Small government contractors are being bought at the fastest pace in at least a decade as buyers target vendors holding “multiple award” contracts that can provide years of federal dollars.
Two Northern Virginia-based firms, General Dynamics and GTSI, are among the companies that have been most active making acquisitions in expanding or stable contracting sectors such as information technology, health, intelligence and computer security.
Multiple-award contracts establish a pool of eligible contractors who then bid on individual orders. These contracts, which are growing more common in federal contracting, can last as long as 15 years. That means acquiring a company with one may be the only way to bid for the work.
In many cases, the acquisitions give the companies access to multiple-award contracts that had been targeted to small businesses.
Such deals are increasing even though the Small Business Administration (SBA) in 2007 established a rule to ensure federal dollars reserved for small businesses don’t go to bigger vendors through acquisitions.
Initially, the rule appeared to slow the number of deals. Last year, however, acquisitions of small service vendors — defined as deals valued at $50 million or less — rose 22.4 percent to 71, according to Houlihan Lokey, an investment bank based in Los Angeles that advises on government contractor transactions.
That was the highest level since at least 2000, and the firm projects that this year’s total will meet or exceed last year’s, said Jean Stack, a managing director at Houlihan Lokey.
Behind the flurry of activity: looser credit and a desire among companies to protect themselves against a sluggish economy and a possible loss of business if the government cuts spending, said John Song, a Houlihan Lokey senior vice president.
The federal government has a statutory goal of setting aside 23 percent of prime contracting dollars each year for small businesses, generally those with $7 million or less in annual revenue. Each agency then sets a percentage target for spending with small vendors.
Agencies awarded about $97.9 billion to small companies in the fiscal year that ended Sept. 30, 2010, according to the SBA. That was 22.7 percent of last year’s $432 billion in government contracts small businesses were deemed capable of performing.
Gary Newell said he and his wife, Heather, sold their small business, Buccaneer Computer Systems and Services, in September 2010 because of uncertainty over whether a cut in the capital gains tax rate, passed under President George W. Bush, would expire.
Buccaneer, which focuses on information-technology contracts with the Centers for Medicare and Medicaid Services (CMS), the Food and Drug Administration and the Defense Information Systems Agency, attracted more than a dozen interested buyers. Vangent, a former unit of Veritas Capital, bought the company.
General Dynamics announced its intention to purchase Vangent in August.
Part of Buccaneer’s appeal was its 10-year multiple-award contract with CMS to provide IT services under a contract called Enterprise System Development.
On some multiple-award contracts, such as the one held by Buccaneer, agencies use one pool of money to award task orders for large and small businesses. If a small vendor is acquired, it can still compete for the orders not reserved for small companies, said Cameron Hamilton, principal at the McLean Group, an investment bank in McLean.
Buccaneer was among nine small businesses that won the right to bid on orders on the $4 billion Enterprise System Development contract in 2007. Since then, Buccaneer and at least two of the other companies have been acquired by larger vendors.
The Department of Homeland Security awarded 28 small businesses spots on Eagle, an IT contract vehicle valued at as much as $45 billion, in 2007. Nine of the small companies have since been acquired, according to the department.
In 2007, the SBA changed the rules for small contractors that are acquired. Before the rule, a buyer of a small vendor remained eligible to compete for some of the acquired company’s set-aside contracts and existing contracts continued to count toward an agency’s small-business goals.
Now, small vendors must notify agency customers within 30 days of being acquired and can’t keep competing for set-asides. Agencies also can’t count those contracts toward their small-business goals.
However, the rule “does not require the contracting officer to terminate or not exercise options,” said Kenneth Dodds, senior lawyer in the SBA’s Office of the General Counsel. An acquired company “can still continue to perform.”
The rule change initially put off some buyers, investment bankers said, until they realized certain acquired small companies still could work on contracts they had won before being bought.
Acquirers realized there would be “very high switching costs” for federal agencies to take away a contract from a company that has been acquired, said Song, with Houlihan Lokey.