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CARES Act: PPP Impact on

Venture-Backed Companies

April 2, 2020

SBA Programs Under the CARES Act: Are You Eligible for Federal Assistance?

The ‘‘Coronavirus Aid, Relief, and Economic Security Act” (CARES Act) is a $2 trillion

economic relief package enacted to help individuals and businesses in the United

States weather the severe financial impact of the COVID-19 pandemic.

• A key feature of the CARES Act is the “Paycheck Protection Program” (PPP)

administered by the Small Business Administration (SBA) under the umbrella of its

existing 7(a) business loan regime.

• This presentation focuses on what we see as the key features and eligibility

requirements of PPP loans.

• Note: the SBA has not yet issued guidance on a lot of the details of how the

program will work, and various groups are lobbying the SBA and Treasury

Department for changes and clarification.2

What is a PPP loan?

Fundamentally, PPP loans are intended to provide qualifying businesses –

typically “small businesses” – with financial support necessary to stay in

business and avoid layoffs and pay cuts during the COVID-19 pandemic.

• PPP loans will be made by commercial lenders who are participating in the

PPP.

• Loan applications may be submitted starting on April 3, 2020, and loans will

be issued to eligible borrowers through June 30, 2020.

• PPP loans are fully guaranteed by the SBA, and do not require borrowers to

issue personal guarantees.

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Who is eligible for a PPP loan?(Overview)

• At a conceptual level, PPP loan eligibility applies broadly to several

categories of businesses. Specifically, in addition to “small businesses,” any

business, nonprofit, veterans organization, or Tribal organization is eligible if

it meets relevant SBA “size standard.”

• On a practical level, the SBA’s complex concepts of “affiliation” will often

render a business ineligible for a PPP loan by aggregating a business’s

employee headcount with the employee headcounts of its investors and its

investor’s other portfolio companies.

• As a result of affiliation and aggregation, an applicant may be deemed to

exceed the relevant size standard and be ineligible for a PPP loan.

4

Who is eligible for a PPP loan?(Size Standards)

In order to be eligible for a PPP loan an applicant must employ not more

than the greater of:

1. 500 employees; or

2. If applicable, the number of employees the SBA has established as the

small business “size standard” for the primary industry in which the

applicant operates.

Note that these industry-based size standards are set forth in North American

Industry Classification System (NAICS) codes, which establish the threshold

below which businesses in various industries qualify as “small.”

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Who is eligible for a PPP loan? (Operations and Certifications)

PPP loan applicants must have been in operation on February 15, 2020,

and certify to the following:

1. The uncertainty of current economic conditions makes the loan request necessary to support the ongoing operations of the applicant;

2. PPP funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, or utility payments;

3. The applicant does not have an application pending for an SBA business loan for the same purpose and duplicative of amounts applied for or received under a covered loan; and

4. During the period beginning on February 15, 2020 and ending on December 31, 2020, the applicant has not received another SBA business loan for the same purpose and duplicative of PPP amounts applied for or received.

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How do I calculate total employee headcount?(“Affiliation” is Key)

Under the SBA’s “affiliation” principles, total employee headcount has two basic components:

1. An applicant’s own employees, including anyone employed on a full-time, part-time, or other basis, but excluding independent contractors; plus

2. All of the employees of each of the applicant’s “affiliates” (as defined by the SBA rules and discussed below), excluding independent contractors.

• Because affiliation can cause an applicant’s employee headcount to exceed the relevant size standard, understanding the affiliation rules is critical to determining edibility.

• This is especially important for emerging companies and venture fund investors, whose relationships can easily trigger affiliation.

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What is an “affiliate”?(“Control” = Affiliation)

The SBA considers entities “affiliates” of one another when one “controls” or has the power to control the other, or if a third party controls or has the power to control both.

• Importantly, the SBA’s definitions of “affiliation” and “control” far more expansive than they are in the corporate context and in other legal regimes.

• For example, minority stockholders of a company are routinely deemed to “control” a company for SBA purposes.

• Accordingly, if a VC fund “controls” multiple portfolio companies, each portfolio company that is controlled by that fund would need to aggregate all of their employees together – along with the employees of the fund itself.

• This is the path to ineligibility . . .

8

What is an “affiliate”?(Control Based on Stock Ownership + Rights)

While there are several ways companies and their investors can be affiliated,1 the most common is through stock ownership:

1. A majority owner (>50%) of a company’s voting equity is an affiliate of the company.

2. A minority owner (<50%) will be considered an affiliate of the company if it can either:

a. Prevent a quorum of the board of the company’s directors or stockholders, or

b. Veto day-to-day operational (as distinguished from extraordinary) actions of the company.

While there is no definitive “list” of rights that are considered “ordinary” versus “extraordinary” over the years, SBA administrative judges have discussed the distinction between “ordinary” and “extraordinary,” and we have insight and guidance based on those cases.

1 For the complete list of bases for affiliation, see 13 CFR § 121.301(f). 9

What is an “affiliate”?(Be Aware the Right to Veto “Ordinary” Actions)

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What is an “affiliate”?(Special Exceptions to Affiliation Rules)

• For companies whose primary NAICS code begins with a 72 (i.e., accommodation, food services, and drinking places) and for which there is more than one location, the company may be eligible for a PPP loan if no single location has more than 500 employees.

• Additionally, if the company’s primary NAICS code begins with a 72, the business has been assigned a franchise code by the SBA, or the company receives financial assistance from an SBIC licensed company, the company need not aggregate “affiliates’” employees with its own.

• For all other companies, the applicant’s employee head count will be aggregated with that of any “affiliates,” and of any affiliates of an affiliate.

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Other Eligibility Considerations(What if an applicant has access to “Credit Elsewhere?”)

• The SBA historically has required recipients of 7(a) business

loans to be unable to obtain credit in the market (the “credit

elsewhere” requirement.)

• The PPP waives the “credit elsewhere” requirement, so

applicants need not establish that a PPP loan is its last or only

option.

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Other Eligibility Considerations(Owners with liquid capital on-hand)

• The SBA historically also has required >20% owners of 7(a)

business loan recipients to inject their own liquid assets above a

certain threshold into the loan recipient in order to reduce the

amount of the required SBA loan.

• Recent SBA guidance indicates that this liquid assets requirement

is part of the waived “credit elsewhere” requirement noted, and

therefore will not apply to PPP loans.

• Note that this guidance has not been formally issued, and may be

subject to further refinement.13

PPP Loan Mechanics(What loan amount can an eligible company apply for?)

• PPP loans are intended to help keep businesses operating and

employees on the payroll for the (hopefully) limited duration of the

COVID-19 pandemic.

• Accordingly, PPP loan amounts may not exceed 2.5x the

applicant’s average monthly “payroll costs” from (generally

speaking) the year prior to the loan.

• Regardless of an applicant’s average monthly payroll costs, all

PPP loans are capped at a total maximum of $10 million.

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PPP Loan Mechanics(What costs are included in “payroll costs”?)

“Payroll costs” include the total amount of any compensation to:

1. Employees - in the form of a salaries, wages, commissions, cash tips,

payments for leave, severance, group health care benefits, retirement

benefits, or state or local taxes assessed on employee compensation.

2. Sole Proprietors or Independent Contractors - in the form of

wages, commissions, income or similar payments.

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PPP Loan Mechanics(What costs are excluded from “payroll costs”?)

Payroll costs do not include:

1. Compensation to an individual employee, sole proprietor or independent

contractor in excess of an annual salary of $100,000, prorated for the

covered period. (Note: For an employee whose salary is $100,000 or more,

only $8,333 per month can be included in the average monthly payroll

costs.)

2. Certain other taxes, compensation for employees whose principal place of

residence is outside the U.S., and qualified sick or family leave for which

credit is allowed under the Families First Coronavirus Response Act.

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PPP Loan Mechanics(How can PPP loan fund proceeds be used?)

During the period from February 15, 2020, to June 30, 2020, PPP loan

proceeds can be used to cover the following:

• Payroll costs,

• Health care benefits,

• Mortgage interest, rent and utility payments, and

• Interest on any other debt obligation incurred before February 15,

2020.

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PPP Loan Mechanics(PPP loan forgiveness basics)

• Recipients can apply for and receive forgiveness of some or all of a

PPP loan.

• Generally speaking (and subject to limitations noted below), the

amount of loan forgiveness will be equal to the amounts the applicant

can document that it paid in the eight weeks following origination of the

loan for payroll costs, mortgage interest, rent and utilities.

• Amounts used to pay interest on other obligations will not be forgiven.

• No amounts paid outside of the covered period of the loan are

forgivable.18

PPP Loan Mechanics(PPP loan forgiveness basics)

• Note that PPP loans cover 2.5x an applicant’s monthly payroll and

other costs (approximately 11 weeks of expenses), but only 8

weeks of those expenses are forgivable.

• Because the CARES Act allows for a maximum forgiveness of

eight weeks of approved costs, the unforgiven loan balance will

be treated as a loan.

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PPP Loan Mechanics(Layoffs and salary cuts can lessen loan forgiveness)

• Consistent with the policy of protecting jobs and salaries during the COVID-

19 pandemic, the amount of forgiveness for a particular loan will be reduced

if a recipient conducts layoff or cuts salaries.

• However, where layoffs or salary cuts occur between February 15, 2020 and

April 26, 2020, the loan forgiveness reduction formula will not penalize the

recipient if the layoffs or salary cuts are reversed prior to June 30, 2020.

• We anticipate that SBA will issue guidance in the near-term on how to

calculate loan forgiveness and reductions in loan forgiveness amounts.

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Other Important PPP Loan Terms

• No personal guarantee or collateral is required.

• The loans are fee-free.

• Payments of principal and interest are deferred for at least six

months, and up to a year.

• Any remaining balance on a loan (after forgiveness is applied) will

remain fully guaranteed by the SBA and subject to a maximum

interest rate of 4% and a 10-year maturity.

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PPP Loans and Economic Injury Disaster Loans (Can a company apply for both?)

• The CARES Act expands access to SBA’s Economic Injury Disaster Loan (EIDL) program to businesses with fewer than 500 employees, subject to the same affiliation principles.

• Eligible businesses that suffer substantial economic injury as a result of a disaster or emergency – including the COVID-19 pandemic - can apply for an EIDL loan until December 31, 2020.

• Key features of the EDIL program include the following:

1. No personal guarantee is required for EIDLs under $200,000.

2. Loans can be made solely upon the applicant’s credit score.

3. Initial advances of up to $10,000 can be issued within three days and need not be repaid.

4. The loan will bear a low rate of interest; however, unlike PPP 7(a) loans, the act does not provide for forgiveness for EIDLs.

5. Businesses may receive both PPP loans and EIDLs, so long as both loans are not used for the same purpose or otherwise duplicative.

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PPP Loan Applications(How and when should a company apply?)

• We expect the SBA to issue guidance and an application process in the coming days or weeks, including clarifying certain aspects of PPP loan eligibility and an application and review work stream.

• Note that because the covered period for the use of loan proceeds ends on June 30, 2020, and the maximum forgiveness period is eight weeks, any loan obtained after May 5 (i.e., eight weeks prior to the end of the covered period) may not enjoy the full forgiveness period.

• For this reason, companies should begin discussing potential applications with their lender and collecting documentation and information related to its employee headcount, average monthly payroll costs and other permitted loan costs for the past year, and SBA Form 1919, which the SBA may modify specifically for the PPP.

• If a company’s existing lender does not plan to offer PPP loans, they can contact other banks in their area that are SBA loan program participants. Existing participating lenders are listed on the SBA website for the district in which the company is located, and the SBA is authorized to add additional lenders for this program.

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Practical Next Steps

• Best point of contact to apply for a PPP loan

• Initial indications of demand and timing

• Considerations for companies with existing facilities

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