Steps Private Equity and Venture Capital-Backed Companies Should Consider Taking for PPP EligibilityPrint PDF
Despite assertions from Congressional leaders on both sides of the aisle that the affiliation rules would be waived for applicants with outside minority investors, additional SBA guidance only provided relief for faith-based organizations (which are discussed in detail in our advisory SBA Clarifies that Houses of Worship and Other Faith-Based Organizations Are Eligible for Loan Programs and May Be Eligible for Relief Under the SBA Affiliation Rules).
Other than these organizations and the other exceptions set forth in the CARES Act and noted in our earlier advisory Can Portfolio Companies of Private Equity and Venture Capital Funds Take Advantage of COVID-Related Stimulus Programs?, the SBA’s affiliation rules have not been waived for any other entities seeking a PPP loan. As previously discussed, the SBA has complex affiliation rules that generally require businesses under common control or otherwise affiliated to aggregate their number of employees for purposes of determining whether the business satisfies the size standard in number of employees established by the SBA for the industry in which the entity operates. In many cases, the rules deem the businesses affiliated not only with their investors, but also with those investors’ other portfolio companies (thus aggregating all employees of all portfolio companies).
The foregoing presents PPP loan eligibility challenges for private equity or venture capital-backed businesses.
An individual or entity is an affiliate of a prospective PPP loan borrower that owns or has the power to control more than 50% of the voting equity securities of such prospective PPP loan borrower. Generally, the SBA will treat convertible securities (including options and warrants) in the calculation of voting equity securities. As a result, employees of a majority-owned portfolio company will be aggregated with all employees within the affiliate family and would be deemed to be part of prospective PPP loan borrower to determine eligibility for a PPP loan.
A minority investor is deemed to be in control, if that individual or entity has the ability, under a prospective PPP loan borrower’s charter, by-laws, or other agreement, to prevent a quorum or otherwise block certain actions by the board of directors or stockholders. SBA guidance suggests that if an individual or entity has the power to authorize or block a borrower from taking certain actions, including the below, that constitutes control and an affiliate relationship:
- payment of dividends or making of distributions
- hiring and firing executives
- determining executive or employee compensation
- establishing/amending incentive equity plans
- budgeting and expenditure decisions
- borrowing or issuing guarantees
- changing the strategic direction of the business
- entering into or amending contracts or joint ventures
- amending or terminating leases
- bringing or defending lawsuits
To the extent that a prospective borrower’s governance documents give an individual or entity the right to control any of these decisions, such borrower should discuss these concerns with their investors and consider amending these rights. The SBA has recently noted that if these rights are irrevocably waived or relinquished by the investor holding such rights, then such investor will not be deemed an affiliate.
In contrast, SBA guidance suggests that certain extraordinary actions are deemed to not constitute control, including the following:
- changing the nature or amount of capital contributions to a company
- changing a company’s line of business (as opposed to only changing business strategy)
- changing the amount or classification of a company’s authorized capital
- changing the number of directors
- encumbering substantially all of a company’s assets
- disposing of a company’s good will
- entering into a confession of judgment
These affiliation rules are fact-specific and should be reviewed carefully, as prospective PPP borrowers must certify to their lender that the SBA’s size guidelines are satisfied.
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.