GovCon Deals Advisory

Government contracting introduces a unique set of risks during mergers, acquisitions, and divestitures. FAR Part 31 cost principles, CAS, and DFARS business system requirements create compliance obligations that directly affect contract continuity, revenue recognition, and post-close integration complexity. There are hidden complexities with FAR, CAS, and DFARS requirements that are often overlooked, which can lead to costly setbacks or missed opportunities.

M&A in government contracting is high risk. Without the right approach, you could face:

• Payment withholds and revenue loss resulting from open or inherited DCAA audit findings or business system deficiencies
• Failed DCAA or DCMA audits triggered by post-close changes to accounting systems, cost structures, or organizational relationships
• Loss of contract eligibility where novation or assignment requirements under FAR 42.1204 are not properly managed
• Reputational damage with contracting officers and agency customers stemming from compliance failures during the transition period
• Post-close integration failures where CAS-covered contracts require disclosure statements and cost impact analyses that were not anticipated in the deal structure

A thorough GovCon due diligence review examines several risk categories that do not appear in standard financial or legal due diligence. Key areas include: the status and findings of any open DCAA audits or DCMA business system reviews, the adequacy of the target’s accounting system, estimating system, and purchasing system under DFARS 252.242-7006 and related clauses, CAS coverage and the existence of current disclosure statements, contract novation requirements and agency consent obligations, indirect rate exposure and the status of any open incurred cost submissions, and the adequacy of cost accounting practices relative to post-close integration plans. Each of these areas can affect purchase price adjustments, representations and warranties, and escrow structuring.

Contract novation is the legal process by which the federal government recognizes a successor in interest to a government contract following a business combination. Under FAR 42.1204, the acquiring entity must obtain government consent before assuming the rights and obligations of existing contracts. The novation process requires submission of a novation agreement to the Administrative Contracting Officer (ACO), along with supporting legal and financial documentation. Until novation is approved, the original contractor remains the party of record on all government contracts. Delays or failures in the novation process can disrupt contract performance, invoicing, and payment, and in some cases may require individual agency approvals across multiple contract vehicles.

Indirect cost rates are a direct input to contract pricing and revenue on cost-reimbursable contracts. In a GovCon acquisition, buyers must evaluate the target’s provisional billing rates, any existing forward pricing rate agreements (FPRAs), and the status of open ICSs for prior fiscal years. Unresolved ICS filings represent contingent liabilities that can result in rate adjustments and contract underbillings or overbillings that surface post-close. Under FAR 42.703, final indirect cost rates must be established for all cost-reimbursable contracts, and the acquiring entity inherits responsibility for submissions that were not resolved prior to close. Buyers should treat the ICS backlog as a quantifiable deal risk requiring specific representation and warranty coverage or escrow consideration.

Sellers in a GovCon transaction benefit from early preparation that reduces the risk of due diligence findings that compress valuation or delay close. Key preparatory steps include: resolving open DCAA audit findings and ensuring business system adequacy determinations are current, reconciling incurred cost submissions through the most recent fiscal year, confirming that CAS disclosure statements are current and accurately reflect actual cost accounting practices, organizing contract files to demonstrate compliance with FAR and DFARS requirements, and identifying any contracts with change of ownership notification requirements. Sellers who present a clean, well-documented compliance posture are better positioned to support the representations and warranties required at close and to defend against post-close purchase price adjustment claims.