The U.S. Small Business Administration (SBA) just issued its long-anticipated Proposed Rule implementing the Small Business Runway Extension Act (the Act). In our previous blog, we discussed the SBA's position that the Act would not be effective until the rulemaking process was completed. If implemented, the Proposed Rule will modify the SBA's method for calculating annual average receipts used to prescribe size standards for small businesses. Specifically, the SBA proposes to change its regulations so that a five-year averaging period (instead of three years) is used when calculating the annual average receipts for all SBA receipts-based size standards and other agencies' proposed size standards for service-industry firms.

Notably, however, the SBA is proposing to restrict the benefit of this change.

First, SBA takes the position in the commentary to the Proposed Rule (consistent with its previous positions and described more fully below) that the change does not go into effect until its rulemaking is completed. Second, the SBA states that the change will not be applied retroactively when it considers size appeals so that SBA will review a size challenge in accordance with the size standard in effect at the time of the challenged company's certification. Third, the SBA is not changing non-SBA size standards and leaves such changes to the individual agencies. Further, the SBA has not abandoned its position that the Act does not mandate this change. The SBA states that it is only proposing these rules in the interests of economy and because the new rules do not conflict with the SBA's existing statutory authority and is consistent with Congress' intent.

The SBA also points out that while this change will benefit growing small businesses, it could detrimentally impact large businesses that are losing revenue. For those businesses, the longer look-back period may cause them to take longer to regain small business size status.

Finally, SBA's commentary reiterates its position that receipts of a former division count when determining size status while the receipts from a concern's former subsidiary do not. There was no additional language in the proposed rule to reflect this sentiment, but contractors and practitioners should take notice.

The Small Business Runway Extension Act

The impetus for the proposed rule began late last year when, on Dec. 17, 2018, the President signed the Small Business Runway Extension Act, which amended the Small Business Act to modify the requirements for proposed small business size standards prescribed by an agency without separate statutory authority to issue size standards. As we previously covered, the Act changes the size lookback for small business size standards from three to five years. This means the SBA will determine the size (and eligibility of small business status) of a contractor by averaging the last five completed fiscal years of revenue or employee count, rather than three years as the law previously prescribed. The change will allow some small businesses on the verge of outgrowing their North American Industry Classification System (NAICS) codes to remain small for longer and to receive the benefit of set-aside contract awards.

As most of our readers know, the SBA's size standards establish eligibility for a variety of federal small business assistance programs such as the SBA's 8(a) Business Development (BD) program, the Historically Underutilized Business Zones (HUBZone) program, the Service Disabled Veteran-Owned Small Business (SDVOSB) program, the Woman-Owned Small Business (WOSB) program, and the Economically Disadvantaged Woman-Owned Small Business (EDWOSB;) program.

Additionally, as we also previously covered and as the SBA reiterated in the commentary to the proposed rule, the SBA issued an Information Notice in December 2018, which provided that the size lookback change created by the Small Business Runway Extension Act is "not presently effective and is therefore not applicable to present contracts, offers, or bids until implemented through the standard rulemaking process."

Proposed Rule

Taken to its core, the key takeaway is that the Proposed Rule serves to implement the Act by amending the SBA's definition of annual receipts by calculating annual average receipts for all receipts based standards from three years to now over the preceding five years. The rule is intended to "help advanced small businesses successfully navigate the middle market as they reach their small business size thresholds . . . [and will] lengthen the time in which the SBA measures size through revenue, from the average of the past 3 years to the average of the past 5 years."

The SBA intends for the Proposed Rule to "promote consistency government-wide on small business size standards" and recognizes the Small Business Act's distinctions that allow agencies other than the SBA to adopt their own size standards, which can be confusing for contractors. As an example, the Proposed Rule provides that "[i]t would be confusing for a service-industry business to use a 3-year average for SBA's receipts-based size standards and switch to a 5-year average for another agency's receipts-based size standards." As such, the SBA proposes to change its regulations on the calculation of annual average receipts for all receipts-based SBA size standards and other agencies' proposed size standards for service-industry firms from a three-year averaging period to a five-year averaging period.

The lookback period change intends to allow mid-sized businesses who have just exceeded size standards to regain their small business status, and for advanced small businesses close to exceeding the size standard to retain their small business status for a longer period. However, the SBA does note that the longer averaging period may disadvantage some smaller small businesses in more need of Federal assistance than their more advanced and larger counterparts in competing for federal opportunities.

The Proposed Rule closely follows the current regulation's period of measurement, with the exception of the previous three-year period being amended to the five-year period (and changes subsequent to that amendment). Specifically, the Proposed Rule provides:

c) Period of measurement

  1. Annual receipts of a concern that has been in business for 5 or more completed fiscal years means the total receipts of the concern over its most recently completed 5 fiscal years divided by 5.
  2. Annual receipts of a concern which has been in business for less than 5 complete fiscal years means the total receipts for the period the concern has been in business divided by the number of weeks in business, multiplied by 52.
  3. Where a concern has been in business 5 or more complete fiscal years but has a short year as one of the years within its period of measurement, annual receipts means the total receipts for the short year and the 4 full fiscal years divided by the total number of weeks in the short year and the 4 full fiscal years, multiplied by 52.

The Proposed Rule also similarly amends the annual receipts of affiliates to the following:

d) Annual receipts of affiliates

If the business concern or an affiliate has been in business for a period of less than 5 years, the receipts for the fiscal year with less than a 12- month period are annualized in accordance with paragraph (c)(2) of this section. Receipts are determined for the concern and its affiliates in accordance with paragraph (c) of this section even though this may result in using a different period of measurement to calculate an affiliate's annual receipts.

The SBA is receiving comments to the Proposed Rule on or before Aug. 23, 2019.

Key Takeaways

While the main takeaway from the Proposed Rule is that the SBA proposes to base its size standards on a five-year average, the implementation will be a bit more complicated. Individual agency rules are not amended and the rule will not impact size certifications made in advance of the final rule. Nevertheless, this promises to be a significant change for small businesses that would have lost their small business size status. Government contractors should be mindful of the SBA's position when reviewing their own certifications.