With President Biden’s signing of the National Defense Authorization Act for Fiscal Year 2022 (Public Law No. 117-81) (the NDAA) on December 27, 2021, employee stock ownership plans (ESOPs) have become more attractive for the Department of Defense (DoD) government contractors.

"The fact that the National Defense Authorization Act will allow government contractors that are or become 100% ESOP-owned, to receive automatic follow-on contracts to continue performing the work, is certainly an additional incentive for a business to consider an ESOP as an ownership transition strategy."

Tim Gibbons, Principal
Business Valuations Team Leader

Background

The NDAA includes the first-ever government contracting program to encourage employee ownership. Specifically, Section 874 of the new law creates a DoD pilot program that allows contractors that are (or become) 100% ESOP-owned to receive automatic follow-on contracts to continue performing the work. The follow-on contract awards under this pilot program will be contingent on whether the contractor’s performance on the prior contract is rated as satisfactory or better.

The pilot program begins January 1, 2022 and runs for five years. DoD will look at “acquisition authorities that could be used to incentivize businesses to become qualified businesses wholly owned through ESOPs and to overcome challenges to partnering with the Department.” The Government Accountability Office is required to provide an assessment of the program within three years after enactment.

Section 874 of NDAA states: “Notwithstanding the requirements of section 2304 of title 10, United States Code, in the case of a follow-on contract for the continued development, production, or provision of products or services that are the same as or substantially similar to the products or services procured by the Department of Defense under a prior contract held by a qualified business wholly owned through an Employee Stock Ownership Plan, such products or services may be deemed to be available only from the holder of the prior contract and may be procured by the Department of Defense through procedures other than competitive procedures if the performance of the qualified business wholly owned through an Employee Stock Ownership Plan on the prior contract was rated as satisfactory (or the equivalent) or better in the applicable past performance database.”

What Does This Mean?

For minority-owned ESOP government contractors who meet set-aside criteria (such as 8(a) designation), the NDAA would allow them to transition to become 100% ESOP-owned and qualify for a sole source award on a follow-on set-aside contract, even after they surpass small-business status.

For small-business government contractors considering an exit via ESOP, this bill would allow them to maintain their current backlog of set-aside contracts, which provides confidence to all stakeholders in the transaction.

Insights:

The NDAA language does not provide for small business set-aside status for an ESOP-owned government contractor competing for a new contract.

The NDAA is unclear on whether the pilot program would apply if government contractors no longer meet the small business requirements (e.g., employee headcount, revenue thresholds). Guidance is needed on that and other practical aspects of how the program will be operated.

Written by Justin Tu, Norma Sharara and Blake Head. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com