Now that the deadline to return Paycheck Protection Program funds has passed, business owners may find themselves with extra loan money to spend. Here's how to spend it so your loans are forgivable.
The deadline to return U.S. Small Business Administration (SBA) Paycheck Protection Program funds with no strings attached has now passed, which means business owners with remaining funds must spend them. Unfortunately, some business owners might find it difficult to meet the SBA's guidance on how to spend the funding.
Confusion around early guidance on how to spend loans from Paycheck Protection Program
"There was quite a bit of economic uncertainty at the beginning of the COVID-19 pandemic, and many business owners who applied for the PPP were unsure of how their organizations would be impacted in the long term," said Eytan Bensoussan, co-founder and CEO of NorthOne. "Different owners interpreted the SBA's vague guidelines differently, causing many to take out loans without completely understanding the terms or provisions."
However, as more guidance has emerged, it has become increasingly clear: About 75% of the funds should be spent on wages and salaries, while the remaining 25% could be used for rent, mortgage payments, and utilities. However, Bensoussan noted that many small business owners preemptively applied for funding before these requirements were clear. Moreover, some business owners found themselves in situations where meeting those obligations was unrealistic.
"The guidance around spending the loan is clear but doesn't account for the reality several businesses are facing," Bensoussan said. "Lockdowns and large unemployment benefits affect many businesses' ability to spend 75% of their loan on payroll. Many owners are choosing to not use their loan at all to ensure they'll be able to pay it back."
For the portion of a Paycheck Protection Program loan that is not forgivable, small business owners will be left with a principal balance that must be repaid within two years at an interest rate of 1%. Those payments would be deferred for the first six months. While this represents a relatively inexpensive loan, many small businesses were not looking to add debt to their books in the middle of a global public health crisis.
"It's likely that many owners will have to pay back a portion of the loan, so it's critical that they create a financial contingency plan for weathering slow business once they're allowed to reopen," Bensoussan added. "The best way to figure this out is to talk to an accountant to get personalized guidance."
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What to do with remaining Paycheck Protection Program funds
If you are still holding Paycheck Protection Program funding and aren't sure how to spend it, Bensoussan said it is important to revisit the guidance released by the SBA.
"The PPP loan was meant to support the necessary ongoing operations of a business, so business owners shouldn't get creative," said Bensoussan. "They should use the loan for payroll (hence the name, Paycheck Protection Protection) rent and utilities, and keep meticulous records that they did so. These will be critical when the time comes to ask the government for loan forgiveness."
If you did not return your Paycheck Protection Program funding, be prepared to withstand an audit and demonstrate to an inspector general that you indeed applied for the funding in good faith. Be prepared to demonstrate both the economic uncertainty your business faced when applying as well as the necessity of those funds to sustain your business's operations.
You should prepare the following:
Document financials prior to application. Demonstrating the business's financial health and stability before the COVID-19 pandemic and application for Paycheck Protection Program funding is important to give a clear picture of the circumstances leading up to the loan application.
Keep minutes of meetings prior to and during the application process. If you have any minutes available from board meetings or company officers' meetings before and after the loan application, those could be helpful to demonstrate the thinking of company leadership at the time.
Detail how the funding was used once your business received it. You should provide a detailed accounting of how any Paycheck Protection Program funding was spent.
- Keep a record of financial performance over the past two months. Providing a detailed accounting of business financials, including cash flow, revenues and expenses, can demonstrate the impact COVID-19 had on your business and why the funding was necessary to operations.
"We're advising it as a good business practice … to refresh recollection and document going back to when you applied, the circumstance and situation," said Daryn McBeth, an attorney at Lathrop GPM. "That's going back several weeks ago now, and a lot of people have forgotten due to COVID-19 and business things they're dealing with."
What is a good faith certification?
When businesses applied for a loan through the Paycheck Protection Program, they were required to certify that "current economic uncertainty makes this loan request necessary to support the ongoing operations of the [business]."
According to McBeth, there are two major elements that constitute a "good faith" application for Paycheck Protection Program funding: economic uncertainty and necessity.
"[Economic uncertainty means] when you applied, what were the financial and workforce conditions you were facing?" McBeth said. "We can easily check the economic uncertainty box; that's a pretty low bar."
The more difficult element to demonstrate is that the funding was necessary to continue operations, McBeth said. This could be a particular challenge to businesses with significant cash reserves that they chose not to use in lieu of applying for a Paycheck Protection Program loan.
Demonstrating good faith certification
Just because your business might have had significant cash reserves does not necessarily mean it is impossible to demonstrate you applied for a Paycheck Protection Program loan in good faith. There are operational reasons you might not have spent that cash, or that money was needed for other critical purposes.
Getting specific financial documentation in order dating back to before your Paycheck Protection Program application can help you withstand scrutiny from the SBA and explain why your application for funding was indeed necessary. According to McBeth, businesses should be able to answer specific questions about their financial situation at the time they determined they would apply for a loan.
"Why did they have that cash? Did they just go through a sale? What did they need and use the cash for? Some of that can be explained away by the burn rate on cash and obligations that any particular business might have," McBeth said.
Businesses that could demonstrate they applied for their Paycheck Protection Program funding in good faith remain eligible for total loan forgiveness if they used the funding for the approved expenses, which include wages and salaries, rent and mortgage payments, and utility bills.
What is the Paycheck Protection Program?
The Paycheck Protection Program provides government-backed, forgivable loans to businesses with 500 employees or less. If your business needs short-term funding to cover payroll and facilities costs, the Paycheck Protection Program is designed to provide fast, low-cost financing with the potential for full loan forgiveness.
Under the CARES Act, small businesses could qualify for loans up to 2.5 times their normal monthly payroll costs, with a cap of $10 million per loan. In addition, Paycheck Protection Program loans include the following terms:
- No application fees
- No personal guarantees or collateral requirements
- Fixed 1% annual percentage rate
- Deferment on the first six months of loan payments
- Partial or full loan forgiveness opportunities
Borrowers could provide documentation of the use of funds to their lender, who then forward it to the SBA. If the usage of the funds is approved by the government, the borrower is eligible for partial or full loan forgiveness. The forgiven amount of the loan does not translate to taxable income due to provisions included under the CARES Act. Additionally, the qualified expenses that the forgiven amount was used to cover can be written off as a tax deduction.
For more information on the coronavirus pandemic and resources to help your business navigate these difficult times, visit business.com's COVID-19 small business resource page.