Some VC, private equity firms on the outside of CARES Act

By Updated: April 10, 2020 9:10 AM CT | Published: April 10, 2020 4:00 AM CT

Thousands of small businesses across the U.S. are scrambling to apply for federal assistance through the Paycheck Protection Program. In fact, Bank of America CEO Brian Moynihan said Tuesday, April 7, his firm has received 250,000 applications since the PPP’s launch last Friday.

While many small businesses are covered under the federal $2.2 trillion CARES Act – Coronavirus Aid, Relief, and Economic Security Act – that Congress passed in response to the COVID-19 pandemic, it excludes some venture capital and angel-backed firms from accessing funds.

The Small Business Administration (SBA) guidelines are structured for companies with fewer than 500 employees. Some special exemptions were made, primarily aimed at hotels, restaurants and franchises.

In the arena of venture capital-backed firms, when considering the aggregation of all employees of companies a venture firm backs, many end up consisting of more than 500 employees, leaving them exempt from the federal funds.

“It (the CARES Act) still has the affiliation rules,” John Bobango, partner of Farris Bobango PLC, said. “They’re very complicated. For each situation, you have to consider and work through the affiliation rules to see how they apply to your business.”

For instance, if a venture capital firm has 10 to 20 investments in portfolio companies, and each of those companies has 10-30 employees and one has 300 employees, under the CARES Act, all of the employees must be aggregated together. In this scenario, all of the companies would be blocked from being able to access some of the PPP funds.

In addition, under the SBA rules, a 10% venture-backed startup can be defined as a large business if more than 50% of its equity comes from a venture capital firm whose portfolio companies collectively employ more than 500 employees.

<strong>Ed Nenon</strong>

Ed Nenon

There are workarounds to comply with the aggregation rules. However, Ed Nenon, principal of Memphis-based SSM Partners, one of the largest private equity firms in Tennessee, said doing so can be expensive, challenging and cumbersome.

Nenon said venture firms can opt to forego certain minority protection rights, such as the ability to stop a company from incurring debt, in order for the firm’s companies to no longer count as affiliates. That way, they can apply on their own for PPP money.

“We’re evaluating these situations uniquely,” Nenon said. “We’re looking at what rights do we have to give up and how easily is that done and what happens if we give up those rights.”

<strong>Brandon Wellford</strong>

Brandon Wellford

Brandon M. Wellford, executive director and president of Memphis Bioworks Foundation, said most of the firm’s companies will not be affected because they concentrate more on early-stage investing and have a small percentage of ownership in the companies.

“Because we’re making early-stage investments, most of our investments are below the threshold and would be included (under the CARES Act) because oftentimes we’re less than a 10% investor,” Wellford said.

Wellford said in situations in which Bioworks or Innova Memphis, a pre-seed, seed and early-stage investor founded by Bioworks in 2007, has a larger investment in a particular company, there will still not be the maximum aggregate number of employees.

“For our case, it hasn’t impacted the companies that we work with, and we’ve been assisting some of the companies who are applying for the PPP loans,” he said.

Nenon said rights that the firm negotiated in the past can be helpful and valuable as a minority owner, so SSM Partners is not giving them up lightly. The firm is, however, waiving rights in its portfolio in “select situations.”

“That process (of waiving rights) is expensive and difficult,” he said. “There’s not a blanket form to use across the portfolio. It’s expensive and a burden, and then there’s a level of complexity that the banks are struggling with as the underwriters of these loans.”

Bobango said there is a little leeway to get around the aggregation rules, but not much.

“It’s (the CARES Act guidelines) going to unfortunately catch a lot of the venture capital-backed companies and private equity groups,” Bobango said. “Those aggregations will impact the venture capital world as well as the private equity world.”

The issue has been a big concern, and many letters have been sent to Congress to reconsider the rules. In California, where there is a substantial number of venture capital-backed companies, three state representatives wrote letters to the U.S. Secretary, asking that venture capital firms have access to PPP funds.

“We were hoping for the venture capital and private equity firms that really invest a lot of money in starting companies and keeping them going that there would be more relief coming sooner,” Bobango said.

There are more than 83,000 venture- and angel-backed firms in the U.S. If the guidelines are not changed, close to 1 million jobs could be affected.

“When you start adding up all the venture capital and private equity firms, I think it permeates a lot of companies and a lot of jobs. If they don’t have access to monies under the CARES Act or the SBA, they will be significantly hard hit and start laying people off,” Bobango said.

“I’m hoping the SBA and the Treasury provide further guidance while there is still money available for the private equity and venture capital-backed companies to apply.”

Topics

SSM Partners Memphis Bioworks Foundation

Christin Yates

Christin Yates is a native Memphian who has worked in PR and copywriting for a decade. She earned her B.S. in public relations and M.S. in mass communications from Murray State University.


Comment On This Story

Section Emails

Sign up to get the latest articles from the Business section.