New rule targets large firms

Businesses that are now classified as small could face a tumultuous time after the introduction of a new Small Business Administration rule. The rule, which took effect June 30, outlines rigorous new standards for when small businesses must recertify their status.

SBA's goal is to purge within one year almost all companies that no longer qualify as small businesses from the contractor database in the Federal Procurement Data System-Next Generation. The move, first announced in November 2006, is needed because federal agencies can claim small-business contracting credit long after the small-business contractor outgrows the status, according to SBA. That period can stretch to two decades in some cases.

Under the new rule, any small business that is acquired by or merges with another company must immediately recertify its size. If it no longer qualifies for small-business status, it can keep the contracts it has, but the government can no longer count them against small-business contracting goals.

The rule also requires agencies to modify contracts that span more than five years to require small firms to recertify their status before the agency exercises an optional extension. That means companies working under a five-year base period may not need to recertify until they are about to begin their sixth year of work.
SBA believes that only a small number of companies will be in that group, said Arthur Collins, director of government contracting at SBA.

Companies working under contracts of shorter durations will also recertify when the first optional extension is used. Most such contracts have one-year options, meaning many companies will have to recertify within the next year.

Small-business advocates foresee a mixture of results from the rules. Many companies will be knocked off the small-business rolls, they predict, but SBA may not purge them all in one year. Meanwhile, the dynamics of mergers and acquisitions will change in big ways as the contract portfolios held by small companies may not be as valuable as they once were.

Defining small businesses is complicated. SBA uses the North American Industry Classification System (NAICS) codes to identify business types and sets thresholds based on revenues or number of employees, depending on the business type.

Larry Allen, executive vice president of the Coalition for Government Procurement, said the recertification rule is fair to small firms, particularly those on long-term contracts. That includes the General Services Administration's schedules program, one of the key vehicles for smaller firms.

Companies on those contracts may have to recertify as infrequently as once every five years, he said. "In the meantime, buyers can ask firms to recertify at the time an order is placed. The coalition thinks this makes sense," he said. "Five years is a sensible time period, much better than the originally proposed annual cycle, as it will not catch firms with an anomalous year of being 'big.' "

Allen was referring to concern some advocates have expressed that a small business with an unusually successful period might seem to have outgrown its small-business status, for those types of companies where status is measured by revenues. But if the increased income came from a single large contract or some other unusual event, it may not be a fair measure of the company's size.

SBA has no idea how many companies will ultimately be purged, Collins said. He intends to analyze the effect of the rule in early 2008, when the first wave of recertifications will be under way.

Guy Timberlake, chief executive officer and chief visionary officer of the American Small Business Coalition, said the rule will be an overall improvement in the system, but it will not solve all the problems. For the most part, certification is an honor system, he said. Companies affirm that they are small, and there is little oversight to confirm the status.

Agencies can choose a NAICS code for a contract that allows larger small businesses to qualify and bid, even when the work bears little apparent relationship to the code, a practice called code-shopping. Right now, companies can protest the NAICS code after the agency issues a request for proposals, but the window is short, and once it's closed, there's no further recourse.

"What it comes down to is if a government agency is going to leverage that NAICS code for a requirement, there's really nothing you can do about it," Timberlake said. "Until there is some accountability where agencies are audited for how they apply NAICS codes ? and that comes down to SBA taking the time and the resources to police that ? that's an entirely different system and requires a different type of enforcement from SBA and government as a whole."

Collins said protest actions will continue to be the main way SBA enforces its size standards, but he added that "the way we have drawn so much attention to the issue is going to help a lot. It's put a spotlight on it."

Associate Editor Michael Hardy can be reached at mhardy@1105govinfo.com.