"Not a great answer for Private Equity"
Earlier this week, DHG and K&L Gates answered FAQs for middle market private equity funds and portfolio companies regarding key business provisions and tax impacts associated with the CARES Act. As it stands, many sponsor-backed companies do not qualify for small business loans under the SBA’s affiliation rules meaning private equity is unlikely to see relief from the Paycheck Protection Program (PPP).
Scott Linch, Managing Partner of DHG Private Equity, highlighted the different resources portfolio companies can consider and balance when navigating uncertainty and cash constraints. He summarized the SBA loans and interaction with corresponding tax provisions as well as the $349 Billion “first come, first served” PPP. The government is “already looking to expand the $349 Billion. A big concern for folks is whether or not the PPP money is going to run out or not,” said Linch.
“Businesses are going to experience some disruption,” said Heather Alley, Partner and DHG National Tax Desk Leader. The CARES Act opportunities to generate cash are not all obvious and nuances already exist. Some of the Act’s provisions will provide opportunities to access much needed cash currently while others will not result in a realized benefit until a later date. Alley offered a brief overview of the current tax relief programs and tax incentives such as employee retention credits, employer payroll tax deferrals, additional interest deductibility, potential accelerated depreciation claims for building improvements, and NOL carryback and limitation changes. She explained the trade-offs between PPP loans and taxpayers not being able to claim retention credits as well as any PPP forgiveness resulting in a failure to use payroll deferral for applicable payroll taxes. “The employee retention credit is a tax provision so it's available to all businesses operating in 2020, not just small businesses. One of the reasons we bring up the employee retention credit is because it's a bit of a trade-off and if you get a PPP loan, you won't be eligible to use the employer retention credit," said Alley.
“The guidance on the PPP has been evolving as new updates surface,” said Rick Giovannelli, Partner and leader of K&L Gates’ global corporate and transactional practice. Giovannelli clarified the latest guidance on SBA loans and was quick to acknowledge “the big question tripping everybody up is affiliates. Affiliates means what you think it does.” He explained who is eligible for the forgivable loans, how much can be borrowed, the loan terms, forgiveness guidance, affiliation rules and exceptions, and minority shareholder rights. He demonstrated how one portfolio company was unable to qualify for the PPP because of the affiliate rule based on equity ownership of 21% and a combination of certain minority shareholder rights activating control.
In addition to explaining the new legislation, Giovannelli discussed several other PPP considerations and factors such as The Bank Secrecy Act, FinCEN's Know Your Customer requirements, AML regulations, The False Claims Act, Borrower’s Certification and the ability for otherwise ineligible businesses to obtain SBIC financing in order to waive the affiliate rule and qualify for PPP loans. He suggested borrowers beware and cautioned against the potential risks and exposure that may be associated with private equity and venture capital investors pursuing the PPP. Most notably was the notion of confidential treatment and the fact that certain information submitted to the SBA or otherwise relating to a PPP loan is subject to disclosure to third parties under the Freedom of Information Act (FOIA). “Be very, very careful and thorough. Understand what you're submitting and make sure it meets the needs of the act,” he said.
Congress is already expected to upsize the allocation for the PPP. But if not the PPP, private equity and venture backed companies may benefit from other tax options and true loan programs already proposed by the Fed such as the Main Street Business Lending Program and the Midsize Credit Facility Program.
About K&L Gates
K&L Gates is a fully integrated global law firm with lawyers located across five continents. The firm represents leading multinational corporations, growth and middle-market companies, capital markets participants and entrepreneurs in every major industry group as well as public sector entities, educational institutions, philanthropic organizations and individuals. For more information about K&L Gates or its locations, practices and registrations, visit klgates.com. This communication may be considered a commercial electronic mail message under applicable legislation regarding unsolicited commercial email.
About DHG Private Equity
DHG provides the best combination of national-caliber talent and resources with the flexibility of a smaller local accounting firm. We leverage our extensive knowledge about, and presence within the middle market, providing a resourceful, one-stop solution at any stage of the deal lifecycle for private equity groups, portfolio companies and companies that may be acquired or sold. We integrate our national industry sectors to bring experience, insight and tangible value to the middle market and private equity industry.