Small-business makeover

Advocates would like to see loopholes plugged and definitions expanded

The government needs to fix its system of defining and providing contracting opportunities to small businesses, according to advocacy groups, industry analysts and many small businesses.

The current system, which the Small Business Administration has been trying to update for years, allows a sizable chunk of revenue earmarked for small firms to instead go to large companies. Regulatory loopholes, reporting errors and possibly fraud are to blame, experts say.

But some observers add that misplaced money isn’t the only issue. They believe SBA’s classification system is outmoded.

Although many agree on the diagnosis, there’s no consensus on the appropriate cure. Some advocates believe the system is too restrictive, while others argue it is not strict enough.

The challenge of defining small businesses has been around for years, and SBA has revised the system from time to time. In 2000, the agency revamped the classification scheme, replacing Standard Industry Classification codes with the more technology-specific North American Industry Classification System codes.

In May 2004, SBA published a final rule requiring firms with small-business contracts that were transferred from other companies — via acquisition, for example — to recertify their size status. The goal is to prevent companies from continuing to receive small-business money after a larger firm has acquired and absorbed them.

Top 100 small federal vendors in fiscal 2006
Click here to enlarge chart (.pdf).

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A new round of modification may be afoot. Congress’ SBA reauthorization bill includes measures intended to address small-business concerns, and the agency is expected to issue a new rule on size recertification, while industry groups and small businesses continue to suggest additional changes.

Meanwhile, everyone is looking to new SBA Administrator Steven Preston for a sense of direction.

“I think a lot of us are waiting to see what he is going to be able to affect and what his agenda will be,” said Guy Timberlake, chief executive officer of the American Small Business Coalition.

Shifting dollars
Small businesses have contended for years that dollars intended for them sometimes go to large firms. Studies released in recent years, some of which SBA conducted, have confirmed those allegations.

Eric Thorson, SBA’s inspector general, recently identified widespread flaws in the procurement system that let large businesses reap small-business awards.

He added that studies have shown that agencies continue to count contracts toward their small-business objectives even after the holders have outgrown their size standards or been acquired by large companies.

In addition, contracting officers may inadvertently feed inaccurate data into the Federal Procurement Data System-Next Generation.

Thorson highlighted the problem of such data-entry errors in testimony before the Senate’s Small Business and Entrepreneurship Committee in July.

Whatever the cause, Paul Murphy, president of Eagle Eye Publishers, said he has noticed “a lot more dollars associated with larger firms that are coded as small businesses. The issue does seem to have grown.”

Eagle Eye’s analysis of federal procurement data places some very large businesses in its list of top small-business contractors for fiscal 2005. SBA and vendors are looking into the situation.

Annual recertification is one potential remedy to the problem of businesses holding on to small-business contracts long after they have exceeded the size boundary.

“It would go a long way toward addressing the problem,” said David Nadler, a partner at Dickstein Shapiro.

An SBA proposal requiring contractors to certify their size status every year surfaced in 2003, and a final rule is pending. “Hopefully, it will be completed in the near future,” an SBA spokeswoman said.

The Senate’s SBA reauthorization bill calls for annual recertification, which Nadler cited as evidence of momentum building toward addressing the problem.

However, some small businesses believe annual recertification could prove disruptive. Shiv Krishnan, president and CEO of Indus, said teaming arrangements on multiyear contracts could suffer if small-business partners had to be let go because they exceeded the size standard.

“The annual recertification could throw a whole lot of plans out of kilter,” Krishnan said. He said recertification every three or five years would be more manageable. That time frame would give contractors time to adjust for changes to subcontractor teams necessitated by changing size status.

Regardless of the governmentwide policy, some pending multiple-award contracts would require small-business awardees to recertify annually. For example, the General Services Administration’s Alliant contracts for small businesses contain that requirement.

Timberlake said government contracting offices should certify a company’s size when they award a contract.

Although companies are required to confirm their size status in representations and certifications submitted with proposals, “apparently, some companies slip through,” he said.

Award-level certification could become part of the government’s process for evaluating proposals.

Timberlake said he isn’t aware of any policy proposals regarding award-level certification but said the topic has come up at various meetings he has attended.

Stretching the limits
While experts continue to debate the question of how often small businesses should have to confirm their status, another question is perhaps even more central: How should small businesses be defined in the first place?

With the publication of a proposed rule in 2004, SBA launched an initiative to restructure the size standards, and it has been weighing industry input ever since.

Advocates are pushing the agency in two opposing directions. Earlier this year, the Information Technology Association of America recommended that SBA define small businesses as those with up to 500 employees or $50 million in annual revenue.

In a letter to SBA, ITAA called the current revenue ceiling of $23 million unrealistic because companies graduating from the small-business category are hard pressed to compete with much larger firms.

“It’s very challenging for a small business to move into that side of the market,” said Dennis Kelly Jr., president of TechTeam Government Solutions.

On the other hand, some observers say, the smallest of the small businesses will have difficulty competing in a size category occupied by $50 million companies.

“There’s such a difference between a company doing $5 million to $10 million in revenue and one doing $50 million,” Timberlake said. He added that he believes a higher revenue cap would hurt many smaller firms.

Some IT executives have suggested creating tiers within small-business size standards. Timberlake said SBA could establish a micro-business threshold for companies with fewer than 20 employees and less than $2 million in revenue, for example.

“Some stratification seems to make sense,” Kelly said. “That would allow the government to more equitably administer the small-business dollars that are out there.”

Such stratification already exists in the Commerce Department’s Commerce IT Solutions NexGen contract, which features three tiers for small businesses.

Following Commerce’s example, the Senate’s SBA reauthorization bill would give the agency’s administrator the authority to create tiers within a given size standard.

The legislation would empower the agency to “establish two or more tiers within an overall small-business size standard cap for the purpose of facilitating the growth and development of small-business concerns.”

The latest round of policy revisions has yet to become law, but some executives say just having legislation under discussion is encouraging.

“That shows us that there are enough people focused on the seriousness and importance of this issue to the economy and the need to do something about it,” Krishnan said.

Middle-market blues

Policy-makers have long viewed small businesses as entities needing regulations and programs to promote their health and success.

Midsize businesses have largely not benefited from the same sort of attention, but that may be changing. In June, the Center for Strategic and International Studies (CSIS) released a report that pointed to the declining professional services middle market as an area ripe for policy development.

Midtier companies earned 44 percent of federal services dollars in 1995, but their slice of the market had dropped to 29 percent by 2004, the CSIS study found.

Thus far, no specific policy recommendations have surfaced. But the report has sparked conversations.

“We’ve used that report as a way to being discussions with policy-makers,” said Alan Chvotkin, senior vice president and counsel for the Professional Services Council, which commissioned the CSIS report.

Small-business advocates also voiced concern over the issue of midsize companies. Firms that exceed the upper limits of small-business categories find themselves competing against the industry’s heavyweights.

“They’re going toe-to-toe with [Computer Sciences Corp.] and Booz Allen [Hamilton] and Lockheed [Martin] and everyone else,” said Guy Timberlake, chief executive officer of the American Small Business Coalition.

Timberlake said he would favor a policy that eases the small-to-middle market transition, but not at the expense of the existing small-business program.

The Professional Services Council pursues a “balanced procurement strategy” that encompasses small and larger firms as well as midtier companies, Chvotkin said.

“I think you’ll see that as a foundation for more in-depth discussion and subsequent policy recommendations,” he added.

— John Moore

The large and the small of IT

The names General Dynamics, Lockheed Martin, Northrop Grumman and Science Applications International Corp. do not generally come up when people think of small businesses. But according to an Eagle Eye Publishers analysis of fiscal 2005 government procurement data, those companies and others with more than $1 billion in revenue are among the top 100 small-business vendors.

Eagle Eye’s findings appear to vindicate the conviction of many small-business leaders that significant amounts of revenue that the government records as small-business contracting are actually going to large firms. The result is that legitimate small firms may lose opportunities, and the government’s success in meeting goals for small-business contracting is overstated.

Last year, the Small Business Administration’s inspector general cited flaws in the procurement process that let large firms obtain small-business awards for which agencies received small-business credit.

SBA’s ongoing review of procurement data shows that the contracts were originally awarded to legitimate small businesses that then either outgrew that designation or were acquired by large businesses, an SBA spokeswoman said.

She said that although critics frequently level accusations of fraud, many such cases stem from rules that allow companies to retain a small-business contract indefinitely — often until the contract expires and no matter how much the company grows during that period.

“We agree that the policies need to be [changed], and in fact, we have made and will continue to develop more appropriate policies,” she said.

— John Moore

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