Congress Passes CARES Act to Fund $349B to US Small Businesses
Forgivable loans of up to $10 million available in exchange for keeping employees on payroll
The COVID-19 virus has accomplished a rare feat that few would have thought possible in the 21st century. I am not referring to the current global pandemic as the coronavirus is merely version 4 of SARS, MERS and H1N1. While COVID-19 is certainly the most virulent compared to theses previous outbreaks, its most dubious distinction is that it is the first health crisis that has infected hundreds of thousands of people, killed millions of jobs, and vaporized trillions of dollars in market capitalization.
In response to the crisis, the US Congress passed the “Coronavirus Aid, Relief, & Economic Security Act” (CARES Act) on March 27th . The Act includes a total budget of $2.2 Trillion, of which $349 billion has been allocated to the Small Business Administration (SBA) to provide liquidity to small and medium sized businesses. The program will allow for companies with fewer than 500 employees to nominally borrow up to 2.5x their recent average monthly payroll under the “Paycheck Protection Program” (PPP) provision. The loan amount will be limited to a maximum of $10 million and the term of use can be retroactive to Feb 15, 2020. One important aspect that more likely impacts smaller technology firms is that the payroll calculation for highly paid professionals is limited to the first $100,000 of their compensation. Once the application has been approved, the loan proceeds can be used for payroll, payroll taxes, utilities, rent (or mortgage) and insurance premiums.
Since the loan will be guaranteed by the federal government the maximum interest rate is limited to 4.0% with a maturity date of 10 years from the date of the application. Further, no personal guarantee is required and many of the typical SBA requirements have been waived.
The most compelling aspect of the PPP provision is that the loan can be forgiven so long as full time employment has not fallen by more than 25% from the applicable prior period, but the requirement can be mitigated by re-hiring employees. Further, 75% of all proceeds must be used for payroll. Repayment schedules are deferred for six months to one year for those portions of the loans that do not meet the forgiveness provisions. For VC backed companies, the loan is akin to non-dilutive R&D grant funding, but with a compressed funding timeline and specific uses of proceeds.
The program will be administered by SBA approved lenders under the existing 7(a) program, so the lending infrastructure is already in place. Unfortunately, there is a standing provision in the 7(a) program that could adversely impact private equity and venture capital backed firms as the 500 employee limit includes an “affiliation” clause that can be difficult to interpret and apply. In simple terms, to the extent a PE or VC investor has a measure of control over decision making of the underlying company (and can include a miniority shareholder), the combined employee count for both investor and borrower is included. Further, if a VC fund “controls” multiple portfolio companies, each portfolio company and the VC itself would need to add their employees together. This provision is being pursued for further clarification by the National Venture Capital Association, so stay tuned. However, the good news for the food tech sector is that any firm involved in food services has been exempted from the affiliation provision.
Applications for the PPP loan will be accepted beginning April 3, 2020 through approved lenders, and many believe that the applications will be processed on a “first come, first serve” basis. There is no word if the program will be augmented with additional funds, so don’t delay in applying if you believe you qualify.
Further, there will also be a $5 billion program administered through various States under Community Development Block Grant (CDBG) programs. The grants will be focused on those areas most affected by COVID-19, so it is presumed that companies located in major urban centers in California, Washington and New York will be given stronger consideration since they have been hardest by the pandemic.
The PPP program will not replace the lost momentum from the pre-COVID days, but for many companies it may be a bridge to a lifeline that is worthy of consideration. In the meantime, stay safe and good health.