SBA rules out of sync with mission

The Small Business Administration is an important resource for entrepreneurs. Its stated mission is to help Americans start, build and grow businesses. It seems, however, that some of SBA’s rules are misaligned with its mission. In particular, the agency’s rules regarding small-business size recertification are highly punitive to business owners. These recertification requirements, which took effect June 30, 2007, created tremendous uncertainty regarding the contract or revenue sustainability of small businesses providing services to the federal government. That uncertainty resulted in the significant devaluation of many small companies.

Because a typical business owner’s life savings are usually concentrated in his or her company, the impact of a material decline in the value of that asset can be severe. Consider the example of a small-business owner in the government-contracting arena who is approaching retirement or otherwise needs to transition away from the business. Under current SBA rules, it might nearly be impossible to attract potential buyers for the company due to acquirer concerns about the sustainability of small-business contracts after acquisition. Historically, private sale has been the primary liquidity option available to small-business contractors. Thus, these rules leave very few attractive exit scenarios, resulting in an environment where entrepreneurs take an inordinate amount of risk relative to reward potential.

Under current recertification rules, raising growth capital is also challenging for owners. Senior credit providers and mezzanine lenders frequently struggle with the uncertainty factor as they consider providing capital to small-business contractors. Meanwhile, equity investors face the same risk-versus-reward questions entrepreneurs do when assessing return scenarios for investments in small-business contractors. These investors frequently assign steep valuation discounts to accommodate for the perceived higher levels of risk.

Due to its own small-business regulations, the government also loses out on opportunities. Each year it forgoes a large amount of capital gains tax revenue from a reduction in the sale of small-business contractors. Rules that encourage contractors to constrain growth to stay below certain size thresholds deprive the federal government of a larger, more capability-rich universe of service providers. As the law of unintended consequences goes, it is possible that the current regulatory environment makes it harder for the government to meet small-business goals. Entrepreneurs are creative and find ways to win or transition work away from set-aside programs.

Given the benefits to both business owners and the government, it is in SBA’s best interest to change its current small-business regulations. Improvements that SBA might want to consider include implementing time and/or growth standards as outlined below:

Time Standard. After owning a company beyond a certain time threshold (in the range of seven to eight years), small-business owners should be allowed to pursue liquidity or capital-raising events with the appropriate certainty that existing work will be sustained after the transaction. Such a standard ensures adequate time for a business to reach maturity and also provides for appropriate owner-retirement options while mitigating the potential for quick-flip abuses.

Growth Standard. If a company achieves a high level of growth and surpasses all size thresholds, the owner would be free to pursue liquidity or capital-raising events regardless of time. This is entirely consistent with SBA’s stated mission.

In addition, small-business regulations should allow for increased flexibility in the case of death, disability or other significant events in a small-business owner’s life.

It is widely understood that small businesses are the foundation of our economy; SBA is an important incubator for these companies. Some of the agency’s regulations, however, conflict with its mission. Positive reforms, such as those mentioned above, would allow SBA to remain true to its mission of helping Americans start, build and grow businesses.