SBA Finally Proposes a Regulation to Harmonize Its Receipts-Based Size Standards with the Small Business Runway Extension Act of 2018

On June 24, 2019, the U.S. Small Business Administration (SBA) finally proposed a regulation which would harmonize its receipts-based size standard regulation with the Congressional directive of the Small Business Runway Extension Act of 2018 (SBREA).  The SBA also proposes to distinguish between the manner in which an entity should calculate its annual receipts for a sale or acquisition of a division as compared with the sale or acquisition of a separate legal entity.  Comments are invited by the SBA until August 23, 2019.  (See Small Business Size Standards: Calculation of Annual Average Receipts, 84 FR 29399, (Jun 24, 2019)).

The SBREA amended section 3(a)(2)(C)(ii)(II) of the Small Business Act (SBA Act), 15 U.S.C. 632(a)(2)(C)(ii)(II), to prescribe that, among the other requirements for establishing a small business size standard, the size of a business concern providing services on the basis of the annual average gross receipts of the business concern is to be measured over a period of not less than 5 years, a two-year extension from the prior 3-year measurement period.  The SBREA appeared to be self-enacting and immediately effective.  The SBA, however, disagreed contending that it was not subject to the statutory change because it possesses separate statutory authority under the SBA Act to establish small business size standards, and the SBREA only amended that section of the SBA Act that applies to agencies without separate statutory authority to issue size standards.  The SBA’s stance on the matter has created considerable consternation for many small businesses in terms of how to represent their size on proposals and has led to a number of size protests.

The SBA contends that the SBREA is inapposite to its actions, because, “[i]n contrast to agencies subject to section 3(a)(2)(C) [15 USC § 632(a)(2)(C)], SBA has independent statutory authority to issue size standards.  Under section 3(a)(2)(A) of the Small Business Act [15 USC § 632(a)(A)], the SBA Administrator may specify detailed definitions or standards by which a business concern may be determined to be a small business concern for the purposes of SBA's programs or any other Federal Government program.  Section 3(a)(2)(B) of the Small Business Act [15 USC § 632(a)(2)(B)] further provides that such definitions may utilize the number of employees, dollar volume of business, net worth, net income, a combination thereof, or other appropriate factors.  To determine eligibility for Federal small business assistance, SBA establishes detailed size definitions for small businesses (usually referred to as “size standards”) that vary from industry to industry reflecting differences among the various industries. SBA typically uses two primary measures of business size for size standards purposes: (i) Annual average gross receipts for businesses in services, retail trade, agricultural, and construction industries, and (ii) average number of employees for businesses in all manufacturing and most mining and utilities industries.”  The SBA further contends that the small business assistance programs, including Federal government contracting and business development programs designed to assist small businesses in obtaining Federal contracts, and for SBA's loan guarantee programs, which provide access to capital for small businesses that are unable to qualify for conventional loans elsewhere, all rely upon the SBA’s program and are therefore not subject to the change established by the SBREA.

Despite its assertion that its view is consistent with its long-articulated interpretation of the SBA Act, and claiming to promote consistency government-wide on small business size standards, the SBA now proposes to change its own size standards to provide for a 5-year averaging period for calculating annual average receipts not just for service industries but for all industries that are subject to receipts-based size standards, including the retail trade, agricultural, and construction industries.  In so doing, it proposes to extend the 5-year rule beyond the services industry that was covered by the SBREA.

The SBA recognized the different relative impacts of 5-year averaging on companies at either end of the size spectrum.  For a rising economy with revenue averages being generally lower based on a 5-year average than under the 3-year average, it will allow: (i) Mid-sized businesses that have just exceeded size standard to regain their small business status, and (ii) advanced small businesses close to exceeding the size standard to retain their small business status for a longer period.  Conversely, when annual revenues are declining, the 5-year average may be higher than the 3-year average.  Businesses that grow beyond their small business status under the 5-year average may be disadvantaged because they may have to wait several years more to regain their small business status, as compared with under a 3-year average. The rule, of course, would neither help nor harm businesses that had less than 5 years of annualized receipts.

Perhaps reflecting some of its seeming antipathy to the change, the SBA noted that there would be areas where the proposed rule might not help some small businesses.  The SBA theorized that “[b]y enabling mid-size businesses to regain small business status and by lengthening the small business status of advanced and successful larger small businesses, the longer averaging period may disadvantage smaller small businesses in more need of Federal assistance than their more advanced and larger counterparts in competing for Federal opportunities.”  The SBA likened the challenges facing these smaller businesses to emerging small businesses trying to compete against larger more established businesses.

In what might be viewed as a bit of pique, the SBA advised that the old 3-year rule will remain in effect until the SBA actually promulgates a new rule.  “Since size is determined as of the date when a firm certifies its size as part of its initial offer which includes price, the 3-year calculation period will apply to any offer submitted prior to the effective date of a final rule.  Thus, even if SBA receives a request for a size determination or size appeal after the effective date of the final rule, SBA will still use a 3-year calculation period if the determination or appeal relates to a certification submitted prior to the final rule's effective date.”  Thus, the frustration encountered by small businesses over the past few months is likely to continue for some months (assuming that curative legislation proceeding through Congress is not enacted in the interim).  For those in size appeals, there is now set forth both fodder for the challenge and the essence of the SBA’s arguments in opposition.

Annual Receipts for Sale or Acquisition of Division Versus Separate Legal Entity

The SBA also proposes to clarify how it believes annual receipts should be calculated in connection with the acquisition or sale of a division as compared with the acquisition or sale of a separate legal entity.  The proposed rule would provide that the annual receipts of a concern would not be adjusted where the concern sells or acquires a segregable division during the applicable period of measurement or before the date on which it self-certified as small.  The SBA explained that this is different from how SBA treats the sale or acquisition of a subsidiary.  “In the case of a subsidiary, SBA's regulations provide that ‘[t]he annual receipts of a former affiliate are not included if affiliation ceased before the date used for determining size.  This exclusion of annual receipts of a former affiliate applies during the entire period of measurement, rather than only for the period after which affiliation ceased.’”  The SBA explained that, “[a]ny receipts attributable to a specific division of a concern are certainly receipts earned by the concern.  Even if that division is later sold, its receipts were always part of the receipts directly received by the concern itself, and SBA believes that those receipts should remain a part of the concern's receipts after the sale for purposes of determining the concern's size.”  Similarly, if an entity acquired a segregable division of another entity. the SBA would not increase the acquiring entity’s overall receipts by the amount of the receipts of the acquired division.  The proposed rule offers some clarity to a situation that has caused confusion in the past.

For more information, or assistance on these matters or in submitting comments, please contact Anthony H. Anikeeff or another member of the Williams Mullen Government Contracts team.