A rule change goes into effect today at the Small Business Administration that aims to mitigate problems with how the federal government awards and counts its small-business contracts.

The new rule, in essence, says contracts may no longer be counted as "small business awards" if a small company is acquired by a large one. Each year, Congress establishes goals for most federal agencies, and the government as a whole, for the percentage of business to be awarded to small firms. Overall, the goal is 23%, and while there are no legal ramifications if goals aren't met, there is substantial political pressure to try, and agencies are encouraged to set some contracts for bidding only by small companies.

Recently, however, several studies have shown that some contract awards reported as going to small businesses have actually been in the hands of large companies. One of the main issues cited has to do with federal regulations that have allowed the contracted firm to be considered small over the life of a contract -- even if the company is acquired by a big business.

The new rule requires companies to recertify their size as soon as their contract is officially turned over to an acquiring company. "We felt we needed to make the change to ensure the reporting of what's going to small business is more accurate," says Gary Jackson, the SBA's assistant administrator for size standards.

Today, the federal government ends a practice that has allowed it to count contracts with large corporations as small-business awards, according to the U.S. Small Business Administration. In the past, when large companies acquired small businesses, the buyers got to keep their new additions' small-business status for the life of its contract with the federal government.

The company now has to immediately be recertified to determine whether it's still a small business, said Gary M. Jackson, assistant administrator for the agency's Office of Size Standards in Washington, D.C. For years, the SBA has added in contracts with these businesses when determining whether the federal government is meeting the goal of awarding 23 percent of contracts to small businesses.

Last year, the government purchased a total of $300 billion in goods and services. Of that figure, more than $65.5 billion went to small businesses. Jackson said he could not estimate how much of this money was going to companies that had outgrown the small-business status.

The nonprofit Center for Public Integrity estimated in September that, because of this special exemption, 30 percent of all defense contract dollars reportedly earned by small businesses and special minority-owned businesses went to the largest defense companies.

Millions of dollars have gone to large corporations, the center said. Since these dollars will no longer be counted toward the contracting goal, many small-business advocates expect businesses that actually meet the size standards to gain ground.

Lloyd Chapman, founder of the American Small Business League and an SBA critic, described the change as a major victory after years of trying to get the agency to change its policies. The elimination of the exemption will not bar a company from working on a contract previously won, Jackson said.

Up until the mid-1990s, federal contracts lasted about one to five years, but today, through multiple-award contracts, they can last anywhere from 10 to 20 years.

A Small Business Administration rule change that takes effect today should make it easier for small businesses to win contracts from the federal government.

The change has to do with how the government classifies contracts that are won by small businesses that are later bought by large companies.

Until today, a government agency would be able to count such a contract toward its Congress-mandated goal that 23 percent of prime contract dollars go to small businesses.

Not anymore. From here forward those contracts will be reclassified, and agencies will have to find new companies to help meet their quota.

" There will be a greater effort by the government to seek out new small businesses for contracts," said Gary Jackson, the assistant administrator for size standards at the SBA.

The new rule could mean a gradual transfer of billions in government dollars from large to small companies.

" It is a long time in coming," said Lloyd Chapman, president of the Bay Area-based American Small Business League. "Its about time that the SBA establish a policy that helps small businesses."

A September study of defense contracts by the Washington-based Center for Public Integrity found that 30 percent of all defense contract money reported as going to small or minority-owned businesses between 1998 and 2003 ended up in the hands of large companies.

One of those companies was San Diego-based Titan Corp., according to the center's study. When Titan bought SenCom Corp. in 2000, it also bought $176 million in contracts that SenCom had won as a small business.
Titan spokesman Wil Williams acknowledged the small business contracts held by Titan, but said the rule change will have a negligible effect on the company's bottom line.

As an entrepreneur and weekend tri-athlete, cindra Stolk thrives on competition. All she wants is a fair shot. That is not what she got last May when Federal Edge, her eight-employee technology services company in Riverside, Calif., was a leading candidate for a $600,000 Air Force contract designated for a small business. Instead, the contract went to GTSI of Chantilly, Va., which posted nearly $1 billion in revenues last year and employs about 700. "It took 18 months and a lot of our blood, sweat, and tears to put that bid together, only to have it picked off by a big business," Stolk says angrily.

At a time when federal contracting is at a record high, Stolk's experience is increasingly common. According to goals set by Congress, 23% of federal contracts are supposed to be set aside for small firms. While the SBA reported recently that the Defense Department exceeded that goal by nearly two percentage points in 2003, Larry Makinson of the Center for Public Integrity, a nonpartisan Washington think tank, says those numbers "just don't add up." Makinson is the editor of a recent CPI report that found that in the past six years more than $47 billion of the Pentagon's small-business contracts has actually gone to large companies. Among the heavyweights singled out in the report is Stolk's rival, GTSI, which won nearly $1.2 billion in small-business contracts.

How are large companies getting away with it? A well-financed lobbying effort helps. So does an unsupervised bureaucratic system with loopholes so large that a billion-dollar defense company can, for instance, classify itself as small. Despite the rhetorical embrace entrepreneurs receive for being the country's leading source of jobs, official Washington shows little interest in fixing a system that is getting worse for small business. "We can't monitor each and every contract," says Emily Murphy, the SBA's senior advisor for government contracting and business development. "Changes do need to be made, but the regulatory process can take six months to a couple of years." Until then, big business is reaping the rewards. Consider, for example, the aptly named San Diego firm Titan, which employs 12,000 and had $2 billion in revenues last year. It has grown in part by acquiring smaller firms that hold lucrative, long-term contracts that were originally set aside for small businesses. A curious regulation permits those acquired contracts to retain their small-business status even after they are swallowed by giants. That means a big payment for the happy owner of the acquired company. But each acquisition depletes the pool of set-asides for companies that remain small and independent. According to Murphy, the SBA is considering a rule that would require firms to recertify their size after an acquisition.

In the meantime, under pressure to streamline their balance sheets, federal agencies are "bundling" small contracts into a single, consolidated contract. Only the largest prime contractors apply, leaving small firms out of the running or forced to bid for subcontracts from the same companies they compete against. That is exactly what happened last summer to John Pless's translation services company, REM Holding Group of Wilmington, Del., when the Army bundled its translation needs into one, massive $2.5 billion contract. Just as the Army was set to anoint Titan as its exclusive supplier, Pless protested to the General Accounting Office that the Army's bundling was unnecessary. But his claim was dismissed, and Titan remains the Army's favorite, leaving Pless in the awkward position of asking his mammoth rival for work.

Its critics blame ordeals such as Pless's on the SBA's standard procedures. The agency relies on a kind of corporate honor system, allowing businesses seeking federal contracts to self-certify as small or large on their applications. Since few federal agencies have time to scour applications for miscoding, or possibly even fraud, policing of the system is left up to small-business owners willing to file a complaint. "It's a system that's just begging to be abused," says Michael Watkins, a former Harvard Business School professor who consults on corporate and government relations. Catching that abuse can end up feeling like a full-time job, says Monty Mauldin of Coats, N.C. Mauldin and his wife, Lilian, run Tiger Enterprises, which leases laundry equipment to nearby Army and Air Force bases. The Mauldins have filed ten complaints with the SBA since 2000. "I don't mind losing in a head-to-head with another, truly small business," says Monty Mauldin. "But we were losing small-business set-aside contracts to big companies." Lloyd Chapman, president of the American Small Business League, a 3,500-member national trade group based in Petaluma, Calif., says the SBA is concealing the extent of the system's disrepair. In October the ASBL sued the SBA in hopes of getting the agency to release a report it completed in January 2003 that Chapman says "confirms widespread fraud in federal contracting." The SBA denies any coverup and is "vetting the report," says Murphy.