Businesses are rushing at breakneck speed to apply for the SBA's new Paycheck Protection Program (PPP) Loans created and funded by the CARES act. The loan forgiveness provision all but promises free money to those that apply. In fact, many businesses seem to apply for that reason alone.
What's wrong with free money?
We're concerned that many businesses overlooked the nuances of the program and failed to accurately calculate their estimated expenses for the 8-week period of coverage. Why does that matter? If businesses do not spend 75% of loan proceeds on payroll costs, they will not qualify for forgiveness of the full loan amount.
The forgiveness threshold of 75% of loan proceeds spent on payroll costs seems clear. What's not clear is the disconnect between maximum loan amount and use of loan proceeds. The loan guidelines state that a borrow can qualify for the lesser of 250% of average monthly payroll costs for $10,000,000. That 250% of average monthly payroll costs does not align with 75% of the loan proceeds used for 8 weeks of payroll costs.
Why the disconnect?
- Maximum loan amount is based on months while loan coverage period is based on weeks. The average month has 30.4375 days (365.25/12). The loan period is 8 weeks (56 days). While 8 weeks sounds like 2 months (4 weeks in a month), there are actually 4.875 more days in 2 months. That means your maximum loan amount is based on an extra 4.875 days. (A better and more accurate approach to calculating maximum loan amount would have been weeks.)
- 75% of 2.5 (or 250%) is 1.875 (or 187.5%). It seems that someone in the government thought that 8 weeks equals 2 months (see above) and that the extra 50% would go to cover those other allowable expenses. Note that 187.5% does not equal 200%.
- PPP loan proceeds can only be used for certain allowable expenses (payroll payroll costs, healthcare premiums, retirement, rent, utilities, mortgage interest, and Economic Injury Disaster Loan (EIDL) refinancing). Use of loan proceeds for any other costs may result in reduced or no forgiveness, penalties, fines, or legal action.
- Lenders are effectively capping the loan amount at your total estimated expenses by forcing you to itemize those estimated expenses during the application process. If your total estimated expenses do not match the requested loan amount, the application will not be processed.
This disconnect may result in a maximum loan amount that is more than your estimated payroll costs for the loan coverage period. Note that we're seeing a number of clients who qualify for a maximum loan amount that exceeds their total use of loan proceeds - a scenario that results in less than 75% of loan proceeds used for payroll costs.
What to do?
Calculate your maximum loan amount following the SBA guidelines and your lender's application process.
Summarize your estimated expenses for the 8-week period, including payroll costs, healthcare premiums, retirement, rent, utilities, mortgage interest, and Economic Injury Disaster Loan (EIDL) refinancing. These are the allowable uses of your loan proceeds and should be the maximum amount of loan that you request to ensure you meet the 75% requirement for forgiveness.
Adjust the amount of the loan request to match your total use of funds.