Bye-Bye, Populated Joint Ventures: SBA Rule Change Mandates Unpopulated JVs

Populated joint ventures (or at least most populated JVs) will no longer be permitted in the SBA’s small business programs, under a new regulation set to take effect on August 24, 2016.

The SBA’s major new rule, officially issued today in the Federal Register, will be best known for implementing the long-awaited small business mentor-protege program.  But the rule also makes many other important changes to the SBA’s small business programs, including the elimination of populated joint ventures.

Under current law, a joint venture can be either populated or unpopulated.  A populated joint venture acts like an actual operating company: it brings employees onto its payroll, and performs contract using its own employees.  An unpopulated joint venture, on the other hand, does not use its own employees to perform contracts.  Instead, an unpopulated joint venture serves as a vehicle by which the joint venture’s members can collectively serve as the prime contractor, with each joint venture member performing work with its own employees.

The SBA’s new regulation changes the definition of a joint venture to exclude populated entities.  The revised regulation, which will appear in 13 C.F.R. 121.103(h), defines a joint venture, in relevant part, as follows:

For purposes of this provision and in order to facilitate tracking of the number of contract awards made to a joint venture, a joint venture: must be in writing and must do business under its own name; must be identified as a joint venture in the System for Award Management (SAM); may be in the form of a formal or informal partnership or exist as a separate limited liability company or other separate legal entity; and, if it exists as a formal separate legal entity, may not be populated with individuals intended to perform contracts awarded to the joint venture (i.e., the joint venture may have its own separate employees to perform administrative functions, but may not have its own separate employees to perform contracts awarded to the joint venture).

In its commentary explaining the change, the SBA focused on joint ventures between mentors and proteges, both in the 8(a) mentor-protege program and the SBA’s new small business mentor-protege program.  The SBA stated that “a small protege firm does not adequately enhance its expertise or ability to perform larger and more complex contracts on its own in the future when all the work through a joint venture is performed by a populated separate legal entity.”  SBA further explained:

If the individuals hired by the joint venture to perform the work under the contract did not come from the protege firm, there is no guarantee that they would ultimately end up working for the protege firm after the contract is completed.  In such a case, the protege firm would have gained nothing out of that contract.  The company itself did not perform work under the contract and the individual employees who performed work did not at any point work for the protege firm.

Although the SBA’s commentary focused almost exclusively on mentor-protege joint ventures, the regulatory change appears in the SBA’s size regulations, which apply both inside and outside of the new small business mentor-protege program.  It appears, therefore, that populated joint ventures will not only be impermissible for mentor-protege joint ventures, but will also be impermissible for joint ventures between multiple small businesses.

It’s worth noting that the SBA’s new regulation refers only to “separate legal entity” joint ventures; that is, joint ventures that are formed as limited liability companies or other formal corporate entities. Theoretically, an informal partnership might be able to operate as a populated joint venture, but that isn’t entirely clear from the regulation–and in any event, may not be advisable from a liability standpoint.

In my experience, most small government contractors already prefer unpopulated joint ventures, largely because of the administrative inconveniences associated with populating a limited-purpose entity like a joint venture.  Nevertheless, a not-insignificant minority has long preferred the populated joint venture form.  Come August 24, 2016, those contractors will have to say goodbye to the possibility of forming new populated joint ventures for set-aside contracts.