CARES Act: How to Get an SBA Loan If You Are a Venture-Backed Startup

*** LIVE UPDATES (Friday, April 3 at Cocktail Time) ***

–> While the PPP program did not really kick-off this morning, according to “The Administrator” per the CARES Act (Jovita Carranza, the current head of the Small Business Administration), over $4.3B loans have been approved…

*** LIVE UPDATES (Friday, April 3 in the MORNING) ***

–> House Minority Leader Kevin McCarthy (R-Calif.) told the Axios Pro Rata Podcast on Thursday that the affiliate rule will be solved to allow venture-backed startups to be eligible (due to the affiliate rule) for the CARES Act Paycheck Protection Program (“PPP”) loans. I am still unclear if this applies to startups with investors that own 50%+.

–> Despite last night’s White House press conference announcing that the program will go live today, many banks are still not OPEN for accepting loans and applications. The banks do not have details about how the entire program works but is responsible for giving the loans, making sure the due diligence is accurate, forgiving the loans, and being paid back by the federal government. As of 9:30am CT this morning, the following banks are and are not ready:

• (OPEN) Bank of America – They have their application up on their site (at least it appears that way. I am not a customer and cannot log in to see if the application is actually there).
• BBVA Compass – “BBVA, as is the case with all eligible lenders, is still evaluating guidance from the SBA and the U.S. Treasury Department. We anticipate making Paycheck Protection Program applications available sometime on Friday, April 3, 2020.”
• Capital One – “Capital One is awaiting updated guidelines and application forms from the Small Business Administration (SBA) and the Treasury Department, and thus we cannot begin accepting applications for Paycheck Protection Program Loans at this time.”
• Chase – “Please don’t send us any SBA or Treasury department forms”
• Citibank – “Our Branch and Call Center Representatives do not have any additional information at this time”
• (OPEN) Frost Bank – “To begin the application process, existing Frost business checking customers can download and complete the form.”
• Silicon Valley Bank – I have spoken to them and they are not ready for the PPP loans as of last night, they are offering existing customers their own venture debt deferral program. If you are a client, they should have already reached out.
• TD Bank – They have an online form that has no information.
• US Bank – “The Small Business Administration is finalizing this new program. We will make our application available as quickly as possible after we receive further information.”
• Wells Fargo – “As soon as we can start accepting applications, we’ll add the link to the online application. Please note that you will only be able to apply online, not by phone or in a branch.”

*** Original Post Below ***

This past week, the U.S. Federal government passed an 880-page bill, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, that will distribute over $2 Trillion in cash aimed to bailout a virus ravaged nation. Roughly, $377B has been allocated to small businesses like you, right?

[WARNING: I am not an attorney. Please get one to help you navigate this complicated issue… But if you can’t afford one due to being forced to close down, keep reading and reach out to your accountant and bank since they already have most of this information — if not more. I also prefer the  National Venture Capital Association’s response to COVID-19.]

You are a venture-backed startup in the energy space. If you are cash flow positive, bravo; hold on and capture market share when you can. For the rest of you, we are already in turbulent and unprecedented times. Many of you are already in the middle of the apocalypse and need help.

This note is specifically about how you can get money ASAP under the paycheck protection program which is the name for the main program inside of the CARES Act dealing with small businesses. There are other funding facilities in the bill,  but they (and how they may apply to you) are less known at this point.

What Is the Purpose of the Money Aimed Towards Small Businesses (Page 8)?

The title says it all: “Keeping American Workers Paid and Employed Act.” The program is specified further on in the bill (see sec. 1102) as the “Paycheck Protection Program.” The CARES Act language amends an existing program that falls under the existing Small Business Act, section 7(a).

If you want to read more about how the CARES Act loans are different than the traditional 7(a) SBA loans, read this article. But I don’t want to get you off track since most of you do not have them now and/or would not have qualified under the old program and it has now been expanded for now until June 30, 2020. Also, I also recommend going to the actual original documents to read it for yourself in case your advisors missed something. I have embedded the links above and here to the actual CARES Act and Small Business Act.

How Long Is the Money Available Under the CARES Act (Page 10)?

The CARES Act has put a tight timeline on this, meaning that you need to get busy. The covered period of the loan started on February 15, 2020, and ends on June 30, 2020. This means that you will need to have your loan granted by June 30 to receive the benefits (see below).

What Is a Small Business in Regards to the CARES Act (Page 14)?

Being a venture-backed startup, it is not obvious whether you qualify as a small business as legally defined by the U.S. federal government. The CARES Act states that you must fit into these categories:

• You must be one of these three:
  1. Must be less than 500 employees or defined as a small business by the U.S. Small Business Administration (don’t ask, but here is the link), or…
  2. Sole proprietors, independent contractors, and eligible self-employed individuals. They can also apply as long as they can show proper documentation, like IRS form 1099-MISC, as determined by the Administrator (a.k.a. the Small Business Administration) and the Secretary of the Treasury (ha ha ha…wtf), or…
  3. Any business with less than 500 employees per location and which fits under Section 72 (Accommodation and Food Services) of the North American Industry Classification System Code. In other words, hotels, casinos, and restaurants. You would know if you are “Section 72.”
• The company was in existence prior to February 15, 2020.
• The company has been impacted by COVID-19. Circumstances include supply chain disruptions, staffing issues, loss of sales or customers, or closure. You will need to provide documentation on this.
• The company must make a “good faith certification” that the funds are necessary and will be used to support the ongoing operations of the eligible recipient; to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments; that the eligible recipient does not have an application pending for a loan under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan; and during the period beginning on February 15, 2020, and ending on December 31, 2020, that the eligible recipient has not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan. This provision actually worries me for your future; however, some of you need to live to fight for another day, so let’s do it.

Potential Definitional Problem with Venture-Backed Startups: The Affiliate Problem (page 17)

There is a real fear and probability that venture capital-backed startups will not qualify for loans under this provision. There is a good WSJ article detailing the problem; however, I prefer to stand on the NVCA’s latest guidance below.

Companies must generally (i) have fewer than 500 employees or (ii) be a “small business” under the applicable NAICS code employee size standard to be eligible for the new CARES Act SBA loans, and importantly for most companies, in both cases the applicable employee number includes the employees of the company’s “affiliates” as defined by SBA rules.

A venture fund (and some or all of its portfolio companies) may be affiliated with the applicant if the fund has certain control rights, or owns 50% or more of the company, and so the “employee” count for a company may include employees of the venture fund and employees of some or all of its portfolio companies.

Companies will have to identify affiliates and make certain eligibility certifications in the loan application, and eligibility determinations should therefore be made carefully and thoughtfully.

There will be enforcement attention on distribution of the loans, and false statements, fraud, or knowing or reckless misrepresentations could have civil and criminal consequences

If you add your affiliates (your VC employees and portfolio investments that also apply), you could be well above 500 — disqualifying startups under the program. In other words, your VC will have to add up all of the employees for every portfolio company whereby they have control rights that may be deemed as having control. I explain further below.

There is a waiver of the affiliation rules outlined in the CARES Act (page 16) that states that affiliations under Section 121.103 of Title 13, Code of Federal Regulations, or any successor regulation, are waived with respect to eligibility for a covered loan. However, I have no idea how the SBA and other key government entities governing the CARES Act will rule upon whether a VC-backed startup qualifies or not.

UNFORTUNATELY, PLEASE ASK YOUR ATTORNEY AND FOLLOW THE LATEST INFORMATION POSTED ON NVCA.ORG TO DETERMINE YOUR ELIGIBILITY. Here is the NVCA letter to the U.S. Secretary of the Treasury, Steven Mnuchin, making the argument.

Affiliation Deep Dive: This is Why the Control Provisions of a Term Sheet are So Important

As I wrote last week, small businesses account for most of the net job creation in the U.S. The federal government has many programs that contract and loan money to small businesses and thus why definitions are so important.

I reviewed the SBA definitions of affiliation that can be found here under the SBA’s website or you can read the actual code 13 C.F.R. § 121.103.

“Generally, affiliation exists when one business controls or has the power to control another or when a third party (or parties) controls or has the power to control both businesses. Control may arise through ownership, management, or other relationships or interactions between the parties. Control may be affirmative or negative. Negative control includes instances where a minority shareholder has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.”

Here is the kicker and why the NVCA wants the Secretary of the Treasury to make it clear (page 15) “In determining whether affiliation exists, SBA may consider the totality of the circumstances, and may find affiliation even though no single factor is sufficient to constitute affiliation. 13 C.F.R. § 121.103(a)(5).”

It is up to you to prove that you have or don’t have affiliation with your investors.

There are 11 sections defining affiliation; however, Sections 1 & 2 matter most to venture-backed startups based upon voting control. I included the chart outlining all provisions at the bottom of this note.

You need to go back into your legal documents and determine how your control provisions work. If your VC(s) have major shareholder status, preferred stock, and/or other provisions that give them control and/or if there are small shareholders that have rights to block “veto” a vote, then you may have to count them as affiliates.

How Much Money Can You Borrow Under the CARES Act (Page 17-18)?

The CARES Act sets a “maximum loan amount” and dictates a formula to help you calculate how much you can borrow. (Do this to ensure your bank is giving you everything you need. You do not need to take it all; however, be informed).

Here is the calculation:

1. Take your average monthly payroll costs incurred during the 1-year period before the date on which the loan is made (except in the case of an applicant that is a seasonal employer, as determined by the Administrator).
2. Multiply your average payroll by 2.5.
3. Your loan cannot exceed $10M even if the two numbers above exceed it (sorry).

What is included in payroll costs (Page 11)?

It includes the compensation and benefits of any employee and independent contractor with an annual salary under $100K, health care expenses, and state and local taxes paid on compensation. The NVCA believes that you can count up to $100K towards their payroll costs, but this may have to be clarified in regulations (Ding Ding Ding… ask your attorney).

Wait a Minute, What Is the Interest Rate (Page 25)?

A covered loan shall bear an interest rate not to exceed 4 percent.

How Long Can I Pay This Back (Page 25)?

The covered loan shall have a maximum maturity of 10 years from the date on which the borrower applies for loan forgiveness under that section.

Do I Need to Give Any Personal Guarantees or Put up Collateral (See Page 24)?

No, borrowers shall not be required to provide a personal guarantee for a covered loan; and No collateral shall be required for the covered loan.

What Can You Pay for With the Loan Proceeds (Page 20)?

This is good news. While the purpose of the program is to retain employees, the loan allows you to use it for many other purposes. Those uses can include:

• Payroll costs
• Group healthcare benefits during the covered period, including paid sick, medical or family leave, and insurance premiums
• Employee salaries, commissions, or similar compensations
• Payments of mortgage interest (excluding principal)
• Rent
• Utilities
• Interest on any other debt obligations that were incurred during the covered period.

Okay, What Is the Catch? Am I Going to Get Screwed If I Take the Money?

Let’s first start out with the good news, under Sec. 1106 (page 41) is Loan Forgiveness. You need to read the provisions of loan forgiveness as outlined in the CARES Act, starting on Page 41.

These circumstances can turn the funds from a loan into a grant:

• If you spend the money on eligible expenses (payroll/rent or mortgage/utilities), up to 100% of the principal will be forgiven (you do not need to pay it back).
• If you reduce the number of your employees, the amount of the loan to be forgiven will be reduced.
• If you reduce the total compensation of the qualified employees by 25% or more, the amount of the loan to be forgiven will also be reduced.
• The Administrator and the Secretary of the Treasury may prescribe regulations granting de minimis exemptions from the requirements under this subsection. (I am not sure exactly what this means, but you should be curious and ask your favorite attorney! Your costs to apply just went up.)

This is key (page 51): “No eligible recipient shall receive forgiveness under this section without submitting to the lender that is servicing the covered loan the documentation required…”

In other words, you better have your DUCKS in a ROW.

Where do I get the Money?

Your current bank that we wired money into should be able to make these loans. Please call them. You can also apply directly here on the SBA’s website.

What If I Need Emergency Cash Now (Page 66)?

The CARES Act also carved out $10B of the bill to expand the SBA “EIDL loan program,” which offers up to a $10,000 emergency cash advance that may not need to be paid back. Please check the SBA for details. This is more aimed towards the really small businesses (like the ones being forced to shut down). 

I am writing a longer narrative based upon the CARES Act (where the money comes from, where the money is going, and a few other interesting facts) that may be launched next week. Enjoy. In the meantime, I hope you stay healthy, sane, and in business.

Appendix: Summary of Affiliation Chart