Why Small Businesses are Afraid to Spend PPP Loans
6/5/2020 Update: After passing both in the House and Senate the PPP reform bill was signed into law by President Trump. The reformed bill now allows a minimum of 60% of the PPP loan to be used on payroll as opposed to 75% from the previous rules in order to qualify for loan forgiveness. Additionally, under previous rules, businesses were required to spend the loan within 8 weeks of receiving the funds. The reform bill has extended that to 24 weeks. The deadline to rehire laid-off workers has also been extended to June 30th.
It’s been a rocky road for small businesses that applies for PPP (paycheck protection program) loans. The initial wave of PPP loans was difficult and confusing to apply for and in the span of just a few weeks funding ran dry. The second wave of funding helped thousands more get loans but many are saying PPP loans won’t help their businesses survive.
The PPP loans are designed to help “freeze” the economy and try and preserve as many businesses as possible during the COVID-19 pandemic. As long as businesses abide by the conditions the US Treasury set then that loan will be forgiven, meaning never have to be paid back. But businesses, restaurants especially, are afraid they won’t be able to follow all the rules of loan forgiveness.
PPP Loan Forgiveness Rules
The biggest condition that businesses are struggling with is that at least 75% of the loan must be used on payroll. The remaining 25% may be used for rent, utilities, and interest on business-related debt. If the loan conditions are not met, then any unforgiven portion of the loan must be paid back in two years with a 1% interest.
Additionally, the loan must be spent within eight weeks from when you first received the loan. This may change as lawmakers in Washington DC are trying to extend the deadline but currently, there is an eight-week deadline. After the eight weeks are up, any unused or unforgiven portion of the loan must be paid back to the government.
Perhaps the most confusing aspect of the PPP loan is the fact that the SBA (small business administration) keeps changing the rules. Since March, the website that outlines rules and guidelines on how to use the PPP loan and forgiveness expectations have changed almost a dozen times.
Some changes have been for the better. Anyone with a loan under $2 million is now unlikely to be audited. Previously, many businesses were afraid to use the loan due to fear of scrutiny by the government. But most changes have been subtle and confusing enough to force many small businesses to adopt a wait-and-see approach.
75% Payroll Misses the Mark
At first glance, dedicating a large portion of the loan to payroll makes a lot of sense. The government wants to keep people employed as much as possible during a temporary pandemic. The unfortunate reality became a protracted social distancing nightmare for the economy rather than just a short pause. Most states have begun phased reopening of retail locations but fear of infection keeps cautious consumers at home.
The healthcare community has been vocal over the fact that most of the US is simply not ready to ease social distancing guidelines yet. Only a handful of states out of the 40+ states meet the minimum recommendations to reopen. It could be months before the economy opens again to pre-pandamic levels and even then there would be significant changes to ensure consumer safety.
What most businesses really need now is not to keep their workers employed but money to cover rent and utilities. Employees’ salary is flexible while rent is not. Such mentality may seem callous to workers but temporary unemployment benefits are keeping people afloat. If businesses close permanently there won’t be anywhere for the temporarily displaced workers to go once the unemployment benefits run out. In this moment, it may be more prudent to prioritize businesses from closing to ensure there won’t be a long term recession or depression.
The fact that most of the loan must be used on payroll forces businesses to either pull their employees off unemployment to pay them for work they cannot yet do (often paying them less than unemployment) or use the loan on rent forfeiting loan forgiveness putting them further in debt just to survive.
Many businesses are foregoing loan forgiveness and just using the loan on rent resigned to their fate of owing the money back. But, many more businesses are afraid that even if they spent the loan on rent now, they would struggle to pay off the additional debt even after the economy opens back up. The loan debt would just add to the rising debt that businesses would incur during the pandemic resulting in difficulty securing more financing or even bankruptcy and eventual closure.
Economists estimate it may take years for the economy to recover from this financial crisis. Health concerns may mean businesses like restaurants may never bounce back to pre-pandemic levels.
A study by MIT and the University of Chicago has found, “The evidence suggests the PPP functioned less as social insurance to support the hardest-hit areas and more as liquidity support for less affected firms.”
Unfortunately, the reality is that for small businesses, the PPP loan will likely not help during the stay at home mandate of the pandemic. The businesses that gain the most from the PPP loan are larger companies that likely could have weathered the pandemic without financial aid but are now incentivized to keep employees rather than lay them off or furlough them.
The earliest businesses to receive the PPP loans will soon face the eight-week deadline. Unless the federal government amends how the loans can be used many businesses may be faced with a lose-lose situation.
For businesses that may need alternatives to the PPP loan, you can find other options here.
