The rule that keeps set-aside work from being subcontracted out — and the similarly situated entity exception that makes teaming workable.
Last reviewed on May 12, 2026.
Federal set-aside programs reserve contracts for small business participation. Congress wrote the Limitation on Subcontracting (LoS) rule to prevent small business primes from winning set-aside awards and then subcontracting most of the work to large businesses. Without LoS, set-asides would become pass-through arrangements that produce small business contract awards without small business performance.
The rule is implemented through 13 CFR 125.6 and the FAR clauses at 52.219-14 and 52.219-3. The current version of the rule — as substantially revised in recent years — applies a uniform set of percentages across set-aside categories rather than the category-by-category percentages that preceded it.
The LoS percentages are stated as a maximum percentage of the contract price that the small business prime can pay to subcontractors that are not similarly situated entities. The current rule:
| Contract type | Maximum paid to non-similarly-situated subs | Minimum prime + similarly situated performance |
|---|---|---|
| Services (except construction) | 50% of contract price | 50% |
| Supplies (non-manufacturer) | 50% of contract price | 50% (subject to non-manufacturer rule) |
| General construction | 85% (15% prime performance minimum) | 15% prime |
| Special trade construction | 75% (25% prime performance minimum) | 25% prime |
Services and supplies share the same 50% rule. Construction is split between general and special trade, with lower minimum prime performance percentages reflecting the historical reliance on subcontractors in construction.
The "similarly situated entity" concept is what makes the rule workable for small businesses that legitimately need subcontractor expertise. A similarly situated entity is a subcontractor that:
Work performed by similarly situated subs counts toward the prime's required performance percentage. A WOSB prime can subcontract significant work to another WOSB and still meet the LoS percentage, because that work counts as if the prime performed it.
The similarly situated exception is the architecture that allows complex teaming on set-aside contracts. A small business prime can assemble a team of similarly situated subs and collectively perform far more scope than the prime alone could, without violating LoS.
The 50% (or other applicable percentage) is measured against the total contract price, including options. The calculation:
Costs that flow through the prime but are not subcontract payments — direct labor by the prime's employees, the prime's own materials, the prime's indirect cost allocation — are part of the prime's performance. So are payments to similarly situated subs.
The measurement is over the contract period as a whole, not month-by-month. A prime can subcontract more than 50% in a given month if balanced by self-performance elsewhere in the contract life. But at the end of the contract, the cumulative percentage must comply.
For supplies contracts, the LoS rule interacts with the non-manufacturer rule (NMR). If a small business prime is not the manufacturer of the supplies it is providing, it must either be eligible under a class waiver for the relevant product category or perform the manufacturing role. The NMR is enforced through 13 CFR 121.406 and effectively requires that small business primes on supply contracts have manufacturing capability or qualify under a waiver.
The interaction matters because a small reseller of manufactured supplies cannot satisfy LoS simply by performing 50% of the contract price — the rule additionally requires that the prime actually be the manufacturer or that the supplies come from a small manufacturer.
The LoS rule is enforced through the standard set of federal contract enforcement mechanisms. Violations can result in:
Joint venture structures change the LoS analysis. Under an approved SBA mentor-protégé JV, the JV is the prime. The 40% protégé performance requirement is separate from but complementary to LoS — the protégé must perform at least 40% of the JV's work, and the JV must meet LoS for the contract type. In practice, an MP JV that performs the 40% protégé share and uses similarly situated subs can readily meet both rules. See joint ventures and teaming for the structural choices.
It depends on the contract type. For services, the prime may not pay more than 50% of the amount paid by the government to firms that are not similarly situated entities. The same 50% applies to supplies, excluding the cost of materials. For general construction the figure is 15%, and for special trade construction 25% — in both cases the prime must perform at least that share of the cost of the contract, excluding materials. The measurement is against the total contract price including options, not against individual invoices.
A subcontractor that holds the same set-aside status as the prime for that contract and is small under the NAICS code the prime assigned to the subcontract. Work passed to a similarly situated entity does not count against the prime's subcontracting limit — it is treated as though the prime performed it. This is the mechanism that makes small business teaming viable on set-aside work: two SDVOSBs on an SDVOSB set-aside can split the work without either breaching the rule.
No. The 40% figure comes from the mentor-protégé joint venture rules and is a requirement that the protégé itself perform that share of the work the joint venture does. The similarly situated exception applies to the limitation on subcontracting, which is a separate test measured at the contract level. A mentor-protégé JV must satisfy both: the protégé performs at least 40% of the JV's work, and the JV as a whole meets the applicable subcontracting limit.
Across the contract, including exercised options. Compliance is assessed against the total, so a month in which subcontractor costs exceed 50% is not itself a violation if self-performance across the contract life brings the ratio back within the limit. That said, a pattern of heavy early subcontracting is difficult to recover from, and contracting officers do ask. Track the ratio continuously rather than reconstructing it at closeout.
The clause at FAR 52.219-14 is a contract requirement, so breach is a performance failure that can support termination and negative past performance ratings. Beyond that, misrepresenting compliance carries potential False Claims Act exposure and, where the arrangement amounts to a small business fronting for a large one, criminal and suspension or debarment risk. This is one of the areas where the enforcement consequences are meaningfully more serious than the administrative ones.