In many industries, small business status under SBA’s government contracting rules depends on a company’s average annual receipts. But if a company is a member of a joint venture, it can be confusing figuring out which joint venture receipts count toward the company’s small business size.
Fortunately, in its recent new rule, SBA has provided two important clarifications. Let’s take a look.
“Proportionate Share” Means Workshare
Currently, the applicable regulation says, “[f]or size purposes, a concern must include in its receipts its proportionate share of joint venture receipts.” Unfortunately, given the way SBA’s joint venture regulations are written, the term “proportionate share” can be interpreted in two reasonable ways.
“Proportionate share” might mean proportionate to each member’s ownership interest in the joint venture. A joint venture operating under the SBA’s rules must be owned at least 51% by the qualifying small business or businesses. (It’s very common, though not required, for a qualifying small business to own 51% of the joint venture and its partner to own 49%.)
Alternatively, “proportionate share” might mean proportionate to each member’s work share. The SBA rules require that the qualifying small business or businesses perform at least 40% of the joint venture’s work. Further, profits are split according to workshare, not ownership. This means that if a small business owns 51% of a joint venture, but performs 40% of the joint venture’s work, the small business receives 40% of the profits, not 51%.
In the new rule, the SBA clarifies that members should calculate their proportionate share by workshare, not by ownership. The new rule states:
For the calculation of receipts, the appropriate proportionate share is the same percentage of receipts or employees as the joint venture partner’s percentage share of the work performed by the joint venture.
Many small businesses own 51% of their joint venture entities, but perform 40% of the joint venture’s work, or something very close to 40%. For them, the SBA’s clarification is especially welcome news because they will be “tagged” with fewer receipts for small business size purposes than would be the case if “proportionate share” referred to ownership.
Subcontractor Receipts are Allocated by Workshare, Too
Some joint venturers have also been confused over what happens when the joint venture has subcontractors. For instance, can subcontracted receipts be excluded completely? And, assuming a total exclusion isn’t allowed, if one of the joint venture members is responsible for overseeing a specific subcontract, are those receipts attributed only to that joint venture member?
In its commentary accompanying the new rule, SBA explains, “[a]s with all contracts, SBA does not exclude revenues generated by subcontractors from the revenues deemed to be received by the prime contractor.” Therefore, “100 percent of the revenues will be apportioned to the joint venture partners, regardless of how much work is performed by other subcontractors.”
SBA then says:
SBA does not believe that it matters which partner to the joint venture the subcontract flows through. Of the [appropriate] percent of the total contract that the joint venture partners must perform, SBA will look at how much is performed by each partner. That is the percentage of total revenues that will be attributed to each partner. This rule makes clear that revenues will be attributed to the joint venture in the same percentage as that of the work performed by each partner.
The bottom line is that subcontractor revenues cannot be excluded, and they’ll be apportioned to the joint venture members in accordance with work share, regardless of which joint venture member oversees a particular subcontract. (My personal preference, by the way, usually is to award subcontracts through the joint venture entity itself, not through one of the members–but that’s a discussion for another day.)
Anyone Want an Example?
Now’s the time when I ordinarily might try to invent an example, probably involving some ridiculously-named fake contractors and perhaps a random ’80s music reference or two. (Do you realize that U2’s New Years Day never made the Billboard Top 40? A travesty!) But the fine folks at SBA have beaten me to the punch: the new rule already has an example, and it’s a pretty good one.
Here it is:
Joint Venture AB is awarded a contract for $10M. The joint venture will perform 50% of the work, with A performing $2M (40% of the 50%, or 20% of the total value of the contract) and B performing $3M (60% of the 50% or 30% of the total value of the contract). Since A will perform 40% of the work done by the joint venture, its share of the revenues for the entire contract is 40%, which means that the receipts from the contract awarded to Joint Venture AB that must be included in A’s receipts for size purposes are $4M. A must add $4M to its receipts for size purposes, unless its receipts already account for the $4M in transactions between A and Joint Venture AB.
SBA’s not going to win any style points for naming its fictional companies, but the example effectively shows how “proportionate share” is calculated and how subcontractor receipts are treated.
Company A will perform 40% of the joint venture’s work, so it is responsible for 40% of the joint venture’s receipts. Presumably, Company A owns at least 51% of the joint venture, so Company A benefits from “proportionate share” not being determined by ownership.
However, although Company A only receives $2 million, it must account for $4 million in receipts. This is because subcontractor receipts cannot be excluded, so the $5 million in subcontracts must be allocated to the partners by work share. Because Company A is performing 40% of the joint venture’s work, 40% of the subcontracted receipts are allocated to Company A.
A Few Final Thoughts
I’ve got a few quibbles with SBA’s new final rule, but by and large I think SBA has done an outstanding job of listening to the broader small business community and responding to problems contractors have faced operating under SBA’s rules. The new rule on joint venture receipts provides some important clarifications, and that’s always a good thing for contractors.
SBA’s new rule takes effect November 16, 2020.
Questions about this post? Or need help with a government contracting legal issue? Email us or give us a call at 785-200-8919.