Episode 003: The State of the Industry: Government Contracting

1. What are you seeing from an industry perspective and activity in the market?
2. You work with all different sizes of companies but are seeing a lot of growth with smaller contractors, how do these businesses usually get started?
3. There is a lot of regulation and compliance around the industry, how does the small contractor make sure they are in compliance or do they have to?
4. What are some of the things that these business owners need to be thinking about as their company scales?
5. In today’s job market how are companies attracting and retaining key talent.
   1. What type of pressure does this put on a company from the standpoint of cost competetitiveness?
6. From a planning perspective, what type of questions are owners asking as they evaluate future exit?
   1. What type of exit strategies are most common?
   2. From a financial planning perspective, the business is their largest asset how do they liquidate those funds for investment and use post retirement?

Commentator [00:00:00]

Welcome to The Wrap a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it so you can listen learn and then get on with your day. Time is tight. That’s why our advisors have wrapped up today’s most timely topics into a podcast with actionable advice. Now let’s get down to business.

Kim Hartsock [00:00:22]

Hey Paul

Paul Perry [00:00:23]

Hey Kim.

Kim Hartsock [00:00:24]

How are you today.

Paul Perry [00:00:24]

I’m doing good. How are you.

Kim Hartsock [00:00:26]

I’m terrific.

Paul Perry [00:00:27]

This is a these conversations are becoming a lot of fun.

Kim Hartsock [00:00:29]

I know we have a lot of smart people.

Paul Perry [00:00:32]

Yeah we do. Who do we have with us today.

Kim Hartsock [00:00:34]

Yes. I’m really excited. We have Hobie Frady from our Huntsville office. He’s our GovCon practice leader. And with all that is going on in the federal government this should be an interesting conversation.

Paul Perry [00:00:45]

Let’s let’s dive right in. Welcome sir.

Hobie Frady [00:00:48]

Thanks. Glad to be here.

Paul Perry [00:00:49]

Glad you’re with us.

Kim Hartsock [00:00:50]

So I talked about that. There’s a lot going on in our federal government but what are you seeing from an industry perspective right now.

Hobie Frady [00:00:56]

So it’s been a good couple of years you know with the rising budgets of all of our clients are cautiously optimistic. We’ve got a re-election coming up in a year and a half and so that will probably give it a little bit of pause. But overall the last couple of years we’ve seen tremendous growth.

Kim Hartsock [00:01:13]

That’s great.

Paul Perry [00:01:13]

So a lot of activity and then in the market with your clients.

Hobie Frady [00:01:16]

Absolutely a lot of growth for the different companies from the small companies to the large companies everybody seems to be on a positive trend. The government starting to release a lot more of the contract awards. Those were backed up for a while but we’re seeing those getting released and money moving.

Kim Hartsock [00:01:30]

So I know that you know government contractors can be very large companies but there’s also quite a few smaller organizations that specialize in government contracting so how do you businesses get started in that.

Hobie Frady [00:01:44]

I mean that’s really probably the biggest part of the market. If I had to guess it’s probably 70 percent of the government contractors out there are zero to 10 million in revenue.

Kim Hartsock [00:01:53]

Really.

Hobie Frady [00:01:54]

You know a lot of them start just a engineer or someone like that that has a good customer following decides he or she doesn’t want to work for the company they’ve been working for customer says we’ll follow you wherever you want to go. They start their own business and they’re off and running. You see it also if there is an acquisition of a larger company by one of the big aerospace and defense companies. They don’t want to be involved in a large company. They like the small intimate setting that they were used to. And so acquisition happens two or three years later there’s five or six new small GovCons that pop up. So I mean it’s a huge part of the market it’s actually our fastest growing market.

Paul Perry [00:02:34]

But I would imagine going for those larger companies to starting your own you’ve got a whole host of people in the background doing a lot of things from a compliance and regulatory standpoint I mean that’s got to be a big issue and a big concern for those starting out.

Hobie Frady [00:02:48]

It is and it doesn’t take them long to figure out that’s not their cup of tea. It’s not the best use of their time especially in today’s environment. I mean talent is hard to come by. We see it all the time and especially talent that knows the industry. So really the best thing for the contractor to do is get to know people that know what they’re doing whether it’s their accountants their attorneys their insurance brokers whoever you know find the people that know what they’re doing in the industry rely on them and you’ll be better off in the long run.

Paul Perry [00:03:17]

So you don’t have to have that all in-house you can you can kind of outsource some of that.

Hobie Frady [00:03:20]

You do. And that’s that’s one of the things we provide. You know you don’t need a full time controller that’s an expert in government contracting if you’re a five million dollar government contractor you might need one for 10 hours a week but you don’t need any other thirty. So that’s kind of how we step in. We’ll give them a scalable option as their business grows we can scale with them once they’re ready to take piece inside they can do that and we’ll move on to another part of the business.

Kim Hartsock [00:03:47]

So you mentioned how hard it is to find talent. And so what are you seeing in terms of how companies are attracting and retaining that key top talent.

Hobie Frady [00:03:57]

You know it’s it’s a constant battle especially I sit in Huntsville and the war for talent is extreme right now. We’re seeing obviously pay increases the government’s kind of coming off a cycle that go in cycles. The most recent one was what we call LPTA low price technically acceptable and that was the common theme of how contracts were being awarded. So as long as we were technically capable of forming lowest price got him. That led to a lot of contractors bidding low prices bidding. Pay cuts for incumbent personnel that type thing were paying the price now because it’s going back toward best value. We’re having to pay more to get people. So that’s a constant battle that’s going on. But you know outside of pay we’re seeing an increase in fringe benefits you know paying more for health insurance more toward retirement accounts. Those types of things and the key individuals you’re seeing on synthetic equity used in a number of places to give them some you know a piece of the pie some ownership and the growth of the company.

Paul Perry [00:04:56]

So how do you stay competitive as a small company.

Hobie Frady [00:04:58]

That’s the balance. You know you’ve got your. You’re having to incur all these additional costs you know attract and retain good people means your rights your costs are going to go up so you’ve got to continually watch that balance. Look for areas where the customer is not as sensitive to costs looking for key personnel and willing to pay for it. And just pick your battles.

Commentator [00:05:19]

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Paul Perry [00:05:31]

You talked a little bit about the bigger guys buying out the smaller ones. I mean how is there. Is there a cyclical calendar to that or is there.

Hobie Frady [00:05:39]

You know it’s it’s really interesting. There’s a lot of baby boomers out there. They’re still on government contractors. You know they started 15 20 30 years ago just like we talked about how a customer went out and started been a nice little lifestyle business for him over the years. But here they sit at 60 65 wondering OK what do I do with this now. And so we’re seeing a lot of movement there. It’s not really the the big companies coming in mind those it’s more of the smaller small. So in other similarly situated Company the owner operators a little bit younger may take a look at that and say hey you know I can take that client relationship and those contracts and I can take them forward. So we’re seeing more the small small the big guys don’t really come after those small contractors as usual a concentration risk. They’re only in a couple of contracts. There’s a client relationship or customer relationship that resides primarily with the owner. And so they’re really just kind of buying the discounted cash flow so there’s not a lot of synergy to be picked up or anything like that. 

Paul Perry [00:06:40]

You know Kim when we were talking to hanny on transaction advisory on one of the other podcasts he always talked about there pitfalls that people when they were trying to exit their their business. I’m imagining there’s probably similar pitfalls specific to GovCon when you’re trying to exit the strategy.

Hobie Frady [00:06:55]

Yeah. And I mean a lot of that’s just people not thinking about it until it’s time to do it. You know you can look through the through the years owning the company and look back on ways you could have done things differently or expanded your client or your customer deck added some core competencies that type thing but by the time you’re you’re at that point where you really need to do something that’s probably a little bit too late. So we just encourage companies as they’re getting started kind of begin with the end in mind know that you are going to have to exit it at some point and start planning toward that. You know from day one. 

Kim Hartsock [00:07:30]

What are the additional things that if you were the owner of a government contracting business versus just a general business. What are the additional things you need to think about though when you enter into a conversation about someone acquiring you. I’d imagine there’s a more detailed due diligence process.

Hobie Frady [00:07:48]

Yeah there is. I mean you’re going to the acquirer is going to look at all your compliance activities and that type thing. But I mean what they’re really looking at a lot of these Smalls will be subcontractors the whole time through. So they never have a prime contract. That’s not that good a reflection on the company from the buyer’s point of view. Your. You’re relying on that prime that they’re dealing with to get that contract over to you. Sometimes they won’t do that. So you know I think one of the things I can do is just look for opportunities to prime. But that gives them a little bit better experience. And probably a little bit more value if they’re looking at exiting.

Paul Perry [00:08:26]

And I would imagine there’s just gotta be some due diligence on your your compliance with regulations DCAA whatever that that be the case when you’re when you are trying to exit you know if I didn’t have the cleanest bills in the past. Is that going to affect me going forward. Have you ever seen anything like that.

Hobie Frady [00:08:42]  

it’ll definitely apply risk. We’re in better shape now. The Defense Contract Audit Agency was years behind on what’s called the incurred cost solutions. Back in 2011 I think there were 20 to 21000 outstanding that were over a certain period time. Oh now I think they’re down in the hundreds. So there’s been a big effort there. That was one of the risks that was hanging out there and acquisitions we would have multiple open years incurred cost not knowing if there’s a liability sitting there or not. Now that that’s more present than that reduces some of that risk. But you’re definitely going to look back at historical and see if there’s been question cost that type of thing.

Kim Hartsock [00:09:19]

A lot of times people will try to make a move to become stronger and have more of a presence in government contracting because they feel like it’s more predictable and maybe quote unquote easier to get. But is that a myth or is that is that true and what are the things that a company needs to consider if they’re trying to get into that arena.

Hobie Frady [00:09:42]

And I would say on that it’s it’s hard to dip your toe in government contract if you’re a commercial company and you’re saying hey you know this is a government application or we’d like to play in this space huge market it’s hard to kind of just dip your toe like I said. You’ve got to be ready to go and face all the compliance issues that you’re going to face. No that it’s changed the way you run your business to a certain extent.

Kim Hartsock [00:10:05]

And what about the economy. How much of an impact is the economy have on a government contractor.

Hobie Frady [00:10:13]

I mean it has some impact obviously budget is a huge issue. You know the good thing about government contracts most of them are fairly long term five years or something like that. So if we’re locked into the contract unless there’s something significant happens you know you can see your runway out in front of you. But you’ve got to constantly be looking not waiting for an opportunity to show up on one of the big boards but out in front of that opportunity. What we call the capture you’re not waiting for the RFP to drop but you’re working the customer working relationship finding teammates that kind of. 

Paul Perry [00:10:43]

You know you should know the RFP before they dropped.

Hobie Frady [00:10:46]

Oh yes. If you’re if you see it the first time when they RFP drops your way late to the game.

Paul Perry [00:10:51]

So the DCAA you talked a little bit about incurred cost submission. Is there anything they’re focusing on this year or next year kind of in the foreseeable future.

Hobie Frady [00:11:00]

You know it’s it’s really kind of been the same thing. You know they’re looking for the standard an allowable cost. We’re seeing a little bit more on the compensation there’s compensation limits and they’re looking at reasonableness of compensation for executives especially on the smaller side. So we’ve seen a little bit of that but it’s typically the normal thing. You know we’re looking at you know the Dual lease standards going into effect next year. There’s a little bit of question on how that’s going to be handled with a new interest component showing up in that which was in a low allowable cost but in a financing lease previous to that it was an allowable cost as the ones put out. So we’ll see how DCAA comes down on that. I’m pretty sure they’ll come down as its on allowable but somebody will probably contest that.

Paul Perry [00:11:43]  

Is there an unallowable cost that most people usually try to push through that always get cut.

Hobie Frady [00:11:49]

I would say one of the things that’s most most often like trade shows the cost of trade shows if you’re there just to market your company as unallowable most people catch that you know the price of the trade show you know shipping the booth there or whatever what they miss is the cost of the people that are working trade show to make sense because that labors on allowable as well. That’s one of the ones that’s frequently missed.

Kim Hartsock [00:12:10]

So outside of compliance and regulation what else should a business owner consider before taking the dive into government contracting.

Hobie Frady [00:12:17]

Well one of the things for government contracting was a lot of it’s on the service side. There’s really not a huge barrier to entry if you’ve got a customer you’ve got technical capability. You know there’s not a lot of going out and buying buildings machinery equipment that kind of thing. So it doesn’t cost cost a lot to get in the business where I think it scares some people away. You know you hear about approved accounting systems and people think they’ve got to go out and spend thousands and thousands of dollars on a system. When you’re a startup contractor quickbooks works just fine. You supplement it with some schedules for reporting and indirect right management and job profitability and we’ve got companies that have 100 hundred and fifty people and they’re still running quickbooks. Everybody says I have to have DCAA approved accounting system. It’s not the system that’s approved it’s the implementation of the system. That’s true. So you can use whatever system you want as long as it’s designed and set up and operating the way it should be.

Kim Hartsock [00:13:12]

That’s a great point.

Paul Perry [00:13:14]

So here on the wrap we’d like to end with wrapping it up in 60 seconds. What’s the what’s the one thing you want the listeners to know based on GovCon industry today.

Hobie Frady [00:13:24]

I mean now I would just say uh it’s great to be on a sustainable industry. Well we have our ups and downs and that kind of thing. But you know for the smaller contractor I would say focus on your business not just what’s happening today but think five 10 years out on what you want to do what you want out of the business. Do you have a succession plan or are you bringing up the next tier of management or do you want to just build exit one day so give that some thought. Don’t wait to the last minute because at that point it’s gonna decrease the value.

All [00:13:53]

Well we appreciate it. Thanks for being here.

Commentator [00:13:57]

And that’s a wrap. If you’re enjoying the podcast please leave a review on your streaming platform to check out more episodes subscribe to our podcast series or make a suggestion for other topics to cover. Visit us at warrenaverett.com/thewrap