Stay “Small” Longer: Recent Changes Make It Easier for Growing Businesses to Pursue Small Business Contracts from the Federal Government

On June 6, 2022, the Small Business Administration (SBA) issued a Final Rule changing how a company calculates its size under an employee-based size standard. In recent years, the SBA also changed how a business calculates its size under a revenue-based size standard. These changes make it easier for growing companies to retain their small business status longer, enabling them to continue to pursue prime contracts or subcontracting opportunities reserved for small businesses. Below, we summarize the key rules going forward for determining whether a business is “small” for purposes of federal government contracts.

NAICS Codes and Size Standards

The relevant size standard for a federal government prime contract is determined by the North American Industry Classification System (NAICS) code the government assigns to the contract. For certain NAICS codes, such as those applicable to manufacturing, the SBA uses an employee-based size standard, meaning an offeror is a small business for that NAICS code if the total number of employees of the offeror and all of its “affiliates,” are equal to or less than the number of employees in the specified size standard. For other NAICS codes, such as those applicable to construction and services, the size standard is a revenue-based size standard, meaning an offeror is a small business for that NAICS code if the total average annual receipts (or revenues) of the offeror and all of its “affiliates” are less than or equal to the specified dollar amount. The SBA’s table of size standards can be found here.

It is critical that offerors aggregate the number of employees / annual receipts of the offeror and all of its affiliates. The analysis of whether a company qualifies as an “affiliate” can be complicated, and the SBA’s affiliation rules for procurements are set forth in 13 CFR 121.103 (Note: Different methods for calculating a business’ size status, including different affiliation regulations, apply under other SBA programs, including those that apply to SBA loans and bond guarantees and Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) contracts).

How Do I Calculate My Company’s Size Under an Employee-Based Size Standard?

Starting July 6, 2022, a business concern must calculate its number of employees under an employee-based size standard by averaging the business’ total number of employees (and those of its affiliates) for each pay period over the preceding completed 24-months. This is double the period that the SBA has previously used to evaluate a company’s size under employee-based size standards, which means companies that experienced rapid growth within the past twelve months may now still be able to qualify as small based on a lower employee count in the earlier months of the two-year period.

When calculating the employee count for SBA size standard purposes, a business must include in the count all individuals employed by the business on a full-time, part-time, or “other” basis, such as temporary employees. This average employee figure also must include the employees of all domestic and foreign affiliates of the business. 

If the business concern has been in business for less than 24 months, it will calculate its number of employees by averaging its number of employees for each pay period during which it has been in business.

For any proposals or quotes submitted before July 6, 2022, businesses should continue to calculate its number of employees using the average employee count over the preceding completed twelve calendar months. If the entity was not in business for 12 months prior to the date its size is determined, then the average number of employees for each of the pay periods it was in business is used to determine the business’ size.

How Do I Calculate My Company’s Size Under a Revenue-Based Size Standard?

Earlier this year, the SBA finally updated its rules to extend the period for calculating a business’ size under a revenue-based standard from three years to five years. The shorter three-year period often penalized businesses that received a significant contract award by depriving them of small business status relatively soon after contract award. By expanding the period used to calculate average receipts by an additional two years, the SBA’s new rules should allow businesses to retain their small business size status longer, as it reduces the impact of one or two exceptional years on the calculation.

On or after January 6, 2022, for a contract with a revenue-based size standards, a business must calculate its average annual receipts based on the total receipts of the company, and its domestic and foreign affiliates, over its most recently completed five fiscal years, divided by five. “Receipts” means “all revenue in whatever form received or accrued from whatever source, including the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.” 13 CFR 121.104.  (See 13 CFR 121.104 for a more detailed description of what is included in, and excluded from, the calculation of annual receipts). 

If the business has been in business for less than five complete fiscal years, its average annual receipts are the total receipts for the period it has been in business, divided by the number of weeks in business, multiplied by 52.

For any proposals or quotes submitted before January 6, 2022, for a contract with a revenue-based size standard, the business may elect to calculate its annual receipts and the receipts of affiliates using either the current five-year lookback period, or the prior three-year lookback period. For these pre-January 6, 2022 size determinations, an entity had the option of selecting the method that resulted in the lowest average annual receipts, potentially extending the length of time a growing business could be considered a small business.

What Does This Mean for My Business?

These changes require an entity that wishes to be considered a small business under a federal procurement contract to be vigilant in determining the specific rules that apply both to the type of contract it is pursuing and the date on which its size is determined for a particular procurement. The longer look-back period could allow businesses that currently do not qualify as small based on ramping up its hiring over the past year to qualify as small under the two-year look-back period—especially given that the two-year period would, initially at least, encompass several months in which businesses may have had reduced employee counts due to the impacts of pandemic-related shutdowns. 

Of course, the longer look-back period could also render businesses that are currently small no longer small, such as if they had much higher employee counts or revenues in the months or years that were previously excluded from the calculation. Therefore, businesses should ensure that they are calculating their size status under the appropriate look-back period and are updating their representations and certifications in the System for Award Management at www.sam.gov accordingly. 

Any business concern that previously qualified as a small business, but will no longer qualify as a small business under the new methods for calculating size, will no longer be eligible to bid on new small business set-aside contracts and may be subject to additional compliance obligations from which small businesses are exempt (e.g., small business subcontracting plan, cost accounting standards, etc.).

Foley has created a multi-disciplinary and multi-jurisdictional team that has prepared a wealth of topical client resources and is prepared to help clients meet the legal and business requirements for participating in SBA programs. To discuss how the new methods for calculating size status may impact your business’s size status, contact Erin L. Toomey ([email protected]), Frank S. Murray, Jr. ([email protected]), Julia Di Vito ([email protected]), or Megan Chester ([email protected]).