Paycheck Protection Program loans, commonly referred to as PPP loans, have been a godsend for millions of small businesses and their employees. As originally envisioned, the purpose of the PPP loans was to provide low interest, forgivable loans to small businesses that have been adversely affected by the Covid-19 Pandemic to cover payroll and other expenses including interest, rent and utilities. The goal of the program is to allow small businesses to survive the depths of the pandemic while keeping their employees on the payroll. Since its inception, PPP loans have enabled millions of workers to stay on employment rolls.
The PPP program has proven to be very popular. Originally authorized as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the initial funds set aside for the program were gobbled up quickly, much of it by larger firms. Congress acted quickly to replenish the program, adding $320 Billion in funding under the Paycheck Protection Program and Health Care Enhancement Act, signed into law on April 24, 2020. The Paycheck Protection Program Flexibility Act of 2020, signed into law on June 5, 2020, amended the PPP to expand loan forgiveness from 8 weeks of eligible costs to 24 weeks, and reducing the percentage of the proceeds that must be used to cover payroll. In early July of 2020, Congress extended the deadline to submit applications for new PPP loans through August 8, 2020. When the original program application deadline closed on August 8, 2020, more than five million borrowers have received over $525 billion in loans through the PPP Program. As part of the Consolidated Appropriations Act of 2021, Congress initiated a new PPP program, providing an additional $284 billion in funding for new PPP loans, and allowing borrowers to access a second draw under the program.
With millions of borrows already holding PPP Loans on their books, and millions more businesses potentially becoming borrowers under the new PPP program for 2021, many borrowers with outstanding PPP loans will have the opportunity to engage in M&A transactions, including mergers, sales, and acquisitions. What happens when a business with an outstanding PPP loan on its books becomes a potential acquisition target? What happens when a business with an outstanding PPP loan seeks to acquire another business? In the context of an M&A transaction that results in a change in ownership of a business with an outstanding PPP loan, the U.S. Small Business Administration (the “SBA”) has provided guidance that outlines the requirements borrowers with outstanding PPP loans must follow.
The PPP Loan Program
PPP loans are overseen by the Treasury Department and backed by the SBA as part of what are known as “7A Loans”. The SBA is authorized to provide a 100% guarantee to lenders on loans issued under the program. Private lenders receive and review PPP loan applications, issue and administer the loans. Most private lenders participating in the program are banks, but other non-bank lenders are also authorized to issue PPP loans. The full principal amount of the loans and any accrued interest may qualify for loan forgiveness if the borrower retains or rehires staff and maintains pre-pandemic compensation levels. However, not more than 25% of the loan forgiveness amounts may be attributable to nonpayroll costs. Loan payments will be deferred for six months but interest will continue to accrue during the six-month deferment. No collateral or personal guarantees are required to receive a PPP loan.
Businesses that satisfy certain requirements will have their loans forgiven. To obtain loan forgiveness, borrowers must submit an application to their lender within ten months after the end of the “covered period” for eligible costs under the loan, which is between 8 and 24 weeks. Generally, forgiveness is granted to borrowers that retained or rehired employees while also maintaining salary levels from before the pandemic. Borrowers can obtain partial forgiveness if they do not satisfy all forgiveness criteria, such as if full-time headcount declined or salaries decreased somewhat. To obtain full forgiveness, (i) the borrower must use 60% of the loan for payroll costs, (ii) the remaining 40% can be used for qualified expenses including mortgage interest and rent, utilities, operational costs, uninsured property damage, and PPE, and (iii) the borrower must attempt in good faith to maintain employment and payroll at pre-pandemic levels.
Change of Control of the Borrower
What is required when a borrower liable for a PPP loan seeks to engage in a transaction that results in a change of control or ownership of the borrower? The SBA, though Procedural Notice (5000-20057), has provided guidance to PPP loan borrowers that may enter into such a change in control transaction.
For purposes of the PPP, the SBA considers a change of ownership to have occurred when: (1) at least 20% of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including a sale to an affiliate or another existing owner of the entity, (2) the PPP borrower sells or otherwise transfers at least 50% of its assets (measured by fair market value), whether in one or more transactions, or (3) a PPP borrower is merged with or into another entity. If a deal does not result in a change of control as contemplated in the SBA notice, then absent some conflicting or additional requirements in the PPP borrower’s loan documents, no consent is required.
Regardless of any change of ownership, PPP borrowers remain responsible for (1) performance of all obligations under the PPP loan, (2) certifications made in connection with PPP loan applications, including the certification of economic necessity, and (3) compliance with all other applicable PPP requirements. Additionally, PPP borrowers remain responsible for obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing those forms and supporting documentation to PPP lenders or lenders servicing PPP loans or to the SBA upon request. While the PPP borrower remains obligated for the PPP loan, any potential buyers should investigate the borrower’s compliance with the terms of the PPP loan and demand copies of, and retain, all required documents, forms and records related to the PPP loan.
Prior to the closing of any deal that results in a change of ownership, any borrower with a PPP loan must notify its PPP lender in writing of the contemplated change of control transaction and provide the PPP lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction.
No Consent Is Required If the PPP Loan Has Been Satisfied or Forgiven
Where a PPP loan has been satisfied, either because the loan has been paid in full or the borrower has completed the process for loan forgiveness, there are no restrictions on a change of ownership and a borrower can proceed without the consent of the SBA or its lender. Specifically, if the borrower has either:
(i) repaid its PPP loan note in full, or
(ii) completed the loan forgiveness process in accordance with the PPP requirements, and
a. the SBA has remitted funds to the borrower’s PPP lender in full satisfaction of the PPP note, or
b. the borrower has repaid any remaining balance on the PPP loan after a portion has been forgiven,
then there are no restrictions on the change of control transaction. Clearly, the preferred way to structure a transaction is to arrange for the PPP loan to be paid in full or for the loan to be forgiven prior to closing. Of course, that might not be possible for all deals. Some borrowers or their purchasers might not be willing (or it might not be possible) to delay closing to fully satisfy the PPP loan.
A PPP Lender May Approve a Change of Control Transaction Without Prior SBA Approval For Certain Transactions
Under certain circumstances, the lender to a PPP borrower may approve a change of control transaction without the prior approval of the SBA. If the change of ownership transaction is structured as a sale or transfer of common stock or other ownership interests, or as a merger, then the owner of such interest may sell or otherwise transfer common stock or other ownership interest in a PPP borrower with lender approval, but without the prior approval of SBA, only if:
(i) the sale or other transfer is of 50% or less of the common stock or other ownership interest of the PPP borrower, or
(ii) the PPP borrower completes a forgiveness application reflecting its use of all the PPP loan proceeds and submits it, together with any required supporting documentation, to its PPP lender, and an interest-bearing escrow account controlled by the PPP lender is established with funds equal to the outstanding balance of the PPP loan.
If the change of ownership transaction is structured as an asset sale, then a borrower with an outstanding PPP loan may sell 50% or more of its assets (measured by fair market value) without the prior approval of SBA only if:
(i) the PPP borrower completes and submits to its PPP lender a forgiveness application reflecting its use of all the PPP loan proceeds, together with any required supporting documentation, and
(ii) an interest-bearing escrow account controlled by the lender to the PPP borrower is established with funds equal to the outstanding balance of the PPP loan. The PPP lender must notify the appropriate SBA Loan Servicing Center of the location and the amount of funds in the escrow account within 5 business days of completion of the change of control transaction.
In either case, after the PPP loan forgiveness application process (including any appeal of SBA’s decision) is completed, the escrow funds must be disbursed first to repay any remaining PPP loan balance, if any, plus interest.
It is worth noting that the PPP borrower does not need to supply the funds for the escrow account to repay the outstanding balance of the PPP loan. The parties to the transaction that will result in a change of ownership could structure the transaction to allocate the burden of funding the escrow account to complete the transaction. For example, the purchaser could fund the escrow or a portion of the purchase price could be allocated to fund the escrow account.
Prior SBA Approval Is Needed For Other Transactions
Where it is not possible or feasible to paydown or otherwise satisfy the SBA loan in full prior to closing, and the parties cannot either (i) structure their transaction as a sale of 50% or less of the ownership interests or assets in the PPP borrower, or (ii) place funds equal to the balance of PPP loan into an escrow account controlled by the PPP lender, then the PPP lender may not unilaterally approve the transaction and prior SBA approval is required to consummate the change of control transaction. Where prior SBA approval is needed for a change in control transaction, the borrower must make the request for approval to its PPP lender and the lender must then submit the request to the appropriate SBA office. The request must include:
(i) the reasons why the PPP borrower cannot fully satisfy, or obtain forgiveness for, the PPP note, or escrow funds equal to the remaining PPP loan balance;
(ii) the details of the requested transaction;
(iii) a copy of the executed PPP loan note;
(iv) any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, seller (if different from the PPP borrower), and buyer;
(v) disclosure of whether the buyer has an existing PPP loan and, if so, the SBA loan number; and
(vi) a list of all owners of 20 percent or more of the purchasing entity.
The SBA will review and provide a determination within 60 calendar days of receipt of a complete request. If deemed appropriate, the SBA may require additional risk mitigation measures as a condition of its approval of the transaction. This means that the SBA may place additional requirements or terms on the parties in order to approve the transaction.
SBA approval of any change of ownership involving the sale of 50% or more of the assets (measured by fair market value) of a PPP borrower will be conditioned on the purchasing entity assuming all the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms. In such cases, the purchase or sale agreement must include appropriate language regarding the assumption of the PPP borrower’s obligations under the PPP loan by the purchasing person or entity, or a separate assumption agreement must be submitted to SBA.
When entering a transaction where SBA approval is required, the parties should build in the necessary time to obtain SBA approval prior to closing. It may also be necessary to notify the PPP lender early in the transaction process. If possible, parties should try and structure their transactions to avoid the need to obtain SBA approval. The time needed to obtain approval vcould very well kill some deals.
Cases In Which the Purchaser Also Has a PPP Loan
With millions of outstanding PPP loans, not only is it possible that the target of a transaction has an outstanding PPP loan, but it is also very possible that the acquiring entity also has an outstanding PPP Loan. If the acquiring entity or surviving merger party has an outstanding loan, then the acquiring entities will need to account for and segregate their PPP loan proceeds. Specifically, in the case of a purchase or other transfer of common stock or other ownership interest, the PPP borrower and the new owner(s) are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower. In the case of a merger, the surviving merger party is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.
Requirements For All M&A Transactions
Regardless of whether SBA or lender approval is required, in the event of a sale or other transfer of common stock or other ownership interest in the PPP borrower, or a merger of the PPP borrower with or into another entity, the PPP borrower (and, in the event of a merger of the PPP borrower into another entity, the successor to the PPP borrower) will remain subject to all obligations under the borrower’s PPP loan. In addition, the new owners or successors are required to continue to use the PPP loan proceeds in the manner authorized under the program. If the new owner(s) use PPP funds for unauthorized purposes, the SBA will have recourse against the new owners or successors for the unauthorized use.
Finally, upon the consummation of a change in control transaction, the PPP lender must notify the appropriate SBA office, within 5 business days of completion of the transaction, of the: (i) identity of the new owner(s) of the common stock or other ownership interest; (ii) new owner(s)’ ownership percentage(s); (iii) tax identification number(s) for any owner(s) holding 20 percent or more of the equity in the business; and (iv) location of, and the amount of funds in, the escrow account under the control of the PPP Lender, if an escrow account is required.
Parties to a potential change of ownership transaction need not avoid or delay closing a deal simply because the target has an outstanding PPP loan. So long as the parties are willing to be creative in their deal structure, there are options to satisfy the terms of an outstanding PPP loan. Sellers and purchasers need to be aware of the notice requirements, documentation and timing needed to close the transaction. Sufficient time will need to be built into the deal to provide the necessary notices and obtain the necessary approvals. As always, parties to potential transactions should consult trusted professionals before entering into such a transaction.