A firm’s small business size status for federal procurements is measured by the firm’s revenues, not by its profits.

As the SBA Office of Hearings and Appeals explained in a recent size determination, measuring small business status by reference to profits would allow some very large companies to qualify as “small.”

SBA OHA’s decision in Size Appeal of TLS Contracting, Inc., SBA No. SIZ-5527 (2014) involved a VA solicitation seeking a contractor to replace a chiller and cooling tower.  The solicitation was set-aside for SDVOSBs under a $14 million size standard.

After opening bids, the VA announced that TLS Contracting, Inc. was the apparent successful offeror.  A competitor filed a size protest, but protested the wrong company–TL Services, Inc.  The SBA Area Office dismissed the size protest, but initiated its own challenge of TLS’s size.  The SBA Area Office subsequently issued a size determination finding TLS to be ineligible under the $14 million size standard due to affiliation between TLS and other entities.

TLS filed a size appeal with SBA OHA.  TLS did not dispute the SBA Area Office’s findings of affiliation.  Instead, TLS took issue with the SBA Area Office’s calculation of its size.  TLS pointed out that under the SBA’s regulations, a firm’s “receipts” are defined as “total income” plus “cost of goods sold” as those terms are defined and reported on IRS tax forms.  TLS argued that because the IRS treats “cost of goods sold” as a negative number, the SBA Area Office should have subtracted “cost of goods sold” from “total income.”  Had the SBA Area Office done so, TLS would have qualified as a small business.

SBA OHA wrote that TLS’s argument was “unpersuasive.”  SBA OHA wrote that “deducting ‘cost of goods sold’ when determining annual receipts contradicts the definition of ‘annual receipts’ in the regulation.”  SBA OHA explained, “[t]his is because the size standard is based on revenue, and deducting ‘cost of goods sold’ from ‘total income’ would measure profitability, not revenue.”  OHA noted that “if size were measured by profit alone, some very large firms could qualify as small.”  SBA OHA denied TLS’s size appeal.

I sometimes hear from government contractors who wonder, as TLS did, whether a firm’s size status is based on its revenues or its profits.  Similarly, there appears to be a somewhat widespread misconception that a firm’s small business status is based on its revenues in a particular NAICS code, rather than the firm’s total revenues.  As explained in the TLS Contracting case, a firm does not qualify as small simply because it was not profitable.  By the same token, a firm does not qualify as small merely because it generated most of its revenues in other NAICS codes.  Government contractors (and their accountants) would be wise to carefully review the SBA’s annual receipts definition before assuming that they qualify as “small.”