The Small Business Administration (SBA) recently issued a proposed rule that would change two size standard calculations. First, SBA is proposing to use a 24-month period, as opposed to the current 12-month period, for calculating employees under employee-based size standards. Second, the proposed rule would allow companies in SBA loan programs to utilize a 5-year average or a 3-year average when calculating average annual receipts (AAR). Comments on these proposals are due by December 2, 2021. Below are key details regarding SBA’s proposed changes and their expected impact for small- and medium-sized businesses.
Employee-Based Size Calculation
Many small businesses operate in industries that have employee-based size standards. To determine small business status under an employee-based size standard, SBA currently uses the firm’s average number of employees in each pay period over the prior 12 months. Section 863 of the 2021 National Defense Authorization Act (NDAA) amended the Small Business Act to extend the measuring period from 12 months to 24 months. According to the NDAA, the change from 12 to 24 months will go into effect on January 1, 2022. SBA now proposes to implement this change in 13 C.F.R. §§ 121.106, 121.903, but it is unlikely that SBA’s final rule will go into effect by January 1, 2022. Based on the language in the 2021 NDAA, the change to 24 months arguably takes effect on January 1, 2022, notwithstanding the absence of a final rule from SBA, though SBA may not agree with that interpretation.
While the NDAA’s change to a 24-month calculation was only intended to cover manufacturing industries, SBA’s proposed change would apply to all employee-based sized standards, including those for nonmanufacturers. That means nonmanufacturers, which are subject to a 500-employee size standard, would also be judged on the 24-month period. We think it makes sense that SBA will judge the small business status of manufactures and nonmanufacturers using the same 24-month period.
Changing the period from 12 months to 24 months for employee-based size calculations would enable some businesses that outgrew their small business size standard to recapture their small business status. However, this assumes the business had fewer employees working for them in months 13-24 than in months 1-12. For those businesses that have had a declining workforce, the shift to a 24-month average could cause them to lose small business status when they would have been small under the current 12-month average. When SBA made a similar change a few years ago to the revenue-based size standards, increasing the measuring period from 3 to 5 years, SBA implemented a 2-year grace period during which firms had the option of using the 3 or 5 year period. SBA has not proposed a similar grace period for the change from 12 months to 24 months for employee-based size standards. We think SBA should implement a grace period in the final rule to minimize the adverse impact on any small businesses with declining workforces.
Average Annual Receipts Calculation
On December 5, 2019, SBA issued a final rule implementing the Small Business Runway Extension Act of 2018 (SBREA) for all SBA loan programs except the SBA Business Loan and Disaster Loan programs, which include, among others, the 7(a) Loan Program and Economic Injury Disaster Loans.
SBA’s proposed rule seeks to extend the SBREA to the SBA Business Loan and Disaster Loan programs by allowing firms to calculate their AAR-based size with either a 3-year average or 5-year average. Under the proposed rule, applicants would be eligible for assistance if their 5-year AAR is equal to or less than the applicable size standard, even if they would otherwise be ineligible under their 3-year average. Under the proposed rule, this election would last indefinitely, and no transition period has been proposed. Further, SBA seeks to allow for this annual receipt calculation to apply to firms seeking admission into the Small Business Investment Company program as well.
Allowing firms to choose between a 5-year and a 3-year calculation would enable more businesses to be eligible for assistance when utilizing their AAR to determine size. Unlike with the proposed modification to the employee-based size calculation, this proposal would allow firms the option of choosing the 3- or 5-year average, increasing the number of firms that can qualify as small.
If you have questions about SBA size standards or how the proposed rule could impact your business, please contact Jon Williams or another member of PilieroMazza’s Government Contracts Group.
Special thanks to Law Clerk, Daniel Figuenick, for his assistance with this post.