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Public Contract Law Journal

Public Contract Law Journal Vol. 52, No. 4

Punished for Outgrowing Small Business Status: How the SBA Can Help Mid-sized Firms Survive in the Federal Procurement System

Amanda Spector


  • Discusses the Small Business Act and small business policies that benefit small businesses, but may raise obstacles for mid-size business.
  • Analyzes past efforts to assist mid-sized businesses who have graduated from small business programs.
  • Proposes recommendations for the SBA to consider in expanding current size standards and more effective in assisting mid-size businesses.
Punished for Outgrowing Small Business Status: How the SBA Can Help Mid-sized Firms Survive in the Federal Procurement System
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This Note addresses how the Small Business Administration (SBA) fails to consider the interests of mid-sized companies when promulgating its small business size standards. While the SBA clearly defines what a small business is, and what it is not, it overlooks the fact that a small business will hopefully outgrow its size standards to become mid-sized, at which point it will face significant obstacles. Some of these obstacles include competing against the largest and most experienced companies in the procurement system and losing the ability to receive “set-aside” contracts which are reserved for small businesses. To truly support small business interests, the SBA ought to expand its size standards for all its small businesses or consider business growth in its current methodology. By making small business standards more inclusive, the SBA can minimize fears of business growth as contractors who are not prepared to enter the “full and open” procurement system can remain in the small business program for an extended period. To implement these solutions, the SBA must first gain a better understanding of contracting opportunities for mid-sized firms once they graduate from the small business program.

I. Introduction

Like many small business owners, Lisa Firestone was forced to make a difficult decision. Should she restrict the growth of her company to remain in the small business program or expand and become a mid-sized firm? In her statement before the Subcommittee on Contracting and Workforce of the House of Representatives, Lisa Firestone explained how she is at a “crossroads” and must face this predicament in deciding her business’s future course.

In 1997, Ms. Firestone established a boutique healthcare consulting company that specializes in federal employee health benefits, managed care, and workers’ compensation. When she first started the business, it was modest and had a consulting team of only four people. In 2005, her company was awarded its first government contract, two years later received its largest contract to date, and since then has experienced “double-digit growth year over year.” This is certainly a laudable achievement, but it is overshadowed by the daunting reality that her company has likely outgrown the size standards that make it eligible for small business contracting.

Ms. Firestone’s company undoubtedly flourished in the Small Business Administration’s (SBA) small business program. In fact, her business’s tremendous success reflects the SBA’s stated goal of fostering small business growth—a goal that has endured through each presidential administration regardless of political affiliations. However, this growth does not come without its consequences, and Ms. Firestone admits that her and her company must “reinvent [themselves] in order to continue to grow and remain relevant in the Federal market.” Once her company loses access to small-business benefits, it will be locked out of competitions for set-aside contracts that are exclusive to small businesses. Therefore, for her company to survive, she must redesign her business model and find a way to offset the loss from set-aside contracts that she previously relied on for revenue.

It is no secret that the United States’ federal procurement system prioritizes small business interests and “has chosen to leverage its purchases to support domestic firms, and more specifically, small businesses.” Contracting Officers are obligated to consider small business concerns during acquisition planning by either entirely setting aside contracts, partially setting aside contracts, and when possible, setting aside portions of larger multiple award contracts. The standard for setting aside a contract is broad and only requires that the Contracting Officer have a reasonable belief that at least two small businesses can provide the goods or services the government needs, which is presumed when a contract takes place under the simplified acquisition threshold. In addition, federal agencies are authorized, and even encouraged, to make sole-source awards to small businesses under certain circumstances such as when there is an urgent and compelling need. These various small business preferences have allowed Congress to consistently reach its goal of small businesses receiving twenty-three percent of all prime contracts. Because of the immense benefits offered to small businesses in their pursuit of securing government contracts, it is not surprising that small business owners, such as Ms. Firestone, are reluctant to forego their preferential treatment.

Small business policies endure because they continue to generate support from politicians who want to demonstrate their dedication to small business concerns. In fact, the small business entity has been described as “[o]ne of the most sacred” areas of “the national political scene.” But, regardless of the unique treatment small businesses receive, there are serious inconsistencies with how the small business program is designed, primarily given the large disconnect between small business policy goals and actual small business practices. For instance, when a small business stifles its own business growth to remain in the small business program, any policy goals surrounding business growth are forgone. In addition to generating contradictory results, small business policies likely impose more costs on the government and contradict the supposed free and open competitive nature that the federal procurement system purports to embody. Regardless of the benefits or drawbacks of small business programs, it is apparent that the current policies are not achieving their intended purpose of envisioning growth because as businesses “grow towards their NAICS [North American Industry Classification System] thresholds, they encounter a ‘benefit cliff’ that disincentivizes growth . . . .” The NAICS is the standard that federal agencies use to classify businesses for purposes related to the U.S. economy.

This Note addresses the fact that small business policies have inevitably caused inefficiencies, specifically because small businesses are restricting their employee count and annual revenue to purposefully remain under a small business classification. When small businesses expand beyond the SBA’s small business threshold, they must compete with the largest firms in the “full and open” procurement space without the forms of government assistance they are used to receiving. When faced with the overwhelming amount of competition and limited options in successfully competing, it is not uncommon for a small business to choose not to outgrow the program. The small business program itself is an example of an unavoidable tradeoffs in government policy. Nonetheless, if the SBA could find a way to assist, and even reward, mid-sized businesses once they experience substantial growth, the SBA’s goals of supporting small businesses may actually be realized.

The SBA should consider two options to address the issue that small businesses are not incentivized to grow into mid-sized firms. The first option is to generally increase the current small business size standards by a certain amount. This would alleviate the problem quickly, but likely would be overinclusive and could only work short-term. The second, and more efficient, yet more difficult to implement solution, is for the SBA to consider business growth as a factor in its methodology to determine small business eligibility. By factoring in a growth component, the current size standards would likely increase, and the SBA could begin the process of accounting for growth, rather than punishing it.

Part II of this Note introduces the Small Business Act of 1953 and tracks key developments regarding small business policies. Included in this section is a discussion of the current SBA size standards and its primary reliance on the NAICS codes that differentiate businesses by industry. Part III elaborates on the obstacles mid-sized businesses face and the decisions they are forced to make to succeed in the federal procurement system. Part IV highlights prior reforms that were initiated to help mid-sized businesses and why they have been both criticized and praised. Finally, Part V proposes two recommendations for the SBA to consider: either the more simplistic but less effective option of generally expanding the current size standards, or the more effective but more complicated option of factoring in business growth into its current methodology.

II. Background of the Small Business Act and the SBA’s Size Standards

A. History of the Small Business Policies

To understand how current small business policies are not achieving their intended purpose, it is necessary to first understand the intended purpose behind the implementation of small business policies. The original purpose of the Small Business Act was to increase small business presence in the federal open market and interestingly not to “favor small business at the expense of its larger competitors.” In fact, increasing small business opportunity was desirable expressly for economic reasons, primarily to “maintain and strengthen the overall economy of the Nation.” Today, the SBA’s size standards do not foster economic vigor to the extent they should as only the smallest of businesses are thoroughly supported by the SBA’s policies. Unfortunately, as a result, small businesses on the verge of becoming mid-sized are supported the least, despite the fact that mid-sized firms contribute significantly to the economy by creating jobs and fostering competition in various industries.

The concept of a small business preference originated during World War II when Congress found that small businesses were economically threatened by their inability to obtain military contracts and material shortages. In essence, small businesses could not compete against large businesses who could help the war effort by making products and providing other needed services. While Congress recognized that the “productive potential of smaller firms must be utilized if the United States is to remain strong[,]” it was unclear how to accomplish this goal.

To mobilize small businesses, Congress created the Small War Plants Corporation (SWPC) in 1942 to loan money to small businesses while instructing federal agencies and large companies to purchase goods and services from those businesses. While the SWPC largely ceased to operate after World War II, a similar initiative resurfaced in 1951 during the Korean War with the creation of the Small Defense Plants Administration (SDPA). Also around this time, Congress began to emphasize that small businesses should be encouraged to contribute to the war effort as much as possible and that the President should aid small businesses in doing so.

After the threat of war diminished, it was questionable whether small businesses would now succeed in a “normal” procurement system without any governmental assistance. Congress doubted that small businesses could independently survive and was “convinced that it would be a mistake to scrap the mechanism developed to meet emergency crises when many substantial obstacles still strewed the path of smaller concerns merely because of their size.” This sentiment resulted in the Small Business Act of 1953, enacted by President Eisenhower, which firmly established U.S. small business policy and created the SBA. Embedded in this Act is the delegation of power to the SBA to promulgate small business policies to ensure that small business interests are being sufficiently met.

Although the Small Business Act of 1953 appeared to be a monumental step in promoting small business policies, it was not until the Act was amended several years later that the program was actually enforced. The Small Business Investment Act of 1958 adopted most of the same principles contained in the 1953 Act but allowed the use of set-asides to ensure that small businesses were actually receiving a “fair proportion” of government contracts. The idea of “setting-aside” certain contracts specifically for small businesses was novel, yet critics doubted that small businesses could actually receive a fair number of contracts if the system did not change more significantly.

Finally, in 1978, Congress again amended the Small Business Act of 1953 and the Small Business Investment Act of 1958 to significantly change how federal agencies interact with small businesses and required that agencies establish definite goals for small-business contracting. One of the most notable changes was the new policy that small businesses should have the “maximum practicable opportunit[ies]” when competing for and in receiving government contracts. This was undoubtedly a major shift from the initial creation of small business policies, which were designed to simply grant small businesses an opportunity to compete in the procurement system.

B. Small Business Administration’s Size Standards

The establishment of small-business preferences in the U.S. procurement system is inevitably premised on the fact that a business must meet the definition of “small.” A small business is defined by statute as one that is “independently owned and operated and which is not dominant in its field of operation.” Although this statutory language appears overly broad and difficult to implement in practice, it was chosen deliberately to account for the fact that a specific definition of “small” could not possibly account for inherent differences between businesses. To this point, the Banking and Currency Committee decided to not even attempt writing a definition for a small business because it would be “impractical” to do so considering the differences among business groups. This resistance to giving small business a rigid definition set the standard that small business policies ought to be reflective of the procurement system as a whole.

As small businesses were never supposed to be given a specific definition, the SBA has adamantly followed an industry specific approach that compares businesses within fields, such as within the retail trade industry or within the construction field. In addition to the SBA size standards reflecting industry norms, Congress has also mandated that the SBA conduct periodic review of its standards. For instance, the Small Business Jobs Act of 2010 requires that SBA review at least one-third of its industry size standards every eighteen months and each individual size standard at least once every five years.

The SBA relies on the NAICS to categorize its size standards. The NAICS codes were adopted by the Office of Management and Budget in 1997 and serve as the standard used by federal statistical agencies to classify business entities into their respective industries. Since 1997, the SBA has organized their size standards according to NAICS codes to determine which industry a business belongs to and the correlating small business size standard associated with it.

The SBA provides size standards for over 1000 narrowly defined industry categories, which many critics believe is overburdensome and far too complex. To illustrate how narrowly defined each industry can be, there are separate categories for rice farming and soybean farming as well as fruit and vegetable canning and frozen specialty-food manufacturing. The precise classification of a business therefore becomes very important, as it is possible for a business to be considered small in one industry yet not small in another. Companies in the Chicken Egg Production category may earn up to $19 million (over a five-year average of annual revenue), while businesses in the Dairy Cattle and Milk Production categories graduate out of their small business classification if they make over $3.75 million across the same time period. While the SBA’s size standards are extremely precise with regard to industry differences, perhaps this high level of specificity causes other considerations to be overlooked, such as whether the standards are prematurely isolating mid-sized businesses.

The SBA uses the NAICS codes by indicating the maximum number of employees or average annual receipt amount associated with each industry. A business’s employee count is calculated by counting the number of individuals that are employed on “full-time, part-time, or other basis.” The method to calculate a business’s employee count is to look at the pay periods of the proceeding twelve calendar months. Also, if a business has acquired an affiliate, or has been acquired as an affiliate, then the overall number of employees includes that in both entities. Businesses are considered affiliates when “one controls or has the power to control the other, or a third party or parties controls or has the power to control both.” With regard to calculating a business’s average annual receipts, the calculation includes “all revenue in whatever form received or accrued from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.” The contractor’s subcontractor costs, reimbursements, and payroll taxes are all included in the receipt calculation.

While a small business’s number of employees or average annual receipts are the principal numerical values used to determine whether a business is small, the SBA considers a wide variety of factors, which are embedded into those numbers and are intended to be comprehensive of “the structure of an industry.” This includes an industry’s “degree of competition, average firm size, start-up costs and entry barriers . . . .” For instance, in defining a small business, otherwise called a business “concern,” the SBA will “take into consideration market share of a concern and other appropriate factors that may allow a concern to exercise a major controlling influence on a national basis in which a number of business concerns are engaged.” If the SBA’s investigation reveals that its size standards are impermissibly allowing for market control in a particular industry, it will ensure that its standards are adjusted to prevent such market control from occurring. It is important to realize that these additional considerations are geared either towards businesses that have just entered a particular industry or large businesses to prevent their domination over smaller firms. For instance, start-up costs are considered for businesses that have recently entered the market to reflect the amount of capital needed for them to begin competing with other firms. Conversely, considering an industry’s degree of competition is designed to mitigate concentrated control by using a four-firm concentration ratio to collect the average annual receipts from the four biggest firms. Like many of the small business policies, there appears to be no consideration for those firms that fall “in between”—those that are neither very small nor particularly large.

III. Obstacles that Mid-sized Businesses Face in the Federal Marketplace

When companies become mid-sized and therefore enter “no man’s land,” they inevitably face the crisis that they are neither small nor large. While some contractors can more seamlessly make the transition out of small business status by, for instance, capitalizing on niche markets, others will end up “stuck” in the very undesirable middle territory. The fundamental problem here is that mid-sized firms are essentially grouped together and treated the same as large firms, despite larger companies having vast resources, the ability to conduct extensive market research, and experience compiling large proposals. Furthermore, newly graduated small businesses have fewer employees than larger firms, which can lead to inefficiencies by requiring too much collaboration and overlapping roles.

Another critical issue is that the notion of a mid-sized business is still an extremely unfamiliar concept in the federal procurement system. While the SBA has issued numerous size standards to define “small,” the category of “other than small” has virtually no statutory or regulatory definition. In fact, the category of “other than small” includes any business that is not a small business, meaning that a billion-dollar entity is treated the same as a business that is one employee past the small business threshold. This over-inclusive category amplifies the need for policy that focuses on mid-sized contractors, so as to not only account for the smallest and largest types of businesses.

The lack of regulatory attention devoted to mid-sized businesses has not gone unrecognized. Unfortunately, it has fostered the conviction that mid-sized companies, while critically important to promote competition and facilitate job creation, are severely undervalued. The GAO, in responding to requests for more information about mid-sized companies, released a report in 2019 that focused on ways to increase mid-sized business opportunities in the federal procurement system. The GAO attempted to quantify a mid-sized business by adding certain multipliers to the current size standards. The GAO thus considered businesses with annual earnings or employees up to five times above the current SBA small size standard to be mid-sized businesses. This number was derived from data on the Federal Procurement Data System-Next Generation. When questioned about the accuracy of this methodology, the SBA officials did not object to the GAO’s calculation, although some emphasized that it is impossible to verify these types of quantifications because a mid-sized business lacks a legal definition.

In addition to the lack of quantifiable information regarding mid-sized businesses, the current federal procurement system only recognizes two kinds of businesses—either those that are small, and therefore eligible to receive small business set-asides, or those that are not small, and therefore not eligible. However, this binary approach completely overlooks the fact that a small business’s growth could be attributed to the small business program itself and that its business model, originally geared towards winning set-aside contracts, may no longer be effective. Therefore, when that business model is no longer an effective way to secure contracts, it becomes extremely difficult for a small business to stay afloat, let alone complete with the billion-dollar industry names.

The presence of mid-sized businesses in the federal procurement system is very minimal and accounts for only 1.5% of contractors in the federal government as of 2018. In fact, the GAO’s research indicates that over ninety-three percent of small businesses that won set-aside contracts in the year 2008 remained small in 2017, a full nine years later. Perhaps even more perplexing is the incredibly small number of contracts that mid-sized businesses received after graduating from small business status. In 2008, just 5,339 small businesses received set-aside contracts. In 2013, five years later, only 104 of those 5,339 businesses grew to become mid-sized (according to GAO’s definition). Additionally, of those 104 businesses that grew to become mid-sized, only twenty-three continued to be mid-sized businesses and received onlyseventy-five federal contracts in total.

Why are so few contractors growing to become mid-sized companies? When a small business owner, such as Ms. Firestone who testified as to her own struggle owning a growing business, begins to approach the top of the threshold for small business classification, meaning that her company will soon outgrow its small business size status, she needs to make some decisions. Her first option is to deliberately inhibit the growth of her company so that it will continue to be eligible for small-business set-asides, in other words, voluntarily remain small. But, as Ms. Firestone mentioned in her statement to the Subcommittee on Contracting and Workforce of the Committee on Small Business,

I am loathe to restrict my growth to stay in the small business program. It runs counter to my entrepreneurial instincts, and it certainly is not good for the economy or the thousands of injured Federal employees who count on us every day to support their recovery and return to work.

Within the current small business policies, Ms. Firestone’s options are limited. She can either alter her business model to focus on subcontracting opportunities within larger businesses, grow her business and hope to survive as a mid-sized company, or restrict her company’s growth. Not only are these choices less than optimal for a successful small-business owner such as Ms. Firestone, but they are also wasteful of the resources that the SBA pours into small business programs.

IV. Prior Reforms & Alternatives

A. Runway Extension Act

Although supporting mid-sized businesses has not been a priority of the SBA, there have been attempts to ease the burdens associated with small to mid-sized business growth. One major development for mid-sized businesses and small business on the verge of graduation was the passage of the Small Business Runway Extension Act of 2018 (Act), which was highly anticipated and met with bipartisan support. The Act alters the length of time that the SBA uses to calculate a business’s annual receipt amount from the previous three-year-averaging system to an extended five-year-averaging-period. This change was administered gradually, but now has been fully implemented.As mentioned previously, the change reflected the persistent concern from small business owners that the three-year-averaging period too quickly pushed businesses out of the small business program whereas a five-year-averaging system would facilitate a more gradual progression. Also, considering that government contracts are growing tremendously in size, the three-year average period was more likely to push the firm out of the small business program after a company was awarded only one or two larger task orders. Overall, this expansion is very beneficial to “larger small businesses,” which now have more time as a result of the change to develop a solid business structure, acquire resources, and develop a competitive edge before entering the competitive marketplace.

While the Act was met with general support, the SBA received comments that requested that businesses be given the permanent option to choose either a three-year-averaging period or a five-year-averaging period depending on which would be better for their business needs. However, the SBA rejected this approach because of the likely confusion that would result from using multiple averaging periods and the impracticability of monitoring two distinct systems of measurement in the procurement arena.

Considering that the five-year-averaging system went into effect only at the beginning of 2020, it remains to be seen how effective it will be in assisting mid-sized businesses or incentivizing small-business growth. Even the Congressional Budget Office acknowledged that it is unclear how many entities will benefit from, or be hurt by, this policy. Nonetheless, to incentivize growth, contractors likely need more than a two-year extension period, as this is only intended to mitigate the undesirable consequences of a year, or two, of very good business. In addition to the elongated averaging period, mid-sized businesses need the SBA size standards to be targeted directly.

B. Creation of a “Mid-sized” Category

A seemingly natural solution, and one that has been proposed, is to create a separate “mid-sized” category. This would allow mid-sized businesses to continue receiving a form of preferential treatment until they become large enough to meaningfully compete. However, the creation of a new category is virtually not an option for the United States, as it would trigger serious international obligations. The United States is a member of the World Trade Organization (WTO) which is the only global international organization that governs trade rules between countries and settles trade disputes that arise. The United States is also a part of one of the WTO’s most important agreements, the Government Procurement Agreement (GPA), which is a framework for international government procurement. The Agreement aims to expand international trade by improving the transparency of contracting and establishing provisions that Member parties are bound to follow.

The WTO member states that signed the GPA must ensure that:

(a) that its entities shall not treat a locally-established supplier less favorably than another locally-established supplier on the basis of the degree of foreign affiliation or ownership; and (b) that its entities shall not discriminate against locally-established suppliers on the basis of the country of production of the good or service being supplied, provided that the country of production is a Party to the Agreement . . . .

When the United States joined the GPA, it agreed to the terms of non-discrimination but retained the right to give preferential treatment to small businesses in the United States, even if that meant rejecting foreign companies. However, this was the only reservation that the United States made with regard to preferential treatment of its domestic businesses; hence, it never asserted that it would give preferential treatment to U.S. mid-sized businesses as well.

As a member of both the WTO and the GPA, the United States has not reserved a right to make policy that prefers mid-sized U.S. businesses, as it has done with statutory preferences of U.S. small businesses. This means that if the SBA created a separate category for mid-sized businesses, it would be discriminating against international vendors by favoring its own mid-sized businesses rather than awarding procurement contracts to otherwise eligible international firms. The sudden emergence of a U.S. preference for its own mid-sized businesses could trigger the European Union, for example, to demand that it also wants to implement policies in favor of European Small-Medium Enterprises (SMEs). This would be problematic as it could harm U.S. businesses that are competing for international procurement contracts.

In addition to the consequences of violating the GPA, and the potential challenge under the WTO dispute process, creating a separate set-aside category for mid-sized businesses would be hugely burdensome on agencies. Considerable time and money would be required to implement this additional set-aside system, including the need to report and track all contracts awarded to mid-sized businesses for compliance purposes. Also, Contracting Officers would have to take on massive responsibilities, such as conducting market research to decide whether to set aside a contract for a mid-sized businesses.

C. Concerns with Adopting the European Union’s SME System

Just as the United States’ procurement system places tremendous significance on small-business interests, the European Union’s contracting system also devotes considerable attention to small business prosperity. In fact, SMEs in the European Union have been described as the “engine of the European economy” by spurring job creation and maintaining general stability.

Unlike the SBA size standards, which defines small businesses and, in turn, creates an additional “other than small” category, the European Union size standards have varying components that give a greater range. The smallest entity of an SME is called a “microenterprise” which is a business that employs fewer than ten people and has an annual balance sheet that is no more than two million euros (around 2.2 million dollars). A bit larger than a microenterprise is a “small enterprise,” which is a business that employs fewer than fifty people and has an annual balance sheet that is no more than ten million euros (around 11.1 million dollars). Finally, a mid-sized enterprise is considered to be a firm that employs fewer than 250 people and has an annual balance sheet that is no more than 43 million euros (around 47.7 million dollars).

While the SME system purports to offer the SBA a baseline to promulgate its own size standards for mid-sized firms, the European Union system is inherently too distinct from United States small business programs to even be used as a guideline. The European Union system uses a “one-size-fits-all” approach to determine if a business is a microenterprise, small, or midsize and does not factor in complex industry differences that the SBA uses when promulgating its size standards. This simplicity is prioritized by the European Commission as it leads to straight-forward and easy-to-understand size standards.

The European Union’s methodology is undoubtedly less complex than the SBA’s methodology. However, the European Union’s broad and simple approach is in stark juxtaposition with how the SBA’s size standards were intended to operate. The United States has traditionally rejected uniform size standards that disregard industry particularities. In fact, the actual text of the U.S. Code concerning small businesses states that “the [Small Business] Administrator shall ensure that the size standard varies from industry to industry to the extent necessary to reflect the differing characteristics of the various industries.” It would therefore be inconceivable to create size standards that diverge so radically from federal policy.

Additionally, while the SME system may initially appear to offer more businesses an opportunity to receive small business classification, the policies could be in fact doing the opposite. By failing to measure comparable firms against one another, the European Union’s policies may be denying small business preferences to firms that are actually considered “small” in some industries and offering small business protection to firms that are actually “large” in most industries. In fact, the European Commission has recognized that its standards overlook industry differences, but has chosen to prioritize simplicity even if that means foregoing small business protection to eligible busi-nesses. While this could be worth the sacrifice for the European Union, the U.S. government, since 1997, has emphasized an industry-approach method to sizing standards, and retaining the NAICS codes is therefore a non-negotiable for U.S. small business policy.

V. Redefining the SBA’s Small Business Size Standards

Congress has attempted to mitigate obstacles that mid-sized companies inevitably encounter as a result of growth. In fact, just recently, in December 2022, a new bipartisan bill, called “Solving the Unnecessary Contracting Cliff for Enterprises to Scale Successfully Act” (“SUCCESS Act”) was introduced in the Senate. The proposed legislation would allow a small business, when it first exceeds its small business size standard, to elect to participate in a pilot program where it could continue to qualify for small business contracts for a period of up to seven years. The purpose of the SUCCESS Act is to assist businesses in transitioning out of small business classification; however, only small businesses involved in commercial and institutional building construction or engineering services can opt into this program. Therefore, it is unclear how helpful this legislation will be for small businesses generally.

Unquestionably, policy involving the SBA’s size standards are particularly complex, as there is often no agreement among small business federal contractors. Very small companies practically always propose lower size standards, “average” small companies prefer to keep the “status quo,” and companies that are on the verge of graduation continuously push for the highest threshold possible. Considering the differing interests here, it is inevitable that reaching a consensus on how to amend the SBA size standards is a difficult task. Nonetheless, there is typically agreement that it is at least time for the SBA to re-evaluate its standards.

To support mid-sized business interests, the SBA should either increase its size standards generally or include small business growth as a factor in its methodology. Both of these solutions aim to equalize the scales between very large companies and mid-sized companies, who are grouped together under the current system and therefore must compete in the procurement arena as comparable firms. The first option, which is to increase the SBA’s size standards generally, is a solution that would be relatively simple to implement but likely would be overinclusive. The second option, for the SBA to revisit its size methodology and incorporate a growth component, would take longer to implement, as it would require a comprehensive review of the current size standards, but ultimately would be more effective at combating this issue. Both proposed solutions, although imperfect remedies, are compelling as they seek to mitigate burdens on mid-sized businesses, are not too expansive, reflect the original intent of the Small Business Act of 1953, and are consistent with international agreements.

A. Generally Increasing the SBA’s Size Standards

The first solution is for the SBA to increase its size standards generally so that mid-sized firms can remain under a small business classification for a longer duration. Admittedly, this remedy mirrors that of the Runway Extension Act and the SUCCESS Act, which both expand the length of time a business can remain “small.” However, as mentioned before, it is too soon to evaluate the effectiveness of the Runway Extension Act, and the SUCCESS Act is still in a preliminary stage.

For this solution to be beneficial to the procurement system generally, the standards must not be expanded too broadly to eliminate any distinction between small and mid-sized businesses. The GAO’s calculation of a mid-sized business, which is defined as an entity that has employees or annual revenue up to five times the current SBA standards, is useful to approximate how far the expansion should reach. Expanding the standards by five times the current amount, which by the GAO’s calculation would include all mid-sized businesses, is too broad because it would include businesses that are at the upper threshold of medium and could feasibly compete without any preferences. But, if the standards are increased by two and a half, then ideally the expansion would only give protection to the smaller of the mid-sized businesses. However, without more data tracking the development of a business once it graduates out of the small business program, it is difficult to determine the exact number the standards should be increased by to be effective.

A benefit to expanding the current standards across-the-board is that it circumvents the issues associated with creating a separate mid-sized category. While establishing a mid-sized business category would trigger concerns with international trade deals, if the SBA simply expanded the definition of “small” to include some of those mid-sized firms, there is substantially less risk of violating trade agreements. This is because the Government Procurement Agreement (GPA), the trade agreement that governs international procurement, does not provide a singular definition of what constitutes a small business. In turn, members of the agreement have varying standards to define small business. For instance, the EU’s definition of “small” is far more all-encompassing than that of the United States’ definition and accounts for businesses that have both 2, and 200, employees. Therefore, since there is no binding, international definition of a small business in international procurement, the SBA may expand its own definition of “small,” continue to favor United States small businesses, and most importantly, uphold its duties as a signatory to the GPA.

Another advantage to expanding the standards is that this solution is consistent with the Small Business Act of 1953. The motivating force behind the Act, and one of the stated reasons for its passage, was the “preservation and expansion” of competition in the federal marketplace. When small business preferences were first introduced, at a time when businesses could not secure wartime contracts, Congress passed small business policy because it was in the best interest of the United States economy. Today, the problem of small businesses not receiving government contracts is less of a concern, but to continue to foster economic vitality, small business policies need to be re-focused to support business growth. A few crucial reasons are that mid-sized businesses create jobs, increase competition, and offer value to the federal government. In addition to economic reasons, Congress also created small business policies to ensure that the full capacity, both actual and potential, of small businesses was being realized. Arguably small business potential is not reaching its highest capacity today because small businesses are faced with the decision of whether to deliberately restrict growth to remain small. By increasing the size standards, small business owners will be less fearful of business growth as they will have more time to prepare economically and organizationally for “full and open” competition.

B. Including a Growth Component in SBA’s Current Methodology

Increasing the SBA’s current size standards generally, and across all industries, is a viable option and would be not too burdensome to implement because it would only require that the current standards be multiplied by a certain amount. However, if the SBA chooses this option, accuracy will be sacrificed in favor of ease of implementation. This is because the SBA lacks the data required to precisely adjust each industry standard according to mid-sized business interests and would first need to gain a comprehensive understanding of federal market trends. But this option may be unrealistic as it would require the SBA to collect, analyze, and implement massive amounts of data to understand how their policies are affecting the market.

An alternative option is for the SBA to undertake a comprehensive review of its current size methodology to incorporate a growth component into its standards. As mentioned above, the SBA already considers a variety of factors when calculating small business standards, such as entry barriers, the costs of starting up a business, and competition within industries that are more susceptible to concentrated market power. Although these considerations benefit some small businesses, the SBA’s calculations are largely derived from Economic Census data, the official five-year measure of American businesses, and those statistics do not account for competitive realities in the federal contracting marketplace. This data, among other shortcomings, fails to consider the negative effects of growth, such as whether a small federal contractor, like Ms. Firestone, can remain competitive, or in business in any capacity, once she graduates from a small business size classification.

The Small Business Jobs Act requires the SBA to review one-third of all industry size standards every eighteen months and ensures that each industry is reviewed at least every five years. Yet, even when the SBA has increased its size standards, the modifications are typically minor and leave many small business owners disappointed. This incites controversial responses, especially from small-business owners who feel that the SBA’s proposed regulations do not align with the SBA’s mission to help small businesses and inevitably retain many of the hurdles associated with small business growth.

To meaningfully adjust its standards, without necessarily having to perform a comprehensive review of the entire small business program, the SBA should begin accounting for business growth in its methodology. Unfortunately, like most data on mid-sized businesses, current research on businesses that have successfully entered the middle market is lacking. Nonetheless, as a starting point, the SBA will need to begin tracking the growth of small businesses once they graduate out of the small business program. This should not be too difficult as the SBA can use the existing database system known as the Unique Entity Identifier (UEI) to track each contractor and ultimately evaluate how they are competing.

Based on the data, if the SBA can determine the growth interval at which a mid-sized business is able to obtain federal contracts without preferential treatment, it can then include an allowance for growth in its current standards. This allowance should ensure that no business is pushed out of the small business category before this point. In other words, if the SBA can pre-determine at what point a small business’s growth into mid-sized is indicative of its ability to obtain contracts and meaningfully compete, it may increase its size standards upwards based on that figure.

If the SBA modified its current standards to account for growth, specifically in industries where small businesses are likely to experience the most rapid growth in the early stages of federal contracting, the current standards will be improved. This option offers a more precise calculation than generally increasing the current size standards; however, the additional research and data collection make it a more arduous process. Nonetheless, the benefits outweigh the added burden, and, if the SBA undertook the necessary steps to track the growth of small businesses, then it could alter its methodology accordingly to ensure that businesses remain in the small business classification until they are ready to compete against other larger firms.

VI. Conclusion

The SBA must address mid-sized business concerns and, as it has done for small businesses, create some type of competitive advantage for them. This will help combat the underlying issue that our current system punishes business growth, rather than rewarding it. Although it would be difficult for the SBA to directly reward business growth as part of its standards, two viable alternatives that at least offset the negative impacts of growth are for the SBA to either increase its size standards generally or consider business growth in its current calculation. Like any government policy, increasing the SBA’s current size standards may cause unintended yet unavoidable consequences. The concern that the size expansion will only benefit a select number of mid-sized businesses is understandable because this solution is purposefully designed to target those firms on the lower end of “mid-sized.” However, if the standards are increased only marginally, or not at all, the expansion will have virtually no effect, which is likely worse.

The two proposed solutions aim to retain the current standards while making adjustments that are reasonable and reflective of data. For instance, the idea behind a two-and-a-half increase of the current size standards is to evenly divide the GAO’s calculation of what could constitute a mid-sized business, and, in turn, only encompasses the smaller part of the mid-sized category. Similarly, if the SBA were to adopt the second approach and incorporate business growth into its methodology, the current standards would be increased according to actual contractor data. In conclusion, the most viable solution to the mid-sized business dilemma is to make the small business standards more inclusive. As a result, successful small businesses owners, like Ms. Firestone, can easily make the transition from small to mid-sized and enter the procurement world confident and prepared to compete.