CARES Act Eligibility: Technology Based Businesses
By Dean Drummond, Partner, Advisory Services
The CARES Act provides a significant funding opportunity for many small businesses, and technology companies are no exception. However, it is important that all companies follow the Small Business Administration (SBA) rules in determining eligibility for relief, calculating the amounts available to borrow and ensuring borrowings are spent appropriately. Failure to follow any of the SBA rules can have adverse consequences to the borrower, which can vary from not having the loan forgiven to penalties for fraud.
The most common attributes impacting a technology company’s eligibility, borrowing capacity and compliance are the affiliation rules and the presence of independent contractors in the company’s workforce.
The affiliation rules were instituted by the SBA to prevent larger institutions from taking advantage of funds intended for smaller businesses. As such, there are both quantitative and qualitative assessments that will affect how the affiliate rules are applied. First, any entity or individual that owns >50% of the equity of the borrower is an affiliate. Secondly, for investors or management that own less than a majority of the shares, there are qualitative hurdles considerations to apply to determine if they are affiliates. The qualitative considerations include whether the investors 1) control the board through board seats, 2) have rights that provide control over business decisions (protective rights alone do not trigger this criteria) and 3) commonality of management. The borrower must include the number of employees of other entities, in which the Affiliate has controlling interest, in order to determine if the borrower is in compliance with the 500 employee rule. These criteria can apply to individuals, entities, or groups of individuals or entities that have identical investments or other contractual or similar arrangements. This determination is complex and may require your bank or counsel to assist in any final determination. If, after assessing the affiliate rules, the total employee count is below 500, the company is eligible to participate in the Paycheck Protection Program (PPP). If there are more than 500 employees, the company could still be eligible if SBA standard size rules provide for more employees for the industry or the company has <$15 million of tangible net worth and <$5 million in average net income after federal income taxes for the last 2 fiscal years.
The use of independent contractors is a common business practice by technology companies as they grow their operations. Independent contractors are not considered employees for purposes of computing average monthly payroll as defined for determining the maximum borrowing amount under the PPP. Independent contractors are also not includable in the analysis of how the proceeds of the debt are to be spent, if the borrower is looking to have the debt forgiven. If a technology company utilizes a significant number of independent contractors, it may still be eligible for a PPP loan. However, the loan amount available to the company will likely be lower than expected. The good news is that impacted independent contractors are eligible to apply for PPP loans separately, which will help offset any burden they are experiencing.
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