Benefiting from set-asides

Even if your company doesn't meet federal requirements, you still can benefit from set-aside contracts


To further its policy of counseling, assisting and protecting the interests of small businesses, the federal government has established set-aside programs for some of them. Preferences have been established to ensure a fair proportion of government purchasing is made through such companies, and tens of billions of dollars are directed to small-business concerns each year. For construction projects in particular, agencies are eager to obtain small-business participation.

If you do not meet set-aside program requirements, you may be able to work with companies that do through joint ventures, teaming agreements and other arrangements. Such arrangements can benefit businesses eligible for set-aside awards because such businesses often lack the resources or experience to successfully complete the work required under the contract.

For example, such a contractor may not have the financial wherewithal to obtain the required bonds for a project and may never have performed a project as large and complex as the set-aside contract. Collaborative arrangements such as joint ventures and teaming agreements can help enable those that do and do not qualify for set-aside contracts to benefit from existing government policy.

Restrictions and rules

Because some options we will discuss require one or both contractors to be a small business, it is important to know whether you qualify.

The Small Business Administration (SBA) issues small-business size standards, divided by industry, that dictate how small a business must be to qualify for federal programs. For specialty trade contractors, including roofing contractors, the limit is $14 million in average annual receipts. For contractors engaging in general construction, the limit is $33.5 million in average annual receipts. Average annual receipts are calculated using the three most recently completed fiscal years.

This size calculation includes receipts of all "affiliated businesses." An affiliated business is a company the small business has the power to control or vice versa, regardless of whether that control is exercised, as indicated by factors such as common ownership, common management and identity of interest (ownership by immediate family members, for example). Power to control exists when a party or parties have 50 percent or more ownership. Power to control also may exist with considerably less than 50 percent ownership by contractual arrangement or when one or more parties own a large share compared with other parties.

Joint ventures

Contractors who do not qualify for set-aside contracts may form joint ventures with businesses that do qualify. However, rules for joint ventures vary according to the type of program and nature of the project involved.

Many set-aside programs fall under SBA rules. SBA defines a joint venture as an association of individuals or companies that, through express or implied contract, seek to engage in and carry out no more than three specific or limited-purpose ventures for joint profit during a two-year period for which they combine their efforts, property, money, skill or knowledge but not on a continuing or permanent basis. A joint venture may be but does not have to be a separate legal entity.

SBA also imposes size and performance of work standards on joint ventures. These can vary based on the type of project or program involved, but ordinarily size restrictions apply to the joint venture as a whole, meaning the respective parties' sizes are combined as with the affiliation rules.

A joint venture will qualify for an SBA set-aside if the combined size of the two parties falls within the appropriate size restrictions for a small business under the regulations. This presents a problem in that it requires both contractors to be substantially below the maximum average annual receipts allowable for small businesses.

In addition, the performance of work standards generally require each venturer to perform at least 15 percent of the work on a general contracting project or 25 percent of the work on a specialty contracting project. Consequently, both parties must have capabilities to perform the required portion of the work under the contract.

Although joint ventures offer opportunities for otherwise unobtainable work, the parties' relationship creates risks, as well. Most significantly, contractors in a joint venture each assume "joint and several" liability for the acts or omissions of the joint venture. In other words, if there is damage to a project, each party is 100 percent responsible to the owner regardless of which venturer caused the damage. This risk can be mitigated between the parties through a joint venture agreement.

Specific programs

Because of the size and performance of work requirements, SBA joint venture rules do not provide enough flexibility to promote meaningful access to set-aside programs if you do not qualify directly. The various set-aside programs contain particular rules for joint venture arrangements, but these, too, are relatively limited. In addition, a majority of set-aside dollars are directed to small-business concerns rather than to these specific programs.

Programs featuring particular rules include small disadvantaged business (SDB), woman-owned small business (WOSB), service-disabled veteran-owned small business (SDVOSB) and historically underutilized business zone (HUBZone) joint ventures.

The rules for each have slight variations, but in general, each program will require the set-aside organization to take the managing role in the operation of the joint venture and receive a substantial portion of the work and benefits from the contract. The most significant limitation may be SBA size restrictions. Joint ventures involving Section 8(a) participants have special rules, which we will discuss later.

SDB joint ventures

A joint venture intending to comply with the rules for SDB set-asides must involve at least one business that is SBA-certified under SDB rules (or at least has applied for certification and not been denied). To qualify, the joint venture must have been formed for the single business venture of proceeding on the particular project and may not be an ongoing joint venture. SBA affiliation rules apply, so the sizes of members of the joint venture combined must meet SBA size limitations for small businesses.

An SDB participant must serve as the managing venturer, and an employee of the SDB must be the project manager. The joint venture must meet the percentage of work requirements, and the SDB participant must perform a substantial portion of the work. The regulations do not specify what constitutes a "substantial portion" of the work.

Because the combined companies must comply with SBA size requirements, such joint ventures only can be used by companies that are comfortably smaller than what SBA's applicable size standards require.

Finding an appropriate venture partner also may be difficult because of the requirement that an SDB participant serve as the managing venturer on the project.

WOSB joint ventures

The rules governing WOSB joint ventures are similar to those that apply to SDB joint ventures. A joint venture must qualify under SBA small-business standards, and the WOSB must serve as the managing venturer and have one of its employees as the project manager. The joint venture must comply with the performance of work requirements, and the WOSB must perform a significant portion of the work.

Because of these restrictions, as with SDB joint ventures, contractors may face difficulties meeting size standards and finding a suitable WOSB partner that can serve as the managing venturer on the project.

SDVOSB joint ventures

The rules related to joint ventures involving SDVOSB companies are similar but not identical to the rules for SDB and WOSB joint ventures, offering greater flexibility than some other program rules but also imposing some stricter requirements.

SDVOSB rules specifically require a written joint venture agreement between the parties that sets forth the purpose of the joint venture and designates the SDVOSB participant as the managing venturer (and one of its employees as the project manager). Beyond that, the agreement must state no less than 51 percent of the joint venture's profits will be distributed to the SDVOSB participant.

In addition, the agreement must specify the parties' responsibilities for performance, provision of labor and contract negotiation. The SDVOSB is required to maintain possession of the project's final records, and all parties must undertake to ensure performance of the entire construction contract.

According to these rules, the joint venture must meet SBA size requirements, but the percentage of work requirements apply to the entire joint venture, not to each member separately. The joint venture agreement must be in place by the time the bid is submitted, and any contract will be issued in the name of the joint venture. SBA reserves the right to audit or inspect the joint venture's records at any time.

HUBZone joint ventures

SBA also has established a related program to provide federal contracting assistance to qualified small businesses located in HUBZones. Generally, HUBZones are economically distressed and depressed areas, and this program is designed to boost employment opportunities and encourage capital investment. To be eligible, a HUBZone small business must be small according to SBA guidelines, have its principal office located in a HUBZone, and have at least 35 percent of its employees reside in a HUBZone. SBA certifies HUBZone small businesses through a written application process.

Although a large, non-HUBZone business cannot act as a prime contractor on a HUBZone set-aside project, it can serve as a subcontractor to a qualified HUBZone small business.

A non-HUBZone subcontractor on a general construction or specialty construction may perform up to 49 percent of the cost of the contract performance incurred for personnel. Joint ventures among HUBZone small businesses are permitted, but both venturers must qualify as HUBZone small businesses. So each business in the partnership must be small and each must otherwise qualify as a HUBZone certified small business.

For procurements having a revenue-based standard, if a joint venture's size exceeds half the size standard for a small business, the joint venture will be permitted as long as each of the businesses is small. For these joint ventures, the performance of work requirements apply to the joint venture as a whole, not to each individual venturer.

Relaxed rules

In certain cases, joint venture size standards and work requirement rules are relaxed. In these cases, size standards apply only to each of the joint venture participants, not to the joint venture as a whole.

In addition, the percentage of work requirements apply to the joint venture together, not to the separate parties.

This approach provides a greater opportunity for joint ventures to be used in connection with procurements meeting certain criteria, projects involving 8(a) mentor-protégé joint ventures and projects using joint ventures with qualified 8(a) participants.

Certain procurements

Certain federal procurements are consolidated into single contracts that are likely unsuitable for small businesses because of size, specialized nature, total dollar value or geographical dispersion of performance sites. Such procurements are referred to as "bundled." Relaxed joint venture rules will apply to encourage more small-business participation.

Relaxed rules also will apply to a procurement that is not bundled but meets certain size restrictions.

For instance, relaxed rules will apply if a procurement's dollar value exceeds half the small size standard. Therefore, if a project involves general construction and the contract dollar amount is greater than $16.75 million (which is half the $33.5 million size standard) or the project involves specialty trade construction and exceeds $7 million (which is half the $14 million size standard), those rules will apply.

8(a) mentor-protégé program

One program SBA established to help small disadvantaged businesses is the Section 8(a) program. This program is designed for certain businesses that meet SBA criteria for demonstrating economic disadvantage with the goal being to provide opportunities for growth and experience for such companies.

Among the key components of the Section 8(a) rules is the mentor-protégé program, which enables qualifying 8(a) companies to work with seasoned contractors to gain experience and improve skills necessary to compete successfully in the marketplace.

A contractor who intends to serve as a mentor must demonstrate commitment and ability to assist the 8(a) protégé in the program by demonstrating good financial health, strong character and the ability to support the 8(a) participant either through his or her practical experience with the 8(a) program or general knowledge of government contracting. The mentor does not have to meet SBA's small-business criteria or be eligible for any set-aside programs.

Typically, a mentor provides technical and contract management assistance to the protégé, enabling the protégé to gain practical experience in the particular contracting business. Mentors also often provide financial assistance to protégés through direct equity investment or by making loans to the protégé.

Through joint ventures with the protégé on particular projects, the mentor brings capabilities and training that will assist the 8(a) participant in performing contracts and other requirements for which it would not otherwise qualify.

The mentor-protégé program's primary advantage for the mentor is the ability to enter into a joint venture with the protégé for the purpose of bidding and performing work set aside for 8(a) participants without being treated as affiliated companies. In addition, by participating in the mentor-protégé program, the mentor is permitted to hold as much as 40 percent of the protégé's stock, which allows the mentor to have a long-term interest in the protégé company's success.

Participation in the mentor-protégé program requires a written agreement assessing the protégé's needs and detailing the specific assistance the mentor will provide. The agreement must have at least a one-year term and is subject to initial SBA approval and an annual review.

Such a relationship will require close cooperation and involvement but has the potential to generate work that was previously beyond the mentor's reach while avoiding some of the pitfalls that threaten joint ventures and teaming agreements, such as findings of affiliation and difficulties obtaining bonding.

Qualified 8(a) joint ventures

Given the nature of the businesses that participate in the Section 8(a) program, SBA is mindful of the potential for abuse. The regulations provide that, outside the mentor-protégé program, joint ventures with 8(a) participants are only permissible where the 8(a) business lacks the capacity to perform the contract on its own and the joint venture agreement is fair and equitable and will provide a substantial benefit to the 8(a) participant.

If SBA concludes an 8(a) business contributes little to the joint venture relationship in terms of resources and expertise other than its 8(a) status, the joint venture will not be approved.

That said, in circumstances in which a joint venture is appropriate and provided the contract size requirements apply to the procurement, SBA size standards will be applied to each party separately, not to the joint venture as a whole. If the procurement does not meet the contract size requirements, each party must satisfy SBA's size standards.

In either case, the performance of work requirements apply to the joint venture as a whole, and the 8(a) participant is required to perform a significant portion of the work.

8(a) joint venture rules require SBA approve a written joint venture agreement before the project begins; the agreement must contain the following provisions:

  • The joint venture's purpose
  • Designation of the 8(a) participant as the managing venturer and an employee as project manager
  • A statement that no less than 51 percent of the net profits will be distributed to 8(a) participants
  • Itemization of all equipment, facilities and resources
  • The parties' responsibilities for performance of work, labor and negotiations
  • The assurance of all parties regarding the contract's performance
  • Certain bank accounts, recordkeeping and financial reports

If these requirements are met, a joint venture between a company that qualifies as small under SBA standards and a qualified 8(a) participant can be successful. If the non-8(a) contractor does not meet the size standards, this arrangement likely will not be productive.

Teaming agreements

A teaming agreement is broadly defined as the joining of two or more contractors for purposes of acting as a potential prime contractor or an agreement between a potential prime contractor and one or more companies to act as subcontractors. Federal Acquisition Regulations specifically permit these types of agreements provided the arrangement is disclosed in the offer or, if the arrangement is made after the offer, the arrangement is disclosed to the government before it becomes effective.

Contractors enter into teaming agreements to reduce costs and improve performance, particularly in complex procurements where each participant has unique skills or capabilities. A joint venture is one manifestation of a teaming agreement, but not all teaming agreements establish joint ventures.

Teaming agreements most commonly establish a prime contractor-subcontractor arrangement. They allow one larger company with experience and bonding capacity and one smaller company that meets the set-aside requirements to bid on a particular government project because, absent such an agreement, they would not individually meet the requirements or qualifications.

When a prime contractor-subcontractor team bids on a project, the contract will be awarded only to the prime contractor. The prime contractor is solely responsible, from the awarding entity's perspective, for ensuring the work performed meets the contractual requirements. Again, this differs from the rules pertaining to joint ventures in which contracts are awarded to the joint venture and both companies are 100 percent responsible for the work.

When teaming agreements are used to obtain work on set-aside contracts, the smaller contractor meeting the set-aside requirement generally serves as the prime contractor, subcontracting a portion of the work to the larger, more experienced contractor, so the contract is officially awarded to a business meeting the set-aside requirements.

Although the regulations allow teams to be formed following the contract award, because the set-aside contractor typically does not have the experience or bonding capacity required to qualify as a responsible contractor, the teaming agreement usually is executed before bid submission and attached as an exhibit to the bid.

Unlike in a joint venture, team members are not presumed to be affiliated based solely on their teaming relationship. However, team members can be found to be affiliated under general affiliation rules, and, therefore, contractors should not team with entities that are or may appear to be affiliated.

If a set-aside project is for minority-owned, woman-owned or service-disabled veteran-owned small businesses, the same limitations on subcontracting apply, and the set-aside contractor must perform the stated minimum percentage of the work. However, anecdotal evidence and experience suggest at least some awarding entities will not hold fast to the minimum percentage requirements provided the set-aside contractor contributes sufficient value to the project and stands to benefit through development of its capacities.

The most common basis for finding affiliation of team members is not common ownership but the "ostensible subcontractor" rule. An ostensible subcontractor "performs primary and vital requirements of a contract" or is a subcontractor upon which the prime contractor is unusually reliant. A prime contractor is considered affiliated with all its ostensible subcontractors. SBA will examine the totality of the circumstances when evaluating the parties' relationship.

To avoid a finding of affiliation, a well-drafted agreement is essential. You should consult your attorney for details and assistance in forming such an agreement.

Selecting a team member

Taking care what contractor you select for a set-aside project is just as important as taking care when selecting subcontractors on private jobs. Although liability for a team member's actions is not as extensive as the liability for joint venturer's actions, a poor team member can cause numerous expenses, inefficiencies and headaches.

The best way to reduce expenses and exposures is to do your homework and spend the time necessary to learn about the other contractor and, if possible, develop a relationship with a well-qualified minority contractor through a series of projects.

On many set-aside projects, the government will provide a list of interested qualifying contractors. Some may be legitimate construction companies that do not have the bonding capacity or experience necessary to perform a complex, large government project. Others may be fly-by-night companies with little more than an office and a telephone that plan to contribute little or nothing to the job other than adding their names in exchange for a fee.

Identifying and selecting a quality team member can be an arduous process, but contracting with a fly-by-night company can lead to a number of issues from failure to receive timely payment to criminal investigations if the government was misled as to what, if anything, the team member contributed to the project.

Pros and cons

Set-aside programs offer substantial financial opportunities through joint ventures, teams or mentor-protégé relationships. However, the requirements and limitations attached to these opportunities necessitate advance planning, research and caution. Numerous pitfalls may invalidate or sink contemplated teams or joint ventures, resulting in an outright rejection of the bid or inability to bid. Worse, a bid may be won and a project commenced before you realize you are stuck with a deadweight team member.

Although the requirements to qualify can be onerous, do not play fast and loose with them. False certifications or misrepresentations regarding status as a small business or scope of work to be performed by a team member may lead to fines, suspension or debarment from federal contracting, or criminal liability.

If you are willing to dedicate the time and resources necessary to identify and develop relationships with suitable team members and with a surety to ensure availability of bonding, you may cultivate a new and profitable facet of your business.

Scott D. Calhoun and David M. Gersh are attorneys with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.



Bonding

When bidding on a set-aside project as part of a team or joint venture, you may encounter difficulties with your surety. Sureties sometimes hesitate to issue bonds covering other team members with whom they are unfamiliar. This is especially true when parties propose to enter a contractor-subcontractor teaming arrangement with the subcontractor providing bonding. A surety may be understandably concerned about issuing bonds when a contract will be issued to the set-aside contractor rather than its client. Difficulties obtaining bonds are compounded by the fact that, frequently, the surety is not contacted until shortly before the bid is due, giving the surety little time to get comfortable with the risk.

Every project, team member and surety is different, and there is no magic fix or standard form that can assuage the surety in every circumstance. The keys to successfully obtaining a bond for such a relationship are communication and planning.

Obtaining a bond for a joint venture should be a relatively simple process. Provided your joint venture partner is willing to execute a personal guaranty and the joint venture agreement contains cross-indemnity provisions among your companies, sureties typically will issue a bond to a joint venture with little hesitation. However, ample time should be allowed to get the documents in order and provide the surety a reasonable opportunity to perform a due diligence investigation of the proposed joint venture partner.

The process becomes more difficult when the parties seek to enter into a contractor-subcontractor teaming agreement and the principal under the bond will not be the party awarded the prime contract. A surety's first reaction may be concern that it is being asked to bond the contract of a third party with which it has no prior relationship. Generally, the surety will need to be comfortable with what you are doing and with the other team member's solvency and stability.

Additionally, you should work with your surety to identify what your surety wants to see in the teaming agreement and work to prepare draft documents that can be used to form a teaming agreement on future projects. Information or documentation from the contracting officer also can help, such as a statement that the awarding entity will accept bids from and recognize the validity of contractor-subcontractor teams.

Ultimately, sureties want to feel comfortable. Last-second entreaties to produce a bond for an unfamiliar arrangement do not instill comfort or confidence. By planning with the surety ahead of time, communicating to ensure the surety's concerns are addressed in a teaming agreement or subcontract documents, and educating the surety regarding the underlying need for the arrangement, an established contractor in a teaming agreement should be able to convince its surety to bond the project.

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