There are many opportunities for small businesses considering work in the federal market, but they come with risks and rewards. Here are some things you need to know.
In today’s political environment, it’s nearly impossible to turn on the news and not hear about the spending patterns of the U.S. federal government. And if you live in the Greater Washington metro area, it’s highly likely that you know executives and business owners who are contracting directly or indirectly with one or more federal agencies.
Government contracting continues to drive a significant portion of the regional economy, so how do you know if it’s a market worth entering?
There are many things to consider before pursuing a government contract. While the industry can be highly rewarding, government contracting also carries with it risks and uncertainties that may not be found in other industries.
Compliance with ever-changing federal regulations can be daunting enough to cause many to shy away from the industry. Spending is driven by politicians and budgeting, which can often differ from the traditional consumer demand model found in other industries. Revenues for government contractors may be highly concentrated with one or a few customers. In addition, a government contracting business may be more tied to the success of the overall United States economy in comparison to a similar business operating in the private sector.
Considering these risks, why would anyone want to enter into the industry?
According to the National Contract Management Association, the federal government entered into nearly $450 billion of contract spending in 2014. Nearly $100 billion of that was contracted in Washington DC, Virginia and Maryland, which along with California and Texas make up the five largest contracting states with the federal government.
Furthermore, the number of solicitations posted on FedBizOpps, has trended upwards from 66,610 in 2010 to 79,985 in 2014, even while total spending has declined in that time period, indicating smaller awards and more opportunity for small businesses. Small businesses actually accounted for 22 percent of contract spending in 2014, up from 19.7 percent in 2010.
With all of that opportunity and potential, how could you not consider entering the industry?
As with any other industry, starting a federal contracting business is a significant decision that should not be made without proper thought and consideration.
Many questions will need to be answered:
- What do I want to do?
- Do I have an expertise that can differentiate my company in the marketplace?
- Do I have the self-discipline to be my own boss?
- Can I afford the financial risk?
- Can I lead others toward a common company mission?
- Am I an entrepreneur?
These questions, however, will only address whether or not to start your own business, but what about a federal contracting business specifically? You have to consider whether or not you qualify for any government set-aside programs. You’ll have to determine if you have, or can obtain, the technical expertise to navigate the regulatory requirements of a government contract. It is also important to ask yourself if you have or can build, the appropriate relationships within the industry, if you’re willing to invest in the needed accounting and compliance infrastructure and if you want to work in a highly regulated environment.
What are set aside programs?
Government set aside programs have been established to assist small businesses and to promote their ability to perform work directly or indirectly with the federal government.
Set aside programs are available for small businesses, generally defined by the Small Business Administration on the basis of the number of employees or average annual receipts.
hese standards may vary by industry and can be found on the SBA website. Every federal government purchase with an anticipated value from $3,500-$150,000, for which there are two or more qualified bidders, must be set aside for small businesses.
In addition, the federal government designates procurement goals to award certain percentages of contract procurement to small businesses.
In addition to general set asides for small businesses, companies in certain government certification programs and socioeconomic categories have the opportunity to receive small business set asides earmarked for those groups. The following are the most common programs available:
- 8(a) Business Development – Business assistance program for small disadvantaged businesses
- Women-owned Small Business – Program implemented to expand the industries in which women-owned small businesses are able to compete for federal contracts
- Hub Zone Program – Historically Underutilized Business Zone program helps small businesses in urban and rural areas gain preferential access to federal procurement opportunities
- Service-Disabled Veteran-Owned Business – Program implemented to allow government procurement agencies to set acquisitions aside and make sole source awards to businesses owned by service disabled veterans
All of these programs may sound very appealing to a business owner. After all, what’s not to like? These set asides allow businesses that meet the appropriate criteria to pursue business with less competition. While in many cases, pursuing set aside contracts makes sense, they should only be pursued if they align with business goals and objectives, the owner’s personal goals and objectives, and the timeline for building and ultimately disposing of the business.
Although it may be hard to envision your long-term exit strategy from your business when you’re just getting started, it is very important in this industry to maintain awareness of your retirement plans as they may impact which contracts to pursue.
Many people form government contracting businesses to be lifestyle companies – that is, companies that can generate a rewarding income stream to the owner, but may not ultimately be attractive to a buyer when the time comes to exit the business. Lifestyle companies can be rewarded with very lucrative set aside contracts that generate high levels of income to the owners and employees of the business.
One must consider, however, that the value of such a business will be limited because a potential buyer may not qualify to maintain these set aside contracts after a sale transaction. On the other hand, if a succession plan can be created to transfer the business to family members, or an employee group, which would still qualify for the set aside program, the company would be perceived to have more value.
Being aware of these types of set aside programs, the short and long term benefits and the risks, are important aspects to consider before entering the federal marketplace.
What about the accounting and regulatory requirements?
Many people may shy away from the government contracting world simply because they are overwhelmed by the regulations and requirements of the industry, the fear of government auditors and the perceived risks that go along with it.
However, the federal government wants to contract with small businesses and there are significant amounts of resources available to help you navigate the federal marketplace.
The rulebook of federal contracting is referred to as the Federal Acquisition Regulations, or FAR. The purpose of the FAR is to provide a uniform and consistent basis for soliciting, awarding and monitoring federal contracts.
While the FAR is the primary set of regulations, each government agency may issue a supplement to the FAR such as the Defense Federal Acquisition Regulation Supplement (DFARS) or the General Services Acquisition Regulation Supplement (GSARS), among others. While this may be starting to sound daunting and very different than private industry, the ABCs of conducting business with the federal government exists, may be obtained online or purchased in hard copy, and can reward one who is willing to invest the time and energy to understand the rules and build a business.
Through the FAR, agency supplements and other related federal regulations, requirements are imposed on government contractors not found in private industry. Before deciding to do business with the federal government, one must understand these regulations and requirements before pursuing a federal contract.
There are also many types of contracts awarded by the federal government, some not commonly found in private industry. Depending on the type of contract you enter into, your business may need to meet certain requirements of an “adequate” accounting system.
A contractor may be required to implement billing methods that could differ from contract to contract and may not be found in private industry. Additionally, the contractor may be subject to audit and oversight by the Defense Contract Audit Agency (DCAA), or another oversight agency.
While the FAR describes more than a dozen types of contract vehicles available to federal procurement officers, there are three main types of contracts commonly found in the industry.
- Firm Fixed Price – Provides for supplies or services for a specific price not subject to adjustment based upon a contractors cost or effort incurred.
- Time and Materials – Provides for payment based upon hours incurred by the contractor at pre-determined fixed hourly rates, plus actual direct costs incurred including direct materials, subcontractor costs and other direct costs.
- Cost Plus – Provides for reimbursement of allowable costs incurred by the contractor up to the specified total award amount, plus a fee.
Federal contracts are also typically awarded in one of two methods, a single award contract in which one of the above contract types is awarded to one contractor, or an Indefinite Delivery / Indefinite Quantity (IDIQ) award, which can be awarded to multiple contractors and are used when the contracting agency cannot reasonably predetermine the precise quantity of supplies or services that will be required. Under an IDIQ contract, the contracting agency will award delivery or task orders to specify award quantities as determined under the contract.
Before entering the federal marketplace a business must understand these types of contracts, as each type of contract comes with its unique risks as well as accounting requirements. Most contractors, except those performing work only under certain firm fixed price contracts, are required to maintain an adequate accounting system.
Generally, to meet the requirements of an adequate accounting system a contractor must have the ability to properly track and bill costs by contract, segregate direct from indirect costs and properly identify and exclude unallowable costs. DFARS identifies 18 criteria that are required of an acceptable accounting system. DFARS states that a contractor’s accounting system shall provide for the following:
- A sound internal control environment, accounting framework and organizational structure.
- Proper segregation of direct costs from indirect costs.
- Identification and accumulation of direct costs by contract.
- A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives.
- Accumulation of costs under general ledger control.
- Reconciliation of subsidiary cost ledgers and cost objectives to general ledger.
- Approval and documentation of adjusting entries.
- Management reviews or internal audits of the system to ensure compliance with the Contractor’s established policies, procedures, and accounting practices.
- A timekeeping system that identifies employees’ labor by intermediate or final cost objectives.
10. A labor distribution system that charges direct and indirect labor to the appropriate cost objectives; Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account.
11. Exclusion from costs charged to Government contracts of amounts which are not allowable in terms of Federal Acquisition Regulation (FAR) part 31, Contract Cost Principles and Procedures, and other contract provisions.
12. Identification of costs by contract line item and by units (as if each unit or line item were a separate contract), if required by the contract.
13. Segregation of preproduction costs from production costs, as applicable.
14. Cost accounting information, as required:
- By contract clauses concerning limitation of cost (FAR 52.232-20), limitation of funds (FAR 52.232-22), or allowable cost and payment (FAR 52.216-7) and
- To readily calculate indirect cost rates from the books of accounts
15.Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms.
16.Adequate, reliable data for use in pricing follow-on acquisitions.
17.Accounting practices in accordance with standards promulgated by the Cost Accounting Standards Board, if applicable, otherwise, Generally Accepted Accounting Principles.
These criteria may not be necessary for companies working in the private sector and can place a significant burden on small businesses, so companies must fully understand these requirements and consider their impact before entering into the federal marketplace or pursuing contracts other than firm fixed price vehicles.
As you can see, there are many opportunities for small businesses considering pursuing work with the federal government. With these opportunities, come risks and rewards. When properly navigated, the federal contracting market is a very exciting and lucrative market to enter as long as businesses are aware of the uniqueness to the industry and make an educated decision to pursue work in this space.