How small is small, when it comes to small businesses? There’s a policy fight brewing in Washington over the answer — with billions of government contracting dollars at stake.
The issue was aired at a hearing last week before the House Small Business Subcommittee on Contracting and Infrastructure, where the U.S. Small Business Administration was accused of slow-rolling changes to the definition of small that Congress mandated last year in the Small Business Runway Extension Act.
The problem is that, while the federal government sets aside certain procurements for small businesses, those companies — if they’re successful — eventually grow to the size where they “graduate” out of the small-business category.
But maturing to the point where they can compete for the government’s business without the advantages they got from qualifying as small can be a longer process.
The act was designed to give graduating small businesses more time before they have to compete on a level playing field with the multibillion-dollar giants who dominate government contracting.
“If the Runway Extension Act goes into effect,” small-business owner Erin Allen told the subcommittee, “I will have a few more critical years to build my infrastructure, develop talent, and comply with the costly new cybersecurity requirements the federal government is putting into place for its contractors.”
The sudden transition from the walled garden of small business set asides to the open savanna of free competition with the giants of government contracting can be a valley of death for small businesses, said Kristina Tanasichuk, CEO of the Government Technology and Services Coalition.
“When these [small] businesses succeed, grow, and bring innovation to their federal customers, they grow out of their size standard and then must compete ‘free and open’ against multibillion-dollar companies,” she said. “Many fall back into their [small] size standard or sell their business.”
She said that the Small Business Runway Extension Act, passed last year with bipartisan support, “addressed this … recognizing a challenge that has plagued successful small businesses.”
There’s a lot at stake, according to Bloomberg Government, as companies generating between $25 million and $500 million in annual revenue get just under 27 percent of federal contracting dollars — about a quarter of that from small-business set asides.
The federal government’s exact definition of small depends upon which business you’re in, but broadly speaking for service industries it’s between $27.5 million to $35 million in annual revenue. Since 1956, according to the U.S. Small Business Administration, that’s been measured as the average of the last three years. The act changed that to the average of the last five — thus giving businesses an extra year or two to make the adjustment to free and open competition.
But, according to Subcommittee Chairman Jared Golden (D-Maine), the SBA has been slow-rolling the changes, claiming they don’t apply to the agency and that they don’t come into effect until implemented by SBA rule changes.
The delay, he said, “is creating widespread uncertainty and confusion” — especially among businesses who would remain small under the changed rules.
David Black, an attorney at Holland and Knight specializing in government contracts law, said that companies were already relying on the new standard in bids they were submitting. “Mid-tier service contractors who would be large under the three-year standard but small under the five-year standard are submitting proposals for small-business set-aside contracts,” he told the subcommittee.
The subcommittee’s ranking GOP member, Peter Stauber (R-Minn.), said small businesses were in “limbo.”
Another witness, Megan Connor, a partner at PilieroMazza law firm, speculated that the SBA might be concerned about the unintended consequences of the law on companies whose revenue was falling. “I would suspect that they might be concerned about the losers under the act, i.e. those that are small under the three-year standard but not under the five-year standard,” she said.
In a statement to HSToday, an SBA spokeswoman said the agency was working to implement the changes: “As is typical procedure for contracting standards changes, the SBA is drafting proposed updates to current regulations to implement the new law,” she said.
The rule-making process would ensure “that the public, stakeholders, and those affected by the new law will have an opportunity to provide feedback through a public comment period. That feedback will help the SBA make the necessary updates to policies and procedure before fully implementing the Runway Extension Act.”
She added that the agency was “conducting a cost-benefit analysis of proposed changes to SBA’s size rule. This analysis is required for any proposed changes to SBA’s size standards.”
Whatever the outcome, some are skeptical the changes will really help mid-tier companies.
“If I was a $10 million a year company, I’d be ecstatic” about the change from a three to a five-year standard, said Bob Lohfeld, founder and CEO of Sev1Tech, a professional services contractor. “But Congress hasn’t really fixed anything for mid-tier companies.”
“There’s still a cliff. You have a year or two more until you get there, but you still fall off it when you do.”
Lohfeld is chairman of the Lion’s Den, a group that GTSC set up to address the challenges graduating small businesses face as they reach the mid-tier.
The problem, says Lohfeld, is that a $40 million a year company — which will have graduated from the small-business category by government measures — is not really better positioned to compete for federal contracts with multibillion-dollar giants than a $10 million a year firm. And by letting them go off the cliff, the government is wasting the investment it makes in special provisions for small businesses.
“Most small businesses go belly-up in the first few years. If you got to $40 or $50 million [annual revenue], you’re not dummies, OK?”
As a $50 million company, “I’m not going to bid to build the next space shuttle, but a 10-year, $20 million a year IT services contract I can do any day of the week,” he said.
Moreover, for that company, “every employee is going to eat, sleep and breathe that contract. It’s a big deal for them.” For the government contracting giants, “$200 million is background noise; it doesn’t move the needle.”
“This is a set of companies that really live the mission,” he says of the mid-tier. “We’re big enough to deliver but still small enough to care.” From a policy standpoint, he argues, “It makes no sense to invest [in set asides and other special provisions] and grow those companies only to abandon them” once they’ve passed an arbitrary size.
“Congress has bailed on the mid-tier,” he said.
What policy makers should look at, rather than simply making the road to the cliff’s edge longer, is some way of assisting firms that that go over the cliff, he said.
“It’s tough to compete on paper with the big boys when I’m not going to have a record” of performing on large contracts, he said. Federal Acquisition Regulations generally require agencies to take past performance on similar contracts into account when evaluating bids and proposals. One possible measure the government could look at would be “relieving that past performance burden, basing it more on capability: Does my company have the capability to do the job?”
If they don’t sell themselves out, fall back into the small-business tier or go out of business altogether, graduating small businesses often merge with others, or recruit private-equity funding and buy other firms, to reach what Lohfeld calls their “Rocky Balboa weight” — a size where they can actually compete with the government contracting giants.
“At $200 or $250 million, I can actually compete with the $1 billion companies and provide a more focused service to the mission,” he said.