Navigating M&A in the set-aside world

In the intricate landscape of government contracting, completing mergers and acquisitions can take on additional complexity, even for relatively simple transactions such as a buyout of an owner-operated firm.

Many government contracting firms have some form of set-aside work (small business, woman-owned small business, 8(a), etc.) especially smaller growing firms. This creates additional complexity when considering an M&A transaction.

Successfully navigating this environment requires planning ahead and a nuanced strategy, with careful consideration of various factors. In this article, we look at some of the core concepts considered by buyers in government contracting: backlog, recompete risk, and subcontract work.

1. Backlog: Building Confidence and Bridging the Gap

Backlog is a cornerstone metric, especially for sellers with set-aside work. Buyers of companies with set-aside work generally fall into two categories: large businesses, that will be disqualified at the recompete, or small businesses, that may breach their size standard. Backlog provides confidence in a prospective buyer that, at a minimum, there is a foundation with which to work. It also provides runway for a buyer to leverage the existing set-aside work for profits or transition into unrestricted work. Furthermore, analyzing the capabilities deployed, past performance gained, and relationships with customers is instrumental in unlocking opportunities for the acquiring entity. A general rule of thumb that generates strong interest from buyers is backlog of approximately three times the revenue of the selling business.

2. Recompete Risk & Customer Relationships: Mitigating Risk

Understanding and assessing the timing and potential challenges of recompetes is critical for a smooth transition post-acquisition. A comprehensive risk analysis will look at more than just the timing of recompetes but delves into the relationship with the customer. Strong customer relationships can lead to favorable recompete outcomes, including potentially steering the recompete to a workable set-aside or unrestricted competition for prospective buyers. Sellers need to carefully consider their near-term recompete risk when deciding when to enter the market. While some recompete risk is inevitable, formulating a defined strategy and positioning it with the customer ahead of time is an excellent way to mitigate recompete risk.

3. Prime vs. Subcontract Work: What is the Relationship

Prime work is almost always more attractive than sub work for buyers. However, subcontract work can still be of great value especially if it leads to strong relationships with large primes.

If a seller has a material amount of subcontract work, the first thing a buyer will want to know is if the prime is relying on the set-aside credit for using the target business. If the prime is relying on the set-aside credit and after the deal is completed, the combined entity no longer qualifies for that set-aside, there is a risk of losing that work.

As a seller, understanding your position in your subcontract agreements is a necessity if you want to maximize your value in an M&A process.

Successfully navigating the complexities of mergers and acquisitions within the set-aside world of government contracting demands a strategic mindset and a thorough understanding of the unique factors at play. Buyers will be particularly interested in companies that build backlog, mitigate recompete risk, and manage subcontract positioning with each prime.   

Brian Peirce supports deal sourcing and execution for Rock Hall Partners, a boutique mergers and acquisitions firm focused exclusively on GovCon.