If you are a startup or small business, the new Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) may provide you access to thousands of dollars (or more) in stimulus funds (i.e. free money) and favorable loans. As part of our Coronavirus Compliance and Stimulus Support Practice, we are analyzing the CARES Act and how our clients can take advantage of it. Please do not hesitate to reach out to us for further support and guidance as you navigate these programs.
Introduction
Now that Congress has enacted the first COVID-19 related stimulus bill – the CARES Act– the question we are being asked is what benefits are available to startup companies and small businesses. There are many and they are substantial. Even if you believe that your organization is well positioned to weather these tumultuous times, these programs offer significant financial offerings that would be of benefit to every business.
Not to be too blunt, but the government is offering free money to small businesses. If you don’t pay attention, you will lose out.
There are three central programs targeting startups and small businesses under the CARES Act:
- Paycheck Protection Program
- Economic Injury Disaster Loan Program
- Employee Retention Credits
This Client Update provides you an overview of these programs so that you can begin to understand how your startup or small business can maximize benefits under the CARES Act.
Paycheck Protection Program (PPP)
What is it?
The Paycheck Protection Program is a loan program operating under the Small Business Administration’s pre-existing Section 7(a) loan program. The concept is that the loan would be available to provide assistance in maintaining payroll and meeting certain other enumerated critical business expenses.
How much can we get?
The maximum size of the PPP loan is directly tied to payroll. More specifically, the loan is generally limited to the lesser of: (i) 2.5 times the average monthly payroll for the one-year period prior to the date the loan is made; and (ii) $10,000,000. This amount is somewhat misleading, as “payroll” includes certain payments made on behalf of employees (like benefits), but there are also caps on the amount of payroll per person that is counted in these calculations (i.e., payroll amounts in excess of $100,000 will be excluded). Certain outstanding balances from Economic Injury Disaster Loans (described below) can also be included, if refinanced as part of a 7(a) loan.
Are we eligible?
Generally, business with 500 or fewer employees will be eligible for PPP loans. This includes sole proprietors, independent contractors, and self-employed individuals.
Note for VC-Backed Startups: In determining what is a “small business concern” for eligibility for Section 7(a) loans, the SBA has “affiliation” rules that look beyond whether the company itself has 500 or fewer employees, by adding to that the number of employees of its “affiliates.” The CARES Act does not expressly exempt PPP loans from the affiliation rules. And we will know more when the SBA puts out the applicable regulations. But for now, VC-backed startups should keep in mind that they may have difficulty proving eligibility for this program.
What can the money be used for?
There are restrictions on how PPP loans can be used. Specifically, the loans can be used for, subject to applicable caps:
- Payroll costs
- costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums
- employee salaries, commissions, and similar compensation
- payments of interest on any mortgage obligation (which shall not include any prepayment of or payment of principal on a mortgage obligation)
- rent (including rent under a lease agreement)
- utilities
- interest on any other debt obligations that were incurred before the covered period
Do we have to pay it back?
Here’s the critical part – the CARES Act has a loan forgiveness provision for PPP loans.
Generally, PPP loans can be forgiven (i.e. you will not need to pay it back) up to a maximum of 8 weeks’ worth of the following expenses, measuring from the loan origination date:
- Payroll costs;
- payments of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation);
- payments on any covered rent obligation; and
- utility payments
None of the costs above can be forgiven unless they relate to an obligation that existed before February 15, 2020. In other words, if you enter into a lease in March 2020, those rent payments would not be forgiven. To the extent your PPP loan amount exceeds the amount that is forgiven, there are favorable interest and repayment terms available. The interest rate on the loan cannot exceed 4%. There is no personal guaranty required nor is there a collateral requirement. In addition, there is a complete deferral of any repayment obligations for at least six months.
Will we get the loan?
There is a big hitch, however. The amount of loan forgiveness is reduced in the event of an unremediated layoff or significant reduction in employee salaries. So, it is important that you understand these rules when determining whether to lay off workers or reduce their salaries, as you may be giving up free money by doing so.
There is another major hitch, as well. You cannot both get a PPP loan and participate in the Employee Retention Credit Program. Keep that in mind as you continue reading.
When can we apply for this?
The SBA has been tasked with putting out regulations and implementing the PPP Section 7(a) loan program, which we are expecting to learn more about in the upcoming weeks. So, you cannot apply to the program just yet.
But keep reading, as there is other money available right now.
Economic Injury Disaster Loan Program
What is it?
The Economic Injury Disaster Loan (“EIDL”) program is another pre-existing SBA grant program which has been expanded under the CARES Act. It is an amendment to the pre-existing Section 7(b) loan program.
How much can we get?
What is critical here, as explained further below, is that the EIDL program offers eligible applicants the opportunity to obtain a $10,000 loan advance, within 3 days, which does not need to be repaid.
The maximum amount of an EIDL loan under the CARES Act is $2,000,000, but it is further limited to the actual amount of economic injury suffered by the business due to COVID-19, as determined by the SBA.
Are we eligible?
Generally, business with 500 or fewer employees will be eligible for EIDL loans. This includes sole proprietors, independent contractors, and self-employed individuals.
Note for VC-Backed Startups: As with the PPP loans, in determining what is a “small business concern” for EIDL eligibility, the SBA has “affiliation” rules that look beyond whether the company itself has 500 or fewer employees, by adding to that the number of employees of its “affiliates.” The CARES Act does not expressly exempt EIDL from the affiliation rules. And we will know more when the SBA puts out the applicable regulations. But for now, VC-backed startups should keep in mind that they may have difficulty proving eligibility for this program.
What can the money be used for?
There are restrictions on how EIDL funds can be used. Specifically, the loans can be used for:
- providing paid sick leave to employees unable to work due to the direct effect of the COVID–19;
- maintaining payroll to retain employees during business disruptions or substantial slowdowns;
- meeting increased costs to obtain materials unavailable from the applicant’s original source due to interrupted supply chains;
- making rent or mortgage payments; and
- repaying obligations that cannot be met due to revenue losses.
Do we have to pay it back?
Unlike the PPP loans, loans under the EIDL program generally have to be paid back. But under the CARES Act, you can request a $10,000 advance on your loan through EIDL, which does not need to be repaid. It does not even matter if you are denied the loan – the $10,000 is yours to keep, as long as you use for it for qualified expenses.
And if you submit your application for an EIDL loan, you should receive the $10,000 non-refundable advance within 3 days.
What are the benefits to applying for this loan?
There’s an additional potential benefit of applying for an EIDL loan, though the eventual SBA regulations will have to flesh this out in more detail. An EIDL loan can be refinanced through the PPP loan program.
Why would you want to do this? Well, remember, the maximum PPP loan is based, in part, on a calculation determined by your average monthly payroll for the prior 12 months. That puts a hard cap on the loan amount. But your loan forgiveness amount is based on 8 weeks of payroll, rent, and certain other expenses.
Depending on your business, the maximum PPP loan amount might be less than the aggregate total of 8 weeks of payroll, rent, and other forgivable loan expenses under the CARES Act PPP loan forgiveness provisions.
In that case, the only way to maximize your potential loan forgiveness is to increase the size of your PPP loan. But remember that in determining your maximum PPP loan, the SBA includes both the calculation based on your average monthly payroll and any outstanding balance on an EIDL loan that can be refinanced as a PPP loan.
In other words, depending on your business, you may be able to maximize the benefit of loan forgiveness under the PPP loan program only by applying for an EIDL loan and refinancing as a PPP loan.
When can we apply for this?
Unlike the PPP loan program, you can apply for an EIDL loan right now. In addition, unlike the PPP loan program, you can both get an EIDL loan and participate in the Employee Retention Credit Program. This would include getting the $10,000 advance. You could not, however, have that EIDL loan refinance as a PPP loan and still participate in the Employee Retention Credit Program.
Like the PPP loan program, there are some favorable terms available. The interest rate on the loan cannot exceed 4%. There is no personal guaranty required for loans of up to $200,000. And the SBA can approve the loan based simply on your credit score without the need for submitting tax returns.
Employee Retention Credit Program
What is it?
Another program that is worth considering is the Employee Retention Credit Program (“ERCP”), which provides a refundable tax credit towards a portion of employee wages paid between March 13, 2020, and December 31, 2020.
How much can we get?
Under the ERCP, eligible employers can get a refundable tax credit of up to 50% of an employee’s wages, maxing out a total benefit per employee of $5,000 (i.e. 50% of an employee’s wages up to $10,000 over the applicable period). “Wages” not only include amounts paid via payroll, but also deductible health plan subsidies.
Are we eligible?
Eligibility for the ERCP requires employers to show that for each calendar quarter for which the credit is sought either:
- their business was fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19; or
- their gross receipts for the present calendar quarter are less than 50% of the corresponding calendar quarter from last year, provided that in that case the credit shall remain available in each calendar quarter until such calendar quarter as gross receipts for the calendar quarter reach 80% of the corresponding calendar quarter from last year (or December 31, 2020, whichever is sooner).
Importantly, if you are an “essential business” under applicable shelter-in-place or other social distancing orders, then you likely do not qualify under the first eligibility test and, instead, will have to rely on the second test.
Now, if you are an eligible employer, that does not mean every employee’s wages are counted for the purpose of receiving the tax credit. That depends on how many FTE employees you had, on average, in 2019.
If you are an employer who had more than 100 FTE employees, on average, in 2019, the only employees whose wages are eligible for the ERCP credit are employees who are still being paid, but are not providing services due to business impacts of COVID-19.
If you are an employer who had 100 or less FTE employees, on average, in 2019, all employee wages (up to the cap described above) are eligible for the credit, even employees who are still providing services.
Note for VC-Backed Startups: If affiliation rules or other criteria make you ineligible for the PPP loan or the EIDL loan, the ERCP credit may be a better option for you.
Please note that if you have employees who take paid sick or family leave under the FFCRA and you receive tax credits for the wages paid while such employees are on leave, such wages are not eligible for the ERCP credit.
What can the money be used for?
To avail yourself of the ERCP credit, you can deduct, dollar for dollar, the amount you, as an employer, owe for applicable employment taxes (generally, employer side social security taxes) for the applicable quarter, up to the amount of the available ERCP credit for that quarter. If the total amount of applicable employer side taxes is insufficient to provide the full benefit of the ERCP credit, you are eligible for a tax refund for the deficit.
Importantly, as noted above, an employer with a PPP loan cannot avail themselves of the ERCP credit. So, it is important to balance which program is more valuable. That being said, there is no explicit analogy for the EIDL program – i.e. one can get an EIDL program loan and the ERCP credit, provided they do not refinance the EIDL loan as a PPP loan.
Conclusion
With all of the focus on how the CARES Act bolsters large companies and politically-favored industries, it is heartening that there is stimulus available for startups and small businesses, as well. While the rules are somewhat byzantine – to an extent the result of fitting these stimulus benefits into already existing programs with their own complex regulations – there is money out there available for many small businesses, some of which can be accessed within days.
We are continuously reviewing the panoply of new laws, regulations, and administrative guidance with a focus on tech startups and small businesses. Please visit our Coronavirus Compliance and Stimulus Support Practice website regularly for our distillation of the latest news on the legal landscape and for practical advice you can use.
Of course, do not hesitate to contact us for support on any of these issues.