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Panoptic Enterprises' FEDERAL CONTRACTS DISPATCH

DATE: December 3, 2004

SUBJECT: Small Business Administration; Small Business Size Standards Issues

SOURCE: Federal Register, December 3, 2004, Vol. 69, No. 232, page 70197

AGENCIES: Small Business Administration (SBA)

ACTION: Advance Notice of Proposed Rulemaking (ANPRM)

SYNOPSIS: The SBA is seeking comments on several issues that were raised by comments on the recently withdrawn proposal to restructure the small business size standards. The issues discussed in this ANPRM address matters pertaining to SBA's size standards but were not part of the proposed changes.

EDITOR'S NOTE: For more on the proposed rule to restructure the small business size standards, see the March 19, 2004, FEDERAL CONTRACTS DISPATCH "Small Business Administration (SBA); Restructuring of Small Business Size Standards."

For more on the withdrawal of the March 19, 2004, proposed rule, see the July 1, 2004, FEDERAL CONTRACTS DISPATCH "Small Business Administration (SBA); Withdrawal of Proposed Small Business Size Standards Restructuring."

The SBA's regulations are in Title 13 of the Code of Federal Regulations (CFR). The SBA small business size regulations are in Chapter 1, Small Business Administration; Part 121, Small Business Size Regulations.

A complete listing of current size standards is available at SBA's Size Standards website at http://www.sba.gov/size/sizetable2002.html, or by calling 202-205-6618 and requesting a copy of the table of size standards.

DATES: Comments must be received on or before February 1, 2005.

ADDRESSES: Respondents may submit comments directly on the Federal eRulemaking Portal at http://www.regulations.gov; by e-mail to: restructure.sizestandandards@sba.gov; by fax to 202-205-6930; by mail or hand-delivery/courier to Gary M. Jackson, Assistant Administrator for Size Standards, 409 Third Street, SW, Washington, DC 20416. Cite "RIN 3245-ZA02" when making comments in reponse to this ANPRM.

FOR FURTHER INFORMATION CONTACT: SBA's Office of Size Standards, 202-205-6618, or by e-mail to sizestandards@sba.gov.

SUPPLEMENTAL INFORMATION: SBA has 37 different small business size standards for 1,151 industries, 13 sub-industries, and 11 special financial and procurement programs. The number of size standards has grown over the years because of the expansion and development of new SBA programs, the increasing size and complexity of the U.S. economy, and demands from small businesses to address unique situations.

On March 19, 2004, SBA published a proposed rule to restructure the small business size standards by basing them primarily on the number of employees of a business concern (as opposed to average annual receipts) and by limiting the number of different size standard levels to ten. SBA believed this would simplify the existing structure of size standards and enable the public to better understand and use them.

SBA received more than 4,500 comments on the proposed changes. Because of the concerns expressed by a large number of comments, SBA withdrew the proposal on July 1, 2004. SBA is continuing its review of the comments and, when completed, will decide what, if any, further actions are necessary.

This ANPRM seeks comments on several issues that were raised in comments on the March 19, 2004, proposed rule but were not part of the changes that were being proposed. SBA is giving the public an opportunity to comment on these issues before deciding on the next course of action.

• Approaches to Simplification of Size Standards: Over the years, SBA's size standards have been criticized as being difficult to understand. Many of these complaints relate to issues regarding the application of size standards, not to the size standards themselves. SBA's March 19, 2004, proposed rule to simplify the structure of size standard was an approach to address one aspect of size standards -- the many different, frequently overlapping, size standards. This ANPRM provides the public with an opportunity to advise SBA on what areas of size standards make them complicated or difficult to use or understand. SBA is interested in whether its March 19, 2004, approach achieves simplification or if other approaches should be examined that address other aspects of size standards. Comments on this issue should explain how a particular aspect of size standards is complicated, and what modifications could be made to improve upon existing policies. The comments should also describe the benefits to small businesses and the users of size standards if such modifications were to be adopted.
  
  
• Calculation of Number of Employees: The March 19, 2004, proposed rule expanded the use of employee-based size standards to industries that have traditionally used receipt-based size standards, such as construction, retail trade, and services. SBA did not propose to change its method for counting number of employees, which is specified in 13 CFR 121.106, How Does SBA Calculate Number of Employees? The most contentious portion of 13 CFR 121.106 is paragraph (b)(2): "Part-time and temporary employees are counted the same as full-time employees."
  
  Many pointed out that under SBA's current method, businesses that utilize part-time employees, temporary employees, or lower-paid employees tend to outgrow an employee-based size standard quicker than a similar business that primarily utilized full-time employees. Many of the commenters recommended calculating employment size on a full-time equivalent (FTE) basis (that is, two part-time employees working 4 hours a day are considered one FTE). Others recommended calculating part-time employees in a different manner from full-time employees. Also, many comments raised concerns regarding the treatment of independent contractors in determining employment size.
  
  SBA seeks comments on alternative methods of calculating the employment size of a business and the feasibility of using FTEs. The comments should clearly describe the alternative calculation method and why it would be preferable to SBA's current calculation of number of employees. Comments recommending an alternative calculation should also address the implications on the types of businesses that could be affected in terms of small business eligibility.
  
  Related to this issue is whether the time period for calculating average employment should be modified from SBA's current method, which uses a rolling average of the pay periods over the preceding 12 months. For example, should average employment be based on a fixed period of time, such as a calendar year? Also, should average employment be based on a longer period than one year? Comments should describe the alternative time period and explain why it would be an improvement to the current averaging calculation.
  
  Many comments on the use of employee-based size standards contend that calculating and reporting to SBA their business' employment size is administratively burdensome. However, other comments pointed out that automated payroll and accounting systems enable businesses to readily document their employment size. SBA is particularly interested in comments that described the process small businesses must follow to calculate average employment and whether producing this information creates an unacceptable burden. Alternative methods of calculating average employment should address the implications on the alternative calculation on administrative burdens.
  
  
• Use of Receipts-Based Size Standards: SBA received several comments recommending that the use of receipts-based size standards be continued. These comments generally provided one of three reasons for their position: (1) receipts are considered a more appropriate measure of business size for their industry than number of employees; (2) average annual receipts are simpler than number of employees for businesses when determining their small business status and less burdensome in providing documentation to SBA in the event of a size protest (SBA evaluates the average annual receipts size of a business based on the Federal tax returns submitted by the business to the Internal Revenue Service (see 13 CFR 121.104, How does SBA calculate annual receipts?)); (3) the use of employee-based size standards could encourage businesses to reduce employment, use fewer part-time and lower-paid employees, convert employees to independent contractors, subcontract more work to other businesses, and make other employment related decisions that they would not otherwise adopt.
  
  SBA seeks comments on whether it should continue to use receipts-based size standards or establish size standards based exclusively on number of employees. SBA is seeking comments on what considerations it should give when deciding whether an industry size standard should be based on average annual receipts or number of employees. Also, SBA would like comments on which industries that have receipts-based size standards would be more appropriate with employee-based size standards, and in what ways are they more appropriate? Comments should address if having one measure of size for some industries and a different measure for other industries creates an unnecessary complication to size standards.
  
  
• Designation of Size Standards for Federal Procurements: The size standard designated for a federal procurement is determined by the North American Industry Classification System (NAICS) industry that best describes the principle purpose of the procurement (see 13 CFR 121.402, What size standards are applicable to procurement assistance programs?). This decision is the responsibility of the contracting officer. Once the NAICS industry is designated, the size standard established by SBA is assigned to the procurement. Because size standards vary by industry, businesses and contracting officers sometimes argue for an incorrect NAICS designation so as to effect the small business eligibility of certain businesses. Some of the comments on the March 19, 2004, proposed rule pointed out that federal procurements that require a contractor to perform a significant amount of activities from several different industries are more difficult to designate a single NAICS industry than for procurements which primarily consists of activities of one NAICS industry. Also, varying size standards by NAICS industry results in some businesses that operate in multiple industries being considered small for some federal procurements but not for other types of procurements.
  
  SBA is seeking comments on whether the process for applying size standards to federal procurements should be modified. Comments supporting a modified process should describe the alternative system and how it would improve the current process. Also, comments should address how the alternative process would make sure that small businesses fairly compete with other businesses that are small in that field of work.
  
  
• Establishment of Size Standards Solely for Federal Procurement: SBA received comments arguing that it should significantly increase size standards to assist small businesses in developing a sufficient infrastructure that will allow them to compete for federal procurements in full and open competition against the leading federal contractors. These comments contended that the requirements and growing size of federal contracts create a situation in which a small business that is awarded one or two federal contracts automatically outgrows the size standard and loses its eligibility to compete for future contracts requiring small business status. Further, businesses that are not small or among the largest federal contractors enter a so-called "dead zone" or "limbo zone" where they must compete for federal contracting opportunities against corporate giants before they have developed a competitive strength to do so.
  
  In 1984, SBA adopted a policy that its industry size standards would apply to all programs. Before then, SBA had one set of size standards for federal procurement and one set for all other small business programs. SBA says it "is concerned that a significant increase in the size standards to reflect trends in federal procurement would create size standards that are too high to realistically reflect small businesses in an industry or for the purposes of most other federal small business programs."
  
  SBA seeks comments on whether a separate set of size standards should be established specifically for federal procurement or whether this would needlessly complicate size standards. These comments should address the public policy justification for establishing such a separate set of size standards -- why should a small business be eligible for one program but not be eligible for another small business program? If separate federal procurement size standards were established, what factors should SBA take into consideration in developing the size standards that are different from SBA's current industry analysis methodology (see SBA's size standards website for proposed rules that describe the industry analysis at http://www.sba.gov/size).
  
  
• Establishment of Tiered Size Standards: A number of comments suggested that SBA establish size standards to direct assistance to different sizes of small businesses (that is, sub-categories of small businesses), such as very small businesses. These comments argued that two levels of size standards are needed to assist small businesses become capable of competing for federal procurements on a full and open basis. These comments recognized that higher size standards may adversely affect the competitiveness of small businesses much smaller than the size standard. Many of these comments tied the establishment of tiered size standards with the estimated dollar value of a federal procurement -- lower dollar value procurements could be reserved for very small businesses while other procurements could continue to be available to all small businesses.
  
  Although legislation would be necessary before SBA could consider establishing tiered size standards, it seeks comments on whether the concept of tiered size standards addresses a compelling need to assist certain segments of small businesses with meaningful federal contracting opportunities. If tiered size standards have potential to better assist small businesses with federal contracting opportunities, how could such a system be structured? Because tiered size standards would create more complexity in federal contracting, what are implications of a small business sub-category on other designated business types (8(a), HUBZone, service-disabled veteran owned small business, women-owned small business, etc.) in terms of assistance to those businesses?
  
  
• Simplification of Small Business Status and Affiliation with Other Businesses: A key provision of SBA's size standards is the consideration of affiliation with other businesses in determining the size of a business. This fundamental concept ensures that federal small business assistance programs are limited to small businesses that, because of their size, possess inherent disadvantages that larger businesses do not experience.
  
  SBA's general principles of affiliation provide that concerns are affiliates of one another when one concern controls or has the power to control the other, or a third party (or parties) controls or has the power to control both. The power to control need not be exercised -- it need only be present. More than 50% ownership of a concern by another will almost always create affiliation. Affiliation may also exist if there is less than 50% ownership of a concern by another. In these situations, SBA will consider factors such as management, previous relationships, shared business or economic interests, economic dependence, convertible debentures, agreements to merge, etc., in determining when affiliation exists in a given situation. Because relationships among business concerns can be extremely complicated and at times difficult to fully discover, the affiliation regulations are more extensive than other size regulations.
  
  SBA invites comments addressing ways to clarify its affiliation regulations. SBA is not considering altering its principles of affiliation, but seeks suggestions on improving the language of the affiliation regulations to make them easier for the public to understand. Comments on affiliation should explain how a current regulatory provision is unclear and suggest revised language.
  
  However, SBA does seek comments on one specific area of affiliation involving the small business eligibility of franchises. SBA has received requests from the temporary staffing franchise industry to allow for an exemption from its franchise affiliation regulations. The SBA is considering excluding certain practices of temporary franchisors as conditions for finding affiliation: (1) the franchisor being the employer of the individuals placed as temporary workers by a franchisee; (2) the franchisor being responsible for the franchisee's payroll and associated costs; (3) the franchisor collecting the franchisee's accounts receivable; and (4) the franchisor remitting client fees to their franchisees.
  
  SBA seeks comments from businesses in the temporary staffing industry, including those independent staffing firms that are not involved in franchise agreements. SBA is interested in knowing how a change in its affiliation rule for franchises would affect the temporary staffing industry, in particular:
  
  
  • Do SBA's current franchise regulations hamper the ability of franchisees to compete in the temporary staffing industry?
    
    
  • Would allowing this exemption continue to allow for temporary staffing franchisees to be "independently owned and operated" businesses?
    
    
  • Does allowing this exemption give franchisors too much control over their franchisees?
    
    
  • Would allowing this exemption give franchisors and franchisees a competitive advantage in contracting over independent temporary staffing businesses?
  
  
• Joint Ventures and Small Business Eligibility: SBA's size regulations have specific provisions determining the small business eligibility of joint ventures. Generally, a joint venture of two or more businesses may qualify as an eligible small business if the aggregate size of all the members does not exceed the applicable size standard (see paragraph (f) of 13 CFR 121.103, What is affiliation?). For certain larger federal procurements, a joint venture whose members individually qualify as a small business may qualify as an eligible small business joint venture. On May 21, 2004, SBA changed this provision to allow a joint venture to compete for multiple opportunities (see the May 21, 2004, FEDERAL CONTRACTS DISPATCH "Small Business Size Standards and Proceedings of the Office of Hearings and Appeals"). However, this change limits an ongoing joint venture to submitting offers on three procurement opportunities over a two-year period. SBA believes that joint ventures among small businesses facilitate opportunities for small businesses to compete for larger-sized federal procurements.
  
  SBA is seeking additional comment on its joint venture eligibility criteria. Comments are sought on the nature of joint ventures formed by small businesses to compete on federal procurements; the duration of such joint ventures; their competitive strength against other small businesses; and other aspects of joint ventures that have a bearing on policies to assist small business opportunities. SBA is specifically interested in obtaining comments on the recent policy of limiting a small business joint venture to three offerings over a two-year period. SBA is concerned about permitting a joint venture among the same small businesses to operate as an on-going concern competing against other small businesses. At the same time, this new policy may be too restrictive in today's federal contracting environment.
  
  
• Grandfathering of Currently Eligible Small Businesses: One of the concerns with the March 19, 2004, proposed rule was the potential effect on small business that might lose small business eligibility due to the restructuring of size standards. Many comments pointed out that businesses develop their business plans over several years premised on the existing regulations. Abrupt changes that take away small business eligibility significantly disrupt these business plans and force businesses to reassess the viability of their strategies.
  
  SBA expects that any new proposed rule addressing the current structure of size standards will have a significantly smaller effect on current small business eligibility than the March 19, 2004, proposed rule. However, any worthwhile changes will invariably have an adverse effect on some small businesses. SBA seeks comments on approaches by which to grandfather small businesses that could be adversely affected by a restructuring. A related alternative may consist of a longer implementation date than the typical 30 day period to allow businesses to adjust to the new regulations. SBA realizes it may be difficult to provide comments without a specific proposal. However, SBA seeks general ideas on approaches and relevant factors it should consider if a provision to maintain small business eligibility becomes necessary for a particular proposal.
  
  
• Effect of SBA Size Standards on the Regulations of Other Federal Agencies: An area of concern expressed by the comments involved the effect of SBA's size standards on the programs and regulations of other federal agencies. SBA is aware of the use of its size standards in a number of federal regulations and is in the process of identifying others. To make sure that future proposals adequately identify and assess the use of SBA's size standards, SBA is requesting assistance in identifying federal regulations and programs that utilize its size standards. In addition, SBA is seeking comments describing the effect a size standard change may have on small entities being subject to different regulatory requirements or their eligibility for federal benefits. Comments on how size standard changes may effect a federal agency's ability to meet the purposes of the regulation would be helpful.
  
  
• Participation of Businesses Majority-Owned by Venture Capital Companies in the Small Business Innovation Research (SBIR) Program: Today, SBA published a final rule modifying 13 CFR 121.702, What size standards are applicable to the SBIR program?, to allow a small business that is 51% owned and controlled by another business concern to be eligible for funding agreements under the SBIR Program (see today's FEDERAL CONTRACTS DISPATCH "Small Business Administration; Small Business Size Standard for Small Business Innovation Research (SBIR) Program"; for more on the SBIR program, see the September 24, 2002, FEDERAL CONTRACTS DISPATCH "Small Business Administration; Small Business Innovation Research Program."
  
  Of the 164 comments submitted on the proposed rule that led to the final rule (see the June 4, 2003, FEDERAL CONTRACTS DISPATCH "Small Business Administration; Small Business Size Standard for Small Business Innovation Research (SBIR) Program"), 60 addressed an issue related to venture capital companies (VCCs) that was not a subject of the proposed rule. Forty commenters thought a concern should be allowed to participate in the SBIR program if one or more VCCs have majority ownership or control of the concern, and that if one or more VCCs owned or controlled a concern, the VCC should not be deemed affiliated with the concern. The justification was that VCC investment is crucial to startups in the biotech industry and that SBIR funds are needed to reduce the private risk of these investments. However, the other 20 commenters were opposed to any proposal that would allow a concern to participate in the SBIR program if one or more VCCs have majority ownership or control of the concern because VCC firms often represent, and are established by, large corporate interests -- allowing VCCs to receive SBIR awards could result in SBIR funds being used to subsidize research projects of large corporations.
  
  Under 13 CFR 121.103, What is affiliation?, when VCCs have control of a firm in which they invest, they are considered affiliated with that firm, just as any other business entity would be if it had ownership or control. 13 CFR 121.103 provides a small number of exclusions from affiliation: concerns owned in whole or substantial part by Small Business Investment Companies (SBICs) or development companies licensed under the Small Business Investment Act are not considered affiliated with the SBIC or development company; concerns owned and controlled by Indian Tribes, Alaska Regional or Village Corporations, Native Hawaiian Organizations and Community Development Corporations are not considered affiliates of these entities solely because of their common ownership and common management; and the regulation excludes VCCs from affiliation with concerns receiving assistance under the Small Business Investment Act -- however, the SBIR program is established under the Small Business Innovation Development Act, not under the Small Business Investment Act.
  
  SBA requests comments on the whether it should propose a change to the size affiliation regulation for SBIR Program purposes by allowing business concerns that are majority owned or controlled by one or more VCCs to be eligible for SBIR awards, regardless of the ownership and control of the VCCs. Specific issues that SBA is seeking information on include the following:
  
  
  • The role of VCC financing on SBIR projects during Phases I and II.
    
    
  • The impact of such a change in eligibility requirements on the composition of SBIR participants. For example, would the program shift towards lower-risk technologies closer to market, or become more geographically concentrated following industries and areas of venture capital focus?
    
    
  • The types of firms and projects that would benefit most from such a change, and those that would benefit the least.
    
    
  • Whether an exclusion from affiliation for VCCs would require justifying limiting the exclusion to VCCs and not including other entities such as not-for-profit organizations.
    
    
  • Whether or not granting VCC exclusion from affiliation would adversely affect the ability of small business concerns without such access to private capital to compete for SBIR awards.
    
    
  • Whether the participation of firms owned and controlled by VCC firms would ultimately create an environment of multiple repeat award winners.
    
    
  • Alternative approaches that may assist small business concerns in obtaining and utilizing VCC funding while participating in the SBIR Program, aside from a policy that requires an exclusion from affiliation for VCC majority-owned small business concerns.
    
    
  • The number and type of small entities that would be affected by a rule that would provide an exclusion from affiliation for VCC companies in size determinations for eligibility for the SBIR Program.
    
    
  • The number of small businesses competing for SBIR awards that have received venture capital funding and the number of VCC majority-owned small business concerns that potentially may be interested in participating in the SBIR Program.
    
    
  • The costs to small entities if SBA implements a rule that would provide an exclusion from affiliation for VCC companies in size determinations for eligibility for the SBIR Program. Such costs include implementation costs and the effect the rule would have on profits or revenues -- that is, whether it would reduce profits or raise or lower revenues.
    
    
  • Comments on any other aspect of the SBIR Program that might directly affect whether or not SBA should propose excluding VCCs from affiliation for purposes of the SBIR Program.

SBA is planning other actions on size standards in addition to this ANPRM:

1. SBA plans to hold a series of public meetings on size standards that will focus on the issues raised in this ANPRM.
   
   
2. SBA is examining a number of specific size standards as separate rulemaking actions, such as the nonmanufacturer size standard of 500 employees regardless of the actual size standard for the particular industry.

FOR FURTHER INFORMATION CONTACT: Panoptic Enterprises at 703-451-5953.

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