All Hope Is NOT lost for PE and VC Backed Startups under the PPP and EIDL of the CARES Act
This note was written by Dani Fontanesi on April 6, 2020. As information is constantly coming in and changing daily, I’ll do my best to update this note accordingly. However, if you have any specific questions, please contact me directly at: Danielle@fontanesilaw.com
I’ve been getting lots of questions on the CARES Act (the Coronavirus Aid, Relief, and Economic Security Act) and how businesses can take advantage of the stimulation package. Here’s a quick summary and answers to some of the questions I’ve seen.
Qualification & the Affiliation Rule
Before getting into the whole summary, I’ll address a quick point on qualification, as this seems to have all startups in a frenzy at the moment. There have been various publications circling the newsfeeds claiming that VC and PE backed companies have lost out on the Paycheck Protection Program (PPP) -- a forgivable loan that can be used for payroll costs, interest on mortgages, rent, and utilities. I discuss this more below, but I just want to start by saying that’s not entirely true.
Currently, qualification is heavily ownership dependent, and due to an “affiliate rule” (described more below), many VC and PE backed companies are currently ineligible because, in sum, the affiliate rule can potentially aggregate headcount of all the companies in a PE or VC firm’s portfolio, making many startups ineligible due to the employee headcount limits.
This may seem like dire news, but as we all know, in this current environment, everything is moving quickly and changing just as rapidly. What’s true today may not be true tomorrow. This same principle applies to the eligibility standards under the PPP. Pelosi (whose home district is San Francisco) has been lobbying, alongside the National Venture Capital Association, to change this “affiliation rule”, and we’re hoping to see change soon. The SBA published its Interim Final Rule, effective April 2, 2020, but it’s still soliciting comments on it, so there's still time for change.
House Minority Leader Kevin McCarthy said last week that he expects VC-backed companies to soon have access to this money. Additionally, in the Interim Final Rule published on Friday, the SBA expressly indicated that it intends to promptly issue additional guidance with regard to the applicability of affiliation rules to PPP loans. So rest assured, hope is not lost.
We expect to see some changes that will impact the eligibility of VC and PE backed companies shortly.
In the interim, some VCs are encouraging their portfolio companies to apply now anyway, with the expectation that the rules will get changed by the time the loan is processed (which, due to the heavy demand, could take a bit of time).
And now, a more detailed discussion of the CARES Act – specifically the PPP and EIDL programs.
What is the CARES Act, and what does it do? (High Level Summary)
The Coronavirus Economic Stabilization Act of 2020 (CESA), at Title IV, Subtitle A of the CARES Act, authorizes the Secretary of the Treasury (the Secretary) to establish and administer a $500 billion program of loans, loan guarantees, and other investments to provide funding across many sectors of the US economy, including:
Public and private companies.
State and municipal governments.
Certain targeted business sectors consisting of: (1) air carriers and related businesses, including repair, inspection, and ticket agent services; (2) air cargo carriers; and (2) businesses critical to national security.
The purpose of this financing is to provide liquidity to eligible businesses, States, and municipalities, related to losses incurred as a result of coronavirus.
(Note: The entire economic stimulus package offers $2 trillion in relief, but this note is focused on how the CARES Act can help small to mid-size businesses, in particular through forgivable loans.)
How can it help my startup or small/mid-size business?
If you qualify, you could be eligible for a forgivable loan under the Paycheck Protection Program (“PPP”) and/or the Economic Injury Disaster Loan Emergency Advance (“EIDL”). I talk about the eligibility requirements below.
What is the Paycheck Protection Program (PPP)?
The Paycheck Protection Program is a loan program administered by the SBA that’s designed for small businesses to keep their workers on the payroll.
When do I need to apply?
Lenders may begin processing these loan applications on April 3, 2020, 2020, and the program will be available through June 30, 2020 (the covered period).
Where can I apply?
You can apply through any existing SBA 7(a) lender or through any federally insured depository institution, federally insured credit union, and Farm Credit System institution that is participating. Other regulated lenders will be available to make these loans once they are approved and enrolled in the program.
Silicon Valley Bank expects to accept PPP applications online Tuesday, April 7, 2020, but they are also expected to get swamped with applications and only have a limited amount of funding. You can find other lenders who are offering this program here.
You can download a copy of the PPP borrower application form to see the information that will be requested from you when you apply.
Other things to know when applying with Silicon Valley Bank.
SVB expects to accept PPP applications online Tuesday, April 7, 2020, but this date is subject to change. Visit their website for the most up-to-date information.
Another consideration to keep in mind is that SVB is taking the "affiliation rule" (discussed below) very seriously. They require you to certify that your company meets these requirements, and they advise applicants to consult with legal counsel before making the required certifications. Falsely certifying something on a federally backed loan could be a federal offense.
SVB's certification requirements are included below:
In order to ensure that you take the SBA’s affiliation rules into account and to help you consider some of the scenarios that might trigger affiliation under these rules, we will ask you to make these additional certifications when you complete your application. Please consult your legal counsel as you review them:
No business which, when combined with the Applicant, would have more than 500 employees (or any higher number provided in SBA standards for the relevant industry): (a) owns or controls more than 50% of the Applicant’s equity, or (b) has, pursuant to the Applicant's charter, bylaws or shareholder agreements, the ability to prevent a quorum or otherwise block action by the Applicant board of directors or shareholders, or (c) has the ability to control day-to-day activities of the Applicant through its Board or Shareholders (including for example, setting employee compensation, hiring and firing of executives, and purchasing or selling equipment);
The Applicant is not one of the types of businesses ineligible for SBA business loans (see 13 CFR 120.110), nor is any owner of 20% or more of the business;
The Applicant has considered the SBA’s affiliation rules and included the employees of its affiliates (at any level) when determining its eligibility for this program; and
The Applicant has considered existing options, convertible securities, and agreements to merge when determining its eligibility for this program."
What can I use the loan for?
SBA will forgive loans (up to a certain amount -- see below) if the money was used for payroll, rent, mortgage interest, or utilities.
Will the entire loan be forgiven?
The loan will only be fully forgiven if the funds are used for payroll costs, interest on mortgages, rent, and utilities, and at least 75% of the forgiven amount must have been used for payroll. Amounts used to pay interest on other obligations beside mortgages will not be forgiven. No amounts paid outside of the 8-week covered period of the loan will be forgivable.
Forgiveness is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Forgiveness will be reduced if full-time headcount declines, or if salaries and wages decrease.
What are the other benefits of the loan?
Loan payments will be deferred for six months.
No collateral or personal guarantees are required.
Neither the government nor lenders will charge small businesses any fees.
Interest rate of 1% (with a maturity of 2 years).
Am I eligible?
This is the million dollar question. The answer is that, due to some archaic and nonsensical rules in the SBA’s definition of “affiliate”, many VC and PE backed companies are currently ineligible.
According to the Interim Final Rule published by the SBA, “you are eligible for a PPP loan if:
1) You have 500 or fewer employees whose principal place of residence is in the United States;
2) You are a business that operates in a certain industry and meet the applicable SBA employee-based size standards for that industry;
i. You are:
A small business concern as defined in section 3 of the Small Business Act (15 USC 632), and subject to SBA’s affiliation rules under 13 CFR 121.301(f) unless specifically waived in the Act;
A tax-exempt nonprofit organization described in section 501(c)(3) of the Internal Revenue Code (IRC), a tax-exempt veterans organization described in section 501(c)(19) of the IRC, Tribal business concern described in section 31(b)(2)(C) of the Small Business Act, or any other business;
ii. You were in operation on February 15, 2020 and either had employees for whom you paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC.
You are also eligible for a PPP loan if you are an individual who operates under a sole proprietorship or as an independent contractor or eligible self employed individual, you were in operation on February 15, 2020.
You must submit documentation necessary to establish eligibility such as payroll processor records, payroll tax filings, or Form 1099-MISC, or income and expenses from a sole proprietorship.
For borrowers that do not have any such documentation, the borrower must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount.
The SBA is still soliciting comments on the Interim Final Rule, and it indicated in the Interim Final Rule that it intends to promptly issue additional guidance with regard to the applicability of affiliation rules at 13 CFR §§ 121.103 and 121.301 to PPP loans.”
What are the “employee based size standards” for my industry?
You can find the “employee based size standards” for your industry here.
Who are my “affiliates”?
Again, this is a million dollar question.
Under the SBA rules, entities are “affiliates” of one another if one controls or has the power to control the other, or a third party controls or has the power to control both.
This is a much more expansive definition of “affiliate” than typically applied in the corporate or legal context. The impact of this broad definition is that minority stockholders are routinely deemed to “control” a company for SBA purposes. If a company is “controlled” by an investor, then the loan applicant would have to aggregate all employees in every other company “controlled” by that same investor (even if those portfolio companies are otherwise unrelated) to determine its headcount for purposes of the employee cap.
There are various ways that companies can be affiliated, but the most common is through stock ownership.
If an investor is a majority owner of the company’s voting stock, that investor (and all other companies that investor controls) is deemed an “affiliate”.
If an investor is a minority owner but can prevent a quorum of the board of directors or stockholders, or can veto day-to-day operational decisions of the company, the investor will likely be considered an affiliate.
More information on the Affiliation Rules for the PPP can be found here.
Since many PE and VC deals include operational covenants that allow investors to veto certain day-to-day management decisions of the company, many of these investors and their portfolio companies will be captured by the affiliate rule.
How can I find out more?
You can find easy-to-ready summaries and guidelines on the SBA’s website here.
You can also contact me with specific questions at Danielle@fontanesilaw.com
What is the Economic Injury Disaster Loans & Emergency Advance?
The Economic Injury Disaster Loan Program (EIDL) can provide up to $2 million of financial assistance (actual loan amounts are based on amount of economic injury) to small businesses or private, non-profit organizations that suffer substantial economic injury as a result of the declared disaster, regardless of whether the applicant sustained physical damage.
The loan advance provides up to $10,000 of economic relief to small business owners in all U.S. states, Washington D.C., and territories that are currently experiencing temporary loss of revenue. The advance does not have to be repaid.
Who can apply?
To be eligible for EIDL assistance, small businesses or private non-profit organizations must have sustained economic injury and be located in a disaster declared county or contiguous county. Any small business can apply, with very limited exclusions. Independent Contractors, free-lancers, gig workers, home-based businesses, and any other sole-proprietor can apply. Non-profits can apply as well.
Do I have to repay the loan?
The $10,000 loan advance does NOT have to be repaid, but the loan itself DOES need to be repaid (although interest rates are expected to be low).
Do I qualify for the EIDL?
This program is for any small business with less than 500 employees (including sole proprietorships, independent contractors and self-employed persons), private non-profit organization or 501(c)(19) veterans organizations affected by COVID-19.
Businesses in certain industries may have more than 500 employees if they meet the SBA’s size standards for those industries.
The affiliation rules described above generally apply to EIDL loans as well.
Can I apply for both the PPP and the EIDL?
Generally yes, as long as both loans are not used for the same purpose or otherwise duplicative.
What are some other potential benefits of the EIDL loans?
No personal guarantee is required for EIDLs under $200,000
The loan can be made solely upon the applicant’s credit score
Initial advances of up to $10,000 can be issued within three days and need not be repaid.
The loan will bear a low rate of interest; however, unlike PPP 7(a) loans, the act does not provide for forgiveness for EIDLs. Only the $10,000 advance portion can be forgiven.
Businesses may receive both PPP loans and EIDLs, so long as both loans are not used for the same purpose or otherwise duplicative.
For more information on any of the above, feel free to contact me at: Danielle@fontanesilaw.com
DISCLAIMER: Danielle Fontanesi, Fontanesi Law, or Fontanesi Legal Consulting (collectively "FLC") does not assume any responsibility for any consequence of your use of this material. FLC does not endorse or recommend the use of these various loan or funding programs. You should consult with an attorney before relying on any information or applying for any funding, especially if you don’t understand the terms or conditions of the various loans. This blog is provided for general informational purposes only and no attorney-client relationship with FLC is created with you when you use the blog. By using the blog, you agree that the information on this blog does not constitute legal or other professional advice. Do not send any confidential information through the blog or by email to FLC, as we do not have any duty to keep it confidential. The blog is not a substitute for obtaining legal advice from a qualified attorney licensed in your state. The information on the blog may be changed without notice and is not guaranteed to be complete, correct or up-to-date, and may not reflect the most current legal developments. The opinions expressed on the blog are the opinions of Danielle Fontanesi, Esq.