Last week the much talked about CARES Act became law. This law is significantly more comprehensive in scope than the previous Families First Coronavirus Response Act and acts as source of funding for businesses in need. The law provides this funding through a number of mechanisms. This summary focuses on the small business loan and grant provisions. Let’s explore using the CARES Act to help your business deal with Coronavirus.
For many small businesses and nonprofits the CARES Act will be a huge help. It allows you to borrow amounts to pay your staff AND yourself. You can also obtain funds to pay rent, mortgage obligations, independent contractors, and other obligations. These amounts can help offset the potential loss of business revenue while allowing you to conduct business operations, or at the very least stay positioned to do so.
The CARES Act allows a small business or nonprofit to borrow funds that may be used for payroll, certain employee benefits, rent or mortgage obligations, utilities, and other debts currently due through the Paycheck Protection Loan Program. In addition, certain loan balances may be forgiven. HOWEVER, IT IS VERY IMPORTANT TO NOTE THAT THERE IS A GAP BETWEEN PERMITTED USES OF BORROWED FUNDS AND USES FOR WHICH A BORROWER MAY BE FORGIVEN. Not every permitted use will be eligible for loan forgiveness, and within a permitted use, not all funds applied to that use are eligible for forgiveness. Despite this gap, the amount of a loan that may be forgiven is sizeable.
Loan terms are 4% annual interest with repayment terms not to exceed 10 years. All loans are eligible for a period of deferment in payments for no less than 6 months and no longer than 1 year.
The Act defines payroll costs to include the salaries of the self-employed, independent contractors, or owners of the business. This may help alleviate the issue of business owners finding themselves in the very real and very difficult spot of choosing between paying staff and affording their own living.
The Act allows you to borrow funds for payment of your rent. However, it may be more useful to attempt to secure a waiver or deferral of rent before applying for these funds. Depending on the landlord and the landlord’s financial situation, the landlord may be willing to make adjustments to the rent that are more favorable to you than borrowing under this loan program and paying a 4% interest charge on what you borrow. Some (potentially many) landlords will not be willing to negotiate, however, and will expect that you will be applying for one of these loans.
As a business with employees, it is likely worth it to pursue these loan funds. While the loan forgiveness only applies to 8 weeks of pay (rather than the full 2.5 months’ worth of payroll you could potentially borrow), 4% interest (and some repayment of principal) may be a small price to pay to keep from disbanding a well-trained workforce or losing all production capacity.
If you are self-employed with no employees, it is also worth considering participating in this program. Again, 4% interest may be a better price to pay than depleting your personal savings or working capital reserve, or turning to a private loan with a higher interest rate and more stringent application requirements.
As a tenant, the Act is beneficial for the same reasons.
The other program created is the Emergency Economic Injury Disaster Loan. This operates somewhat similarly to the Paycheck Protection Loan Program, with some distinctions. The SBA will determine loan eligibility here based on more traditional assessments of creditworthiness. Loans are not eligible for forgiveness, but bear interest at lower rates. AND MOST SIGNIFICANTLY, any business applying will receive a $10,000 advance grant. This grant does not need to be repaid, even if the business is not approved for a Disaster Loan.
Outline of Basic Provisions: Paycheck Protection Program
The CARES Act provides relatively immediate funding to small businesses and nonprofits through two primary mechanisms: 1) the Paycheck Protection Program, and 2) increased access to emergency grants. Both of these programs are described in Title I of the Act, Keeping American Workers Paid and Employed Act.
Paycheck Protection Loan Program
This is the more significant of the two options. The Act provides $349 billion in federally backed loans to small businesses under a modified SBA 7a loan program. These funds will available to eligible businesses according to various terms.
Who is Eligible to Borrow?
Generally, any business having less than 500 employees is eligible to borrow under this program. Individuals who operate as sole proprietorship or as an independent contractor and eligible self-employed individuals are eligible to receive a covered loan.
The law makes frequent reference to sole proprietors and eligible self-employed individuals. This may lead to some concern from S corporation shareholders and general partners that they’ve been left out, but this is not the case. The Act provides that an eligible self-employed individual may participate in the program and receive a loan. “Eligible self-employed individual’’ means an individual who— (1) regularly carries on any trade or business within the meaning of section 1402 of such Code, and (2) would be entitled to receive paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act if the individual were an employee of an employer (other than himself or herself).
S corporation shareholders that work in the business are employees under tax law and would be included in the sorts of payroll costs that I describe in the next section. Partners of a partnership similarly will be included as eligible borrowers as they have “net earnings from self-employment”, a defined term that includes a partner’s distributive share of partnership income. Further, “payroll costs” as used in the Act includes “net earnings from self-employment”.
What May I Use Borrowed Funds For?
A business may use borrowed funds for a few specific purposes. The common thread of these is maintaining current employment and operational capacity. Permitted uses include:
- payroll costs (a very important and much broader term than would initially appear);
- costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
- employee salaries, commissions, or similar compensations; payments of interest on any mortgage obligation (which shall not include any prepayment of or payment of principal on a mortgage obligation);
- rent (including rent under a lease agreement);
- and interest on any other debt obligations that were incurred before the covered period.
Importantly, payroll costs include the sum of:
- payments of any compensation with respect to employees that is a salary, wage, commission, or similar compensation;
- payment of cash tip or equivalent; payment for vacation, parental, family, medical, or sick leave;
- allowance for dismissal or separation;
- payment required for the provisions of group health care benefits, including insurance premiums;
- payment of any retirement benefit;
- or payment of State or local tax assessed on the compensation of employees;
- and the sum of payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in 1 year, as prorated for the covered period. This is hugely important for small business owners because it means you can borrow funds to pay your employees, their benefits, AND yourself.
contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in 1 year, as prorated for the covered period. This is hugely important for small business owners because it means you can borrow funds to pay your employees, their benefits, AND yourself.
Note that the Act expressly includes payments to independent contractors as a component of payroll costs. Many small and midsized business outsource a number of tasks to outside specialists and workers. If you have independent contractors that provide services for you and you can determine your average payment to them per month then you can borrow under this Act to continue to pay them. This may prove useful for paying your web designer, your cleaning and janitorial company, your bookkeeper or accountant, freelance production staff, and many others.
What Can I NOT Use Borrowed Funds For?
You cannot use borrowed funds to pay any Emergency Family Medical Leave Act amounts or Emergency Paid Sick Leave amounts that were created under the Families First Coronavirus Response Act. Payments pursuant to these laws have a tax credit attached to pay for them.
You cannot use these funds to pay any amounts of salary that would be in excess of $100,000 annualized. This means for your highest earners, or yourself, you may only borrow that amount of their salary that would pay them $99,999.99 per year. You also may not use funds to pay a person with a principal residence outside of the US.
How Much Can I Borrow?
The Act allows you to borrow the lesser of $10,000,000 or (i) the product of your average monthly payroll cost measured over the 1 year period prior to your loan application multiplied by 2.5, and then adding the balance of any loans you are refinancing to that product, or (ii) if you are a younger business, then product of your average monthly payroll cost measured over the January 1, 2020 to February 29, 2020 period multiplied by 2.5, and then adding the balance of any loans you are refinancing to that product.
Note, there is a disconnect in that you may use borrowed funds for several purposes, but the maximum borrowing amount is determined solely by reference to your payroll cost.
How Do I Apply?
Banks will serve as the point of contact for application for Paycheck Protection Loan Program loans. To apply contact your bank. Some banks have already posted application materials, but it is not clear that all banks have done so. If your bank is not participating you may contact another bank. Your bank is prohibited from conducting any analysis of your creditworthiness and is only allowed to consider whether the business existed on February 15, 2020 and whether the business had employees or independent contractors. The lender is not allowed to consider whether you could obtain credit elsewhere.
Application materials will likely be based on existing SBA loan documents. SBA Forms 1919 and 1920 will likely be involved in addition to other application materials your bank requests. For applicants that are sole proprietors, independent contractors, and eligible self-employed individuals, the applicant must provide documentation supporting the existence of the business and obligations the loans will be applied to such as payroll tax filings, financial statements, and forms 1099-MISC received. It is not entirely clear yet what else a lender may accept. The Act directs the SBA and Secretary of the Treasury to issue regulations on this subject. I would expect the regulations and lenders in the interim to accept tax return documents. This would be helpful as not all transactions require the preparation of a 1099-MISC, and not all sole proprietors or general partners have payroll tax filings.
The lender will require you to certify the following:
- that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient;
- acknowledging that funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments;
- that the eligible recipient does not have an application pending for a loan under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan; and
- during the period beginning on February 15, 2020 and ending on December 31, 2020, that the you have not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan.
What are the Loan’s Terms?
These loans will be non-recourse and not subject to personal guaranties. They will have an interest rate no greater than 4%. Terms will be periods of 10 years or less.
When Should I Apply?
The sooner the better. You may apply loaned funds to the allowable uses only in the window running from February 15, 2020 to June 30, 2020. This period matters because it is the window for which many of the benefits are tied. Personal guaranties, for example, do not apply to loans made in this window, but may apply after.
How Do I Pay Back the Loan?
The CARES Act grants all borrowers a deferment of all payment of principal and interest deferred for 6 to 12 months. Certain loans will eligible for loan forgiveness. Forgiven amounts will equal the sum of the following costs incurred and payments made during the covered period:
(1) Payroll costs.
(2) Any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation).
(3) Any payment on any covered rent obligation.
(4) Any covered utility payment.
Note, the covered period here is different than the period relevant to making loans. This forgiveness related covered period means the 8 week period beginning on the date of the loan origination. Also, note that expenses eligible for forgiveness are fewer than those for which you may use borrowed funds. This is very important to keep in mind because you may be borrowing more than is eligible to be forgiven. Only 8 weeks of the allowable uses will be forgiven, and not all allowable uses will be forgiven.
The forgiven amount is also subject to some limitations. The most important of these is that interest is NOT forgiven. Forgiveness will not apply to any amounts other than the principal balance. Note that refinanced debt obligations are also excluded. The Act reduces forgiven amounts if a business borrows funds and then terminates employees during that 8 week period.
Loan forgiveness is not automatic, and you will need to apply. The application process will require submission of certain documents and the Act expressly forbids forgiving any loan without provision of the required documentation. The required documentation is:
- documents verifying the number of full-time equivalent employees on payroll and pay rates including—(A) payroll tax filings reported to the Internal Revenue Service; and(B) State income, payroll, and unemployment insurance filings;
- documents, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments;
- a certification from a company representative that—(A) the documentation presented is true and correct; and (B) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments; and
- any other documentation the SBA Administrator determines necessary.
Any balance remaining after forgiveness will bear interest at 4% and have a repayment term of 10 years or less.
Can I Rehire Any Employee I Already Let Go?
Yes. Employers that re-hire workers previously let go because of the Coronavirus will not be penalized for having reduced payroll. If you had to let go of staff and rehire any terminated employees prior to April 26, 2020 you will be able to borrow funds to pay their salaries. Further, the termination will not affect your potential borrowing limit or forgiveness.
Outline of Basic Provisions: Emergency Economic Injury Disaster Loan Grant
Any business with less than 500 employees or that operates as an independent contractor, private nonprofit, or sole proprietorship (with or without employees) may apply to participate in this program. During the “covered period” (this time it means January 31, 2020 to December 31, 2020) small businesses and nonprofits are eligible for a separate loan under this program. Approval here is not quite the low bar applied to the paycheck protection program. A lender may consider the applicant’s credit score or other demonstration of ability to repay the loan.
One of the most favorable provisions of this program is the ability of an applicant to request an emergency grant. During the covered period you may request a grant of up to $10,000 as an advance on any loaned funds. The money must be provided to you within 3 days of the SBA Administrator’s receipt of your request.
The advance may be used for:
- providing paid sick leave to employees unable to work due to the direct effect of the COVID–19;
- maintaining payroll to retain employees during business disruptions or substantial slowdowns;
- meeting increased costs to obtain materials unavailable from the applicant’s original source due to interrupted supply chains;
- making rent or mortgage payments; and
- repaying obligations that cannot be met due to revenue losses.
The reason the advance grant is so favorable is that it does not have to be repaid and is a true grant rather than an advance on the loan. In fact, you get to keep the advance even if you’re ultimately denied for the loan. However, if you apply for a loan under the payroll protection program as well as a loan under this emergency grant program the advance grant will be deducted from your loan forgiveness. So you may apply for both programs, but you won’t receive free money twice. In fact, it may be beneficial to apply for both and use the borrowed funds for different purposes.
After the $10,000 advance grant, the remainder of the program is an extension of the SBA’s disaster loan program, with some modifications built in. For example, the SBA is directed to waive any personal guarantee on advances and loans below $200,000, the requirement that an applicant needs to have been in business for the 1-year period before the disaster, and the requirement that the applicant demonstrate the applicant was unable to obtain credit elsewhere.
To apply, an applicant only needs to make a request and certify your eligibility. The application materials are available on the SBA’s website. The SBA estimates the application will take a little over 2 hours to complete, so clearly there’s been more put to it than the statute states.
These grants may prove very favorable for small businesses and nonprofits. They provide funds quickly. You may use them for much of the same payments as the payroll protection loans. Examine this opportunity more closely, and don’t write if off just because the loan is not forgivable. This may be as helpful an aid as the Paycheck Protection Loan.
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