Finding the Right Fit Under CARES: Understanding the SBA Loan Programs Available Under the CARES Act and Determining Eligibility and Business Need
On Friday March 27, 2020, President Donald J. Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), providing hope for struggling businesses. Among other measures, the CARES Act provides multiple avenues of relief and assistance to small businesses devastated by COVID-19 through programs administered by the Small Business Administration (“SBA”). In particular, the CARES Act changes the size limits for consideration as a “small business concern,” making more businesses eligible for assistance through these programs.
Each business is unique so owners should consider the various assistance and incentive programs now available under the CARES Act prior to making any short- and long-term planning decisions. Given the different eligibility criteria, the programs and incentives must be evaluated separately for each business taking into account the eligibility requirements, the applicable industry in which the business operates and financial and other contractual commitments of the business during this challenging time.
The Nossaman CARES Act Team is here to help in this endeavor.
PAYCHECK PROTECTION PROGRAM (“PPP”)
What is the PPP?
The PPP introduces a new type of SBA loan intended for small businesses to maintain their payroll levels. PPP loans are 100% federally guaranteed and are available from April 3, 2020 until June 30, 2020 for eligible businesses to cover the cost of:
- insurance premiums and group health care benefits;
- employee compensation (with some limitations for employees with salaries over $100,000 and exclusions for non-U.S. based employees);
- interest on mortgage obligations (but not repayment of principal);
- rent and utilities; and
- interest on debt incurred prior to February 15, 2020.
The maximum amount of a PPP loan that may be borrowed through June 30, 2020 is equal to the lesser of:
- $10 million; or
- 2.5 times the business’ average total monthly payroll costs, as defined in the CARES Act. 1
Unlike most typical SBA loans, PPP loans are unsecured loans requiring no collateral, no personal guarantee from the business owners, and no requirement that the borrower demonstrate that credit cannot be obtained elsewhere. PPP loans have a maximum 10-year term and the interest rate may not exceed 4% per annum. PPP loans will be made available through SBA-approved lenders, who must offer borrowers a 6 to 12 month deferment on payment of principal, interest and fees.
A recipient of a PPP loan is eligible for loan forgiveness for amounts spent during the 8-week period after the loan origination date on payroll costs (as defined in the CARES Act), rent, mortgage interest, or utilities. The amount forgiven must not exceed the principal amount of the loan. The amount that may be forgiven is decreased if the business has laid off employees or decreased employee compensation during the 8-week period following the origination of the loan. However, this reduction penalty does not apply to the extent the business restores their employee count and compensation by June 30, 2020.
Who can apply for a PPP loan?
To be eligible for a PPP loan, a business must be one of the following:
- small business under the existing SBA regulations; or
- business, nonprofit organization, veterans’ organization, or Tribal business that employs not more than 500 employees or the number of employees in the size standard applicable to your industry (for some industries this could be as high as up to 1,500 employees).
Businesses in the accommodation and food services industries (such as restaurants, bars and hotels) with more than one physical location are also eligible for a PPP loan so long as they employ not more than 500 employees at each physical location. For example, a restaurant owner that operates in two locations and employs, in the aggregate, more than 500 employees across both locations would still qualify for a PPP loan so long as each location does not have more than 500 employees.
The CARES Act also waives the SBA’s existing affiliation rules for:
- any business in the accommodation and food services industries with not more than 500 employees on the loan origination date;
- any business operating as a franchise that has been assigned a franchise identifier code in the SBA Franchise Directory (available here); and
- any business that receives financial assistance from a Small Business Investment Corporation (“SBIC”).
Note, however, that all other eligible businesses are still subject to the SBA’s existing affiliation rules. These affiliation rules aggregate an applicant’s full-time and part-time employees with those of their domestic and foreign affiliates. Identifying which companies qualify as “affiliates” under the SBA regulations can be a fact-intensive inquiry, but the key to affiliation is the ability to control a business.
To be eligible for a PPP loan, the business must have been operating on February 15, 2020 and must have, as of that date, employees for whom the business paid salaries and payroll taxes, or paid independent contractors. Additionally, when applying for a PPP loan, a borrower must certify that:
- the loan request is necessary to support the business’ ongoing operations, due to the uncertainty of current economic conditions;
- the loan funds will be used by the business to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments;
- the business does not have an application pending for another SBA loan for the same purpose; and
- the business has not received an SBA loan between the period February 15, 2020 and December 31, 2020 for the same purpose.
How to apply for a PPP loan?
PPP loans under the CARES Act will be disbursed by SBA-approved lenders directly to borrowers, not by the SBA itself. Note that the SBA will need to issue regulations on PPP loans, including guidance on their forgiveness and deferment, within 30 days of the enactment of the CARES Act (i.e., by April 27, 2020). While it is unlikely that lenders will make PPP loans available to borrowers until such regulations and guidance have been issued, businesses should not wait until then to contact their lenders. It would be wise for businesses to contact their lenders now to ask whether the lender is participating in the PPP and, if so, to express an interest in taking out a PPP loan. A list of the 100 most active SBA lenders can be found here.
ECONOMIC INJURY DISASTER LOAN PROGRAM
In addition to introducing the PPP, the CARES Act also expanded the SBA’s existing Economic Injury Disaster Loan (“EIDL”) program to provide for more favorable borrowing terms.
What is an EIDL?
An EIDL is a low-interest federal loan issued by the SBA to alleviate economic injury to small businesses or nonprofit organizations experiencing injury. Ordinarily, an EIDL is a working capital loan of up to $2 million that can be used by a business to pay fixed debts, payroll, accounts payable and other bills that the business cannot pay as a result of the disaster. EIDLs are not meant for business expansion. The interest rate on EIDLs is fixed at 3.75% per annum for small businesses and at 2.75% for nonprofits. The maximum term of an EIDL is 30 years.
Ordinarily, to be approved for an EIDL, a business must demonstrate the following:
- an acceptable credit history;
- an ability to repay the loan;
- that the business is located within a state or county that has received an economic injury disaster declaration;
- that the business has suffered a substantial economic injury as a result of the disaster; and
- that the business is unable to obtain credit elsewhere.
In addition to the above, the business must provide the SBA with the following:
- collateral for loans of more than $25,000 (however, generally in practice the SBA often will not a reject loan application for lack of collateral);
- a personal guarantee from the business owner(s) for loans of more than $200,000; and
- documentation including complete copies of recent federal income tax returns, schedule of liabilities, and personal financial statements for all owners of the business.
How does the CARES Act change EIDLs?
Businesses previously eligible to receive EIDLS, including small businesses, continue to remain eligible for EIDLs after passage of the CARES Act. However, the CARES Act expanded EIDL eligibility for the period between January 31, 2020 and December 31, 2020 (the “covered period”) to include any business, nonprofit organization, veterans’ organization, or Tribal business that employs not more than 500 employees or the number of employees in the size standardapplicable to relevant industry.
For any loan application resulting from COVID-19, the CARES Act relaxes the normal requirements in the following ways:
- personal guarantees for loans up to $200,000 are not required; however personal guarantees from owners of more than 20% of the borrower will still be required for loans in excess of that amount;
- the CARES Act waives the requirement for the borrower to demonstrate that it is unable to obtain credit elsewhere;
- while the CARES Act does not require the borrower to have been in business for a one year period prior to the COVID-19 outbreak, the business must have been in operation as of January 31, 2020; and
- the SBA can approve an EIDL based solely on the credit score of the applicant or other means of determining the applicant’s ability to repay the loan, without requiring the submission of tax returns. This should expedite approval of EIDLs during the covered period.
Applicants of EIDLs would still be subject to the SBA’s affiliation rules, as expanded under the CARES Act (discussed above).
How to qualify for an EIDL?
To qualify for an EIDL under the CARES Act, an applicant must have suffered “substantial economic injury” from COVID-19. EIDLs under the CARES Act are based on a company’s actual economic injury as determined by the SBA, capped at $2 million. EIDL loans may be used for payroll and other costs as well as to cover increased costs resulting from supply chain interruption and to pay obligations that cannot be met due to revenue loss.
The CARES Act also permits applicants who submit EIDL applications during the covered period as a result of COVID-19 to request an advance of up to $10,000 to pay allowable working capital needs. The advance is expected to be paid by the SBA within 3 days of the application. This advance is essentially a grant and is not required to be repaid, even if the application is denied. However, if the business is subsequently approved for a PPP loan (see discussion below), the amount of the advance must be deducted from any loan forgiveness amounts under the PPP loan.
WHAT ARE THE RELEVANT CONSIDERATIONS IN DETERMINING WHICH LOAN IS MORE APPROPRIATE?
The following considerations should be taken into account when determining whether to apply for a PPP loan or an EIDL:
- The different eligibility requirements for each program.
- PPP loans are capped at $10 million, with an applicant’s limit determined by a formula tied to payroll costs. EIDLs are capped at $2 million.
- PPP loans can have maturities of up to 10 years with deferment of interest and principal for between 6 to 12 months. EIDLs can have maturities of up to 30 years and principal can be deferred for up to 12 months; however, interest will continue to accrue on an EIDL during the deferment period.
- PPP loan interest rates are capped at 4%. EIDL interest rates for COVID-19 are capped at 3.75% for businesses and 2.75% for nonprofits.
- PPP loans may be forgiven. EIDLs may not be forgiven; however, applicants may receive an emergency grant of up to $10,000 that is not required to be repaid.
- Businesses that have already applied for or received EIDLs due to COVID-19 can seek to refinance their EIDL with a PPP loan to take advantage of the PPP’s loan forgiveness provisions.
- PPP loan applications must be made to SBA-approved lenders. Applications for EIDL must be submitted directly to the SBA.
CAN A BUSINESS RECEIVE BOTH A PPP LOAN AND AN EIDL?
Generally, a business that meets the eligibility requirements of a PPP loan as well as an EIDL can apply for loans under both the programs. However, where the business has both a PPP loan and an EIDL, the business should use the EIDL for a purpose other than covering payroll costs.
Given the very favorable terms of these two SBA loan programs and the potential for loan forgiveness under PPP loans, eligible businesses who have been economically impacted by COVID-19 should strongly consider taking advantage of one or both of these loan programs.
OTHER RELIEF MEASURES FOR BUSINESSES
In addition to relief under the CARES Act, some states may have their own loan, grant or other incentive programs to assist businesses overcome the challenges created by COVID-19.
The Nossaman CARES Act Team is here to assist on COVID-19 relief measures under the CARES Act and/or state relief programs.
1 “Payroll costs” is defined in the CARES Act to mean compensation to employees that is a salary, wage, commission or similar compensation; cash tips; vacation, parental, family, medical, or sick leave; allowance for dismissal or separation; group health care benefits; retirement benefits; and state or local taxes on the compensation of employees. With respect to sole proprietors or independent contractors, “payroll costs” is defined as an amount not more than $100,000 in one year (prorated for February 15 to June 30, 2020).