Small businesses beware the dangers of government prime contracts

Prime contracting with the federal and state government can be a dangerous game for the small consulting business or the weak of heart. Read on before you take on the responsibilities inherent in a government prime contract.

The federal and state government contracting marketplace is a dangerous place for the small business that has little or no serious government contracting experience. Besides being a viciously competitive environment, there are hidden dangers that can destroy an unprepared small business. I’ll present just a few examples of these dangers and point out some ways to mitigate them. This is not a “how to” article; think of it, instead, as a sign reading, “Caution! Curves ahead!”

Prime contractors
The first point you need to understand is that the distinction between prime contractor and subcontractor is very important. The first sells to the government, and the second sells to those that sell to the government. The prime has no middleman.

If you’re a small business or, especially, a single-person operation, try not to be the prime. The government regards the prime as the single point of contact, and responsible party, for accountability of the cost and for the schedule and performance of all aspects of the contract. This compliance is managed by the contracting officer (CO), who is usually a lawyer and is always different than the project manager (PM) that you deal with on a daily basis.

COs do not care that you and the PM have agreed on a different “interpretation” of the contracted activities. They will demand contract compliance to every aspect of the contract, as it is written, including any applicable laws and regulations. After you’ve won the contract, you may find out that you’re being held responsible for much more than you thought. Below, I’ll cover two such problems that can bury you, if you’re not careful.

Government paydays
If you’re a small startup company with between 1-15 people, and you’re a prime, you’re in big trouble unless you have a sizable cash reserve. The prime gets paid according to the government’s idea of when to pay bills. Typically, you can invoice the government 30 days after you start the contract, and it has up to 90 days to respond to the invoice. You may have to carry the expense of your employees and any equipment investment for four or five months without income. This is the default payment schedule that the federal government and many state governments follow.

If you’re savvy and negotiate and bid for “rapid payment schedule” and “partial invoicing,” you may be able to invoice in 15 days and get payments within 30 days after that. That cuts the time for the first payment to a maximum of two months. As you can imagine, this could be really critical if you need the cash flow. Here’s a true example:

A one-person consultant company won a contract as the prime to provide a very powerful graphics workstation to an office at NASA. They had to deliver it within 30 days. The consultant bid $50,000, including $41,000 for equipment and software with the rest for his labor and profit. He won. He figured he would order the equipment and invoice NASA for its costs and then pay for the equipment when NASA gave him the money. Wrong! The contracting officer at NASA told our neophyte that he was welcome to submit his first invoice no sooner than 15 days after completion and delivery of the contracted services. He would then get paid before the end of the fiscal year—almost six months away, seven months counting the contract time.

Unfortunately, he didn’t have a spare $41,000 lying around and couldn't wait for more than seven months to get paid. He could (1) take a short term loan at $7,434 per month (and cut his profit out entirely) or (2) he could sell the contract. He sold the contract to a large company that put up the funds for his workstation. He got a grand total of $800 for his work and a million dollars worth of lessons learned. If there is a "next time," he’ll know to negotiate and bid for “rapid payment schedule” and “partial invoicing” and will plan his deliverables to limit his risk and exposure.

Bureaucracy by volumes
If you read the fine print in your contract as the prime, you will see clauses that state that various other documents are “included by reference.” This is a casual statement that is followed by lists of FAR, ITMRA, OMB, GSA, GAO, USC, FIPS, MilStd, and DFAR coded references. (See the Virtual Library for explanations of the coded references.)

This means that the “included by reference” clauses (or whole documents) are sections of text that you can legally cut-and-paste into your contract in order to add some requirement without having to print out the entire text of every requirement in every contract. Within this “boilerplate” text, there might be references to additional regulations, laws, and requirements—and then these references might also refer to other documents. A recent, simple three-month, $40,000 consulting contract included more than 4,000 pages of regulations, laws, and legal requirements as a part of its eight-page “contract.”

Default “Gotchas!”
There are many default requirements you’ll want to avoid in the typical government contract, and you’ll need to know what to negotiate for in their place. For example, you might want to avoid the default payment schedule, as outlined above, and instead negotiate for the rapid payment schedule (labeled SubPart 13.3 in typical government contracts). Another important point to potentially negotiate for is the ownership rights to items delivered under the contract (labeled SubPart 27.4 in typical government contracts), especially software and research data. It is possible to resell what you’ve been paid to develop, if you negotiate correctly—otherwise the default option can leave you with no ownership rights to those items.

The bottom line is that these contractually binding requirements that are “included by reference,” and the default conditions that may exist in the contract, constitute a potentially massive increase in the size, scope, requirements, and costs in the compliance and delivery of a contract to a government client. Compliance with all of these requirements falls to the prime contractor.

A significant advantage in being a subcontractor is that you’re dealing in a business-to-business relationship. This often means that you get paid within a few days of billing the prime, your client. It also means that it’s often easier to work with the prime in getting the job done. For example, access to information and people, as well as to office space, computers, materials, transportation, etc., may be provided by the prime.

Read more on government contracting
For more about government contracting, check out these Tom Watkins’ articles:

This is just a sample of the dangers of government contracting for the small business. Go into this with your eyes wide open, because if you take a contract as a prime, and don’t have a complete understanding of all of the contract’s implications, you may find you’ll expend 2-15 times more effort in administrative overhead than in getting the job done.

Tom Watkins is director of government systems at Management Technology Consulting, Inc.


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