Paycheck Protection Program: Certifications and Eligibility

As seed funding slows during the time of coronavirus, we’ve started to receive calls from early-stage startup and small business clients regarding the Paycheck Protection Program (PPP), especially after the application was released last week Friday, April 3, 2020. 

The two most common questions we have received thus far are:

1. What it means to certify that the "current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant,” and
2. Whether venture-backed startups can apply for the PPP?

To that end, we discuss the two issues, and outstanding ambiguities associated with the issues, in this blog.

Q1: Is the loan “necessary to support the ongoing operations of the Applicant”?

One of the questions we have received from a business is whether it can truly certify, in the application, that the "current economic uncertainty makes this loan request necessary to support (their ongoing operations” if they either have savings or, due to financing, some financial runway to support payment of business obligations and salaries of employees at this time.

At present, there is no guidance from the Small Business Association (SBA) how much or, more appropriately, how little money a business needs to have in its bank account to so certify.  [FN 1] There is nothing saying that a business needs to first spend down its savings or reserves before applying for the PPP.  [FN 2] Even lawyers have noted that there is “room for interpretation” as to what this certification even means. [FN 3] Of course, they have recommended -- and notably, the application for most banks requires -- that the business document the bases of any required certifications to minimize risk of legal action under the False Claims Act (“FCA”), 31 U.S.C. § 3729 et seq.  [FN 4]

Finally, there is a question as to what guidance surrounding this certification would even look like, if eventually provided by the SBA or US Treasury Department.  According to Forbes:

"One idea for the Treasury is to wield the revenue-decline standard that appears in the CARES Act (see Section 2301 pages 67–68). This allows certain employers affected by COVID-19 to receive a refundable payroll tax credit. It’s 50% of qualified wages (including health benefits) up to $10,000 per employee for wages paid after March 12, 2020, and before January 1, 2021.

Your business is eligible for this credit only if (1) the operation of that business is fully or partially suspended by the government due to COVID-19, or (2) the business’s gross revenue is less than 50% of what it was the prior year’s calendar quarter, in which case the credit is available until the business recovers to earn at least 80% of the prior year’s revenue. It’s important to note that businesses which receive a loan under the new Paycheck Protection Program are not eligible for this payroll tax credit.”  [FN 5]

Q2: Can a venture-backed startup apply for the PPP?

A related question is whether a startup can meet the “less than 500 employees” eligibility criteria after the startup has been funded by, and hence possibly “associated with,” a venture firm, as provided under 13 CFR §121.301.  

The employee count could be determined by the employees of the company and the company’s “affiliates,” as defined by SBA rules and with exceptions for restaurants and hotels with fewer than 500 employees per location.   According to the National Venture Capital Association’s (NVCA) SBA Lending and Affiliation Guidance for SBA Loan Programs, “[t]o the extent a venture capital firm is ‘affiliated’ with the applicant and other of the firm’s portfolio companies, all such companies will be deemed to be affiliated with one another – and therefore the employee counts aggregated (which may move a company that has substantially fewer than 500 employees to be deemed to be ineligible as over 500).”  [FN 6]

The key issues in determining whether, for the purpose of the calculation, a venture fund is truly an “affiliate” of a startup is control over the startup.  Logically, if a venture fund owns more than half of the voting securities of a business, this will constitute majority control. However, that is not often the case for venture-backed startups.  Most venture funds do not own more than 50% of the startups in which they invest.  [FN 7]

So, presuming that the venture fund does not own more than 50% of the startup, what other questions can startups consider in determining whether they are controlled by and hence “affiliated” with their funders for the purpose of meeting the “less than 500 employees” eligibility requirement?  The following questions may be worth considering:

1. Does any funder control the company’s Board?  [FN 8]
2. Does any funder have control rights so as to “prevent a quorum or otherwise block board or stockholder actions”?  [FN 9]
3. Does any funder have negative covenants in any investment agreements/documentation that allow the funder to “block day-to-day operational decisions of the company”?  [FN 10]

Finally, for those really early-stage companies who have not undergone a priced round to date, they likely need to review the side letters accompanying their standard convertible note or SAFE notes so as to determine whether, in theory, an investor could purchase 50% or more of the outstanding shares of the company, at this time.

Footnotes:

1. See https://www.quarles.com/publications/paycheck-protection-loans-sba-answers-some-questions-punts-on-others/
2. See https://www.venable.com/insights/publications/2020/04/paycheck-protection-program-forgivable-loans
3. See https://www.ropesgray.com/en/newsroom/alerts/2020/04/SBA-and-Treasury-Provide-Additional-Information-on-Paycheck-Protection-Program?
4. See https://www.gibsondunn.com/implications-of-covid-19-crisis-for-false-claims-act-compliance/
5. See https://www.forbes.com/sites/brucebrumberg/2020/04/06/free-money-for-small-business-beware-legal-risks-of-paycheck-protection-loan-program-until-more-guidance-issued/#6e28aabd2843
6. See https://nvca.org/wp-content/uploads/2020/03/VC-SBA-Lending-and-Affiliation-Guidance-for-SBA-Loan-Programs.pdf
7. See https://www.forbes.com/sites/edwardzimmerman/2020/04/01/venture-backed-startups-can-access-sba-7a-loans--what-the-experts-arent-telling-you/#3b13fa0a7fec (hereinafter, “Edward Zimmerman Article”).
8. See Edward Zimmerman Article.
9. See https://nvca.org/wp-content/uploads/2020/03/VC-SBA-Lending-and-Affiliation-Guidance-for-SBA-Loan-Programs.pdf (hereinafter, “NVCA Article”).
10. See NVCA Article.

Smith Shapourian Mignano PC is available to answer any questions or concerns you may have regarding the Paycheck Protection Program.

This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.