VeradiVerdict - Issue #79
The Coronavirus Aid, Relief, and Economic Security (CARES) Act is a $2 trillion economic stimulus passed by the federal government to help support the US economy during the ongoing COVID-19 pandemic. The Act allocates $450 billion towards support programs for small- and medium-sized businesses (SMBs), including venture-backed startups. There are two main programs of interest for startups.
The Family First Coronavirus Response Act (FFCRA) allows employers with less than 500 employees to use wages paid for sick leave and related incidents as payroll tax credit toward Social Security taxes and retention tax credits. The program allows companies to essentially use their immediate funding to support their employees’ paychecks, using as credit for later on.
The Small Business Administration’s Paycheck Protection Program (PPP) provides forgivable loans to businesses with less than 500 employees. Startups must demonstrate with good faith that they need the funding to support their business given the economic downturn from the pandemic. The loan has various complexities regarding investor holdings in the business and the business’s affiliations, but ultimately can provide up to $10 million in forgivable loans at 0.5-1% interest to qualifying businesses.
The PPP operates off of a $350 billion budget that’s deployed in a first-come-first-serve manner. That means that the first qualifying businesses to apply will get loan funding, and those who apply after the $350 billion has been deployed will not be able to receive anything. This makes it critical that businesses consult with legal counsel and advisors and begin their applications immediately.
The FFCRA and PPP have the power to bring huge economic relief to small businesses and startups that are suffering with the economic conditions of the pandemic. With these programs, speed in applying is of the utmost importance in ensuring that businesses get supported with the allocated funds.
The CARES Act
On March 27, 2020, the CARES Act became law. CARES is short for Coronavirus Aid, Relief, and Economic Security. The Act, a reactionary measure to the economic turmoil spurred by the coronavirus pandemic and public health protocols, amounts to a $2 trillion economic stimulus –– the largest in the history of the country. You may have heard of the Act for its more prominent features, such as the $1200 direct deposit to tax-paying Americans and an enhanced unemployment program. However, the Act’s coverage is extremely broad, bringing funding to everything from the airline sector to lending programs.
One key feature of the CARES Act is that it specifically allocates $450 billion towards lending programs administered by the Federal Reserve. Much of this lending is targeted to trickle down to small- and medium-sized businesses (SMBs) to assist them with expenses and/or payroll in the current harsh economic conditions.
That means that small, venture-backed startups are eligible for financial assistance from the federal government, but the funding is limited and in high-demand, so it’s critical to act fast moving forwards.
There are two main programs that concern startups: the FFCRA and the SBA PPP. Below, I’ll discuss their specifics, their requirements for startups, and how you can go ahead with applying.
Family First Coronavirus Response Act (FFCRA)
The FFCRA targets businesses with less than 500 employees and is mainly targeted at helping employers continue to financially support their employees, with tax credit incentives.
All employers must provide 2 weeks of paid sick leave at full salary (maxed at $511/day) to employees who are subject to government- or healthcare-provider-mandated quarantine due to diagnosis or symptoms of COVID-19.
All employers must provide 2 weeks of paid sick leave at 2/3 salary (maxed at $200/day) for employees caring for someone else who is subject to a government- or healthcare-provider-mandated-quarantine or school/childcare closures.
All employers must provide an additional 10 weeks of paid family/medical leave at 2/3 salary for those affected by school/childcare closures.
Wages paid for FFCRA leave can be used as payroll tax credit towards the employer part of Social Security taxes. If the wages do not cover the entirety of the credit, you can also petition the IRS to get an advance of the credit.
In order to be eligible, businesses must post the federally-provided poster on their premises.
Additionally, employers that have been significantly affected by COVID-19 (a litmus test is a minimum 50% reduction in gross sales compared to 2019) can also take retention tax credit, based on eligible wages to a maximum of $5000/employee. For companies with less than 100 people, they can take credit on all wages paid. For companies with more than 100 people, they can take credit on wages paid exclusively for non-working hours. This is mutually exclusive with the former tax credit on Social Security –– so companies must choose whether to take a retention tax credit OR a Social Security tax credit. Additionally, companies that take this credit are ineligible to receive forgiveness for SBA PPP loans (to be discussed later). Companies can take social security payroll tax deferral on wages paid from March 15 to the end of 2020 until they receive loan forgiveness for an SBA PPP loan.
Small Business Administration Paycheck Protection Program (SBA PPP)
The PPP is mainly geared towards giving financial loans to SMBs. Unlike the FFCRA, the loan is more general and is likely to be of more interest to most companies. For companies incorporated prior to 2/15/2020 with less than 500 employees, the government is offering up to $10 million of a loan at 0.5-1% interest that converts into a grant (via loan forgiveness). The actual amount that companies get is around 2.5 times the average monthly payroll (calculated from the past 12 months of payroll). The treasury suggests the loan term of 2 years, with no loan payments for the first six months. Companies are eligible for loan forgiveness for all qualifying expenses paid by the loan over the eight weeks after receiving the loan. Qualifying expenses would be things like payroll, rent, interest, mortgage, debt, etc. These loans are also not mutually exclusive with EIDL loans.
The federal motive of the PPP is to help companies pay paychecks to their employees in times of low profits due to the ongoing pandemic. Thus, to receive the loan, companies must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Companies also need to provide information regarding their 2019 taxes, 2019 payroll, and more.
The most critical thing about the PPP is that it offers $350 billion total in economic assistance to companies. Loans are granted on a first-come-first-serve basis, so once the $350 billion are spent, it is impossible to apply for a PPP loan. It’s therefore essential that startups move extremely fast with regards to applying for PPP loans.
A good first step is for companies to consult with legal counsel and PR about their ability to demonstrate good faith in taking the PPP loan. Again, the loan is targeted towards companies that need the funding to pay wages for its employee, and it is critical that the companies that receive PPP loans can demonstrate a need for that.
Some conditions for the loan are that you must disclose all investors with over 20% ownership of your company (in Appendix C of the application). Another key caveat is that VC-backed startups are subject to the “Affiliation Rule” of the SBA. The Affiliation Rule essentially says that the government judges whether a business is small (under 500 employees) by counting the number of employees in that business as well as in affiliated companies.
The Affiliation Rule doesn’t necessarily mean a startup is ineligible, but it does complexify the application. The most recent guidance considers majority holders (entities that own more than 50% of the business’s voting securities) as affiliates. It also considers minority holders who have “control” over the business via bylaws, preventing quorum, etc. as affiliates. The best route is to simply consult with legal counsel to understand the ways that the Affiliation Rule interacts with a business, given its equity and investment structure, and then decide whether or not to move forward with a PPP application. Additionally, restaurants, hotels, franchises, and SBIC-backed businesses are exempt from the Affiliation Rule.
When considering with whom to apply for a PPP loan, it’s a good idea to consult with counsel and your board members and advisors. For the most part, banks will likely prioritize customers that they have existing relationships with because it minimizes delays related to onboarding and Know Your Customer (KYC) approval. Again, the $350 billion is likely to run out quick as companies from around the country apply for loans. Thus, try to apply with a bank that you have an ongoing, strong relationship with to streamline the process.
Some banks have already launched their applications or related information, including:
Veem (a payments platform for businesses)
A more comprehensive list of banks offering PPP loans can be found here. It’s unclear exactly which banks are offering the loans, but it seems that most major financial institutions have some kind of application for the program. Notably, for crypto enthusiasts, Silvergate Bank is absent from the list.
Both the FFCRA and the PPP offer incredible benefits to startups and small businesses that may be suffering with the economic downturn from the COVID-19 pandemic. They offer real mechanisms of relief that may help keep businesses afloat in these difficult times. The PPP specifically provides a lot of general funding to help businesses manage ongoing expenses and support their employees. Ultimately, both programs, along with the entirety of the CARES Act, are monoliths with numerous caveats, complexities, and more.
The most important step moving forward is to consult with legal counsel, boards, and advisors immediately to understand the best direction to proceed. Applications for PPP loans will launch widely Monday April 6. Once the $350 billion allocated for the program has been spent, no more loans will be offered. It’s absolutely critical that businesses and startups move forward with their applications quickly and effectively to ensure they get federal support through this pandemic.
* Thanks to my friend and fellow investor Amy Wu for good insights on this topic
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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. The firm invests in equity, pre-sales/IEO rounds, and cryptocurrencies on the secondary markets. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.
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