Regulatory Context of Recent Changes to SBA Size Standards
A business can self-certify as small for a federal government contract if it meets the applicable size standard associated with the NAICS code that is assigned to that contract. NAICS codes and associated size standards can be found at 13 CFR § 121.201. Each size standard is determined by: (1) the average number of employees employed by the company, or (2) the company’s average annual revenue.
On December 17, 2018, President Trump signed into law the Small Business Runway Extension Act of 2018 (Runway Extension Act), which increased the measurement period for calculating average annual revenue for small businesses from three to five years. The Runway Extension Act did not affect employee-based height standards. We have addressed this change in previous alerts, which can be found here. The general purpose of the Runway Extension Act was to allow companies with growing revenues more time within the five-year calculation to stay small before being locked out of competition for SBA reserved contracts.
Although the Runway Extension Act was signed into law on December 17, 2018, the SBA did not implement the changes to its regulations until January 6, 2020 (84 Fed. Reg. 66561) and even then included a transition period allowing entrepreneurs to choose between a 3-year or 5-year period for average annual revenue until January 6, 2022. The option to choose the 3-year or 5-year period for average annual revenue has ended on January 6, 2022, except for SBA Business Loan and Disaster Loan Programs. Although the final rule extended this preferred option to other SBA financial assistance programs (i.e. business loans, disaster loans, SBG and SBIC programs), the SBA has confirmed that it will not renew or allow choices for government contracting programs because government contracts involve competition and each competitor should be required to follow the same calculation period when he is competing for a government contract. Regulations governing the calculation of average annual revenue can be found at 13 CFR § 121.104.
Consistent with changes to the calculation of annual revenue under the Runway Extension Act, on January 1, 2021, Congress also ordered changes to employee-based size standards through language included in Section 863 of the National Defense Authorization Act for Fiscal Year 2021 (FY2021 NDAA). Specifically, when 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 size calculation based on an employee-based size standard will allow businesses to remain eligible for SBA programs for a longer period of time and will better reflect the actual size of a business.
Impact of SBA Final Rule Changing Employee-Based Size Standards
Employee-based size standards apply primarily to manufacturers, but companies in certain sectors of environmental remediation, insurance, mining, publishing, research and development, telecommunications , transportation and utilities also determine the size based on the number of employees. Therefore, the final rule will not affect all small businesses, but will change the way size is calculated for businesses that determine size based on the number of employees.
Unlike the incremental changes that were made to annual revenue calculations as a result of the Runway Extension Act, the final rule provides no transition period for the 24-month employee calculation to take effect. As of July 6, 2022, companies that determine their size based on the average number of employees must use the 24-month period.
However, similar to the intent of the Runway Extension Act, the final rule will allow concerns using employee-based height standards a longer track to determine eligibility for SBA programs. For example, a company that may have had a significant increase in hiring due to supply shortages over the past year will now have 24 months to determine its size, reducing the impact of temporary employment peaks. Businesses that may have recently lost their eligibility based on the 12-month calculation due to large increases in hiring over the past year can now recertify as a small business if the 24-month period month causes them to fall below the relevant size standard. The SBA expects the final rule to result in a net gain of about $158 million in federal contract dollars for small businesses, as more businesses will be eligible for those contracts due to the longer size calculation period.
Contractors using employee-based size standards should carefully review the requirements of 13 CFR § 121.106, which now includes the 24-month calculation period, to determine the impact of these changes on their size.