It has been widely publicized that many small businesses did not receive funding in PPP “Round 1”. Coinciding with the timing of approval by Congress of “Round 2” on Thursday 4/23/2020, the SBA issued FAQ 31 to its FAQ document. This is on the heels of well-publicized reports of public companies receiving, and eventually returning, large SBA loans under the PPP program.
In addition, on April 28, Treasury Secretary Mnuchin told CNBC that the government will perform a full audit on any company taking out more than $2 million from the PPP loan program. “We will make sure that what was the intent for taxpayers is fulfilled here,” Mnuchin said in a CNBC interview. “This was a program designed for small businesses. It was not a program that was designed for public companies that had liquidity.'”
FAQ 31 (see below for full excerpt) introduces additional guidance regarding qualification: “. . . Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant. Borrowers must make this certification in good faith, taking into account their current business activity and 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. . .”
What does the new guidance mean?
It is important to note the following key elements:
- Borrowers were already required to attest on the application that “current economic uncertainty makes the loan request necessary to support ongoing operations of the applicant”.
- The CARES Act had specifically and intentionally excluded a requirement that borrowers establish they did not have access to credit elsewhere (which is typically required for SBA 7(a) Loans), but was silent in terms of a liquidity standard. This apparently has been revised now, at least in the eyes of the SBA and the US Treasury.
- With this new guidance, “Borrowers must make this [original] certification in good faith, taking into account their current business activity and 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.”
- Safe Harbor – To emphasize its point, the SBA is offering a Safe Harbor for applicants that may no longer think they qualify. “Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.”
There are three key points here that each borrower needs to examine:
1. “Current Business Activity”
The example is silent in terms of what “current business activity” should be taken into account. Each business might be impacted in one or more different ways, from reduced sales, diminishing backlog and sales outlooks, contracts put on hold, stretched receivables, increased credit risk, disrupted supply chains, pressure on staffing and wages due to increased state and federal unemployment benefits, closures, or uncertainty on when they can open for business again, just to name a few examples.
In addition, what if an employee becomes infected in the workplace? What additional costs or lost revenues might be incurred?
2. “Other sources of liquidity”
The example in FAQ 31 cites that public companies with substantial market value and access to capital markets would be unlikely to be able to make the certification in good faith.
Public companies with access to capital markets, significant cash balances, or available lines of credit may be perceived to have other sufficient sources of liquidity (whether they would feel compelled to tap that liquidity to maintain employment and incur losses is another question. . . ).
The FAQ provides no examples for small privately-held businesses. Whether that is an intentional omission is unknown; however, with the latest announcement from the Treasury, we now know that any loan greater than $2 million will be audited.
It seems reasonable to question whether existing liquidity is sufficient to weather an unprecedented public-health-driven economic crisis. It might seem “possible” that current liquidity is sufficient under one scenario, but what if the business conditions linger for months, quarters, or years? How available will emergency capital be from traditional lending sources at that time? If it is available, might it be under acceptable and reasonable terms?
3. “Not significantly detrimental”
We already know that anyone that applied for the PPP loans attested that current economic uncertainty makes the loan request necessary. When uncertainty increases, the need for liquidity and cash flow shifts from being very important to critically vital.
Most small, privately held businesses have limited access to liquidity beyond the owners’ personal assets and/or traditional financing which is underwritten based on expected cash flows and collateral and allowed borrowings are often governed by a defined borrowing base. Many or most of traditional financing agreements also include certain financial covenants which, if not maintained, can result in technical default (if not waived by the bank). Traditional financing, with these types of restrictions and criteria, may limit access to liquidity, sometimes when it is needed most.
This is where the rubber meets the road. Many business owners might desire to help their employees and keep them off the unemployment rolls, but, will a business with reduced sales continue to keep employees on payroll, incur losses, and go further into debt by tapping this liquidity? What if declining sales or aging receivables causes a reduction to your borrowing base and access to liquidity under your line of credit? What if this causes the loan to go into technical default? Is that significantly detrimental?
For many small businesses, a line of credit is their last lifeline for business continuity. When weighing whether to accept PPP Loan funds for liquidity to keep the bulk of the workforce employed, would the alternative of potentially exhausting this line of credit lifeline be considered significantly detrimental?
So what does this mean to most privately-owned small and medium sized businesses and what should you do if you applied for and received an SBA loan? Clearly the fact that large public companies received these loans and elected to return the funds sets a precedent to take note of. That said there is a big difference between the extremes of a public company that can issue stock and a mom and pop small business in terms of “sufficient liquidity” and capitalization. The latter that are in dire need of these funds would hopefully easily pass this requirement just as easily as a Fortune 500 firm might fail.
We hope that for the companies that fall somewhere in between, that common business sense might prevail. Given the revised guidance issued by the SBA and the pending May 7, 2020 deadline for returning loan proceeds, we strongly encourage you, your organization’s management, and board of directors to carefully and immediately review your company’s financial situation and reconsider the relief you may have already received with a PPP loan. Specifically, consider whether your circumstances fall within the spirit and intent of this economic relief program.
It is unfortunate that the new guidance is not more clear and objective as it may well leave well-meaning business owners with real-time questions about whether they should take the PPP Loans and ensure the employment of their employees.
What if you no longer feel you qualify?
If you have been approved for a PPP loan and repay the loan in full by 5/7/2020 (i.e. no loan forgiveness) then your original attestation will be accepted in good faith and the new requirements will not be enforced and the borrower will be offered safe harbor. If not, it apparently is assumed that you have accepted this revised version of the attestation.
What if you believe you still qualify?
If you do receive and keep PPP funding, it is critical that you maintain complete and accurate documentation to support your eligibility for such funding, the specific use of these funds, as well as your qualifications for forgiveness under the terms of the program. Speak to your advisors and legal counsel and keep good records. This documentation will be crucial were your business to be audited and/or investigated. This defensive documentation will greatly minimize your potential exposure related to your participation in this loan program.
Many of the factors influencing whether you qualify or should apply for these loans are organization specific. We encourage you to consult with legal counsel if you have questions regarding your organization’s eligibility to receive funds.
Please contact Scott Touro, MBA at email@example.com for more information.