Small Business Definition: How Exactly the SBA Defines a Small Business
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When you think of a small business, what comes to mind? Maybe a business that a friend or neighbor started due to their passion or skill in a particular area? Or perhaps you think of the local neighborhood restaurant down the street where everyone there knows your name?
According to its definition of small business, the Small Business Administration (SBA) may not consider either of those a “small business.” In fact, the SBA requires that businesses meet certain specifications to officially be considered a small business.
This designation is dependent on the number of employees and annual receipts, and can impact eligibility for government contracts and SBA loans.
The SBA is very strict about this, said Tiffany Bussey, director of the Morehouse College Entrepreneurship Center (MCEC), an Atlanta-based center for small business development.
You may think you have a small business, but according to specifications noted by the SBA, do you truly qualify as one? This article is of particular importance for business owners because the repercussions for misrepresenting the size standard of a business includes suspension and debarment.
Keep reading to learn how the SBA defines a small business, why fitting within this definition is important and what this means for a small business owner.
SBA’s size standards
The overall goal of the SBA is to promote small businesses, which account for 99.9% of all businesses in the United States. A 15-person consulting firm might not have the leverage of a large consulting firm like Deloitte, but the smaller company still has a right to be in business.
“The focus is to encourage small business,” said Bussey. “The idea is ‘Let’s grow these small businesses.’ Let’s help them,” she said.
A size standard is defined as the largest amount a business can have in either revenue or number of employees to be considered a small business. These values are based on many different factors, such as how much competition exists in an industry, startup costs, average firm size in a particular industry, barriers to entry and firm distribution by size. Other factors include market trends, changes in technology and how the industry has performed in previous years.
Industries within a certain sector are given a code by the North American Industry Classification System (NAICS), the national standard for classifying businesses to collect and analyze data about the U.S. economy. For example, the NAICS code for Hydroelectric Power Generation is 221111, while Highway, Street and Bridge Construction is 237310.
How the SBA determines a business size: Number of employees and sales
Each industry with a NAICS code has a size standard in the SBA’s Table of Small Business Size Standards. For example, the size standard for Hydroelectric Power Generation is 500 employees, while the size standard for Highway, Street and Bridge Construction is weighed by annual receipts, at $36.5 million.
As long as a business meets the sizing standard within its industry, it is considered a small business.
Finding average annual receipts: Annual receipts are the “total income” plus the cost for goods sold. This information can usually be located on your income tax return. Average annual receipts are determined by taking the average of the last three fiscal years of a business. If a business is less than three years old, you can take its average revenue per week and multiply that number by 52 to determine an estimate for the average annual receipts.
Finding number of employees: To calculate the number of employees, you will need to find the average number of persons employed per pay period over the last 12 months you have been in business. This calculation should include every person on the payroll no matter how many hours worked, or if a person was employed temporarily. If you have been in business for less than 12 months, then the number will be the average number of people employed per pay period.
Affiliates: Receipts and employees of affiliates should be included in the calculations, whether as number of employees or amount in annual receipts. Affiliation occurs when an outside party owns 50% or more of a business, or less through a contract. It also occurs when one or more parties own a significant share compared with others. An affiliate is considered to have the power to control, even if it does not actually control the entity. To calculate the receipts of the affiliate, add the average annual receipts or number of employees of the business to the annual receipts or number of employees to the affiliate business.
Size standards, which are reviewed every five years, were created for two reasons. First, each industry is unique and deserves to have specific consideration as a result. Second, the standards are established to help small businesses thrive and be more competitive in their respective industries.
This chart shows the sizing standards for industries divided by sector.
Why is it important to fit the SBA’s small business definition?
SBA loans generally require that the applying business meets sizing standards. Its loan programs are for working capital and fixed assets. Meeting sizing requirements is one of a number of eligibility requirements, such as having a sound purpose and showing that a business can repay the small business loan.
“It’s a nice advantage for small businesses since it can be very difficult for them to gain access to capital,” said Bussey. “The SBA is telling banks or whomever, that should this person default, we’ll make sure to step in and make sure that it’s paid.”
For federal contracts, a business must self-certify and ensure it fits the sizing standards, otherwise the business is ineligible to bid for the contract. “Most government contracts, when they come out, there’s usually a percentage to set aside just for small businesses to promote their involvement,” said Bussey.
Misrepresenting a business is against the law and can be punished with being barred or suspended from the SBA.
Are you an SBA small business?
Now that you are aware of the proper way to define a small business, here is a step-by-step process to determine if your business qualifies:
- Locate the NAICS code for your business. If you don’t have this number on hand, visit census.gov to run a search for NAICS code.
- After locating the code for your industry, find the corresponding code on the Table of Size Standards on the SBA website. Identify the sizing standard for your industry. It will either have a number representative of the annual receipts or number of employees. Note the amount.
- Run a calculation for your business relative to the sizing standard of your industry. If the amount is for a certain number of employees, determine the number of employees, either full-time or part-time and temporary, that your business had in the last 12 months. If the number represents the average amount in annual receipts, calculate the average amount in receipts for the last three years. Don’t forget to include affiliates. Refer to the previous section about calculations for additional assistance.
- Compare the figure for your company and the sizing standard for the SBA. If your calculation is at or below the sizing standard, then you are considered a small business. You will be eligible for certain loans and government contracting with the SBA.
In addition to meeting these standards, there are a few more requirements to know for being classified as a small business:
- Owned and operated independently
- For-profit business of any legal structure
- Not nationally dominant in its industry
- Located and operated physically in the United States or its territories
The term “small business” is more than an approximation. The term has actual specifications through guidelines provided by the SBA. As you continue to grow your business, one of the key things to do is to learn what the sizing standard is so you can plan financially relative to this definition for funding and bidding on government contracts.