The landscape of government contracting is ever-evolving, and in the quest for innovation and efficiency, the 2022 National Defense Authorization Act (NDAA) introduced a groundbreaking provision: Section 874. This provision establishes a five-year federal pilot program to bolster employee stock ownership plans (ESOPs) within Department of Defense (DoD) contractors. This initiative significantly departs from traditional contracting methods, offering unique advantages to ESOP-owned companies.
“We recognize the innovative potential in encouraging non-traditional companies, like businesses wholly owned by an ESOP, to work with the Department of Defense. While there are many companies that have a level of employee ownership, a business wholly owned by an ESOP is different.” Joint Congressional Statement 2022
Overview
The NDAA Section 874 program, at its core, incentivizes ESOP ownership by enabling 100% ESOP-owned contractors to secure sole-source follow-on contracts. This means that companies wholly owned by an ESOP can receive contracts for the continued provision of products or services without undergoing a competitive bidding process. Such contracts are awarded based on the satisfactory completion of previous engagements, providing a streamlined pathway for ESOP-owned firms to secure government contracts.
- Participation is restricted to only nine contracts for nine contractors so that competition may be fierce; interested contractors should act quickly to assist their contracting officer in applying.
- Contractors can only apply through a contracting officer.
- To be considered for the program, contractors must have received a minimum rating of satisfactory (or equivalent) for the predecessor contract; also, the contractor must have been 100% S-corporation ESOP-owned during the predecessor contract’s performance period.
- Contractors cannot subcontract over 50% of the amount paid under the follow-on contract.
- Qualifying ESOP companies are not required to be a small business.
- Applications are due by April 28, 2023, and contracts must be awarded by August 31, 2023.
- The program will remain in effect until December 7, 2026.
Eligibility Criteria
The eligibility criteria for participation in the program are straightforward. Companies must be entirely owned by an ESOP and must have a track record of satisfactory performance in existing DoD contracts. While the program primarily pertains to follow-on contracts, efforts are underway to expand preferential opportunities for employee-owned companies, spearheaded by the Employee-Owned Contractors Roundtable (ECR), a coalition instrumental in the proposal and passage of the pilot program.
Why the Section 874 Program
The rationale behind promoting ESOPs among government contractors is multifaceted. ESOPs offer a viable alternative to traditional mergers and acquisitions, circumventing complexities associated with security clearances and novation requirements. By selling equity to an employee trust, contractors can ensure business continuity while preserving independence and critical designations. Moreover, ESOP ownership brings substantial tax benefits, including exemption from federal income taxes and capital gains taxes for selling shareholders.
Small Business
ESOPs present an attractive exit strategy for small business owners, especially those meeting set-aside criteria. Minority-owned businesses qualifying for small disadvantaged business programs like the 8(a) set-aside can implement ESOPs without compromising their eligibility for set-aside contracts. This provision underscores Congress’s intent to support the growth and sustainability of minority-owned enterprises within the government contracting ecosystem.
Application and Submission
Submissions will be accepted until April 28, 2023, or until the Defense Pricing and Contracting (DPC) Office approves the award of nine contracts for the pilot program. The deadline for awarding follow-up contracts that do not involve a full and open competition is August 31, 2023.
After the submission, the offices that evaluate the applications—the Defense Pricing and Contracting (DPC) Office and the Contract Policy Office—will reply with a determination within thirty days. The CO may then negotiate and award a follow-on contract to the ESOP-owned company without requiring full and open competition when those Offices approve the CO’s application.
The Future State
Looking ahead, the NDAA pilot program is poised to catalyze broader legislative support for ESOP-owned government contractors. As ESOPs become increasingly integrated into the industry’s fabric, the benefits of employee ownership—both tangible and intangible—will continue to resonate. Embracing ESOPs in the competitive arena of government contracting will yield enhanced stability, deeper employee engagement, and smoother ownership transitions.
Conclusion
The 2022 NDAA Section 874 program heralds a new era of empowerment for government contractors, underscoring the transformative potential of ESOPs in driving innovation, efficiency, and equity within the defense sector. As stakeholders navigate the intricacies of this pioneering initiative, the enduring promise of ESOPs as a catalyst for organizational growth and prosperity shines ever brighter.
