The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) created a new program within the U.S. Small Business Administration’s (SBA’s) flagship 7(a) Loan Program called the “Paycheck Protection Program” (PPP). Under the PPP, SBA will guarantee 100 percent of the amounts loaned by participating lenders to certain U.S. small businesses, nonprofit organizations, veterans organizations and tribal businesses. The legislation authorizes $349 billion for the PPP. Eligible participants are permitted to borrow up to $10 million under the PPP (covered loans) from February 15, 2020 through June 30, 2020 (covered period).

Focus on Eligibility to Date

Nearly all of the focus to date in determining a business’ eligibility for a covered loan has centered around one of the following two areas:

• whether the business (together with its affiliates) is a “small business concern” under the Small Business Act pursuant to the size standard established by SBA in 12 C.F.R. 121.301(a); or
• whether the business (together with its affiliates) has no more than 500 employees (or, if a business seeking a covered loan [together with its affiliates] operates within an industry for which SBA has established a number of employees standard of more than 500, the number of employees so established by SBA).

Some businesses may find themselves feeling that they are small, but not able to satisfy either of these two requirements and, therefore, not eligible to receive a covered loan.

Another Potential Path to Eligibility

There may, however, be hope. A little-publicized alternative standard is available for determining whether a company is a “small business concern” under the Small Business Act that is not found anywhere in SBA’s regulations. Rather, it is found in an amendment to the Small Business Act enacted through the Small Business Jobs Act of 2010. This amendment accomplished two things: First, it required SBA to establish an alternative size standard under the SBA’s 7(a) loan program that uses maximum tangible net worth and average net income as an alternative to the use of industry standards; and second, it established interim alternative standards. More than nine years have passed since this amendment was enacted, and SBA still has not yet established an alternative standard. Thus, the interim standard established by this amendment remains available to determine whether a company is a “small business concern” and, therefore, eligible to receive a covered loan.

Under this interim standard, a business is a “small business concern” if the business (together with its affiliates):

• has a maximum tangible net worth that is not more than $15 million; and
• has an average net income after federal income taxes (excluding any carryover losses) for the previous two full fiscal years that is not more than $5 million.

This interim standard potentially expands the coverage of the PPP a little more broadly, although the affiliation rules still apply to this standard.

Although not defined in the Small Business Act, SBA generally defines “tangible net worth” as net worth minus goodwill. We note that, under SBA’s general definition, intangible assets are not subtracted from the net worth of the business — only goodwill is subtracted from the calculation. In addition, SBA regulations that establish similar size standards for other SBA programs include a methodology for determining “net income after Federal income taxes” with respect to businesses that are not required to pay federal income taxes at the enterprise level, but rather are required to pass income through to the business’s shareholders, partners, beneficiaries or other equitable owners. In our view, this methodology would also apply to the interim standard. Specifically, such a business’s “net income after Federal income taxes” is its net income, reduced by an amount equal to the sum of:

• if the business (and its affiliates) are not required by law to pay state (and local, if any) income taxes at the enterprise level, an amount equal to the product of (1) the business’s (and such affiliates’) net income, multiplied by (2) the marginal state income tax rate (or by the combined state and local income tax rates, as applicable) that would have applied if the business and its affiliates were taxable corporations, plus
• an amount equal to the product of (1) the business’s (and such affiliates’) net income, less any deduction for state and local income taxes calculated under the preceding bullet with respect to the business and its affiliates, as applicable, multiplied by (2) the marginal federal income tax rate that would have applied if the business and its affiliates were taxable corporations.

Conclusion

A business that satisfies the above interim size standard will be eligible to receive a covered loan under the PPP even if the business employs more than 500 persons (or a higher number of employees if it operates in an industry for which SBA has established a number of employees standard of more than 500) or otherwise fails its industry-based size standard according to its NAICS code.

*Yueyang (Sophie) Zhang, an associate in the Corporate and Securities Practice Group, contributed to the research for this article.