Are Startups Eligible for the SBA’s New Paycheck Protection Program (PPP) Loans? (IN11298, Version 2)

Summary

Congressional Research Service Insight IN11298, Version 2, by Sean Lowry, dated March 31, 2020. It explains that the Coronavirus Aid, Relief, and Economic Security Act created the Paycheck Protection Program, whose covered loans carry a 100% loan guarantee, a maximum term of 10 years, no fees and an interest rate not to exceed 4%, for a covered period from February 15, 2020 through June 30, 2020. It then describes the affiliation rules, under which an investor deemed to control several businesses can make all of them ineligible if together they employ more than 500 people, a concern for startups backed by venture capital funds and angel investors. The Act waives those rules for identified franchises, businesses financed by Small Business Investment Companies, and accommodation and food services businesses with no more than 500 employees per location.

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INSIGHTi

Are Startups Eligible for the SBA’s New
Paycheck Protection Program (PPP) Loans?

Sean Lowry
Analyst in Public Finance

March 31, 2020
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act; P.L. 116-136), among other
provisions, created the Paycheck Protection Program (PPP). Under the PPP, a lender may provide
“covered loans” to assist small businesses (defined as either businesses that have 500 or fewer employees
or that meet the general size standards under the Small Business Act), small 501(c)(3) nonprofit
organizations, and small 501(c)(19) veterans organizations that have been adversely affected by COVID-
19. These covered loans—also known as PPP loans—have
 a 100% SBA loan guarantee;
 a maximum term of 10 years;
 no associated fees; and
 an interest rate not to exceed 4%.
PPP loan proceeds can be applied to specific purposes, such as payroll (including compensation to
employees and owners), leave payments, state and local taxes assessed on compensation paid by the
business, mortgage or rent, utilities, and interest on any other debt obligations paid during the covered
period. The covered period runs from February 15, 2020, through June 30, 2020.

The SBA’s Affiliation Rules
Despite directly employing 500 or fewer employees, some startups (and other small businesses) might be
ineligible for PPP loans because of the SBA’s “affiliation rules.” The affiliation rules are designed to
prevent “big” businesses from accessing SBA’s programs that are statutorily required to benefit only
independently owned and controlled “small business concerns.” For example, a business of 1,000
employees could break up into five businesses with 200 employees each—all owned by the same parent
company—in order to fall under the 500 employee threshold.
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IN11298

CRS INSIGHT
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Under the SBA’s affiliation regulations, an investor could be deemed to have “control” of multiple
businesses, thereby making all of the affiliated businesses under that investor’s control ineligible for SBA
assistance if they, in the aggregate, are too “big” to be eligible. Control can be determined in a number of
ways, such as a single investor owning 50% or more of the value of the business’s stock or its voting
rights for its board of directors (who review important business decisions made by management). Control
can also be determined in some less than obvious ways, including by having multiple investors with
minority ownership, family links between multiple entities, and certain contractual relationships or
“economic dependency.” The affiliation rules also apply to both for-profit business and nonprofit
relationships. As such, the SBA’s affiliation rules could be particularly important for lenders that issue
PPP loans and the businesses that seek them.
In particular, affiliation rules could prevent certain startups and other businesses that have received
investments from private investment funds and investors (e.g., private equity funds, venture capital funds,
and “angel investors”) from being eligible for PPP loans. Private equity funds tend to invest in a broad
array of businesses (including smaller businesses and larger, more established businesses). Venture capital
funds and angel investors often target their investments to startups and more early stage companies. These
private investment funds and investors often seek to control the company’s business decisions by
purchasing a majority of the business’s stock, thereby giving them control over management decisions.
Alternatively, these funds and investors may condition their investments on receiving a special class of
the business’s stock that gives them disproportionate voting shares, relative to their share of ownership of
the total value of stock issued (“high vote shares”). Both strategies are intended to protect the rate of
return on investment. These arrangements, though, could lead a fund or an investor to having “control”
over multiple businesses. In the aggregate, if all affiliated businesses employ more than 500 employees,
then potentially all of the businesses under the affiliation network are ineligible for PPP loans.

PPP Exceptions to the Affiliation Rules
The CARES Act waives the affiliation rules in three specific instances:
1. businesses owned by franchises identified by the SBA,
2. businesses that receive financial assistance from licensed Small Business Investment
Companies (SBICs), and
3. businesses operating in the accommodation and food services industry (North American
Industry Classification System (NAICS) Code 72) that have no more than 500 employees
per physical location. For example, if a single investor wholly owns a set of five hotels,
organized as separate businesses, that each employ 200 people, then the affiliation rules
are waived; the investor could receive PPP loans for each of the five hotel businesses.
For more information on SBA loan programs and the SBA-related provisions of the CARES Act, see CRS
Report R46284, COVID-19 Stimulus Assistance to Small Businesses: Issues and Policy Options, by
Robert Jay Dilger, Bruce R. Lindsay, and Sean Lowry.

IN11298 · VERSION 2 · NEW
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