On June 6, 2022, the U.S. Small Business Administration (SBA) published a final rule (87 FR 34094) (Final Rule) that announced a new method for calculating small business employee-based size standards. As a result of the Final Rule, effective July 6, 2022, the SBA will increase the current 12-month average to a 24-month average to calculate an entity’s number of employees for the purpose of determining eligibility to participate in all SBA programs. Additionally, the SBA will permit entities participating in its Business Loan, Disaster Loan, Surety Bond, and Small Business Investment Company (SBIC) Programs to use a five-year averaging period as an option in addition to the existing three-year averaging period for the purpose of calculating average annual receipts. This change may allow certain small businesses to remain as small businesses for longer and permit certain mid-sized businesses that have outgrown their size status to regain their small business status.

The SBA has issued a Final Rule that materially expands the existing methodology businesses use to qualify as a small business in various situations. The Final Rule follows a proposed rule (68 FR 60396) the SBA issued for comment last November. In particular, the Final Rule addresses two significant changes to how the SBA will calculate business size for the purpose of qualifying for SBA assistance programs under an employee-based size standard. Section 863 of the 2021 National Defense Authorization Act required the first change, which, of note, amended part of the Small Business Act, 15 U.S.C. 632(a)(2)(C)(ii)(I), to increase the lookback period for SBA's employee-based size standards from 12 months to 24 months for manufacturing entities. Based on this change, the size of a business concern under an employee-based size standard will be calculated by averaging the entity’s number of employees employed on a full-time, part-time, or other basis for each pay period in the preceding completed 24 calendar months. The Final Rule implements this change and extends this lookback period to both manufacturing and non-manufacturing entities.

The Final Rule is limited to employee-based size standards for government contractors that compete for government contracts under a small business status using an employee-based size standard. Under the current regulations, the SBA’s calculation of size standards based on receipts is based on a five-year averaging period, which recently changed from a flexible three-year or five-year period as of January 6, 2022. Thus, to the extent a government contractor uses a receipts-based size standard methodology for small business eligibility on its government contracts, the Final Rule does not change the current five-year average calculation methodology and, therefore, will not affect their size status.

Unlike the eligibility for government contract set-asides, the Final Rule does alter the calculation for receipts-based size standard methodology for SBA loan programs. Specifically, the Final Rule extends the application of the Small Business Runway Extension Act of 2018, Public Law 115-324 (SBREA), which was implemented on December 5, 2019 (84 FR 66561). SBREA modified the receipts-based size standard methodology for certain SBA small business programs but excluded Business Loan and Disaster Loan Programs. In particular, SBREA amended section 3(a)(2)(C)(ii)(II) of the Small Business Act (15 U.S.C. 632(a)(2)(C)(ii)(II)) to permit a business concern to average its receipts over five years when qualifying for certain small business programs, rather than the original three years established in the Small Business Act. SBREA permitted a two-year transition period that expired on January 6, 2022.

The Final Rule also extends this amended five-year average receipts-based methodology to the SBA’s Business Loan Programs (the 7(a) Loan Program, the Microloan Program, the Intermediary Lending Pilot Program, and the Certified Development Company (CDC/504) Loan Program) and to Disaster Loan Programs (the Physical Disaster Business Loans, Economic Injury Disaster Loans, Military Reservist Economic Injury Disaster Loans, and Immediate Disaster Assistance Program). The Final Rule also permits the five-year average receipts-based methodology to be used by a business concern to qualify for Surety Bond and SBIC Programs.

The Final Rule offers the five-year average annual receipts-based methodology as an alternative to the three-year average annual receipts-based methodology but does not mandate either methodology. This option to use the three- or five-year average applies only to applicants in its Business Loan, Disaster Loan, Surety Bond, and SBIC Programs, and this change is expected to be available indefinitely. The Final Rule also limits the use of the five-year average methodology only to calculating average annual receipts, not for other loan application purposes.

The Final Rule does not include a transition period for either of the changes discussed herein. For the employee-based size standard methodology, the SBA reasoned that with the consistently increasing trend in employment since the COVID-19 pandemic, a 24-month employee average will likely be lower than a 12-month average. Therefore, according to the SBA, there is insufficient benefit to warrant a transition period. For the changes to qualifications based on average annual receipts, the SBA reasoned that financial assistance programs are not competitive but rather evaluated on an individual application basis. As such, there is no need for a transition period.

Takeaways

Government contractors and other businesses that seek to take advantage of SBA programs should understand that the Final Rule will take immediate effect on July 6, 2022, with no transition period. Business concerns must also be aware that the Final Rule will materially change the employee-based methodology that the SBA will use to determine a company’s size status. While the SBA believes that little harm will result from this change, government contractors should nonetheless consider whether this change will affect its ability to qualify as a small business based on the expanded lookback period. By contrast, business concerns seeking to take advantage of the SBA’s Business Loan, Disaster Loan, or SBIC Programs will likely benefit from an option to select a five-year lookback period for annual receipts, as opposed to the present three-year lookback period. Companies should be aware that this option to use three- or five-year averages only applies to Business Loan, Disaster Loan, Surety Bond, and SBIC Programs, and not to size calculations based on receipts when used to qualify for federal government contracts that have been set aside for small business concerns.