Is it Technically Wrong for a Public Small Company to Have Applied for a PPP Loan?

Many small public firms are being ridiculed in the media for applying and receiving SBA PPP Loans. But was it wrong for them to apply? The answer is technically YES, but I understand the confusion and I do think that it is not fully their fault- the SBA and the SBA Lenders need to accept some blame. When the stats are published regarding the importance of small businesses to the economy, those stats include both public and private small business firms, together both employ about 50% of the American workforce.

Misinformation Regarding Loan Program

The program (as most federal regulations that are written and published in the Federal Register) is not written in simple English. It is also not written for the common business owner to understand if they qualify for the loan or not. The regulation appears to have multiple "for profit business qualifications" including being "defined as a Small Business in accordance with 15 U.S.C. 632" or "...have less than 500 employees" in your business, or be an enterprise that is "approved by the administrator". Depending upon how you read the regulation, it is easy to dismiss " independently owned and operated" as a critical requirement, especially in the rush to submit applications. Ultimately these firms applied, but the SBA Lenders processed the loan and the SBA administrator approved the loan.

WHO IS RESPONSIBLE FOR THE ERROR?

I believe that it is the responsibility of the banks and SBA Lenders to properly qualify the recipients during the application process, throughout the application underwriting process, and at the time of closing. Technically, once closing has occurred, those monies should belong to the recipient, unless intentional fraud can be proved in the loan process. The SBA Lenders should have realized that a public NASDAQ firm would not be compliant with the SBA program qualifications. The SBA Lender should also have realized, in the case of franchises,that is was a violation of the affiliation rules for the payroll of all the independent franchise units to be aggregated so that the parent company would receive the proceeds. Further, some companies that received the loan money clearly have more than 500 employees.

WHY DID THIS ERROR OCCUR?

I think the primary error is actually how the regulation was written. With its confusing provisions, it is easy for an organization to make an error in initiating an application process. There was a rush to get applications submitted because the approvals were be done on a "first come first serve basis". With the regulation not being easy to read and there being no clear restriction against small public companies applying, many firms began expecting these loans proceeds starting April 3 and applied accordingly.

I also think that there was an inherent conflict of interest in using bank controlled SBA Lenders to process the applications. I believe that banking organizations did see these emergency loans as a means to protect their current clients from default on current loans owed to the bank, the avoidance of withdrawal of emergency funds from bank deposits, and the reduction of need to use unsecured lines of credit that could actually increase the loan default rate for the bank. During a crisis like this, banks do need to protect themselves from increases in the loan default rate that will adversely impact the bank reserves and its profitability. I am concerned that banks provided favoritism to current clients by helping to process loans in advance of the April 15 begin date and potentially queuing data in the system to automatically be submitted by the bank as soon as website was available. I do hope that those who applied for the loan actually typed the data into the public website, as every other non-client firm was required to do. If they had entered data themselves, then errors would have been detected sooner by the applicant company officer .It is true that when loans are paid to a non-qualified borrower, then those monies are not available to qualified borrowers who were legitimately in the queue and needed those funds. The resulting delays could adversely effect the very survival of a small business and cause higher unemployment costs.

It is important to realize that there are many small public companies that do not have the financial reserves to weather a storm like this. I do wish that the federal and state governments did provide to these entities an equivalent 0% 6-12 month interest free loan that could be used to supplement their emergency reserves so that they can maintain payroll and overhead expenses. It is very difficult and expensive for such small firms to go back to the public markets and secure a secondary public offering to raise capital. Many believe that it is easier for such firms to secure short-term bank loans, but those bank loans will be difficult to qualify for and have high interest costs because of increased risk. So, in the interim, I fear many small public companies will need to lay-off employees and may fail.

DETAILS ABOUT THE CARES ACT AND PAYROLL PROTECTION PROGRAM

The CARES ACT created the PPP Loan program to be administered by the Small Business Administration. The goal of the program is to assist small businesses with fewer than 500 employees to receive low interest forgivable loans to enable and continue payroll and the payment of overhead costs during the declared COVID emergency. In summary, "The Paycheck Protection Program is a loan designed to provide a direct incentive for small businesses to keep their workers on the payroll".

The SBA website nor the CARES ACT did place a limitation or disqualification of public small business applying for a loan. The program was published with references to both the requirements of being an SBC organization and a limitation on the number of employees. The program does not require a business to have a specific amount of emergency reserve funds nor require it to use any potential lines of credit or capital sources before applying or using the funds. Therefore, the loan acts as a supplement to any other sources that the organization may have access to.

In reviewing the official interim rules, published on April 3, the mission of the loan program is " The Paycheck Protection Program and loan forgiveness are intended to provide economic relief to small businesses nationwide adversely impacted by the Coronavirus Disease 2019 (COVID–19)." The interim rule also states " With the COVID–19 emergency, many small businesses nationwide are experiencing economic hardship as a direct result of the Federal, State, tribal, and local public health measures that are being taken to minimize the public’s exposure to the virus. These measures, some of which are government-mandated, are being implemented nationwide and include the closures of restaurants, bars, and gyms. "

The SBA was mandated and authorized to amend its current loan programs and use the allocated funding to "Section 1102 of the Act temporarily permits SBA to guarantee 100 percent of 7(a) loans under a new program titled the ‘‘Paycheck Protection Program.’’ Section 1106 of the Act provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the Paycheck Protection Program. "

In accordance with the interim rule, " small businesses need to be informed on how to apply for a loan and the terms of the loan under section 1102 of the Act as soon as possible because the last day to apply for and receive a loan is June 30, 2020."

Here is a summary of qualifications referenced and known on April 15 as the online application process began:

• ...a borrower will be considered together with its affiliates for purposes of determining eligibility for the PPP. Under SBA rules, entities may be considered affiliates based on factors including stock ownership, overlapping management, and identity of interest. 13 CFR 121.301.
• ...An entity generally is eligible for the PPP if it, combined with its affiliates, is a small business as defined in section 3 of the Small Business Act (15 U.S.C. 632), or (1) has 500 or fewer employees whose principal place of residence is in the United States or is a business that operates in a certain industry and meets applicable SBA employee-based size standards for that industry...
• In accordance with the Small Business Act, a Small Business is generally defined as " (1) For the purposes of this chapter, a small-business concern, including but not limited to enterprises that are engaged in the business of production of food and fiber, ranching and raising of livestock, agriculture, and all other farming and agricultural related industries, shall be deemed to be one which is independently owned and operated and which is not dominant in its field of operation:  Provided , That notwithstanding any other provision of law, an agricultural enterprise shall be deemed to be a small business concern if it (including its affiliates) has annual receipts not in excess of $750,000." Here is a checklist that is provided by a third party to help companies verify that they are considered an SBC for the Small Business Administration loans.

Based on the information above, it is certainly possible for business enterprises to be confused regarding their qualification for the loan. The only qualification that is most evident and reported in the media is that the "employee base must be below 500 employees". Therefore, it is the responsibility of those who are assisting in the loan process or who are completing the underwriting to verify that the company meets the criteria. It would have been very easy for the SBA to include in the loan application the written criteria for the loan and the fact that it is technically disqualified because it is a small public company. The loan application had a long list of disqualifications that he applicant had to confirm, but it did not reference the fact that a small public company was also a dis-qualifier.