Recent changes to the U.S. Small Business Administration (SBA) regulations affect how large businesses can take small business credit for subcontracting to their own mentor-protégé joint ventures (MPJVs). SBA’s final rule directs that, when a large federal prime contractor issues subcontracts to its own MPJV, it may only count the protégé’s work (under the JV) towards its small business subcontracting goals. This will have a notable effect on how large businesses calculate and meet their subcontracting plan goals when their MPJVs are in the subcontracting pool.
Large businesses with federal prime contracts exceeding $650,000 are required to develop a small business subcontracting plan. Under the plan, the large businesses are required to “make a good-faith effort to meet their subcontracting plan goals.”
Until May 2023, SBA’s regulations stated that “purchases from a corporation, company, or subdivision that is an affiliate of the prime contractor or subcontractor are not included in the subcontracting base. Subcontracts by first-tier affiliates shall be treated as subcontracts of the prime.” Under this prior version of the regulation, affiliates of the prime contractor were excluded from the subcontracting base. Because mentors are, by definition, not affiliates of their own MPJVs, the previous version of the regulation suggested large business prime contractors that are mentors in an MPJV were not prohibited from counting subcontracting dollars from subcontracts to their own MPJVs towards their small business goals.
In April 2023, SBA revised 13 C.F.R. § 125.3(a)(1)(i)(B) to state that “Purchases from a corporation, company, or subdivision that is an affiliate of the prime contractor or subcontractor, or a joint venture in which the contractor is one of the joint venturers, are not included in the subcontracting base. Subcontracts by first-tier affiliates, and subcontracts by a joint venture in which the prime contractor is one of the joint venturers, shall be treated as subcontracts of the prime.”
In effect, the new regulation means that, when a large business prime contractor issues a subcontract to its own MPJV, work performed by the small business protégé is considered a small business subcontract. However, work performed by the large business mentor as part of the MPJV is not. This division of credit for a single subcontract to a single entity (the joint venture) into two subcontracts to each of the members is confusing and was, at the time, unprecedented (but see the discussion below from the Department of Veterans Affairs). This change could drastically affect how federal prime contractors calculate and meet their subcontracting plan goals. The SBA described the effect of the new regulation, noting that it “separates out the treatment of joint ventures from that of affiliates.”
SBA explained the change, writing:
Section 125.3 discusses the types of subcontracting assistance that are available to small businesses and the rules pertaining to subcontracting generally. Paragraph 125.3(a)(1)(i)(B) provides that purchases from a corporation, company, or subdivision that is an affiliate of the prime contractor or subcontractor are not included in the subcontracting base. SBA received an inquiry as to whether this language would allow a prime contractor to count an award to a joint venture in which it is a partner as subcontracting credit. That was not SBA’s intent. SBA believes that exclusion is covered in the current regulatory text, which already alludes to not counting awards to affiliates. Nevertheless, in order to clarify that a prime contractor cannot count an award to a joint venture in which it is a partner as subcontracting credit, SBA proposed to add clarifying language to that effect.
Several commenters sought revisions to the clarifying language and argued that the proposal is, in fact, a change in policy and not a clarification. One commenter asked that SBA still allow subcontracting credit for the amount performed by the small business partner in a joint venture. Another asked that “or sales to” be removed from the proposed language, believing that is the exact opposite of what the proposal is seeking to do. One commenter noted that SBA’s proposed language does not implement its intended change to the rule, because it states, “joint venture . . . that is an affiliate of the prime contractor.” The commenter pointed out that a large business that is also a minority-member of a mentor-protégé joint venture is not affiliated with that joint venture due to the exclusion to affiliation afforded mentor-protégé joint ventures. As a result, SBA’s proposed language would not effectuate the rule change it seeks. SBA agrees that the proposed language did not adequately capture SBA’s intent and clarifies that intent in this final rule. First, the final rule separates out the treatment of joint ventures from that of affiliates. Second, SBA is not including the “or sales to” language in the final rule. SBA notes that, where an other-than-small contractor subcontracts to its own unpopulated joint venture, the work performed by a small- business member of that joint venture is considered a subcontract and the contractor may take subcontracting credit for that small business work.
The new rule became “effective on May 30, 2023 [and] applies to all solicitations issued on or after that date.” For MPJVs, the change compels a revised strategic approach to meeting small business goals and a closer look at how their calculations are made. It also sets up the peculiar circumstance where other contractors can claim small business credit for the full value of subcontracts issued to an MPJV, but the mentor in the same JV cannot.
This new change might sound familiar to those MPJVs that bid on the U.S. Department of Veterans Affairs (VA) solicitation for the Transformation Twenty-One Total Technology Next Generation 2 (T4NG2) contract. In the April 5, 2023 update to the T4NG2 solicitation, well before the SBA revised the rule, the VA provided that “[f[or Mentor/Protégé Joint Ventures, subcontracts to the Mentor only count if the Mentor qualifies for that socio-economic category.” Later, in answering a question about the update, the VA explained its reasoning, saying, “the intent of the Small Business Participant Commitment is to account for work by the actual entity performing it.”
Joint ventures should closely watch both the SBA and VA positions as we may be seeing a pendulum swing toward taking away some of the benefits previously enjoyed by joint ventures participating in the Mentor-Protégé program.