How SBA's Proposed Size, Status Recertifications Rule Could Impact Small Business M&A

The U.S. Small Business Administration (SBA) on Aug. 23, 2024, issued a Proposed Rule that significantly changes the effect of recertifications of size and socioeconomic status under set-aside contracts following a merger or acquisition of a contractor with small business awards. Comments are due on Oct. 7, 2024. If finalized in its present form, the proposed rule could impact the valuation of small business pipelines by eliminating post-mergers and acquisitions (M&A) transaction eligibility for orders under restricted multiple award contracts (MACs) and set-aside orders under Federal Supply Schedule (FSS) contracts. Because SBA states that many of its proposed rule changes are "clarifications" of its existing rules, potential M&A buyers should consider the effect of SBA's proposed rule in their valuation of small business targets even before the rule is finalized. Affected concerns should also strongly consider filing comments on the proposed rule to ensure their perspectives are taken into account by SBA in its formulation of the final rule.

Background and Context

The valuation of a small business acquisition target is based in part on the income it can be expected to generate for the buyer after the acquisition closes. When an acquisition target has small business set-aside contracts, buyers understand a transaction may limit the target's eligibility for future set-aside contracts. But under present SBA rules, there is a presumption of continuing eligibility for remaining option periods under existing set-aside contracts and future task orders under certain "MACs." A buyer will typically include an assessment of the revenue that can be expected from an acquisition target's remaining set-aside contracts, including future task orders under MACs.

It is common for an M&A involving a small business contractor to result in a change to its size or socioeconomic status. This is because the contractor becomes "affiliated" and "controlled" for size and status purposes with its buyer by virtue of the transaction. Since 2006, small business contractors have been required to recertify their size and socioeconomic status within 30 days of an M&A transaction involving a sale of equity or a finalized novation in a transaction involving the sale of assets related to a business segment. However, a recertification that the contractor was no longer small did not necessarily require termination of the set-aside contract(s). Rather, it merely required that the awarding agency cease taking credit for its small business goals.

Until November 2020, post-M&A size and status recertifications did not impact a contractor's eligibility for remaining option periods under set-aside contracts and orders or the awarding of future set-aside task orders under any kind of multiple-award indefinite delivery/indefinite quantity (IDIQ) contract (restricted, unrestricted and FSS). Moreover, closing a transaction while set-aside proposals or offers were still pending did not change a seller's eligibility.

In November 2020, SBA issued a final rule that changed the effect of post-M&A recertifications on eligibility for new task orders under unrestricted MACs (except for FSS contracts, which continued to follow the prior rule). In addition, the November 2020 rule changed the effect of a post-M&A size recertification on eligibility for pending proposals for set-aside awards. If the transaction closed within 180 days of proposal submission, the contractor was no longer eligible to receive a set-aside contract or a set-aside task order under an unrestricted MAC or FSS contract. (SBA's Office of Hearings and Appeals interpreted the November 2020 final rule as not impacting eligibility for task orders under restricted IDIQ contracts.)

Now, four years later, SBA is proposing to expand further the disqualifying impact of post-M&A recertifications on eligibility for new set-aside task orders, pending proposals and even option periods under MACs.

Key Changes Regarding the Effect of Post-M&A Recertifications of Size and Status

As an overarching matter, SBA is proposing to consolidate and relocate its recertification requirements for all its size and status programs in a single, new section of its regulations: 13 CFR 125.12. Three of the biggest proposed changes from the Proposed Rule that could negatively impact small business valuations are the following:

No Future Task Orders or Options Under Restricted Multiple Award Contracts. Since SBA first required post-M&A recertifications in 2006, a recertification as "other than small" has had no impact on a contractor's eligibility for future task orders or task orders under MACs that were restricted to small businesses or a subcategory based on socioeconomic status (unless the contracting officer requested an order-specific representation). As long as there was no order-specific representation requested at the order level, contract holders remained eligible for future task orders and option periods even though they represented as "large" or without the required status following the relevant M&A transaction.

SBA is proposing to change this. Under proposed section 13 CFR 125.12, SBA would establish a "disqualifying representation" following an M&A transaction. A holder of a restricted MAC, whose recertification removes their size or SBA status, would be ineligible for future task orders or option periods. As the Proposed Rule states:

If a concern has a disqualifying recertification in response to any triggering event for recertification, aside from a contracting officer request for recertification on a specific order or agreement, the concern is ineligible to submit an offer for a set aside or reserved award under a multiple award contract after the triggering event occurs. (Emphasis added.)

Unlike the current regulation, it would no longer matter whether the MAC itself was restricted or unrestricted.

Thus, if the proposed rule is finalized, for acquired firms that must recertify as other than small, they will not be eligible for future set-aside task orders under restricted MACs. Without the possibility of future new income streams from set-aside orders under these contracts, this could adversely impact the valuation of a contractor holding such contracts when an M&A transaction is likely to result in a disqualifying representation.

No Future Restricted Task Orders Under FSS Contracts. If finalized, SBA's proposed rule would have a similar impact on restricted task orders under a General Services Administration (GSA) FSS contract. GSA FSS contracts are unrestricted MACs. Under SBA's current regulations, FSS contracts are excepted from the rule that applies to restricted task orders under unrestricted MACs. This is consistent with FAR 8.405-5, which provides that in the absence of a contracting officer's request for an order-specific size representation, size for a restricted task order under a FSS contract is made "at the contract level" – i.e., based on the contract holder's size and status representations at the time it submitted its proposal for its initial FSS contract award or at the time of its size and status representations at the time it secured its current five-year option period. (A different rule applies for sole-source task orders made to 8(a) contractors.)

Under the proposed rule, SBA seeks to "clarify" that though it has excepted FSS contracts from the general recertification rule applicable to unrestricted MACs, that exception does not apply to future set-aside orders when a disqualifying recertification is required:

If there is a disqualifying size recertification in response to any event in [new proposed] § 125.12, including a merger, sale, or acquisition, the concern must notify the contracting officer for the underlying multiple award contract and the contracting officer for all existing orders, and update its SAM.gov profile to reflect its current size status. The concern is no longer eligible for set-aside orders or agreements against the FSS MAS [Multiple Award Schedule]. In those instances, size is determined as of the date that the triggering event occurred or offer for the particular order or agreement, depending on the cause for recertification. (Emphasis added.)

Thus, under the proposed rule, a post-M&A disqualifying size or status representation will render a FSS contract holder ineligible for future restricted task orders under its FSS contract, even if the contracting officer does not request an order-specific representation. If the proposed rule is finalized, for acquired firms that must recertify as other than small, they will not be eligible for future set-aside task orders under FSS contracts.

Loss of Eligibility Under Pending Proposals for Set-Aside or Reserved Contracts and Orders. Since November 2020, SBA's regulations have required offerors to promptly notify contracting officers of a change in control caused by M&A activity and recertify size for any pending proposals for set-aside contracts and task orders. If the transaction triggering the recertification occurred within 180 days from submission of the proposal, a disqualifying recertification rendered the offeror ineligible for the contract or proposal. As noted in the Notice of Proposed Rulemaking (NPRM), recent SBA Office of Hearings and Appeals (OHA) cases have been construed to hold that the "180-day" rule does not apply in the case of task orders under restricted MACs. This meant that buyers have been able to assign potential value (depending on how they assess the seller's potential winning percentage) to pending task order proposals under such restricted MACs.

SBA's NPRM states that the agency believes these cases misconstrued the intent of the 180-day rule. SBA is proposing to clarify its intent and treat restricted task order proposals the same way as proposals for other set-aside contracts and task orders. Therefore, under the proposed rule, if a novation, merger, acquisition or sale triggers a disqualifying recertification that happens within 180 days after the offer date but before the award is made, the entity is ineligible to receive the pending small business set-aside award, even though it is under a restricted MAC.

SBA's NPRM also goes on to extend the disqualifying recertification even in cases where the task order award is made more than 180 days after the triggering event (i.e., the merger or acquisition). Thus, if the pending proposal is for a task order under a set-aside MAC, the concern is ineligible for award because the concern is not eligible for set-aside orders. (This will be true regardless of whether the transaction occurred more than 180 days after proposal submission.) This means buyers would be less likely to assign value to pending proposals for task orders under restricted MACs.

Questions Remain About the Timing of the Applicability of SBA's Implementation of Elements of Its Proposed Rule

The proposed rule is unclear as to the timing of its changes, particularly as it relates to MACs awarded before the effective date of the final rule. There is a related question as to whether SBA can retroactively apply its proposed rule to restricted MACs and FSS contracts awarded before the rule takes effect. Even though the proposed rule would make significant policy changes with respect to the impact of post-M&A recertifications on task orders under restricted MACs and FSS contracts, SBA refers to these changes as mere "clarifications." This may signal an intent by SBA to apply this retroactively – as a clarification is not a change that is barred by retroactive application. As currently written, the Proposed Rule does not identify when it will become effective or whether it will apply to recertifications submitted prior to SBA's issuance of a final rule. As such, small business concerns that have already undergone, or are considering, a sale of their business have relied upon the current SBA regulatory regime in making business valuation and sale decisions. Based on existing case law, companies and acquirers might have assigned significant value to eligibility for future task orders and options during the life of certain MACs, which enhances the company's attractiveness and marketability.

Based on how SBA applied and enforced its November 2020 rulemaking (which changed size and status eligibility for restricted task orders under unrestricted MACs), it will not be surprising if SBA asserts that the rule applies to all task order procurements under existing restricted MACs and FSS contracts, including those that were awarded before the final rule's effective date. In a case addressing whether the November 2020 final rule applied to an IDIQ contract awarded in 2015, SBA's OHA concluded that the final rule applied to task orders awarded under existing contracts, explaining it this way:

Elsewhere in the regulatory preamble, however, SBA explained that its intent was to close a loophole in its regulations, whereby set-aside orders might be awarded to large businesses under unrestricted MACs, even though the contractor's "size and status were not relevant to the award of the underlying MAC." (citation omitted) Given SBA's stated concerns, the revisions to § 121.404(a)(1)(i)(A) are most reasonably understood as applying to all orders issued after November 16, 2020. This is true because there is no indication in the regulations or the accompanying commentary that SBA intended to permit the loophole to continue indefinitely, until such time as all unrestricted MACs expired. Certainly, SBA could have included language in the rule exempting previously-awarded MACs if that had been SBA's intent.

Avenge, Inc., SBA No. SIZ-618, 2022 WL 17423607.

It seems likely SBA will seek to have this final rule applied similarly. (One topic for comments on the proposed rule may be to get SBA to expressly address whether a Final Rule will apply to task orders issued under previously awarded contracts.)

However, a question remains as to whether such a Final Rule can be given such retroactive effect. It is established that a regulatory amendment that "creates a new obligation, imposes a new duty, or attaches a new disability, in respect to transactions or considerations already past" cannot be given retroactive effect to previously solicited contracts. Kearfott Guidance & Navigation Corp. v. Rumsfeld, 320 F.3d 1369, 1374 (Fed. Cir. 2003). There is a question of whether restricting size and status eligibility for future restricted task orders under restricted MACs and FSS contracts creates a "new disability" in respect to those contracts that would prevent retroactive application.

There may also be questions about whether SBA is exceeding its statutory authority in unilaterally implanting a policy change this significant without new legislation from Congress. As the U.S. Supreme Court has noted recently, agencies have "only those powers given to them by Congress and an agency's 'enabling legislation' is generally not an 'open book to which the agency [may] add pages and change the plot line.'" West Virginia v. Env't Prot. Agency, 597 U.S. 697 (2022). Federal courts "presume that 'Congress intends to make major policy decisions itself, not leave those decisions to agencies." Id. Following the Supreme Court's decision earlier this year overruling the Chevron deference previously afforded to federal agencies on matters of ambiguous statutes, "[c]ourts must exercise their independent judgment in deciding whether an agency has acted within its statutory authority." Loper Bright Enters. v. Raimondo, 144 S.Ct. 2244 (2024).

Holland & Knight does not intend to take a position on any of these questions through this blog. We intend only to note their existence and that they may be raised in the future before and after SBA finalizes its rulemaking.

A Procedure for Formal Size Determinations Following Post-M&A Size Recertifications

SBA is also proposing to provide a procedure for stakeholders, including competing MAC holders, to police the accuracy of post-M&A size recertifications. M&A activity is often public knowledge through press releases. It is already common practice for competitors to raise questions about a concern's size based on published information about recent M&A activity. However, there is currently no mechanism for the government or a competitor to request a review of the accuracy of a post-M&A size recertification.

The Proposed Rule also seeks to specifically authorize requests for formal size determinations relating to size recertifications required by the new proposed 13 C.F.R. § 125.12. Because the proposed rule would render a concern ineligible for orders set aside for small businesses or set aside for a specific type of small business under a MAC where the concern submits a disqualifying recertification, SBA proposes to authorize any contract holder to request a formal size determination of another contract holder following a post-M&A size recertification relating to a MAC. Formal size determinations could also be requested by the contracting officer, the relevant SBA program manage, or SBA's Associate General Counsel for Procurement Law.

Although unrelated to post-M&A recertifications, it is also worth noting that SBA is proposing to allow a size protest in connection with the award of an order issued under a multiagency MAC, where the protest relates to the ostensible subcontractor rule (because it is at the order level, not the MAC level, where undue reliance may become an issue). SBA's NPRM invites comments on this concept.

Potential Impacts of the Proposed Rule

SBA's Proposed Rule, if finalized with the current language, seems likely to change the M&A landscape for small business government contractors. By eliminating eligibility for future task orders and options under restricted MACs and future restricted task orders under FSS contracts, the proposed rule would reduce the amount of future revenue a buyer could expect a small business acquisition target to generate if the transaction causes the target to make a "disqualifying" recertification. Less expected future revenue generally means a lower valuation.

Beyond these obvious impacts on the M&A market, the downstream effects of these proposed changes are likely more significant than SBA may be aware. Small businesses often attract top executive talent that are instrumental in growing their businesses by offering executive compensation packages that are frequently structured with earn out provisions that compensate these individuals based on future company performance. Additionally, many small businesses grow through minority investment activities by private equity groups. Shorter runway periods and less favorable exit strategies for small businesses based on the proposed regulatory changes are likely to disincentivize executives or a private equity group's intent to invest in the company, which can impact a small business's ability to grow.

Conclusion

Holland & Knight will continue to monitor developments regarding the Proposed Rule and provide updates. Public comments on the proposed rule are currently due by Oct. 7, 2024. We will also publish a series of other blogs regarding other changes to SBA's regulations included in the Proposed Rule, such as changes to the Mentor-Protégé Program, 8(a) Program and others. Please contact the authors if you have specific questions for your business.