Joint Venture Rules Let More Participate in Federal Set-Asides

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By: Raymond J. Sherbill

Lerch Early's Legal Update

In a growing trend, companies that do not themselves qualify for federal preferences for small disadvantaged businesses can help and joint venture with other companies that are qualified, and thereby enjoy many of the benefits these programs offer.

Federal agencies annually reserve a total of over $12 billion in federal contracting opportunities for award to “8(a)” companies, which are businesses that have successfully applied for a determination of being socially and economically disadvantaged under Section 8(a) of the Small Business Administration Act. In addition, other categories of disadvantaged small businesses, such as companies owned and controlled by service-disabled veterans, qualify for a growing allotment of set-aside contracts and other preferences.

Affiliation Rule

In years past, a hard and fast SBA rule prevented larger businesses, and even small businesses that did not qualify as disadvantaged, from associating with 8(a) and other disadvantaged businesses in the performance of set-aside contracts. The rule is called “affiliation,” the notion that if a large or non-disadvantaged business has significant involvement or becomes too intertwined with the operations of a qualified disadvantaged business, the SBA will treat the two as if they were one company; if it applies the previously qualified small disadvantaged business will no longer be eligible for federal set asides or other benefits.

However, the hard affiliation rule put the disadvantaged businesses at an even greater disadvantage by preventing them from doing what normal start-ups might do to team or joint venture with an established company to gain the qualifications needed to actually win a federal contract. In 1998, the SBA created two carefully drawn exceptions to the affiliation rule, and refined and clarified these exceptions in 2004. The effect has been to let more 8(a) companies and other disadvantaged businesses participate in ever larger contracts, and to allow non-disadvantaged companies also to participate in the set-aside solicitations.

Mentor-Protégé Program

One exception to the hard affiliation rule is the SBA’s mentor-protégé program. The mentor can be a company of any size, even a large publicly traded company. The protégé must be an 8(a) firm which is under a certain size or which has not yet won a federal contract. The SBA requires the mentor and protégé to sign and submit an agreement meeting a variety of requirements assuring that the mentor will indeed help the protégé. If the SBA approves all arrangements, the mentor can purchase up to 40% ownership in the protégé, and up to a 49% profit interest in a federal contracting joint venture with the protégé, without being deemed affiliated with the protégé. The Department of Defense and other agencies now have other versions of mentor-protégé programs that are applicable, for example, to service-disabled veteran-owned companies that are not 8(a)-qualified.

Competitive Joint Venture

The other exception to the hard affiliation rule is the 8(a) competitive joint venture. An 8(a) joint venture must consist entirely of members that are “small businesses” under the applicable SBA size standard, and one or more 8(a) companies must have a majority of the profit interest. Additionally, as if to justify why the group of joint venturers have joined together, an 8(a) participant must be particularly “small” and the contract must be particularly “big.” Thus the SBA rule requires the 8(a) company to be less than half the applicable contract size standard, and the contract value to be more than half the size standard (or more than $10 million if the size standard is employee based).

Unfortunately, unlike mentor-protégé arrangements, the SBA will not approve 8(a) joint ventures until time of contract award, so if your joint venture fails to meet these and other rigorous SBA requirements, you could find out then that you lost a contract you would have otherwise won.

However narrow the path is to follow these exceptions to the affiliation rule, they are increasingly popular. Disadvantaged small businesses now realize they can leverage a relationship with another company to win much larger contracts than otherwise would be possible, and non-disadvantaged companies realize they can participate and have a meaningful indirect stake in a set-aside contract while helping a disadvantaged business. In the competitive world of federal contracting, a joint venture can provide the edge both kinds of companies need to win.

Ray Sherbill represents clients in government contracting matters with the procuring agencies or the Government Accountability Office, and in other matters before federal and state regulators. For more information about joint ventures, contact Ray at rjsherbill@lerchearly.com or (301) 347-1275.

This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.