You can add one more thing to think about in a merger and acquisition (M&A) transaction if a Small Business Administration (SBA) Paycheck Protection Program Loan (PPP loan) or SBA Economic Injury Disaster Loan (EIDL loan) is present. Like other deal considerations, due diligence, structuring, allocation of risk, and a proper understanding of applicable rules and regulations are key to avoiding undesirable consequences for both the buyer and the seller. These considerations apply if a PPP loan or EIDL loan is in process or if the loan has closed and is in place.
While the PPP loan program is no longer accepting new loan applications, there have been indications the program may reopen. If it does, buyers or sellers who are seeking loans while negotiating M&A transactions need to carefully consider several factors. Depending on their binding nature, letters of intent and purchase agreements need to be analyzed under the SBA's affiliation rules to determine if the buyer is "affiliated" with the seller for purposes of determining either company's eligibility under the loan programs. While either entity may meet the size, eligibility, and need requirements on its own, if affiliated, together the entities may lose such eligibility.
In such a case, key questions are:
- Does the letter of intent or purchase agreement trigger affiliation under SBA rules?
- If so, do the combined entities meet the size, eligibility, and need requirements of the loan programs?
If a buyer has already obtained a PPP loan or an EIDL loan, the analysis is relatively straightforward. PPP loan and EIDL loan rules prohibit multiple loans under the same program for the same entity. While, an entity may borrow under both programs, SBA rules prohibit borrowings under both programs if the intended use of proceeds is duplicative. In addition, the contemplated M&A transaction may violate the terms of the buyer's loan documents, which may prohibit the transaction or trigger a default. Lenders have some discretion in the loan documents that they use under these SBA loan programs. As such, a careful review of the actual loan documents is always obligatory.
In this case, key questions are:
- Does the seller also have a PPP Loan or an EIDL loan?
- Is the seller assigning the PPP or EIDL loan to buyer and the buyer is assuming the loan?
- Will multiple PPP or EIDL loans violate SBA rules?
- Do the seller or buyer loan documents restrict or prohibit the proposed transaction or use of funds?
If a seller has obtained a PPP loan or an EIDL loan, there are a few more considerations that must be factored into the negotiations. Depending on the timing and urgency of the closing, the intention of the parties with respect to retention or assignment of the loan, the risk profile of the transaction to the buyer, and the transaction's effect on seller's workforce and payroll, the structure of the deal may need to be revised.
If the seller has an EIDL loan, an asset sale or change in seller ownership will require prior SBA consent regardless of whether the loan is intended to be assigned.
If the seller intends to assign a PPP loan to the buyer in an asset deal or through operation of law through a stock deal or merger, SBA rules require consent of the SBA for any such assignment or change in ownership during the first twelve months of the loan and, thereafter, requires consent of the underlying lender. In both cases, the SBA requires an escrow to be set up with the full amount of the PPP loan pending a forgiveness determination. Lastly, the loan documents need to be reviewed as they most likely also require the consent of the lender prior to any such assignment both during and after the initial twelve month period.
If the seller intends to retain the PPP loan and benefit from any forgiveness, the transaction's effect on the forgiveness analysis is critical. If the closing occurs during the PPP loan covered period, any reduction in headcount or payroll for the seller as a result of the transaction could reduce the forgiveness amount, absent the availability of any of the forgiveness reduction safe harbors.
Key questions in this context are:
- Will the seller retain the PPP loan or assign it to the buyer?
- If the seller is retaining the loan, is the closing before or after the end of the "covered period"?
- If closing is before the end of the covered period, will there be a reduction in workforce or payroll for the seller during the covered period as a result of the transaction?
- If closing is after the covered period, is it before or after the forgiveness application is filed?
- If closing is before the forgiveness application is filed, which party is responsible for the filing?
- If the seller is assigning the loan to buyer, which party bears the risk of the forgiveness determination or an audit?
- Can the deal be structured, or timed, to mitigate any of these risks?
- Do the seller PPP loan documents prohibit or restrict the transaction or require any lender consent?
Lastly, a buyer should mitigate any risk attendant to a seller's PPP loan or EIDL loan even if the loan is intended to be retained by the seller. Liability risks under the False Claims Act, potential successor liability theories, whistleblower actions, and compulsory or random SBA audits are all present in these types of transactions.
Comprehensive due diligence should be conducted to ascertain whether the seller met the eligibility and need criteria, accurately and completely filled out its loan application, used the proceeds properly, and otherwise complied with all other loan program requirements. A buyer should protect itself through optimal deal structuring and timing to the extent it has the flexibility, securing specific seller reps, warranties, and indemnities tailored to the SBA loan programs, requiring purchase price holdbacks or escrows, pre-closing conditions, and post-closing covenants and obtaining rep and warranty insurance. In addition, due to the heightened sensitivity and public interest in these loan programs, buyers should stay cognizant of potential media exposure and public scrutiny and be prepared to respond to any inquiries or bad press.
Navigating an M&A deal where a PPP loan or an EIDL loan is present requires a thorough analysis within complex legal and factual frameworks. While this bulletin is intended to address the highlights of the considerations that should be considered, Taft's Mergers and Acquisitions practice group and SBA Task Force teams stand ready to assist with any evaluation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.