PPP Loan Qualification for VC Portfolio Companies – When “Negative Control”​ May Create an Affiliation with a Minority Shareholder

One of the criteria to qualify for an SBA Paycheck Protection Program loan (“PPP Loan”) is that your business does not have more than 500 employees. What many venture capital backed companies may not realize is that due to the SBA’s rules on “affiliation,” they may also need to count the employees of such VC’s other portfolio companies in getting to 500, even if such VC is a minority shareholder in the applicant. In other words, a portfolio company may be ineligible to receive a PPP loan if a VC shareholder “controls” the company, and that VC also controls other portfolio companies, which, when aggregated, have over 500 employees. This rule also would apply to private equity backed entities and companies with corporate strategic investors.

What constitutes “control.” Any entity that owns or has the power to control more than 50 percent of the borrower’s voting equity is considered an affiliate of the borrower. Further, the SBA will deem that a minority shareholder exercises “negative control” if it “has the ability, under the borrower’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.” Thus, if a minority shareholder may exercise “negative control” over the PPP loan applicant, the borrower will be considered an affiliate of the minority shareholder and an affiliate of any business that the minority shareholder controls.

Indeed, this leaves much for interpretation, and commentators point to the SBA Office of Hearings and Appeals (“OHA”) for case law guidance. Although arguably not directly on point, this case law may be instructive and potentially controlling.

Examples of “negative control.” According to OHA case law, examples of negative control could exist if a shareholder has the ability to block actions that are “essential to the daily operation of the company.” These actions may include, but are not limited to, borrowing money or incurring debt; encumbering assets; or paying dividends.

What to do? If your minority shareholder(s) exerts control over your company, it is important that you consult with an attorney to determine the magnitude of such control, and request, if practicable, a waiver of certain rights from the shareholder(s), or if your loan has already been processed, to discuss best practices in handling any potential improper PPP application certifications. The government has provided a limited safe harbor until May 7, 2020, to return funds if any of the SBA’s subsequent guidance has changed the validity of an applicant’s certifications. As for the magnitude of penalties, past and future borrowers must also consider the potential for criminal investigations and civil proceedings under the False Claims Act.

This article is provided by Christopher Frigon, Esq., Managing Partner of Frigon Maher & Stern LLP, solely in his personal capacity, and is intended for general information purposes only and does not constitute legal advice.