- Startup advocates fear that new Small Business Administration guidelines may have retrospectively excluded many companies from the small business loan program that Congress approved as part of its $ 2 trillion coronavirus aid package.
- Many startups applied for the loans that the SBA promised to grant when the money was used for payroll, rent, and other basic costs.
- The revised rules indicate to companies that when certifying that they need the loans, they need to consider whether they have access to other sources of cash, possibly to funds from their company or other investors. So far, companies have only had to certify that they need the funds due to the “current economic uncertainty”.
- Some startups are already giving back the money they received under the program, and lawyers representing venture firms and venture-backed companies say many more could do so.
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Startups’ start-ups and venture capitalists have a new reason to be concerned about the small business lending that the federal government is providing as part of its corona virus support efforts.
In the past two weeks, the Small Business Administration that oversees the program has issued new rules and guidelines that may effectively retroactively exclude startups from participating in the program, advocates of startups told Business Insider.
Some companies are already returning money that they received under the program in response to the new rules after applying for them. They believe they are eligible under the guidelines in force at the time and after being encouraged by Treasury Secretary Steve Mnuchin, said Ed Zimmerman. Chairman of the Tech Group at the Lowenstein Sandler law firm.
The SBA and the finance department under which it operates have “really clouded the water with the new rules,” said Zimmerman. “They said, ‘Come and get it while it’s hot.’ And right after you brought your plates to the sink, they said, ‘By the way, there might have been some poison in this hot dog.’ “
“So what should you do now?” Zimmerman continued. “Put your finger in your throat?”
The $ 2 trillion stimulus package approved in March provided $ 349 billion for the SBA to lend to small businesses that had difficulty making ends meet as a result of the coronavirus crisis. If the companies used the loans to pay their payslips and things like rent and utilities, the SBA promised to forgive them. After the initiative, known as the Paycheck Protection Program, ran out of money, Congress replenished it with another $ 320 billion last month.
Numerous startups applied for and received loans under the program. For example, of Bullpen Capital’s 60 portfolio companies, more than half applied for PPP loans, partner Duncan Davidson told Business Insider.
Shake Shack was criticized for getting a loan
The program has been controversial, especially after the initial allocation expired and many small businesses were unable to get help. Critics raised objections when major or prominent companies such as Shake Shack, Sweetgreen, the parent company of Ruth’s Chris Steak House, and the Los Angeles Lakers recognized that they had received loans under the initiative. Many such companies have since promised to return the money.
Supposedly in response to these reports and in response to so-called “misunderstandings” about which borrowers could participate in the program, the SBA updated its guidelines and rules. Previously, companies with 500 or fewer employees were generally eligible for the program if they could certify that they needed the loans to support their day-to-day operations due to the “current economic uncertainty”.
Following the new guidelines introduced by the SBA on April 23, a few weeks after the program started, the agency added some important new terms.
When companies determine whether they need the loans, they now have to check under the new regulations whether they have access to other sources of capital, including from their investors or owners or the public stock markets, and can use this money to support their business on one Manner “that is not materially harmful to the business”. The agency further refined its rules earlier this week to specify that among the companies that need to check whether they have access to other sources of money are those that belong to private companies or are supported by private equity funds.
Although startups or venture funds are not specifically mentioned in the guidelines, venture capital is generally seen as a kind of private equity. And venture advisors and advocates fear that venture back startups may be forced to return their loans if they already have substantial cash or have investors with available funds.
The SBA “introduced a new standard that changes the rules of the game after the players leave the field, and then everyone tries to figure out what that means and how I reevaluate it,” said Zimmerman.
Startups are already giving back the SBA money
Under the new rules, companies that return the money they received under the program by May 7th cannot be held responsible for providing an incorrect certificate of their loan needs. Some startups are already refunding the money or are requested to do so.
One of Byron Dailey’s clients is a risk fund that has recently invested in three different startups, each of which has applied for a loan under the SBA program. All three are likely to have to return these loans now, fearing that they may not be eligible under the new guidelines for access to other sources of capital, said Dailey, who heads Fenwick & West’s private investment fund practice.
“We are in the process of telling some of these companies that they need to return it,” he said.
Zimmerman advises his startup clients and venture companies to hold board meetings to see if their companies are eligible for the loans. The directors now have to consider whether the startups have access to other sources of money, he said. Investors and founders also have to think about whether the venture company’s or its startup’s reputation will suffer if the news that they have participated in the program is released, he said, in the wake of the Shake Shack news.
Companies could be prosecuted
And that’s not all. Companies could be prosecuted under the program, which could overshadow them years later, he said. The SBA announced this week that it would review all loans under the program that were larger than $ 2 million and other smaller loans. Those who the department believes have issued false certificates of need could be prosecuted, Mnuchin said this week.
The problem for startups that took out the loans is that many of them have already spent part of the money they received, Zimmerman said. Many have also assured employees that they will not be fired, or the landlords that they will be paid thanks to these loans, he said.
“I am in board meetings all the time and I talk to founders and board members about whether they should feel shitty about what they have just done,” said Zimmerman. “And I think that is inexcusable for the Ministry of Finance. You could and should have formulated a better standard.”
The controversy is just the latest problem that startups have encountered with the loan program. When the program was first adopted, many startups and venture capitalists were concerned that venture-backed companies may have other SBA rules that seemed to imply that startups count not only their own employees, but also those of other companies as their employees would not be eligible to be owned by their venture supporters. However, the agency soon issued guidelines that made it clear that startups generally do not need to apply this rule.
Do you have a tip about a startup or the venture industry? Contact this reporter at twolverton@businessinsider.com, send him a message on Twitter @troywolv, or send him a secure message via Signal at 415.515.5594. You can also contact Business Insider securely through SecureDrop.
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