Being small is the key that opens most of the doors in federal small business contracting, and the SBA decides who is small. Most people assume that means counting a firm’s own employees or revenue against the size standard. It does, but with an important twist: the SBA counts the employees or receipts of the firm’s affiliates too. Understanding affiliation is essential, because a firm that looks small on its own can be large once its relationships are taken into account.
The basic idea
Under the SBA’s regulations, businesses are affiliates when one controls or has the power to control the other, or when a third party controls or has the power to control both. Control can be affirmative or negative, and it does not matter whether the power is actually exercised. When firms are affiliated, their sizes are combined for every size determination. The question is never just “how big are you?” It is “how big are you and everyone who controls you or whom you control?”
Where control comes from
The regulations describe several sources of control, and a contracting officer or SBA area office will look at all of them:
- Ownership. A person or entity owning a majority of a firm’s voting stock controls it. Large minority holdings can also confer control, especially when other holdings are small and scattered.
- Management. Officers, directors or managing members who also control another firm can create affiliation between the two.
- Identity of interest. Close family members, or firms with substantially identical business or economic interests, may be treated as one party. Heavy economic dependence of one firm on another can be a factor.
- Newly organized concerns. A new firm formed by former officers or key employees of another firm, serving the same line of business with that firm’s help, may be affiliated with it.
- Franchise, license and other agreements. Affiliation depends on whether the arrangement gives one party control over the other’s operations.
The SBA also considers the totality of the circumstances. Several connections that are each insufficient alone can add up to affiliation together.
The ostensible subcontractor rule
One form of affiliation matters especially in contracting. If a small prime relies on a subcontractor to perform the primary and vital requirements of a contract, or is unusually dependent on that subcontractor, the SBA may treat the two as joint venturers for size purposes, combining their sizes for that procurement. The rule targets arrangements in which a large firm effectively performs a set-aside contract through a small front. Indicators include the subcontractor performing most of the work, supplying the key personnel, having been the incumbent, or providing the prime’s bonding or financing. The rule is why teaming arrangements on set-asides must leave the small prime genuinely in charge.
Exceptions and safe harbors
Not every relationship creates affiliation. The regulations exclude certain investments by venture capital and investment companies in specific programs, and they provide that firms in an approved SBA mentor-protégé relationship are not affiliated based on the assistance the mentor provides or on a joint venture formed under the program. Joint ventures between small businesses are permitted for many purposes without creating general affiliation, subject to rules about how the venture is structured and how work is performed.
Why it matters so much
Size status is a representation you make in every offer, and a competitor can protest it after award. An adverse size determination can cost the contract and, if the representation was made carelessly, far more. Before certifying as small, map every ownership, management and business relationship your firm has and ask whether any could be read as control. When the answer is unclear, the SBA offers guidance at sba.gov, and a lawyer who works with size rules can review the facts. Affiliation is the part of the size standard most firms overlook, and the part that most often surprises them.