By: Maria Panichelli
It’s no surprise that in today’s market, with a growing number of Federal government contracts set-aside for various types of small businesses, teaming relationships are increasingly popular. Large contractors like teaming because it provides them access to contracts for which they would otherwise be ineligible. Small businesses know that teaming is a good way to break into the federal contracting arena, an arena in which experience and past performance can prove critical to securing a contract. By teaming with a more experienced, larger contractor, a small company can acquire the experience needed to secure future federal contracts on its own. However, teaming is not without its downsides.
For small businesses in particular, teaming can pose significant risks. If done improperly, teaming can destroy a concern’s “small” business status, or otherwise render it ineligible to participate in the various Small Business Administration (“SBA”) programs. Small businesses most often lose their status in one of two ways: (1) a finding of “affiliation” pursuant to 13 C.F.R. § 121.103; or (2) violation of the percentage of work requirements set forth at 13 C.F.R. § 125.6. Small businesses need to be educated about these common pitfalls, and how to avoid them. This article seeks to do just that.
“Affiliation” can alter a small business’ size and render it ineligible to compete for small business set-aside contracts. When two companies are found to be “affiliated,” their respective sizes (determined by either revenue or number of employees) are added together; the total is what is evaluated when determining whether the company is actually “small” based upon the SBA’s “Small Business Size Standards.” If the sizes of the two businesses, added together, exceed the applicable size standard, neither can be considered “small.” Accordingly, a finding of “affiliation” is something small businesses want to avoid.
Affiliation is governed by 13 C.F.R. § 121.103, which explains that “concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists.” (13 C.F.R. 121 § 121.103(1)). In assessing whether or not two businesses are affiliated, the SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships; the SBA may find affiliation even though no single factor is sufficient to constitute affiliation. (13 C.F.R. 121 § 121.103(2, 5)). In the teaming context, affiliation generally occurs in one of two ways.
First, a teaming relationship on a single project can result in a finding of affiliation under the “Ostensible Subcontractor” rule. The Ostensible Subcontractor rule holds that a small business that “is unusually reliant” on a subcontractor will be deemed affiliated with that subcontractor for size determination purposes. In other words, a small businesses can run afoul of the SBA’s affiliation rules if the small business teams with a subcontractor on a particular project, but then allows that subcontractor to control that project. In order to determine whether the subcontractor is, in fact, in control of a given project, the SBA will look to a variety of factors, including, but not limited to: whether it is the small business prime contractor or the subcontractor that is performing the vital components of the project; whether the small business prime contractor is financially reliant on the subcontractor; whether the small business has the requisite experience or managerial capability to control the project; and whether it is the small business prime contractor or the subcontractor who is, in reality, controlling the means and methods necessary to successfully complete the project. If the subcontractor appears to be the party in control, the SBA is likely to find that the small business prime contractor and subcontractor are affiliated.
Affiliation can also occur when there is an ongoing relationship between two companies, where one business appears to control the other, or where the two companies appear too closely related or intertwined. In the teaming context, this type of general affiliation can occur if a small business repeatedly teams with the same subcontractor/teaming partner, is financially reliant on its teaming partner, shares employees, office space, equipment or other resources with the teaming partner, or if the small business and its teaming partner have common ownership. Familial relationships, or previous employee/employer relationships are also considered to be signs of affiliation.
By now you should be asking, “How do I avoid affiliation?” The advice we give our clients is simple: maintain control over your company and every project on which you are the prime contractor. If you are going to team with a subcontractor, make sure you do not have other ties to that company. If possible, avoid teaming with companies owned by family members, or companies at which you were previously employed. If you must team with such a company, be very careful that you do not appear reliant on, or intertwined with, that business. Hire your own employees, rent your own office space, and secure your own equipment. Do not allow your company to rely too heavily or regularly on a teaming partner for financial support, and avoid having another business serve as a guarantor of your credit line. Team with different concerns, rather than repeatedly teaming with the same company, especially if you have other ties (financial, familial, or work-related) to that company. Overall, maintain corporate formalities, and ensure that all transactions with other companies are made at arms-length. These tips should help you avoid a finding of general affiliation.
To avoid the perils of the “Ostensible Subcontractor” rule, the same type of principals apply. You may enter into subcontracts, but make sure that you retain control over how the subcontract is performed. Do not rely on subcontractors for financial assistance, or expect them to supply the managerial experience needed to complete the project. Perhaps most importantly, do not allow subcontractors to take over or perform the most vital aspects of the contract. Also, make sure your company performs the requisite percentage of work, as discussed below.
Percentage of Work Requirements
The SBA regulations are very specific about the percentage of work a small business prime contractor must perform on a project to remain eligible for that project, and future small-business set-asides. 13 C.F.R. § 125.6 sets forth these “Prime Contractor Performance Requirements” (aka limitations on subcontracting). Each type of small business has its own requirements, and the percentages further vary depending upon the nature of the contract (services, supplies/products, general construction or specialty construction) being performed. For example, an 8(a) business performing a general construction contract is governed by different self-performance requirements than a SDVOSB performing a supply contract. It is critically important to pay attention to how these percentages are calculated for your particular type of business, and the nature of your contract. In some cases, the required percentage of work is calculated using the total cost of the contract; in others it is calculated using the cost of the contract incurred for personnel. The applicable work percentage requirements for each type of small business can be found as follows:
- 8(a) – 13 C.F.R. § 125.6(a)
- WOSB/EDWOSB – 13 C.F.R. § 125.6(a)
- VOSB/SDVOSB – 13 C.F.R. § 125.6(b)
- HUBZone – 13 C.F.R. § 125.6(c) and § 121.600
If a small business fails to self-perform the amount of work required by these regulations it may have to surrender its small-business status and could thereby lose its ability to compete for future set-aside contracts. It is, therefore, vital to demonstrate to the SBA your compliance with these regulations. To that end, small business prime contractors should include in every teaming agreement (and resulting subcontract) the percentages (by number) and the specific scopes of work (by description) that will be performed by the small business prime contractor.
In summary, it is important for small business contractors to remain cognizant of the rules pertaining to affiliation and self-performance when entering into teaming agreements. Failure to pay attention to these issues could result in the loss of a concern’s eligibility to participate in small business programs. In contrast, if a small business is aware of the issues above, is careful to avoid such pitfalls, and properly structures its teaming relationship, teaming can be a rewarding, and very profitable experience. If you have any questions about how to properly team, contact a legal professional.