Recertification: One year later

The Small Business Administration implemented a rulethat became effective June 30, 2007, and requirescompanies that have been acquired to recertify their small-companystatus within 30 days of the deal closing. Thisrule has significantly altered transaction structures and valuationsin the government services mergers and acquisitions market.The level of uncertainty surrounding thetransferability of contracts and sustainabilityof relationships has materially increased, atleast in the minds of active buyers. For mosttransactions involving small businesses, fewerbuyers are taking a serious look, and for thoseconsidering an offer, scrutiny has increasedand due diligence has deepened. What's more,pricing and terms have changed in the buyers'favor.In those instances when a company fails torecertify as small, the government customerloses small-business credit for all future businesswith that contractor. Before a more reasonedresponse to these rules can be developed,further industry experience with governmentcontracting officers' behavior isneeded. Government actions will vary byagency and by contract type and duration.For now and in the short term, recertificationrules have changed the marketability andvaluation in the small-business arena. Theserules are important because small businesses? those with less than $50 million in revenue? represent more than two-thirds of governmentservices M&A transactions.In some instances, these cautious buyerreactions make sense. In other instances, goodsmall businesses will be overlooked.Here are some of the issues and factorsinvolved: There is no requirement that thegovernment take any action because of thefailure of an acquired small business to recertify.The acquired contractor is highly likely tocontinue to perform the work for the durationof the contract. The government customerwould have to invoke the termination-for-convenienceoption to remove the contractorbefore the end of the contract period. Optionyears provide the first clear opportunity forthe government to change contractors by failingto exercise those options.Most government contract offices are busyenough without the extra effort of replacingcontractors that are performing well.However, there will be instances when anagency's small-business contracting goals areimportant enough to warrant the extra effortrequired to replace an existing contractor toretain small-business credit. I expect thatwould be the exception rather than the commonpractice, even though many contractscontain small-business utilization targets.Most government agencies are sensitive tothe proportion of their contracting volumerepresented by small businesses. Provisionsin the Federal Acquisition Regulation provideguidance on small-business utilizationfor prime contracts and subcontract positions.To one degree or another, agencyheads, the administration and members ofCongress monitor the level of small-businessrevenues to determine whethertargets are being met.The effects of these government regulationsand small-business goals, generallyshared by Congress, must be understood ina real-world context. What will matterto government contracting officerswhen deciding how to respondto a failure to recertify as small?The historical record of generallysolid contractor performance,heavy contract office workloads,high switching costs and the extraeffort required to change the statusquo suggest that business continuityis likely. Under the new rules, sustainingsmall-business contracts and maintainingcustomer relationships will be similar tohistorical experience.Although buyers must make a greatereffort in due diligence to ferret out thegreat small companies with sustainablebusinesses, the effort can pay off, as it hashistorically.