Navigating the Paycheck Protection Program (PPP) eligibility and forgiveness has proven to be complicated. Frequently changing and sometimes unclear direction creates challenges even for owners of smaller, single entity companies. These complexities increase exponentially in the context of an M&A transaction and, until recently, no guidance has been provided.
The SBA released a procedural notice on October 2, 2020, “to provide information concerning the required procedures for changes of ownership of an entity that has received Paycheck Protection Program (PPP) funds.” The IRS then issued additional FAQs on November 16 to specifically address employee retention tax credit concerns. Below are the key takeaways.
What Constitutes a Change of Ownership?
There are three situations the SBA has defined as “change of ownership” for a PPP borrower:
- A borrower sells or transfers 20% of the ownership interest (common stock, etc.)
- 50% of a borrower’s assets are sold or transferred
- A borrower is merged with another entity
The notice clarifies that the original PPP borrower is responsible for all obligations, certifications and compliance items associated with their loan regardless of changes in ownership. They must also notify their lender in writing, and the lender must continue to submit the required monthly 1502 reports until the loan is fully satisfied.
Parties in an M&A transaction must be wary of the necessity certification, especially if the loan is over $2 million, and the potential for having to respond to the new Necessity Questionnaire. When borrowers apply for the loan they agree that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” While the certification is based on facts as they exist at the time the application is processed by the SBA, owners who were already considering a potential sale must take the potential resulting liquidity from the transaction into account.
Read “What is a PPP Loan Necessity Questionnaire, and What Do You Need to Do?”
When is SBA Approval Required? Can the Lender Approve a Change in Ownership?
There are certain conditions in which PPP lenders are given authority to approve the change of ownership. If a loan is “fully satisfied,” meaning repaid in full or the process of forgiveness has been completed (and any amount not forgiven is repaid), then there are no further restrictions to close the sale or transfer of ownership. Assuming the loan is not fully satisfied, borrowers must follow certain procedures to continue without SBA approval.
If the sale or transfer is of 50% or less of the ownership interest or the borrower completes a forgiveness application and places the outstanding balance of the loan in an escrow account with the lender, then the lender may approve the transaction. The escrow account must be interest bearing and the funds must first be used to repay any remaining loan balance upon disbursement.
If the transaction is structured as a sale of over 50% of assets, the borrower must complete the forgiveness application and place funds in escrow with the lender. The PPP lender is also required to notify the appropriate SBA Loan Servicing Center within five business days of the completion of the sale, and to include the location and amount of the escrow account.
SBA approval is, however, required if a change of ownership does not meet any of the conditions above. In that case, the lender will submit the request to the appropriate SBA Loan Servicing Center detailing reasons why the loan cannot be fully satisfied, and the funds are not able to be escrowed.
Generally, it would be best to meet the conditions above, if at all possible, as SBA approval for review and determination could take up to 60 days.
Other Procedural Guidelines
Whether SBA approval is required or not, the procedural notice outlined other required practices.
- In the event the PPP borrower merges into another entity, the successor will remain subject to all obligations under the loan.
- If the purchaser of ownership interest in a borrower has a separate PPP loan outstanding, the borrower and new owner are both responsible for segregating funds and expenses and demonstrating compliance for each loan.
- If the successor of a merger also has a PPP loan outstanding, that entity is responsible for segregating funds and expenses and demonstrating compliance for both loans.
- PPP lenders are required to notify the SBA of new owners, ownership percentages and tax identification numbers of owners above 20% along with the escrowed funds information.
Employee Retention Tax Credits
Additional guidance was also released on November 16 in response to hesitation from buyers acquiring a target that had received a PPP loan because of potential disqualification of employee retention tax credits (ERTCs). The CARES Act specifies that business owners cannot claim ERTCs and receive PPP loans. This means that no entities in the aggregated employer group are eligible for an ERTC if any single entity in the group received a PPP loan. The IRS has clarified that targets in an acquisition may be treated differently depending on the status of their PPP loan.
If the target employer received a PPP loan but fully satisfies the loan or applies for forgiveness and establishes an escrow account (as mentioned above) prior to the closing of the transaction, the members of the newly expanded aggregated employer group, including the target employer, will not be treated as having received a PPP loan. If the loan is not fully satisfied and no escrow established, the pre-transaction aggregated employer group (which excludes the newly acquired target) may still be eligible for the ERTCs; however, the acquired target is still treated as holding the loan and therefore is ineligible.
In an asset sale transaction, the acquiring employer will not be treated as holding the PPP loan in respect to the ERTC regardless of whether a loan is assumed in the sale. If it is assumed, however, there are limitations to the qualification of newly acquired target employees’ wages after the transaction in calculating the credit amount.
Further, in both purchases of equity and assets, any pre-transaction ERTCs claimed by the purchasing group will not be subject to recapture due to the target employer PPP loan.
Given the IRS and SBA’s recent guidance, PPP loan recipients involved in an M&A transaction likely should gather loan documentation, begin the forgiveness application process, get in touch with your lender and communicate your plans to your tax advisors. As part of any transactional due diligence, it is essential for buyers to be aware of the benefits a target company and its employees have taken advantage of with regard to the CARES Act and other COVID-19 related guidance, including PPP loans and the status of any intended forgiveness. Parties to M&A transactions should be aware of other related consequences that may arise due to PPP loans, including the impacts to both buyers and targets of the nondeductibility of expenses paid with loan proceeds received by a target.
Read “IRS Issues Additional PPP Guidance on Timing: Expectation of Forgiveness Equals Nondeductible Expenses in 2020”
Contact Adam Hill at firstname.lastname@example.org, Samantha Smudz at email@example.com, Peter Myeroff firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.