M&A: SBA small business certification rules

Last July 1st, a significant change in the Small Business Administration regulations became effective. If a small businesses merges or is acquired it now must now re-certify that it still a small business within 30 days of closing. One of the drivers for the SBA rule change was to ensure that small business goals were accurately reported under long-term, GWACs, GSA and MAS contracts. While this certainly seems fair on the surface, this may not work in the favor of small businesses in the long term.

Just to simplify - When a large government contractor evaluates a target (usually smaller) company, one of the key economic metrics is the type, length and profitability of their contact base. Many of these small firms have grown up and graduated from the small business program. Many times they are still performing contracts that were awarded to them as small businesses.

What value does an acquiring firm put on these? In the old days (pre-July 1, 2007), there was no clear answer to this question. It depended on many factors such as technical or niche capabilities, mission critical services or people, company tenure with the buying agency, etc.

What’s the value of these small contracts to an acquiring firm now? My guess is not much. A small business now has to immediately notify the procuring agency that they no longer qualify as a small company. So what? Well, now the agency can no longer credit that work toward their small business goals. This will put pressure on the government procurement folks to meet their small business goals some other way – new set asides, re-visit upcoming options – does the government not exercise contract options? Do they re-compete the contract as a set aside? Obviously these scenarios are not going to benefit the existing target company.

Jerry Grossman wrote an article for Washington Technology about a month ago on government M&A deals.

http://www.washingtontechnology.com/print/23_08/32744-1.html

I thought it was a great article. Toward the end of his piece, he notes that two thirds of the deals are sub $50M in revenue and indicates that pricing on these deals has softened. I would add that given the new regulatory environment, this price softening is likely to remain a reality for the average small business owner for some time to come.

For large businesses, from a practical perspective, this pool of small business acquisition targets is now off the table. For small business contractor owners looking for an exit strategy – I expect they’ll need to adjust to lowered valuation expectations.

If you are a small business with a good management team, I think there is opportunity here. The well-run small businesses trying to grow may have opportunities to grow through acquisition. Available financial resources will always be an issue, but decreasing valuations should increase potential acquisition targets.

Let me know what you are seeing in the federal market as a result of the SBA small business certification rule change. I welcome your comments.