- Some startups may get loans from the $350 billion Small Business Administration program created by the new stimulus package.
- Late last week and over the weekend, the SBA and Treasury Department issued some rules and guidance that seem to make it easier for startups to apply and qualify for the aid.
- The vast majority of startups have fewer than 500 employees and so would be considered small businesses, but the SBA’s rules concerning the ties companies have to their investors and their investors’ portfolio companies seemed to disqualify most venture-backed companies from applying for the new loans.
- Even with the new rules and guidance, there’s still a good deal of uncertainty about whether startups will qualify for the loans and some investors are being cautious about the program, a representative of the National Venture Capital Association told Business Insider.
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Startups may get access to a key piece of the new $2 trillion stimulus package after all.
One of the central components of the law, meant to stabilize a US economy that’s been throttled by the response to the coronavirus epidemic, is a $350 billion loan program for small businesses. Immediately after Congress passed the act, venture capitalists and startup advocates raised concerns that startups would be excluded from the program, due to rules that would seem to bar certain companies.
But late last week and over the weekend, the Treasury Department and the Small Business Administration, which will oversee the loan effort, issued rules and guidance for the program that could make it easier for startups to apply for and receive the aid, advocates for Silicon Valley said.
“There were a couple things that moved last week that did matter,” said Justin Field, senior vice president of government affairs at the National Venture Capital Association, an industry trade group. He continued: “It’s messy, but we think that … there’s a path forward for a certain number of these companies to apply.”
The new guidance and draft rules set aside or relax some of the SBA’s regulations around so-called affiliations, which were the biggest collective obstacle facing startups from participating in the stimulus package’s loan program. Under the SBA’s affiliation rules, many startups could be deemed too big to qualify for the loans.
Most startups are small in size, but may have lots of affiliates
The loan program in question, dubbed the Paycheck Protection Program, offers a pool of money for small business — defined as those with 500 or fewer employees — to use to pay workers, mortgages and rent, utilities, and interest payments on debt. The federal government is promising to forgive the loans if companies maintain their workforces and their employees’ salaries.
At first glance, the vast majority of startups would seem to qualify as small businesses and be eligible for loans. Some 97% of venture-backed startups for which employment information was available had 500 or fewer employees, according to data from the NVCA and PitchBook.
But in determining how many employees companies have, the SBA looks not just at their own workforces but also those of any entities with which they are affiliated. So, if a company is majority-owned by another company, the parent company would be considered an affiliate of the first company, and the parent company’s employee base would be counted toward that of the first company.
And the SBA can consider a company or person to be an affiliate of another even if one doesn’t have majority control over the other. If a company has one large shareholder or several shareholders with large and relatively equal amounts of control, it could be considered affiliated with those investors — and with every other company over which those investors exercised similar control.
Those affiliation rules are problematic for venture-backed startups. Many of them have investors that have large, effectively controlling stakes. And many of those investors have similar power over lots of other startups. Instead of having just 50 employees, say, a startup under the SBA rule could be considered to have hundreds, once all of the employees at its affiliated startups and investors are combined.
Lenders don’t have to check on affiliations
The NVCA and other Silicon Valley advocates had been hoping Congress or the Treasury Department and the SBA would set aside those affiliation rules for the new loan program and clarify that startups are eligible for the it. Thus far, neither Congress nor the Treasury Department or the SBA have done so.
But the Treasury Department and the SBA did take four important steps that should open the program to at least some startups, Silicon Valley advocates said.
The biggest step is that the draft rules for the loan program — officially called an interim-final rule — remove from lenders the obligation of having to determine whether the affiliation rules apply to particular loan applicants, Field said. Without that move, the lenders could be held liable by the government if they handed out a loan to a company that didn’t actually qualify because of the affiliation rules. Now, the lenders can simply rely on the certification of the company’s CEO or owners that it qualifies.
The change means that more startups will likely be able to get loans than they otherwise would and in more timely fashion. Checking into startups’ affiliation likely would have been a painstaking, time-consuming task. And in questionable or marginal cases, the lenders would have had an incentive to deny the loans.
“We do think that did get rid of a major gating factor, in that now banks can process these applications,” Field said.
The SBA has at least two sets of rules regarding determining a company’s affiliations. In its draft rules for the lending program, the agency made clear that it will rely on the set of rules that appear to offer more leeway for venture-backed startups. That was another important step for Silicon Valley, Field said.
The disregarded rules spell out in some detail situations where an investor would be considered to have control of a company and therefore be an affiliate of it. The rules the SBA will use are a bit more vague — and open to interpretation — on when minority investors would be deemed to have enough control to be considered affiliates.
Only the company has to certify that it qualifies
A third step taken by the SBA and the Treasury Department that was helpful for Silicon Valley was to eliminate a requirement that investors who owned as little as 20% of a company certify that any loan funds the company received would be used for payroll and other purposes specified by the program, Field said. Under the draft rules, only the company itself has to make that certification.
That was important to the venture community, because otherwise startup backers may have been placed in a situation where they had to guarantee the funds would be used for legitimate purposes but have no control or ability to ensure that they were, Field said. Without that change, minority investors could have been held criminally liable if founders they backed embezzled the funds or used them go on a big party, he said.
“That’s not really a fair place to be,” Field said. “But they fixed that.”
The last helpful step the SBA took was that it clarified it won’t use its so-called “totality of circumstances” principle to determine whether a company has affiliates, he said. That principle works as a kind of catch-all in the agency’s affiliation rules that allows it to determine that certain companies or investors are linked, even if one doesn’t have substantial ownership or control over the other. With the SBA setting aside that principle, fewer startups are likely to get tripped up by the affiliation rules, Field said.
“They have gotten rid of some of the uncertainty around the rules,” he said.
There’s still a lot of uncertainty
Still it’s not clear how many startups will be able to apply for the loans or how many actually will. Even if lenders won’t be checking whether startups are ineligible due to their affiliations, the SBA likely will do some kind of assessment after the fact, Field said. It could retroactively find that certain startups weren’t qualified for the loans and force those companies to repay them and potentially hold their representatives criminally liable.
Many startups are looking into the loan program, Field said. But many of their venture backers are being more cautious about it — precisely because there’s still uncertainty about whether their startups really qualify, he said.
For now, the NVCA is willing to wait and see if and how well the program works for venture-backed companies rather than continuing to press for changes that would make clear that they can participate, Field said.
“This is where we just got to give policy makers some breathing room. Let them do what they’re going to do, let the process play out and understand what’s really happening on the ground,” he said. “If it’s messy but workable for a large percentage,” he continued, “we’re in a crisis, that’s good enough.”
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