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Scott Orn

Scott Orn, CFA

Kathryn Hickey of PilieroMazza PLLC on CARE Act Stimulus Loans

Posted on: 03/31/2020

Kathryn Hickey

Kathryn Hickey

Partner - PilieroMazza PLLC

Kathryn Hickey of PilieroMazza PLLC - Podcast Summary

Kathryn Hickey of PilieroMazza PLLC discusses eligibility for startups under the CARE Act stimulus loans. She explains the SBA rules around “affiliates” and solutions for VC backed startups to be eligible for the loans.

Kathryn Hickey of PilieroMazza PLLC - Podcast Transcript

Scott: Hey, it’s Scott Orn at Kruze Consulting and before we get to just a fabulous podcast with Kathryn Hickey up here at La Mazza who’s an SBA loan expert, quick shout out to our friends at Rippling. Rippling is the number one amazing payroll, benefits and IT solution for startups. They do great payroll, they do great benefits and they also have an integrated IT solution that allows you to enable all your new hires so that they can automatically log into all their favorite web services. It saves us a ton of time when we are hiring new people at Kruze Consulting, which has been pretty frequently. So, love Rippling. Also, a quick shout out to the Kruze tax team. The Kruze tax team is working so hard. They’re amazing. They’re cranking out tax returns, they’ve finished all the compliance that your startup needed for the year already. Super proud of them. Go Kruze tax. We love you. Now to the podcast with Kathryn who’s just a super expert. Amazing podcast. Thanks.
Singer: (singing). It’s Kruze Consulting’s Founders and Friends with your host, Scottie Orn.
Scott: Welcome to Founders and Friends Podcast with Scott Orn at Kruze consulting. Today my very special guest is Kathryn Hickey from PilieroMazza, an SBA focused consulting firm. Welcome Kathryn.
Kathryn: Thank you, Scott.
Scott: So, you are like the experts on SBA lending. We were actually put in touch by the folks at Goodwin Procter and thank you so much for taking the time. It’s late at your hour. Do you want to just kind of retrace your career a little bit and kind of let the audience know how you got to this point?
Kathryn: Sure. I’m happy to. So, I have spent the bulk of my career as a corporate transactional attorney. So, I do a lot of M&A transactions as well as private financing transactions, venture capital, private equity along with general corporate governance advising. I joined PilieroMazza about a year and a half ago and the company, our firm was founded as a government contracting boutique many years ago and has since grown. But a lot of the core clients that we represent are government contractors, small businesses, many of whom have taken advantage over the years of SBA loan programs including 7(a) loans. So, we do a lot of work with those clients specifically on the specific regulatory framework of the US Small Business Administration, the SBA, and that is the government agency that administers these SBA loan programs, which I know you and I are going to talk a little bit more about today. So, a lot of times that comes up in the context of transactions because there will be buyers who utilize SBA lending to help finance the acquisition of a small business, things like that. In the current Cares Act, the 7(a) program has been expanded beyond kind of those traditional uses to be accessible to a much broader range of companies. So now there’s a lot of interest outside of the traditional government contracting small business community. People want to know what are these loans, how can we take advantage of them and how do we figure out if we’re eligible. So that’s I think why I’m here today with you, Scott.
Scott: That’s a great overview. I’m familiar with SBA loans. My mom actually owned like a small business retail operation and her company was bought by someone who took on the SBA loan. So, I remember how effective it was. The whole design of SBA loans was to unlock credit for small businesses, right, and make those kinds of acquisitions work. It’s so interesting to see where we are now where $350 billion of stimulus is being directed through the SBA and all the banks that work it. It’s a fascinating time, I’m sure. I’m sure it’s like once in a million, but also, it’s probably a little too crazy for you.
Kathryn: It’s been a very busy week, I will say.
Scott: I feel the same way, I’m so tired. So, a couple things. SBA loans typically have… Maybe we can just talk about some of the mechanics real fast and then we can talk about some of the how to calculate how much loans are available to companies and things like that. But one of the big things I noticed was that the personal guarantee had been removed, all the SBA loans I’d ever heard of always had a personal guarantee to kind of keep the borrower on the hook. I think the strategy was maybe evident for Congress. But what’s your take on that? Is that a good thing, a bad thing? How are you seeing that?
Kathryn: I think it’s a good thing for borrowers here. I also think logically it makes sense in the context of how the paycheck protection loan program, the PPLs have been modified from the typical 7(a) structure. The key feature is for traditional 7(a) loans, those loans are only available for companies who can demonstrate that they don’t have access to credit elsewhere. So, by definition, it’s for companies that traditional lenders don’t deem to be creditworthy. That’s why they want to make these funds available to help give liquidity to that part of the market, the small businesses who really need it. That lack of credit access has been removed as a requirement for the paycheck protection loan program. So as a result, we have credit worthy businesses who probably do already have lines of credit with institutional lenders who have financing facilities, but that may not be sufficient, those existing facilities may not be sufficient in the current crisis that’s been generated from the COVID-19 disaster scenario. So, Congress recognized we need to make these funds available to more than just our typical very small pre-credit worthiness group of companies. As a result, in all likelihood, the personal guarantee feature is not going to be as material. Also, keep in mind that the way this program is designed is if you do things the way you’re supposed to with the funds, in all likelihood, all if not, and if not all, most of the loans should be able to be forgiven down the line. So again, keeping the borrower on the hook here is not Congress’s primary objective. I think their primary objective is to get this money out there and not necessarily see it come back in the door.
Scott: Yeah. That’s a great point. You said something super interesting about forgiveness. Maybe you could talk a little about that. I thought it was only kind of the equivalent of two months of payroll forgiveness. But how does that equate to the total loan amount? Because maybe it maybe is awash or how’s the math done in your head?
Kathryn: It’s more or less equivalent because the amount of a loan that company is eligible to receive is equal to 2.5 times your average monthly payroll as determined on a rolling 12-month average basis. So, you take your monthly payroll as averaged out, multiply it by 2.5 and that’s your loan amount subject to a $10 million cap. So, if you look then at the forgiveness period, which is eight weeks, that’s going to get you really close to the full amount of the loan that you’re likely eligible for.
Scott: Yeah, that’s a great point. I was doing the math a little. Thank you for clarifying that. There’s something else you talked about where some of these companies are not the traditional SBA lender, so they’ve already got credit facilities or debt placed. How are you anticipating the interplay on seniority between an existing lender and a company with the SBA loans? Is the SBA going to need to be senior? Is the existing lender going to be able to stay senior? How’s this going to work?
Kathryn: That’s a great question. In most contexts, in my experience, the SBA lender requires first priority senior status in the lending food chain.
Scott: I always heard that to myself. Then of course you’re going to have the other creditors saying, “Our documents say we’re senior too.” What’s going to happen?
Kathryn: Yeah. So, it’s a little bit… It’ll be interesting to see how this plays out because I think one of the main goals of these paycheck protection loans is for them to be deployed very quickly. So, there’s not going to be a lot of room for those kinds of negotiations between lenders, which oftentimes is like the slowest part of a deal. I don’t think there’s going to be a lot of room for that. So, in some cases it’s possible if the SBA lender is insisting on senior status, it might be the difference. If that’s not okay for you and your current lender, then maybe we move on to the next applicant. That’s one possibility. Another possibility may be that given the posture of these loans and the fact that the repayment is not necessarily first priority, maybe the SBA is going to take a different stance on requiring that seniority here. I honestly don’t know the answer.
Scott: That’s super interesting. You’re right about the inter-creditor agreement. The SBA and the bank are not going to be able to figure out an intercreditor agreement fast enough so that’s kind of [inaudible].
Kathryn: The loan program’s going to be over by the time that gets worked out.
Scott: Yeah, yeah. Yeah. That’s a great point. Well, then the other thing I wanted to talk about was just especially for our clients, the venture back companies, there’s this concept in SBA about affiliates. Maybe you can define it because this is like your sweet spot. You’re an expert here. But what I’ve been talking to venture capital lawyers and venture capital startups, everyone’s worried about this affiliate problem and whether it’s startups can partake in the program.
Kathryn: Yes, understandably so. I’ll just start out by saying in case it’s not clear to any of your listeners that the reason the affiliation concept matters is because in order to be eligible for one of these loans, you need to be underneath the required business size, which is primarily determined based on how many employees you have. You have to have fewer than 500 employees. That applies not only to the company that is applying, but if you have affiliates as determined under the SBA affiliation rules, you have to aggregate your employees with the employees of all of your affiliates. So, you can imagine for a company with venture capital investors and those venture funds have investments in multiple portfolio companies, if all of them are deemed to be affiliated, you’re very quickly going to be over the 500 limit and you’re going to be bumped out of eligibility. So that’s why there’s such a concern here. In my experience, having started my career in kind of the general commercial world and then transitioned into the government contracting SBA world, the concept of affiliation under the SBA rules is different from what you might think of in a normal corporate context. It’s a lot more specific and it focuses on not only ownership, so there’s a bright line rule that is pretty much sacrosanct if you own more than 50% of a company, you’re deemed to be affiliated with that company. So majority ownership equals affiliation, which kind of knocks out a lot of private equity funds. But for venture capital funds where they play mostly minority investments, they’re still potentially on the table if they don’t trip up any of the other affiliation issues. The main affiliation rules that apply in the business loan context here are ones that are driven by whether or not a minority investor has the ability to control the day to day decision making of the company. There’s a lot of case law where these types of control rights, we call them sometimes negative controls because investors often retain for themselves the right to block certain actions in order to protect their investment in the company and those negative controls or blocking controls, some of them have been reviewed by the SBA and deemed to be permissible. Others which get more towards day to day operations have been reviewed by the SBA and deemed to be too much control and that level of control has been held to create affiliation between the company and a minority investor. So those are the ones that we’re really focusing on. Unfortunately, a lot of those rights are rights that are very common in venture capital investment documents.
Scott: Yeah, that’s such a great… You described that so well. So, the simple, the first test is kind of like if someone owns 51% of the company or more, and that’s very kind of easy for all of us to see, but these negative controls provisions are… They’re a little bit of the hidden got you there. You mentioned that the SBA has reviewed some of these and decided some of those are just not going to be kosher, they’re not going to work. Maybe you can give a couple examples of those negative control provisions.
Kathryn: Yeah. I’ll give a couple examples, which are the ones that I view as most problematic because they’re very common features of venture capital terms and also there’s very clear precedent in the SBA that those are pretty much 100% not allowed for a particular investor to control. One of those is the ability to declare dividends and make distributions. Oftentimes, venture capital investors have the right to approve the declaration of any dividend or payment of any dividend and that can’t be done without certain investor approval. To the extent that right is held by a specific investor, that’s going to be an impermissible negative control that’s going to result in affiliation. Now I want to emphasize the fact that by our reading of the rules, we think that this is really only problematic to the extent there’s one investor that has this right and it’s specific to them so that there’s essentially a veto held by one minority investor. So, sometimes you’ll see these rights are enjoyed by a whole class of equity holders. So if all of the preferred equity holders voting together have to approve a distribution, then depending on the percentage ownership, if they all own relatively small portions of the preferred stock, and so multiple combinations of investors could aggregate for any particular decision to approve a distribution, then the flip side of that is no one of those investors controls the vote. No one of them has to approve in order for the action to be permitted. So, you have to focus not only on the substance of the right, the ability to declare a dividend, but also which of the investors controls it. If somebody, if there’s no one person who controls that vote, then you still might be okay. But if there is a clear party that controls the vote, that’s when you need to be worried about, well, how do I mitigate that?
Scott: That’s an incredible observation. So, if there’s multiple VCs in a share class essentially, right? Is it limited to share class or could it be like a series A investor owns 20%, a different series B lead owns 20%, is that permissible or is it only when there’s multiple VC firms in this specific share class?
Kathryn: So, it’s not that one or the other of those scenarios is permissible or impermissible. What it really comes down to is no matter how the right is structured, whether it’s aggregated share classes together or one share class voting together, what it really comes down to is does one investor control that vote.
Scott: One like one Sand Hill Road, VC firm essentially. Do they control… It’s that veto concept that you came back to.
Kathryn: Yes, although I would clarify that a lot of times we see funds come in, they’ll put funds in, affiliated funds will co-invest. So, it might be technically different entities. But if those funds are affiliated through like a common parent then they would be considered affiliated for purposes of the vote and that would all flow up together. But conceptually, yeah, what you described as the way that it would work.
Scott: Yeah. The caveat you’re saying is like sometimes venture capital funds have like a sidecar fund or an employee investment fund or things like that that just kind of mimics whatever the VC fund does but at a much smaller percentage. Okay. That’s super interesting. Some of the other stuff I read, I wasn’t sure, but things like approving the operating plan and a veto rights or share class vote on whether the company could sell itself or not. Are those things that you’ve seen as negative control provisions as well?
Kathryn: They are. So, some negative controls that are very common and which the SBA generally does not have a problem with, so these controls can exist, they can be exercised by single investor but they will not be deemed to be impermissible are ones that are what we would consider extraordinary actions, really big decisions that go towards kind of the fundamental value of the investment. So, approving a sale of the company, a dissolution of the company, bankruptcy, the creation or issuance of a new class of stock or reclassification of existing stock, those are some of the big ones that you’re allowed to give negative control over to investors and that’s not going to create affiliation. The ones that the SBA doesn’t like are ones that they consider to be less those extraordinary actions and more relevant to day to day operational decision making. So those would include the ability to control the compensation of executive employees, the ability to control hiring and firing decisions of executive employees, the ability to approve amendments or changes to the company’s employee equity incentive plan, like a stock option plan. Those are rights that have specifically examined by the SBA and held to be impermissible. Another one is you mentioned like operating plants, the ability to control a budget or an operating plan of that nature if vested in an investor, that would be an impermissible negative control too. There are a lot of those types of things that have been reviewed by the SBA and that the SBA has found, and again this is important, a lot of the precedent while we’re referring to it in this context of the business loans for guidance, it’s actually been issued under a different statutory regime, a lot of the precedent here exists in decisions that were reviewed for affiliation that is relevant to government procurement. So, if a company was awarded a contract that was set aside for small businesses and then was protested and said, “You’re not actually small because you have these affiliation issues,” that’s more the context where most of this case law has developed. There has not been a lot of case law in the business loan context, but that’s all we have to point to and the SBA has indicated that those are the appropriate affiliation precedents to refer to. But I do want to make clear that technically those apply in a different context. We think they’re going to be held to be similarly applied here.
Scott: That’s a great clarification, great description, Kathryn. So, if you’re a startup with, how would you go about… Would you have your law firm read your stock purchase agreement, your articles incorporation and give you a recommendation on whether you’re qualifying for the or disqualified because of the affiliate rules? How would you go about making this actionable?
Kathryn: Yeah, so here’s my advice for any company that is thinking they want to apply, but they know that they have some VC fund investors or other fund investors and they want to make sure that they’re eligible and it’s important in this context because when you apply for the loan, it’s most likely going to be treated as you’re certifying that you are eligible, you’re certifying that you are small under the standards taking into account affiliation issues. So, you want to make sure that you’re not misrepresenting that to the government. So, what I would start with doing is yeah, talk to your legal advisors and have them review the governing documents, anything that contains rights between the company, its shareholders, or among the shareholders. So, in a standard VC investment package, you’re probably talking about the charter, the investor’s rights agreement. You should also look at any voting agreements, other shareholders agreements, buy-sell agreements, et cetera so that your advisor can get a sense of what are all of the control rights that are out there, what are the investor protective provisions and try to really narrow down hopefully a very short list of the ones that might be problematic. Then if you have ones that look like just on their face, we think these based on precedent definitely create affiliation, what can we do to mitigate that? You can certainly amend the documents to remove or modify the rights to put them into a more permissible, more gray area context. Or something that we’re considering for some of our clients is rather than amending the documents, talking to the investors and seeing if they’d be willing to sign essentially waivers of those specific rights for the duration of the SBA loan. So, you’re saying, “We recognize that we can’t have these rights for you to be eligible for the loan. So, for as long as you have assistance backed by the SBA in the company, we’re going to waive these rights.” Then obviously that needs to be an enforceable waiver. But we think that that should be sufficient to enable these companies to apply. As long as that’s in place before you’re making the application, you can make a good faith certification that you’re eligible because you’ve eliminated those rights that create affiliation.
Scott: That is an incredible tip and I’ve been racking my brain on what to do and how to advise our clients. That is just so helpful. You’re right about when you certify something to the government, and I’ve read the application, you and I were talking before we turned the mics on, the application is actually out as of an hour or two ago. It does ask you to certify. You are certifying and they ask you to list any 20% owners and they ask you to certify that you do not have an affiliate arrangement. So, this is super important and people should not kind of willy nilly certify without knowing all the facts and getting some type of opinion, some type of assistance from their law firm. But the waiver idea is such a good idea. I think most investors will sign up for that because they realize that keeping people in jobs is super important and that’s what the act is. The Cares Act is designed to keep people on jobs and not letting people go when they don’t really want to. So, I would anticipate most investors would agree with that.
Kathryn: Yeah. Frankly, we have had a lot of conversations with the investors themselves, with investors who are saying, “What can we do to help our portfolio companies and help them get access to these funds?” So, a lot of them are actually very serious about, to the extent we can waive a limited portion of our rights for a limited period of time to get access for our companies that really need this money, many are willing to do it. So, it’s definitely worth having the conversation. I do want to make just one big disclaimer for anybody who wants to try and pursue this waiver concept. This is what we currently think is going to be permissible, but we are engaged in kind of active discussions with the SBA to confirm that that is going to be sufficient in their view, and it is possible, I hope this isn’t the case, but it’s possible that they could come back and say, “No, that’s not going to fly.” So, before you actually implement this, make sure you talk to your advisors and figure out what the most recent word is on whether that is going to be sufficient or whether you need to do something more drastic like an actual amendment. Because again, the landscape on all of this stuff is changing literally by the hour. So, what we’re giving out now as guidance is based on the best information we have right now and it’s possible it could change tomorrow.
Scott: Such great advice and I got to get you out of here because it’s late your time. I have one final question around the affiliate stuff, which is for seed stage companies that are doing safe notes or convertible notes, how does the SBA look at that? Because they’re technically kind of a debt instrument, at least the convertible notes are. The safes are closer to equity. But is the SBA evaluating safe notes and convertible notes or are they just treating them as like ownership on an as converted basis to make it simple?
Kathryn: That’s a great question. For the most part, the SBA treats those types of instruments as ownership on an as converted basis. They treat them as if they have been exercised.
Scott: Yeah, that’s what I thought. Okay. Kathryn, it is late your time. I’m eternally grateful. You’ve opened my eyes in the waiver and alternative plus your advice on hey, things could change two hours from now so make sure your legal advisor signs off on this is great advice. We’re super grateful for your time at Kruze Consulting and please let us know if we can ever repay the favor.
Kathryn: Thank you so much, Scott. It’s been my pleasure.
Scott: Then just let people know where they can find you because I think you’ve demonstrated that you’re an amazing lawyer and that people should be retaining you for that advice.
Kathryn: Sure. Thank you. Anybody can feel free to find me on my firm’s website. It is That’s My direct email address is KHickey, K-H-I-C-K-E-Y@PilieroMazza,
Scott: Thank you so much, Kathryn. When we blast this out on social media and the Kruze’s website, we will link to what your company’s website, so you’ll all be taken care of there. Again, can’t thank you enough. Very, very grateful. I think I’m rambling or repeating myself, but you really opened my eyes on this stuff. Thank you so much.
Kathryn: Thank you, Scott.
Scott: All right. Take care.
Kathryn: Bye.
Singer: (singing). It’s Kruze Consulting, Founders and Friends with your host Scottie Orn.
Scott: Hey, it’s Scott Orn and thanks again for listening to that podcast with Kathryn Hickey. She is just such an expert, such a pleasure to talk to. Amazing, amazing help really. Really help clarify the affiliate rules from me big time. Before we go, another shout out to Rippling. We love them for payroll. We love them for benefits management. They have a great IT solution. It’s just so easy to provision your new employees. If you have to let people go, which is always sad, it can actually help you de-provision people from web services so it saves you a lot of time there too. Never a pleasant thing, but it does help that process quite a bit. Again, Kruze tax team is cranking. The Kruze FP&A team is doing tons of budget actuals right now. With the slowing of financing and the slowing of business, a lot of companies are asking to be doing budget actuals now, which is pretty exciting. Like I always tell people, budget actuals always pay for themselves. You always spot that spend that you didn’t really need. So, kudos to the FP&A team. Until we’ve talked again. I’ll see you later. Take care out there. Thanks.

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