SBA proposes rules that will change the M&A landscape for small businesses, recertifications will impact eligibility for awards

The Small Business Administration (“SBA”) recently issued a proposed rule that changes the effect of recertification of business size following mergers and acquisitions (“M&A”). Interestingly, the proposed rule is ostensibly an omnibus proposal in that it covers a range of issues under SBA’s socioeconomic contracting programs. For example, the proposed rule includes changes to SBA’s negative affiliation check regulations (discussed here ), joint venture rules, mentor-protégé rules, and more. Comments on the proposed rule are due by October 7, 2024.

SBA’s recertification policy has long been a subject of debate, particularly with respect to eligibility following recertification of a business as “other than a small business” following an M&A event. Under the current regulatory regime, a small business is generally considered small throughout the life of the contract, including for orders issued under a long-term contract. Thus, when a contractor is required to recertify its size following a novation, merger, sale, or acquisition or an M&A event, or prior to the end of Year 5 of a long-term contract, the current rule provides that the impact of that recertification applies to goal setting. That is, if the business is no longer small, it continues to be eligible for future orders under that long-term contract, but the agency cannot count those awards as small business awards (i.e., goal setting credits).

Indeed, the issue of goal setting and eligibility has been extensively discussed in several SBA Office of Hearings and Appeals (“OHA”) decisions—and in some Government Accountability Office decisions—which have repeatedly found that the clear language of SBA’s recertification regulations relates to goal setting, not eligibility. SBA’s position in these decisions (and similarly reflected in its initial comments on the proposed rule) demonstrates that the agency disagrees not only with the legal rationale behind these decisions, but also with the outcome (i.e., that the business remains eligible).

The SBA’s proposed regulations significantly change the status quo—recertifications will no longer be tied to credit targeting (for the most part) and will instead impact eligibility. As a start, given that the current regulations address size and status recertification across multiple provisions, the SBA is first proposing to move away from this fragmented system by consolidating its recertification regulations into a single new section, 13 CFR § 125.12. According to the SBA, this would “simplify the text and provide for easier, more consistent interpretation and application of the regulations.”

The SBA’s proposed recertification system under the new, streamlined approach is as follows:

M&A Events

Recertification is required within 30 calendar days of an approved novation, merger, acquisition, or sale, including pre-existing agreements entered into by the enterprise or an affiliate of the enterprise, that results in a change in controlling interest, and recertification must be for the size standard in effect at the time of recertification that corresponds to the NAICS code originally assigned to the award.

Note: M&A events under the proposed rule are linked not only to the company but also to an “entity related to the company.” The proposed rules also cover “preliminary agreements”, which differs from current regulations.

Long-term contracts

For long-term contracts (including multiple award contracts) and orders with terms greater than five years (including options), the firm must recertify its size and status no more than 120 days before the end of the fifth year of the award and no more than 120 days before exercising any option thereafter. The contracting officer may also require recertification of size and/or status, if deemed appropriate, prior to the end of 120 days in the fifth year of the long-term contract or order.

The SBA proposed rule would then classify size and status recertifications (for the above) as qualifying or disqualifying. A qualifying certification means that the business is “considered a small business or a small business program participant for up to five years from the date of recertification and remains eligible for deferred or reserved awards unless a later disqualifying recertification occurs.” The impact on disqualifying certification is discussed below.

Pending proposals

If a merger and acquisition event (above) occurs within 180 days of the offer date (e.g., proposal submission) but before the contract is awarded, the business is ineligible to receive a pending small business reserved or reserved award.

If the M&A event occurs more than 180 days after the offer date but before award, the company’s eligibility depends on whether the awarded effort is a single or multiple award contract. In the case of a pending single award or reserve, an award will count as a small business award or small business program participant award for goal setting purposes for up to five years from the date of the award unless a disqualifying recertification occurs. On the other hand, in the case of multiple award for small business set aside or reserve, the business is not eligible for the pending order because it would not qualify for orders set aside for small businesses or set aside for a specific type of small business.

Future rewards postponed or reserved

Contract Officer Request: If a firm receives a disqualifying recertification in response to a contracting officer’s recertification request, the firm is ineligible for the specific order or contract but remains eligible for other waived or reserved awards and awards without limitation.

M&A Event: If the business has a disqualifying recertification following an M&A event (above), in addition to the contracting officer’s request for recertification, the business is ineligible to bid for a deferred or reserved award under a multiple award contract following an M&A event. However, the business will continue to be eligible for unrestricted awards under the multiple award contract and orders issued under a single small business contract.

Options

For single award small business set aside or reserve award or any unrestricted award, the business that files a disqualifying recertification remains eligible to receive the option. The procuring agency may not count the option period as an award to the small business or small business program participant for purposes of setting goals. Such a business may make a qualifying recertification for a subsequent option period if it meets the applicable size standard or becomes a certified small business program participant.

For multiple award for small businesses or reserve award, a company that submits a disqualifying recertification will not be eligible to receive the option.

Joint ventures

When a joint venture must recertify its small business status following an M&A event, the joint venture may recertify as small if all parties to the joint venture qualify as small at the time of recertification or the small protégé in the still-active mentor-protégé joint venture qualifies as small at the time of recertification. Notably, the joint venture may continue to recertify as small even if the recertification date is more than two years after the joint venture receives its first award (recertification is not considered a new contract under 13 CFR § 121.103(h)).

Federal Delivery Schedule

Under current regulations, Federal Supply Schedule (“FSS”) contracts (and related Master Purchase Agreements (“BPAs”)) are treated differently, with volume being determined as of the date of the bid for the FSS contract (or the option year for that FSS contract) rather than on individual orders or BPAs against it. The SBA proposed rule eliminates this exception, meaning that where an M&A event triggers recertification, volume would be determined either as of the date of the recertification event or as of the date of the order or BPA on which the contracting officer requests recertification. Thus, if recertification after an M&A event results in a business being non-small business, it would be considered non-small business for the FSS contract itself, which then carries over to any future orders and BPAs that may be issued against it.

Note: In this case, SBA’s initial comments clearly stated that “SBA believes that both GAO and OHA are misinterpreting SBA regulations.”

To go

In simple terms, the SBA proposed rule is a major change to the current recertification scheme. Because the SBA proposed rule ties size/status recertifications to award eligibility rather than targeting (for the most part), small businesses that go through an M&A event and are no longer small will be deemed ineligible for set-aside procurement, including under the FSS program.

Practically speaking, because small business valuations are partially tied to the target’s contract portfolio, those valuations will necessarily decline—for owners seeking a majority liquidity event for their hard work—making it harder to achieve a lucrative exit. Indeed, as discussed in a previous article ( here ), because the proposed regulations also change the SBA’s negative control rules, small business owners will likely face additional challenges because the calculus of minority investment opportunities without control will also change. The impact of the proposed SBA changes does not end with the M&A landscape, however.

In addition to mergers and acquisitions, as proposed, this provision could potentially cause contracting agencies to rethink their procurement decisions. That is, it is no secret that contracting agencies want strong competition for complex contracting requirements, particularly in IT, cybersecurity, and other complex services. So, for example, if the pool of beneficiaries under an agency’s multiple-award contract with a deferred completion date is reduced because merger and acquisition activity has rendered some bidders ineligible for the contracts, those contracting officials may inevitably turn to other entities to recompete for their most sophisticated contracting requirements.

In such a scenario, agencies could also potentially decide to abandon these set-aside vehicles altogether—for example, if the remaining pool of small businesses is too small or lacks the capacity or prior performance necessary for larger, more complex efforts—or to keep these multiple award vehicles alive only for their smallest requirements. Ultimately, SBA’s proposed rule will likely have a significant impact on small business growth opportunities and the set-aside vehicle landscape. Industry should therefore take this opportunity to submit comments so that SBA can consider these issues as it develops the final rule.