Basics of Qualifying as a Small Business for United States Federal Government Contracts

Author, David Fletcher

Emerging companies, startups and other early-stage companies often hear about the potential benefits of entering the US government market, and for good reasons. Public funding can bring with it a lucrative and reliable revenue stream and provide valuable exposure to long-term customers. Qualifying as a small business for federal procurement purposes can have the added benefit of affording preferential status in the contracting process, as competition for certain opportunities is restricted exclusively to such businesses, and many prime contractors look to small business firms to fulfill their own subcontracting goals. This article provides a summary of the basics of small business status and key aspects of qualifying that any business considering doing so should understand.

Threshold business requirements

As a starting point, before evaluating whether you meet the definition of “small” for federal contracting purposes, your firm must be organized for profit, have a place of business in the US and operate primarily domestically (or make a significant contribution to the US economy by paying taxes or using domestic products, materials or labor). Any legal form of organization is acceptable, although a joint venture cannot have majority participation by non-US business entities.

If you meet these initial requirements, you will also need to register in the federal government’s System for Award Management (SAM) (available at SAM.gov) before you can bid on government opportunities. Once you complete the registration process, you will be issued a Unique Entity Identifier (UEI) and Commercial and Government Entity (CAGE) code. You will use these business identifiers in responding to federal procurements. As you complete your SAM registration, you will be asked to provide basic company information (e.g., address, point of contact), along with making certain representations and certifications about your firm’s status and qualifications. One of those items concerns small business status.

What does it mean to be ‘small’?

In the SAM registration process, each entity identifies the industries that best match its products and services, categorized by North American Industry Classification System (NAICS) code. A business will have a primary NAICS code – generally the industry in which your receipts, employees and costs are most heavily concentrated – but may identify as many other NAICS codes as are relevant to its operations. The Small Business Administration (SBA) sets, and periodically updates, a size standard for each NAICS code, which is a threshold level of average annual receipts or employee headcount under which a business is considered “small” for purposes of that industry.  To qualify as small for each NAICS code in your SAM profile, your business must be below the applicable size standard.

Annual receipts consider all revenue from any source, ranging from sales to rent, interest and dividends. The formal definition is provided in the SBA’s regulations and generally refers to “total income” plus “cost of goods sold” from your federal income tax returns. The SBA expressly describes the few, limited exclusions – e.g., net capital gains or losses, proceeds from transactions between affiliates, etc. You then calculate your firm’s average to compare it to the designated size standard by adding total receipts for the five most recently completed taxable years and divide that number by five. For any year in the measurement period for which you have not yet filed taxes, use any other available information to make a reasonable estimate, such as your accounting records and financial statements.

If a size standard is measured in terms of a firm’s employee count, the SBA considers all individuals employed, whether on a full-time, part-time or other basis (except for volunteers who are not compensated in any way), including employees from a temporary agency or professional employee leasing company. The business should count all such employees for each pay period over the previously completed 24 calendar months and divide by 24 to arrive at the average. If a firm has not yet been in business for a full 24 months, it can use the average across the total number of pay periods during which it has been in business.

Once your SAM profile is complete with your small business designations for each applicable NAICS code, for each contracting opportunity that you consider responding to, the contracting officer will identify the relevant NAICS code, which determines the size standard offerors must meet for that particular competition if the procurement is set aside for small businesses. This means that, to bid on this opportunity, your business must qualify as small for the contract-specific NAICS code; it is not sufficient to have other NAICS codes (or a primary NAICS code) for which you are small in SAM.

Be on the lookout for socioeconomic requirements in contract opportunities as well. A procurement may be set aside for a subset of small businesses that qualify as woman-owned, service-disabled veteran-owned, or disadvantaged, for example, and each of these programs has its own requirements beyond small business status. Carefully evaluate any size- or status-based bidding restrictions before submitting your offer.

Affiliation: A trap for the unwary

In determining whether a firm is small based on the size standards described above, the SBA considers the receipts or employee count, as applicable, of all of the firm’s “affiliates” as well. This means that you must aggregate your company’s numbers with the numbers calculated in the same manner for each of your domestic and foreign affiliated entities. The SBA’s concept of who constitutes an affiliate is different from what most ordinarily think of as affiliates in the corporate context. The SBA considers entities to be affiliates of each other when one controls (or has the power to control) the other or when a third party controls (or has the power to control) both, regardless of whether control is actually exercised. Affiliation can arise from ownership, including minority investments in various circumstances, common management or board members, prior relationships or ties between entities, family relationships and contractual relationships, among other things. A minority shareholder with the ability to block a quorum of the firm’s board or veto certain corporate actions may be considered an affiliate, for example. The nuance of the SBA’s affiliation rules can be complex, and careful consideration of the applicable regulations is important in determining whether the firm must consider the receipts or headcount of affiliates before representing its small business status.

Why understanding – and carefully documenting – qualification is critical

Small business status is a self-certification that a business makes in SAM and in responding to any federal opportunities set aside for small businesses. In other words, the SBA does not proactively certify firms as small or conduct advance reviews to determine whether a firm qualifies. While this may seem like it simplifies the process of bidding on applicable work, it also means that a firm later found not to have qualified can be accused of making a false representation to the federal government. This could form the basis for False Claims Act liability, with the potential for up to treble damages (i.e., being responsible for repaying three times the amount of money the firm received under the contract at issue) and penalties. The government also has the right to pursue criminal actions and other civil penalties against ineligible firms that received small business awards, as well as the individuals involved, and to pursue suspension or debarment of an ineligible firm from federal contracting. Taking care to thoughtfully assess small business status at the outset in view of the SBA’s regulations and document the good faith efforts the firm undertakes to do so is critical.

Once properly registered as a small business, your firm has the potential to enjoy the preferential treatment in contracting such status affords – both in terms of bidding in restricted prime contract competitions with the US government and positioning yourself favorably for subcontract opportunities with large firms with small business subcontracting goals. A firm’s representations in SAM must be updated at least annually, and recertifications can be required when certain changes in ownership or control take place. Designate an internal position or department responsible for periodically evaluating the firm’s ongoing status and tracking these associated obligations.