The United States Congress has passed the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) to respond to the medical and economic impact of the COVID-19 pandemic.
The CARES Act provides relief to small businesses primarily through two loan programs administered by the U.S. Small Business Administration (SBA): a new $349B Paycheck Protection Program (PPP) and a $10B expansion of the existing Economic Injury Disaster Loan Program (EIDLP).
In this bulletin we discuss the availability of each of these programs to private equity portfolio companies, and their important terms and conditions.
The CARES Act authorizes the SBA to issue forgivable loans of up to $10M to eligible small businesses to enable them to maintain their payroll through the coronavirus crisis. Loan forgiveness may be reduced if a business reduces employee headcount or reduces employee salaries and wages between February 15 and June 30, 2020.
Under existing SBA rules, for a business to be eligible for an SBA loan, it must:
(1) be a partnership, sole proprietorship, LLC, corporation or joint venture organized for profit;
(2) together with its affiliates, either (a) employ fewer than a specified number of employees or (b) earn annual revenues below a specified threshold;2
(3) have a place of business in the U.S.; and
(4) operate primarily in the U.S. or make a significant contribution to the U.S. economy through tax, labor or use of products.
To qualify for loans under the PPP, the requirements related to a business’s nexus to the U.S. continue to apply, but a business does not need to satisfy the above organization and size requirements so long as it is:
Unlike the SBA’s existing regime for small business loans, loans made under the PPP do not include a revenue cap and do not require personal guarantees. All regular fees charged to borrowers will be waived.
Considerations for private-equity owned businesses
Applicants under the PPP will be aggregated with their “affiliates” for purposes of determining whether they constitute an eligible small business for purposes of counting employees against the 500-person threshold.
Entities (whether U.S. or foreign) are considered affiliates where one has the power to control the other, or the entities are under the common control of a third party, whether by ownership, common management or contractual relationships. Non-U.S. employees of an affiliate count toward the 500-employee threshold.
For example, a portfolio company with 100 employees fails to meet the 500-employee limit if its sponsor also owns three other portfolio companies with 150 employees each, even if all of the employees of these other companies report to work abroad.
We expect that these affiliation rules may present challenges for many private equity-backed portfolio companies that wish to access the program.
Note, however, that the following categories of businesses are exempt from the affiliation rules under the PPP:
Maximum principal amount: Lesser of $10M and 2.5 times average monthly payroll during the preceding 12 months.
Interest rate: Maximum annual interest rate of 4%. Interest payments are deferred for one year and there are no prepayment penalties.
Use of proceeds: PPP loans may be used for payroll costs, including paid sick, medical or family leave, healthcare benefits, salaries or commissions, mortgage interest payments, rent and any other debt obligations incurred prior to February 15, 2020. They may not be used to pay (1) certain federal taxes, (2) individual compensation over $100,000 per year, (3) compensation to non-U.S. employees or (4) sick or family leave under the Families First Coronavirus Response Act (you can read more about U.S. emergency employee leave in our bulletin here).
Loan forgiveness: PPP loans will be eligible for loan forgiveness for amounts spent during an eight-week period commencing on the loan origination date to pay interest on mortgage obligations incurred before February 15, 2020, rent under leases in effect before February 15, 2020, payments for utilities for which service began before February 15, 2020 and payroll costs. A borrower’s loan forgiveness may be reduced:
Loan forgiveness will apply retroactively, allowing employers that made layoffs between February 15 and April 27 to rehire employees without penalty prior to June 30, 2020.
The CARES Act also expands the SBA’s existing EIDLP by authorizing an additional $10B for loans to assist small businesses in dealing with the effects of COVID-19 and allowing all eligible businesses to apply for such loans immediately.3
To be eligible under the EIDLP, a business must satisfy the existing SBA criteria described above related to organization type, size and nexus to the U.S. The additional funds under the EIDLP are available to all currently eligible small businesses, as well as the following additional applicants:
Recipients of PPP loans for payroll, mortgage payments or other COVID-19-related debt obligations are not eligible to receive an EIDLP loan for the same purpose.
Considerations for private-equity owned businesses
Private-equity backed portfolio companies will face the same aggregation rules for PPP loans. The exclusions for accommodation and food services businesses, franchises and small venture investment company backed entities do not apply to the EIDLP.
Only small businesses that have suffered actual economic injury resulting from the coronavirus will be eligible for loans under the EIDLP. Additional terms and conditions of EIDLP loan include:
_________________________
1 The SBA has issued detailed guidance on its Size Program and Affiliation Rules, which is available at https://www.sba.gov/sites/default/files/articles/affiliation_ver_03.pdf.
2 The employee and revenue thresholds vary based upon the industry in which the business is primarily engaged and are generally 100-1,500 employees and $1M-42M, respectively.
3 For EIDLP loan applications made between January 31, 2020 and December 31, 2020, the SBA will waive existing requirements (1) for personal or collateral guarantees (only on advances and loans of less than $200,000); (2) that an applicant must be in business for one year prior to COVID-19; and (3) that an applicant be unable to obtain other credit. Small businesses will be authorized to request up to $10,000 in advances on EIDLP loans, which the SBA will distribute in three days.
Read all our coronavirus-related updates on our COVID-19 guidance for organizations resource page.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2023 by Torys LLP.
All rights reserved.