Paycheck Protection Program (PPP) Pitfalls

UPDATE: The SBA has extended the grace period to May 14, 2020.  All other aspects remain unchanged.

The Paycheck Protection Program (PPP) is one of the most influential aspects of the CARES Act legislation enacted by the U.S. Congress to combat the economic effects of the COVID-19 pandemic. In two massive tranches of funding, the PPP pumped nearly $660 billion into the economy and, through the Small Business Administration (SBA), down into the hands of small businesses that are and remain in desperate need.

The rollout of the program was a herculean effort and one that required (relatively) swift action through both chambers of Congress, and the underpinnings and spirit of the legislation never wavered—put stimulus funds into the hands of small business owners that comprise nearly 70% of the U.S. economy. And while the stimulus funding was often touted as “free money”, the program itself is, in fact, a forgivable federal grant with conditions. Now, with the benefit of some hindsight, the finer details of those conditions are starting to emerge. One point in particular, the innocuous-sounding SBA FAQ #31, is raising more than a few eyebrows and even some alarm bells.

In the SBA’s Frequently Asked Questions regarding the oversight and management of the PPP, on an on-going basis the SBA clarifies finer points of the PPP, often in response to questions that arise from lenders, borrowers, or the media. As the second tranche of funding was preparing for roll out in late April, a furor erupted as word got out that publicly-traded companies, often with access to capital in the market without applying for PPP funds, had been recipients of significant amounts of stimulus dollars. In addition to the significant reputational black eye these companies suffered, the SBA was prompted to clarify a point about the certifications to which each company attested when they applied, and they provided an easy out for those in doubt.  Any borrower that applied for a PPP loan prior to the issuance of guidance which made them reconsider their eligibility can repay the loan in full by May 7, 2020 and avoid any issues.

PPP funds are intended for small businesses facing “current economic uncertainty” that makes a loan “necessary to support ongoing operations.” While the SBA suspended their usual requirement that borrowers must not be able to access credit from another source or lending institution, borrowers must also act in good faith that they’ve considered alternative sources of liquidity and found that pursuing those options would do more harm than good. In essence, companies and not-for-profit organizations that apply should consider PPP funds not as a first line of defense but rather as a last resort for funding.

Having learned their lessons from other economic disasters and subsequent stimulus packages (think Hurricane Katrina in 2005 or TARP funds in 2008), the government will have heightened scrutiny on companies that applied for and utilized PPP funds. In fact, U.S. Treasury Secretary Steve Mnuchin announced on April 28^th that all companies that received more than $2 million in PPP funds will be subject to a full audit prior to approval of any loan forgiveness.

Here are some practical considerations to keep in mind for companies that may have concerns about the PPP’s recently-released fine print:

1. Document internal discussions about the necessity of applying for PPP funds and that company management has given consideration to other sources of funding prior to applying. These contemporaneous records can be in the form of board meeting minutes or simply internal documentation like emails. Consider also involving your legal counsel to advise on whether or not a company meets the subjective threshold of “necessary to support ongoing operations.”
2. Keep up to date with new information about the PPP. The SBA updates their FAQs frequently, and they are an excellent source of information. We want to stress again that the guidelines continue to be developed and refined; we are all awaiting additional information.
3. Ensure that PPP funds are utilized specifically in accordance with the guidelines. Remember that no more than 25% of the PPP funds can be used for expenses other than payroll. It would behoove businesses to consider some of the SBA’s guidelines on other types of loans as well, like encouraging funds to be spent on items made in the USA.
4. Consider opening up a specific bank account for the use of PPP funds to reduce the amount of hassle in tracking specific SBA-approved expenses.
5. Critically consider furlough and lay-off decisions and the impact that these actions will have on potential loan forgiveness.
6. Prepare a contingency plan in the event that not all of the PPP loan will be forgiven. The PPP includes a six-month deferral on initial payments and a term of two years. Can operations absorb a debt payment for 24 months after loan forgiveness has been determined?
7. If in doubt, the SBA has included a grace period through May 7^th that companies who feel that their need may not rise to the level of “necessity” may return the funds in full as a measure of good faith.

Please reach out to any LGT advisor about your specific situation before proceeding and also for assistance with the process. We are here to help.

Stay informed about future developments by frequently visiting our COVID-19 Financial Updates page.