Startups Decide It’s Easier to Skip PPP Money Than Decipher Rules

(Bloomberg) -- A U.S. government loan program designed for small businesses was initially welcomed as “free money” by many startups in Silicon Valley. Now, with a Monday deadline for recipients to decide whether to keep their loans, and confusion surrounding who should apply, many tech companies are deciding that the cash isn’t worth the trouble.

“We’ve gone through the five stages of grief,” said Bilal Zuberi of Lux Capital, who said that several of the companies he has invested in seriously considered tapping the loans, part of the Small Business Administration’s Payment Protection Program, which can be forgiven if companies use the money to pay employees. But each time the startups thought they had overcome a legal or technical obstacle to be part of the program, another emerged, he said. Now, out of five of his portfolio companies that likely qualify, Zuberi says there’s just one that might take the money.

There’s a growing divide over the loan program in Silicon Valley, where small companies have already laid off tens of thousands of workers. To stay afloat, some startups are moving ahead with the loans, despite a lack of clarity around the rules, and the potential for steep penalties if a recipient is found not to have met all the obligations. Other companies are simply forgoing the money to avoid potential legal and reputational damage. 

By taking a loan, “you are necessarily reducing funds available for other companies,” said Devon Tivona, chief executive officer of corporate travel startup Pana. “The public is judging some companies as worthy or unworthy of the funds.” He decided not to apply.

For the startups that do decide to make a bid for a PPP loan, the process can be arduous. The first step for many is finding out if they could be counted as an “affiliate” of one of their venture backers, which would disqualify them from the program. Shedding that affiliate designation means getting rid of provisions in financing documents that allow a venture backer to veto decisions such as hiring key executive staff or major expenditures.

Dismantling such provisions is tricky but possible. Mark Leahy, co-chairman of the startup and venture capital practice at law firm Fenwick & West, says he has worked on changing control provisions for two startups that wanted to apply for the loans—although one decided not to proceed. Although it’s complex, the process can be done in about 24 hours if necessary, Leahy said.

“No lawyer wants to be the reason the company doesn’t get money,” he added.

Because the rules are so intricate, some startups said it took days to parse through them. That was the case when they were originally issued, and again with each update provided by the government.

One particularly important update came last week. Venture capitalist Chris Fralic had scheduled a noon board meeting on Wednesday with a portfolio company to discuss whether it should accept a loan. Then, 10 minutes before the call, the Treasury Department released new guidance. “Three things you’ll never forget where you were,” the First Round Capital VC on joked the Twitter. “OJ verdict. 9/11. PPP clarification to question 46.”

The clarification reiterated that the government would conduct heightened scrutiny of loans over $2 million, but would presume that loans under that amount automatically satisfied the requirement of being “necessary” for the borrowers. The update was good news for startups receiving smaller checks. However, the Department of Justice could still investigate companies who took less than $2 million, Leahy said. 

The program’s labyrinthine rules were daunting for many startups. “The resources we had to deploy as a small business just to understand the benefits was so challenging,” said Senreve Chief Executive Officer Coral Chung, whose business makes luxury handbags and was growing quickly until the pandemic struck. She found herself poring over the details of the loans while also scaling back a product launch, rescinding a job offer, cutting her own salary, renegotiating rent with Senreve’s landlord and boarding up the company’s storefront. In part because the business was in a strong position going into the crisis, and in part because of advice from VCs backing the company, she ended up deciding not to apply, she said.

“Venture-backed startups are going to be scrutinized after the fact,” said Nick Sturiale of Ignition Partners, who thinks the loans can only buy about two months of extra time for most companies. “Unless the company is facing imminent death, and this keeps death away from the doorstep, the cost is way too high for the runway extension.”

But for some startups in the most affected sectors—like travel and restaurant services—the loans are a matter of survival.

Take Foodsby Inc., a Minneapolis-based marketplace for office lunches backed by Greycroft and others. Business plummeted 90% in late March due to the novel coronavirus. Before the stimulus package was enacted, Foodsby CEO Ben Cattoor cut two-thirds of his staff. He still envisions a bright future for the company, as people return to work and more businesses order individually boxed lunches. It’s safer, he says, than asking employees go out or having staff serve themselves from open containers with shared serving utensils. But to enjoy those more prosperous days when workers get back to offices, Foodsby has to make it until then.

“We took it. We intend to keep it,” Cattoor says about his PPP loan, which was more than $2 million. But the CEO says he’ll also likely have to pay it back. Unlike many startups whose loans will be forgiven, the bulk of his won’t be, he said, in part because he was forced to do layoffs before applying.

Some investors and startups say they want to avoid PPP loans because of a perception they are intended for businesses like dry cleaners and family-run restaurants, rather than companies backed by venture capital. Others argue that if the point of the program is to preserve employment and help small businesses overall, venture-backed companies should be eligible.

One startup that studied the program and decided not to apply is Textio Inc., a Seattle-based startup that helps companies write more clearly and weed out bias. “We concluded that the program was not meant for venture-backed startups,” said CEO Kieran Snyder. She said the company reached the decision that PPP’s intended recipients were “true small businesses,” like local restaurants. 

All Turtles, a San Francisco-based app development studio with 32 employees in the U.S., received an $830,000 loan from the program last month, and is keeping the money. “I’m using it for its intended purposes, which is keeping people employed. Otherwise, we would have had a harder time doing it,” said founder Phil Libin. “We’re counting on startups to produce a lot of the innovation that’s going to get us past the crisis, so it would be bad for the world for startups to be excluded from public assistance.” Libin, a former VC, said he hasn't taken a paycheck in about a year and that his investors were supportive of the decision to keep the money to help avoid layoffs.

“A startup job is still a job,” said Garry Tan, managing partner at Initialized Capital, which has invested in several startups currently weighing the PPP question. His advice: “Pause and take a moment. Is it life or death for the startup? Be thoughtful about it.”

Companies have until June 30 to apply for a PPP loan. One of Tan’s startups, accounting service Plate IQ, relies heavily on restaurants for business and is now processing one-third the number of invoices it handled before the pandemic hit. Plate IQ had its loan paperwork completed and ready to go, said CEO Bhavuk Kaul. As of last week, he was still deciding whether to submit it.

©2020 Bloomberg L.P.

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