Most contractors, when starting their journey into the world of federal contracting eventually run into the same question: What size is my business? In the world of federal contracting, the size of your business can determine whether you can bid on certain procurements, participate in certain programs, and more. Miscalculating or misrepresenting your business size could open you up to size protests, and other severe repercussions. So, knowing the accurate size of your business could be critical to the success or failure of your federal contacting business. But don’t fear, in this edition of our Back to Basics series, we will discuss some of the basics around calculating the size of your business and why it all matters.
What does “size” mean for federal contracting?
As Julie Andrews so astutely sang in Sound of Music, “Let’s start at the very beginning, a very good place to start.” When talking about calculating size, the first thing to ask is, what does size even mean? While this may seem like a fairly simple question, it can have varying answers based on who you are asking, and why you are asking it. Often businesses will informally gauge their business “size” by looking at other businesses in their industry and comparing themselves. This will lead to the inevitable thought of, “I guess I am pretty small compared to that company” or “wow I’ve got a lot of employees and revenue compared to that business that does what I do in this town, so I guess I am a large business.” While that may make for good shop talk at your next industry convention or at your local coffee shop, when it comes to federal contracting, the Small Business Administration (SBA) demands something much more concrete. In the realm of federal contracting, when an agency or other business discusses the “size” of a certain business, what they are truly meaning is, are you smaller, or bigger than the size standard establishes for the applicable NAICS code? Size for federal contracting is categorized by NAICS code, either specified in the solicitation you would like to bid on, or that you chose to represent your business’s primary industry. Specifically, the SBA expects a business claiming to be small to “not exceed the size standard for the NAICS code specified in the solicitation.” That is what size roughly means when you are dealing with federal contracting.
What is a NAICS code?
Given the last answer, some contractors’ next question may be, “what is a NAICS code?” (side-note, when saying NAICS, remember that it is pronounced “naykes” like the word “cakes”, although if you pronounce it differently, that is allowed). NAICS code is short for North American Industry Classification Code System, and each NAICS code is a six digit number that directly correlates to a defined industry, and size standard. Contractors must select a primary NAICS code to represent what their company does when registering their business on SAM.gov and participate in different federal contracting programs. (A list of the NAICS Codes, as well as the industries and sizes assigned to them is published by the SBA here). For example, if I decided that I was finally bored of watching my extensive movie collection, and I wanted to start a business making movies for the Government, I would likely choose for my business, NAICS code 512110, whose assigned industry is “Motion Picture and Video Production”, which has assigned to it currently a $40,000,000 size standard (don’t worry we will get to what that all means below). Of course, businesses can be multi-faceted, so I could have my primary NAICS be 512110, but then also do other work in other related NAICS codes, making those my “secondary NAICS codes.”
In addition to this, each solicitation will have a single NAICS code assigned to it by the procuring agency “which best describes the principal purpose of the product or service being acquired.” Going back to my example, if the Government wanted some private contractors to produce films for the Government, they would probably issue a solicitation with the earlier discussed NAICS Code 512110 assigned to it, thus putting offerors on alert to what size standard may apply as well as what that the agency believes best describes the work they will be looking for. While a contractor’s self-assigned NAICS code can determine what size a contractor needs to be to classify itself as a small business for contracting programs (such as SDVOSB, 8(a) etc.), the NAICS code that is assigned to a procurement determines if a contractor is small enough for that specific procurement. (Important side note, there are ways to appeal or contest NAICS codes that are assigned to solicitations, which we don’t have time to go into here, but if you are interested in that, I encourage you to check out our post about NAICS code appeals here.)
How to determine the size of your business
With the definition of size and what dictates the size standard out of the way, we can finally get to the big question at hand, how do you determine the size of your business for federal contracting? As hinted to above, it all relies on the NAICS code.
If you are a contractor and want to apply to participate in a small business program, such as the 8(a) Program, one of the multitude of requirements for that program is to simply be a small business. This is a situation in which you would look at your primary NAICS code to see what the assigned size for that NAICS code currently is (the sizes are regularly updated for inflation etc.). You then conduct the necessary size calculation (discussed below), and if your final calculation is smaller than the assigned size for that NAICS code, then you are “small”. If not, then you are “other than small” (SBA doesn’t use the words “large business”). So, for my earlier examples, my pretend filmmaking business would need to be smaller than $40,000,000.
For a solicitation, a contractor would look at the procurement documentation itself to see what NAICS code the agency assigned the solicitation, then do the needed calculation to determine if they would qualify as a “small business” for that procurement. So, shifting gears from the movies, to music, let’s say an agency wanted a contractor to produce a recording of a concert it was organizing. Presumably that agency would utilize NAICS Code 512250, Record Production and Distribution, which carries a size standard of 900 employees. If I had also started a record production line of business at my hypothetical movie business, due to my love of music (this would be an example of a secondary NAICS code), and wanted to bid as a small business on this procurement, I would need to have my size calculations result in fewer than 900 employees.
While reading this, I am sure you had a couple things pop into your mind: 1) How do I “calculate” the size, like you keep referring to?; and 2) there are size standards based on revenue AND employees? Don’t worry, that’s exactly what we will cover next.
How do you calculate size under an employee size standard?
As alluded to, there are two types of size standards, a receipts-based size standard, and an employee-based size standard. The regulations and table of size standards will list these out for each NAICS code, so when faced with a size question, you can reference those to see exactly which standard and size applies to the NAICS code at issue. First, we will look at how to compute size under an employee-based size standard.
Continuing with my examples from above, let’s pretend that there is a contract assigned NAICS Code 512250, Record Production and Distribution, which carries a size standard of 900 employees. SBA states that when determining your business’ size for an employee size standard, you calculate the average number of employees based upon the “numbers of employees for each of the pay periods for the preceding completed 24 calendar months.” This includes employees of any domestic and foreign affiliates. Additionally, part-time employees are counted the same as full-time employees.
Using our example, for simplicity’s sake, we will assume I have been in business for over 24 months, so I would gather information on how many employees (including part time employees) I had for each pay period, add them all up, then divide by the number of pay periods I had during those 24 months. If the result of that calculation is below 900, then I am “small” for that solicitation.
If your business has not been in operation for 24 months, you use the average number of employees for each of the pay periods that you have been in business.
Also if you have any affiliates, then the SBA has specifics on how to properly calculate your “average” employees. In general, you would add the average number of employees of your business with the average number of employees for each affiliate, but there are additional wrinkles for when they became affiliates, or if they are former affiliates.
How do you calculate size under a receipts-based standard?
The other size standard is based on receipts (or for lack of a better word, money), not number of employees. Utilizing our earlier examples, lets propose that the government wanted to have someone produce a movie about the World War I museum in nearby Kansas City, Missouri, and issued a solicitation under NAICS code 512110. As discussed, that NAICS Code carries with it a $40,000,000 size standard. If my hypothetical film business wanted to bid on that solicitation as a small business, our receipts based size calculation would need to be below $40,000,000. To make this calculation, first you need to figure out what “receipts” are.
SBA states that to calculate receipts based size standards, you first need to determine what constitutes “receipts”. SBA explains that receipts include “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.” This is basically the “total income” (or for a sole proprietorship “gross income”), plus “cost of goods sold” as shown on a business’ tax forms. This may seem like quite a big amount of revenue to include, as you may be accustomed to multiple types of write offs, deductions etc. on your taxes, but SBA does not allow such reductions. For determining size, SBA has a narrow list of what can be excluded from the “receipts” and those are the only items that may be excluded. SBA makes it quite clear that “[a]ll other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from receipts.”
Now that we have defined what “receipts” are, the calculation itself can be examined. To determine size based on a receipts size standard, a business will take its annual receipts for the past five completed fiscal years (which as you recall is total income plus costs of goods sold) and divide it by five. If you have fully completed five fiscal years, then that’s as simple as it gets. Looking at my example, let’s say my fictitious film company has been going for at least five years, and for the past five years has the following financial info:
- Year 1: Total Income of $3,000,000, and costs of goods sold of $250,000.
- This makes Year 1 receipts: $3,250,000 (i.e., Total Income + Costs of Goods Sold).
- Year 2: Total Income of $5,000,000, and costs of goods sold of $350,000.
- This makes Year 2 receipts: $5,350,000
- Year 3: Total Income of $15,000,000, and costs of goods sold of $500,000.
- This makes Year 3 receipts: $15,500,000.
- Year 4: Total Income of $13,000,000 and costs of goods sold of $400,000.
- This makes Year 4 receipts: $13,400,000.
- Year 5: Total Income of $20,000,000 and costs of goods sold of $650,000.
- This makes Year 5 receipts: $20,650,000.
To find my size, I would do the following equation:
($3,250,000 + $5,350,000 + $15,500,000 + $13,400,000 + $20,650,000) / 5 = SIZE
This would result in my hypothetical size being $11,630,000, well below the size standard of $40,000,000, making my hypothetical film studio “small” for that specific procurement.
However, life and business is rarely simple, so SBA does provide directions on if your business has not been in business for five years, or possibly had a short year in its five years.
If a business has been in business for less than five years, the business simply takes the total receipts for the period the business has been operating divided by the number of weeks it has been in business, multiplied by 52. If a business has one short year within its five completed fiscal years, to determine its size, it will take its total receipts for that short year, and the four other full fiscal years, divide them by the total number of weeks in the short year and four full years, then multiply that number by 52.
Why does this matter?
Being able to accurately calculate size has far reaching implications across the federal contracting landscape. First, when you register on SAM.gov you must represent whether you are small or not, and what your primary NAICS code is. This is basically your name tag that will be used for all your federal contracting interactions, meaning it needs to be accurate to avoid any sort of false representations or certifications. Agencies may rely on the information on SAM to determine your size and eligibility, so keeping that information, including size, accurate and up to date is crucial.
Also, your ability to participate in certain small business contracting programs may be prohibited if you are not small, or you could face ramifications for falsely stating you are “small”. For example, in addition to meeting the other requirements of the 8(a) Program, you must also be a small business in your primary NAICS code. You could perfectly meet every other aspect of eligibility for the 8(a) Program, but if your business is not small, you simply cannot be admitted into the program, or if your size subsequently changes, it will put your participation in that program at risk. This goes for other small business contracting programs as well, such as the SDVOSB program.
A small business will commonly need to meet a certain size to bid on and be awarded contracts. In my examples, we discuss how the NAICS assigned to the solicitation will determine if I am “small” for those hypothetical contracts or not. If those contracts were specifically set-aside for “small business” under those NAICS codes, then ONLY businesses that are small under that assigned NAICS code could bid on and be awarded that contract. If you happen not to be small, competitors may file size protests against you, putting your award at risk (there could be false representation concerns too).
Also, important to note is the risk of affiliation. We discuss this in another Back to Basics that you definitely should read, but in short, if you are found as an affiliate of another business under SBA’s rules you combine both business’ sizes which could make your business and the affiliate too large for certain procurements or small business program participation.
What starts as a simple question of “is your business small” can actually mean so much more in federal contracting, sending you down a rabbit hole of employee pay periods, and receipts calculations. That’s why it is so important to arm yourself with as much knowledge as possible regarding size and how it is calculated. While this Back to Basics does exactly what it says, and provides some basics for contractors to understand, the world of size calculations, determinations, representations, and protests can be quite nuanced and fact specific. So, be sure to take your time to read the regulations and size standards, and reach out to a qualified federal contracts attorney when there is any doubt, as these complicated issues can truly mean the life or death of a contract award.
Questions about this post? Or need government contracting legal assistance? Email us.