On March 27, 2020, Congress passed, and the President has signed into law, the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act includes relief to small businesses across the country in the form of up to approximately $350 billion in aggregate loans to be administered by the Small Business Administration (SBA) and its network of lending financial institutions, referred to as Paycheck Protection Loans. Each loan is intended to be used to cover an eligible borrower’s payroll, mortgage interest, rent and/or utilities expenses for up to eight weeks from origination of the loan. If an eligible borrower uses the loan for qualifying expenses while maintaining its workforce, some or all of the loan amount can be forgiven without negative credit or tax consequences.
The CARES Act is a complex and novel piece of legislation that will require significant interpretation in its application going forward, and over the coming weeks regulators will provide further guidance regarding the approved Paycheck Protection Program (including with respect to the “Affiliation” issue described below that many startups could face). In order to assist our clients and friends of the firm to start to digest the program, this article summarizes loan eligibility and key terms as described in the CARES Act itself.
If you think the Paycheck Protection Program could apply to your business, we encourage you to consult further with your legal and financial advisors for guidance on the nuances of the CARES Act, and reference www.SBA.gov for program updates and the most current application information.
Generally — A borrower that was in operation on February 15, 2020, may be eligible for a Paycheck Protection Loan if it has no more than 500 employees (or no more than 500 employees per location for certain borrowers in the accommodation and food services industry), and certifies that the uncertainty of current economic conditions makes necessary the loan request to support its ongoing operations. For purposes of determining if a borrower employs no more than 500 employees, individuals employed on a full-time, part-time or other basis are included, but the CARES Act does not specify whether such determination only includes U.S.-based service providers.
SBA Affiliation Rules and Impacts for Startups — Under ordinary circumstances, a borrower’s affiliates are considered by a lender when determining whether a borrower is eligible for an SBA loan. The CARES Act explicitly waives these SBA affiliation rules with respect to borrowers in the accommodation and food services industry; however, the new law as adopted is otherwise silent on how the typical SBA affiliation rules apply to venture-backed companies in determining whether a borrower has no more than 500 employees.
This has the potential to be problematic for startups because the SBA affiliation rules are highly complex and could cause lenders to group together several otherwise unaffiliated portfolio companies of a single venture capital firm in determining whether a borrower has no more than 500 employees. For reference, the SBA’s guide on size and affiliation rules can be found here.
Further guidance will be needed from regulators in order to determine the availability of these loans to venture capital financed startups. The NVCA and other industry groups are discussing the SBA affiliation rules further with regulators, and we plan to provide an update when available.
Credit Elsewhere — A borrower does not need to show it is unable to obtain credit elsewhere, which is usually a factor in SBA loans.
SBA Disaster Loans — A borrower that has taken out an SBA Economic Injury Disaster Loan (EIDL) for purposes other than payroll costs and the other “Uses” (described below) between January 31, 2020, and the date Paycheck Protection Loans are first made available will continue to be eligible for an additional loan through the Paycheck Protection Program. A borrower that has taken out an EIDL for payroll costs or otherwise between January 31, 2020, and the date Paycheck Protection Loans are first made available may be able to refinance its EIDL through the Paycheck Protection Program.
Prioritization of Certain Borrowers — The SBA is to issue guidelines to lenders and agents to ensure that the processing of the Paycheck Protection Program prioritizes borrowers in underserved and rural markets, including veterans, businesses owned by socially and economically disadvantaged individuals, women and businesses less than two years old.
Employee Retention Payroll Tax Credit — Under the CARES Act, a company that has seen (i) operations fully or partially suspended by government order or (ii) gross receipts fall by more than 50% in a quarter measured against the same quarter from 2019, may be eligible for a refundable tax credit equal to 50% of qualified wages paid to employees, up to a maximum credit of $5,000 per employee. For eligible employers with greater than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services. For eligible employers with 100 or fewer full-time employees, all employee wages qualify for the credit, whether or not the employee is providing services. However, a company may not receive both an Employee Retention Payroll Tax Credit and a Paycheck Protection Loan.
Maximum Amount — The sum of (i) borrower’s average total monthly “payroll costs” during the one-year period leading up to loan origination multiplied by 2.5 (i.e., 2.5 times average monthly payroll costs) plus (ii) the outstanding amount of borrower’s EIDL, if any, made between January 31, 2020, and the date Paycheck Protection Loans are first made available (such amount to be used to refinance the Disaster Loan), in all cases capped at $10 million.
- Payroll Costs — Includes salary, wages, commissions, tips, PTO, health insurance, retirement benefits and local employment taxes for U.S.-based service providers, capped at $100,000 annualized paid to such service provider. Excludes compensation to employees residing outside the U.S. and qualified sick leave and family leave wages that are creditable under the Families First Coronavirus Response Act.
- Seasonal Employers — Can use a measurement period of either (i) the 12-week period beginning February 15, 2019, or (ii) March 1, 2019 - June 30, 2019, instead of the one-year period leading up to loan origination.
- Companies Not in Business on June 30, 2019 — To use a measurement period of January 1, 2020 - February 29, 2020.
Maturity — Loans may have up to a 10-year term.
Interest Rate — The interest rate of each loan may not exceed 4% during the “covered period.”
- PLEASE NOTE: Inclusion of “covered period” (February 15, 2020 - June 30, 2020) adds ambiguity in this context. It could be interpreted to allow lenders to increase the interest rate after June 30, 2020. Borrowers should review lender-provided loan documents to confirm the interest rate terms of their Paycheck Protection Loan.
Fees — SBA will not collect any fees on loans issued under the Paycheck Protection Program.
Deferment — All loan payments (principal, interest and fees) are deferred for at least six months, and up to one year.
Prepayment — Loans will not have any prepayment penalties.
Nonrecourse — Loans are to be nonrecourse, except to the extent the loan proceeds are used for a purpose other than borrower’s payroll, mortgage interest, rent and/or utilities expenses.
Collateral/Personal Guarantee — A borrower (and its stakeholders) will not need to provide any collateral or personal guarantee during the “covered period.”
- PLEASE NOTE: Inclusion of “covered period” (February 15, 2020 - June 30, 2020) adds ambiguity in this context. It could be interpreted to allow lenders to require collateral and/or a personal guarantee to spring into effect upon the loan continuing to remain outstanding (or not completely forgiven) after June 30, 2020. Borrowers should review lender-provided loan documents to confirm the collateral and personal guarantee terms of their Paycheck Protection Loan.
Uses — A borrower may use the loan for payroll costs, continued group health care benefits, salaries/commissions, mortgage interest payments, rent, utilities and interest on other debt obligations incurred prior to February 15, 2020.
- PLEASE NOTE: Loan amounts used to satisfy interest on prior debt obligations are not eligible for forgiveness (described further below).
Maximum Amount — The sum of all payroll costs, mortgage interest payments, rent and utility payments incurred and made by borrower during the eight weeks following loan origination, capped at the total loan principal amount, is eligible for forgiveness.
Reduction of Forgiveness Amount — A borrower’s maximum forgiveness amount can be reduced if it reduces its number of Full-Time Equivalents (FTEs) and/or reduces wage or salary compensation, as follows:
- Number of Employees — The maximum forgiveness amount will be reduced in the same proportion that the borrower’s FTEs are decreased during the relevant eight-week period measured against the borrower’s monthly average FTEs from either (i) February 15, 2019 - June 30, 2019 or (ii) January 1, 2020 - February 29, 2020, at the borrower’s election.
- Salary and Wages — The maximum forgiveness amount will be reduced dollar-for-dollar for any wage or salary reduction of an employee in excess of 25%, measured against the wage and salary for such employee during the most recent full quarter prior to loan origination. However, employees paid more than $100,000 in 2019 are not subject to the 25% limitation on salary decreases described above.
- Rehires and Salary Increases — A borrower that previously reduced its workforce or the salary/wages it pays its employees may be able to limit the reductions to loan forgiveness described above if such borrower subsequently increases its workforce or the salary/wages it pays its employees by June 30, 2020.
Tax Impact — The ultimate amount of forgiveness received by a borrower is not taxed as income.
Documentation Process — To verify the forgiveness amount, the borrower will submit to the originating lender documentation verifying FTEs and payroll rates, including (i) payroll tax filings and state filings and payment receipts for mortgage, rent and utilities, (ii) breakdown of how the loan amount was utilized among employee retention, mortgage, rent and utilities and (iii) certification from an officer that the amount for which forgiveness is requested was used to retain employees, make payments on covered rent obligations or make covered utility payments.
- PLEASE NOTE: A borrower could consider creating a separate bank account to track the uses of loan proceeds to make it easier to provide this certification
Lenders — At the outset, the Paycheck Protection Program will be administered out of the existing network of approved SBA lenders (a recent list of active lenders is here). However, the SBA and Treasury will work to add additional lenders over time that are determined to have the necessary qualifications to process, close, disburse and service loans made with the guarantee of the SBA.
Review and Approval — The SBA has delegated authority to lenders themselves to make eligibility determinations without needing to go through SBA channels, which determinations are to be based only on eligibility criteria above (i.e., ability to repay should not be considered).
Loan Application — A description of the typical SBA loan process can be found here. However, the SBA may update the loan application process in an effort to reduce loan application and review timelines. Borrowers should refer to www.SBA.gov for the most current application information.
Access additional Fenwick guidance in our COVID-19 Resource Center.