Congress passed the Coronavirus Aid, Relief, and Economic Security Act (also known as the “CARES Act”) in March. It is the single largest economic stimulus package ever in the history of the United States and will add $1.8 trillion to the already colossal federal budget deficit (the difference between revenue in and spending out).
Your federal government is already is massive debt and can’t technically afford new spending, let alone a spree like this. So to pay for the CARES Act the government has to borrow money, thereby incurring debt. In this case, the Federal Reserve will be financing the operation by buying government debt. To do so, it will print more money (which will make all money less valuable, thereby causing inflation, etc.). More on this another time.
In any event, this $2 trillion in Monopoly money is supposedly meant to benefit “Main Street,” the government’s favorite euphemism for “regular people” (i.e., small business owners). The major program geared to that end is the so-called “Paycheck Protection Program” (PPP). We need the PPP, says our esteemed Senate Minority Leader Chuck Schumer, because
The private sector will not provide the aid our nation requires. The efforts of individual states or individual citizens—heroic as they are—will not be enough, and we dare not abandon them in these dark times. The American people need their government. They need their government to act strongly, boldly, and wisely.
I agree that our government should not abandon those it forced to shut their small business. But, as usual, the government’s proposed solution does little to accomplish any of its stated goals. As of May 12, 2020, over 100,000 small businesses have closed forever because of the COVID-hysteria-created shutdowns.
Incurring massive new debt in order to temporarily maintain employee payroll only does harm when it is all but certain that small businesses won’t be unable to establish the same revenue streams in place before the shutdown. Without revenue, businesses will be unable to keep employees on the payroll, pay for overhead, or (dare I say) turn a profit. They’ll also be unable to repay loans.
Strict Requirements of the PPP
Small business owners should think twice before accepting a loan under the PPP. At first glance, the program sounds great because it is a “loan” that need not be repaid if certain requirements are met. The problem will be complying with the requirements.
Here is the basic breakdown (a full summary is available here on the Treasury Department fact sheet):
- Any business with 500 employees or fewer can apply (apparently having 499 employees qualifies you as a “small” business)
- The loan amount is up to 2 months of average “payroll costs” + 25%
- The loan only covers 8 weeks and must be used as follows:
- 75% of the loan must be spent on “payroll costs” defined as:
- Employee salary, wages, and tips (up to $100,000 annualized)
- Employee benefits (health insurance, retirement, sick/family/vacation leave)
- State and local taxes on pay
- 25% of the loan can then be used for:
- Mortgage interest or rent
- Owner compensation replacement (i.e., the business owner can actually get some pay limited to 8 weeks of 2019 net profit)
- 75% of the loan must be spent on “payroll costs” defined as:
The loan money cannot be used for anything else or in different proportions, otherwise it must be paid back in full. Treasury Secretary Steve Mnuchin (who lives on Park Avenue and worked at Goldman Sachs) says so:
This is the way the program was designed by Congress, and we think it has the right intent to get the money to employees. I don’t have the flexibility to change that . . . . [P]eople who say they want to use more money for overhead — they can go out and borrow an EIDL [Economic Injury Disaster Loan] loan.
That’s right, local business owner! If you don’t like it, go get another loan! One you’ll have to pay back in full regardless!
The Problem with PPP
Let’s take an example. For this I will use the business my grandfather owned when I was young, a small manufacturing company just outside Northeast Philadelphia. Unfortunately he is no longer with us, so the figures are only estimated.
The business was incorporated and had 20 employees. Its annual gross revenue was $3 million, or $250,000/month. Payroll costs average $120,000/month and overhead is an additional $80,000 month (mortgage, insurance, maintenance, taxes, etc.). Based on that, the business had a profit margin was $600,000, a 20% profit margin (which is a luxury many other businesses do not have).
In the age of COVID-19, this business would be classified as “non-essential” and largely shut down. His customers’ businesses would be in the same boat. Knowing my grandfather, the last thing he would do is layoff a single employee. But with revenue all but gone, he would need a loan to stay afloat. So he applies for the PPP.
Under the government’s rules, he would qualify for a $300,000 loan to cover 8 weeks. Seventy five percent of that ($225,000) must go to payroll costs, leaving $75,000 to cover two months’ worth of other designated expenses. The problem is clear.
Two months of payroll costs average $240,000. So 80% of the loan would go to payroll, leaving only 20% ($60,000) to cover 8 weeks’ worth of overhead (which averages $80,000 per month). Not only can my grandfather not take a paycheck for the next two months, but he must also either go into his pocket or take out additional loans to cover the difference.
Why not cut payroll or layoff some employees? The PPP rules don’t allow it. If a loan recipient wants loan forgiveness, he or she must:
- Maintain full-time employees at same level as April 1, 2019 to June 30, 2020; and
- Keep wages at least 75% of what they were in the previous quarter.
Even if my grandfather cut payroll by 25% ($90,000/month), that would leave only $120,000 to cover the 8 weeks of overhead, which we already know is insufficient.
Remember, there is also little/no revenue coming in at all during the next two months because the country is still on lockdown. Assuming that lasts even longer than two months, what’s a business owner to do? Take on more debt? And pay it back how?
The PPP Ponzi
Fear not, you may not even have to debate this problem with your spouse or business partners because chances are you won’t get a PPP loan anyway. Why is that? Apparently, the feds took a detour on their way to Main Street.
Check this out, courtesy of CNBC:
According to the CNBC/SurveyMonkey Small Business Survey released [May 4, 2020], which surveyed 2,200 small business owners across America, while the $660 billion PPP was instituted to give them a lifeline through the coronavirus and economic shutdown, only 13% of the 45% who applied for the PPP were approved. Among all respondents, 7% already received financing and 18% are still waiting for a response from a lender.
The math: 990 applications, 128 approvals. Per the same article:
This lack of aid relief has many on Main Street [(!)] hemorrhaging red ink. According to the survey, 31% can operate only a few months or less, 7% less than a month and 6% less than a week under the current economic lockdown conditions.
Karen Kerrigan, CEO of the Small Business & Entrepreneurship Council, says the regulations imposed on borrowers under the PPP has also been a challenge. Among them: the 25/75 rule that says business owners must use 75% of the funds they receive only for payroll, and 25% for rent, mortgage payments, utilities and other operating expenses in order to get loan forgiveness.
‘In many cases this has been a deal breaker. Rent and other operating expenses are high and getting only a quarter of the loan to cover those costs is not enough,’ she explains.
This bold plan doesn’t seem very strong or wise. Can we blame the banks instead of the feds?
According to Rohit Arora, CEO of Biz2Credit, an online lending platform for small business loans, ‘large banks haven’t focused on small business loans given to companies with less than 50 employees. They have deemed it too labor intensive.’
Well why should they? The bank fees are much more lucrative in processing larger loans for larger businesses. Per the Treasury Department, the feds “will pay lenders fees for processing PPP loans in the following amounts:
- 5% for loans of not more than $350,000;
- 3% for loans of more than $350,000 and less than $2,000,000; and
- 1% for loans of at least $2,000,000.
Using the example above, my grandfather’s loan would generate the bank a paltry $15,000 fee, while processing the loan for the Los Angeles Lakers (yes, they got a PPP loan and then returned it when they were roasted in the media) would score a $46,000 fee. By the way, the Lakers generated $434 million in revenue last year and are worth $4.4 billion.
What bank would want to do all of that paperwork for a true small business, you know, one with less than 50 employees, when it could process for professional sports teams and publicly traded companies?
Move along, grandpop. Can’t you see there’s a pandemic going on?
According to the Wall Street Journal, approximately 47% of the loan dollars approved were for loans of $1 million or more. To extrapolate: About half the loans go to companies with monthly payroll costs of $400,000, more than 3 times that of my grandfather’s business.
So it should come as no surprise that banks stand to make billions from the PPP, as unemployment continues to rise and people struggle to pay their rent. At least one business sector is generating revenue.
What Should We Do?
I won’t advise anyone to turn down PPP funding if they have no alternative or if their overhead is low. But many businesses are in for slow and long recoveries. If your business was already in debt before the shutdown, incurring more potential debt is far from ideal. It almost always leads to disaster, and PPP money cannot be used to pay off most pre-existing debt.
My advice would be to carefully consider the alternatives while planning for a future that’s no so bright. Many lower wage employees will make their full wage (or more) under increased unemployment benefits, so laying someone off isn’t necessarily a death knell. Also, businesses that forego loans can get a tax credit equal to 50% of wages for every employee up to $100,000 in base compensation.
As far as future planning, consider making payroll cost cuts permanent and streamlining your business. Any employee who is not working to their maximum capacity is probably not essential.
Learn about and use technology so you can handle your marketing instead of outsourcing that to a firm.
Reduce the size of your physical space and rely more on cloud computing and video conferencing. For what you pay the bank to live in your home, you should be able to double its use as an office.
The government never truly has the wellbeing of “Main Street” as its sole concern because it knows it doesn’t have to. Perhaps one day we can change that. For now, be careful about the strict rules surrounding these “too good to be true” government loans. Because should you take a loan and fail to comply with the rules, there will be no forgiveness. And you do not want the federal government as a creditor.