Space has become central to protecting U.S. national security interests as Americans increasingly rely on space-based services to support everyday life. As a result, the U.S. government has bolstered investment in the space sector creating a wealth of opportunities for contractors. For example, the U.S. Department of Defense’s (DoD) budget request for fiscal year 2025 is seeking $33.7 billion for space programs.
This follows a notable restructuring of the U.S. national security apparatus to prioritize space with the creation of the Space Force and Space Development Agency. In addition, various other agencies like the National Oceanic and Atmospheric Administration (NOAA) have increased their investment in the space sector.
The U.S. government has also pushed to make contracting with the government more accessible to private space companies with instruments like Other Transaction Agreements (OTAs) and streamlining contracting requirements for commercial item procurements. In a fiscal environment where capital is tight, these new opportunities have helped smaller space companies secure huge investments from private equity, as well as strategic contractors, which have accelerated technological development and growth.
Notably, deal flow in the space sector has increased dramatically. A report from Raymond James found 152 transactions in the defense and space industry during the first half of 2024, a 60% increase compared to the first half of 2023.
This comes as venture capital is pushing space startups to pursue government contracts and grants. Federal contracts undoubtedly have their advantages as they can provide stability, increased cash flow, and seed money risk-averse investors otherwise would not provide; however, they are a double-edged sword as they impart various requirements that present significant consequences if not properly understood and complied with. Contracting with the government mandates certain obligations that contractors must thoroughly understand prior to the award of a contract or grant.
Considerations for Space Companies and Investors
Recertification Rules
On August 23, the U.S. Small Business Administration (SBA) proposed a rule that would have a considerable impact on how businesses acquire small government contractors. Currently, it is understood that small businesses that are no longer small following an acquisition remain eligible for set-aside task orders and option exercises under multiple award contracts, provided that the ordering agency cannot count these orders and options toward its small business goals.
However, the proposed rule seeks to clarify that the SBA never intended for acquired businesses that are no longer small to remain eligible for set-aside orders or options under multiple award contracts. Acquired businesses that are no longer small remain eligible for unrestricted orders under multiple award contracts, orders under single award set-aside contracts, and options under either of the foregoing, but agencies are not permitted to count such orders and options toward their small business goals.
The proposed rule will certainly impact valuation of small businesses as potential acquisition targets. As small businesses grow and enter the mid-size market, competition becomes fierce making it hard for these businesses to survive, which makes these companies attractive acquisition targets for companies with the infrastructure and funding to support that growth. However, a small business target touting opportunities under a multiple award contract may see its pipeline diminished post-acquisition under the proposed rule.
Small space companies with multiple award vehicles, who are considering a sale within the next 12 months, should evaluate the impact of the proposed rule.
Affiliation Rules
Over the past five years, private investment in space-related companies has increased dramatically. In 2023, private investment surpassed $12 billion—about 30% more than the year before. Private equity, in particular, sees space as its next profitable opportunity as it seizes on “buy-and-build opportunities” and valuable early stage research fostered by Small Business Innovation Research (SBIR) programs. While the space industry has become particularly enticing to private equity groups, certain government contracting rules should be at top of mind, namely affiliation requirements.
Under SBA’s affiliation rules, the SBA calculates the size of a business by aggregating the number of employees or the annual receipts of a business with those of all of its affiliates. Entities are affiliates when one entity owns or controls or has the power to control the other. Even minority investments in a small businesses can trigger affiliation, in particular where a minority investor has the ability to block certain actions of the company, known as “negative control.” While previously only the regulations for veteran-owned small businesses enumerated the permitted negative controls, SBA’s August 23 proposed rule intends to identify six specific permitted negative controls applicable across all socioeconomic programs.
Depending on the goals of an investment, firms must consider these affiliation rules when making investments or otherwise risk ongoing small business eligibility. These considerations must be reflected across investment documents including in agreements to merge, shareholder agreements, and stock options, if applicable. Affiliation rules can quickly jeopardize the goals of a transaction if not fully understood and followed.
Takeaways for Space Sector Businesses Pursuing Federal Contracts
The space sector is seeing historic investment from the federal government, opening new opportunities for space-related businesses. While government contracts present great opportunities for stable growth and capital infusions, companies should consider the risks to maintaining eligibility for desired contracts under the affiliation rules and new recertification requirements when deciding whether and how to work with the federal government. Government contracts require strict compliance with their terms and companies should be wary of the costs of that compliance.