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Can a small business be created on paper by a bigger business to benefit from exclusively small business government contracts?

Baltimore, MD |

Is it legal for a company to create a wholly-owned subsidiary and call it a "small business" to have it bid on "small business" government set-aside contracts?

The overhead of this type business is lower than what true small businesses have. These businesses could be structured conveniently by the owning business make it look profitable and independent on paper. The small "business" could share a lease, use the same I.T. infrastructure, accounting and personnel departments. Why would any business ever not bid on a small business government set-aside contract? Would it be due to its lack for foresight to incubate a "small business" for this purpose?

If it is illegal to circumvent the intent of the regulations, who investigates this if the contracts are from the Federal government?

Attorney Answers 3


A company created in the manner you suggested would not be certified by the SBA as a company that qualifies for small business set aside (sole source) contracts. There is a process by which the SBA qualifiies a company that claims to be majority owned by minorities, women, veterans and/or disabled veterans. You have to prepare a myriad of government forms that would flesh out whether or not the company is qualified for 8(a) or other forms of set asides.

You need to contact an attorney that specializes in these contracts. There are also consulting firms that provide seminars and prepare the submission to the SBA. It is clearly illegal to defraud the government which can result in a qui tam suit against the offending company for triple damages, attorneys fees, and all payments made by the government to the offending company. Not a good idea!!!

Good luck!
Phillip M. Smith Jr.
Los Angeles Tax & Business Attorney

THESE COMMENTS ARE NOT LEGAL ADVICE. They are provided for informational purposes only. Actual legal advice can only be provided after consultation by an attorney licensed in your jurisdiction. The answer to question does not create an attorney-client relationship or otherwise require further consultation. Mr. Smith is licensed to practice law throughout the state of California with offices in Los Angeles County. He is authorized to handle IRS matters throughout the United States, and is also licensed to practice before the United States Tax Court. His phone number is 323-292-4116 or his email address is

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There is also no need to do it anymore, since size standards are now applied based on the NAICS code. You can be a large business in a specific class and be small in the other.


The "smallness" of a business for purposes of the Small Business Administration is measured by the size of the business (either gross revenues or employees). Included in that measurement are the "affiliates" of the business. Affiliates include parent or subsidiary companies and companies with common ownership. So the SBA regulations would not permit a "large" company to legally form a "small" subsidiary.

Obviously, for a large company to pass off a small subsidiary as small or to hide its ability to control the small company and take advantage of SBA loan programs or government contracting preferences would be fraud. Like trying to fool Mother Nature, trying to fool the federal government is not a successful survival tactic I have not seen large companies try to do this because there is insufficient financial incentive and because it is too easy to find a real small business that is willing to "front" for a large business (by treating the large business as a subcontractor). Of course, this doesn't always work because of the SBA regulations that require (in most cases) the small business prime contractor to do 50% of the work in a set-aside contract.

Small business status and some of the more specific small business categories are still to some extent handled initially by self-certification. However, more and more an application and review process is getting implemented. For example, the Department of Veterans Affairs has a rather involved process for Service Disabled Veteran Owned Small Businesses that want to do business with the VA. To knowingly lie on any of these applications would be a federal crime.

The other reason this doesn't work is that competitors in a set-aside procurement have the ability to challenge (i.e., "protest") the company's small business status, thus kicking off a government investigation of that status. This investigation is normally handled by the SBA. Of course, if the matter has the smell of fraud, the FBI might get involved.

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As of March 2011, it has become patently illegal to form an affiliate and claim it to be small. The new law passed last year defines claiming status as "small" on the Representations and Certifications that accompany a proposal pursuant to 13 CFR 121, is now defined as a "taking" and thus becomes a false claim under the False Claims Act. If you are not familiar with the repercussion of that act, it is found in the United States Code in Volume 28. 28 U.S.C. contains the criminal provisions of the US Code. There are methods; however, whereby large business can obtain a competitive edge in the market by using the "Small Business Advantage" by either teaming or forming a Mentor Protégé relationship with a small business. I have several articles here on AVVO about this subject and present frequently on the topic. There are 13 Federal Agencies that have Mentor Protégé programs active at the present time but by and far the most lucrative is the SBA program. It allows for a joint venture to be formed between a large and small (protégé) firm and the small firm is only required to perform 40% of the work of the joint venture while the large firm may perform 60% of the work. There are many more incentives for the large firm as well that require a much more legal and technical answer than can be explained here. The SBA program can be found at or 13 CFR 124.520. Good luck.

Advice dispensed on AVVO by our firm is meant to assist viewers in their search for general advice. A particular issue requires consultation with an attorney or specialized advice from an expert. Always seek the advice of a competent professional before embarking on a course of action that involves a financial or legal decision.

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