SBA and PPP Loan Eligibility Update Regarding VCs, PE firms, ESOPs and Companies in Chapter 11

Since the passage of the CARES Act and the creation of the Paycheck Protection Program (PPP), the SBA has published three separate Interim Final Rules to provide further guidance and regulation. On April 24, 2020, the SBA provided an additional Supplement to these previously published Interim Final Rules, specifically impacting Sections 1102 and 1106 of the CARES Act as related to the PPP Loans.

In this supplement, the SBA clarifies that Hedge Funds and Private Equity Funds are investment entities and thus are not eligible for section 7(a) SBA loans nor PPP loans. The supplement also goes on to clarify guidance on eligibility for companies that are owned by Employee Stock Ownership Plans (ESOPs), as well as companies that have started Chapter 11 bankruptcy proceedings.

Venture Capital and Private Equity Portfolio Companies:

With respect to portfolio companies of investment funds, this supplement confirms what Aprio has already been advising clients: that borrowers must use the affiliation rules published in the Second PPP Interim Final Rules, April 3, 2020.  These rules state that portfolio companies of investment funds must apply the same affiliation rules as any other company.

While this supplement does not explicitly list Venture Capital Funds, it is probable that this latest guidance is meant to target all types of investment funds, regardless of how the industry characterizes such fund. Operating under this assumption, Venture Capital Funds are also excluded from eligibility for section 7(a) SBA loans as well as PPP loans.

As footnoted in the supplement, “the CARES Act waives the affiliation rules if the borrower receives financial assistance from an SBA licensed Small Business Investment Company (SBIC) in any amount. This includes any type of financing listed in 13 CFR 107.50, such as loans, debt with equity features, equity, and guarantees. Affiliation is waived even if the borrower has investment from other non-SBIC investors.”

However, the SBA reminds borrowers that they must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

Employee Stock Ownership Plans (ESOP)

Over the last few years, many companies have migrated to be owned by ESOP’s, which are qualified retirement plans; these plans generally own up to 100% of operating companies.

This latest supplement clarifies that a company owned by an ESOP can apply for the PPP loan and that the ESOP structure does not prohibit it from applying. The ESOP-owned business would still need to meet the other PPP requirements.

Chapter 11

The SBA also confirms in this supplement that if your company is a debtor in a bankruptcy proceeding, you cannot apply or receive a PPP loan.

The bottom line

Through the additional interim rules and supplement, the SBA is reminding all applicants that the company must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  For companies concerned about their ability to certify this, there is a safe harbor in place: if the loan is re-paid in full by May 7, 2020, the borrower would be considered to have made the certification in good faith.