What Does the Stimulus Package (CARES Act) Mean for Your Startup?


The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was passed and signed into law on March 27, 2020. This article summarizes three components of the Act that are most relevant to startups: the Paycheck Protection Program, tax credits, and wage tax deferral.

CARES Act - Paycheck Protection Program

The CARES Act authorized $349 billion in loans for eligible small businesses. Additional funding for the PPP was approved, and this amount was increased to $659 billion by the Paycheck Protection Program and Healthcare Enhancement Act. The main purpose of the program (also known as the “Paycheck Protection Program”) is to enable small businesses to retain their current employees and rehire any they have already had to lay off. The loans are subject to partial forgiveness based on certain expenses paid during the 8-weeks post disbursement.

Who is Eligible for the Paycheck Protection Program?

Eligible business include small businesses — including nonprofits, veterans organizations, tribal concerns, self-employed individuals, sole proprietorships, and independent contractors — with up to 500 employees. Certain business with more 500 employees are also eligible.

"Affiliation" Rules for Venture-Backed Startups

As mentioned above, to be eligible for a Paycheck Protection Program loan, a business cannot have more than 500 employees. In determining whether an applicant meets the 500-employee cap, the SBA will consider and include the employees of an applicant’s “affiliates.”

The SBA generally considers an "affiliate" to include any company that controls or has the power to control the applicant business, whether through ownership, management, or other relationship between the parties.

For example, control exists where a minority shareholder (such as a venture capital or private equity firm) has the ability under the applicable investment documents to block an action by the applicant’s board of directors or other shareholders. Historically, this has made it difficult for venture-backed companies to be eligible for other SBA loans, by requiring them to include all of the employees at every company their investors have backed as part of their employee count (which is likely above the 500 minimum threshold).

The Treasury Department has reiterated its traditional rules for affiliation under 13 C.F.R. 121.301 in the context of the PPP.

PRO TIP: Since applicants are required to self-certify that they are eligible for a CARES Act loan, it is strongly recommend that venture-backed talk to their startup lawyers if they are unsure if the affiliation rules impact their eligibility.

Certification for Need

Under the CARES Act, all applicants are required to certify in their application that "[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant." It is not entirely clear how this need would be interpreted -- and likely won't be clarified until further enforcement action. However, the Department of the Treasury has stated the following (emphasis added):

Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.

PRO TIP: Based on this, all startups are strongly recommended to thoroughly document the following, including at a board meeting or through a written board consent, before accepting any PPP funding:

  • Business activity at the time of applying for the loan. This may include, for example, the impact to their revenue from COVID-19, their cash positions and other liquid assets, and their expected runway on current funding.
  • Access to any other forms of capital that would not be significantly detrimental to the startup. It's not entirely clear how this would be interpreted, but it may include, for example, access to venture capital funding on reasonable terms and/or low-interest bank loans.

The Treasury Department has clarified that any company that receives a PPP loan and returns the funds by May 18, 2020 will not be in violation of this certification. For this reason, the board of any startup with substantial amount of funding and runway that has already received a PPP loan should discuss whether the startup should return the PPP funding, taking into consideration the risk of potential enforcement action as well as potential reputational risk.

PRO TIP: As of May 13, 2020, the SBA has issued guidance that provides a safe harbor for smaller loans: any borrower who, along with its affiliates, has received a loan with a principal amount of less than $2 million will be deemed to have made the certification regarding need in good faith.

How Much Can I Borrow?

Under the Paycheck Protection Program, eligible businesses may borrow varying amounts. The maximum loan size is the lower of $10 million or the amount listed below.

Applicants should use payroll costs from the 12 months preceding the application, likely March 2019 through April 2020. However, note that although the CARES Act and Interim Rule provides that average monthly payroll costs should be calculated over the 12-month period preceding the application, the application form itself states that monthly payroll costs will be calculated using 2019 payroll costs for most applicants.

Seasonal or new businesses may elect to use the following methods to calculate the loan amount:

If you are a seasonal business and were in business from February 15, 2019 - June 30, 2019: You may borrow up to 250% of your average monthly payroll costs (see below) during that time period OR you can opt to choose March 1, 2019 as your time period start date.
If you are a new business and were not in business between February 15, 2019 - June 30, 2019: You may borrow up to 250% of your average monthly payroll costs between January 1, 2020 and February 29, 2020.

The maximum amount you can borrow is tied to your payroll costs, as described above.

Payroll costs include:

  • Salary, wages, commissions, tips, or similar compensation;
  • Vacation, parental, family, medical, or sick leave pay;
  • Allowance for dismissal or separation;
  • Group health care benefits (including insurance premiums);
  • Retirement benefits (such as 401(k) matching); and
  • State or local payroll taxes.

If you are an independent contractor or sole proprietor applying for a loan, your payroll costs would include your wages, commissions, income, or net earnings from self-employment or similar compensation.

The Payroll costs do not include:

  • Compensation paid to any individual employee in excess of $100,000 per year (payment for retirement and other benefits not subject to $100,000 cap);
  • Most payroll tax and withholding;
  • Compensation paid to an employee whose principal place of residence is outside of the U.S.; and
  • Qualified paid sick leave or family leave wages allowed under Families First Coronavirus Response Act (whether or not such credit was applied for).

What Can the Loan Funds be Used for?

Loan funds can be used for the following qualified expenses:

  • Payroll costs (see above), including continued group health care benefits;
  • Mortgage interest;
  • Rent;
  • Utilities; and
  • Interest on any existing obligations (as of the covered period).

How Does Loan Forgiveness Work?

The amount of loan forgiveness can be up to the full principal amount of the loan and any accrued interest.

The total forgiven amount is calculated in two steps:

Step 1. Determine how much you spent in qualified costs (see below) over the eight weeks following receipt of the loan.

Step 2. Calculate any required adjustments due to changes in your workforce or wages paid (see below).

Step 1

This step is fairly straightforward. Total the amounts of qualified costs your business incurred during the 8-week period following receipt of the loan. These costs generally include:

  • Payroll costs (see above);
  • Mortgage interest;
  • Rent; and
  • Utilities.

Note that the qualified costs used to determine your forgivable amount are broader than the payroll costs used to calculate the amount of the loan. However, please note that, per guidelines from the U.S. Department of the Treasury, due to the high level of interest in the loans, at least 75% of the forgivable amount must have been used for payroll.

Step 2

If you reduce staff or lower wages, then the amount of your loan that will be forgiven may decrease (note that there is a way to cure this - see below).

Layoffs. If you have had a reduction in your full-time staff, the calculation is as follows:

A. Calculate the average number of full-time employees per month for the 8-week period after loan disbursement (i.e., the date that the lender makes the first disbursement of the PPP loan to the borrower), and then multiply that number by the payroll costs from Step 1.

B. Calculate the average number of full time equivalent employees per month during the period of February 15, 2019 through June 15, 2019, or (at your choice), the average number of full time equivalent employees per month during January and February 2020.

C. Divide A by B. That is your forgiveness reduction.

Pay cuts. If you reduce pay for one or more employees by more than 25%, the calculation is as follows:

  • Basically, the calculated forgiveness amount will be reduced by the amount in excess of 25%. By way of example, if you pay someone $75,000 and reduce their pay to $50,000, that comes out to a reduction of about 33%. A 25% reduction in their original salary of $75,000 would have resulted in a new salary of $56,250. However, in this example you reduced the salary to $50,000. Thus, the loan forgiveness amount is reduced by $6,250 ($56,250-$50,000).

What can I do if I've already laid people off?

Reduction amounts caused as a result of terminating staff or reducing or wages as described above that occur during the period beginning on February 15, 2020, and ending 30 days after March 27, 2020 shall not reduce the amount of loan forgiveness if, by June 30, 2020, your company rehires the previously-terminated employees or reverses the reduction in wages.

PRO TIP: The Treasury Department has clarified that the forgiveness amount won't be reduced for any laid-employee whom the borrower offered to rehire, even if the employee refused to go back to work, so long as the following are satisfied:

  • The offer to rehire must be for the same position, at the same salary and for the same number of hours.
  • A written offer of rehire must be made in good faith
  • The laid off employee’s rejection must be documented in writing.

What happens to amounts that are not forgiven?

Pursuant to guidelines issued by the U.S. Department of the Treasury, the loans will carry an interest of no more than 4% (currently set to 1% per interim guidelines from the U.S. Department of the Treasury) and will have a maturity date of 2 years. The initial payment will be deferred for 6 months.

Will I have to pay tax on the forgiven amount?

No. The loan forgiveness amount is also excluded from taxable income.

Paycheck Protection Program and Economic Injury Disaster Loans (EIDL)

In order to apply for a Paycheck Protection Program loan, a business cannot currently have another application pending or approved under the SBA 7(a) loan program for the same purpose. In other words, a business cannot apply for both a CARES Act loan and an SBA Economic Injury Disaster Loan (EIDL) in connection with the same economic injury caused by COVID-19. While SBA has not provided any additional guidance on the topic, and the exact scope of the restrictions remains to be seen, it may be possible for businesses to apply for both PPP and EIDL loans for different purposes, such as using the CARES Act loan for payroll expenses and the EIDL for other business related expenses, such as marketing or other debt that cannot be paid as a result of COVID-19 related impacts.

Are There Any Other Important Factors I Should Know About the Paycheck Protection Program Loans?

Unlike other SBA disaster loans, a business applying for a Paycheck Protection Program loan does not need to show inability to obtain funding elsewhere.

There is also no collateral or personal guarantee requirement.

How Can I Apply for a Paycheck Protection Program Loan?

The Paycheck Protection Program loans will be administered by banks and other lenders. All SBA-certified lenders will have delegated authority to process loans quickly, and most other banks and credit unions are eligible to participate in the program.

If you meet the eligibility criteria, contact your bank and ask if it will be participating in the Paycheck Protection Program, when they expect to begin accepting applications, and if they have any other information.

The SBA has provided a sample application, which applicants can use to prepare the information needed prior to submitting an application. The SBA and banks are currently also working on further information about the types of information and documentation that will be needed. However, it's expected that applicants will likely need the following documentation to submit an application:

  • Proof that they were in business on February 15, 2019 (or other relevant timeline);
  • Documentation of payroll costs for the 1-year period before the loan application; and
  • Financial statements for fiscal year 2019.

When Can I Apply for a Paycheck Protection Program Loan?

According to the U.S. Department of the Treasury, eligible business can start applying for loans starting April 3, 2020, and independent contractors and self-employed individuals can start applying April 10, 2020.

PRO TIP: Eligible applicants are encouraged to apply as quickly as possible due to the funding cap of the program.

Where Can I Find More Information?

Because the CARES Act was enacted only recently, it may take some time for the Act to be interpreted and implemented by regulators. The SBA is expected to provide additional guidance to businesses and lenders in the coming weeks.

CARES Act - Tax Credits

Who is eligible?

If you either:

  1. have had to fully or partially suspend operations due to a COVID-19 related government shutdown order, or
  2. can show 50% loss in gross receipts compared to the same quarter in the prior year,

Then: you may qualify for a tax credit for eligible employees on its payroll between March 13, 2020 through December 31, 2020. For example, if you had $100,000 in gross receipts in Q12019 and $40,000 in gross receipts in Q12020 (a 60% decrease in gross receipts), then your business would qualify for tax credits.

How does it work?

The amount of the credit is 50% of the qualifying wages of the employer, limited to $10,000 for each eligible employee for all quarters. The credit only applies to wages paid after March 12, 2020 and before January 1, 2021.

If you have up to 100 employees: You may claim the tax credit for all employees, whether or not they are providing services.
If you have more than 100 employees: You may only claim the tax credit for full-time employees who are (1) being paid but (2) not providing service due to either a full or partial shutdown or a reduction in gross receipts.

Are there any limitations?

Businesses cannot receive both tax credits and the CARES Act SBA loan (above) and the amount of the credit is reduced by any paid sick leave or family leave wages that qualify for credit under the Families First Coronavirus Response Act (whether or not such credit was applied for).

When does the credit end?

Eligibility ends when gross receipts in a quarter exceed 80% compared to the same quarter in 2019. Using the above example, if in Q32020 your gross receipts increase to $80,000, and gross receipts in Q32019 were $100,000, then your eligibility for tax credits would end in Q32020.

CARES Act - Wage Tax Deferral

Under the Act, most businesses will be allowed to defer the 6.2% employer payable Social Security taxes for employee wages that are paid between March 27, 2020 through December 31, 2020. Half of the deferred wages would need to be repaid by the end of 2021, and the other half of the deferred wages would be due by the end of 2022. Businesses cannot receive both tax credits and any forgiveness of a CARES Act SBA loan (above).

Modifications to SBA Disaster Loan Program

The CARES Act also expanded on the existing SBA Economic Injury Disaster Loans (EIDL). The EIDLs have always been available to small businesses for disasters. However, this is the first time that a virus or pandemic event has been defined as a “disaster” for the purposes of these loans. Because of the historic and unprecedented nature of the current COVID-19 pandemic, the SBA has made numerous modifications to the EDILs. Such updates include:

  • Available to businesses in every state and territory (any business that applied previously but was denied because relief for Coronavirus related economic injury was not currently available in their location can now reapply).
  • Loans up to $2 million.
  • Term of 30 years.
  • Interest rates for small businesses is 3.75%; nonprofits is 2.75%.
  • First month’s payments are deferred for a full year from the date of the promissory note.
  • Approval is based on the applicant’s credit score (not repayment ability, no tax return is required, and a prior bankruptcy will not disqualify an applicant).
  • Loans less than $200,000 can be approved without a personal guarantee.
  • Real estate is not required as collateral (general security interest in business property is required instead).
  • Expanded access for sole proprietors and independent contractors.
  • Not required to show inability to obtain credit elsewhere on reasonable terms.
  • An emergency cash advance of $10,000 that can be forgiven if spent on paid leave, maintaining payroll, increased costs due to supply chain disruption, mortgage or lease payments or repaying obligations that cannot be met due to revenue loss.
    • This emergency grant may be available to applicants even if they do not qualify for additional funds.

If you have been in business since at least January 31, 2020, you can apply for an EDIL here.


DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.