Hundreds of our clients have spent a good portion of the last two weeks preparing applications for loans under the PPP program. The great news is that the SBA approved many of their applications and funds have started rolling in. While the receipt of funds may provide much-needed temporary relief, that relief might be short-lived if companies find out that they have to repay the loans because they did not properly plan for the use of loan proceeds. Companies only have eight weeks from the first date of funding (the “covered period”) to spend borrowed funds, so time is of the essence.
Following are five steps you should take right away if you borrowed under the PPP program.
1. Calculate expected payroll costs during the covered period.
Despite the fact that the CARES Act (the “Act”) allows borrowers time to rehire workers or reinstate salary/wage reductions (more on both later), one fact remains—if you do not spend the money you borrowed, you are going to have to repay it. As a result, it is very important to determine anticipated payroll costs during the covered period in order to make sure that there is no shortfall.
2. Determine your FTE hurdle.
Under the Act, there is a pro rata reduction in loan forgiveness if average FTEs during the covered period are less than historical FTEs. For purposes of measuring this adjustment, companies have the option of selecting either the period from February 15, 2019 through June 30, 2019, or the period from January 1, 2020 through February 29, 2020 (seasonal employers should use the period from February 15, 2019 through June 30, 2019). The period that results in the lowest FTE level is the one you will want to use for PPP planning purposes. One related note: while the SBA has not yet released detailed guidance on FTE calculations, it has indicated for other programs that it considers an employee a full-time equivalent if the employee works at least 30 hours per week.
3. Project anticipated FTEs in the covered period.
Loan forgiveness is based on the following formula:
Qualifying Costs Incurred and Paid During the Covered Period
Multiplied by
FTEs in the Covered Period Divided by FTEs in the Prior Period
As a result, you need to make sure you have at least as many FTEs in the covered period as you did in the prior period. If you do not, you will have to repay a portion of the loan proceeds, unless the reduction was the result of workforce reductions that occurred from February 15, 2020 through April 26, 2020, and you rehire those workers by June 30, 2020. Note: You will not receive “extra credit” in the form of additional loan forgiveness if your number of FTEs at the end of the covered period is higher than in the prior period.
For example, let’s assume the following facts:
- You borrowed $2,500,000.
- Your FTEs in the covered period were 80 percent of FTEs in the prior period.
- None of the 20 percent reduction in FTEs was caused by reductions that occurred between February 15, 2020 and April 26, 2020.
In this example, you would have to repay 20 percent of the loan, or $500,000. Better to know that upfront than to find out when you submit your application for forgiveness.
4. Quantify expected non-payroll costs.
One of Congress’s goals is to provide small businesses with enough proceeds to fund payroll during the covered period, which is roughly two months. However loan amounts are equal to 2.5 times monthly payroll rather than 2.0 times monthly payroll because Congress also wanted to provide funding for qualifying non-payroll costs, including interest on mortgages on real or personal property, rent under leases, and specified utilities (all limited to arrangements in place before February 15, 2020).
However, since the primary goal of the program is to ensure continued employment, the SBA implemented a rule limiting non-payroll costs to 25 percent of the forgiveness amount. This is very important to understand, because many businesses will find that the amount they spend on qualifying non-payroll costs during the covered period will not amount to 25 percent of loan forgiveness.
For example, let’s assume a company:
- had an average monthly payroll of $1,000,000;
- borrowed $2,500,000 (2.5 times $1,000,000);
- had covered period FTE levels equal to the historical FTE levels used to determine the amount of the loan and, as a result, the company spent $2,000,000 on payroll during the covered period; and,
- spent $300,000 on qualifying non-payroll costs during the covered period.
In this example, the company only spent $2,300,000 on qualifying costs and, as a result, must repay $200,000. Again, it is important to identify a shortfall like this early, because you may be able to implement strategies to increase payroll costs during the covered period and avoid repaying part of the loan.
5. Quantify the impact of pay reductions.
This one is particularly important, because the Act states that there is a reduction in the amount forgiven if any employee’s pay declined by more than 25 percent compared to the amount paid to the employee in the last full quarter. The amount of the reduction in forgiveness is equal to the amount of the pay reduction in excess of a reduction of 25 percent.
There are two important exceptions to this rule:
- The reduction in loan forgiveness does not apply to reductions in the wages of an employee who made more than an annualized salary of $100,000 during any single pay period in 2019.
- The reduction in loan forgiveness does not apply if by June 30, 2020, you restore wages to the level existing at February 15, 2020.
These examples all highlight the complexity of the forgiveness rules and the importance of early planning. Unfortunately, we expect complexity will only increase, as there are a number of vague or conflicting provisions in current SBA guidance that the SBA will need to address over the next few weeks. We are continuing to closely monitor news from the SBA but, in the meantime, feel free to contact us if you would like to discuss PPP planning, including limitations on the use of funds and strategies for maximizing loan forgiveness.
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