Introduction
 
The Small Business Administration (“SBA”) has recently proposed significant changes to the federal small business regulations. These proposed changes, if implemented, will affect contractors doing business with the federal government whether they are small businesses, partner with small businesses, or are looking to increase contract awards by taking part in the proposed expanded mentor/protégé program.
 
The first group of proposed regulatory amendments implements the National Defense Authorization Act of 2013 and was published on December 29, 2014. These proposed changes include modifications to the limitations on subcontracting, which limits the amount of work a small business can subcontract if it is awarded a contract as a small business set-aside.
 
The second group of proposed regulatory amendments was published on February 5, 2015. In it, the Small Business Administration proposes an overhaul of the Small Business Mentor Protégé Program. It further proposes to change the rules on small business joint ventures.
 
Taken together, these proposed changes will significantly alter the small business landscape in an environment that is increasingly focused on awarding contracts with a goal of reaching small business participation numbers.
 
Proposed Changes To The Limitations On Subcontracting Rule
 
The limitations on subcontracting rule provides that an awardee of a small business set-aside can only subcontract a certain percentage of work to other contractors. The calculation of this percentage depends on the type of work primarily being performed, with different rules applying for service contracts, supply contracts, general construction contracts, and special trade construction contracts.
 
The first change in the proposed regulation is how the rule will be calculated for service and supply contracts. For those contracts, the amount of subcontracting allowed by the small business would be fifty percent of the amount paid by the government. This is a significant change from the current method, which allows subcontracting of fifty percent of the cost of personnel or the cost of manufacturing the supplies. For general contracting, the formula remains fifteen percent of the amount paid by the government, and for special trade construction the formula remains twenty-five percent of the amount paid by the government.
 
The most significant change, however, is that the proposed regulations would add an exception for “similarly-situated entities.” Thus, two or more small businesses can team together to perform the required percentage of the work on a small business set-aside, and subcontract out the balance to other than small business and be in compliance with the regulations. Finally, the proposed regulations create substantial penalties for violations of the limitations on subcontracting. Penalties of the greater of $500,000 or the dollar amount spent over the permitted ceilings would be added for businesses that violate the limitations on subcontracting.
 
Proposed Changes To The Small Business Mentor/Protégé Program
 
Currently, the SBA administers one mentor/protégé program related to the 8(a) Business Development program. The program has proven to be a successful way for emerging businesses to learn from seasoned contractors, with both enjoying the economic benefits of the partnership. The emerging business can bid on a solicitation it would have been otherwise unable to fulfill while the mentor gains access to 8(a) and small business set-asides. In addition to the SBA’s 8(a) mentor/protégé program, thirteen agencies have their own form of the program. In 2010, Congress gave the Small Business Administration authority to create mentor/protégé programs for other socio-economic groups such as women-owned small businesses and Historically Underutilized Business Zones (“HUBZones”). Then in 2013, Congress, in the National Defense Authorization Act, authorized the Small Business Administration to create mentor/protégé programs for all small businesses and directed the SBA to create rules for the agencies’ (except Department of Defense) mentor/protégé programs.
 
In response, the SBA has proposed a “universal” mentor/protégé program available to all small businesses. The 8(a) mentor/protégé program will remain separate in the regulations, but the SBA proposes to make the universal mentor/protégé program identical to the 8(a) mentor/protégé program.
 
Under the universal mentor/protégé program, a business is eligible to be a protégé if it qualifies as a small business under its primary North American Industry Classification System (“NAICS”) code. A business will qualify as a mentor under the proposed regulations if it is a “for-profit business concern that demonstrates a commitment and the ability to assist small business concerns.” A mentor may generally only have one protégé at a time, but the SBA may authorize up to three concurrent protégés if the mentor “can demonstrate that the additional mentor-protégé relationship will not adversely affect the development of any of the protégés.” A business may not serve as both a mentor and protégé at the same time. The mentor/protégé relationship is created through a written agreement “identifying specifically the benefits intended to be derived by” the protégé that is approved by the SBA before the businesses can receive any benefits under the program. The mentor/protégé agreement will last for three years and will be subject to annual review by the SBA. Finally, the mentor may own an equity interest of up to 40 percent in the protégé in order to raise capital for the protégé.
 
After the SBA approves a mentor/protégé agreement, the businesses may then jointly bid on small business set-asides through the formation of joint ventures, provided the protégé qualifies as small under the NAICS code assigned to the solicitation. The joint venture may also be considered “small” for any socioeconomic category for which the protégé qualifies, such as Women-Owned Small Business or HUBZone.
 
Under its 2013 authority, the SBA also had the chance to create guidelines for the agencies’ mentor/protégé program. The SBA did not propose regulations establishing guidelines for the agencies’ mentor/protégé programs, but rather sought comments on whether there is “a “continuing need for other small business mentor/protégé programs once SBA’s various mentor-protege programs are implemented.” It will be interesting to see if the final regulations supercede the agencies’ programs and what guidance will be given to those already approved by those programs.
 
Proposed Changes To Small Business Joint Ventures
 
The proposed regulations not only significantly expand the mentor/protégé program, they also change what form of joint venture the mentor and protégé can form to pursue contracts. First, the proposed regulations specify that “any joint venture must be in writing.” While this has always appeared to be the case, there was some confusion as to whether “informal” joint ventures did not have to be reduced to writing.
 
Second, the SBA sought comments on whether “informal” joint ventures should be permitted at all. An “informal” joint venture is one in which the joint venture is reduced to writing, but there is no separate legal entity formed and filed with a state. From the proposed regulations, it appears that the SBA is inclined to eliminate the informal joint venture option.
 
Third, the SBA’s proposed rule would eliminate “populated” joint ventures. A “populated” joint venture is one that has its own personnel that belong to the joint venture and operates independently of the joint venture members. The proposed rule addresses the issue that it was difficult to apportion work between the mentor and protégé and ensure that the protégé actually benefited from the arrangement for “populated” joint ventures. The proposed rule would retain the existing exception that the joint venture can have its own employees who perform administrative functions and it will be considered an “unpopulated” joint venture.
 
Conclusion
 
The changes proposed by the SBA to the federal small business regulations are substantial and will affect all contractors providing goods or services to the federal government. While these rules are only proposed and may change during the comment period (particularly given the open-ended questions the SBA has asked), they afford insight into the SBA’s thinking on the parameters of the final rules to be issued.