Has your business become addicted to the small business programs that helped it get started in federal contracting? Has that dependence made your business unsalable?
Dedicated to helping the owners of small and midsize businesses prepare themselves and their companies for successful transition, we at Go Beyond LLC attend lots of conferences, lectures, and meetings around the topic of buying and selling of lower middle market businesses. We often hear Private Equity (PE) and mergers & acquisitions (M&A) professionals comment about how difficult it is to sell small Federal contractors in the Small Business Administration socio-economic categories: Woman Owned Small Business, Small Disadvantaged Business, Service Disabled Veteran Owned Small Business, and HUB-zone Small Business.
The Federal government has created a protected space for certain types of businesses, based on the socio-economic characteristics of the owners: specified annual prime contracting goals for designated small businesses. The current, government-wide procurement goal stipulates that at least 23% of all federal government contracting dollars should be awarded to small businesses. In addition, targeted sub-goals are established for the following small business categories:
- Women Owned Small Business – 5%
- Small Disadvantaged Business – 5%
- Service Disabled Veteran Owned Small Business – 3%
- HUBZone – 3%
Additionally, large prime contractors are required to meet subcontracting goals along similar lines. If you fit into one of these categories, it is much easier to find a place on the team of a large business as it prepares to compete for a lucrative federal contract. Of course, you must also have to have a solid reputation for delivering value and being a good subcontractor. There’s no free lunch, as they say.
Life can become comfortable in this protected space, and owners can be tempted to limit growth and scope of work so their company can stay safely within the size standards of its primary North American Industrial Category System (NAICS) code. Some even choose to avoid the responsibility of being a prime contractor and stick entirely to subcontracting. They tell themselves that there is nothing wrong with remaining a small company. That’s true, there isn’t anything inherently wrong with staying small.
However, there are drawbacks to maintaining a business portfolio that consists entirely, or even primarily, of set-aside prime contracts and niche subcontracts. You limit the business’s attractiveness to potential buyers, be they large strategic buyers, PE firms, your key managers, your employees, or even members of your own family. If you are like most owners — with 60 percent to 80 percent of your net worth tied up in your business – this is a significant risk with potentially grave consequences for your future retirement and legacy.
Why are potential buyers not attracted to these businesses? They are looking for something that will provide a return on their investment at a low risk. Most buyers don’t fit your socio-economic category or your primary NAICS code’s small business size standard. Even if the Government customer allows them to finish the period of performance on the contract, they will not be allowed to compete for the follow-on contract. The future cash flow stream for that work will end. How about those subcontracts? Prime contractors will not be able report payments to the new owner as satisfying their small business utilization requirements. They may even squeeze the new owner out of participating in those contracts. The future cash flow stream for that work also will end. Potential return on investment is low. Risk is too high. Potential buyers likely will look for better deals.
You still might find a buyer, if you have a significant piece of intellectual property such as a patent that would be part of the deal, or if your company operates in a specific niche they want to buy into for strategic reasons. However, they will make you stick around for a few years, and a good part of the sale price will be in the form of earn outs. In order to get paid, you’ll have to prove to them that the company will continue to prosper and continue to grow without you.
Step 1 — Make sure you get back to basics. Tighten things up so the business is operating in a world-class manner.
Step 2 – Specialize, don’t generalize. Figure out that one main thing you can be best-in-class at doing, and redesign your business around that.
Step 3 — Develop a culture of discipline and relentless execution, and keep pushing toward your preferred future. Make sure you have a management team can operate without you.
Step 4 – Kick the habit. Fill your new business pipeline with Full & Open opportunities outside the protected space of small business programs. Win a few of these before you think about putting the company up for sale.
Step 5 – Be coy about entering new subcontract agreements. Try to negotiate a guaranteed work share to lock in future cash flows from those subcontracts.