Market Watch: SBA recertification -- Defuse this time bomb

Jerry Grossman

Recently, the Small Business Administration announced its intention to institute "re-certification procedures," applicable to companies seeking to continue their work under small business contracts beyond the initial contract period.

This procedure would seem a direct contradiction to the fundamental purpose of the federal government's long-standing commitment to nurturing and developing small businesses -- the building of successful mid-size and large businesses. Uncle Sam seems to be saying, "We'll help you get larger, but when you've got a real company, $20 million-plus in revenue and growing nicely, we'll aid in your shrinkage."

Also, a natural byproduct of growing a small business is building value for the owners. Re-certification, if instituted, would mitigate or reverse shareholder value growth, whether the company remained independent or in the context of a sale.

A company at the threshold of disqualification as a small business because of growth must navigate the transition out of the program and into the full and open competitive arena. During this period of heightened risk, the loss of contracts and customers is the last thing such a company needs.

A fundamental requirement in establishing a business is building customer confidence and loyalty, essentially creating a "brand." In a service company, branding is critical to establishing the difference among companies in a highly competitive marketplace.

While any initiative such as the SBA small business set-aside program has its discriminatory aspect, the idea of fostering small-business formation and growth has spawned many good businesses over the years. Initiatives have attracted many talented executives and employees to the industry, and boosted the entrepreneurial spirits of highly motivated technical people.

Many projects and tasks outsourced by the government are best-suited to small, aggressive companies. The government should foster these high-energy businesses, who often bring fresh ideas to address the technical, managerial and logistical challenges faced by federal, civil and defense agencies.

Consider the ultimate objectives of entrepreneurs who start government IT and defense services companies. Building a business, serving national priority needs, solving complex problems and creating a strong company culture are some of the primary motivators. Creating a challenging professional environment, including attractive financial rewards, is usually high on the list of objectives.

In federal IT companies, the compensation systems frequently include stock options and other forms of equity participation. Both founders and employees who hold equity stakes in their companies harvest these equity investments over time or coincident with a future initial public offering, re-capitalization or strategic sale of the company.

Under the re-certification proposal, companies with small-business contracts with option years remaining would lose these years if sold to a larger company. This would reduce not only the prospective sale value of the company, but also its ability to find a willing buyer. Accordingly, government policies should recognize the importance of value building to the health and success of government services providers.

A predictable result of the re-certification program will be to force small businesses to become more fully competitive at a much earlier stage, to successfully transition out of eligibility for small business set asides. Many promising small companies will not meet this requirement, robbing the government of a continuing supply of capable small to mid-size businesses.

Hopefully, the re-certification process will be given additional thought before it is implemented. *

Jerrry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hlhz.com.

About the Author

Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.

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