The Paycheck Protection Program (“PPP”) is a new forgivable loan program authorized by the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, signed into law on March 27. This program comes at a crucial time as many small businesses are facing extreme financial difficulties resulting from public health measures designed to slow the spread of COVID-19. The CARES Act authorizes the Small Business Administration (“SBA”) to guarantee 100% of PPP loans and provides forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP. Small businesses will be able to use funds from the PPP to pay payroll costs, employee benefits, mortgages, rent, and utilities for up to eight weeks after the loan origination date. As small business face difficulties in response to COVID-19, the PPP extends a lifeline to many, but upon its passage and administration, it has also raised questions for a particular subset of small business—VC-backed start-ups.
The PPP is an SBA section 7(a) loan program, so applicants are required to meet certain requirements to prove eligibility as a “small business concern.” These eligibility requirements include an affiliation rule which has been a source of particular concern to start-ups funded by venture capital. Like many other small businesses, start-ups have been hard-hit by this crisis. As of April 2, the New York Times reported that more than 50 start-ups had cut or furloughed roughly 6,000 employees as a result of coronavirus-related difficulties. That number is likely significantly higher today and does not account for the newly jobless gig workers who are not considered employees, yet remain reliant on income derived from providing services through failing start-ups’ platforms. The demise of tech start-ups also threatens to exacerbate concentration in the tech industry (and resulting antitrust concerns) as many workers seek job security at companies like Google and Amazon.
The CARES Act identified exceptions to the SBA’s 7(a) loan eligibility requirements for certain businesses, explicitly exempting franchises and businesses in the Accommodation and Food Services industries from certain size requirements, including the affiliation rule, according to the SBA’s recent guidance. The CARES Act did not indicate that any other exceptions to the SBA’s standard eligibility criteria, as outlined in 131 C.F.R. §121.103, will apply to businesses in other industries.
The eligibility requirements governing various SBA loan programs are laid out in two statutes: 131 C.F.R. §121.103 and §121.301. The size requirements identified in both statutes are nearly identical. Across the board, the SBA’s affiliation rule essentially renders ineligible for 7(a) loans any applicant business which, together with its affiliates, employs more than (a) 500 employees, or (b) the number indicated by the SBA’s industry size standard, whichever is greater. Generally, entities are deemed affiliates “when one controls or has the power to control the other, or a third party or parties controls or has the power to control both.”
The SBA finds affiliation in a number of ways, including ownership, management, identity of interest, and negative control (including protective provisions which enable shareholders, such as VCs, to block corporate action). The SBA may also find affiliation based on a “totality of the circumstances” and other relationships between parties. However, if the lender (usually a bank) has determined that there is no affiliation, “the SBA will not overturn that determination so long as it was reasonable when made given the information available to the SBA Lender at the time.”
The catch is that “affiliation” is defined in slightly different ways depending on what type of SBA loan the business is seeking. Section 103(a)(8) notes that applicants in the SBA’s Business Loan Program are required to meet the size standards as set forth in Section 301, a key detail easily missed by a cursory reading of Section 103 (or text search for “affiliation”). Following the announcement of the PPP, this misreading spread quickly amongst industry professionals, resulting in widespread concern that the more stringent affiliation standards set forth in Section 103 would present a massive roadblock to start-ups and other venture-backed companies seeking a PPP loan. Most notably, Section 103(c)(2) finds affiliation where “two or more persons . . . each owns, controls, or has the power to control less than 50 percent of a concern’s voting stock, and such minority holdings are equal or approximately equal in size and the aggregate of these minority holdings is large as compared with any other stock holding[.]” There is no analogous provision in the affiliation standards laid out in Section 301, which governs PPP loans. If the Section 103 standard did apply to PPP loans, as the rumor-mill had many believe, nearly every VC-backed company would be rendered ineligible in one fell swoop.
Recent guidance issued by the Treasury Department confirms that eligibility for PPP loans, including affiliation standards, will be governed by Section 301. Start-ups funded by VC firms whose minority holdings may be considered “large as compared with any other stock holding” will not be automatically rendered ineligible. The Treasury Department’s guidance also specifies that a minority shareholder will no longer be considered an affiliate if she “irrevocably waives or relinquishes any existing rights” which could give rise to a finding of control and, thus, affiliation under Section 301’s standards. Moreover, the guidance explicitly permits lenders to “rely on borrowers’ certifications” regarding the applicability of affiliation rules to the applicant company.
While this guidance provides some consolation, portfolio companies still have some reason for concern. The $350 billion appropriated for PPP loans are to be doled out on a first-come-first-serve basis, so businesses with murky eligibility status may face a disadvantage as conservative lenders prioritize approval of more clear-cut applications. Additionally, the particular negative controls and protective provisions which may give rise to a finding of affiliation remain uncertain because existing caselaw primarily analyzes these terms under Section 103, not Section 301. Therefore, because the two sections have different language, whether a court will analyze and find affiliation arising from different types of negative controls and protective provisions remains uncertain. If banks fail to administer the program properly and approve loans for companies that fail the size requirements, the bank could lose the federal guarantee. The longer banks delay approval of loan applications, the less funding will be available for PPP loans.
It is likely that additional guidance, and perhaps amendments, will be issued to benefit companies in the venture capital space. House Minority Leader Kevin McCarthy has assured the public that venture-backed companies will be eligible for PPP loans. Speaker of the House Nancy Pelosi has also voiced support for eliminating the affiliation rule for CARES Act loans. However, critics argue that lawmakers should be cautious in relaxing the affiliation standard. Even though the PPP is designed to curb job losses, the program remains funded by taxpayers who “don’t want to foot the bill for venture capitalists who can then keep their own powder dry for the inevitable turnaround.” Many in the VC industry are also concerned about the public ire and reputational damage which could result from start-ups taking advantage of PPP loans. Other investors see the coronavirus “black swan” event as an opportunity for the market to weed out weaker companies. Nonetheless, founders seeking to protect their employees are in a tough position: apply for a PPP loan and (if successful) risk backlash from investors and the general public, or accept additional VC money (if any is even available) at extremely unfavorable terms.
 Coronavirus Aid, Relief, and Economic Security (“CARES”) Act of 2020, Pub. L. No. 116-136, § 1102, 134 Stat. 281, 286, available at: https://www.congress.gov/116/bills/hr748/BILLS-116hr748enr.pdf.
 The terms of PPP loans are extremely favorable to businesses: the maximum interest charge is 4%; repayment of principal, interest, and fees may be deferred for six to twelve months; no personal guarantee is required. Lowell A. Citron, et al., SBA Paycheck Protection Program, Lowenstein Sandler LLP (Mar. 30, 2020), https://www.lowenstein.com/news-insights/publications/articles/sba-payment-protection-program-buxbaum-lomot-sica-citron [https://perma.cc/JWL9-64WM].
 Treas. Dep’t, The CARES Act Provides Assistance to Small Businesses (last visited Apr. 13, 2020), https://home.treasury.gov/policy-issues/cares/assistance-for-small-businesses [https://perma.cc/B56L-6KD5].
 See 15 U.S.C. § 636(a).
 Industry insiders have dubbed the situation “the great unwinding.” Erin Griffith, Start-Ups Are Pummeled in the ‘Great Unwinding’, N.Y. Times (Apr. 1, 2020), https://www.nytimes.com/2020/04/01/technology/virus-start-ups-pummeled-layoffs-unwinding.html [https://perma.cc/95CX-QWDK].
 CARES Act § 1102 (a)(2)(D).
 The section waiving affiliation rules for certain business explicitly notes “[d]uring the covered period, the provisions applicable to affiliations under section 121.103 of title 13, Code of Federal Regulations . . . are waived with respect to eligibility for a covered loan . . . .” CARES Act § 1102 (emphasis added).
 See 131 C.F.R. §121.103; see also 131 C.F.R. §121.301.
 131 C.F.R. §121.103(f).
 Baker Donelson has published a helpful explainer with examples. CARES Act: Understanding SBA’s Loan Eligibility Requirements, Including Affiliation Rules, Baker Donelson (last updated Mar. 31, 2020), https://www.bakerdonelson.com/CARES-act-understanding-SBAs-loan-eligibility-requirements-including-affiliation-rules [https://perma.cc/CGH5-3MK8].
 131 C.F.R. §121.301(f)(6).
 131 C.F.R. §121.103(a)(8).
 Some law firms’ websites even suggested that the Section 103 affiliation rules govern PPP loan eligibility. SBA “Paycheck Protection” Loan Program under the CARES Act, Gibson Dunn (Mar. 27, 2020) https://www.gibsondunn.com/sba-paycheck-protection-loan-program-under-the-cares-act/ [https://perma.cc/J7RB-47ME] (“Section 121.103 of Title 13 of the Code of Federal Regulations sets forth the general principles the SBA uses to determine affiliation.”).
 Ed Zimmerman, Wait, What?! Treasury Clarifies “Affiliation” Rules For SBA Section 7(a) Loans (& Startups Are…), Forbes (Apr. 4, 2020), https://www.forbes.com/sites/edwardzimmerman/2020/04/04/wait-what-treasury-clarifies-affiliation-rules-for-sba-section-7a-loans--startups-are/#441cf73046bb [https://perma.cc/G5G5-JQGL].
 131 C.F.R. §121.103(c)(2).
 See U.S. Treas. Dep’t, Affiliation Rules Applicable to U.S. Small Business Administration Paycheck Protection Program, at n.1 (Apr. 3, 2020), https://home.treasury.gov/system/files/136/Affiliation%20rules%20overview%20%28for%20public%29.pdf [https://perma.cc/6XEW-MGG2].
 U.S. Treas. Dep’t, Paycheck Protection Program Frequently Asked Questions (Apr. 8, 2020), https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequenty-Asked-Questions.pdf [https://perma.cc/8WEC-FK69].
 Dan Primack, Bipartisan Push Could Save Private Equity-Owned Small Businesses, Axios (Apr. 2, 2020), https://www.axios.com/private-equity-stimulus-cash-pelosi-mccarthy-38fef7fa-f6ac-43ca-9a7f-662b9cd66f27.html [https://perma.cc/YQL3-34N2].
 Zimmerman, supra note 18.
 Citron, et al. supra note 2.
 Dan Primack, Kevin McCarthy: Startups Will Be Eligible for Coronavirus Stimulus Loans, Axios (Apr. 2, 2020), https://www.axios.com/coronavirus-vc-startups-small-business-loans-6ae9e125-fbbb-4349-9d67-ce68d4a5ac57.html [https://perma.cc/6RRN-XYRN].
 Primack, Bipartisan Push, supra note 23.
 Kara Swisher, Your Friendly Tech Bro Might Be Looking for a Loan, N.Y. Times (Apr. 8, 2020), https://www.nytimes.com/2020/04/08/opinion/coronavirus-venture-capital-stimulus.html [https://perma.cc/QX57-4YM9].
 Griffith, supra note 5.