Main Street Lending Program Miss: Where the Fed’s Rescue Package Falls Short

An interesting aspect of crisis-era government programs is that they’re usually borne out of good intentions—programs like the Federal Reserve’s Main Street Lending and Payroll Protection Programs.

Take the SBA’s nearly $700 billion Payroll Protection Program- on paper, the program makes a lot of sense, and at the time it was passed, it seemed sufficient to at least dull the impact of COVID-19 containment measures. As usual, though, the devil has clearly been in the details.

SBA Affiliation Rule Excludes Venture-Backed Startups

Rushed rollouts, abuse of the legislative gaps (intentional and otherwise), and confusing guidance on everything from demonstrating need, to affiliation, to forgiveness, have cast a pall on the PPP. And worse, the misguided decision to apply the SBA’s affiliation rules has meant that a vast number of venture-backed companies are excluded. These companies are Burkland’s core customer group. Despite being squarely in the group of severely impacted small companies that Congress was expressly trying to help, these companies have been excluded.

Main Street Lending Program is a Miss, Too

The same, unfortunately, can largely be said about the Federal Reserve’s Main Street Lending Program (MSLP). Much like the PPP, the $600 billion MSLP will make relatively inexpensive four-year loans available to many small and medium-sized businesses through eligible banks. The lending will occur in a manner that provides a critical source of capital to companies navigating the economic shutdown while also lowering balance sheet risk for the lenders.

But also like the PPP, the initial Main Street Lending Program guidelines exclude a significant portion of the U.S. small business ecosystem - in this case, companies losing money - and thus is unlikely to be of much assistance to many Burkland clients and most startups.

Eligibility for Main Street Lending

There are many nuances and details to the MSLP. Still, broadly speaking, an “eligible borrower” is defined as a for-profit business located in the U.S. with 15,000 or fewer employees and 2019 annual revenues of $5 billion or less, and not an “ineligible borrower” under the SBA’s guidelines such as passive entities, life insurance firms, hedge funds, etc.

Furthermore, the borrower must also demonstrate an inability to obtain adequate credit elsewhere, refrain from certain capital distributions, buybacks, and compensation payments, and make “commercially reasonable” efforts to maintain payroll during the life of the loan.

It also has to be in “good financial standing” in the eyes of the lender, which essentially translates into the ability to service and repay the loan. It’s much more of a traditional loan than the PPP, but as far as credit goes, it’s a pretty good option and will be a lifesaver for many businesses.

High-Growth Startups Excluded

There’s a catch, though. In two of the three MSLP program sleeves, loan amounts are calculated as the lesser of $25 million and 4-6 times the company’s 2019 earnings before taxes, interest, depreciation, and amortization, or EBITDA (in the third, it’s $200M). While not explicitly barring loss-making companies from the program, this formula ensures any company with negative 2019 EBITDA, such as most high-growth startups supported by venture capital investors, is out of luck.

A generation of venture-backed startups, working on some of the most cutting-edge technology in the world (including life sciences, mobile, and consumer product ideas) are facing the same pressures as their larger brethren, but risk again being excluded from the support they need.

Venture-Backed Startups

Burkland works extensively with venture-backed startups on their finance needs, and we can attest that using EBITDA to measure a company’s ability to repay debt is superficial at best and highly flawed at worst. The startups we work with are often very well-financed, with cash runways measured in years. They’re unprofitable because of the tremendous costs associated with developing, engineering, marketing, deploying and growing new products and services, not because their business models are inherently doomed or because they don’t have money in the bank. Sadly, in many cases, this cohort of loss-making, venture-backed startups are the very same companies that will create a disproportionate number of new jobs when the recovery occurs.

Final Guidelines TBD

A bipartisan group in Congress, along with several prominent business associations, have suggested the Federal Reserve update the MSLP to include firms with negative EBITDA so long as they are “financially sound,” i.e., well-financed with the wherewithal to properly support the debt - an underwriting decision best left to the lender anyway.

Such changes may be included in the final guidelines when the MSLP is actually rolled out in the coming weeks. Still, we’re not holding our breath - the nuances of the startup ecosystem are unlikely to be understood by a government agency more concerned with avoiding the moral hazard of using taxpayer funds to prop up “bad” businesses. For startups left on their own to deal with the economic fallout of COVID-19, working closely with your finance team and your key stakeholders, including investors, to fully model out survival scenarios and contingency plans remains the best bet for navigating the crisis.

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Burkland offers expert CFO servicesaccounting services, and tax services to startups across the USA. Please reach out to us to learn more about what we can do for you, or if you have questions about federal, state, and local resources available in response to the COVID-19 outbreak.