On July 25, 2016, the SBA published its final rule establishing a government-wide mentor-protégé program for the benefit of all small businesses as protégés.  This widely-anticipated rule, implementing provisions of the Small Business Jobs Act of 2010 and the National Defense Authorization Act for Fiscal Year 2013, provides increased opportunity for small and large businesses to partner with one another.  Effective August 24, 2016, this new program is expected to unleash a flood of new mentor-protégé agreements (MPAs) as well as joint ventures eligible to compete on set-aside procurements, and it could likely result in an increase in the number of set-aside procurements.

Below we discuss the benefits from participating in this program, the requirements for the mentor-protégé agreement (“MPA”), the eligibility criteria for mentors and protégés, and the requirements for joint ventures established pursuant to the MPAs. Given the numerous benefits to participating in this program, including the opportunity to joint venture, the SBA has layered into this final rule the requirement for numerous express certifications of compliance and severe consequences for violation of the SBA’s regulations, MPAs, and/or joint venture agreements.  A separate blog post will address the changes that the SBA is implementing in the final rule to the SBA’s current regulations governing the 8(a) business development (BD) program.

SBA’s Mentor-Protégé Program – The Basics

SBA’s mentor-protégé program is supposed to “allow all small businesses to tap into the expertise and capital of larger firms, which in turn should help small business concerns become more knowledgeable, stable, and competitive in the Federal procurement arena.” This program serves an important development function that should ultimately enable small businesses to independently perform larger and more complex contracts on their own.

Under the program, a firm that has an SBA-approved MPA is not affiliated with its mentor firm solely because the protégé firm receives assistance from the mentor under the MPA. This assistance can vary, including: (1) technical and/or management assistance; (2) financial assistance in the form of equity investments and/or loans;^[1] (3) subcontracts (either from the mentor to the protégé or vice versa); (4) trade education; and/or (5) assistance in performing prime contracts with the Government through joint venture arrangements.  Absent this affiliation exemption, any of these types of assistance could lead to a finding of affiliation between two companies, which, in turn, could cause the small business to exceed the applicable size threshold.

Moreover, a protégé may joint venture with its SBA-approved mentor and still qualify as a small business for any Federal government contract or subcontract, provided that the protégé qualifies as small for the size standard corresponding to the NAICS code assigned to the procurement. In the same vein, such joint ventures will qualify for a contract reserved or set-aside for specific programs, such as for Service-Disabled Veteran-Owned Small Businesses (SDVO SBs) or Women-Owned Small Businesses (WOSBs), if the protégé firm also meets the particular program-specific requirements.  Absent this exemption from affiliation, a joint venture formed by a large and small business would not satisfy the small business size standard and/or program-specific requirements to be able to compete on set-asides.

Both small and large businesses can benefit from participation in the mentor-protégé program: small businesses receive assistance that they would not otherwise have access to and still maintain their small status, while large businesses can perform set asides that would not otherwise be open to them via joint ventures with their protégés and simultaneously acquire 40% equity interest in their protégés. And, all program participants benefit from strengthening their competitive position in set aside procurements.

Anticipated Impact of the SBA Mentor-Protégé Program

Extrapolating from data from the 8(a) BD program participants with signed MPAs and JVs and FY 2012 information from the Federal Procurement Data System – Next Generation, the SBA anticipates that under the final rule, approximately 2,000 small business concerns (SBCs) will become active in the small business mentor-protégé program and protégé firms may obtain Federal contracts totaling possibly $2 billion per year. Moreover, the SBA notes that with SBCs able to compete for more and larger contracts, Federal agencies may choose to set aside more contracts and for certain types of SBCs rather than using full and open competition.  Because there will be more small businesses able to compete for these opportunities, the added competition could result in lower prices to the Government, a benefit that the SBA is unable to quantify.

The SBA also notes that there could be distributional effects among large and small businesses, though the SBA is unable to estimate the potential distributional impacts of these transfers with any degree of precision. Without being able to estimate numbers associated with these impacts, the SBA anticipates that there will be a transfer of some Federal contracts from large businesses to SBC protégés.  There may be fewer Federal prime contract opportunities for large businesses as Federal agencies decide to set aside more procurements for SBCs as well as on procurements competed on a full and open basis where HUBZone protégés are eligible for an evaluation adjustment.

SBA’s Mentor-Protégé Program – By the Numbers

The authorized number of mentor-protégé relationships for mentors and protégés is unchanged from the proposed rule:

• Mentors can have a maximum of three protégés at any given time under either of the mentor-protégé programs. This number is in the aggregate across the two programs. The SBA settled on this number for a few reasons, including that it mirrors the historical limitation on the number of protégés in the 8(a) BD program and that the SBA did not want large businesses to benefit disproportionately from this program. Note that the default is for a mentor to have one protégé at a time, but the SBA may authorize a mentor to have additional protégés where the mentor can demonstrate that the additional relationship will not adversely affect the development of either protégé firm (e.g., the protégés may not be competitors).
• Protégés can have up to two mentors where the two relationships do not compete or otherwise conflict with each other, and the protégé demonstrates that (1) the second relationship pertains to an unrelated, secondary NAICS code or (2) the first mentor does not possess the specific expertise that is the subject of the MPA with the second mentor.

The SBA removed the restriction on small businesses acting as both a mentor and a protégé in the new mentor-protégé program from the final rule.

In terms of duration, MPAs last for a period of three-years.  But, the final rule allows an MPA to be extended for a second three-year period, provided that the protégé has received the agreed-upon business development assistance and will continue to receive additional assistance from the mentor.

Requirements for Entry into the SBA Mentor-Protégé Program

The MPA must:

• Be a written agreement setting forth an assessment of the protégé’s needs and providing a detailed description and timeline for the delivery of the assistance the mentor commits to provide to address those needs.
• Address how the assistance to be provided through the MPA will help the protégé firm meet its goals as defined in its business plan.
• Establish a single point of contact in the mentor who is responsible for managing and implementing the MPA.
• Provide that the mentor will provide such assistance to the protégé firm for at least one year.
• If relevant, identify how the assistance to be provided by the proposed mentor is different from assistance provided to the protégé through another mentor-protégé relationship, either with the same or a different mentor.
• Provide that either the protégé or the mentor may terminate the agreement with 30 days advance notice to the other party to the mentor-protégé relationship and to SBA.

In order to qualify as a mentor, a concern must be:

• For-profit. (Note that a mentor can be either a small or large business).
• Capable of carrying out its responsibilities to assist the protégé firm under the proposed MPA. To eliminate any potential confusion, the SBA removed the requirement that the mentor possess a good financial condition and now requires a proposed mentor demonstrate that it can meet its obligations under the MPA by, for example, submitting to the SBA copies of the federal tax returns it submitted to the IRS, or audited financial statements, including any notes, or in the case of publicly traded concerns, the SEC filings for the past three years.
• Possesses good character.
• Not appear on the federal list of debarred or suspended contractors.
• Able to impart value to a protégé firm due to lessons learned and practical experience gained or through its knowledge of general business operations and government contracting.

In order to qualify as a protégé, a business concern must:

• Qualify as small for the size standard corresponding to its primary NAICS code or for a secondary NAICS code with respect to which it is seeking business development assistance.
• Identify any other mentor-protégé relationship that it has through another Federal agency or SBA and provide a copy of each MPA to the SBA.

SBA Approval and Ongoing Review of Mentor-Protégé Agreements

The SBA is establishing a separate unit with the Office of Business Development whose sole function will be to process mentor-protégé applications and, once approved, review the MPAs and assistance provided under them. This new unit will process and make determinations with respect to all small business MPAs, with the SBA’s Associate Administrator for BD (AA/BD) making the ultimate decision.  While the SBA has established this dedicated unit with the hopes that the need for “open” and “closed” enrollment periods – a feature that many commentators objected to – will be unnecessary, should an enormous volume of applications overwhelm this unit, the SBA has left open the possibility that it could institute “open” and “closed” periods and only accept mentor-protégé applications in “open” periods.

The SBA will not approve an MPA if the SBA determines that the assistance to be provided is not sufficient to promote any real developmental gains to the protégé, or that the agreement is merely a vehicle to enable the mentor to receive small business contracts. The regulations provide a process with a specific timetable set out whereby a protégé may request reconsideration of its MPA should it be declined.

The importance of receiving timely SBA approval of the mentor-protégé cannot be understated – a joint venture between a mentor and protégé only receives the exclusion from affiliation upon the SBA’s approval of the MPA. In other words, the SBA’s approval of the MPA must occur before a JV submits an offer on a particular government prime contract or subcontract.

Annually, the SBA will review the mentor-protégé relationship to determine whether to approve its continuation for another year. The SBA will review the protégé’s annual reports and may not approve continuation of the MPA if the mentor has not provided the assistance set forth in the MPA or the assistance has not resulted in any material benefits or developmental gains to the protégé.  Unless rescinded in writing as a result of the review, the mentor-protégé relationship will automatically renew.  Moreover, the SBA reserves the right to terminate the MPA at any time (i.e., not limited to the annual review) if it determines that the protégé is not benefiting from the relationship or the parties are not complying with the MPA.

Should the mentor and protégé wish to revise to their MPA, the parties must provide the SBA the proposed changes in writing and receive the SBA’s approval of all changes to the MPA in advance of them being made.

Ongoing Requirements to Remain in the Mentor-Protégé Program

Requirements placed on a mentor for it to remain in the mentor-protégé program include:

• Annual Reporting. A mentor must annually certify that it continues to possess good character and a favorable financial position.
• Renewed Commitment in Case of Change in Control. Should there be a change in control of the mentor, the mentor must express in writing to the SBA that it acknowledges the MPA and it continues its commitment to fulfill the obligations under that agreement for the previously SBA-approved mentor-protégé relationship to continue.

Similarly, protégés must satisfy their own requirements, including:

• Annual Reporting. Within 30 days of the anniversary of SBA’s approval of the MPA, the protégé must report to the SBA on the mentor-protégé relationship, including identification of the technical, management and/or financial assistance provided by the mentor; all subcontracts awarded by the protégé to the mentor or mentor to the protégé; information on federal contracts awarded to the mentor-protégé performing as a joint venture; and a description of how that assistance has impacted the development of the protégé.
• Annual Certification. The protégé must certify to the SBA whether there has been any change in the MPA terms.
• Close Out Reporting. When the mentor-protégé relationship ends, the protégé must submit a close out report to the SBA on whether the protégé believed the mentor-protégé relationship was beneficial and describe any lasting benefits it received. If the protégé fails to report as required, the SBA will not approve a second mentor-protégé relationship.

Joint Venture Requirements

As discussed above, firms that have an SBA-approved MPA can bid and perform as a joint venture on set-asides. In performing a contract set aside or reserved for small businesses, the small business partner to the joint venture must perform at least 40% of the work performed by the joint venture and must be more than administrative or ministerial functions so that it gains substantive experience.  (The joint venture itself must perform the applicable percentage of work required by the limitations on subcontracting requirements set forth at 13 C.F.R. § 125.6.)

The following requirements will be applicable to such joint ventures:

• Agreement. The joint venture agreement must be in writing. While the SBA does not impose any specific format on the agreement, the joint venture agreement must contain provisions (1) setting forth the purpose of the joint venture, (2) designating the protégé as the managing venturer of the joint venture and an employee of the protégé as the project manager responsible for performance of the contract (see below), and (3) provisions pertaining to ownership, profits, bank accounts, itemization of equipment and specification of responsibilities among others.
• Project Manager. The project management of a joint venture must be an employee of the protégé firm (or, at time of offer, have a signed letter of intent committing to employment by the protégé). SBA has also clarified in this rule that the project manager cannot be employed by the mentor and merely become an employee of the protégé to perform the joint venture’s contract as this individual would have no ties to the protégé and is not bound to stay with the protégé after completion of contract performance.
• Financial Reporting. The joint venture agreement must contain provisions providing for submission to the SBA of (1) quarterly financial statements showing cumulative contract receipts and expenditures (including salaries of the joint venture’s principals), not later than 45 days after each operating quarter of the joint venture, and (2) a project-end profit and loss statement, including a statement of final profit distribution, no later than 90 days after completion of the contract.
• Registration. The joint venture must be separately identified in SAM as a joint venture with a separate DUNS number and CAGE code than those of the individual joint venture members. Moreover, the joint venture must do business under its own name. The SBA wants to be able to track contract awards to joint ventures of mentor and protégés.
• Form. The joint venture may be in the form of a formal or informal partnership or exist as a separate limited liability company or other separate legal entity. (Where the members create a separate legal entity joint venture, the small business must own at least 51% of the joint venture.)
• Population. If the joint venture exists as a formal separate legal entity, it may not be populated with individuals intended to perform contracts awarded to the joint venture. Without the protégé’s employees actually performing the work, there is no guarantee that they would be developing new expertise, experience, and past performance. Allowing use of populated joint ventures also obscures whether the protégé firm performs at least 40% of all work done by the joint venture, performed more than merely ministerial or administrative work, and otherwise gained experience that could be used to perform a future contract independently. (However, the joint venture may have its own separate employees to perform administrative functions.)

The final rule imposes the follow certification and reporting requirements on a joint venture:

• Pre-Performance Certification of Compliance. Prior to performance of any contract set aside for small businesses, the small business partner must submit a written certification to the contracting officer and SBA, signed by an authorized official of each partner to the joint venture, stating: (1) that the parties entered into a joint venture agreement as prescribed by SBA’s rules; and (2) the parties will perform the contract in compliance with the joint venture agreement and applicable performance work requirements.
• Annual Reporting on Performance of Work Requirements. Annually, the small business partner must submit a report to the relevant contracting officers and SBA, signed by an authorized official of each partner to the joint venture, explaining how and certifying that the performance of work requirements are being met for each contract set aside for small business that is performed during the year.
• Close Our Reporting on Performance of Work Requirements. At the completion of every set-aside contract, the small business partner must submit a report to the relevant contracting officer and SBA, signed by an authorized official of each partner to the joint venture, explaining how and certifying that the performance of work requirements were met for the contract, and further certifying that the contract was performed in accordance with the required provisions of the joint venture agreement.

Finally, the new regulations provide that when a procuring agency evaluates past performance of a mentor-protégé joint venture in connection with a set-aside procurement, the agency MUST evaluate the past performance of the member companies, in addition to the joint venture itself. This new provision helps to reduce significant risk and uncertainty in past performance evaluations of newly formed joint ventures, particularly when the joint venture itself has no past performance of its own.

Consequences for Violations

As explained above, there are numerous benefits to both protégés and mentors. Violations of the regulations and relevant agreements are punishable by severe consequences.

With respect to participation in the mentor-protégé program, should SBA determine that a mentor has failed to provide its protégé the business development assistance set forth in its MPA, the SBA will provide the mentor a brief time to respond and explain when it will provide such assistance. Failure to respond or a response lacking an adequate explanation for a mentor’s failure to provide the agreed-upon assistance will result in SBA’s termination of the MPA, at which point the mentor will be ineligible to serve as a mentor for a two-year period thereafter.  The SBA also may consider a mentor’s failure to comply with the MPA as a basis for debarment.  Importantly, the SBA reserves the right to recommend to an agency procuring from a joint venture comprised of the terminated MPA members that the agency encourage the mentor to comply with its MPA or, where a protégé is capable of independently performing the contract, to substitute the protégé firm in place of the joint venture.  If the parties to the mentor-protégé relationship change the MPA without the SBA’s prior approval, the SBA may terminate the mentor-protégé relationship and may also propose suspension or debarment of one or both of the firms.

With respect to joint ventures between a protégé and mentor, the SBA regulations state the (1) failure to enter into a joint venture agreement that meets the SBA requirements, (2) failure to perform a contract in accordance with the joint venture agreement or performance of work requirements, and (3) failure to submit the required certifications can serve as a ground for suspension or debarment.

Planning Ahead

The following are a few recommendations for those interested in participating in the SBA’s expanded mentor-protégé program:

• Time is of the essence. With a significant number of entities newly eligible for protégé status, companies interested in obtaining timely SBA review and approval should get their applications into the SBA as quickly as possible before there is a backlog.
• Strategic selection. In light of the limits on the number of mentor-protégé relationship, companies should consider their counterparts wisely and make selections based on the greatest potential for competitive advantages.
• Prepare for impact of a flood of applications. If the SBA becomes overwhelmed with the flood of new mentor-protégé applications, applicants could anticipate extended timelines for approval, which could jeopardize eligibility for target set-aside procurements. Similarly, the SBA offices, which approve joint venture agreements, could face similar resource constraints. If SBA does not have, and is unable to obtain, sufficient staff to review and approve applications and agreements, the SBA may impose scheduled open and closed periods.
• Competitive pressure. With more mentor-protégé relationships and associated joint ventures, small businesses will need to consider the impact on their ability to compete as a prime contractor against joint ventures backed by the resources, experience, and past performance of large businesses.
• Early termination of current 8(a) MPAs. In order to optimize ability to form a mentor-protégé relationship with the ideal counterpart, companies may increasingly seek to terminate their current 8(a) MPAs in order to pursue other opportunities.Check back on Wednesday, July 27, 2016 for a blog post on the changes to the 8(a) program. Next week, we will be hosting a one-hour webinar to explain this rule in more detail.

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Check back on Wednesday, July 27, 2016 for a blog post on the changes to the 8(a) program. Next week, we will be hosting a one-hour webinar to explain this rule in more detail.

^[1] In the final rule, SBA has clarified that mentors will not be required to divest their ownership interest in protégé firms once the mentor-protégé relationship ends.  The affiliation rules are sufficient to protect against large businesses unduly benefiting from small business contracting programs as these rules once again become applicable when the mentor-protégé relationship ends.