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Affiliation Issues in Financing Small Business Government Contractors: Traps for the Unwary

April 4, 2014

Contracting programs like the 8(a) Business Development Program, the Service-Disabled Veteran-Owned Small Business Concerns Program, and the Woman-Owned Small Business Program present tremendous opportunities for small businesses to grow and thrive by providing access to potentially lucrative government contracts with limited competition (“set aside” contracts).  But easily and often overlooked compliance issues may, by operation of law and regulation, “deem” these companies larger than they are and permanently end their eligibility for set-aside contracts.  This can happen when companies are too closely intertwined in the Government’s eyes, and seen as “affiliated” such that their employees and revenues are added together as if they were the same company.  Affiliation exists when the Government determines in its own, fact-specific discretion that one business controls or has the power to control another business or when a third party controls or has the power to control both businesses.  Clear as mud.

Making matters more difficult, there are very few “bright line,” easy-to-follow rules about when affiliation exists.  Each case is fact-specific, and subject to challenges before administrative tribunals like the Small Business Administration Office of Hearing and Appeals.  Over the years, these tribunals developed a body of law that provide general guideposts for compliance, but there are no guarantees.  This injects tremendous risk into the process of running a business that depends on set aside contracts because the SBA recently established new penalties for, among other things, missing affiliation issues and incorrectly certifying a company’s size and eligibility for a particular procurement.  These penalties may include exclusion from further government contracting, the Government attempting to recover the full value expended on the resulting contract, and even criminal prosecution.  Ignorance of the rules is not a defense, but seeking advice and making a good faith effort to comply may be one.  

One of the most common sources of affiliation is the level of economic dependence between companies.  Stated differently, a contractor is likely to listen to and follow the advice of its financing source—whether a lender, an equity owner, a loan guarantor, a teaming partner that extends uncommon payment terms, or any other arrangement—and that tie may mean the two firms are not separate or independent.  Rather, they are affiliated, added together, and the sum of the revenues or employees may cause the small business to be deemed too large for set-aside work.  Other areas of affiliation risk include, but are not limited to:  common ownership; common management; familial relationships; newly organized businesses; joint ventures; and former affiliates.

Given that exclusion from further set-aside contracting is one of the more tame risks associated with small business contracting, compliant operations are vitally important.  Noncompliance can have catastrophic consequences.  If nothing else, contractors are well advised to conduct a compliance review frequently – at least annually – to make sure no inadvertent affiliation issues are present.  Contractors are also well suited to do business with financiers experienced with these rules in order to avoid inadvertent, costly mistakes.

By David Robbins, Chairman, Government Contracts Practice Shulman Rogers Gandal Pordy & Ecker, PA, (301) 945-9254; drobbins@shulmanrogers.com; and former acting Air Force Deputy General Counsel (Contractor Responsibility).