In the past few weeks, Silicon Valley startups have grappled with a confusing, ethical quandary: whether to take money from the government to weather the economic downturn brought on by coronavirus.
Congress passed the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act on March 27, which included $349 billion in forgivable loans for small businesses to help avoid laying off employees. The Paycheck Protection Program, as it’s called, is run through the Small Business Administration, and the loan applications are processed by banks like Bank of America or Silicon Valley Bank. The SBA will forgive the loans if the recipient uses the money to help keep all its employees on the payroll for eight weeks.
The program began accepting applications April 3, and by Thursday morning, April 16, had already loaned out every dollar allotted to it. The SBA is now saying it’s “currently unable to accept new applications.” Congress will very likely replenish the PPP with cash, but it remains unclear when.
For some in VC and startup circles, the first reaction to news of the program was to take advantage of the “free money” from the government. But as the discussions among startup founders, investors, and advisers continued, it soon became clear that the decision to apply for a loan wouldn’t be a simple one.
Main Street or Palo Alto?
Many people in the tech startup and investment communities have gone through an evolution in thinking about the new loan program in the past three weeks. One of the first big questions was whether the PPP loans were really meant for tech startups.
“Very quickly the conversation turned to, ‘There’s a finite amount of money and is it right morally and ethically to take the money when other companies might need it more?'” says Ryan Denehy, CEO and founder of the virtual IT support startup Electric. Denehy’s company initially considered applying for one of the SBA loans, but eventually decided against it.
“They have a moral dilemma,” says Jeff Richards, a partner at the venture capital firm GGV Capital, which is one of Electric’s investors. Richards says startup founders have been asking the question: “If I take that $2 million loan, is that $2 million that could have gone to a corner bakery, or a florist, or a barbershop?”
Jeff Richards, GGVC
The thing I’ve noticed is that everybody is coming in with their heart in the right place.”
Richards says he’s been involved in numerous conversations with startup founders, board members, other VCs, and lawyers about the SBA loans for the past two weeks.
“The thing I’ve noticed is that everybody is coming in with their heart in the right place,” he says of the startup founders he’s talked to. “You’d assume that if there was suddenly a big pot of money coming from Washington that it would just be a land grab, but they all want to do the right thing.”
Tech startups may play with more money than Main Street businesses, but some are truly in distress and in danger of laying off staff. Some believe those companies are every bit as entitled to the loans.
“There’s a misconception that SBA loans are meant for tattoo parlors and restaurants, and that’s wrong,” says Justin Field, the SVP of Government Affairs at the National Venture Capital Association. “The SBA offers loans of up to $10 million dollars, and I don’t know of many coffee shops that are going to need that much money to make payroll.”
Whether a tech startup can qualify as a small business depends on its business type. Five hundred or fewer employees is a rule of thumb for most businesses, but the SBA has different cutoffs for different business types. For instance, “Internet Publishing and Broadcasting and Web Search Portals” can have up to 1,000 employees and still be considered “small.” For other types of businesses, the SBA provides a yearly revenue threshold.
Whether a company is a self-contained entity or an affiliate of an investor has been a much discussed question among startup founders during the past few weeks. To qualify for one of the loans, a startup can’t be considered an “affiliate” of another entity. Field explains that if a VC controls more than 50% equity in a startup, that automatically defines the startup as an affiliate. If the VC controls less than 50% equity but still has the power to block a decision by the startup’s board of directors, then the startup is still considered an affiliate. However, if the VC has to get the buy-in of another investor to overrule the board, then the startup wouldn’t be considered an affiliate and would be eligible for a loan.
But after these basic requirements, the establishment of “need” gets more subjective. “There are no concrete guidelines,” Richards tells me. “That’s why it ends up being a judgement call.”
Jeff Richards, GGVC
There are no concrete guidelines. That’s why it ends up being a judgement call.”
The central question is whether the business has been “materially damaged” by the coronavirus downturn. Denehy’s company, Electric, for example, has seen a “disruption,” but not a drastic slowdown, mainly because the company specializes in providing IT support for companies with distributed workforces and remote workers. Electric also has a few billion-dollar investment firms behind it—GGVC and Bessemer.
Many other tech startups haven’t been so lucky. Richards told me he’s talked to enterprise startups that have seen 80% of their revenues evaporate almost overnight due to the virus. And companies with such depressed numbers can have trouble raising additional capital through typical sources.
For many startups, the decision of whether to apply comes down to the question of how much cash the company had on hand when the virus hit.
“If you have more than 12 months of cash runway, you don’t apply,” says GGVC’s Richards. “If you need more cash, you can go to the equity markets, [even though] you may not like the terms.”
Electric’s Denehy told me that at the end of all the emails and Twitter threads and board room discussions, the prevailing wisdom is that if a company has enough cash to get through the end of the year without layoffs, then they shouldn’t apply. It’s really for companies that are “in dire straights” right now.
Richards tells me that if a startup took a PPP loan without really needing it to survive, that fact could come out later in an SBA audit.
The optics of something like that could be very bad for a startup, Denehy says. “There was a lot of chatter that if you take the loan and you had the loan forgiven and it comes out later that you really didn’t need it, that wouldn’t look good,” Denehy says. “It’s public record—someone could find out later and show that you didn’t really need it.”
Even if a company does need the money, there are real questions about whether the SBA loans will be disbursed quickly enough to prevent layoffs.
One of the major shortcomings of the PPP is its first come, first served basis. There’s no triage mechanism for making sure the applicants with the greatest or most urgent need get their loans processed and disbursed first. This first come, first served rule may have meant that some startups hurried to get their applications in before fully thinking through their level of need.
Richards points out that the rule might also have disadvantaged some of the small Main Street business applicants, because they typically don’t have a dedicated financial officer on staff that can get the paperwork together quickly. In comparison, a tech startup probably does have an employee like that.
Regardless, the applications from small businesses, many of them tech startups, have poured in. Silicon Valley Bank, which specializes in serving startups, reportedly received 5,000 applications on April 7, the day it started accepting them (four days after the SBA said banks could begin accepting applications). The bank is said to have hastily built a web portal to accept the PPP applications. According to a source familiar with the matter who requested anonymity, 70% of the applications reportedly were processed successfully, but 30% of applicants had “a less than wonderful experience” and likely had to start the process all over again.
Ryan Denehy, Electric
For companies who are just now applying, it could potentially be months before you receive the money.”
Silicon Valley Bank has yet to confirm or deny the accuracy of those dates and figures.
The applicants that didn’t file early may not get the benefit intended by the program. “The expectations that the law firms were setting was that for companies who are just now applying, it could potentially be months before you receive the money,” Denehy tells me. “When you look at the number of loans the SBA normally approves in a year, then look at how many they will have to approve now, you can’t conclude that you’re going to be getting your check within a week or two weeks.”
The SBA said Wednesday April 15 that it had already approved more than 1.4 million PPP applications, totaling about $305 billion of the $349 billion set aside. And by the following morning, the rest of the money was already gone.
Now it’s up to Republicans and Democrats in the Senate to come to an agreement on how much more money should given to the program, and whether or not other types of businesses should be allowed to apply for loans. Meanwhile, the Labor Department reports it processed 5.2 million unemployment claims last week, and millions of small business jobs likely hang by a thread as small employers struggle to make payroll.