Small Business: Status of Small Disadvantaged Business Certifications
Published: 2001-01-19T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: The federal government has an annual, governmentwide procurement goal of at least five percent for small disadvantaged businesses (SDB). SDBs are eligible for various price and evaluation benefits when being considered for federal contract awards. SDB firms must have their SDB status certified by the Small Business Administration (SBA). Because of concerns over reports that fewer businesses were receiving SDB certification than expected, GAO examined the SBA certification processes to (1) determine the number of businesses that SBA had certified as socially and economically disadvantaged since the implementation of the Small Disadvantaged Business Certification program and (2) obtain views on reasons for the current difference in the number of SDB certifications from the number that had previously self-certified as SDBs. SBA records show that 9,034 small business firms were certified as SDBs as of August 24, 2000. According to SDB officials, 6,405 of these were automatically certified because of their 8(a) certification. The number of SDBs that have been certified by SBA is significantly lower than the 30,000 projected by SBA based on the number of firms that had self-certified as SDBs. Possible reasons for this discrepancy include (1) company reluctance to participate because of their uncertainty as to when or how the program would be implemented, (2) the perception by businesses that the application process is burdensome, and (3) the belief by some companies that the benefits do not justify the effort.

section_title: Letter
paragraphs: The federal government, by statute, has an annual, governmentwide  procurement goal of at least 5 percent for small disadvantaged businesses  (SDB). SDBs are eligible for various price and evaluation benefits when  being considered for federal contract awards. Recently, SDB firms are  required to receive certification of their status as an SDB from the Small  Business Administration (SBA) in order to receive these benefits and for  agencies to be able to count contracts awarded to these firms toward their  SDB goals. In your capacity as Chairman of the Subcommittee on  Government Management, Information, and Technology, House Committee  on Government Reform and as a Member of the Subcommittee, you  requested that we provide information on the status of SDB certifications  under the new Small Disadvantaged Business Certification (SDBC)  program. You were concerned about reports that there were fewer  businesses receiving SDB certification than expected. As agreed with your  office, the objectives were to (1) determine the number of businesses that  SBA had certified as socially and economically disadvantaged since the  implementation of the SDBC program and (2) obtain views on reasons for  the difference, if any, in the number of SDB certifications from the number  that had previously self-certified as SDBs.
To identify the number of SDBs certified by SBA since the implementation  of the SDBC program, we reviewed data contained in SBA's Pro-Net  database, as well as information provided by SBA's Offices of Government  Contracting and Minority Enterprise Development, and Small  Disadvantaged Business Certification and Eligibility. We also reviewed  SBA's Office of the Inspector General's (OIG) audit report on the SDB  certification program; a pivotal U. S. Supreme Court decision, Adarand  Constructors, Inc. v. Pena; and applicable federal statutes and regulations.
To obtain views on the reasons for the level of SDB certifications, we  interviewed SBA officials and representatives from two federal agencies'  Offices of Small Disadvantaged Business Utilization, as well as officials  from the U. S. Chamber of Commerce, and other small business advocacy  organizations. We did not verify SBA-provided data. Also, we did not  validate the reasons given for the level of SDB certifications nor could we  identify empirical evidence that could validate or refute these views.
subsections: section_title: Background
paragraphs: The SDB program in various forms has been in existence for the past 14  years. While criteria to qualify as an SDB remained essentially the same  during this period, a Supreme Court decision in 1995—Adarand v. Pena— resulted in the federal government examining how it implemented  “affirmative action” programs, including certain procurement preference  programs. Subsequently, the federal government established a program to  certify SDBs as eligible for preferences when being considered for federal  prime and subcontracting opportunities.
subsections: section_title: THE SDB Program Pre- Adarand
paragraphs: The SDB program was established by the National Defense Authorization  Act of 1987, and applies to the Department of Defense (DOD), the National  Aeronautics and Space Administration (NASA), and the U. S. Coast Guard.  The implementing regulations define SDBs as small business concerns that  are owned and controlled by socially and economically disadvantaged  individuals who have been subjected to racial or ethnic prejudice or  cultural bias and who have limited capital and credit opportunities.  African, Asian, Hispanic, and Native Americans are presumed by regulation  to be socially disadvantaged. An individual who is not a member of a  designated group presumed to be socially disadvantaged had to establish  individual social disadvantage on the basis of clear and convincing  evidence which, according to the SBA's OIG audit report, is a difficult  standard to meet. Under this standard, an applicant must produce evidence  to show that it is highly probable that the applicant is a socially  disadvantaged business concern. The regulations further specify that to  qualify as an SDB, a small business concern had to (1) be at least 51 percent  owned and controlled by a socially and economically disadvantaged  individual or individuals; (2) meet the SBA-established size standard based  on the business' primary industry as established by the Standard Industrial  Classification (SIC) code; and (3) have principals who have a personal net  worth, excluding the value of the business and personal home, less than  $750,000. The Federal Acquisition Streamlining Act of 1994 (FASA)  expanded the program to all federal agencies.
In addition to the governmentwide programs, various other federal laws  contain provisions designed to assist SDBs that are applicable to specific  executive departments or independent agencies. For example, the Surface  Transportation and Uniform Relocation Assistance Act of 1987 required the  Department of Transportation to expend not less than 10 percent of federal  highway and transit funds with disadvantaged business enterprises.  Amendments in 1987 and 1992 to the Airport and Airway Improvement Act  of 1982 imposed similar requirements with regard to airport programs.
Other statutes contain provisions to encourage contracting with SDBs by  various departments and agencies, including the Department of Energy,  the Department of State, the Environmental Protection Agency, and the  Federal Deposit Insurance Corporation.
Prior to the recent changes in the SDB program, small business concerns  could self-certify that they were small and disadvantaged. According to an  SBA official, unless otherwise challenged by an interested party, the  contracting agency accepted the self-representation to be accurate.  Between 1987 and the Adarand decision, self-certified SDBs were eligible  to receive two main benefits: (1) a 10 percent evaluation preference in  competitive DOD acquisitions where that award was based on price and  price-related factors and (2) the ability to compete for contracts set-aside  for SDBs for certain DOD acquisitions where agency officials believed that  there was a reasonable expectation that offers would be received from at  least two responsible SDBs. Though FASA extended the authority to  implement these benefits to all federal agencies, because of the 1995  Adarand decision and the effort to reform federal affirmative action  programs in light of the decision, regulations to implement the authority  were delayed.
section_title: The Adarand Case
paragraphs: In the 1995 Adarand decision, the Supreme Court held that all federal  affirmative action programs that use racial classifications are subject to  strict judicial scrutiny. To meet this standard, a program must be shown to  meet a compelling governmental interest and must be narrowly tailored to  meet that interest. The Court questioned whether the program at issue in  the Adarand case, which involved highway contracts at the Department of  Transportation, met that test. The Court decision resulted in the federal  government's examining all affirmative action programs, including  procurement preference programs. One issue that was addressed following  the Supreme Court decision was the government's policy that allowed  firms to self-certify as SDBs.
section_title: The SDB Program Post- Adarand
paragraphs: The Supreme Court decision in Adarand resulted in the administration  having to make changes to the SDB program. Tasked by the administration,  the Department of Justice (DOJ) conducted a review of affirmative action  in federal procurement programs. DOD, one of the largest contracting  agencies, was the focus of the initial post-Adarand compliance actions by  the federal government. DOJ reviewed the procurement mechanisms used  by DOD, including set-asides, direct competitive awards, and price  evaluations. On May 23, 1996, DOJ issued a proposed structure to reform  affirmative action in federal procurement to ensure compliance with the  tests of constitutionality established in the Adarand decision. The DOJ  proposal included a 2-year ban on DOD's use of set-aside programs for  SDBs and the elimination of the SDB set-asides for civilian agencies,  allowing only bidding and evaluation credits. The proposal also included  standards by which a firm could apply to be certified as an SDB. This  proposal also reduced the burden of proof from “clear and convincing  evidence” to a “preponderance of the evidence” standard. This lesser  evidentiary standard requires that applicants show that they are more likely  than not to meet the criteria for social disadvantage.
Because of its experience in certifying 8(a) businesses and resolving  protests in connection with both the 8(a) and the previous SDB set-aside  programs, SBA was chosen to pilot and administer a centralized program  for SDB certification. In August 1998, SBA set up the Office of Small  Disadvantage Business Certification and Eligibility to implement the DOJ  proposal. According to an SBA official, SBA projected that by October  1999, an estimated 30,000 firms would apply to SBA for certification based,  in large part, on the number of firms that self-certified as SDBs under the  previous program.
Under the SDBC program, small businesses seeking to obtain SDB  procurement opportunities must first demonstrate that they meet the  eligibility criteria to qualify as an SDB. Effective October 1, 1998, small  business concerns must receive certification from SBA that they qualify as  an SDB for purposes of receiving a price evaluation adjustment when  competing for a prime contract. As of January 1, 1999, monetary incentives  became available for prime contractors that met and exceeded their  subcontracting goals. Also, effective October 1, 1999, SDBs that waived the  price evaluation adjustment and large business prime contractors that used  certified SDBs as subcontractors in certain industries were eligible for  evaluation credits.
While the SDB set-aside program was suspended, price and evaluation  credits continued with the following three procurement mechanisms: (1)  qualified SDBs are eligible for price evaluation adjustments of up to 10  percent when bidding on federal prime contracts in certain industries, (2)  prime contractors may receive evaluation credits for their plans to  subcontract with SDBs in major authorized SIC groups, and (3) prime  contractors that exceed specified targets for SDB subcontracting in the  major authorized SIC groups can receive monetary incentives.
Although on September 30, 2000, the initial pilot covering civilian agencies'  authority to use price and evaluation credits expired, the administration is  seeking a 3-year extension of the program as part of SBA's pending  Reauthorization Bill. The DOD authority was extended for another 3  years. During this time, SBA, DOD, and the Department of Commerce are  to evaluate the performance of the program and determine whether the  program has benefited SDBs and whether the reinstitution of set-asides  should be considered.
section_title: More Than 9,000 Firms Certified, More Than Two-Thirds From Existing 8(A) Certifications
paragraphs: As of August 24, 2000, according to SBA officials, 9,034 small business firms  were certified as SDBs. Of these firms, 6,405 were grandfathered into the  SDBC program due to their 8(a) status. The remaining 2,629, or 29 percent,  were small business firms that applied to the program and were certified by  SBA. According to SBA, 5,456 small business firms applied to the program,  which was a significantly lower number than the 30,000 applications SBA  anticipated. Of the 5,456 applications submitted for certification, SBA  returned 1,990 applications as incomplete and denied 241 applications for  SDB certification. Applicants withdrew 307 applications for unknown  reasons. The remaining 289 applications were in various stages of  screening and processing.
Of the 9,034 certified SDBs, according to an SBA official, 6,405 firms, or 71  percent, were automatically grandfathered into the SDB program due to  their 8(a) certification. Of those firms that were grandfathered, 5,689 firms  were 8(a) business development firms, and 716 were firms that recently  graduated from the 8(a) program but qualified as an SDB because they still  met the ownership and personal wealth criteria, according to an SBA  official. The official also reported that, as of August 24, 2000, SBA had  certified 2,629 firms as SDBs—1,302 firms were certified in the first year of  the program from August 24, 1998, through August 23, 1999; and 1,327 firms  were certified from August 24, 1999, through August 24, 2000. Table 1  shows the composition of the SDB certifications.
According to SBA officials, 5,456 applications were submitted by small  businesses for SDB certification from August 24, 1998, to August 24, 2000.  Of the 5,456 applications, 3,377, or 62 percent, were determined to be  complete and passed the screening phase of the certification process.  According to SBA officials, 1,990 applications, or 36 percent, were  determined to be incomplete and subsequently returned to the applicant  during this period, and 89, or 2 percent, were “in- screening,” meaning that  the application was being reviewed by an analyst for completeness. Table 2  shows the status of the applications submitted to SBA by small business  concerns for SDB certification.
SBA certified 2,629, or 78 percent, of the 3,377 applications it considered  complete from August 24, 1998, through August 24, 2000. SBA denied  certification to 241 applicants, or 7 percent, according to SBA officials. The  two primary reasons SBA officials gave for denying certification were  either that (1) the designated group members exceeded the economic  threshold, or that (2) the nondesignated group members did not meet the  social disadvantaged standard. As for the remaining 507 complete  applications, SBA officials also reported that applicants withdrew 307  applications for unknown reasons, and 200 were “in process,” meaning they  were being reviewed to determine whether or not the applicant met the  eligibility criteria. Table 3 shows the status of all complete applications  submitted to SBA as of August 24, 2000.
section_title: Officials Identify Uncertainty About the Program, Costs, Benefits, and Qualifications as Factors for Low Number of Applications
paragraphs: The number of SDBs that have been certified through the SDBC program is  significantly lower than the 30,000 projected by SBA, based on the number  of firms that had self-certified as SDBs. Officials from SBA, two federal  agencies' Offices of Small and Disadvantaged Business Utilization, the U. S.  Chamber of Commerce, the Women's Business Enterprise National  Council, the National Minority Supplier Development Council, and the  National Small Business United cited four broad factors, which they  believed, combine to likely explain the lower-than-anticipated number of  SDB certification applications. These factors included, for some firms: (1)  confusion about the program's implementation, (2) the administrative and  financial burden of applying, (3) questions regarding the benefits of  obtaining the SDB certification, and (4) not qualifying as SDBs.
SBA officials and officials from other organizations we interviewed agreed  that businesses might not have applied for certification due to uncertainty  about when or how the SDB certifications would be implemented.  Criticisms and lack of buy-in from outside groups on the SDB certification  process and changes to the program's implementation dates may have  created confusion for some firms, while some others may have adopted a  “wait-and-see attitude.” Officials from two of the seven organizations that  we talked to said that, when developing the certification process, SBA did  not solicit the support of small business advocacy organizations that  represent the interests of small business concerns. The two officials also  stated that some advocacy groups opposed the structure and criteria used  to establish SDB certification as well as the onerous documentation  requirements. Consequently, those groups have not encouraged their  members to participate in the program because these issues are not  resolved. One of the officials also believed that SDB owners were not  educated about the process, which might have lead them to not apply for  certification.
Compounding the problem of conflicting or inadequate information about  the certification requirements, according to SBA officials, was the shifting  of implementation dates. The implementation date for the requirement that  prime contractors use only certified SDBs in meeting their subcontracting  goals and receive evaluation credits under the SDB participation program  also changed several times. For example, the implementation date for the  program was originally January 1, 1999, then changed to July 1999 with a  final extension to October 1999. Consequently, according to SBA and some  of the advocacy group representatives, SDBs may have delayed applying  for certification because of uncertainty as to actual deadlines and, in some  cases, may have adopted a wait-and-see attitude regarding program  requirements and criteria.
Officials interviewed from six of the seven organizations agreed that  another key factor explaining the lower-than-anticipated number of  applicants was that small business owners view the application process as  an administrative burden compared with self-certification. Officials from  four of the seven organizations interviewed pointed out that the  certification requirement was a financial burden compared with the self- certification process. Previously, firms only had to attest that they qualified  as SDBs. To be certified as SDBs, firms have to complete and submit one of  several different SDB applications, depending on the type of business to be  certified. In addition to the administrative burden, businesses can incur  significant expenses under the new certification procedures to ensure that  their application package is complete and accurate. For example,  businesses can go to a private certifier to help them complete their  application, but this service can cost up to several thousand dollars,  depending on the services performed. According to one small business  advocacy official, this expense can be prohibitive for a number of firms.
Adding to the issues of confusion about the program's requirements and  administrative burden, according to officials interviewed, is the view held  by some small businesses and shared by several SBA officials that there is  no real benefit to participating in the program. Officials gave different  reasons for this view. Two officials we interviewed, as well as officials from  SBA, said that some small businesses believe that they are unlikely to  receive federal contracts due to both real and perceived restrictions on  agencies' use of price evaluation adjustments and therefore questioned the  value of obtaining SDB certification. An SBA official pointed out, for  example, that DOD, which accounts for about 67 percent of federal  procurement dollars spent, is statutorily barred from using price evaluation  adjustments once it exceeds its SDB contracting goal. Alternatively, two  officials from other organizations we interviewed said that other firms do  not see the benefit to certification because they feel confident that they can  receive contracts through open competition regardless of their certification  status, particularly those that have established contracting relationships.  Consequently, small businesses' view that the certification process is an  administrative and financial burden combined with the low value placed on  SDB certification are factors that may have discouraged small businesses  from applying for certification, according to these officials.
Finally, an SBA official we interviewed pointed out that, in some cases,  firms that had previously self-certified as SDBs might not currently qualify  for SDB status. Although she did not have data that could show how many  firms fit in this category, the SBA official believed that, based on her  experience, exceeding the personal wealth threshold of $750,000 was one  reason for firms to either not qualify or no longer qualify as an SDB.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the Administrator of the Small  Business Administration, for her review and comment. On December 19,  2000, we received oral comments from the Associate Administrator, Office  of Planning and Liaison (formerly Associate Administrator, Office of  Government Contracting and Minority Enterprise Development), and from  the Assistant Administrator, Office of Outreach and Marketing (formerly  Assistant Administrator, Office of Small Disadvantaged Business  Certification and Eligibility). Both officials stated that they generally  concurred with the information included in the draft report, however, they  provided clarifying technical information that we have included in this  report as appropriate.
section_title: Scope and Methodology
paragraphs: To determine the number of businesses that SBA had certified as socially  and economically disadvantaged since the implementation of the SDBC  program, we met with and obtained information from SBA and reviewed  data contained in the SBA Pro-Net database. In addition, we reviewed the  SBA OIG's audit report on the SDB certification program, laws and  regulations pertaining to SDBs, and a Supreme Court decision. We did not  verify data provided by SBA.
For our second objective, to obtain views on the reasons for the lower- than-expected SDB certifications, we interviewed officials from SBA, DOJ's  Office of the Assistant Attorney General for Civil Rights, as well as officials  from the U. S. Chamber of Commerce, the Women's Business Enterprise  National Council, the National Minority Supplier Development Council, and  the National Small Business United. Also, we sent letters to 30  representatives from federal agencies' Office of Small Disadvantaged  Business Utilization requesting their view on reason for the lower-than- expected SDB certifications. Of the 30 federal agency representatives, we  received views from Commerce and DOJ within the time frame specified in  our letter, which we have included in this report. We did not validate the  factors cited by these organizations for explaining the lower-than-expected  certifications, nor was there empirical evidence available to validate or  refute these views. Also, we did not evaluate the performance and  implementation of the SDB program to achieve the governmentwide goal  or its effectiveness in certifying SDBs.
We conducted our review in Washington, D.C., from July through  September 2000 in accordance with generally accepted government  auditing standards.
As agreed with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report for 30 days. At that  time, we will send copies of this report to appropriate congressional  committees and interested Members of Congress. We will also send copies  to the Honorable Aida Alvarez, Administrator, Small Business  Administration; the Administrator, General Services Administration; and  the Director, Office of Management and Budget. We will also make copies  available to others on request.
If you have questions regarding this report, please contact me on (202) 512- 8984. Major contributors to this assignment were Hilary Sullivan, Geraldine  Beard, William Woods, and Sylvia Schatz.
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