The Paycheck Protection Program (PPP), which was established by the federal government under the CARES Act earlier this year, has benefited some 700,000 businesses feeling the economic pressures resulting from the COVID-19 pandemic. As M&A activity starts to pick up, buyers and sellers need to be aware of new guidance from the Small Business Administration (SBA) regarding changes in ownership. The inclusion of a PPP loan in an M&A transaction necessitates additional diligence and tailored discussions between the parties to ensure the transaction is appropriately structured and can close when desired by the parties.
The current notice, issued Oct. 2, is SBA’s first guidance that explicitly addresses changes in ownership of PPP borrowers. The notice should be carefully reviewed by PPP borrowers that are looking to engage in an M&A transaction, by persons or entities considering acquiring a business, by PPP lenders that may be asked to consent to a change of ownership transaction, and by potential financing sources for acquisitions. We provide some background on the terms of PPP loans and the SBA policies that require lender and SBA consent to certain M&A transactions and summarize the key provisions and requirements of the notice below.
Change of Ownership Definition
The Notice deems that a change of ownership occurs when:
- at least 20% of an organization’s common stock or other ownership interest is sold or transferred (including transfers to an affiliate or an existing owner);
- a PPP borrower sells or transfers at least 50% of its assets, or
- a PPP borrower merges with or into another entity.
Before closing any such transaction, a PPP borrower must notify the lender in writing of the pending deal, providing the transaction documents. If the borrower has satisfied the debt prior to closing, or if forgiveness of the PPP loan has been determined (and the PPP borrower has repaid any unforgiven balance), then no restrictions will apply. However, any outstanding balances remain the responsibility of the PPP borrower, regardless of the change in ownership.
Change of Ownership Transaction Where Prior SBA Approval is NOT Required
SBA approval is not required for:
- stock sales or mergers involving 50% or less of the borrower’s ownership interest;
- borrowers who have completed and applied for loan forgiveness and established an escrow account with the PPP lender (the escrow account must be funded in an amount equal to the outstanding balance of the PPP loan); or
- asset sales if the borrower meets the escrow account condition.
Funds in escrow are released once the loan forgiveness process is completed. At that time, funds first are released to the PPP lender to cover any remaining loan balance and accrued interest with any remaining funds then going back to the borrower.
Change of Ownership Transaction Where Prior SBA Approval IS Required
If a deal does not fit any of the aforementioned criteria, then prior SBA approval of the change of ownership is required. To obtain the SBA’s prior approval, the PPP lender must submit to the SBA a request for approval including, (i) the reason that the PPP borrower cannot repay the PPP loan or escrow funds with the PPP lender as described above, (ii) the details of the transaction, (iii) a copy of the PPP promissory note, (iv) any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, seller (if different from the PPP borrower), and buyer, (v) disclosure of whether the buyer has an existing PPP loan and, if so, the SBA loan number and (vi) a list of all 20+% owners.
The SBA may condition its approval on additional “risk mitigation measures.” For example, SBA approval of any change of ownership involving the sale of 50% or more of the assets of a PPP borrower will be conditioned on the purchasing entity assuming the PPP loan, including responsibility for compliance with the PPP loan terms. In such cases, the purchase or sale agreement must include “appropriate language regarding the assumption of the PPP borrower’s obligations under the PPP loan by the buyer, or a separate assumption agreement must be submitted to the SBA.”
The SBA commits in the notice to review and provide its determination within 60 days of receipt of a completed request. However, we expect this timing to be problematic for certain transactions.
Conditions to all Change of Ownership Transactions
The SBA notice provides that, whether or not the transaction requires the SBA’s prior approval, the PPP borrower (and, in the event of a merger of the PPP borrower into another entity, the successor to the PPP borrower) will remain subject to all obligations under the PPP loan. In addition, if the buyer uses PPP funds for unauthorized purposes, the SBA will have recourse against the buyer for the unauthorized use.
If the post-acquisition owner(s) or successor to the PPP borrower has a separate PPP loan, then, following consummation of the change of ownership transaction: (i) in the case of a transfer of ownership interests, the PPP borrower and the new owner(s) are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower, and (ii) in the case of a merger, the successor is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.
Thus, SBA’s new guidance creates a strong incentive to repay any PPP loan or complete the forgiveness process prior to undertaking a sale of more than 50 % of the stock or assets of the PPP borrower. Otherwise, the borrower either will have to escrow significant funds while it awaits a forgiveness decision or await review and approval by SBA under a new, untested process.
Odin Feldman Pittleman strongly advises PPP borrowers to seek guidance regarding the feasibility of any change in ownership to ensure that the current update addresses their specific situation. For more information, contact the OFP Corporate Group.