[Federal Register Volume 69, Number 232 (Friday, December 3, 2004)]
[Proposed Rules]
[Pages 70197-70202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-26609]


========================================================================
Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

========================================================================


Federal Register / Vol. 69, No. 232 / Friday, December 3, 2004 / 
Proposed Rules

[[Page 70197]]


-----------------------------------------------------------------------

SMALL BUSINESS ADMINISTRATION

13 CFR Part 121

RIN 3245-AF22


Small Business Size Standards; Selected Size Standards Issues

AGENCY: U.S. Small Business Administration.

ACTION: Advance notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: This Advance Notice of Proposed Rulemaking (ANPRM) seeks 
comments from the public on several issues that were raised during the 
public comment period of the U.S. Small Business Administration's (SBA 
or Agency) recently withdrawn proposal to restructure its small 
business size standards. The issues discussed in this ANPRM address 
matters pertaining to SBA's size standards but were not part of the 
March 19, 2004, proposed changes. To assist SBA with examining how best 
to restructure and simplify its size standards, the Agency invites 
comments on these issues to take into consideration in any future 
proposal. This ANPRM also seeks comments on an issue concerning the 
participation of businesses that are majority-owned by venture capital 
companies in the Small Business Innovation Research (SBIR) Program. 
Specifically, the SBA is seeking comments on whether it should provide 
an exclusion from affiliation with venture capital companies in 
determining small business eligibility for the SBIR Program.

DATES: Comments must be received on or before February 1, 2005.

ADDRESSES: You may submit comments, identified by RIN 3245-ZA02 by any 
of the following methods:
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> E-mail: <a href="/cdn-cgi/l/email-protection#e59780969197908691909780cb968c9f809691848b81848b8184978196a5968784cb828a93"><span class="__cf_email__" data-cfemail="7b091e080f090e180f0e091e550812011e080f1a151f1a151f1a091f083b08191a551c140d">[email protected]</span></a>. Include RIN 
3245-ZA02 in the subject line of the message.
    <bullet> Fax: (202) 205-6930.
    <bullet> Mail: Gary M. Jackson, Assistant Administrator for Size 
Standards, 409 Third Street, SW., Washington, DC 20416.
    <bullet> Hand Delivery/Courier: Gary M. Jackson, Assistant 
Administrator for Size Standards, 409 Third Street, SW., Washington, DC 
20416.
    Upon receipt of a written request under the Freedom of Information 
Act, SBA will make available all public comments received.

FOR FURTHER INFORMATION CONTACT: SBA's Office of Size Standards at 
(202) 205-6618 or at <a href="/cdn-cgi/l/email-protection#63100a19061017020d0702110710231001024d040c15"><span class="__cf_email__" data-cfemail="6f1c06150a1c1b0e010b0e1d0b1c2f1c0d0e41080019">[email protected]</span></a>.

SUPPLEMENTARY INFORMATION: On March 19, 2004, SBA published a proposed 
rule to restructure its small business size standards by establishing 
them based primarily on the number of employees of a business concern 
and by limiting to 10 the number of different size standard levels (69 
FR 13130). SBA believed this would simplify the existing structure of 
size standards and enable the public to better understand and use them. 
The proposed rule also included changes to several specific program-
related and specialized size standards as an effort to reduce the 
overall variation of size standards.
    The SBA received more than 4,500 comments on the proposed changes, 
with a majority of the comments expressing support for the proposal. 
More than 2,300 comments that supported the proposal agreed with the 
position advanced by one organization by submitting an identical 
comment, which focused primarily on the proposal to revise the 500 
employee size standard for nonmanufacturers to 100 employees. Of the 
remaining comments, most of them objected to the proposed size 
standards. These opposing comments raised concerns about SBA's 
methodology for converting receipts-based size standards to employee-
based size standards and their resulting levels, the number of 
potential businesses losing small business status, the thoroughness of 
SBA's regulatory flexibility analysis of the proposed changes, the 
determination of the employee size of a business, and SBA's overall 
approach to simplifying size standards. As a result of the concerns 
expressed by a large number of comments, SBA withdrew the proposal on 
July 1, 2004 (69 FR 39874).
    SBA remains committed to modifying its size standards in a manner 
to make them simpler and easier to use. SBA seeks input from the public 
on several issues on which it believes additional comment would be 
helpful before deciding the next course of action. These issues concern 
various aspects of size standards that have implications on the 
restructuring proposal but were not part of the changes in the March 
19, 2004, proposed rule. Specifically, these issues pertain to the 
approach to simplify size standards, the calculation of number of 
employees (including how SBA defines an employee for size purposes), 
the use of receipts-based size standards, the designation of size 
standards for Federal procurements, the establishment of size standards 
for use solely in Federal procurement programs, the establishment of 
tiered size standards, the simplification of affiliation regulations, 
the simplification of the small business joint venture eligibility 
regulations, the grandfathering of small business eligibility, and the 
impact of SBA size standards on the regulations of other Federal 
agencies.
    SBA is planning other actions on size standards in addition to this 
ANPRM. First, SBA plans to hold a series of public meetings on size 
standards. These meetings will focus on the issues raised in this 
ANPRM. Second, SBA is examining a number of specific size standards as 
separate rulemaking actions, such as the nonmanufacturer size standard 
which received a large number of comments supporting a reduction to the 
size standard.
    This ANPRM also seeks comments on an issue concerning the 
participation of businesses majority-owned by venture capital companies 
in the SBIR Program. Under SBA's affiliation regulations, a business 
concern that is majority-owned by a company must include the size of 
the company and all of its affiliates in determining small business 
status for the SBIR Program and for most other programs. SBA seeks 
public comments on whether it should provide an exclusion from 
affiliation with venture capital companies in determining small 
business eligibility for the SBIR Program, assuming such companies met 
the other eligibility criteria for the program.
    Approaches to simplification of size standards. As discussed above, 
SBA proposed to restructure its size standards as a way to simplify and 
make

[[Page 70198]]

them easier to use. The March 19, 2004, proposal would have 
accomplished this by primarily modifying the structure of size 
standards. Many of the comments agreed with this approach. However, 
many other comments contended that the current structure is not 
complicated or difficult to understand, and that the proposal would in 
fact make size standards more complicated.
    Over the years, SBA's size standards on occasion have been 
criticized as being difficult to understand. Many of these complaints 
relate to issues regarding the application of size standards, not to 
the size standards themselves. This ANPRM provides the public with an 
opportunity to advise SBA on what areas of size standards make them 
complicated or difficult to use or understand. SBA's March 19, 2004, 
proposal to simplify the structure of size standard is an approach to 
address one aspect of size standards. SBA is interested in whether this 
approach achieves simplification or if other approaches should be 
examined that address other aspects of size standards. Comments on this 
issue should explain how a particular aspect of size standards is 
complicated, and what modifications could be made to improve upon 
existing policies. The comments should also describe the benefits to 
small businesses and the users of size standards if such modifications 
were adopted.
    Calculation of number of employees. The March 19, 2004, proposed 
rule expanded the use of employee-based size standards to industries 
that have traditionally used receipt-based size standards, such as the 
Construction, Retail Trade, and the Services Sectors. SBA did not 
propose to change its method for counting number of employees. Under 
the Small Business Size Regulations, 13 CFR 121.106, SBA calculates 
number of employees in the following manner:

Section 121.106 How Does SBA Calculate Number of Employees?

    (a) In determining a concern's number of employees, SBA counts all 
individuals employed on a full-time, part-time, or other basis. This 
includes employees obtained from a temporary employee agency, 
professional employee organization or leasing concern. SBA will 
consider the totality of the circumstances, including criteria used by 
the IRS for Federal income tax purposes, in determining whether 
individuals are employees of a concern. Volunteers (i.e., individuals 
who receive no compensation, including no in-kind compensation, for 
work performed) are not considered employees.
    (b) Where the size standard is number of employees, the method for 
determining a concern's size includes the following principles:
    (1) The average number of employees of the concern is used 
(including the employees of its domestic and foreign affiliates) based 
upon numbers of employees for each of the pay periods for the preceding 
completed 12 calendar months.
    (2) Part-time and temporary employees are counted the same as full-
time employees.
    (3) If a concern has not been in business for 12 months, the 
average number of employees is used for each of the pay periods during 
which it has been in business.
    (4)(i) The average number of employees of a business concern with 
affiliates is calculated by adding the average number of employees of 
the business concern with the average number of employees of each 
affiliate. If a concern has acquired an affiliate or been acquired as 
an affiliate during the applicable period of measurement or before the 
date on which it self-certified as small, the employees counted in 
determining size status include the employees of the acquired or 
acquiring concern. Furthermore, this aggregation applies for the entire 
period of measurement, not just the period after the affiliation arose. 
(ii) The employees of a former affiliate are not counted if affiliation 
ceased before the date used for determining size. This exclusion of 
employees of a former affiliate applies during the entire period of 
measurement, rather than only for the period after which affiliation 
ceased.
    Many comments recommended that SBA modify its method for 
calculating the number of employees of a business concern. These 
comments pointed out that under SBA's current method, businesses that 
utilize part-time employees, temporary employees, or lower-paid 
employees would tend to outgrow an employee-based size standard quicker 
than a similar business that primarily utilized full-time employees. 
Calculating employment size on a full-time equivalent (FTE) basis was 
often mentioned as an alternative. Calculating part-time employees in a 
different manner from full-time employees in determining the overall 
employment size of a business was also suggested. Comments on this 
issue also raised concerns regarding the treatment of independent 
contractors in determining employment size.
    SBA seeks comments on alternative methods of calculating the 
employment size of a business concern and, in particular, the 
feasibility of using FTEs. The comments should clearly describe the 
alternative calculation method and why it would be preferable to SBA's 
current calculation of number of employees. Comments recommending an 
alternative calculation should also address the implications on the 
types of businesses that could be affected in terms of small business 
eligibility.
    Related to this issue is whether the time period for calculating 
average employment should be modified from SBA's current method, which 
uses a rolling average of the pay periods over the preceding 12 months. 
For example, should average employment be based on a fixed period of 
time, such as a calendar year? Also, should average employment be based 
on a longer period than one year? Comments should describe the 
alternative time period and explain why it would be an improvement to 
the current averaging calculation.
    If SBA chooses to modify its calculation of number of employees, 
the method must be one that allows businesses to provide supporting 
documents to the SBA, in the event of a size protest, in a verifiable 
manner and one that would not create an excessive administrative 
burden. Many comments on the use of employee-based size standards 
contended that calculating and reporting to SBA their business' 
employment size is administratively burdensome. However, other comments 
pointed out that automated payroll and accounting systems enable 
businesses to readily document their employment size. SBA is 
particularly interested in comments that described the process small 
businesses must follow to calculate average employment and whether 
producing this information creates an unacceptable burden. Alternative 
methods of calculating average employment should address the 
implications on the alternative calculation on administrative burdens.
    Use of receipts-based size standards. SBA received a number of 
comments recommending that it continue to use receipts-based size 
standards. These comments generally provided one of three reasons for 
their position. First, receipts are considered a more appropriate 
measure of business size for their industry than number of employees. 
Second, average annual receipts are simpler than number of employees 
for businesses when determining their small business status and less 
burdensome in providing documentation to SBA in the event of a size 
protest. (SBA evaluates the average annual receipts size of a business 
based on the Federal tax returns submitted by the business to the 
Internal Revenue

[[Page 70199]]

Service (13 CFR 121.104)). Third, the use of employee-based size 
standards could encourage businesses to reduce employment, use fewer 
part-time and lower-paid employees, convert employees to independent 
contractors, subcontract more work to other businesses, and make other 
employment related decisions that they would not otherwise adopt.
    SBA seeks comments on whether it should continue to use receipts-
based size standards or establish size standards based exclusively on 
number of employees. SBA in particular seeks comments on what 
considerations it should give when deciding whether an industry size 
standard should be based on average annual receipts or number of 
employees. Also, for what industries are receipts-based size standards 
more appropriate than employee-based size standards, and in what ways 
are they more appropriate? Comments on this issue should address if 
having one measure of size for some industries and a different measure 
for other industries creates an unnecessary complication to size 
standards.
    Designation of size standards for Federal procurements. The size 
standard designated for a Federal procurement is determined by the 
North American Industry Classification System (NAICS) industry that 
best describes the principle purpose of the procurement (see 13 CFR 
121.402). This decision is the responsibility of the contracting 
officer. Once the NAICS industry is designated, the size standard 
established by SBA is assigned to the procurement solicitation. Some 
comments pointed to this process as an area that makes size standards 
complicated. Because size standards vary by industry, businesses and 
contracting officers have at times argued for an incorrect NAICS 
designation so as to effect the small business eligibility of certain 
businesses. Other comments pointed out that Federal procurements that 
require a contractor to perform a significant amount of activities from 
several different industries are more difficult to designate a single 
NAICS industry than for procurements which primarily consists of 
activities of one NAICS industry. Furthermore, varying size standards 
by NAICS industry results in some businesses that operate in multiple 
industries being considered small for some Federal procurements but not 
for other types of procurements.
    SBA seeks comments on whether the process for applying size 
standards to Federal procurements should be modified. If so, the 
comments should describe an alternative system and how it would improve 
upon the current process. Comments should also address how the 
alternative process would ensure that small businesses fairly compete 
with other businesses that are small in that field of work.
    Establishment of size standards solely for Federal procurement. SBA 
received comments arguing that it should significantly increase size 
standards to assist small businesses in developing a sufficient 
infrastructure that will allow them to compete for Federal procurements 
in full and open competition against the leading Federal contractors. 
These comments contended that the requirements and growing size of 
Federal contracts create a situation in which a small business that is 
awarded one or two Federal contracts automatically outgrows the size 
standard and loses its eligibility to compete for future contracts 
requiring small business status. These comments further contended that 
businesses that are not small or among the largest Federal contractors 
enter a ``dead zone'' or ``limbo zone'' where they must compete for 
future Federal contracting opportunities against corporate giants 
before they have developed a competitive strength to do so.
    In 1984, SBA adopted a policy that its industry size standards 
would apply to all programs. Before then, SBA had one set of size 
standards for Federal procurement and one set for all other small 
business programs. SBA is concerned that a significant increase in the 
size standards to reflect trends in Federal procurement would create 
size standards that are too high to realistically reflect small 
businesses in an industry or for the purposes of most other Federal 
small business programs.
    SBA seeks comments on whether a separate set of size standards 
should be established specifically for Federal procurement or whether 
this would needlessly complicate size standards. These comments should 
address the public policy justification for establishing such a 
separate set of size standards. That is, why should a small business be 
eligible for one program but not be eligible for another small business 
program? If separate Federal procurement size standards were 
established, what factors should SBA take into consideration in 
developing the size standards that are different from SBA's current 
industry analysis methodology (see SBA's size standards Web page for 
proposed rules that describe the industry analysis at http://www.sba.gov/size)? Also, please address whether separate Federal 
procurement size standards that are higher than the current size 
standards would adversely affect the assistance to a particular segment 
of small businesses extending assistance to relatively successful 
larger small and mid-sized businesses.
    Establishment of tiered size standards. A number of comments 
suggested that SBA establish size standards to direct assistance to 
different sizes of small businesses. That is, SBA should establish size 
standards for sub-categories of small businesses, such as a very small 
business. These comments generally argued that two levels of size 
standards are needed to assist small businesses in developing into 
competitive businesses capable of being successful on Federal 
procurements competed on a full and open basis. These comments 
recognized that higher size standards may adversely affect the 
competitiveness of small businesses much smaller than the size 
standard. Many of these comments tied the establishment of tiered size 
standards with the estimated dollar value of a Federal procurement. 
That is, lower dollar value procurements could be reserved for very 
small businesses while other procurements could continue to be 
available to all small businesses.
    Two programs have provided for special treatment of sub-categories 
of small businesses. Both of these programs were authorized by 
legislation. Under the Small Business Competitiveness Demonstration 
Program (Pub. L. 100-656, the Small Business Competitiveness 
Demonstration Program of 1988, as amended), procurements of $25,000 or 
less are reserved for emerging small businesses, defined as businesses 
one-half of the applicable size standards. This program applies to 
Federal procurements in four designated industry categories 
(construction, refuse systems, non-nuclear ship repair, and 
architectural and engineering services) issued by 10 participating 
agencies (64 FR 29693, dated June 2, 1999). Until recently, the SBA 
also had a Very Small Business (VBS) Program.\1\ For purposes of that 
Program, a very small business was defined as one with 15 employees and 
$1 million or less in average annual receipts (13 CFR 125.7). The 
Program authorized Federal agencies in 10 geographic locations to 
reserve procurements of $2,500 and $50,000 for very small businesses. A 
legislative

[[Page 70200]]

provision also established a business category termed smaller 
enterprise for purposes of the Small Business Investment Company (SBIC) 
Program (Pub. L. 104-205, 110 Stat. 3009-740). A smaller enterprise is 
defined as a business with $6 million or less in net worth and $2 
million or less in net income (13 CFR 107.710). Under the SBIC Program, 
a small business investment company's portfolio must include a certain 
proportion of its financings to smaller enterprises.
---------------------------------------------------------------------------

    \1\ The VSB Program was a pilot program authorized under Section 
304 of the Small Business Administration Reauthorization and 
Amendments Act of 1994 (Pub. L. 103-403). This pilot program was 
extended to September 30, 2003, by the Small Business 
Reauthorization Act of 2000, and further extended through June 4, 
2004, by Public Law 108-217, 118 Stat. 591.
---------------------------------------------------------------------------

    Although legislative authority would be necessary before SBA could 
consider establishing tiered size standards, it seeks comments on 
whether the concept of tiered size standards addresses a compelling 
need to assist certain segments of small businesses with meaningful 
Federal contracting opportunities. If tiered size standards have 
potential to better assist small businesses with Federal contracting 
opportunities, how could such a system be structured? Because tiered 
size standards would create more complexity in Federal contracting, 
what are implications of a small business sub-category on other 
designated business types (8(a), HUBZone, service-disabled veteran 
owned small business, women-owned small business, etc.) in terms of 
assistance to those businesses?
    Simplification of small business status and affiliation with other 
businesses. A key provision of SBA's size standards is the 
consideration of affiliation with other businesses in determining the 
size of a business. This fundamental concept ensures that Federal small 
business assistance programs are limited to small businesses that, 
because of their size, possess inherent disadvantages that larger 
businesses do not experience.
    SBA's general principles of affiliation provide that concerns are 
affiliates of one another when one concern controls or has the power to 
control the other, or a third party (or parties) controls or has the 
power to control both. The power to control need not be exercised; it 
need only be present. More than 50% ownership of a concern by another 
will always create affiliation (with certain exceptions, summarized in 
the next paragraph). Affiliation may also exist if there is less than 
50% ownership of a concern by another. In these situations, SBA will 
also consider factors such as management, previous relationships, 
shared business or economic interests, economic dependence, convertible 
debentures, agreements to merge, etc., in determining when affiliation 
exists in a given situation. The regulations have been developed over 
many years to provide guidance to the public on how SBA evaluates 
affiliation. Because relationships among business concerns can be 
extremely complicated and at times difficult to fully discover, the 
affiliation regulations are more extensive than other size regulations.
    SBA invites comments addressing ways to clarify its affiliation 
regulations. SBA is not considering altering its principles of 
affiliation. Rather, it seeks suggestions that have the potential of 
improving the language of the affiliation regulations to make them 
easier for the public to understand. Comments on affiliation should 
explain how a current regulatory provision is unclear and suggest 
revised language.
    The SBA does seek comments on one specific area of affiliation 
involving the small business eligibility of franchises. SBA has 
received requests from the Temporary Staffing Franchise industry to 
allow for an exemption from its franchise affiliation regulations. The 
SBA is considering excluding certain practices of temporary franchisors 
as conditions for finding affiliation. The practices are (1) the 
franchisor being the employer of the individuals placed as temporary 
workers by a franchisee, (2) the franchisor being responsible for the 
franchisee's payroll and associated costs, (3) the franchisor 
collecting the franchisee's accounts receivable, and (4) the franchisor 
remitting client fees to their franchisees. Before developing a 
proposed rule, SBA seeks comments from businesses in the temporary 
staffing industry, including those independent staffing firms that are 
not involved in franchise agreements. SBA is interested in knowing how 
a change in its affiliation rule for franchises would affect the 
temporary staffing industry, in particular:
    <bullet> Do SBA's current franchise regulations hamper the ability 
of franchisees to compete in the temporary staffing industry?
    <bullet> Would allowing this exemption continue to allow for 
temporary staffing franchisees to be ``independently owned and 
operated'' businesses?
    <bullet> Does allowing this exemption give franchisors too much 
control over their franchisees?
    <bullet> Would allowing this exemption give franchisors and 
franchisees a competitive advantage in contracting over independent 
temporary staffing businesses?
    Joint ventures and small business eligibility. SBA's size 
regulations have specific provisions determining the small business 
eligibility of joint ventures. In general, a joint venture of two or 
more businesses may qualify as an eligible small business if the 
aggregate size of all the members does not exceed the applicable size 
standard (13 CFR 121.103(f)). For certain larger Federal procurements, 
a joint venture whose members individually qualify as a small business 
may qualify as an eligible small business joint venture. On May 21, 
2004, SBA adopted a change to this provision that allows a joint 
venture to compete for multiple opportunities (69 FR 29192). However, 
an ongoing joint venture is limited to submitting offers on three 
procurement opportunities over a 2 year period. SBA believes that joint 
ventures among small businesses facilitate opportunities for small 
businesses to compete for larger-sized Federal procurements.
    SBA is seeking additional comment on its joint venture eligibility 
criteria. Comments addressing the nature of joint ventures formed by 
small businesses to compete on Federal procurements, the duration of 
such joint ventures, their competitive strength against other small 
businesses, and other aspects of joint ventures that have a bearing on 
policies to assist small business opportunities are also encouraged. 
SBA is specifically interested in obtaining comments on the recent 
policy of limiting a small business joint venture to three offerings 
over a 2 year period. SBA is concerned about permitting a joint venture 
among the same small businesses to operate as an on-going concern 
competing against other small businesses. At the same time, this new 
policy may be too restrictive in today's Federal contracting 
environment.
    Grandfathering of currently eligible small businesses. As mentioned 
above, one of the concerns with the March 19, 2004, proposed rule was 
the potential impact on small business that might lose small business 
eligibility as a result of the restructuring of size standards. Many of 
these comments pointed out that businesses develop their business plans 
over the next several years premised on the existing regulations. 
Abrupt changes that take away small business eligibility significantly 
disrupt these business plans and force businesses to reassess the 
viability of their strategies.
    SBA expects that any new proposed rule to address the current 
structure of size standards will have significantly less impact on 
current small business eligibility than the March 19, 2004, proposal. 
However, any worthwhile changes will invariably have an adverse impact 
on a few small businesses. SBA seeks comments on approaches by which to 
grandfather small businesses that could be adversely impacted by a 
future restructuring. A related alternative may consist of a longer 
implementation date than the typical 30

[[Page 70201]]

day period to allow businesses to adjust to the new regulations. SBA 
realizes that it may be difficult to provide comments without a 
specific proposal. However, SBA seeks general ideas on the approaches 
and relevant factors it considers if a provision to maintain small 
business eligibility becomes necessary for a particular proposal.
    Impact of SBA size standards on the regulations of other Federal 
Agencies. An area of concern expressed by the comments pertained to 
SBA's analysis of the impact of the March 19, 2004, proposed changes. 
Under the Regulatory Flexibility Act (5 U.S.C. 601-612), Federal 
agencies must assess whether their regulatory changes will 
significantly impact a substantial number of small entities. In 
reviewing these comments, SBA believes it has sufficient information by 
which to fully analyze most of the concerns raised by these comments.
    However, one area that is more difficult to examine involves the 
impact of SBA's size standards on the programs and regulations of other 
Federal agencies. SBA is aware of the use of its size standards in a 
number of Federal regulations and is in the process of identifying 
others. To ensure that future proposals adequately identify and assess 
the use of SBA's size standards, SBA is requesting assistance in 
identifying Federal regulations and programs that utilize its size 
standards. In addition, SBA welcomes comments describing the impact 
that a size standard change may have on small entities being subject to 
different regulatory requirements or their eligibility for Federal 
benefits. Comments on how size standard changes may effect a Federal 
agency's ability to meet the purposes of the regulation will also be 
helpful.

Participation of Businesses Majority-Owned by Venture Capital Companies 
in the SBIR Program

    The U.S. Small Business Administration (SBA) seeks public comments 
on whether it should provide an exclusion from affiliation for venture 
capital companies (VCC) in size determinations for eligibility for the 
SBIR Program. Under such a policy, VCCs that invest in SBIR 
participants would not be considered affiliates of the SBIR participant 
and their size would therefore not be included in determining the size 
of the participant.
    On June 4, 2003, SBA proposed in the Federal Register, 68 FR 33412, 
to modify Sec.  121.702 of its Small Business Size Regulations (13 CFR 
part 121) to allow a small business that is owned and controlled by 
another business concern to be eligible for funding agreements under 
the SBIR Program. The size standard for the SBIR Program requires that 
an eligible small business concern, with its affiliates, have no more 
than 500 employees. The proposed rule did not propose to change this 
500 employee size standard for the SBIR Program. The rule proposed only 
to modify the small business eligibility requirements so that the SBIR 
awardee must meet one of the two following additional criteria: (1) It 
must either be a for-profit business concern that is at least 51% owned 
and controlled by one or more individuals who are citizens of, or 
permanent resident aliens in, the United States (as the regulations 
currently require); or (2) it must be a for-profit business concern 
that is 100% owned and controlled by another for-profit business 
concern that is itself at least 51% owned and controlled by one or more 
individuals who are citizens of, or permanent resident aliens in, the 
United States. Comments on the proposed rule were due to SBA by July 7, 
2003. SBA received 164 comments to the proposed rule. SBA has not yet 
issued its final rule, but expects to do so in the very near future.
    Sixty commenters addressed an issue related to VCCs that was not a 
subject of the proposed rule. Forty commenters stated that a concern 
should be allowed to participate in the SBIR Program if one or more 
VCCs have majority ownership or control of the concern. In addition, 
most of these 40 commenters believed that if one or more VCCs owned or 
controlled a concern, the VCC should not be deemed affiliated with the 
concern. The justification offered was that VCC investment is crucial 
to startups in the biotech industry and that SBIR funds are needed to 
reduce the private risk of these investments. The remaining 20 
commenters, however, were opposed to any proposal that would allow a 
concern to participate in the SBIR Program if one or more VCCs have 
majority ownership or control of the concern. These commenters 
expressed their concern that because VCC firms often represent and are 
established by large corporate interests, allowing their subsidiaries 
to receive SBIR awards could result in SBIR funds, which are reserved 
for small business concerns, being used to subsidize research projects 
of large corporations.
    The relationship of a VCC or other investment vehicle to an SBIR 
participant is a broader policy question than SBA sought to address 
with the June 4, 2003, proposed rule. Under current regulations (Sec.  
121.103, ``What is affiliation?''), when VCCs have control of a firm in 
which they invest, they are considered affiliated with that firm, just 
as any other business entity would be if it had ownership or control.
    SBA's Small Business Size Regulations in 13 CFR 121.103 provide a 
small number of exclusions from affiliation. Concerns owned in whole or 
substantial part by Small Business Investment Companies (SBICs) or 
development companies licensed under the Small Business Investment Act 
are not considered affiliated with the SBIC or development company. 
Also, concerns owned and controlled by Indian Tribes, Alaska Regional 
or Village Corporations, Native Hawaiian Organizations and Community 
Development Corporations are not considered affiliates of these 
entities solely because of their common ownership and common 
management. Further, the regulation excludes VCCs, as defined in U.S. 
Department of Labor regulations (29 CFR 2510.3-101(d)), from 
affiliation with concerns receiving assistance under the Small Business 
Investment Act. (The SBIR Program is established under the Small 
Business Innovation Development Act, not under the Small Business 
Investment Act.)
    SBA believes that determining whether VCCs should be excluded from 
affiliation under Sec.  121.103, assuming the small business concern 
meets the ownership and control criteria established by the SBA, 
requires a separate rulemaking action, affording the public an 
opportunity to comment directly on SBA's proposal. Although SBA's June 
4, 2003, proposed rule did not address this issue, substantial public 
interest has persuaded SBA to seek additional comments directly on this 
question. SBA has not determined at this time if it will propose to 
exclude VCCs from affiliation or to provide some other type of 
exemption for VCC investments, but is seeking public comment on whether 
it should propose such a change to its affiliation rule.
    SBA requests comments on the issue of whether it should propose a 
change to the size affiliation regulation for SBIR Program purposes by 
allowing business concerns that are majority owned or controlled by one 
or more VCCs to be eligible for SBIR awards, regardless of the 
ownership and control of the VCCs. SBA is seeking information on how 
such a change is likely to impact the program and its participants, and 
how such a change could be implemented while at the same time ensuring 
that the SBIR Program remains a program that benefits small business 
entrepreneurs.
    Specific issues that SBA is seeking information on include the 
following:
    1. The role of VCC financing on SBIR projects during Phases I and 
II.

[[Page 70202]]

    2. The impact of such a change in eligibility requirements on the 
composition of SBIR participants. For example, would the program shift 
towards lower-risk technologies closer to market, or become more 
geographically concentrated following industries and areas of venture 
capital focus?
    3. The types of firms and projects that would benefit most from 
such a change, and those that would benefit the least.
    4. Whether an exclusion from affiliation for VCCs would require 
justifying limiting the exclusion to VCCs and not including other 
entities such as not-for-profit organizations.
    5. Whether or not granting VCC exclusion from affiliation would 
adversely affect the ability of small business concerns without such 
access to private capital to compete for SBIR awards.
    6. Whether the participation of firms owned and controlled by VCC 
firms would ultimately create an environment of multiple repeat award 
winners.
    7. Alternative approaches that may assist small business concerns 
in obtaining and utilizing VCC funding while participating in the SBIR 
Program, aside from a policy that requires an exclusion from 
affiliation for VCC majority-owned small business concerns.
    If SBA ultimately determines that it is necessary to develop a 
proposed rule on this issue, then it will perform an analysis mandated 
by the Regulatory Flexibility Act (RFA). As part of an RFA analysis, 
SBA must determine whether the rule will have a significant economic 
impact on a substantial number of small entities. The RFA defines small 
entities as small business concerns, small not-for profit 
organizations, and small governmental jurisdictions. Thus, SBA is 
seeking comments to determine the number and type of small entities 
that would be affected by a rule that would provide an exclusion from 
affiliation for VCC companies in size determinations for eligibility 
for the SBIR Program. In addition, SBA is seeking comments on the 
number of small business concerns competing for SBIR awards that have 
received venture capital funding and the number of VCC majority-owned 
small business concerns that potentially may be interested in 
participating in the SBIR Program.
    As part of an RFA analysis, SBA must also determine whether the 
rule will have a significant economic impact on these small entities. 
To make this determination, agencies seek information about the 
percentage of revenues or profits affected by the rule. Therefore, SBA 
is also seeking comments on the costs to small entities if SBA 
implements a rule that would provide an exclusion from affiliation for 
VCC companies in size determinations for eligibility for the SBIR 
Program. Such costs include implementation costs and the effect the 
rule would have on profits or revenues, i.e., whether it would it 
reduce profits or raise or lower revenues.
    Comments on any other aspect of the SBIR Program that might 
directly affect whether or not SBA should propose excluding VCCs from 
affiliation for purposes of the SBIR Program are also welcome.

    Dated: September 15, 2004.
Hector V. Barreto,
Administrator.
[FR Doc. 04-26609 Filed 12-2-04; 8:45 am]
BILLING CODE 8025-01-P


</pre><script data-cfasync="false" src="/cdn-cgi/scripts/5c5dd728/cloudflare-static/email-decode.min.js"></script></body>
</html>