On March 27, 2020, Congress passed, and President Trump signed, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) in response to the COVID-19 emergency. Specifically, the CARES Act includes $349 billion to establish the new Paycheck Protection Program (the PPP) that expands the existing SBA Section 7(a) loan program until June 30, 2020 to provide 100% federally-backed loans to eligible businesses. 

The CARES Act expands access to the existing Small Business Administration (the SBA) Section 7(a) loan program for both lenders and portfolio companies. Under the CARES Act, business development companies (BDCs) and small business investment companies (SBICs) may have the opportunity to apply for Section 7(a) lender status and portfolio companies of BDCs and SBICs may have the opportunity to apply for and receive Section 7(a) loans.

The US Department of Treasury (the Treasury) and the SBA will have 15 days to write and adopt regulations to implement the legislation and allow lenders and borrowers to begin accessing the expanded program. The regulations are expected to include a simplified application process for prospective PPP lenders and for portfolio companies.

The full text of the CARES Act is available at this link.

Who is eligible to provide a PPP loan?

Lenders currently authorized to extend loans under the Section 7(a) loan program are automatically authorized to approve and extend new PPP loans. The SBA’s list of the 100 most active currently eligible SBA 7(a) lenders can be found here. 

The CARES Act authorizes the Treasury and the SBA to designate additional lenders to extend PPP loans. Depending on the regulations that the Treasury and the SBA implement, BDCs, SBICs and other non-bank lenders may now be eligible to access the Section 7(a) loan program that they have previously been unable to access. 

The regulations implemented by the SBA and Treasury are also expected to include a simplified application process for prospective PPP lenders, including BDCs, SBICs and other non-bank lenders. The SBA and Treasury are required to adopt these regulations within 15 days, so pending applicable regulations, BDCs, SBICs and other non-bank lenders may consider preparing to apply for PPP lender status. 

Who is eligible to receive a PPP loan?

Under the SBA size standards, and subject to the SBA affiliation rules described below, many BDC and SBIC portfolio companies may be eligible to apply for PPP loans to help pay operational costs such as payroll, rent, group health benefits, insurance premiums, and utilities. Eligible portfolio companies that may receive PPP loans include any business concern, nonprofit organization, veteran’s organization, or tribal business that has no more than 500 employees (or employs the standard number of employees established by the SBA for the industry in which the entity operates). The SBA’s size standards make reference to the North American Industrial Classification System (NAICS) codes and are based on either the number of employees or receipts, depending on the industry, and can be found here.

Do the SBA affiliation rules apply to PPP portfolio companies?

In determining how many employees it is deemed to have for SBA purposes, a portfolio company applying for a PPP loan should consider the SBA affiliation rules. Under these rules, entities are generally required to aggregate the employees of their affiliates in their employee count determination. 

For SBA purposes, entities are “affiliates” when one controls or has the power to control the other, or a third-party or parties controls or has the power to control both. It does not matter if control is actually exercised. “Control” is defined expansively under the SBA regulations to include majority ownership of voting equity, contractual control-type rights, management control, identity of interest, economic dependence, and a number of other types of “control” that can exist in majority and minority ownership scenarios. In determining whether affiliation exists, the SBA may consider all connections between the business and a possible affiliate; even though no single factor is sufficient to constitute affiliation, the SBA may find affiliation on a case-by-case basis where there is clear and convincing evidence based on the totality of the circumstances.

Under the PPP, the affiliate aggregation rules are specifically waived for:

• businesses in the accommodation and food services sector;
• franchises; and
• any business that receives financial assistance from an SBIC. 

Notably, the broad aggregation rules in the SBA’s “small business” size test may require a portfolio company’s size to be considered together with all other portfolio companies of its major investors (including, for private equity and venture capital funds, portfolio companies of earlier or later funds with common management). For instance, if a private equity fund is deemed to control the portfolio company, then the employees of every other portfolio company that the private equity fund controls will be included in the private equity fund’s total number of employees, unless any of three affiliation rule waivers described above apply. This may make PPP loan eligibility difficult for such portfolio companies. 

Portfolio companies that are not eligible for a PPP loan due to the SBA affiliation rules may want to consider similar programs or facilities being established by the Federal Reserve to enable additional lending options to small and midsized businesses having between 500 and 10,000 employees. Details of these Federal Reserve initiatives have yet to be announced, but we will provide updates as matters develop with respect to these programs.

How can a portfolio company use a PPP loan?

A portfolio company can use a PPP loan to cover:

• payroll costs; 
• costs related to the continuation of group health care benefits; 
• employee salaries, commissions, or similar compensations; 
• payments of interest on any mortgage obligation; 
• rent and utility payments; and 
• interest on any other debt obligations that were incurred before February 15, 2020.

What are the terms and conditions of a PPP loan?

Maximum Amount: Generally, PPP loans are capped at 2.5 times the average monthly payroll costs of the portfolio company and, in no event can a PPP loan exceed $10 million.

Portfolio Company Certification: Eligible portfolio companies are required to make a good faith certification to the PPP lender that the portfolio company (i) requires the funds to operate due to the current COVID-19 economic disruptions and (ii) will use the funds for eligible PPP uses (discussed above).

Interest Rates: The interest rate on a PPP loan cannot exceed 4%.

Credit Elsewhere: Eligible portfolio companies will not be required to demonstrate that they are unable to obtain credit elsewhere. 

Collateral: There will be no collateral requirements for PPP loans. 

Personal Guarantee: There will be no personal guarantee requirement for PPP loans.

Qualifying for a PPP Loan

A PPP lender is required to consider the following before determining whether a borrower is eligible to receive a Section 7(a) loan:

• That the borrower was in operation on February 15, 2020; and
• that the borrower (i) had employees for which it paid salaries and payroll taxes, or (ii) paid independent contractors reported on tax Form 1099-MISC.

Are PPP loans eligible for forgiveness?

A portfolio company can apply for PPP loan forgiveness if it demonstrates that the loan proceeds were used for the eligible purposes discussed above. Indebtedness will be forgiven (and excluded from gross income) in an amount equal to the costs incurred and payments made for eligible purposes (e.g., payroll/benefits (excluding employee compensation above $100K), mortgage interest, rent and utilities) during the covered period (eight-weeks beginning on the date the lender originates the PPP loan for the portfolio company). Forgiveness amounts are limited to the principal amount borrowed. 

However, if the portfolio company reduces salaries or cuts employees, the forgiveness amount will be correspondingly reduced. If the portfolio company rehires the employees or ends the salary reduction before June 30, 2020, the loan amount eligible for forgiveness will not be affected. The SBA is required to issue regulations governing loan forgiveness within 30 days of the enactment of the CARES Act. 

A portfolio company seeking loan forgiveness with respect to a PPP loan is required to submit to the lender that is servicing the loan an application that provides certain documents and makes certain certifications. The SBA is required to issue regulations that provide further details regarding PPP loan forgiveness within 30 days of the enactment of the CARES Act.

Conclusion

The CARES Act may expand access to the Section 7(a) loan program for BDCs, SBICs and their portfolio companies through the PPP. Pending applicable regulations, BDCs, SBICs and other non-bank lenders may consider preparing to apply for “designated lender” status under the legislation and should begin to consider whether their portfolio companies may qualify to apply for a PPP loan under the new, expanded program. 

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