Only the types of business concerns described below are eligible to receive PPP loans:
- A business (or nonprofit organization or veterans’ organization) that, together with its affiliates, has 500 or fewer employees whose principal place of residence is in the United States
- A business whose primary NAICS code starts with 72 (accommodations and food service), and that has, together with its affiliates, 500 or fewer employees per location
- A business (or nonprofit organization or veterans’ organization) that, on its own, meets the size standard (employee-based or receipts-based) established by the SBA for the NAICS code applicable to its primary industry, and, together with its affiliates, meets the size standards established by the SBA for the NAICS code applicable to its primary industry or the primary industry of itself and its affiliates on a combined basis, whichever is higher (see SBA size standards)
- A business that, together with its affiliates, is a “small business concern” in that it has a tangible net worth not in excess of $15 million as of March 27, 2020, and an average net income after federal income taxes (excluding carry-over losses) for the two full fiscal years before the date of the application not in excess of $5 million
- Sole proprietors, independent contractors, and self-employed persons
- A business operating as a franchise that is assigned a franchise identifier code by the SBA
- Any business that has received financial support from a Small Business Investment Company (SBIC)
For purposes of determining the number of employees that an applicant has in order to evaluate whether it is eligible for a PPP loan, the applicant must aggregate its employees with all of the employees of its affiliates. The affiliation analysis is focused on whether another entity has the right to control the applicant, whether through its ownership of voting securities or negative control covenants over ordinary course business decisions (as opposed to extraordinary business decisions). As a general matter, the SBA deems entities to be affiliated with each other when one controls or has the power to control the other, or when a third party controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists. This topic was a source of concern for many companies with institutional investors, including venture capital and private equity funds, and the National Venture Capital Association (NVCA) requested rulemaking to clarify the application of the affiliation rules under to PPP loans.
On April 3, 2020, the SBA published an interim final rule addressing that issue, but the affiliation interim final rule did not provide an exception to affiliation rules for companies with venture capital or private equity fund investors. The affiliation rules are critical to an applicant’s analysis of whether it is eligible for a PPP loan based on its size status. For example, to determine whether an applicant meets the first test above, i.e., 500 or fewer employees, the applicant must aggregate its own number of employees with the number of employees of all of its affiliates for purposes of determining eligibility. The affiliation rules applicable to PPP loan eligibility are summarized as follows:
- Affiliation based on ownership. Any individual or entity that owns more than 50% of the voting securities of an applicant is deemed an affiliate. Such individual or entity must aggregate together its employees, along with the employees of any other entities that it controls, together with the number of employees employed by the applicant, in order to determine whether the applicant has more than 500 employees.
- Treatment of options, convertible securities, and agreements to merge. Note that in determining whether any equity holder owns more than 50% of the voting securities, options/convertible securities/agreements to merge (provided they are “agreements in principle” and not agreements that are open or under negotiations towards the possibility of a merger) are given present effect, and treated on a fully vested and/or on an as-exercised basis. Options, convertible securities, and agreements that are subject to conditions precedent which are incapable of fulfillment or are speculative or legally unenforceable are not given present effect.
- Equity holders seeking to sever affiliation through the relinquishment of control should be mindful that temporary relinquishment of control, combined with a provision that restores the prior status quo once it is no longer necessary for PPP loan eligibility, very likely would not prevent affiliation.
- Negative control by minority equity holders. The SBA will deem a minority equity holder to be in control if that individual or entity has the ability, under the concern’s operating agreement, charter, by-laws, shareholder's agreement, or similar document, to prevent a quorum or otherwise block action by the board of directors or the equity holders. Negative control can also result from a minority equity holder’s ability to block ordinary actions essential to the company’s operations. In Size Appeal of Southern Contracting, the SBA’s Office of Hearings and Appeals (OHA) explained that a company giving minority owners the ability to block certain extraordinary actions of the company did not provide negative control to the minority owners, if those blocking rights function to protect the investment of the minority owners, and not to impede the majority’s ability to control the company’s operations or to conduct the company’s business as it chooses. See Size Appeal of Southern Contracting Solutions, LLC, SBA No. SIZ-5956, 2018 (S.B.A.), 2018 WL 4492382.
- The chart below describes rights that the OHA has found in particular cases to indicate affiliation, as well as the rights that do not typically create affiliation. However, note that the OHA has suggested that a single indication of negative control is not necessarily, by itself, sufficient to find affiliation. Thus, whether negative control exists depends on the specific facts and circumstances of the individual company. Determining whether a particular company has affiliates under the negative control test thus requires a case-by-case analysis.
Ordinary Decisions (Indicating Affiliation)
Extraordinary Decisions (Indicating No Affiliation)
- Taking on new debt
- Issuing dividends (other than tax distributions)
- Establishing or amending the applicant’s employee incentive plan
- Setting officers’ compensation
- Hiring and/or firing officers and executives
- Purchasing equipment
- Making changes to a budget or approving capital expenditures outside of the budget
- Incurring expenses over $5,000
- Entering into contracts or joint ventures
- Incurring or guaranteeing debts or obligations
- Initiating or defending a lawsuit
- Amending or terminating leases
- Adding new members
- Dissolving the company
- Filing for bankruptcy
- Amending the organizational documents of the company (e.g., certificate of incorporation/formation, bylaws or operating agreement)
- Issuing additional capital stock
- Increasing or decreasing the size of the board
- Entering into a substantially new business
- Selling all or substantially all the company’s assets
- Disposing of the company’s goodwill
- Submitting a company’s claim to arbitration or entering into a confession of a judgment
- Entering into a change of control transaction
- Mortgaging or encumbering all or substantially all of the company’s assets
- Committing any act that could result in a change in the amount or character of the company’s contribution to capital
- Affiliation based on common management. Affiliation based on common management arises where the CEO or president of the applicant (or other officers, managing members, or partners who control the management of the applicant) also controls the management of one or more other businesses. Affiliation also arises where a single individual, concern, or entity that controls the board of directors or management of one applicant also controls the board of directors or management of one or more other businesses. Affiliation also arises where a single individual, concern or entity controls the management of the applicant concern through a management agreement. Therefore, prospective applicants should carefully evaluate with their management team and controlling board members, and with any entities which have control over the applicant pursuant to a management agreement, whether any such persons control any other entities.
- Affiliation based on identity of interest. Affiliation based on identity of interest arises when there is an identity of interest between close relatives, as defined in 13 CFR 120.10, with identical or substantially identical business or economic interests (such as where the close relatives operate concerns in the same or a similar industry in the same geographic area). Where the SBA determines that such interests between close relatives should be aggregated, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one are in fact separate. For example, two family members who collectively own 60% of the voting securities of an applicant may be deemed affiliates of each other, and since they own more than 50% of the voting securities of the applicant, each would need to add the employees of any other entities they respectively control to the number of employees employed by the applicant, for purposes of determining eligibility for a PPP loan.
- Severing affiliation. The SBA has provided guidance that a minority equity holder can sever its affiliation with an applicant by irrevocably waiving or relinquishing any existing rights specified in 13 CFR 131.301(f)(1), assuming that such rights were the only rights causing the affiliation. Venture capital and private equity-backed companies should take note that such rights must be irrevocably waived. Any rights that “snap back” are likely to be given present effect, and the affiliation would not be severed.
- Affiliation as applied to the Alternative Size Standards. As noted under “Eligibility” above, a business that, together with its affiliates, is a “small business concern” is also an eligible borrower if it meets both tests in the SBA’s “alternative size standard”. In an FAQ released on April 8, the SBA provided that a business could meet those tests if, as of March 27, 2020: (1) maximum tangible net worth of the business is not more than $15 million; and (2) the average net income after federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than $5 million. The SBA clarified in the April 8 FAQ that the affiliation rules must be applied to the alternative size standard. This has provided an opening for private equity and venture capital investors to consider whether, after applying the affiliation rules, a portfolio company will meet those tests because the tangible net work and net income of the entire affiliated group meets those standards. The SBA has not issued any guidance on this approach, but absent additional guidance, it appears that institutional investors may rely on the alternative size standard for portfolio companies that are otherwise able to make the necessary certifications. This raises questions, such as whether to count the funds, whether to count the management company, whether to calculate net income on a book or tax basis and whether negative amounts can be netted against positive amounts. There is no place on the application for the alternative size standard so applicants relying on the alternative size standard should use Addendum A to articulate the basis of its eligibility. Addendum A should clearly describe the calculations as applied to each affiliate company, descriptions of any assumptions it is making and any other relevant facts.
The following types of businesses are specifically excluded from PPP loan eligibility by one of the recent interim final rules, or are ineligible to receive such a loan based on statute:
- No PPP loans for “illegal” businesses. The Initial Interim Final Rule confirmed that businesses engaged in any activity that is illegal under federal, state, or local law are ineligible for PPP loans. For example, this may prevent cannabis companies from obtaining PPP loans.
- No PPP loans for businesses or business owners with prior government loan delinquencies or defaults. The Initial Interim Final Rule stated that any applicant, or any other businesses such applicant owns or that is controlled by it or any of its owners, is disqualified from a PPP loan if such applicant is currently delinquent on, or has defaulted within the last seven years on, a direct or guaranteed loan from the SBA or any other federal agency. For businesses with institutional investors, this may require diligence regarding whether any portfolio companies of such institutional investors are or have been delinquent or in default under any loans obtained from or guaranteed by the SBA or any other federal agency.
- Ineligible borrowers. The following non-exhaustive list of businesses are generally ineligible for SBA loans pursuant to 13 CFR §120.110, and they are also ineligible to receive PPP loans:
- Financial businesses primarily engaged in lending (e.g., banks)
- Life insurance companies
- Businesses located in another country or owned by undocumented aliens
- Pyramid sale distribution plans
- Businesses involved in any illegal activity
- Businesses in which the lender or an associate owns an equity interest
- Businesses that derive more than one-third of their gross annual revenue from legal gambling
- Private clubs and businesses which limit the number of memberships for reasons other than capacity
- Government-owned entities (except businesses owned or controlled by a Native American tribe)
- Businesses with an associate who is incarcerated, on probation or parole, or who has been indicted for a felony or crime of moral turpitude
- Businesses primarily engaged in political or lobbying activities
- Businesses which have a prurient or sexual nature
- Companies considering a PPP loan should review the entire list of ineligible businesses in 13 CFR § 120.110 and determine that they are not among the businesses made expressly ineligible.
Use of Proceeds and Loan Forgiveness
The CARES Act generally provides for forgiveness of loan proceeds that are used for permitted purposes. It is anticipated that the rules regarding forgiveness will be supplemented and may change as further rulemaking and guidance is issued. Such additional guidance is due to be issued by April 26, 2020.
- At least 75% of PPP loan proceeds must be used for Payroll Costs and no more than 25% of loan forgiveness may be attributable to non-Payroll Costs. The CARES Act provided that, in addition to Payroll Costs, PPP loans could be used for certain rent, utility, and mortgage interest payments and that all such uses of proceeds during the eight-week period following the disbursement of a PPP loan could be forgiven, subject to certain limitations. The Initial Interim Final Rule confirmed initial SBA and U.S. Department of the Treasury guidance that these non-Payroll Costs may not comprise more than 25% of the loan forgiveness amount and further provided that at least 75% of PPP loan proceeds must be used for Payroll Costs. The CARES Act would also permit PPP loans to be used for other purposes currently permitted for Section 7(a) loans, which include broad categories such as working capital, purchasing furniture and fixtures, inventory, and purchasing machinery or equipment; however, SBA guidance with respect to PPP loans has not provided any clarification as to whether there are PPP-specific limits on such uses that were previously permitted for Section 7(a) loans. Borrowers will be required to provide documentation verifying how proceeds are used. Note that this use of proceeds does not terminate after the eight-week loan forgiveness calculation period. If the proceeds are not fully utilized in those eight weeks, they still must be used for permitted purposes.
- Principal and interest may be forgiven. The CARES Act provides for forgiveness of all or a portion of the principal amount loaned under the PPP loans. The Initial Interim Final Rule indicated that interest accrued on a PPP loan may also be subject to forgiveness, subject to the limitations set forth in the CARES Act and elsewhere in the Initial Interim Final Rule. Lender promissory notes seem to vary on this point, so the terms of your lender’s specific promissory note may affect whether interest is subject to forgiveness.
- Reduction of the amount eligible for loan forgiveness. The amount of loan forgiveness may be reduced if a borrower has enacted layoffs, furloughs, or wage or salary reductions prior to its receipt of its PPP loan disbursement. It should not, however, subject the borrower to any specific scrutiny with respect to the loan as long as the borrower uses the proceeds for other permitted purposes. For borrowers that have already reduced their workforce or payroll costs, we see the following two primary considerations from a practical perspective.
- First, reductions in headcount and/or reductions in wages and salaries lower a borrower’s “payroll costs” and thus may reduce a borrower’s amount of forgivable expenses. Consider how the loan amount compares to (1) the borrower’s payroll expenses at current staffing levels (excluding the portion paid as wages or salary to any employee that is paid in excess of $100,000 on an annualized basis), and (2) the borrower’s anticipated rent, mortgage interest, and utilities expenses for the eight-week period after the loan is received. Would eight weeks of payroll costs at the borrower’s current payroll rate equal at least 75% of the loan amount? The remainder of the PPP loan proceeds may be used for rent, mortgage interest, or utilities expenses (all for obligations incurred before February 15, 2020) and, as long as they do not exceed 25% of the total loan proceeds, such amounts may be eligible to be forgiven. If a borrower uses less than 75% of the loan proceeds on payroll costs, or if a borrower does not spend the full loan amount on these eligible expenses during the eight-week period, then the borrower will not qualify for full forgiveness. Instead, such borrower would qualify for forgiveness only for a reduced amount based on the amount actually spent on eligible expenses during the eight-week period immediately following the loan disbursement.
- Second, there is a formulaic test under the CARES Act that determines the loan forgiveness amount. The loan forgiveness amount may be reduced if a borrower decreased its employee headcount and/or wages and salaries by more than 25% between February 15, 2020, and April 26, 2020. If the decreases occurred during this period, the additional reduction to the PPP loan amount to be forgiven could be avoided if the borrower reversed the decreases in employee headcount and/or wages and salaries by June 30, 2020. If the employee headcount and/or wage and salary decreases occurred before or after this time period, it is not clear under the CARES Act and subsequent guidance whether the borrower would be able to avoid a reduction to the amount of its PPP loan that would be forgiven. This reduction of loan forgiveness is separate from the practical limitations noted above and is based on a set of formulas contained in the CARES Act. To calculate this further reduction of forgiveness, a borrower would need to compare its average monthly full-time equivalent employee headcount and wage and salary amounts for individual employees in the time periods specified in the CARES Act, against its average monthly full-time equivalent employee headcount and the wage and salary amounts for such employees during the eight-week period after the PPP loan is disbursed. Again, for businesses that have reduced their employee headcount and/or salaries and wages between February 15, 2020, and April 26, 2020, this reduction to the amount of the PPP loan that may be forgiven may be avoided if the employee headcount and/or wage and salary reductions are reversed by June 30, 2020.
As noted elsewhere in this update, further guidance on forgiveness is due to be provided by the SBA through rulemaking to be issued by April 26, 2020, which may clarify or modify the description provided above.
 The SBA FAQ issued on April 8, 2020, confirmed that a business that qualifies as a small business concern under section 3 of the Small Business Act, 15 U.S.C.632 may truthfully attest to its eligibility for PPP loans on the application unless otherwise ineligible. (Please see FAQ below for more information).
 Notably, the summary of affiliation rules applicable to the PPP Loans, which was published on the Treasury Department’s website on April 3, 2020, does not include the other bases for affiliation based on identity of interest set forth in 13 CFR 121.301(f)(4)(iii) and (iv) (common investments and economic dependence). As explained in an internal SBA memo dated April 4, 2020, the SBA has concluded that those bases for affiliation were made inapplicable to PPP loans by the CARES Act. The failure of the rule to include the common investments and economic dependence factors is more favorable for applicants with VC and PE fund equity holders.