What Startups Need to Know About PPP and the CARES Act
Duncan Davidson, General Partner of Bullpen Capital, is a highly experienced VC and a serial entrepreneur, having founded, been on the executive team, or a Board member of multiple billion-dollar companies. Earlier this week, Davidson talked with Steve Barsh, Managing Partner at Dreamit Ventures, about the CARES Act and how startups can benefit. Below, we highlight practical insight founders can use to take advantage.
Information on this page was current as of April 3, 2020
What is the CARES Act?
Congress passed the CARES Act on March 25th, 2020, to provide economic relief to American people and businesses in response to COVID-19. It serves as a bridge loan for the whole economy. Of the total $2 trillion stimulus package, the CARES Act sets aside $349 billion of direct financial aid for American small businesses. Most importantly for startups, the CARES Act expanded loans under the Payroll Protection Program (PPP).
In short, the government wants to give you financial support because they want small businesses to survive, employee headcounts to remain stable, and businesses ready to bounce back when the economy improves.
What are my immediate do’s and don’ts? (as of April 3, 2020)
Do’s:
To apply for these loans, contact your existing bank where you keep funds for your checking account, payroll, etc.
If you already have venture debt, talk to that lender. They’ll have to be involved because you’re getting another loan and they have certain rights.
Read rules around qualification, baselines, and forgiveness. Then do the math.
Be ready to apply and gather needed info so you’re prepared to fill out your bank’s online forms when applications are live.
Don’ts:
Don’t apply to the SBA for a normal loan. The way this program works, you don’t go to the SBA. If you try to file for a normal SBA loan, you may disqualify your business.
Don’t play lawyer and try to change the legal docs. Due to the high volume of applicants for these loans, founders will not have leverage to negotiate.
Don’t assume the loan will come in or that it will be forgiven. Come up with a ‘default alive’ plan for your startup based on worst-case scenarios and plan for it.
Don’t worry if your bank is not accepting applications yet. Banks are overwhelmed and many still do not have the guidance they need from the Treasury Department to start granting loans. Banks are still getting systems and processes in place to be able to distribute loans under the new program. The money is not going to run out.
Is my startup eligible for a loan?
All small businesses with 500 employees or fewer that are established US entities prior to February 15th, 2020, are eligible. This headcount figure includes full-time employees and contractors.
What are the terms of the loan?
These are payroll protection loans up to $10 million with capped interest rates at 4%. The size of the loan is based on your referenceable average monthly payroll expense for US employees. Interest payments, principal payments, and fees are deferred for at least six months and no longer than one year. The loans don’t require a personal guarantee or demand securing against personal collateral. The government gives you the loan with the intention that if you don’t downsize your employees, it turns into a grant. Loan forgiveness is part of what makes this program great. If your loan does get forgiven, you don’t have to pay back the principal or pay interest. You have to qualify to get these loans and qualify to get your loan forgiven. The loan is intended to be general-purpose money and can be used for anything (rent, payroll, etc.).
How do I determine the size of my loan?
Revenue and projected revenue are not factors for determination here. The size of your loan is based on your referenceable baseline average monthly payroll expense for US employees. You can borrow 2.5x your monthly payroll costs incurred during the one-year period before the date of the loan. Newer businesses can elect to use the first two calendar months of 2020 as their reference period. Payroll expenses include benefits for both contractors and employees. When calculating monthly payroll expenses, you have to cap each individual (employee or contractor) that gets paid more than $100 thousand annually at $100 thousand. You cannot include international employees in this calculation. This post will help you determine which expenses are included and excluded from the analysis. If we assume your monthly payroll expense averages out to $1 million, you’d be entitled to a $2.5 million loan.
How and when do I apply for my loan?
The way this program works, you don’t go to the SBA or a federal online website. Go to your bank. Most banks can handle this because they’re SBA lenders and FDIC-insured. The bank gives you the loan and in the background the SBA guarantees it. US Treasury Secretary Steven Mnuchin wants this program to start April 3rd, 2020. However, the banking system will likely still be negotiating so you won’t be able to apply through your bank until that concludes. It seems likely that applications will go live for most banks the week of April 6th, 2020. Startup-focused banks, like Silicon Valley Bank, will also be offering the program and have put out helpful resources for preparation. Bank of America is already accepting PPP applications and received 58,000 small business applications on the first day (updated April 3rd, 2020). If you’re wondering how your bank is participating, here’s a list of banks offering economic relief to businesses. If your bank’s application is not yet live, the Treasury Department put out an example application you can use to prepare.
When can I expect money in my account?
Operate your business as if you won’t get this money. Given the chaotic rollout of the process and the unclear guidance on venture-backed startups, don’t expect money to show up in your bank account until 4-6 weeks. For planning purposes, assume this magic money doesn’t show up until mid-May. It may come much, much sooner, but for now, don’t plan on it.
How is loan forgiveness determined?
Forgiveness is determined two months after you get the loan. The government looks at your average employee headcount after two months and if you don’t decrease relative to your baseline the loan becomes a grant. The baseline for comparison is elected by the borrower and can be either February 15th through June 30, 2019 or January 1st through February 29, 2020. It’s possible to downsize right now and still get forgiven two months after getting the loan because they’re looking at the average headcount. Let’s assume your referenceable baseline a year ago was 50 employees and during the two months, you average 50 employees. In that case, the loan is likely 100% forgiven and turns into a grant. If your headcount drops, your loan won’t be completely forgiven. Loans are forgiven in proportion to your headcount decline. There are also adjustments built into this to ensure you can’t just keep headcount high and cut salaries. The current intention is that your bank will handle the forgiveness process.
What are “affiliation rules” and how do they impact loan qualification?
You may have noticed that the startup and venture world has been in crisis mode over the past week over something called “affiliation rules.” As written, the PPP program mandates that venture capital-backed startups may be required to count both their own employees and the employees of the startup’s venture investors (and its portfolio companies), if the VC firm owns more than 50% of the startup. That could push the employee count of the startup over 500 – effectively disqualifying it.
For example, if a big investor has effective control of your company, then your effective headcount includes all the employees across that investor’s entire company portfolio. Let’s say that venture firm has five other startups where they own more than 50% of each and those companies employ 2,500 people. So instead of being a 100-person company, you’d get labeled as a 2,600-person firm (100 + 2,500) and thereby disqualified from these small business loans. There is currently bipartisan support to ensure that this technicality does not preclude startups from receiving PPP loans, and the National Venture Capital Association (NVCA) has also been lobbying vigorously to get a waiver on these affiliation rules (they will provide an update shortly). In short, founders should not be overly concerned about this provision.
If you are very early stage, you have even less reason to worry about this, since your investors likely do not have “effective control” of your startup. Affiliation rules likely only apply to venture-backed companies. Founders with friends and family or angel funding are often excluded because it’s unlikely those parties control the company or have VC-style protections.
In this context, control is defined as the investor’s ability to block a quorum of the board.
Two tests are used to determine “effective control”. Let’s assume your board has five people: two common, two investors, and one independent. In that case, the common/independent members have majority control of the board. If the investors do not control the board, you pass the first hoop. The second test asks: do investors have effective control even if they don’t control the board? This hinges largely on the protective provisions in their preferred stock agreement. There are varying views on which protective provisions exclude a company from the rule, but the following protective provisions are generally acceptable:
The startup can’t increase the number of shares without shareholder approval
The startup can’t sell the company without shareholder approval
Will there be another stimulus in the future?
Yes, there will likely be another bill like this. The government is currently discussing a $2 trillion infrastructure bill. This being said, founders should act as though this is the only money you’ll get. If you qualify for the program, you should take it.
How should my company operate if funding doesn’t come?
Your company needs to get into what Davidson calls “default alive.” Create a plan for your current money to survive at least 18 months. Paul Graham puts founders through a similar thought exercise by asking, “on the money they have left [...], by default do they live or die?” Graham advises it’s always better to ask this question too early rather than too late. Founders need to evaluate their companies on this basis now to ensure they’ll have enough time to make necessary adjustments. Put aside all prior assumptions on the speed of growth and what venture investors want to see. Right now they only want to see survival. This undoubtedly means downsizing. To cut your burn rate, instead of laying employees off, Davidson recommends putting employees into furlough and continuing to pay their medical benefits. In effect, employees are put on a leave of absence, retain medical coverage, continue to vest stock, and can be hired back very quickly.
Who can give me advice on this?
If you have venture investors, go to them. The NVCA is the most up to speed on what’s going on. Cooley and other law firms have helpful content as well. In the end, the best source of advice on how to benefit from the CARES Act will be your bank. Over 1,000 banks are qualified to handle SBA loans, chances are yours is one of them.
Other resources to dive deeper:
Fred Wilson’s post on CARE Act basics
Vitalize Venture Group’s guidance on loans
Forbes articles on startup strategy and the CARES Act
Dreamit’s Twitter list of news and updates
New updates on the CARES Act and the PPP in our latest #DreamitLive from April 6:
By Elliot Levy, Healthtech Associate at Dreamit Ventures
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Learn more about Dreamit Healthtech, a growth-focused program for digital health and medtech startups with revenue, pilots, or early product-market fit.