Angel-Backed Startups Jump into SBA Loans. But Disaster, Paycheck Protection Loans or Both? What to Do Now.
Time may be of the essence in taking advantage of these programs. Here’s what to consider.
Startup founders are notoriously resourceful, persistent, optimistic and resilient. The best are also lightning quick to jump on potential opportunities. So when I circled around with founders in my early stage startup portfolio on filing for SBA Disaster Loans prior to the passage of the CARES Act, I was not surprised to hear that many of them had. Or had attempted to. For sure all the above qualities were needed for anyone filing with the SBA recently as there were wide reports of site crashes.
SBA Disaster Loans are an existing SBA program with new terms that include quick three-day advances, but since the passage of the CARES Act startups have begun to focus more closely on the Paycheck Protection Loans. PPLs have features that are more favorable to startups than Disaster Loans, primarily the non-recourse and loan forgiveness provisions but will take time to roll out. PPLs may be worth waiting for if you run a startup that has ample runway. It is not yet clear how long that wait will be since PPLs are a new program under the SBA guaranteeing private lenders and it all needs to be rolled out; some advisors have told me off-the-record that while PPL applications are online now on the SBA and banks will have theirs ready April 3rd, they are targeting May 1st (earliest) for the loans themselves.
Note that SBA Disaster and Paycheck Protection Loans may not make sense for all startups. I am an angel stage investor, and so my portfolio largely has the relevant fact set that reflects that: I often initially fund when companies are pre-revenue, sometimes with the first check, into SAFEs and convertible notes, and most of the Founders still hold the vast majority of the equity; many do not yet have venture capital funding (so, importantly, the SBA’s affiliation rules are less of an issue for them). Hopefully there will be clarity around the affiliation rules for venture-backed startups very soon; the National Venture Capital Association is working hard on that.
Startup Founders know that they have to carefully and continually anlyze their best options for funding, and seek advice specific to their facts and circumstances from their legal and accounting advisors. But here are the reasons why many Founders have applied for SBA Disaster Loans, who it still may make sense for, why many will wait instead for the PPL rollout, why some will do both and other considerations.
Why SBA Disaster Loans? Since the passage of the CARES Act, a primary reason to seek a Disaster Loan (rather than wait for the PPL roll-out), appears to be the Advance (below), the possibility of getting funds sooner than with a PPL and hedging any risk that a startup may not be able to get a PPL. Applying for both may make sense for some startups. Disaster Loans have generally generous terms: low 3.75% interest rate, principal up to $2 million, and repayment terms up to 30 months, and perhaps most importantly the opportunity to get an Advance (see below). Plus other favorable credit features (a startup can be in business <1 year, eligible even if they can get credit elsewhere, personal guarantee for loans <200k have been waived (but are required for amounts >200k)). Disaster Loan amounts are capped at $2M, while PPLs may provide loans in excess of that. Like PPLs, Disaster Loans are for working capital (employee retention, payroll, rent, utility, etc.).
Disaster Loan Emergency Advance: The CARES Act has a beneficial advance provision for cash-strapped startups filing for SBA Disaster Loans that is not in the PPLs (described more below): eligible small businesses can request an emergency grant of up to $10,000 which does not have to be repaid under certain circumstances, such as if the loan is denied. Advances are to be awarded within three days of an application. The Advance is one of the most helpful features of Disaster Loans; startups with short-term capital who do not need an advance, or that have ample runway and time to let the PPL program rollout, may want to save the time and effort and consider waiting for a PPL. (Although, of course, they run the risk of not getting A PPL.) A startup that already applied for a Disaster Loan should let that process work through; please read Optionality & the Queue OR What to Do If You Already Applied for a Disaster Loan (below).
Why Paycheck Protection Loans (PPLs) May Be Better. The CARES Act created a new funding program with more generous terms for startups than the Disaster Loans for a limited covered period of February 15-June 30, 2020. The Paycheck Protection Loan Program provides for private loans underwritten by the SBA; because of the SBA’s loan guarantee these loans are non-recourse (e.g., no collateral needs to be pledged and no personal or other guarantees) and have the possibility for loan forgiveness (in part) for eligible startups that comply with the PPL program requirements. PPLs will have interest rates not to exceed 4%, with repayment terms up to 10 years. While Disaster Loans are capped at $2M, PPLs can exceed that. There are a lot of important details to the operation of the PPLs, in particular the calculation of payroll and loan forgiveness. For a good summaries of these details, I recommend Morse Barnes-Brown & Pendleton’s Plain Language Guide to the CARES Act here and Goodwin Procter’s CARES Act Bulletin here.
It is important to note that you get the PPLs through a bank (not the SBA, as with the Disaster Loans) so startups should act now to reach out to their banking relationship to see whether they will be participating in the PPL program, and do the research and preparation on putting together financial information. Between the SBA providing further guidance and the banks establishing their internal procedures, I have gotten this off-the-record feedback from banking sources: the PPLs likely won’t be ready before mid-April to early May AND The. Money. Will. Go. Fast.
Relevant Eligibility Criteria & Requirements: Generally these are low for both: have 500 or fewer employees (including PT employees), plus a number of relevant certifications. For Disaster Loans, a startup had to have been in business on January 31, 2020.
Disaster Loans Waive the Personal Guarantee Requirement, BUT There’s A UCC Lien: The CARES Act waives the requirement that Founders give personal guarantees on advances/loans of $200,000 or less for Disaster Loans, as well as the related requirement to provide personal tax returns. However, the SBA will place a UCC Lien on a startup’s assets upon issuance of a Disaster Loan. The UCC Lien for the Disaster Loans is less advantageous for startups, obviously, than the non-recourse PPL (noted above).
How Do Paycheck Protection Loans and Disaster Loans Interact? The CARES Act restricts a borrower from receiving a PPL and a Disaster Loan for the same working capital purpose (presumably working capital needs arising from Covid19); however (and this is big for those who filed for a Disaster Loan) I have heard from an SBA loan expert that advised that startups should be careful to narrowly specify the use of proceeds (for instance, ‘time define’ it and say “March payroll, utilities and rent’) so that they are well-positioned to skirt any overlap restrictions. The same advice is relevant to applying for/taking down the Disaster Loan itself: if a startup also want the option of a PPL, narrowly define the use of proceeds. The SBA typically responds to Disaster Loan applications within 2–3 weeks, and even if that timing can’t be adhered to during this unprecedented crisis, the Disaster Loans will likely be available sooner. If and when you get a PPL, you can use PPL proceeds to pay off your Disaster Loans. If a startup has short-term capital and does not need an advance then waiting for the PPL terms and mechanisms to be put in place may save critical resources. Alternatively, needing an advance (up to $10,000) and cash in the short-term, or simply wanting to hedge the risk of not getting a PPL, would argue toward applying for a Disaster Loan now and possibly a PPL when they rollout. For a good comparison in chart form of Disaster Loans versus PPLs, see the KROST (CPAs) firm bulletin here.
Optionality & the Queue, OR What If You Already Made A Disaster Loan Filing? Before the passage of the CARES Act, many Founders had already made Disaster Loan filings. Realizing that the SBA would be flooded and they would be in a “queue” system, these Founders figured it would be important to be at the front of the line to quickly secure short-term cash if necessary. In an unfolding political scenario amidst a high-stakes Covid19 world, they wanted optionality, with the understanding that they would continue to carefully analyze their options under federal funding programs, as well as other potential sources of capital (customer deals, venture debt, existing investors, revenue loans). That made sense, and demonstrated laudable resourcefulness. New Disaster Loan filings do not make sense now IF a startup has sufficient runway and can hold out for the PPL rollout, unless they are primarily looking to hedge the risk that they may not get a PPL. For startups that have already made Disaster Loan filings keep the application on file for optionality. If they want to be able to take advantage of the more generous loan forgiveness and other terms of the PPLs, startups should be careful to narrowly define the use of proceeds (as noted directly above, for instance, ‘time define’ the use of proceeds for ‘March payroll, utilities, rent’ to avoid “double-dipping”) and then apply separately for a PPL as soon as they are available. Typically the SBA gives 60-days for a startup to make a decision on accepting or rejecting a loan, so keep the application open and let the process work. Startups can decide what to do if and when they get an approved PPL. As for SBA Disaster Loan Advances, a startup that needs it should apply for it. Again, being careful about how they describe the use of proceeds.
Which Startups Do SBA Loans Not Make Sense for: At this date, it looks like many VC funded startups. This is because SBA Loans generally have complex affiliation rules which may determine when portfolio companies of the same VC firm must be aggregated for purposes of eligibility as a “small business”. The National Venture Capital Association has been doing great work to provide guidance to venture-backed startups on federal programs generally, and are on top of issues around the application of the affiliation rules. See their guidance here. Arguably the affiliation rules could apply to startups funded by angel investors as well, if they have participated in further funding rounds and their portfolio companies have grown. The afiliation rules are complex, and their applicability depends on may factors involving “control” — contractual and ownership percentages so this an area where legal aDvice specific to a startups facts is necessary. Some startups and investors are considering amending investment documents to address this. Kruze Consulting is staying on top of developments, see their helpful guidance on this here.
This Article was updated March 31st to reflect new guidance, and the passage of the CARES Act. It is important to consult your legal and tax advisor before taking any action relating to an SBA loan, and to stay on top of developments in SBA federal funding programs. The National Venture Capital Association, as well as many law firms that represent startups, provide frequent updates and details.
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Thanks for the photo Alesia Kazantceva. You can find her photos on unsplash.com or saltnstreets.com.