the certification you were both trying to protect would die on the way to protecting it.

At $295 million that constraint mostly disappears. A $150 million veteran-owned firm can acquire a $30 million service-disabled veteran owned company and the combined business stays small and stays veteran owned.

So the size ceiling was binding on status-preserving transitions too. It just came off.

That does not make the two piles the same. Pile one survives a sale to almost anybody small. Pile two still requires a buyer who carries what you carry, and that is a much shorter list. But the list got longer, and if you have been told a qualifying successor was not realistic at your size, that advice may have just expired.

One exception, and it is worth knowing

HUBZone does not work like the others.

The other certifications turn on a personal characteristic of the owner. Your company is service-disabled veteran owned because a service-disabled veteran owns and controls it, and a buyer who is not one cannot inherit that, whatever either side intends.

HUBZone asks a different set of questions. It requires that at least fifty-one percent of the company be owned and controlled by United States citizens, that the principal office sit in a HUBZone, and that at least thirty-five percent of the employees live in one. Only the first of those looks at the buyer at all, and citizenship is a far wider gate than veteran status or any of the others. It is a threshold most buyers already clear.

So HUBZone is the one certification a buyer can inherit without qualifying personally. It is also the one that is conditional in a way the others are not. The other two requirements are operating conditions, and they are exactly the things a new owner disturbs without meaning to. A buyer who folds your office into their headquarters has ended the certification, whatever the purchase agreement says about preserving it.

And it does not carry itself across the closing. The rules give you thirty days from the day the transaction becomes final to show the SBA that the company still meets all three requirements.

None of which takes away the point. The buyer list for a HUBZone firm is much longer than the buyer list for a service-disabled veteran owned one, and I would guess most HUBZone owners have never been told that, or the conditions attached to it.

What this does not change

The recertification rules themselves are untouched by this proposal. Thirty days after a change in controlling interest you recertify size and status both, and the consequences of a disqualifying answer are what they were in January.

The proposal is a proposal. Comments close 21 September and a final rule will follow at whatever pace it follows. If you are transacting this quarter, today's standards govern your deal.

And the two-year arithmetic does not move. If your record has to season, it seasons on the same schedule regardless of where the ceiling sits.

What to do about it now

Answer one question: how much of your revenue is size-based and how much is status-based?

Most owners haven't really looked at their portfolio that way. They know their set-aside percentage as one number, because that is how it appears in every report they have ever been handed. Splitting it is not hard, but it does take somebody going through the portfolio contract by contract.

It is worth doing before this rule finalizes rather than after, because the two piles are now two different assets with two different buyer lists, and the work you would do to protect one is not the work you would do to protect the other.

If you want to know which side of that line your business sits on, that is a conversation rather than a form, and it is one I am glad to have. My practice is built around exactly this question for owners two or more years out from a transition.

One more thing. Comments on the proposed rule close 21 September. If your firm has something to say about how these standards land in your industry, that window is open and it is short.