The Law of Unintended Consequences - Part Deux

When the Small Business Administration (SBA) changed the rules on set-aside contracts last June, they were trying to improve the accuracy of the reports they give Congress, the President and the public. (See SBA.GOV for more) They didn't mean to kill the merger and acquisition market for small Government contractors.

At least, I don’t think they did…

Since the beginning, Federal spending on contracts set aside for small and small disadvantaged businesses were counted as Small/Small Disadvantaged procurement for the life of the contract. If the company that won the contract outgrew their classification, spending on the contract was still counted against the Federal goal for small/small disadvantaged procurement (currently 23%). If the company was acquired by a large company, the spending on set-aside contracts was still accounted against the goal. If the company was acquired by another small company and the new combined firm was no longer small…

You get the idea.

When the Federal Government first started tracking set-aside spending that wasn’t much of a problem. Most contracts were for a discrete amount. Even the occasional incrementally funded contract or contract with options didn’t distort the data that much. How spending should be counted only became an issue when the predominate contract for small business spending became an “ordering vehicle.”

There are lots of different kinds of ordering vehicles – IDIQs, MACs, GSA Schedule contracts, GWACS – but they have one thing in common. Their primary value isn’t in the funding provided at award (usually nothing) it’s in their marketing potential.

When a new vehicle is awarded, the business development folks hit the street to market the vehicle to every agency and program that could possibly place an order against it. If the vehicle was awarded as a small or small disadvantaged business set aside, marketing that vehicle is vastly easier because the agency can take credit against its set-aside goal. As a result, the vehicle is much more valuable to the enterprise that one without that status. Conversely, if a vehicle loses its set-aside status, it becomes much less valuable. Sometimes, it becomes completely worthless.

June 30th, 2007, the rules changed.

Effective 30 June, 2007, all contracts held by companies that have acquired another company or have been acquired must be recertified as to the status of the current holder. All contracts held by any company acquired by or acquiring another company after that date must be recertified immediately upon completion of the merger/acquisition. In addition, all set-aside contracts must be recertified on or before the five-year anniversary of the award AND upon exercise of each and every option thereafter.

Literally thousands of contracts held by large businesses as a result of acquisitions of small businesses became worthless. You might think that assessment harsh, but consider this.

Most large companies hold at least one GSA schedule 70 contract for IT products or services. The rate structures of large companies tend to benefit from economies of scale not achievable by small businesses. As a result, their rates are lower and so are their prices. That’s why some contracts are set aside exclusively for small business – to give them a chance to compete.

If such a large company were to acquire a small company that offers similar products or services on a schedule 70 contract awarded as a set-aside, the company could market that vehicle to prospective clients based on its size status even though the prices (and profits to the new owner) might be higher.

If that contract loses its status, it becomes simply a duplicate vehicle with higher rates. No agency would place an order against it in preference to another vehicle with the same company with lower rates. Accepting an order might even be a problem for the contractor under GSA’s “most favored pricing” contract clause.

The prospective valuation of some small or small disadvantaged Government contractors was heavily influenced by the potential value to a buyer of their “set-aside vehicles.” When the value of those vehicles to a buyer dropped (or evaporated) so did the valuation of the business.

I don’t think they meant to do that.

Did they?