Businesses may need to “social distance” too: affiliate rules and payroll protection loans.
For the past several weeks I have been closely following the legislation and rule making concerning the CARES Act, payroll protection loans, and related provisions. One of the most confusing is how attribution/affiliation rules apply to companies that want to take out payroll protection loans. Two interesting issues that that I’ve seen are:
- Can the owner of an operating business use payroll protection loan proceeds to pay rent (a covered expense) to her affiliate real estate holding company?
- Can VC-backed start-ups, that would qualify as small businesses if they were stand-alone companies, apply for payroll protection loans?
Before attempting to answer these questions, we have to know a little about SBA’s rules concerning ownership attribution and affiliation. First, these rules are complex, and fact driven. Thus, the following general guidelines need to be analyzed in light of a specific business. However, typically, a company is an affiliate of another company, and the affiliates employee count will be added to the number of employees of the business applying for the payroll protection loan if: (a) there is 50% or more control of voting stock (or equity); (b) less than 50% control, but holding a blocking position due to control of a block of stock (or equity); (c) control of a large amount of equity by a few owners, when no other owners have more than a small stake; (d) when ownership is widely held such that no owner can exert control, the business’s officers and directors are deemed to have control. Items (a) and (b) are conclusive presumptions of control. Items (c) and (d) are rebuttable presumptions of control. Further, holders of convertible debt or bonds, option, and warrants can be attributed ownership.
The point is: if one company can control another (either affirmatively or negatively) they will be deemed affiliates, which may mean a business cannot qualify for a payroll protection loan. These rules apply to portfolio companies too. However, there are limited exceptions.
As to the property owner-operator paying herself rent, there is nothing in the CARES Act that would specifically prohibit this. Simply, there is no answer as neither SBA nor Treasury have issued detailed regulations addressing these types of situations. However, given the income caps in the CARES Act, the point was to get money into the hands of workers, not investors. I believe there will ultimately be limits on what a property owner-operator can pay in rent (perhaps limited to the mortgage obligation).
As to the VC-backed small business, unless the business is a franchise or in the hospitality industry, the standard SBA affiliation rules appear to apply, as of now. However, if the affiliate stopped being affiliate prior to the date of the loan, its employees need not be counted. Employees if an affiliate acquired prior to the date of the loan would be counted.
Again, rule making and guidance are still coming out. As business, banks, and regulation writers consider these issues, the rules may change… so stay tuned!