As small businesses backed by venture capital or private equity analyze whether they may qualify for the benefits of the SBA Paycheck Protection Program (PPP), we are starting to see “knee-jerk” reactions by many of these small businesses asking or demanding that their investors eliminate key (and largely customary) investor protective provisions (whether by stockholder approval or approval by the director designated by such investor). As we have previously noted, the SBA’s affiliation rules make it harder (and in some instances impossible) for small businesses backed by venture capital or private equity to obtain the benefits of this program without eliminating previously negotiated investor protections. The benefits of the PPP must be balanced by the company and investor against the importance of these protective provisions which are integral to investor power and decision making. However, we want to note that that the mere existence of these protective provisions is not, in and of itself, a prohibition against eligibility for obtaining the benefits of the PPP. As such, eliminating these protective provisions should be the last step in the analysis as to whether and how a company may obtain the benefits of the PPP and not the first step.
To secure the benefits of the PPP, a company must have not more than 500 employees or such number for the applicable industry in the North American Industry Classification System (NAICS). Included in this calculation are the number of employees of controlled portfolio companies of venture capital or private equity funds if the applicable investor is deemed to be affiliated with the subject company. As such, once potentially troublesome provisions linked to affiliation are identified, the next step in the analysis is to determine the number of employees that may be attributable to the company applying for the PPP. Assuming that the investor is an affiliate of the subject company, then the company and the investor must determine whether the company, together with the controlled portfolio companies of the investor, would have greater than 500 employees or such number for the applicable industry in the NAICS. If the number of employees of the company together with the employees of the controlled portfolio companies of the investor are less than 500 or such number for the applicable industry in the NAICS, then the company would have no need to eliminate any protective provisions to be eligible to obtain the benefits of the PPP.
If the company (when combined with such other controlled portfolio companies) has more than 500 employees or such number for the applicable industry in the NAICS, then the company and the investors will have to consider modifying these protective provisions and any other provisions which provide for blocking rights over “day-to-day” activities if access to the PPP benefits is desired. In a previous article we noted some ways in which this may be accomplished but the list is not exhaustive and investors and the company will have to determine if (i) the benefits of the PPP are necessary for the company and outweigh the burdens imposed on investors in losing these protections and (ii) if so, whether they can negotiate a compromise position which provides the investor with a level of comfort that it will continue to have meaningful input into the strategy and operations of the company. As such, before agreeing to remove any protective provisions, venture capital and private equity fund, investors should require that their portfolio companies undertake a fulsome analysis to determine whether and how to obtain the benefits of the PPP before jumping to the conclusion that removal of protective provisions is required. Investors also should aggregate the data necessary to determine the number of employees of those of their portfolio companies likely to be considered affiliates under the SBA rules.
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