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Financial Bridges – A Lending Refresher

Financial Bridges – A Lending Refresher_The Main St. Lending Program

Good fortune is what happens when opportunity meets with planning.   Thomas Edison

Running a business always involves uncertainty but the COVID-19 pandemic has raised uncertainty to a completely new level. At the core, a profitable business comes down to the interplay of supply and demand, and companies are suffering on both sides. Demand (both retail and B2B) has deteriorated for most businesses due to lockdowns. Supply chains have been ruptured, and even as some areas start to reopen from lockdowns, the need to increase physical distance between employees is putting new limits on capacity.

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We do not yet know where we are on the path to economic recovery – while the number of COVID-19 cases may have peaked, business uncertainty has not, and no one knows how the economic recovery will play out (V-shaped, U-shaped, W-shaped, “swoosh” or otherwise). So, it is best to plan for almost any scenario. While your company may have been generating consistent, positive cash flow prior to the pandemic with little or no need for external financing, your latest forecasts may show a need for outside funds to push through this unprecedented and unpredictable time.

The good news is, there are ways to access funds with help from the government. If your business received funds under the Paycheck Protection Program (PPP) but that won’t be enough to sustain operations until demand has improved further, or if you decided not to apply for PPP funds but are interested in other types of loans, here is a primer to help you decide the best fit for your business.

The Main St. Lending Program (MSLP)

Goal: To sustain otherwise healthy businesses whose operations have been harmed by the pandemic. The MSLP is not intended to prop up businesses that were shaky prior to Covid-19; therefore, the amount a company can borrow is tied to its 2019 EBITDA. The Program is meant to bridge a gap between the PPP, which intended primarily for businesses with up to l500 employees, and the Fed’s bond-buying program that supports credit markets for large corporations.

Who is Eligible: With a revised $250,000 minimum loan amount (or $10 million for business seeking to upsize existing debt), the MSLP is targeted at companies with revenues of up to $5 billion, and up to 15,000 employees.

Basic Terms: Loans must be repaid over five years (originally four, but recently changed) and can be prepaid without penalty. Principal and interest payments are deferred (unpaid interest is capitalized) for one year for eligible borrowers. The interest rate is usually SOFR + a spread of 250-400 bps (referencing LIBOR is allowed if the lender specifies a replacement for when LIBOR is phased out).

Unlike the PPP, MSLP loans are full recourse to the borrower and cannot be forgiven. While the Federal Reserve is guaranteeing the majority of the risk, lenders that participate in the Program must retain a small portion – that gives them some “skin in the game” which means they are less likely to make loans to wildly risky businesses.

The MSLP offers three options. In all cases, borrowers must be U.S.-based companies with up to 15,000 employees, or 2019 revenues up to $5 billion. The business must have significant operations and a majority of its employees in the U.S., and must make “reasonable efforts to maintain its payroll and retain its employees” during the term of the loan. We summarize the key terms of the three MSLP options below:

 

Minimum Amount

Maximum Amount

Repayment Schedule

% held by the bank

Main Street “New” Loan Facility

$250,000

Lesser of $35 million or 4x 2019 adjusted EBITDA + existing debt + undrawn available credit lines.

Years 1 & 2 – no principal due

Years 3 & 4 – 15% per year

Year 5 – 70%

5%

Main Street “Priority” Loan Facility

$250,000

Lesser of $50 million or 6x 2019 adjusted EBITDA + existing debt + undrawn available credit lines.

Years 1 & 2 – no principal due

Years 3 & 4 – 15%;

Year 5 – 70%

5%

Main Street “Expanded” Loan Facility

$10 million

Lesser of $300 million or

-   35% of outstanding and undrawn debt; or

-   6x 2019 adjusted EBITDA + existing and undrawn available debt

Years 1 & 2 – no principal due

Years 3 & 4 – 15%;

Year 5 – 70%

5%

All MSLPs

●  Interest = LIBOR + 3%; first year’s interest is deferred (capitalized).

●  Loans may be secured or unsecured

●  Certain types of businesses are ineligible, such as not-for-profits, financial firms, passive businesses and others

 

For example, consider XYZ Co., which had an EBITDA of $7.2 million last year. It has a short-term note of $500k and a $1 million undrawn line of credit. How much could XYZ Co. borrow under the “New” loan facility? EBITDA x 4 = $28.8 million, plus $1.5 million in existing and undrawn available debt = $30.3 million. Since that is less than $35 million, that is the maximum the company could borrow. Under the “Priority” loan facility, XYZ Co.’s maximum loan would be $44.7 million, since 6x EBITDA plus the $1.5 million in debt/lines of credit = $43.2 million, which is less than $50 million.

There are certain restrictions on the use of MSLP funds, and some differences between the three facilities in terms of the MSLP loan’s seniority. In general, an MSLP loan cannot be subordinated to any other debt other than mortgage debt. We summarize key covenants and restrictions here:

  • Borrowers cannot repay any principal or interest on any other debt, beyond debt payments that are mandatory and due, until the Main Street loan is repaid in full;
  • Borrowers must not seek to cancel or reduce any committed lines of credit with any lender;
  • Borrowers must follow restrictions in the CARES Act regarding executive compensation, stock repurchases, and dividends for the term of the MSLP loan plus 1 year. Exception: S-corporations and other tax pass-through entities can make distributions to the extent reasonably required to cover owners’ tax obligations arising from the entity’s earnings;
  • Borrowers must have a reasonable basis for believing they can meet their financial obligations for at least the next 90 days and must not expect to file for bankruptcy during that time;

Regarding employee retention, MSLP borrowers should make commercially reasonable efforts to maintain their payroll and retain their employees while the loan is outstanding. The Federal Reserve clarifies that businesses that have already laid-off or furloughed workers as a result of COVID-19 are still eligible to apply for Main Street loans. The Fed has provided term sheets that specify all of the terms and restrictions. For a good summary of the Fed’s term sheets, click here.

As of the date this was written, the Fed had not yet launched the MSLP. Many lenders are assessing how they will deploy the program when it opens; some may only work with existing bank customers.


The EIDL Program, and SBA 7(a) Loans

Businesses that do not need the $500k minimum required by the MSLP, and not-for-profits that are not MSLP-eligible may want to consider the SBA’s Economic Injury Disaster Loan (EIDL) Program. However, due overwhelming demand created a huge backlog, and the SBA is now accepting new applications only from agricultural businesses.

Goal: To help entities suffering substantial economic injury as a result of a declared disaster, whether or not the business sustained physical damage. The Covid-19 pandemic qualifies as a declared disaster nationwide.

Who is eligible: Businesses with 500 or fewer employees; sole proprietors; independent contractors; most private nonprofits.

Basic Terms: When the program was launched, the maximum loan was $2 million, based on the extent of economic injury. The huge number of applicants led the SBA to abruptly drop the cap to $150K. Loans carry an interest rate of 3.75% for businesses and 2.75% for non-profits. Borrowers have up to 30 years to repay the loan, and payments on Coronavirus EIDLs are deferred for one year.

While EIDLs usually require a personal guarantee, this is being waived for loans of up to $200,000, through the end of 2020. Since the EIDL terms appear to be in flux, business owners should clarify the status of a personal guarantee requirement with their lender and weigh this carefully before proceeding. Collateral is not required for EIDLs up to $25,000; above that, a general security interest in business assets will be used for collateral. EIDL borrowers must allow the SBA to review their tax records.

Companies can request an emergency advance of up to $10,000 that can be forgiven if the EIDL application is later denied and the funds are spent on maintaining payroll, paid leave, mortgage or rent, cost increases due to supply chain disruptions, or to cover other expenses that cannot be met due to pandemic-related revenue losses. As of now, this is also limited to agricultural businesses.


EIDL and PPP?

Companies can participate in the PPP and qualify for an EIDL, although the amount of economic injury assessed for the EIDL will be reduced by the amount of a PPP loan.  While Congress appears likely to loosen some of the PPP’s restrictions on the use of funds, EIDLs can be used for many business expenses, including:

  • Working capital to continue business operations
  • Expenditures to address the economic injury suffered
  • Payroll
  • Sick leave for employees unable to work because of COVID-19;
  • Increased supply costs;
  • Rent or mortgage payments;
  • Repaying debt that cannot be otherwise repaid due to revenue losses.

Note that EIDLs cannot be used to refinance debt incurred prior to the disaster, to repair physical damage, or to pay dividends.

SBA 7(a) Loans are another possible source of funds for businesses. These loans are not related to Covid-19 relief and are available for small businesses at any time. A company can borrow up to $5 million, and the SBA guarantees 85% of loans up to $150,000 and 75% for higher amounts. The interest rate is negotiated between the borrower and the lending bank, with a cap set by the SBA.

To protect lenders and the SBA, collateral is required for loans over $25,000. For loans greater than $350,000, collateral is required “to the maximum extent possible” up to the loan amount. If a company’s fixed assets are not sufficient, lenders must take equity in the personal real estate (residential and investment) of the principals as collateral.


Asset-based Lending and Factoring

If PPP, EIDL and/or SBA 7(a) loans are not sufficient, or a business does not qualify for those programs for some reason, another alternative is asset-based lending (ABL). This can make sense for a business with large amounts of inventory, equipment, or accounts receivable that needs funding now to get through a cash flow crisis.

With ABL, the assets are not sold – they serve as collateral. If the business fails to make its loan payments, the lender can take the assets. The process of valuing the collateral is more costly, and ongoing monitoring is more extensive than with traditional loans, so companies tend to use asset-based lending only if they cannot obtain funds from a traditional lender. For businesses in need of cash quickly, who do not have time to go through ABL process, factoring may be a solution. With factoring, also known as invoice or accounts receivable factoring, receivables/invoices are sold, at a small discount, to a factoring company. Since factoring is not lending it is generally easier and faster to obtain.

There are a number of sources of funds to help businesses get back on their feet after the supply and demand “one-two punch” the pandemic has delivered to the global economy. While borrowing money may be counter to a company’s practices under “normal” conditions, it can make sense if it is a bridge that allows a viable business to return to solid ground.

At G-Squared Partners, we have helped many companies to analyze their need for funds and understand their alternatives. We are helping many businesses to work through a variety of financial challenges during this time, and we invite you to contact us today for a free, no-obligation conversation about how we could help your business.

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