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Can Portfolio Companies of Private Equity and Venture Capital Funds Take Advantage of COVID-Related Stimulus Programs?

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| Legal Advisory

Updated on April 8, 2020: please read our advisory, Steps Private Equity and Venture Capital-Backed Companies Should Consider Taking for PPP Eligibility.

In response to the overwhelming domestic and global economic impact of the COVID-19 pandemic, Congress recently enacted legislation to provide relief to small businesses across the United States.

The Economic Injury Disaster Loan Program and the Paycheck Protection Program

Each of the Coronavirus Preparedness and Response Supplemental Appropriations Act (providing small businesses with relief under the Economic Injury Disaster Loan Program (EIDL)) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (providing small businesses with relief under the Paycheck Protection Program (PPP)) are means by which businesses can access capital to alleviate the immediate economic effect of COVID-19.

Each of the EIDL and PPP are programs administered by the Small Business Administration (SBA), with eligibility requirements under each program that a business qualify as a “small business” under existing SBA rules. 

EIDL. Eligible businesses under the EIDL may receive up to $2 million in loans (at interest rates of 3.75% per annum) to use for working capital and ordinary course expenditures (with loan amounts being limited to the economic injury sustained by the business from COVID-19). Please see a recent Nutter advisory as to the EIDL program.

PPP. A major focus of the CARES Act is geared toward providing financial assistance to help businesses keep workers on the payroll during the physical and economic shutdown. The CARES Act includes the financial assistance in the form of a $349 billion federally guaranteed loan program, that will provide eligible entities with loans to cover the costs of payroll, health care benefits, mortgage interest, rent, utilities, and certain other obligations. The maximum amount of each loan is $10 million, with the actual permitted amount tied to the borrower’s payroll costs (and effectively limited to 2.5x the average monthly payroll incurred over the one-year period prior to the loan, with exceptions for seasonality and limitations on certain highly-compensated employees). When paired with an eight-week loan forgiveness program, the PPP will effectively serve as a federal grant to eligible entities to keep employees on the payroll (or rehire employees that were recently laid off). The loans also contain certain requirements: no stock buybacks, no dividends, no forgiveness, and no large layoffs. Please see a recent Nutter advisory as to the PPP program.

EIDL and PPP Eligibility of PE/VC Portfolio Companies

Determination of a Small Business

Eligibility to receive a loan under either program requires a business to be considered a “small business” by the SBA. 

  • Generally speaking, one is considered to be a small business if it has fewer than 500 employees, although there are some exceptions which are more specifically described in our earlier advisory linked above.
  • However, the applicant business will also be aggregated with “affiliates” which may result in employees of other companies (which may have no connection to the applicant business, other than a common investor) being deemed to be part of the applicant.
  • In short, while a business might on first blush meet the EIDL or PPP eligibility requirements, the question of whether the business is an “affiliate” of another business should be considered closely, particularly when the business has PE/VC funds as shareholders.

Determination of an Affiliate

An affiliate relationship exists if a party has actual control or the power to control certain actions of another. For example, a company that is majority-owned by an investor is an affiliate of that investor. If the investor has majority control over other companies, those other companies are part of the affiliate family. In that instance, all of the employees within the affiliate family would be deemed to be part of an applicant business to determine eligibility under the SBA’s programs.

Control is not solely based on majority ownership, unfortunately. The determination of control is fact-based and may exist if a stockholder has the ability to control or block certain actions that are part of the standard operations of the business. Based on existing case law, the SBA has deemed certain standard venture capital negative covenants requiring the approval of a named investor or their board designee such as approving capital expenditures outside of a company’s budget, hiring or firing executives or changing such executive’s compensation, and making or declaring dividends to be sufficient levels of control to deem an investor an affiliate. By contrast, certain extraordinary actions, such as an investor having the ability to approve a sale of the company, are not deemed to create a controlling interest.

Exceptions to the affiliation rules apply in limited scenarios under the PPP with respect to the accommodation and food services sector and franchises.

PE/VC Portfolio Company Recommendations.

The small business size test in concert with the SBA aggregation rules may require a portfolio company’s size to be considered with ALL other portfolio companies held by its lead investors (which may also include portfolio companies of earlier or later funds). This presents eligibility challenges for portfolio companies of PE/VC funds, and accordingly, we recommend an assessment of portfolio companies in light of the EIDL and PPP programs and the SBA size of the business and aggregation rules.

While it is possible that additional legislation will be passed to tighten affiliate rules or that the SBA will enact a regulatory fix in implementing the CARES Act, portfolio companies (and their PE/VC sponsors) should closely review their governing documents to determine what level of control is held by certain stockholders of the company and consider whether to amend certain rights which may create a barrier to eligibility for the PPP or EIDL.

This advisory was prepared by Jonathan Calla, Kelly Dutremble, Joshua French, Joshua Gray, Kate Henry, Meghan Kelly, and Shannon Zollo in Nutter’s Private Equity practice group. For more information, please contact any of the above individuals; or your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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