Federal Government Factoring Update
Kwesi Rogers
President
Federal National Payables, Inc.
This article was published in the July 2010 issue of the Commercial Factor, a publication of the International Factoring Association.
Downloadable PDF version
Downloadable PDF version of the Commercial Factor.
As Shirley Temple Black also known as Little Miss Shirley Temple so eloquently stated "Our whole way of life is dedicated to the removal of risk. Cradle to grave we are supported, insulated and isolated from the risks of life and if we fall our government stands ready with Band Aids of every size." When my kids fall and draw blood they often ask for a $.25 superhero band aid to facilitate the healing process. When the United States' economy fell into a tailspin in 2007 our government passed the American Recovery and Reinvestment Act, delivering the $787 Billion "band aid". But just as a child suffers a bit when the wound's goo, hardened in the gauze, pulls away some tender new flesh, the government contracting community is experiencing an "ouch" with some of the new stimulus control initiatives proposed by the Obama Administration. Control, making the money a little less free, becomes the first step in a removal process and it creates both risks and opportunities.
Compliance, Ethics and Internal Controls
For all federal government contracts exceeding $5,000,000 in value and spanning a period greater than 120 days contractors must have a written code of ethics and conduct with an emphasis on commitment to compliance with procurement laws and regulations, internal corporate policies, prompt internal reporting of violations and clear penalties for violations. The administration did take into consideration that small businesses have few resources to administer training programs and exempt small business from the ongoing training requirement. In many cases these new ethics laws are also applicable to companies rendering a service to the government indirectly as a subcontractor.
A factor financing a small business found in violation of the government's recent compliance and ethics regulations could experience consequences that weaken the customer and prohibit or delay collection of the accounts. However where there is risk there is opportunity for factoring companies. Borrowers, performing well financially and obtaining financing from banks, could find themselves in violation of their lenders' covenants if they run into trouble on these new compliance and ethics standards. This could turn an otherwise bankable business into a customer who needs factoring assistance to recover.
For many reasons, prime contractors frequently employ subcontractors on federal jobs. It is common for the subcontractor to invoice the prime contractor and, according to the subcontract, receive payment when the prime contractor is paid by the government. What happens if the prime receives the money and does not pay the subcontractor? The subcontractor will eventually complain to the government. Is this a violation of ethics standards? Are the subcontractors' accounts less risky to factor as a consequence? Though this application of the standards is unlikely it is not outside the realm of possibility.
Insourcing
The Obama Administration has made Insourcing a priority. Insourcing policy establishes that inherently governmental work should be performed by federal employees and not vended out to private contractors. Insourcing is a major piece of the Obama Administration's acquisition reform agenda. The Administrator for Federal Procurement Policy at the Office of Management and Budget stated that the Obama Administration's 2011 budget proposal will "rebalance" the relationship between the government and its contractors through more oversight and Insourcing. The current budget proposes adding nearly 20,000 new civilian and military personnel to the Department of Defense and spending $158 million at civilian agencies to hire over 10,000 acquisition personnel to perform work now done by contractors. The budget goes on to say that acquisition support functions and information technology support will represent about one third of the jobs that are Insourced. Therefore if you are factoring a government contractor that does approximately $10 million in annual revenue with the government and has approximately 75 employees providing information technology support and acquisition support services they could lose up to 50% of their billable employees to Insourcing. A factoring client that suddenly looses 50% of its revenue will place the borrower under significant stress. All veterans of the factoring industry know the measures to which a desperate client may resort when their backs are up against the wall. But again there is the silver lining to this dark cloud. Under such circumstances, there are sure to be opportunities for factors to assist in the recovery of government contractors ejected from banks because they were adversely affected by Insourcing.
Contracting and Tax Accountability Act of 2009
The Contracting and Tax Accountability Act of 2009 prohibits the award of a contract or grant which exceeds the Simplified Acquisition Threshold to contractors that have "seriously delinquent" tax arrearages. In the past, factors fairly routinely financed federal contractors delinquent with their taxes if a negotiated payment agreement was in place with the IRS. The Contracting and Tax Accountability Act makes such factoring relationships more difficult to approve. Certainly a contractor's ability to satisfy their obligation is predicated upon the company having sufficient revenues to meet the payment schedule. However, the act essentially requires the repayment according to the agreement but also prohibits new awards probably necessary to accomplish repayment until the obligation is repaid in full. The politics of the bill aside, factors considering funding government contractors with past due tax obligations must consider whether or not the existing funded contract backlog will remain stable long enough for the contractor to satisfy its obligation to the IRS. As a factor you may consider simply collecting out if the contracts are not renewed during their option years leaving insufficient revenue for your customer to meet its obligation to the IRS. That strategy assumes that as the revenues drop the customer still continues making payments. If the customer falls behind you run the risk that the IRS levy funds due the factor. The FACA filing gives you legal rights but the "Service" still has your money. As Run DMC sang, "It's Tricky"!
Contract Types
Over the past 20 years the percentage of procurement dollars spent on service contracts has grown dramatically compared to the percentage spent on products. Most service contracts are structured as cost reimbursement contracts. The current administration has stated that cost-reimbursement contracts shall be used only when circumstances do not allow the agency to adequately define its requirements. In essence the administration has realized that the contractor has less incentive to control costs in a cost reimbursement contract than they do when performing on a fixed price contract. The challenge with this initiative is, fixed price contracts require a well-defined requirements section. The government is under staffed and its contract acquisition workforce becomes younger and less experienced as senior staff members retire in increasing numbers. There are numerous potential risks and opportunities here for those interested in factoring government contractors. Many small government contractors do not have the systems or processes to adequately capture all of the costs when bidding for new work. These contractors may succeed in winning new work but it is unlikely that they will succeed in turning material profits that develop into balance sheets banks would feel comfortable lending into. On the other hand factors may find that customers squeezed by cost overruns in a fixed price contract fail financially at great risk to the factor. This writer has seen contractors employ government provided inputs in their price proposal only to discover the inputs were incorrect. In some cases, the contractor was still held to their pricing, incurring significant losses, regardless of the government's error. If this becomes significant enough, at some point a factoring customer will become desperate, a circumstance most factors would just assume avoid.
Summary
The government spent in excess of $500 Billion on contract goods and services in fiscal year 2008. This writer is not aware of another industry that grew as fast in the period from 2001 to 2008. New procurement initiatives are introduced with almost every new administration. Despite initiatives such as those discussed above, the government must run and contractors will continue to play an instrumental role in how the federal government operates. The government market will continue to be a robust growth opportunity for those factors who seize the opportunities and diligently mitigate the risks.
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