Federal Small Business Contract Eligibility: Is Your Business 'Small'?

Is your company eligible to bid on a federal government small business set-aside contract? In 2010, the federal government awarded nearly $100 billion in contracts to small businesses, so determining if your business is "small" for purposes of these procurements might be worth your while.

The government doesn't have a one-size-fits-all policy for what constitutes a small business. Instead, the government determines size on a contract-by-contract basis. In some cases, a company with 1,000 employees can be small while, in others, a firm with less than $1 million in annual revenues might be too large to receive a set-aside contract.

Find out if your company qualifies as small for a particular federal procurement by following the steps below.

Look at the Government Solicitation You Want to Bid On

First, look closely at the government solicitation you're interested in bidding on (the U.S. government posts federal solicitations online on its government contracting website). If you see Federal Acquisition Regulation (FAR) clause 52.219-6 (Notice of Total Small Business Set-Aside) in a government solicitation, you'll know that only small businesses are eligible to receive that particular contract.

Next, look to see which North American Industry Classification System (NAICS) code the government has assigned to the solicitation. A NAICS code is a six-digit number classifying the contract work by its primary purpose. For instance, if the government seeks custodial services, it would likely assign NAICS code 561720 (Janitorial Services) to the solicitation. If the government wants a new courthouse, it might assign NAICS code 236220 (Commercial and Institutional Building Construction).

Each solicitation contains one (and only one) NAICS code. If you're reviewing the solicitation on the government's contracting website, the NAICS code can usually be identified within the contract opportunity.

Determine the Solicitation's Size Standard

The next step is to determine the size standard that corresponds to the NAICS code in the solicitation. A size standard is a threshold, represented either as a number of employees (for example, 500 employees) or a dollar figure (for example, $14 million) that your business must fall below to be deemed "small" for that contract. Procuring agencies often include size standard information in their solicitations. (You can learn more about these standards on the Small Business Administration (SBA) website.)

Size standards vary widely by industry type. The SBA uses different factors to determine what qualifies as a small business for a particular industry. The SBA will look at the average company size in an industry, how many assets the average business has, how much business the largest companies in the industry receive, and how much the size of a company varies across the industry. (To learn more, read the SBA's size standards methodology.)

Calculate Your Company's Size

Once you know the appropriate size standard, you must figure out whether your business qualifies as small under that standard. The process varies considerably based on whether the solicitation contains a revenue-based size standard or an employee-based size standard.

Revenue-Based Size Standards

If the Solicitation includes a revenue-based size standard, as in the custodial services and construction examples above, your company is small if its average annual receipts over the past three completed fiscal years are less than the size standard.

"Average annual receipts" means "total income" (or "gross income," for a sole proprietorship), plus "cost of goods sold," as the terms appear on IRS tax forms, minus four permissible deductions. So, for instance, if your small business is a limited liability company reporting its taxes on Form 1065, you would first add line 8 (total income) to line 2 (cost of goods sold) to produce your baseline number. If your company hasn't yet filed its tax return for a particular year, use your financial statements or books of account.

From the baseline, you can deduct four items:

• net capital gains and losses
• taxes collected for and remitted to a taxing authority, if included in total income (such as sales taxes)
• some transactions between your business and an affiliate, and
• "pass through" amounts collected on behalf of a third party—such as amounts collected by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder, or customs broker.

Calculating your average annual receipts varies slightly depending on whether you have been in business for three or more years, or less than three years.

If you've been in business for three or more years. Using the above formula, calculate your annual receipts for each of the preceding three completed fiscal years prior to the date you intend to submit your initial offer (including price) on the solicitation. For example, assume your company's fiscal year ends on December 31, and you plan to submit an offer in April 2011. In that case, you would use your annual receipts for 2008, 2009, and 2010. Do not use financial information for an ongoing fiscal year.

Add up your annual receipts for the prior three completed fiscal years, then divide the result by three. If the result is less than the size standard, congratulations—your company is small for the procurement, assuming you don't have any affiliates (see "Beware of Affiliation," below).

If you've been in business for less than three years. If your company has been in business for less than three completed fiscal years, determine your receipts for the total period the company has been in business (including the ongoing fiscal year). Divide the result by the number of weeks your company has been in business, then multiply that number by 52 to arrive at your "average annual receipts."

Employee-Based Size Standards

If the solicitation includes an employee-based size standard, you must count your average number of employees over the prior twelve months. But first things first—who's an "employee"?

For purposes of federal small business set-aside contracts, you must count full-time, part-time, and temporary employees, including those obtained from professional employee organizations or employee leasing companies. Do not count unpaid volunteers, such as part-time college interns (although you must count interns if they are paid). In addition, you can exclude bona fide independent contractors from your employee count.

After you determine who counts as an employee, simply add the number of employees on your payroll for each pay period for the twelve months immediately preceding your initial offer on the solicitation. If your company has been in business for less than twelve months, use the same formula, going back to your first pay period.

Then, divide the result by the number of pay periods to arrive at your average employee count. If it falls beneath the size standard, your business is small and eligible for award, assuming you don't have any affiliates (see "Beware of Affiliation," below).

Beware of Affiliation

Even if your company qualifies as small in its own right, it might exceed a size standard if it has any affiliates. "Affiliation," in the world of government contracting, includes acknowledged affiliates (like parent and sister companies), as well as companies that share certain close ties, like common ownership, management, and even familial relations.

When the government calculates a company's size, it adds the revenues or employees of any affiliates. So, if Wal-Mart owns a majority stake in your company, the government will treat you as a $400 billion business—even if your stand-alone revenues are minuscule.

If you think your company might have an affiliation problem, you should review the SBA's affiliation guidelines and ensure that you are actually small before submitting your offer.