As previously posted on Forbes.com.
The Coronavirus Aid, Relief and Economic Security Act—better known as the “CARES Act”—is the largest economic relief bill in U.S. history. It represents a $2 trillion relief package designed to stabilize the U.S. economy. Its flagship offering? The “Paycheck Protection Program” (“PPP”), a loan initiative designed to provide funds to small businesses as they ride out the COVID-19 storm. And a critical sector of the economy is asking one very important question: Do venture capital (“VC”)- and private equity (“PE”)-backed companies qualify for PPP loans?
The answer? It depends.
The PPP loan initiative is available to small businesses. For these purposes, small businesses are generally defined as those business concerns that have no more than 500 employees. But the SBA’s “affiliation” rules require that a business also add an affiliate’s employees to its total. As a result, the affiliation rules can turn a business that, standing alone, has fewer than 500 employees, into a business that fails the 500-or-fewer-employees test. To take a simple example: Company A has 200 employees. Its affiliate, Company B, has 350 employees. Under the SBA’s affiliation rules, Company A is treated as having 550 employees. The upshot? It generally would not qualify for a PPP loan because it has more than 500 employees.
Venture Capital And Private Equity
Venture capital and private equity play an important role in financing small businesses. And over the past two decades, there has been a marked uptick in private capital. Today, private markets deploy trillions of dollars in capital—much of it to fund small businesses that would, standing alone, fall below the SBA’s 500-or-fewer-employees rule.
VC and PE firms conventionally finance their investments in portfolio companies through preferred stock instruments. These instruments often provide “negative” control rights, such as veto rights. Likewise, VC and PE funds often bargain for protective covenants to safeguard their investments. These protective covenants and “negative” control rights are at the core of the affiliation issue.
How Do The Affiliation Rules Apply To PE- And VC-Backed Companies?
There is nothing in the SBA’s affiliation rules that outright prohibits PE-backed companies from receiving PPP loans. But if a VC or PE fund is deemed to be affiliated with a company, then all of the portfolio companies that are “controlled” by the fund may come into the affiliation equation. That calculus can quickly become unwieldy, as it may add all of the employees of all of the other portfolio companies that the fund controls to the company’s employee count. You can see where this goes.
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