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What the Sequestration Means for Small Business

Over-reliance on government contracts can crush your start-up, says Rocket Lawyer's Charley Moore.
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After Win Construction secured its first federal contracts in 2004, business was good--for a time.

Between 2004 and 2011, the company received some $2.6 million in government contracts, allowing it to grow and expand its workforce.

But then came the budget battles of 2011 and 2012, leading to fewer contracts and ultimately this year's massive across-the-board cuts, known as the Sequestration. The construction company has since been forced to cut back its payroll.

"Nobody has said, 'Because of the sequester we're not going to do as much work as we have been doing,'" said Win Construction's Willone Eubanks. "But effectively, that's exactly what's happening."

The Sequestration is a child of The Budget Control Act of 2011, passed to end the 2011 U.S. Debt-Ceiling Crisis, which threatened to push the country into sovereign default. The statute introduced the creation of the Congressional Joint Select Committee on Deficit Reduction, options for a balanced budget amendment and automatic budget sequestration.

After months of partisan bickering failed to produce a budget compromise, on March 1 the Sequestration began the much-dreaded process of slashing federal spending by $85 million in the remainder of the 2013 fiscal year and cutting some $1.1 trillion over the next decade. The spending cuts primarily hit education, defense, and social programs.

According to a study by Dr. Stephen Fuller of George Mason University, if the cuts are fully implemented, more than 2 million jobs could be lost--nearly half of them coming from small businesses.

"Many small businesses are subcontractors, suppliers and vendors to larger scale businesses that are the prime federal contractors that have little recourse when their contracts with their primes are scaled back or terminated," Fuller said. "In fact the suppliers and vendors may not even know that their business is linked to a federal contract that could be canceled due to something called sequestration."

Say what you will about Uncle Sam's sticky fingers, but many firms rely on his hefty pocket book to survive, if not thrive. Each year, the federal government spends more than $500 billion on private-sector contractors and in 2011 small firms received some $91 billion in federal contracts.

Tapping into the federal government's considerable coffers might be great while the going is good, but it comes at a price: unpredictability. While most business relationships are based on logical arrangements, when Washington gets involved, all bets are off.

A successful business depends on forecasts, or being able to gather and interpret all available data and arrive at actionable conclusions. Granted, the ebbs and flows of business and consumer demand can be difficult enough to follow--how can businesses make plans to anticipate the fickle folks on Capitol Hill?

Despite its deadlock, the government will continue to be a major revenue source for many small businesses. How can firms balance the business opportunities of federal contracts with their inherent unpredictability?

The answer is simple: diversify.

Take defense contractors, who are already experiencing extensive cuts from U.S. troop withdrawals in Afghanistan. High-tech company Beacon told the AP it receives 90 percent of its revenue supplying information management software to the Navy, but anticipating the Sequestration last year, decided to diversify and begin selling to manufacturers and other companies. 

More than two months after the Sequestration began, nobody still seems to know what its ultimate effect will be on the economy. For entrepreneurs and small business owners alike, it is a stark reminder not to rely too heavily on government contracts for predictable long-term growth.

Last updated: May 28, 2013

CHARLEY MOORE | Columnist | Founder & chairman, Rocket Lawyer

Charley Moore is the founder of Rocket Lawyer, the simple and affordable online legal service that is used by millions of businesses, entrepreneurs, lawyers, and individuals for any legal situation, world-wide.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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