SBA rules out of sync with mission

Positive reforms would benefit business owners, government

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.

About the Author

John Allen is founder and CEO of Bluestone Capital Partners. He previously served as co-head of the defense and government services group at BB&T Capital Markets|Windsor Group.

Reader Comments

Sun, Aug 2, 2009 Sara

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often. Sara

Wed, Jul 29, 2009 OH & VA

I have trouble with this being a major concern. The size limitation for a Small Business is $25 MILLION and the government and pseudo-govt entities seem to only want to deal with LARGE and LARGE SMALL;s .. Really small businesses barely stand a chance. One recent SB set-aside initially asked for primes with $60 MILLION/yr of PRIMING experience. SMALL BUSINESS???? My company is a very small enterprise, but has been in business over 15 years. But it is treated with no respect and had 0 chnace of getting any work directly through the govt. If I were foreign or lie (like the folks I know who lists their spouses or claim to female owned when they are not), then I might have a chance, but even then I doubt it. As a sub you have to take lower rates, but to get on schedule, you can't use the prime rate and can't afford to hire others using the sub rate as the billing rate

Thu, Jul 16, 2009 Differing View Arlington

If I understand your argument correctly, the SBA rules are unfair and counterproductive because they make it difficult for small government contractors to build businesses and then sell them to larger contractors for tens of millions of dollars. Obviously, that's bad for those of you who make money facilitating such transactions, but I don't think that's the purpose of small business set-aside and 8(a) programs. The purpose of SBA programs is to give small businesses and minority owners a boost so they can build viable businesses. The purpose is NOT to help them build and sell--and then perhaps build and sell again on the taxpayers' dime. Large companies that purchase them should not get the benefits of small business set asides. This hurts the ability of small business owners to sell out and reap millions, but it does not hurt their ability to build a business--which is the purpose of the SBA programs. Everyone understands that many people who start government small businesses, perhaps most, do so with the intent of selling, most likely when they are on the verge of graduating. They don't really intend to build a permanent business. While there is nothing wrong with that, I don't believe that's the purpose of the SBA program.

Thu, Jul 16, 2009 Jason Hull Charlottesville, VA

Thanks for this solid analysis of the shortcomings of the sizing system. It seems that many of these rules forget about the law of unintended consequences, and it's the government buyer who suffers the most from them.

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