COVID-19 has left an impact on the M&A landscape. Before you purchase an organization that has received a PPP loan, consider these strategies to mitigate y...
Key insights
- Require a seller to repay any PPP debt at closing to eliminate pitfalls.
- Delay the closing or make it an asset purchase, but understand the pros and cons to each strategy.
- If you assume the PPP loan, perform appropriate due diligence and set up the appropriate escrows to protect yourself.
- CLA can help you perform any necessary due diligence.
Need help navigating your next M&A deal?
COVID-19 has certainly left its mark on the merger and acquisition (M&A) landscape in 2020. The latest example is the impact of the Payroll Protection Program (PPP) loans authorized under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Mitigate the risk of buying an organization that has received a PPP loan with the following strategies.
Treat it like any other debt
The vast majority of deals are completed on a cash-free, debt-free basis with all debt and debt-like items being paid prior to, or contemporaneously with, the closing. Require a seller to repay the debt at closing to eliminate potential pitfalls, such as:
- Negative publicity — Whether you are a publicly traded strategic buyer or a large private equity fund, you risk media backlash if you receive loan forgiveness — even if you were not the one that requested the loan initially.
- Difficulty to transfer — If you assume the loan, as we will discuss later, you will likely need approval from the SBA and the lender. Lenders have been reluctant to allow the loan to be transferred. This process has some complexity.
Note, however, that a downside to requiring the PPP loan to be paid at closing is that it results in a direct hit to the sale proceeds paid. If one of the other options discussed below is selected, the amount retained by the seller will be greater — without additional money needed from the buyer.
Delay the closing
If practical, delay the closing until the final determination on forgiveness is received so you can mitigate the risk associated with the PPP loan. While it is still possible to receive negative press, it is less likely since the entire transaction occurred prior to your ownership. Also, you would not need to get approval for the assignment, because the loan wouldn’t need to be assigned.
The downside is that you give the seller more time to change their mind or for the business to significantly change during the waiting period. The opportunity cost of not owning the asset is also a risk. If you still choose this approach, consider the possibility of a subsequent eligibility audit and whether or not that responsibility would transfer to you based on the deal structure, and address those possibilities when you draft the indemnification and escrow provisions of the agreement.
Make it an asset purchase
Structure the deal as an asset purchase or reorganize it so that the PPP loan remains with the seller and does not transfer to the buyer. In this option, the obligation to obtain the forgiveness is left with the seller.
The seller would need to consider if they have incurred enough approved expenses to get the maximum forgiveness — as they would not likely have additional expenses after the close — as well as the tax implication of the structure.
Assume the loan and protect yourself
You may find that the options above simply do not work. If you still want to do the deal, perform appropriate due diligence and set up the appropriate escrows to protect yourself.
Work with the PPP lender to see if they allow the transfer of the loan. As mentioned above, lenders have been reluctant to allow the transfer. Start these conversations early in the process if you intend to close the deal prior to the final forgiveness.
Additionally, perform due diligence on the process that the target used to acquire the PPP loan, which includes the certification of eligibility and additional documentation.
Certification of eligibility
Determine whether the organization was eligible to receive the loan at the time of the application. This has been a common theme as we have progressed through this process. Make sure the company was the correct size after taking affiliation rules into account, was in existence for the required timeframe, and was impacted by COVID-19.
Although the certification is only based on the facts that existed at the time of application, understand that you should still consider the impact of the SBA’s “present effect” rule. If you had an agreement in principal prior to the application, such as a letter of intent with certain characteristics, you could inadvertently have the target included as an affiliate of your organization.
Additional documentation
Determine whether the organization maintained all of the necessary documentation to support the application and the subsequent measurements that will govern forgiveness. While the computations were not overly complex, there are some specific criteria that were used to calculate the loan amount.
Confirm that calculations were done correctly and were appropriately supported. Additionally, there are specific expenditures, in nature and timing, that will determine the amount of the loan that is eligible for forgiveness. Verify that the documentation is readily available for all pre-closing periods and that there is a process in place to capture the required documentation following the closing.
Purchase agreement
Finally, draft the purchase agreement to provide the appropriate protections, such as escrow accounts. There are a number of ways to structure the final funds flow, but consider the most common approach:
- Reduce the consideration for any amount of the debt that is likely not to be forgiven based on analysis of the expenditures that have and will be incurred during the forgiveness period.
- Set up an escrow account (to be released to the seller once the final forgiveness is achieved) for the amount likely to be forgiven based on the analysis.
- Create appropriate indemnifications to protect the buyer in the case of a subsequent audit of the PPP loan.
How we can help
COVID-19 has had a tremendous impact on M&A transactions. In addition to the complications added by PPP loans addressed in this article, it has also greatly impacted normalized earnings before interest, taxes, depreciation, and amortization (EBITDA) calculations, working capital considerations, and the financial health of a company’s customer base. Now, more than ever, make sure that you are doing the appropriate due diligence to avoid surprises post close. CLA can help you navigate these tricky waters.