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CARES Act 101

With the Paycheck Protection Program (PPP) officially accepting loan applicants today (April 3), there’s been a lot of chatter around how the congressional stimulus impacts start-ups and the venture-backed ecosystem. I couldn’t find a single portal of information and so I pulled together the below as a quick 101 reference on what’s happening and what’s relevant. A huge thank you to the lawyers and bankers who have been doing the heavy lifting (including Deutsche Bank, Morgan Stanley, Silicon Valley Bank, Lowenstein Sandler, Goodwin Procter, Skadden, Perkins Coie, Haynes & Boone, and KROST in particular for sharing or publishing your insights). The below should be taken as informational only and I encourage reaching out to counsel as well as your banking partners with specific questions on eligibility and process given how quickly things are changing. I also recognize and appreciate the various concerns around venture-backed startups applying for federal stimulus dollars and have anecdotally seen businesses both choose to as well as choose not to apply for PPP loans. I’d love to keep this up-to-date — if you spot any errors or changes or have questions feel free to shoot me a note at jason@ivp.com.

Last update: 4/8/20

What is the CARES Act?

What is relevant for start-ups and portfolio companies?

The CARES Act authorizes $849Bn of loans for businesses, broken down as follows: $454Bn for businesses, states and municipalities, $349Bn for small business loans, and $46Bn for airlines and national security ($25Bn for airlines, $4Bn for cargo air carriers and $17Bn for businesses critical to national security).

What is the difference between EIDL and PPP?

While PPP loans are:

What if a company does not meet SBA eligibility?

Who is the lender?

EIDL: The SBA

PPP: A Bank that is already an SBA lender or any federally insured depository institution, federally insured credit union, and Farm Credit System institution that is participating. Other regulated lenders will be available to make these loans once they are approved and enrolled in the program.

When can I apply?

EIDL: Now

PPP:

Who can apply?

EIDL:

PPP:

What are the affiliation rules?

EIDL: Affiliation rules become important when SBA is deciding whether a business’s affiliations preclude them from being considered “small.” 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.

PPP: Affiliation rules become important when SBA is deciding whether a business’s affiliations preclude them from being considered “small.” 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

What is the maximum amount of the loan?

EIDL: The maximum loan size is $2 million. Applicants who apply for this loan may request an advance of up to $10,000 from the SBA. The advance will be distributed within 3 days. Applicants are not required to repay this advance.

PPP: The maximum loan size is $10 million. The calculation is as follows:

Payroll includes:

Payroll excludes:

What is the annual interest rate?

EIDL: 3.75% for businesses, 2.75% for non-profits

PPP: 1%

What is the term of the loan?

EIDL: Up to 30 years

PPP: 2 years

When is the first loan payment due?

EIDL: One year after the loan origination date (interest is accrued during the deferment)

PPP: At least six months after the loan origination date (interest is accrued during the deferment)

What can we use the loan for?

EIDL: Financial obligations and operating expenses that could have been met had the disaster not occurred

PPP: Permitted costs which are:

Is there a loan forgiveness program?

EIDL: No

PPP: Yes — calculated as the amount spent on Permitted costs by the borrower during an 8-week period (the “Covered Period”) after the origination date of the loan

What reduces the forgiveness?

EIDL: N/A

PPP: The amount forgiven is reduced based on failure to maintain the average number of full-time equivalent employees versus the period from either February 15, 2019, through June 30, 2019, or January 1, 2020, through February 29, 2020, as selected by the borrower. The amount forgiven is also reduced to the extent that compensation for any individual making less than $100,000 per year is reduced by more than 25% measured against the most recent full quarter. Reductions in the number of employees or compensation occurring between February 15, 2020, and 30 days after enactment of the CARES Act will generally be ignored to the extent that reductions are reversed by June 30, 2020. Forgiven amounts will not constitute cancellation of indebtedness income for federal tax purposes.

How do I get forgiveness?

EIDL: N/A

PPP: You must apply through your lender for forgiveness on your loan. In this application, you must include:

What collateral is required?

EIDL: The SBA will place a UCC lien against the assets of the business

PPP: No collateral is required from either the business or its owners

Is a personal guarantee required?

EIDL: Yes, for loans > $200,000, owners of > 20% of the business, managing members of LLCs, managing partners of LPs. However, no liens will be taken against real estate owned by the guarantor

PPP: No.

Do I need to have filed my 2019 Taxes to apply?

EIDL: No, 2019 Taxes do not have to be filed prior to applying for the loan. However, businesses will be asked to submit IRS form 4506T, which provides the SBA with access to historical tax returns

PPP: Will depend on the lender

Who is eligible for Midsize Business Loans?

Midsize Business Loans may be provided to (i) “eligible businesses” and (ii) nonprofit organizations (to the extent practicable), with between 500 and 10,000 employees. (Sec. 4003(c)(3)(D)(i))

“Eligible businesses” are defined to include 1. Air carriers (though such amount is limited); or 2. a United States business “that has not otherwise received adequate economic relief in the form of loans or loan guarantees provided under [the CARES Act].” (Sec. 4002(4)). Such businesses must have been (i) created or organized in the United States or under the laws of the United States and (ii) have significant operations in and a majority of its employees based in the United States. (Sec. 4003(c)(3)©).

Loan Timing

Midsize Business loans under Section (B)(4) must be made prior to December 31, 2020. (Sec. 4029).

Loan Repayment Terms

Maximum interest rate of 2% per year. (Sec. 4003(c)(3)(D)(i))

Automatic payment deferment for at least 6 months (or longer per the Treasury Secretary’s discretion). (Sec. 4003(c)(3)(D)(i)).

Conditions for Eligible Businesses to Receive Midsize Business Loans

Midsize Business Loans are subject to the following conditions (unless waived by the Treasury Secretary):

1. Dividends. The borrower will be prohibited from paying dividends or making other capital distributions on its common stock during term of the loan, and for a year after the date the loan is no longer outstanding (Sec. 4003(c)(3)(A)(ii)(I));

2. Stock Buybacks. The borrower cannot make stock buybacks of equity securities of the borrower, or any parent of borrower, that are listed on a national securities exchange (except to the extent required by a preexisting contract), during term of the loan, and for a year after the date the loan is no longer outstanding (Sec. 4003(c)(3)(A)(ii)(I));

3. Employee Compensation. The borrower must agree to cap all employee compensation (including salary, stock, and bonuses) for a period ending one year after the loan is repaid as follows:

a. Employees receiving more than $425,000 per year cannot receive (i) more compensation than they received in 2019 (except for compensation determined through a collective bargaining agreement entered into prior to March 1, 2020) or (ii) severance pay or other benefits upon termination exceeding twice the 2019 compensation amount. (Sec. 4003(c)(3)(A)(ii)(III) referencing Sec. 4004(a)(1)).

b. Officers or employees receiving more than $3 million per year cannot receive total compensation in excess of (i) $3 million plus (ii) 50% of the excess over $3 million. (Sec. 4003(c)(3)(A)(ii)(III) referencing Sec. 4004(a)(2).

The Treasury may waive the foregoing conditions as necessary “to protect the interests of the Federal Government.” (Sec. 4003(c)(3)(A)(iii))

Required Borrower Certifications

Additionally, to participate in the Midsize Business Loan program, prospective borrowers are required to certify to the following:

1. Impact of COVID-19. The uncertainty of economic conditions as of the date of the application makes necessary the loan request to support the ongoing operations of the recipient;

2. Intent to Maintain Compensation. Funds will be used to retain at least 90% of the borrower’s workforce, at full compensation and benefits, until September 30, 2020;

3. Intent to Maintain Workforce. The borrower intends to restore not less than 90% of the workforce that existed as of February 1, 2020, and to restore all compensation and benefits to the workers of the borrower no later than 4 months after the termination date1 of the public health emergency in response to COVID-19;

4. Domestic Status. The borrower is (i) created or organized in the United States, (ii) domiciled in the United States, and (iii) has significant operations and a majority of its employees based in the United States.

5. No Bankruptcy. The borrower is not a debtor in a bankruptcy proceeding.

6. No Outsourcing. The borrower will not outsource or offshore jobs for the term of the loan and 2 years after completing repayment;

7. Collective Bargaining Obligations. The borrower will not abrogate existing collective bargaining agreements for the term of the loan and 2 years after; and

8. Neutral in Organizing Efforts. The borrower will remain neutral in any union organizing effort for the term of the loan. (Sec. 4003(d)(2)(D)(i)(I)-(X)).

These certifications are expected to be included on a form provided as part of the application for the Midsize Business Loan.

Additional Eligibility Restrictions are Likely to be Included in Forthcoming Regulations

The Midsize Business Loan requirements currently do not include any specific conditions related to prudential considerations (i.e., borrowers’ ability to pay back the loan), minimum amounts of collateral, or limitations on uses of loan proceeds. Such conditions (or others) may be added as the Treasury Department and the Federal Reserve publish additional details concerning the implementation of the Midsize Business Loan program pursuant to future regulations and guidance.

Additionally, subsequent guidance and regulations may include “class” waivers of specific restrictions on stock buybacks, dividends or executive compensation on a sector-wide or case-by-case basis, as contemplated by Section 4003(c)(3)(A)(iii) of Title IV.

No Loan Forgiveness

Midsize Business Loans are not eligible for loan forgiveness. (Sec. 4003(d)(3).

Tax Treatment

Note that Midsize Business Loans shall be treated as indebtedness for tax purposes. (Sec. 4003(h)).

Loan Timing; Application Procedures

There is no process available today to apply for a Midsize Business Loan. Regulations are in the process of being prepared that will implement the program, but the CARES Act does not include a specific timeline for the launch of this particular program.

Conflicts of Interest

Midsize Business Loans are not permitted to be made to “covered entities”, which are defined as any entity in which 20% or more (by vote or value) of the equity of such entity is owned by the President, Vice President, head of an Executive department, or Member of Congress, or any spouse, children, son-in-law, or daughter-in-law of the foregoing (each, a “Covered Individual”). (Sec. 4019).

The Chief Executive Officer and Chief Financial Officer (or individuals performing similar functions) of the borrower must certify to the Secretary and Board of Governors of the Federal Reserve that the entity is eligible to obtain the Midsize Business Loan and is not an entity in which a Covered Individual directly or indirectly holds a controlling interest.

Lender Restrictions

Although the forthcoming regulations may provide additional restrictions, Title IV of the CARES Act only provides that the direct loans would be made by “banks and other lenders”. While the Treasury Secretary has broad discretion over the Midsize Business Loan Program, note that the applicable taxpayer protections and other requirements under section 13(3) of the Federal Reserve Act related to collateralization, taxpayer protection and borrower solvency still apply. (Sec. 4003(c)(3)(B)).

Syndication Rights

Midsize Business Loans must be offered as part of a bilateral loan agreement and may not be issued as part of (i) a syndicated loan, (ii) a loan originated by a financial institution in the ordinary course of business, or (iii) a securities or capital markets transaction. (Sec. 4003(c)(3)(A)(i)(II)).

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