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Startup advocates worry venture-backed companies that got money under the $670 billion small-business loan program are going to have to give it back

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  • Advocates of startups are worried that new guidelines issued by Small Business Administration may have retroactively disqualified many businesses from the small-business loan program Congress enacted as part of its $2 trillion coronavirus aid package.
  • Many startups applied for the loans, which the SBA has promised to forgive if the money is used for payroll, rent, and other basic expenses.
  • The revised rules advise companies that when certifying they need the loans, they need to consider whether they have access to other sources of cash, potentially including money from their venture or other investors; previously, companies only had to certify they needed the funds due to the "current economic uncertainty."
  • Some startups are already giving back the money they received under the program, and attorneys that represent venture firms and venture-backed companies say many more may do so.
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Startup founders and venture capitalists have a new reason to worry about the small business loans the federal government is handing out as part of its coronavirus relief effort.
Over the last two weeks, the Small Business Administration, which is overseeing the program, has issued new rules and guidelines governing it, which may effectively retroactively disqualify some startups from participating in the program, startup advocates told Business Insider.
Some companies are already giving back money they received under the program in response to the new rules after applying for them, thinking they were eligible under the then-current guidelines and after being encouraged to do so by Treasury Secretary Steve Mnuchin, said Ed Zimmerman, chair of the tech group at the law firm Lowenstein Sandler.
The SBA and the Treasury Department, under which it operates, have "really muddied the water" with the new rules, Zimmerman said. "They said, 'Come and get it while it's hot.' And then right after you were bringing your plates to the sink, they said, 'By the way, there might have been a little poison in that hot dog.'"
"So what are you supposed to do now?" Zimmerman continued. "Stick your finger down your throat?"
The $2 trillion stimulus package Congress passed in March earmarked $349 billion for the SBA to hand out in loans to small businesses that were struggling to make ends meet due to the coronavirus crisis. If the companies used the loans to pay their payrolls and things like rent and utilities, the SBA promised to forgive them. After the initiative, dubbed the Paycheck Protection Program, ran out of money, Congress last month refilled it with another $320 billion.
Numerous startups applied for and received loans under the program. Of Bullpen Capital's 60 portfolio companies, for example, more than half applied for PPP loans, partner Duncan Davidson told Business Insider.

Shake Shack drew criticism for getting a loan

The program has already run into controversy, especially after the initial allocation started to run out, and many small businesses weren't able to get any aid. Critics raised objections when big or prominent companies including Shake Shack, Sweetgreen, the parent company of Ruth's Chris Steak House, and the Los Angeles Lakers all acknowledged getting loans under the initiative. Many such companies have since promised to return the money.
Ostensibly in response to those reports, and in response to what it called "misunderstandings" about which borrowers were could take part in the program, the SBA updated its guidance and rules. Previously, companies with 500 or fewer employees were generally eligible for the program if they could certify that they needed the loans to help support their ongoing operations due to the "current economic uncertainty."
But under the new guidelines, which the SBA started putting in place on April 23 — several weeks after the program launched — the agency added some crucial new terms.
When companies determined whether they need the loans, they now need to consider, as part of the new rules, whether they have access to other sources of capital, including from their investors or owners or the public stock markets and can use that money to support their operations in a way "that is not significantly detrimental to the business." The agency further clarified its rules earlier this week to specify that among the companies that need to consider whether they have access to other sources of money are those owned by private companies or backed by private equity funds.
Although the guidance doesn't specifically mention startups or venture funds, venture capital is generally considered to be a kind of private equity. And venture advisors and advocates are worried that venture-back startups could be forced to give back their loans if they had substantial cash on hand already or have investors with ready funds.
The SBA "inserted a new standard changing the rules of the game after the players have left the field, and then everyone was sort of scrambling to figure out what does that mean and how do I reassess," Zimmerman said.

Startups are already returning the SBA money

Under the new rules, companies that return the money they received under the program by May 7 won't be held liable for making a false certification about their need for the loans. Some startups are already refunding the money or are being advised to do so.
One of Byron Dailey's clients is a venture fund that recently invested in three different startups, each of which had applied for loans under the SBA program. All three are probably going to have to give those loans back now, because of concerns that they may be ineligible under the new guidelines about access to other sources of capital, said Dailey, who leads Fenwick & West's private investment funds practice.
"We're in the process of trying tell some of these companies they need to give it back," he said.
Zimmerman is advising his startup clients and venture firms to hold board meetings to reexamine whether their companies qualify for the loans. Directors need to now consider the issue of whether the startups have access to other sources of cash, he said. Investors and founders also need to be thinking, in the wake of the news about Shake Shack, about whether the reputation of the venture firm or their startup will take a hit when news that they participated in the program becomes public, he said.

Companies could face criminal charges

And that's not all. Companies could face criminal liability under the program that could shadow them for years afterward, he said. The SBA said this week it would audit all loans under the program that were larger than $2 million as well as other, smaller loans. Those whom the department believes to have made false certifications of need could be criminally prosecuted, Mnuchin said this week.
The problem for startups that took the loans is that many of them have already spent some of the money they received, said Zimmerman. Many have also made assurances to employees that they won't be laid off or to landlords that they'll be paid, thanks to those loans, he said.
"I am constantly in board meetings and constantly talking to founders and board members about whether they should feel shitty about what they've just done," Zimmerman said. "And I kind of think that's unforgivable on the part of Treasury. They could have and should have articulated a better standard."
The controversy is only the latest problem startups have run into with the loan program. When the program was first passed, many startups and venture capitalists were concerned that venture-backed companies would be ineligible because of other SBA rules that seemed to imply that startups would have to count as their employees not just their own workforces but those of other companies owned by their venture backers. However, the agency soon issued guidance that made it clear that startups generally wouldn't have to apply that rule.
Got a tip about a startup or the venture industry? Contact this reporter via email at twolverton@businessinsider.com, message him on Twitter @troywolv, or send him a secure message through Signal at 415.515.5594. You can also contact Business Insider securely via SecureDrop.
SEE ALSO: The $2 trillion stimulus law could leave startups out in the cold. Here's why Silicon Valley is worried.
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