The SBA’s implementation of the Payroll Protection Program (PPP) has been a mess. The intention was to provide needed relief to businesses that were impacted economically by the COVID-19 crisis. But, while very well-intentioned, it’s implementation has been flawed. In particular, the SBA has given inconsistent guidance that continues to change and evolve, leaving companies left to wonder if they qualify or not. The result has been not just confusion but also job losses that were likely not what Congress intended the program to result in.
The Paycheck Protection Program was established by the CARES Act to help small businesses keep paying their workers. The program allows businesses with fewer than 500 employees to apply for low-interest loans to pay for their payroll, rent, and utilities. The program’s original $349 billion was allocated between April 3 and April 16. The second allotment of $320 billion was signed into law on April 23 and the SBA began accepting applications on April 27.
The program sparked confusion from the start. After its enactment but before it was implemented, there were questions about the SBA’s “affiliation rules” which can disqualify companies if the aggregated number of employees at affiliate companies is greater than 500. That rule was designed to prevent companies under common ownership from accessing SBA funds, but as it applied to PPP, it potentially excluded any venture-backed companies where venture firms owned greater than 20% equity (and where the companies were not affiliated, they just shared a common investor). Those rules seem to have been ironed out and there was initially a rush of venture-backed companies wanting to avail themselves of help under the PPP.
Many VCs urged caution (see my post describing Foundry’s view that companies should carefully consider if they met the program criteria for example, and a New York Times article on the subject, as just two examples), wanting to make sure that any company applying truly qualified for the money. It was always our belief that some venture-backed companies could and should apply (venture-backed companies employ about 2.7M people in the US) but it was unclear from the start which companies were (or should be) eligible. This confusion was compounded by several problems with the way the program was set up. The funds allocated by congress were limited and everyone expected the program to be oversubscribed. Secondly, the funds were to be given out on a first-come, first-served basis. This exacerbated the first issue and meant that anyone considering a loan needed to rush to apply and many companies did so without the space and time to think through whether it made sense for them. Additionally, the funds were distributed through the existing banking system – the only practical way to get that much money into the hands of companies that quickly for sure, but also leading banks to prioritize their own customers over others (see below for ways this created challenges to the fair disbursement of funds) and to their prioritizing larger loans over smaller ones.
The language of the act requires companies to certify that the uncertainty of current economic conditions makes it necessary to apply for the PPP loan to support its ongoing processes but it was not clear what “necessary” actually meant. Subsequent to this, the SBA released a series of FAQs in an attempt to clarify which companies qualified but this only served to further confuse things. In particular is the question of what “economic necessity” means for a business, which was the standard set in the original act by Congress. Particularly confusing to many companies was the statement that companies needed to consider whether they had alternative financing options. This concept was first brought up in the infamous question # 31 on one of the SBA’s FAQs that was released about a week ago. In that FAQ the SBA stated (emphasis added):
[B]efore 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.
The original FAQ related to public companies but was quickly extended to include private ones. Exactly what this means isn’t clear. It doesn’t appear to mean that a company needs to have a financing offer, just that they could likely raise money elsewhere; and while the PPP isn’t a “cap table protection program”, as venture attorney Ed Zimmerman has pointed out, it’s not at all clear where the bar is on alternative financings and how a company should evaluate the likelihood of its obtaining money elsewhere. Nor is it clear what that last statement means, “not significantly detrimental to the business.”
This new guidance came on the backs of some companies clearly abusing the intent of the program, if not at the time the exact language of the Act. For example, AutoNation car dealerships ($77M), Ruth’s Chris Steak House ($20M), and the Los Angeles Lakers ($4.6M). It’s understandable that public option, as well as the SBA itself, felt that the program should be clarified such that companies like these were not eligible (each of the companies above have said they will return the money).
At the same time, as I’ve written about a few times, PPP money is not getting to many of the kinds of businesses that Congress clearly intended to be helped. This is particularly true for women and minority owned businesses but also true for a wide swath of Main Street businesses that either lacked the banking relationships to access funds (which were distributed through a subset of banks in the US that were qualified under a specific SBA program) or for whom the loan program or its forgiveness element wasn’t practical. For instance, the measurement of payroll for forgiveness – a central element of the program – is 8 weeks after funds disbursement, which makes it impractical for businesses that are unable to restart their businesses in that time period (it would make much more sense to have the repayment period begin after a state’s stay at home order has been fully lifted). Additionally, the initial terms of the loan stated that the full amount of the loan needed to go to payroll, rent/mortgage, and utilities with no specific percentage of the funds going to each. Now, no more than 25% can go towards rent/mortgage and utilities.
As companies try to figure all this out, the PPP Safe Harbor has been extended to May 14 (meaning that companies can return their loans by that time and avoid any potential penalties). But we’re still waiting on final clarification on the rules, which the SBA has said is forthcoming (but have not yet been released – we’re 4 days out from the safe harbor ending). The result is confusion and quite a bit of disagreement across businesses. Many companies are trying to rely on the initial intent of the act – preserving payroll – and arguing that if they plan to reduce staff but for taking the PPP money they should qualify for the loan. That clearly isn’t the way the SBA is interpreting the Act nor how they’re guiding the business community (but it is likely closer to what Congress intended when they passed the Act). Just where the line is between need (and payroll preservation) and greed isn’t very clear. This must be clarified and done so quickly. That Treasury Secretary Steve Mnuchin has stated that all loans greater than $2M will be audited is adding to the pressure companies are feeling to get this right (and presumably the vast majority of those audits will have the benefit of a year or more of hindsight; it will be hard in many cases to divorce what actually happened from what a company thought was happening in real time).
The lack of clarity is causing real world challenges for businesses. In just one example, Zumasys, Inc., a California software company, has sued the SBA saying that it should not have to pay back its $750K loan since the SBA changed its rules for eligibility after their loan had been dispersed. They argue that they already spent the money for what the program was intended for and qualified based on what they understood the rules to be at the time. I’m not arguing for their case – just pointing out that 4 weeks into the program the SBAs changing guidance is causing real issues. This is a meaningful issue for companies who took money and kept people employed in good faith based on their understanding of the program at the time only now to have the rules changed on them. If a company returns the money they’re still on the hook for the payroll they incurred. Presumably (and we know this from our own direct experience) some will have to cut deeper now to compensate.
In related news, The Washington Post reported yesterday that the Economic Injury Disaster Loan Program (also administered by the SBA) has reduced their loan limit from $2 million to $150K and is only accepting applications from agricultural interests, due to its backlog.
It’s clear that the SBA is out of its depth and cannot cope with both the volume and the complexity of our country’s small business needs right now. While US entrepreneurs are the ones dealing with the clumsy handling of these loans in the short term, our overall economy will be dealing with the fallout for years.