What’s in your wallet? Government contractors
that receive small business set-aside contracts and have outgrown
their size standards could potentially reduce their company's value
by not taking action to counter the effect of the new U.S. Small
Business Administration (SBA) size recertification rules, which
became effective on June 30, 2007 (71 FR 66434).
Contractors that fail to meet the relevant size regulations after
recertification risk losing future revenues if the contracting agency
cannot count as small business contracts any awards under new or
existing “long-term” contracts. Recertification can
be required by any one of the following five triggers: (1) within
30 days after a contract novation; (2) within 30 days after an acquisition
or merger is complete; (3) within 120 days prior to the end of the
fifth year on a “long- term” contract; (4) before any
option exercise after the fifth year on long-term contracts; and
(5) on any competition for an order, if requested by the contracting
officer. If an agency cannot count an award as a small business
contract, it may decide to award the contract to another company
that is still small under the new small business recertification
rules.
Your company's value is driven by the risk and return on future
revenues, and the increased risk that a government agency will not
award you a new contract or exercise an option year on an existing
long-term contract can reduce the value of your company. Whether
you are performing a valuation for internal reasons (issuing stock
options, estate and gift planning, making charitable contributions,
converting from an S corporation to a C corporation, or shareholder
disputes), external merger and acquisition reasons (buying or selling
a company), or post-sale reasons (FAS 141 purchase price allocations),
you need to be aware of factors that could help you maintain the
value of your small business in spite of the new regulations.
Diversify Contract Backlog
Positioning your company to be able to win both small business set-aside
and full and open contracts will increase your valuation. The predictability
of your contract backlog greatly increases with full and open contracts
because they are not subject to the contracting officer’s
request for a size recertification. Riskier cash flow streams result
in a lower valuation. Offsetting a portion of the riskier small
business set-aside cash flows with cash flow streams from full and
open contracts will help you maintain or increase the value of your
company.
Develop Specialized and Unique Offerings
Developing and maintaining proprietary, unique solutions can differentiate
your company from your competitors and make your small business
more attractive to a buyer as compared to other acquisition candidates.
If the buyer really needs the service or solution that your
company offers as a strategic complement to the buyer’s business,
the buyer may be willing to take on the riskier cash flow streams
from small business set-aside contracts.
Maintain Strong Relationships with Your Customer Agencies
Ensuring the positive perception of the value your company delivers
to your customer agencies is a key factor in maintaining long-term
and profitable relationships. Aspire to deliver value to your customers
in excess of the competition. Value can be provided through “mission
dominance,” an in-depth understanding of the agency’s
challenges by specializing in certain types of projects; by having
a strong track record of successfully completed projects; or through
the ability to reduce costs by having a superior technical solution.
When a prospective buyer sees that an agency holds your small business
in high regard, the prospective buyer has a slightly greater comfort
that services are needed thus resulting in a higher likelihood that
the contracting officer could still exercise option periods on existing
contracts even if your company no longer qualifies as a small business
upon size recertification.
Increase Management Depth
Winning new business and managing the operations of your small business
should not be a one-person operation. The experience and depth of
management is critical in effectively growing the business to future
expectations. Surround yourself with a management team that works
well together and has experience in relating to your customer agencies.
Whether it’s a valuator or a potential buyer looking at your
company, a strong management team will significantly increase your
value as compared to a company dependent on one person for its success.
Summary
The new recertification rules have changed the playing field when
it comes to valuations of small businesses that have grown past
their size standards or been acquired by a large business. Small
government contractors are less attractive takeover candidates because
of the greater uncertainty in future revenue and earning streams.
Buyers will be forced to do much more due diligence research into
a small business, and will probably want to pay much less up front
money or withhold a significant part of the purchase price until
the small business actually delivers the future revenues (known
as an “earnout”). A proactive approach to mitigating
the effects of the new SBA recertification rules will help reverse
the effect of the new rules. But it will take a concerted effort
on the part of a business owner and its management team.
Dave is a Partner with CB&H and
a member of the Firm's Government Contractor Services Group.
Nonyerem is a Senior Consultant with CB&H and a member of the
Firm's Government Contractor Services Group.
your
company offers as a strategic complement to the buyer’s business,
the buyer may be willing to take on the riskier cash flow streams
from small business set-aside contracts.
