Can you Get a Loan under the SBA Paycheck Protection Program (“PPP”) if you are a Startup?
Startups may be eligible for PPP SBA loans after careful evaluation of the “affiliation” rules with their counsel.
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), signed into law on March 27, 2020, includes funding for the Small Business Administration (SBA) to fund loan programs to assist small businesses. One of the SBA programs is the Paycheck Protection Program (“PPP”), which provides for a forgivable loan to cover payroll and certain other costs over the 8-week period after the loan is made.
Much has been written about the PPP; here we cover the applicability of the PPP to startups. The PPP applies to businesses with fewer than 500 employees. While at first glance most startups have fewer than 500 employees, the SBA has certain “affiliation” rules that would require the company to count the employees of its investors (and potentially other companies the investors are affiliated with) in the employee count, which could exceed 500 employees.
- For the technically minded (and when discussing with professional advisors), the starting place is the right set of SBA affiliation rules. The SBA has clarified that the affiliation rules applicable to the PPP are found at 13 CFR Section 121.301, not 13 CFR Section 121.103. The 301 affiliation rules are more friendly to startups than the 103 rules.
- The first test for affiliation is whether the investor (e.g. a venture fund) owns more than 50% of the voting securities of the company. This is a bright-line test and pretty intuitive – if an investor owns a majority of the company, it is an affiliate of the company.
- It is not that common, however, for a single fund to own more than 50% of the shares of a company in a venture financing. Therefore, many startups should pass the first test.
- The second test is less intuitive, however, because it applies to minority investors. A minority investor will be deemed an affiliate of the company (thereby potentially causing the number of employees to exceed 500) if the investor (i) has the ability to prevent a quorum or (ii) otherwise block action by the board of directors. While not completely free from doubt, the stronger view is that the requirement is applied to each individual investor and not collectively to a group or class of investors.
- Startups should discuss the quorum requirement with their counsel based on a review of applicable legal documents to determine whether a single investor can prevent a quorum.
- Actions by the board of directors can be blocked in a number of ways by investors. Counsel for the company should again review the applicable legal documents. Common ways in which an investor may block actions by the board include:
- Provisions in the Articles of Incorporation requiring the vote of the investors as a class on certain matters, such as declaration of dividends, amending the Articles of Incorporation in a way that would adversely affect the investors etc.
- Provisions in the venture documents, particularly the Investors Rights Agreement, giving the investor-appointed director veto rights over certain matters.
- Fortunately, not all blocking rights by the investors or investor-appointed director result in a venture fund being deemed affiliated with the company. The National Venture Capital Association (NVCA) recently provided guidance on the types of rights that may result in affiliation in Affiliation in the Context of SBA Loans – Guidance for Venture Capital Investors, although care should be taken in applying the prior decisions of the SBA as most were decided under Section 103 rather than 301. The SBA may take a more liberal view of affiliation under Section 301 compared to Section 103, particularly as Congress’ intent is to provide relief to small businesses, which should include startups.
- In future financing rounds, startups should pay particular attention to protective provisions granted to larger investors that are common in venture financings to understand how they could impact qualifying for SBA loan programs.
If you require any further information about affiliation rules under the PPP, please contact Edward Grenville, Managing Shareholder, Inspire Business Law Group, PC (email@example.com; +415 279 0779; www.inspirelawgroup.com).
This article is provided for educational and informational purposes only and is not intended to be, and should not be construed as, legal advice.