Indirect rate structure is the most common source of purchase price re-trades in GovCon M&A — not because the rates are wrong, but because the documentation behind them does not exist.
Indirect rates are the mechanism by which a GovCon company allocates its non-direct costs to contracts. The three standard pools are fringe benefits (employer-paid benefits, allocated on direct labor dollars), overhead (indirect costs that support direct contract performance), and G&A (general and administrative costs, allocated across the total cost base). Each pool has a defined allocation base, and the rate is expressed as a percentage of that base.
A buyer's QoE team will ask for pool definitions, allocation base rationale, FAR 31.205 unallowable cost exclusion evidence, and three years of provisional-to-actual rate reconciliations. A company that produces these under diligence pressure — rather than maintaining them as ongoing documentation — signals operational risk. Buyers model the EBITDA impact of restating to a defensible structure and use the delta as a purchase price adjustment. At 9x, a $1M EBITDA adjustment from rate structure issues costs $9M in enterprise value.
FAR Part 31.205 defines cost types that are unallowable for reimbursement on government contracts — entertainment, certain marketing costs, certain legal fees, personal use of company assets, and others. A company that has not systematically segregated and excluded unallowable costs from its indirect pools carries contract billing risk. When the QoE team identifies unallowable items in the pools, the adjustment runs through EBITDA at the full multiple.
The preparation timeline matters. A rate structure that needs to be rebuilt — new pool definitions, corrected allocation bases, unallowable cost remediation, outstanding ICS filings — takes 12 to 18 months to stabilize. The deliverables that constitute a transaction-ready structure: written pool definitions for fringe, overhead, and G&A; documented allocation base rationale referencing FAR 31.203; a FAR 31.205 unallowable cost policy with systematic application evidence; and three years of provisional-to-actual rate reconciliations.
In-depth coverage from Steve Radanovic, GovCon CFO Practice Lead at Sync Executive Partners.
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Take the Diagnostic →Indirect rates in government contracting are the percentage rates used to allocate a contractor's non-direct costs to contract work. The three standard pools are fringe benefits (employer-paid benefits), overhead (costs that support direct contract performance), and G&A (general and administrative costs). Each pool is divided by its allocation base — typically direct labor dollars — to produce the indirect rate.
Indirect rates cause re-trades when the pool definitions are undocumented, the allocation bases have shifted without formal documentation, unallowable costs have not been systematically excluded, or provisional-to-actual rate variances have not been reconciled. Buyers model the EBITDA impact of restating to a defensible structure and use the delta as a purchase price adjustment.
FAR Part 31.205 defines the cost types that are unallowable for reimbursement on government contracts. Unallowable costs must be identified and excluded from indirect cost pools before billing to the government. Common unallowable costs include entertainment, certain advertising and public relations costs, certain legal fees, and personal use of company assets. Systematic exclusion of unallowable costs from indirect pools is required for both compliance and defensible transaction financials.
A provisional indirect rate is the estimated indirect rate used for billing purposes during the fiscal year, before final actual costs are known. At year end, the company calculates its actual indirect rates and reconciles them against the provisional rates billed. The difference is settled through a rate adjustment. Provisional rates must be set annually based on a budget model and reconciled quarterly to avoid large year-end variances.
For a transaction, the indirect rate structure documentation should include: written pool definitions for fringe, overhead, and G&A specifying what cost types belong in each pool; documented allocation base rationale referencing FAR 31.203; a FAR 31.205 unallowable cost policy with evidence of systematic application in the accounting system; three years of provisional rate budgets and actual rate reconciliations; and a DS-1 disclosure statement if CAS-covered.