Defense Authorization Act Provision Makes 100% ESOPs Eligible for Small Business Set-Asides

A potentially major improvement in rules for ESOP defense contractors was included in the Senate Armed Services Committee’s markup of the 2022 National Defense Authorization Act (NDAA, S 2042). An amendment from Sen. Jean Shaheen (D-NH) would provide that the Department of Defense should create a pilot program that would allow companies that are or become 100% ESOP-owned to receive noncompete follow-on contracts for the work, even if they no longer meet applicable small business or other set-aside requirements. The award would be contingent on a finding that the contractor’s performance was satisfactory or better. The program would run for three years, and the Government Accountability Office would be required to provide an assessment of it with two years of the program’s sunset.

The specific language of the bill on contracting states that “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.”

The House version of the bill (H.R. 4350; see p. 486 of the chair's mark) “directs the Secretary of Defense to evaluate whether the corporate structure of nontraditional defense contractors wholly owned by ESOPs enables them to successfully transition between experimental prototyping to full-scale development.” The language also “directs the Secretary of Defense to submit a report to the House Committee on Armed Services, not later than March 1, 2022, that includes: (1) the number of firms wholly owned through ESOPs that were awarded prototyping agreements during the past year; (2) data on the ability of firms wholly owned through ESOPs to attract and retain a talented workforce in a competitive market; (3) an evaluation of how these firms were able to leverage the capital needed to bridge the funding gap between prototype demonstration and full-scale development; and (4) any challenges that prevent firms wholly owned through ESOPs from partnering with the Department of Defense to scale their technologies and capabilities.” The review also would 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 impetus for the bill came from the Employee-Owned Contractors Roundtable (ECR), a coalition of federal government contractors that are organized as private S corporations wholly owned through an ESOP. The two bills will now be voted on in each house of Congress, and a conference committee will need to iron out the final language.

Thanks to Corey Rosen of the NCEO for this summary.