Avoid the Wrath of the SBA’s Present Effect Rule
Many government small businesses make the huge step of merging with other companies for viable business reasons. However, when considering small business mergers and acquisitions impact, the SBA’s “present effect” rule, the SBA considers agreements to merge (including agreements in principle) as having a present effect on the power to control a concern. 13 CFR 121.103 (d)(1). Without having a thorough understanding of the M&A process, contractors can find themselves at a disadvantage.
Small business mergers and acquisitions have become more frequent. However, businesses that are buying out companies with existing government contracts should be aware of special risks and pitfalls. When there is a change or control, SBA regulations can become a landmine. For buyers, Government contractor investments require tailored diligence to avoid significant future liabilities and the potential loss of ongoing Government contracts.
Small Business Mergers and Acquisitions Letter of Intent Affiliation
When there is a small business merger or merging a company with a federal project, buyers are always interested in securing existing and future federal contract work. However, the letter of intent can become a problem if there is the language that the seller has no official ability to participate as a small business.
- If the purchaser buys all assets of the seller, then it can run the risk of immediately becoming large in the SBA’s eyes. This present effect can be daunting if you do not have proper legal counsel.
For small business size standard purposes, merger and acquisition are effective as of the date of that an ‘agreement in principle’ is reached, even though the merger or acquisition itself is not yet consummated.”
New SBA rules may significantly increase recertification transaction costs in small business mergers and acquisitions for traditional acquirers, including private equity firms and other strategic buyers.
POWER TO CONTROL
When a small business decides to merge or acquire another company, the SBA, for size determination purposes, also looks at the effect of the transaction on one company’s ability to control the other. This issue can be the focus of any SBA size protest. When one company buys another’s subdivision, the impact of affiliation and the ability of one to control the other surfaces.
- Companies must carefully review government contracting regulations to see how the transaction impacts their ability to continue to get federal projects.
- Merger and acquisition documents must be crafted in a way to avoid affiliation and control landmines.
- Conducting your due diligence is critical to getting a favorable outcome.
SMALL BUSINESS MERGER AGREEMENT
IS THERE ONLY AN AGREEMENT TO MERGE?
SBAOHA has consistently decided that under the present effect rule, there is no small business merger agreement in principle where parties merely commit to negotiating exclusively with one another. Making a small business size standard determination will be seen as premature. However, there can still be separate facts that lead to potential affiliation. In other words, businesses cannot claim that there is no final agreement but still conduct present business to the extent that the relationship is suspect or questionable.
When deciding to negotiate merging a company or assignment of government contract issues, you must still look at the ability to control. Small businesses, especially 8(a) certified companies, must always communicate with the SBA early in the negotiation phase.
Mergers and acquisitions of small businesses with federal government contracts can involve millions of dollars. Besides, there could be issues of a novation agreement, or risk to the agency when companies buy, sell or merge.
For help with new small business mergers and acquisitions consulting under the SBA present effect rule, call our government small business lawyers at 1-866-601-5518 for immediate help.