On February 11, 2011 the Small Business Administration issued final rules that resulted in extensive changes to SBA’s Section 8(a) Small Disadvantaged Business program. The new rules become effective March 14, 2011. While the rules address a wide array of areas in the 8(a) program, the most significant changes relate to joint ventures between 8(a) companies and non-8(a) companies as well as the frequently used mentor-protégé agreements. These changes warrant close attention to 8(a) contractors and those that seek to do business with them.

The 8(a) Disadvantaged Business program is designed to assist small business with managerial, technical, and procurement assistance so these businesses may grow and compete independently of the 8(a) program. It is intended as a temporary advantage to help these businesses develop. The program utilizes a number of tools to accomplish this, two of which are the most well known. First, government agencies may set aside a contract to be competitively bid among 8(a) participating firms. Second, contracts may be awarded on a sole-sourced basis in certain circumstances. In addition, the SBA obligates government agencies to have a certain percentage of its procurements each year be performed by small businesses, including 8(a) participants.

The SBA recognizes that these set asides and procurement requirements create a market for larger, non-8(a) companies to contract with 8(a) participants. The SBA has long had a variety of regulations governing joint ventures and mentor-protégé arrangements between 8(a) companies and larger companies. The new regulations, however, make many changes to these existing regulations. The major changes are as follows:

1. Joint Ventures

  1. Written Agreement: The new regulations require that all joint venture agreements must now be in writing. Further, the joint venture must do business under its own name. The joint venture does not, however, need to be a “formal” joint venture (e.g – a separate legal entity such as a LLC). Finally, the joint venture may be “populated” (have its own separate employees) or “unpopulated” (no separate employees).
  2. Affiliation of Joint Venture Members: For the purposes of 8(a) rules, all companies that an 8(a) participant is “affiliated” with are examined for the purpose of determining if the company is “small” for the purposes of the 8(a) program. Thus, 8(a) participants do not wish to be “affiliated” with their larger joint venture partners. The new rule extends the time in which a joint venture may exist without creating any “affiliation” between the members. A single joint venture is now eligible to be awarded three contracts over a two year period without implicating the “affiliation” rules. Moreover, the same two joint venture members may form a second or third joint venture which may then receive three additional contracts each. SBA cautions that at “some point, however, such a longstanding inter-relationship or contractual dependence between the same joint venture partners will lead to a finding of general affiliation.” The three year time period begins to run on the date the joint venture is awarded its first contract.
  3. Ownership and Sharing of Profits: If a joint venture is a separate legal entity, then the 8(a) participant firm must own at least 51% of the entity and receive a percentage of the profits commensurate with its ownership percentage. In an informal joint venture, the 8(a) participant must receive profits from the joint venture in a percentage equal to the amount of work it performed.
  4. Performance of the Work: Where the joint venture is an “unpopulated” joint venture, the 8(a) member must perform 40% of the work. This work must be more than just administrative or ministerial work. If the joint venture is populated with individuals that will be performing the work, the 8(a) participant must be able to demonstrate what it will gain from performance of the contract and how this will assist it in its business development. Similar rules apply where both joint venture members are technically subcontractors to the joint venture.
  5. SBA Joint Venture Approval: The SBA must approve the written joint venture agreement before the joint venture can be awarded any contracts.
  6. Performance Reports: The 8(a) participant in a joint venture must report annually to the SBA and describe how it is meeting or has met the percentage performance requirements described above for each 8(a) contract it performs as part of joint venture.

2. Mentor-Protégé Agreements

The SBA’s mentor-protégé program is designed to allow mentors to provide business development assistance to 8(a) protégé firms. This includes the performance of prime contracts with the federal government. The new regulations altered various aspects of this program.

  1. Mentor Firm – Mentor firms may now be non-profit entities as well as for profit businesses. The non-profit entity would be required, however, to meet all of the elements of eligibility to serve as a mentor.
  2. Number of Protégés – A mentor generally may not have more than one protégé at a time. SBA may grant a waiver to this restriction if the mentor can establish the new mentor/protégé relationship will not adversely affect the development of the existing protégé (e.g. – the second protégé firm may not be a competitor of the first). Three protégés is the limit allowed in any circumstance, however.
  3. Number of Mentors – A protégé may generally have only one mentor. It may, however, have a second mentor, with SBA approval, where the second mentor relationship relates to an unrelated, secondary NAICS code, the first mentor does not possess the expertise the protégé is looking to receive, and the second relationship will not compete or conflict with the first relationship.
  4. Joint Ventures – A mentor and protégé may form a joint venture as a small business for any government prime contract or subcontract as long as the protégé qualifies as “small” for the procurement. In addition, this joint venture may pursue sole source 8(a) set asides as long as the protégé has not exceeded the dollar limits provided in other sections of the SBA regulations. This, of course, serves as a direct benefit to the mentor organization as it gains access to a series of procurements that it otherwise would not be able to compete for.
  5. Written Agreement – There must be a written mentor/protégé agreement approved by the SBA. The agreement must describe the assistance the mentor proposes to provide and a timeline under it will do so. The assistance must be crafted so as to help the protégé meet its goals under the SBA-approved business plan. If SBA elects to reject the proposed agreement, the regulations set out an appeal process to review this decision.
  6. Potential Consequences to Mentors – If the SBA determines the mentor is not providing the assistance outlined in the written agreement the mentor will be notified by the SBA of its noncompliance finding. If the mentor fails to respond within thirty days or does not provide “adequate reasons” for noncompliance, the SBA will terminate the mentor/protégé agreement, the firm will be ineligible to participate as a mentor for two years from the date of the termination, and the SBA may recommend to the “relevant procuring agency” that it issue a stop work order for each contract the mentor/protégé are performing as a joint venture. Noncompliance may also serve as a basis for debarment of the mentor.

As noted above, the regulations also address many other aspects of the 8(a) program. These include changes, among others, to the non-manufacturer rule for manufacturing and supply procurements, issues related to an 8(a) company’s graduation or other completion of its program, new rules related to how SBA will account for spousal assets in determining economic disadvantage, changes in ownership and control requirements of the 8(a) entity, income limitations of the 8(a) owner, and a refinement of what constitutes an improper excessive withdraw from the company. It is advised, therefore, that 8(a) participants review the new rules or consult counsel to determine what, if any, impact they may have on their specific circumstance.

In the past months there have been widely circulated reports of abuse in various small business programs. For example, the SBA suspended a large information technology contractor last September due to its alleged abuse of the Alaska Native Corporation preference program. Similarly, on March 3, 2011 a Government Accountability Office audit of the 8(a) program identified fourteen firms received set-aside or sole-source 8(a) contracts through fraud or abuse. The value of these 8(a) contracts was $325 million. Given this context and these new rules, contractors currently participating in the 8(a) program or who are looking to become involved in a joint venture must be fully aware of the new rules of the road.