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LEGAL DEVELOPMENTS ALERT: New Law Revises Small Business Size Formula

On December 17, 2018, President Trump signed the Small Business Runway Act of 2018 (“SBRA”), which revises the formula for calculating revenues to determine eligibility for small business set-asides to use a five-year average instead of a three-year average. The intent of the law is to avoid prematurely cutting off fledgling small business concerns from set-aside work. Using a five- year average reduces the likelihood that a revenue spike in a single year will prevent a company from competing for small business set-aside contracts. The new law will allow some firms that did not previously qualify as small to compete for set-aside work. The change could also bar some firms that were considered small under the three-year size formula from qualifying as small, depending on their prior-year revenue experience.

The Small Business Act and the implementing regulations of the Small Business Administration (SBA) provide that small business size status is generally determined either based on average employees or average gross receipts, depending on the industry. The average number of employees is calculated “based upon numbers of employees for each of the pay periods for the preceding completed 12 calendar months.” 13 C.F.R. § 121.106(b)(1). Gross receipts have long been calculated using “total receipts of the concern over its most recently completed three fiscal years divided by three.”  13 C.F.R. § 121.104(c).  Though the detailed methods of calculation are prescribed in the SBA regulations, the 12-month and 3-year periods are set by statute. See 15 U.S.C. 632(C)(ii)(I)-(II).

The SBRA now requires that average revenues shall be calculated based on a period of not less than five years. Calculating gross receipts using a five-year average may allow some companies to be considered small for a longer period, because revenue increases will be spread out over a longer period. In the immediate term, contractors should evaluate whether revenues from four or five years ago will affect their small business size status. The size status of companies that have been in business fewer than five years could also be affected by the change because SBA regulations presently calculate the size of businesses that have been in business fewer than three years using a weeks-based formula, which might now be extended to firms in business fewer than five years. 13

C.F.R. § 121.104(a). Notably, contracts that have already been awarded should generally not be affected by the change in law, because businesses that qualify as small for a contract at the time they submit their initial proposal (including price) are generally considered small throughout the life of that contract. 13 C.F.R. § 121.404(a).

It is important for small businesses to be mindful of statutory and regulatory changes that may affect their size status. In recent years, the Department of Justice has targeted misrepresentations of business classification in enforcement actions under the False Claims Act, as explained by Smith Pachter McWhorter attorneys in a recent Law360 article, DOJ Focuses FCA Priorities On Small Business Contracts.

Our firm closely monitors small business rules and represents clients on related compliance matters, disputes, and enforcement actions. If you have any questions, please contact us.

Daniel H. Ramish

Jonathan D. Shaffer

Armani Vadiee