What every emerging growth company needs to know about the CARES Act
On March 27th , 2020, the U.S. Small Business Administration signed The Coronavirus Aid, Relief, and Economic Security Act. Abbreviated as the CARES Act, the legislation introduced the new Paycheck Protection Program, or PPP, with $349 billion in funding, and expanded the already existing Economic Injury Disaster Loan Program, or EIDLP, with $10 billion of additional funding.
While both programs are generally aimed to help small businesses, not every bootstrapped and VC-backed startup is eligible to apply.
Below we overview the key takeaways for emerging growth companies in assessing the new forms of assistance, eligibility criteria and how to mitigate against potentially disqualifying factors.
“Small Business” Definition
In order to qualify for one of the CARES Act programs, a business must generally be:
· fewer than 500 employees; or
· fewer than the number of employees the SBA has designated as the size standard based on a company’s applicable 6-digit North American Industry Classification System (“NAICS”) Code, whichever is greater.
An important thing to bear in mind is that the number of employees of the company will be aggregated with the number of employees of all the company’s domestic and foreign affiliates. This can get very tricky for venture capital-backed startups.
Control Rights and Affiliation
According to the SBA’s rules on affiliation, companies are affiliates of one another in cases when one has the power to control the other, or when a third party has a power to control both. This fact can make applying for an SBA loan very challenging for VC-backed startups.
The general rule states that ownership of 50% or more of the company’s voting shares make up for the ownership-based control and trigger affiliation between entities. Such affiliation will also extend to any other business deemed to be controlled by the same majority owner. Even where a VC firm owns less than a majority of the voting securities of a business, determining VC affiliation with portfolio companies depends on the analysis of the positive or negative controls that the VC has over the company.
As for the investors with only a minority shareholding, affiliation with a company depends on the investor’s ability to prevent a quorum or otherwise block shareholders’ actions.
Affiliation rules can be triggered in other situations where multiple companies have common management or where the totality of circumstances is met. Businesses can find affiliation on a case-by-case basis even if no single factor standing alone would otherwise be sufficient.
As most VC’s have “protective provisions” that require the consent of the class of shares of which they hold a majority, or the consent of a board member that they have the right to designate, absent further guidance from the SBA, this could render the benefits of the CARES Act unavailable to many VC-backed startups.
Differentiate between EIDLP and PPP
When applying for either the EIDLP or the PPP, it is important to understand that while both programs are aimed at helping small businesses, the funds that may be procured under these programs cannot be used for the same purpose.
· EIDLP loans are available for up to $2 million, carry an interest rate of 3.75% and have a maximum term of 30 years.
· Only those loans for amounts of $200,000 or greater must be guaranteed by any owner having a 20% or greater interest in the applicant (the CARES Act removed the requirement for personal guarantees on loans under $200,000).
· The CARES Act also removed standard EIDLP requirements that the borrower not be able to secure credit elsewhere or that the borrower have been in business for at least one year, as long as it was in operation on January 31st , 2020.
· Applicants may request an expedited disbursement that is to be paid within three days of the request. The advance may not exceed $10,000 and must be used for authorized costs but is otherwise not repayable if the EIDLP loan is not approved.
· Covered loan period: Retroactive to February 15th , 2020, through June 30th , 2020.
· Under the PPP, the funds can only be used for payroll, health care benefits, mortgage interest, rent, utility payments or interest on other debt obligations incurred prior to February 15th , 2020.
· The loan amount can not exceed the lesser of (1) 2.5x average monthly payroll costs during the 1-year period before the date on which the loan is made; or (2) $10 million.
· The legislation also temporarily increases the maximum amount for an SBA Express loan from $350,000 to $1 million through December 31, 2020.
· Borrower requirements include good faith certification that the loan is necessary because of economic uncertainty caused by COVID-19 and will be applied to maintain payroll and make required payments.
· Borrowers must also certify that they are not receiving this assistance and duplicative funds for the same uses from another SBA program.
· No collateral or personal guarantee are required.
Under the PPP, loan recipients will be eligible for loan forgiveness for an 8-week period after the loan’s origination date in the amount equal to the sum of the following costs incurred during that period:
· Payroll costs (compensation above $100,000 excluded)
· Payment of interest on mortgage obligations
· Rent obligations
· Utility payments
The amount forgiven cannot exceed the amount borrowed. Loan forgiveness will be proportionally reduced if the average number of employees is reduced during the covered period as compared to the same period in 2019. The amount of loan forgiveness will be reduced by the amount of any reduction in total employee salary or wages during the covered period that is in excess of 25% of the total salary or wages.
Any remaining outstanding amounts (e.g., if not forgiven) will be repayable during a term not to exceed 10 years.
While the SBA is still expected to issue more definitive guidelines in the near term, emerging growth companies and startups should gather information and begin applicable application processes. While EIDLP loans may not seem like a viable option for many startups because of the personal guarantee requirements, it is clear that for cash-burn efficient companies, the total funding may be limited given the eligibility requirements in PPP loans.
For this reason, every emerging growth company and startup should assess its qualifications for SBA assistance under the CARES Act (and otherwise). Venture capital-backed companies should coordinate with their investors to mitigate any disqualifying factors. Good counsel can help.
Hope this is helpful.
Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley, San Francisco and Los Angeles offices, where he is a member of the Private Equity & Venture Capital, M&A and Transactions Practices and the Technology, Health Care, and Energy Industry Teams. Louis focuses his practice on advising entrepreneurs and their management teams, investors and financial advisors at all stages of growth, from garage to global. Louis especially enjoys being able to help his clients achieve hyper-growth, go public and to successfully obtain optimal liquidity events. Louis was the founder of a Silicon Valley boutique law firm called L2 Counsel. He previously served as both the co-managing partner and co-chair of the emerging growth and venture capital practice of a global law firm in Silicon Valley.
Louis Lehot - Directors' College 2019
Partner, DLA Piper LLP Louis Lehot's corporate, securities and M&A law practice focuses on advising public and private…