Over the past few weeks, Silicon Valley startups have faced a puzzling ethical dilemma: whether to withdraw government money to weather the economic downturn caused by the coronavirus.
Congress has passed $ 2 trillion Aid, relief and economic security linked to the coronavirus (CARES) of March 27, which provided $ 349 billion in forgivable loans for small businesses to avoid laying off workers. The Paycheque Protection Program, as it is called, is managed by the Small Business Administration and loan applications are handled 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 of their employees on the payroll for eight weeks.
The program started accepting applications on April 3 and by Thursday morning April 16 had already loaned every dollar allocated to it. The SBA now says it is “currently unable to accept further nominations.” Congress will most likely replenish the PPP with money, but it’s unclear when.
For some in venture capital and startup circles, the first reaction to the program’s announcement was to take advantage of the government’s “free money”. But as discussions among startup founders, investors, and advisors continued, it soon became clear that the decision to apply for a loan would not be a straightforward one.
Main Street or Palo Alto?
Many people in the tech and investment startup communities have seen an evolution in their thinking about the new loan program over the past three weeks. One of the first big questions was whether PPP loans were really for tech startups.
“Very quickly the conversation turned to, ‘There is a finite amount of money and is it morally and ethically right to take the money when other businesses might need it more?’ says Ryan Denehy, CEO and founder of virtual IT support startup Electric. Denehy’s company initially considered applying for one of the SBA loans, but ultimately decided against it.
“They have a moral dilemma,” says Jeff Richards, partner at venture capital firm GGV Capital, who is one of Electric’s investors. Richards says startup founders asked the question, “If I take this $ 2 million loan, could that $ 2 million have gone to a local bakery, florist, or salon? hairdressing ?
What I have noticed is that everyone comes in with their hearts in the right place.
Jeff Richards, GGVC
Richards says he’s been in numerous conversations with startup founders, board members, other VCs, and lawyers about SBA loans over the past two weeks.
“What I’ve noticed is that everyone comes with their hearts to the right place,” he says of the startup founders he spoke with. “You would assume that if there was suddenly a big pot of money coming out of Washington, it would just be a land grab, but they all want to do the right thing.”
Tech startups can gamble with more money than Main Street companies, but some are really in dire straits and are at risk of laying off staff. Some believe that these businesses are equally entitled to loans.
“There is a misconception that SBA loans are for tattoo parlors and restaurants, and it is wrong,” said Justin Field, senior vice president of government affairs at the National Venture Capital Association. “The SBA offers loans of up to $ 10 million, and I don’t know a lot of cafes that will need that much money to make their payroll.”
Define the “need”
Whether a tech startup can qualify as a small business depends on its type of business. Five hundred employees or less is a rule of thumb for most businesses, but the SBA has different thresholds for different types of businesses. For example, “Internet publishing and distribution and web research portals” can have up to 1,000 employees and still be considered “small”. For other types of businesses, the SBA provides for an annual income threshold.
Whether a company is a stand-alone entity or a subsidiary of an investor has been a hotly debated question among startup founders in recent weeks. To qualify for one of the loans, a startup cannot be considered an “affiliate” of another entity. Field explains that if a VC controls more than 50% of a startup’s equity, it automatically defines the startup as an affiliate. If the VC controls less than 50% of the equity but still has the power to block a decision by the startup’s board of directors, then the startup is still considered a subsidiary. However, if the VC needs to get buy-in from another investor to bypass the board, then the startup would not be considered a subsidiary and would be eligible for a loan.
But after these basic requirements, establishing “need” becomes more subjective. “There are no concrete guidelines,” Richards tells me. “That’s why it ends up being a judgment call.”
There are no concrete guidelines. That’s why it ends up being a judgment.
Jeff Richards, GGVC
The central question is whether the business has been “materially damaged” by the coronavirus slowdown. Denehy’s business, Electric, for example, experienced a “disruption,” but not a drastic slowdown, primarily because the company specializes in IT support for distributed-workforce businesses and workers on the job. distance. Electric also has a few multi-billion dollar investment firms behind it – GGVC and Bessemer.
Many other tech startups weren’t so lucky. Richards told me he spoke to business startups that have seen 80% of their income evaporate almost overnight because of the virus. And companies with such low numbers may find it difficult to raise additional capital through typical sources.
For many startups, the decision to apply comes down to how much money the company had when the virus hit.
“If you have more than 12 months of cash flow, you don’t apply,” says Richards of GGVC. “If you need more cash, you can go to the stock markets, [even though] you may not like the terms.
Denehy from Electric told me that at the end of all the emails, Twitter threads, and boardroom discussions, the prevailing wisdom is that if a company has enough money to spend the end of the year without layoffs, then she should not apply. It really is for businesses that are “in dire straits” right now.
Richards tells me that if a startup took out a PPP loan without really needing it to survive, that fact might show up later in an SBA audit.
The optics of something like this could be very bad for a startup, says Denehy. “There was a lot of talk that if you took the loan and had the loan canceled and later came out that you really didn’t need it, it wouldn’t look good,” says Denehy. “It’s in the public domain – someone might find out later and show you don’t really need it.” “
Blues of disbursements
Even if a business needs the cash, there are real questions as to whether SBA loans will be disbursed quickly enough to avoid layoffs.
One of the main shortcomings of PPP is its first come, first served principle. There is no triage mechanism to ensure that applicants with the most urgent or urgent needs get their loans processed and disbursed first. This first-come, first-served rule may have meant that some startups rushed to apply before they really thought about their level of need.
Richards points out that the rule may also have put some of the smaller Main Street business candidates at a disadvantage, as they typically don’t have a dedicated financial officer on staff who can quickly put the documents together. In comparison, a tech startup probably has an employee like this.
Either way, applications from small businesses, including many tech startups, have poured in. The Silicon Valley Bank, specializing in services to startups, would have received 5,000 applications on April 7, the day it started to accept them (four days after the SBA said banks could start accepting applications). The bank reportedly hastily built a web portal to accept PPP requests. According to a source familiar with the matter who requested anonymity, 70% of applications would have been processed successfully, but 30% of applicants had “a less than wonderful experience” and probably had to start the process again.
For companies that have just applied, it can take months for you to receive the money. “
Ryan Denehy, Electric
Silicon Valley Bank has yet to confirm or deny the accuracy of these dates and figures.
Applicants who have not submitted their application earlier may not benefit from the benefits provided by the program. “The expectations of law firms were that for companies that had just applied, it could be months before you received the money,” Denehy tells me. “When you look at how many loans the SBA normally approves in a year, and then how many they’ll have to approve now, you can’t conclude that you’re going to get your check in a week or two.”
The SBA said on 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 the next morning, the rest of the money was already gone.
It is now up to Republicans and Democrats in the Senate to agree on how much more to spend on the program and whether or not to allow other types of businesses to apply for loans. Meanwhile, the Labor Department reports that it processed 5.2 million jobless claims last week, and millions of small business jobs are likely hanging by a thread as small employers have struggling to make their pay.