Since the start of the COVID-19 pandemic, publicly-traded companies have raised billions of dollars in long-term bonds at low interest rates, enabling them to generate much-needed capital to withstand economic turmoil. Most of these bonds have 10 year terms at low single-digit interest rates, giving them a significant advantage over their private company counterparts.
As private company borrowers submit their Paycheck Protection Program (PPP) Loan Forgiveness Applications, they must be prepared to document compliance with their good faith certification of eligibility for the loan. There are several elements to the certification, including the level of uncertainty and the pandemic’s effect on the business at the time of loan application.
However, the most confusing and subjective component of the Small Business Administration’s (SBA) requirements is that borrowers must take into account 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.” As noted above, while this statement has a different meaning to a public company versus a private company, private company PPP borrowers must still document compliance with these terms.
Below are four key considerations for private companies as they prepare to document compliance with their PPP loan’s good faith certification.
1.No access to public capital markets.
Privately held borrowers should comment on the fact that they do not have access to public capital markets (equity or debt). Public markets are liquid, whereas private markets are illiquid and come at a significantly increased cost to access capital.
Consider the following:
- Capital is scarce and expensive for private companies, and these companies are often funded through owners’ savings or by borrowing.
- There is significant time, effort, and cost involved in accessing other forms of liquidity (including both debt and equity), and many options were unavailable at the outset of the pandemic given the mandated closures and economic uncertainty.
- It’s often difficult to increase the capacity of your current debt arrangements or to obtain loans from a new lender without interfering in existing arrangements.
- Short-term access to equity capital is generally not available to private companies and equity investments require significant time and cost.
2.Use of existing lines of credit.
The SBA’s guidance uses the words “in a manner that is not significantly detrimental to the business.” This begs the question of whether it is detrimental to draw down your line of credit to maintain workers (rather than reduce costs through layoffs) and fund losses. Although a borrower may have a line of credit available, it must still meet this standard.
Consider the following:
- The purpose of a line of credit is to bridge working capital needs rather than to fund losses. Banks would not expect or allow borrowers to fully expend lines of credit instead of reducing costs.
- A line draw down could be “significantly detrimental” to the business since the company would have no further capital reserve or access to additional liquidity if needed.
- Lines of credit aren’t a permanent source of liquidity. They are designed to be temporary and not create a long-term obligation for the company. Lines of credit have to be renewed annually and there is no guarantee that the bank will renew the line.
- Lines of credit may be subject to debt covenants which the company may not be able to meet due to the pandemic’s economic effects.
- If the company breaches a covenant, the bank can prevent drawdowns on the line, leaving the company without backup liquidity.
- If you have an asset-based line of credit, a borrower may have reduced line capacity due to declining revenues, receivables, and inventories.
3.Cash on hand.
In addressing compliance with the good faith certification, borrowers should evaluate the amount of existing cash or other liquid resources they maintain on their balance sheet. It’s necessary to consider the absolute dollar amounts as well as the correlation of existing cash amounts to the size of the business operation they support.
Consider the following:
- Maintaining adequate cash reserves provides flexibility and can help your business survive in a pandemic. It’s important to keep a reasonable level of cash on hand relative to overhead (i.e., how many months of overhead, payroll, etc. does the cash balance cover?).
- Drawing down cash balances to maintain workers during a period of declining business activity could have “significantly detrimental” effects.
- Without adequate working capital, the company will be unable to maintain its level of business.
- Benchmark your cash and working capital levels against industry standards to determine reasonableness.
4.New borrowings (outside of lines of credit or PPP loans).
Borrowers should address their ability to access to other forms of credit beyond a PPP loan. Focus on the urgency of the need as well as the time and effort involved in securing a new loan.
Consider the following:
- What was the state of lending at the time of your PPP loan application? Banks were generally not making new loans due to the level of uncertainty.
- It is both time consuming and costly to get a new loan, especially if you began the process at a new bank.
- What’s the overall debt capacity of your business, and does any further capacity exist?
While we wait for more specific guidance on how the SBA will determine compliance with the good faith certification requirements, borrowers must plan ahead so they are prepared to respond when asked. It is important for borrowers to note that compliance with the good faith certification is based on the situation that existed at the time they submitted their PPP loan application. Most importantly, remember that this is a good faith certification. Borrowers must be straightforward and honest in their assessment of their need for a PPP loan based on the requirements of the CARES Act and subsequent guidance from the SBA.
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