On October 2, 2020, the Small Business Administration (SBA) issued guidance (the Guidance) on the required procedures for changes of ownership of an entity that has received Paycheck Protection Program (PPP) funds. The Guidance was published in the form of a Procedural Notice (the Procedural Notice) which can be found here. Parties considering an M&A transaction involving a target that is a PPP borrower should be aware of how the Guidance may affect the transaction process. While the Procedural Notice creates additional regulation on an already complex process, many borrowers will welcome a new procedure contained in the Guidance that allows target-borrowers to avoid having to obtain SBA consent before closing an M&A transaction. See our prior client alert discussing the potential impact of PPP loans on M&A transactions here.
Congress created the PPP under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) through the SBA to provide forgivable loans to eligible small businesses facing economic hardship, primarily in order to retain U.S. employees on their payroll during the COVID-19 pandemic. Our prior client alerts on PPP loans can be found on our COVID-19 crisis response group website here.
“Change in Ownership”
The Guidance applies to transactions resulting in a “change of ownership” of a PPP borrower, which the SBA identifies as occurring in three situations: (1) at least 20% of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions1, including to an affiliate or an existing owner of the entity; (2) a PPP borrower sells or otherwise transfers at least 50% of its assets (measured by fair market value); or (3) a PPP borrower is merged with or into another entity.
Under the Guidance, not all change of ownership transactions will require SBA approval. Regardless of whether SBA approval is required, all PPP borrowers must provide written notice of any potential change of ownership transaction to their PPP lender prior to the closing of the transaction, including copies of the relevant transaction documents. PPP borrowers must also comply with the specific requirements of their PPP lender.
Prior Approval Not Required if PPP Loan is Fully Satisfied
Prior approval from the SBA is not required if the PPP borrower has either (a) repaid the PPP loan in full or (b) completed the loan forgiveness process in accordance with the requirements of the PPP and with respect to a completed loan forgiveness process, (i) the SBA has remitted funds to the PPP lender in full satisfaction of the PPP loan or (ii) the PPP borrower has repaid any remaining balance on the PPP loan.
Prior Approval Not Required in Certain Change in Ownership Transactions
If the PPP loan is not yet satisfied, SBA approval hinges on the type of transaction and the extent of the “change of control.”
If the change of ownership transaction is structured as a stock sale or merger, SBA approval will not be required if either (a) the sale or other transfer is of 50% or less of the common stock or other ownership interest of the PPP borrower or (b) (i) the PPP borrower completes and submits a forgiveness application for the full amount of the loan and (ii) an interest-bearing escrow account is established by the borrower with the lender in an amount equal to the outstanding balance of the PPP loan.
If the change of ownership transaction is structured as an asset sale, SBA approval will not be required if either (a) less than 50% of the assets (measured by fair market value) of the PPP borrower are sold or (b) (i) the PPP borrower completes and submits a forgiveness application for the full amount of the loan and (ii) an interest-bearing escrow account is established for the full amount of the balance of the PPP loan, which must be controlled by the PPP lender and disbursed first to repay any remaining PPP loan balance plus interest.
Whether or not purposefully intended by the SBA in drafting the Guidance, note that SBA approval is not required in an equity sale when 50% or less of the common stock or other ownership interest is sold, whereas in an asset sale, the threshold for avoiding SBA approval is a sale of less than 50% of the assets. In other words, a sale of exactly 50% would be treated differently depending on whether the transaction is structured as a sale of equity or sale of assets.
In both stock and asset transactions in which the borrower submits a forgiveness application and establishes an escrow account to avoid seeking SBA approval to the transaction, once the forgiveness process is completed, the escrow funds must be disbursed first to repay the lender any remaining PPP loan balance plus interest, and then the borrower will receive the remaining funds. In transactions structured with cash consideration, it is likely that a portion of the purchase price equal to the amount required to be placed into escrow would be funded by the buyer at closing, with the balance to be released to the target-borrower after the forgiveness process is complete. In cases involving non-cash consideration, the parties will need to determine how to fund the cash into escrow. Additionally, while SBA approval to a transaction is not required when using this escrow process, approval of the borrower’s PPP lender is still technically required in order to close the transaction (which would occur in connection with that lender’s establishment of the escrow account).
If SBA approval is not required, the PPP borrower must still provide certain information to its PPP lender, and that PPP lender must still provide a notice to the SBA containing that information within five business days of the completion of the change of ownership transaction. The Procedural Notice sets out the information required to be provided in the PPP lender notice of the change of ownership transaction.
Where Approval by the SBA is Required
If prior approval by the SBA cannot be avoided, the Procedural Notice provides detailed instructions on how to obtain the SBA’s authorization. Although not expressly provided in the Procedural Notice, PPP lenders will require their PPP borrowers to provide at least the amount of information that the PPP lenders need to submit the request for approval to the SBA, along with any other information required by the internal procedures of such PPP lender. In such change of ownership transactions, the SBA has 60 days from receipt of a request for approval to review and provide a determination regarding the forgiveness application.
In all cases described above involving the acquisition of a controlling stake in a target-borrower’s business, the target-borrower must either repay the PPP loan balance or submit a forgiveness application before closing the transaction (i.e., a borrower can retain its PPP loan without obtaining SBA consent to an M&A transaction only when it is selling 50% or less of its common stock or other ownership interest, or selling less than 50% of its assets). Accordingly, in cases in which PPP debt continues to support the target’s balance sheet and is viewed positively by the buyer for post-closing operations, formal SBA consent will be necessary before selling a control stake. In cases in which the PPP funds have been exhausted or the funds are not required for post-closing operations, parties will be motivated to finalize their forgiveness process or at least submit an application in order to take advantage of the new escrow exception.
Questions concerning the Procedural Notice may be directed to the Lender Relations Specialist in the local SBA Field Office, which can be found at https://www.sba.gov/tools/local-assistance/districtoffices.
1All sales and other transfers occurring since the date of approval of the PPP loan must be aggregated to determine whether the relevant threshold has been met. For publicly traded borrowers, only sales or other transfers that result in one person or entity holding or owning at least 20% of the common stock or other ownership interest of the borrower must be aggregated.
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