Startups and SBA Loans

Last week Congress passed the CARES Act which provides a vast array of financial relief provisions to people and businesses in the US.

Congress is providing relief to small businesses via a forgivable loan program administered by the Small Business Administration (SBA). The SBA has long been in the business of making small business loans, but the loans under the CARE Act are very different. Here are the primary provisions of these CARE Act loans (cut and paste courtesy of my friends at KE Law):

• Loan Program Eligibility.  Any business concern (including franchises) as well as non-for-profit organizations, with no more than 500 employees are eligible to receive a single loan under this Act.  The maximum amount of the loan is the lesser of (1) $10M, and (2) 2.5 times the monthly payroll costs determined over a specific testing period.  No personal guarantees or collateral will be required for loan eligibility under this Act.

• Loan Proceeds Usage.  Loan proceeds can be used for payroll and other compensation costs, health benefits, insurance premiums, mortgage interest, rent, utilities and interest on other outstanding debt.

• Loan Forgiveness.  Perhaps the most important element of the Loan Program is its loan forgiveness element.  Pursuant to the Act, borrowers under this Act will be forgiven a specific sum equal to the sum of (1) certain payroll costs, (2) mortgage interest payments, (3) rent, and (4) utility payments that were incurred during an 8-week period beginning on the loan borrowing date.

• Forgiveness Penalties.  Given the intent of the Act to save American jobs and salaries, the amount of the foregoing loan forgiveness will be reduced by certain factors.  These factors include a reduction in the average number of full-time employees as well as substantially reduction (beyond 25%) in employees’ salaries.

• Other Terms.  The maximum loan term under the Act will be 10 years (for amounts that were borrowed that are not subject to loan forgiveness), and the maximum interest rate is 4%.  The first payment on any loan under this Act will be for at least six (6) months, but not longer than a year.

• How to Apply.  Eligible business should seek competent counsel immediately to work on the application, as the loans will begin to be available likely by the middle of April 2020.  Required information for the application will include payroll documentation, tax filings, unemployment insurance filings, proof of payment of payroll taxes, mortgage applications and the like.

So this sounds great for startups, right?

Well not so fast.

The law as written requires “affiliates” to aggregate their employees into a total and that must be below the 500 employee threshold in order to qualify for these loans. And most of the lawyers that I have talked to over the last few days read the affiliate provision in the CARES Act such that any venture capital-backed startup would need to affiliate with all of the other startups that are backed by the same venture capital firm or other kind of investor.

There are many folks in startup land (lawyers, investors, CEOs, lobbyists, etc) who are working with Congress and the SBA to address this issue. Many of the largest employers in small businesses in the US are backed at some level by investors who back many startups, including angels, seed funds, VC firms, and corporate investors.

From what I can tell, based on some work but not exhaustive work, this was not intentional on the part of Congress and there seems to be a willingness to figure this out.

If you are planning on accessing these loans, I recommend talking to a lawyer who is well versed in venture capital and startup law and make sure you are looking carefully at the affiliate provision. And if you have a relationship with your elected officials in Washington, you might want to reach out to them and explain that the Cares Act affiliate rules are problematic.

It is my hope that this “bug” in the law will get fixed over the next week or so. It may be possible for the SBA to address this issue without the need for any more work by Congress and that would be ideal in my view.