As small businesses reel from the business disruption caused by the COVID-19 pandemic, it’s important to know the cash needs of your business over the coming months and the financing options available to you.
One compelling option is a hallmark of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (H.R. 748) signed into law by President Donald Trump on March 27, 2020—the Small Business Administration’s (SBA) 7(a) loan expansion, also known as the Paycheck Protection Program. It’s recommended that all small businesses with under 500 employees—or the applicable industry size standard, as provided by the SBA—consider applying for the loan if you’ve experienced business disruption as a result of COVID-19.
Below, we’ll explore:
- Modeling and identifying your cash needs over the next three and 12 months
- Understand your financing options, including the SBA 7(a) loan program
- Evaluating and applying for your SBA 7(a) loan
Cash Flow Modeling
Your organization should begin by assessing its cash needs under various scenarios likely to impact operations.
Variables to consider:
- Immediate liquidity already available to you, including cash and accounts receivable that are still deemed collectible
- Overhead obligations over the next three and 12 months, including payroll, leases, debt service, insurance, and other overhead obligations necessary to operate the business
- Revenue expectations over the next three and 12 months, under various scenarios likely to impact your business and industry
This type of model helps your management team run what-if scenarios and fully assess the company’s ability to fund its obligations through the immediate three-month period and intermediate 12-month period.
Understand Your Financing Options
Once you know how much capital you need over the next three and 12 months, understanding where to get that capital is essential.
Companies that were unprofitable and illiquid at the beginning of the year will likely find it difficult to obtain new capital over the next several months, while companies that were profitable and generating cash flow have numerous options to protect the viability of their business. Many companies may soon find themselves vulnerable to violating loan covenants, perhaps for the first time.
There are four main options available to you.
This includes two options from the SBA: its 7(a) loan program expansion and the Economic Injury Disaster Loan (EIDL).
As part of the CARES Act, Congress enacted a significant expansion of the SBA’s 7(a) loan program, allowing for forgivable loans of up to $10 million to small businesses with less than 500 employees. See below for more details about the program and how to apply.
The EIDL can provide up to $2 million of financial assistance to small businesses or private, not-for-profit organizations. It provides relief from economic injury caused directly by a disaster—in this case COVID-19—but isn’t intended to replace lost sales or revenue. Learn more in this article.
Senior Bank Loans
Senior bank loans are exactly as they sound. They’re asset-backed loans provided by many of the major banks you know and work with every day and can be the most immediately available financing sources for your business, even in times of distress.
Thoughtfully prepared projections and negotiations with senior lenders could result in a successful extension of borrowing capacity.
Junior and Equity Capital
Junior and equity capital represents largely unsecured investments in the form of loans or equity investments from investors and institutions.
There are thousands of junior and equity capital investors in the country, but they have higher return requirements and deploy capital in more specific situations. Also, when there are material decreases in profitability or prospects for business, these investors tend to shy away from riskier investments.
Capital can be available in some situations and should be discussed as part of a broader financing plan.
As a last resort, it may become necessary to generate cash by restructuring the business’s operations, which includes reducing staff or cutting R&D. For more details on restructuring options, including business recovery plans, see this article.
Evaluate and Apply for Your SBA 7(a) Loan
The significant expansion to the SBA 7(a) loan program comes with some interesting benefits to businesses.
- Loan amount. The lesser of $10 million or 2.5 times the average monthly qualifying payroll costs.
- Allowable uses. This includes payroll costs (capped for individuals with annual compensation in excess of $100,000), mortgage, rent, utility, and insurance.
- Loan forgiveness. Eligible borrowers will be forgiven the amount spent on allowable items during an eight-week period after the origination date of the loan. The amount forgiven would be reduced proportionally if a reduction in employees occurs or a reduction of 25% of an employee’s compensation occurs.
- Personal or collateral guarantee. This isn’t required.
- Credit availability elsewhere. Eligible borrowers don’t need to prove credit is unobtainable elsewhere.
- Eligible borrowers. Must have fewer than 500 employees, or the applicable industry size standard, as provided by the SBA.
- Application period. You can apply February 15, 2020–December 31, 2020.
- Common limitations. Organizations must have 500 or less employees, which will be tested using the so-called affiliate model, which combines all businesses under common control. This means many venture capital and private equity investments won’t be eligible. The CARES Act offers a waiver to the affiliate rule for restaurant industries, certain franchises, and hospitality. There will also be some restrictions if applicants already have an existing EIDL loan.
As an example, if a business has $1 million in qualifying monthly payroll costs, the maximum loan amount would be $2.5 million, of which $2.5 million would be forgivable if spent on allowable uses in the eight-week period following the funding date of the loan, assuming reduction in employees doesn’t occur.
How to Apply
Applications are expected to be available for submission in early April.
To apply for the loan, contact an SBA 7(a) lender. The SBA’s 7(a) loan program will be serviced through existing and new SBA 7(a) lenders.
Utilizing an existing banking relationship with an SBA 7(a) lender may help expedite the process. A bank that has a high volume of activity with SBA 7(a) loans may be best prepared to answer technical questions that come up during the application process. The country’s top SBA 7(a) lenders are listed on the SBA website.
Importantly, it’s anticipated that SBA lending programs within commercial banks and the SBA program itself, will be resource constrained for the foreseeable future as a result of the SBA 7(a) loan expansion. Get your application in early, and seek advice so your application can be submitted timely and accurately.
We’re Here to Help
Securing financing resources can be a complex process. Concurrently with applying for the SBA 7(a) loan program, consider modeling your cash needs over the next three and 12 months and evaluating your financing options. To learn more, contact your Moss Adams professional.
Note on COVID-19
During this unparalleled time, we’re closely monitoring the COVID-19 situation as it evolves so we can provide up-to-date guidance and support to help you combat uncertainty. For regulatory updates, strategies to help cope with subsequent risk, and possible steps to bolster your workforce and organization, please see the following resources: