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Guiding our clients through the Paycheck Protection Program

Dorothy Pavloff

| 06/29/20

In April, Congress passed the CARES Act, a massive piece of relief legislation intended to counter the negative economic impacts of the US government’s requirement to shelter-in-place and social distancing during the initial phase of the COVID-19 pandemic.

 

Within the CARES Act is the Paycheck Protection Program (PPP), a financial program designed to provide funding for payroll and other payments to small businesses. These loans, which may be forgiven if certain conditions are met, were distributed by the Small Business Administration (SBA) through banks across the nation.

 

Because Attivo provides CFO services to emerging growth, venture-backed companies, we knew immediately that by focusing on this program we could provide cash runway relief to many of our clients.

 

Guidance for Affiliation and Economic Necessity created confusion

 

When the initial guidelines for the CARES Act were released, many CEOs began to wonder, “Could this program be right for us?” The definition of who qualified, for how much, and the conditions under which these loans would be forgiven was unclear. As a first step, we contacted each of our clients to determine if there was interest in pursuing a PPP loan. While nearly all of our clients were interested in learning more, the guidelines provided by the SBA regarding affiliation and economic necessity made it unclear if our clients would be eligible.

 

The issue around “affiliation” questioned whether a venture-backed company is affiliated with its venture investor’s other portfolio companies and therefore aggregated as a part of a larger entity. Since the threshold for a small business was defined as 500 or fewer employees, aggregating employees would disqualify many potential venture-backed applicants. Venture firms had different interpretations of how the affiliate guidance should be applied, and whether or not they needed to surrender preference and voting rights to eliminate concerns about affiliation. A few venture firms would not change their rights, which meant their companies would not be eligible for a PPP loan.

 

The SBA’s definition of “economic necessity” was vague and the need for thoughtful consideration became even more essential, particularly given the fact that the loan application requires CEOs to certify the need with the potential for criminal and financial penalties for misapplied loans. We quickly realized a thorough analysis with supporting documentation would be needed to support a client’s application and economic necessity claim.

 

We encouraged clients to consider their economic necessity by factoring in their current cash balance, operating cash runway, and support from existing investors. We then documented this analysis, in particular the key factors considered, and in many cases presented what we found to the company’s board of directors.

 

Concerns around affiliation and the potential for criminal and financial penalties if the government did not agree with a company’s assessment of economic need, led many of our clients to forgo applying for a PPP loan. Our client base went from 100% having an interest in applying for a PPP loan to only 31% after going through our evaluation process.

 

Applying for a PPP loan was no less difficult or unambiguous

 

The challenges did not stop once a company determined it wanted to apply. Application rules were unclear and changed daily. The first-come, first-serve nature of the application process with a capped amount of aid available created a sense of panic along with a highly reactive push to try and grab available funds. These issues were compounded by the fact that most banks supporting venture-backed companies were not ready to process applications and distribute funds.

 

Many banks that serve the venture-backed community had not previously been a part of SBA loan programs so they needed to build systems to enable their many clients to apply online during a condensed period of time. Each bank’s unique application changed frequently and created confusion. Several banks asked applicants to resubmit their applications due to the changes.

 

Additionally, many banks serving venture-backed companies would only process applications for their existing customers due to “know your client” laws that require financial services firms to verify the identity, suitability, and risks associated with a business relationship. These factors led to long process queues and uncertainty about when applications would be processed and funds would be distributed.

 

PPP rules continued to evolve, raising more questions for venture-backed companies

 

Continued lack of clarity and shifting definitions of what was needed to qualify for a loan caused confusion and frustration even during the second phase of applications. Many newly specified parameters released throughout the process by the Treasury as FAQs notably impacted venture-backed companies. While it was unclear that applicants should consider alternate sources of liquidity during their initial application, according to FAQ #31 released on April 23rd, it became clear that they should have.

  • Applicants must make a reasonable, good faith determination of need
  • Applicants will need to assess “their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business” [emphasis added]

(Source: https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf)

 

If other sources of liquidity were available, it then became critical that boards consider whether the capital would be available on terms or otherwise in a manner that was not significantly detrimental to the business.

 

During the initial phase of applications, many companies applied and received funding prior to the SBA clarifying the guidelines regarding economic necessity. FAQ #31 created confusion and concern such that several companies re-thought their position on economic need and either returned their funds or pulled their application.

 

As a result of the ongoing confusion, on May 13th, the SBA released FAQ #46 which provided new guidelines regarding how the SBA will review a borrower’s good-faith certification concerning economic necessity. This statement said that any borrower who received a PPP loan with a principal amount less than $2 million would be deemed to have made the required certification in good faith. The SBA determined borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment than borrowers that obtained larger loans. This was frustrating because these guidelines were published nearly a month after the PPP process began and some companies had already made decisions to forego a loan when they could have been safely eligible.

 

As the definitions of economic necessity changed over time, we saw several of our clients return their funded loans. Given the vagueness of the guidelines, with no “brightline” test for who should apply, many risk-averse investors did not want their companies to submit an application.

 

From where we initially thought close to 100% of our clients might apply for the PPP loan, we had only 31% apply and 26% accept the funds. All that applied received a PPP loan.

 

Our client PPP statistics:

PPP terms of forgiveness are still evolving

 

On June 8th, new legislation called the PPP Flexibility Act made the following changes:

  • The loan period extension. Existing borrowers can choose to extend the original 8 week period to 24 weeks or keep your existing timeline. New borrowers have a 24-week covered period or until December 31, 2020, whichever is sooner.
  • Payroll cost requirements. Payroll must account for at least 60% of the forgiveness amount. This was previously set at 75%.
  • Employee headcount and payroll safe harbor. Loan recipients have a longer safe harbor to restore your workforce levels and wages to the pre-pandemic levels required for full forgiveness. This now must be done by December 31, 2020 as opposed to June 30, 2020. The new law adds exceptions if you’re unable to find qualified employees or restore business operations to February 15, 2020 levels due to operating restrictions.
  • Longer payback period. For the portions of the loan that are not forgiven, new borrowers now have five years to repay the loan instead of two. Existing PPP loans can be extended up to five years if the lender and borrower agree. The interest rate remains at 1%.
  • Payroll taxes. The new law allows businesses that took a PPP loan to also delay payment of their payroll taxes even after they receive forgiveness of their PPP loan, which was prohibited under the CARES Act and previous guidance.

(Source: https://home.treasury.gov/news/press-releases/sm1026)

 

On June 16th, the Treasury Department issued the loan forgiveness application based on these new guidelines. As this continues to be a fluid situation, we continue to monitor new guidelines from Congress and the SBA.

 

A sector by sector analysis of the Paycheck Protection Program

 

Let’s review the positives and negatives of each sector’s response to the Paycheck Protection Program, and use that to form takeaways as we consider what we’ve learned from this process.

 

What Attivo learned while advising venture-backed companies through the PPP process

 

As our firm looks back on the Paycheck Protection Program’s loan application process and its impact on our clients, we’ve started collecting what we’ve learned and refining how we’ll advise clients in the future. Here are some of our big takeaways as a firm:

  • Finance firms need a dedicated response team. We moved quickly to create a dedicated response team for all things PPP (and additional government support loans) and will be quick to do so again the next time a large piece of financial legislation that impacts venture-backed businesses comes through.
  • Clients need more frequent contact during a crisis. Our team checked-in regularly with our clients to determine what level of support they wanted in regard to applying for a PPP loan.
  • Following government updates diligently leads to better advising. We followed government updates on an hourly basis, which allowed us to provide the best possible information and guidance to our clients.
  • There must be a focus on client support when future funding emerges. Attivo is committed to supporting clients in a changing environment. This means being willing to help a client determine their actual needs and evaluate all options available to them.

 

Attivo has learned the importance of patience with complex legislation. As new legislation emerges, we will work with our clients and partners to provide solutions and opportunities. Ultimately, our clients that received and retained PPP loans saved jobs and extended cash runway.