On July 6, 2022, the Small Business Administration (SBA) changed its rules for calculating size based on the number of employees from a 12-month calculation period to a 24-month calculation period (87 Fed. Reg. 34094 (the final rule)). Government contractors should review the Final Rule and revised 13 CFR §121.106 to determine how these recent changes will affect their size status for government contracts and subcontracts.
Regulatory background for recent changes to the SBA’s size standards
A company may identify itself as small for a federal government contract if it meets the applicable size standard associated with the NAICS code assigned to that contract. The NAICS codes and associated size standards can be found at 13 CFR § 121.201. Each size standard is determined by either: (1) the average number of people employed by the company, or (2) the company’s average annual revenue.
On December 17, 2018, President Trump signed the Small Business Runway Extension Act of 2018 into law, extending the measurement period for calculating average annual revenue for small businesses from three years to five years. The Runway Extension Act did not affect employee-based sizing standards. We’ve addressed this change in previous alerts, which can be found here. The general purpose of the Runway Extension Act was to give companies with increasing revenues more time to remain small within the five-year calculation before being locked out of competition for SBA decommissioning contracts.
While the Runway Extension Act went into effect on December 17, 2018, the SBA did not implement the changes into its regulations until January 6, 2020 (84 Fed. Reg. 66561), and even then provided for a phase-in phase that allowed contractors to choose between a 3-year or 5-year average annual revenue period through January 6, 2022. The option to choose either the 3-year or 5-year average annual revenue period, ended January 6, 2022, except for SBA’s corporate lending programs and catastrophe loans. While the Final Rule extended this elective option to additional SBA financial assistance programs (i.e., corporate loans, catastrophe loans, SBG and SBIC programs), the SBA confirmed that it will not renew or allow an election to the government contract programs because government contracts involve competition, and each Competitor should be obliged to respect the same calculation period when bidding for a public contract. 13 CFR §121.104 provides the rules for calculating average annual earnings.
Consistent with the changes made to the calculation of annual revenue under the Runway Extension Act, on January 1, 2021, Congress also approved changes to employee-based sizing standards through language in Section 863 of the Fiscal Year 2021 National Defense Authorization Act ( FY2021 NDA). Specifically, by passing the NDAA for fiscal year 2021, Congress directed the SBA to change the calculation period from 12 months for the average number of employees to 24 months. This extended period of sizing to an employee-based sizing standard will allow companies to remain eligible for SBA programs for a longer period of time and will better reflect a company’s true size.
Impact of the SBA’s final rule amending employee-based sizing standards
Employee-based sizing standards apply primarily to manufacturers, but companies in certain environmental remediation, insurance, mining, publishing, research and development, telecommunications, transportation, and utilities industries also determine size based on the number of employees. Therefore, the Final Rule does not affect all small businesses, but changes the calculation of size for businesses that size based on the number of employees.
In contrast to the incremental changes made to the calculation of annual earnings as a result of the Runway Extension Act, the Final Rule does not include a transition period for the 24-month employee calculation. From July 6, 2022, corporations that measure their size based on the average number of employees must apply the 24-month limit.
Similar to the purpose of the Runway Extension Act, however, the Final Rule allows for concerns using employee-based sizing standards a longer runway to determine eligibility for SBA programs. For example, a company that may have seen a significant increase in hiring over the past year due to supply shortages now has 24 months to size, resulting in temporary spikes in employment having less of an impact. Businesses that may have recently lost their eligibility based on the 12-month calculation due to a significant increase in hiring over the past year can now re-certify as a small business if the 24-month period results in them being under the relevant size standard. The SBA expects the Final Rule to result in a net gain of approximately $158 million in federal small business contract dollars as more companies are eligible for these contracts due to the longer timeframe to calculate size.
Contractors using employee-based sizing standards should carefully review the requirements of 13 CFR §121.106, which now includes the 24-month calculation period, to determine how these changes affect their sizing.
Copyright © 2022 Womble Bond Dickinson (US) LLP All rights reserved.National Law Review, Volume XII, Number 193