Set-aside contracts exist to put work in the hands of small businesses. To keep that purpose intact, federal rules limit how much of a set-aside contract a small prime can pass along to other firms. This requirement is known as the limitations on subcontracting rule, and it is one of the most important compliance obligations for small firms that win set-aside work.
The basic idea
In general, when a contract is set aside for small businesses or awarded under an SBA program, the prime contractor agrees that it will not pay more than a certain percentage of the amount it receives from the government to subcontractors that are not similarly situated. A similarly situated entity is, broadly, a subcontractor that has the same small business program status that qualified the prime for the award and is small for the NAICS code the prime assigned to the subcontract.
Work performed by similarly situated subcontractors generally does not count against the limit. That allows small firms to team with other qualifying small firms without violating the rule.
The limits by type of work
Under current SBA regulations and the corresponding FAR clause, the limits vary by the type of contract:
- Services (other than construction): the prime may not pay more than 50 percent of the amount paid by the government to non-similarly situated subcontractors.
- Supplies or products (other than from a nonmanufacturer): the same 50 percent limit applies, generally excluding the cost of materials.
- General construction: the limit is 85 percent, excluding the cost of materials.
- Specialty trade construction: the limit is 75 percent, excluding the cost of materials.
Mixed contracts, nonmanufacturer rules and specific programs add further detail. Because these rules are revised from time to time, confirm the current text on acquisition.gov and in SBA regulations before relying on these summaries.
How compliance is measured
Compliance is typically measured over the period of performance, and in some cases at the order level for indefinite-delivery contracts, depending on the contract terms and what the contracting officer specifies. That means you need to track payments to subcontractors throughout the contract, not just at the end.
Practical habits include:
- Projecting the workshare split during proposal preparation
- Confirming the size and program status of each subcontractor
- Tracking subcontractor payments against amounts received from the government
- Reviewing the numbers regularly and adjusting staffing if needed
Why it matters
Agencies may ask offerors to explain how they will comply, and violations can carry serious consequences, including potential penalties under the Small Business Act. Beyond the legal risk, a pattern of passing most of the work to large partners can raise questions about affiliation and the integrity of the set-aside.
The rule is not meant to prevent teaming. It is meant to ensure the small business that won the contract performs a meaningful share of it. If your team structure is complex, talk to a government contracts attorney or advisor before you finalize it.