[Note: this article pertains only to the EIDL loans, and NOT the Paycheck Protection Program (PPP), which was also authorized under the CARES Act. It refers specifically to the loan portion, and not the emergency grant that many businesses have received.]
On March 27, 2020, in response to the COVID-19 pandemic, the U.S. Congress passed the CARES Act, which aimed in part to provide substantial economic assistance to businesses impacted by this unprecedented crisis. The US Small Business Administration (SBA) was authorized to expand its Economic Injury Disaster Loan (EIDL) program, with substantial funding provided for immediate distribution to businesses.
Six weeks later, the SBA has processed a deluge of applications, and prospective borrowers are beginning to receive final documentation to sign up for the EIDL loans. Businesses are being approved for loans of various sizes, which appear to be based on the overall size of the business (e.g. total revenue). The loans have a fixed interest rate of 3.75%, repayable over 30 years, with the first payment deferred for 12 months.
Although loan approval is likely to come as a big relief, included in the fine print are a number of requirements that all EIDL borrowers should be aware of. At a minimum, borrowers will want to understand how they are allowed to use the loan proceeds, what kinds of records they are required to keep, the implications for compensation from other sources like insurance or other government aid programs, and collateral and insurance requirements.
Spoiler alert: meticulous record keeping is a must.
Use of Proceeds. The EIDL loan proceeds are to be used “solely as working capital to alleviate economic injury” caused by the COVID disaster. The SBA.gov website defines working capital as “the amount of capital that is available for the day-to-day operations of a business. Working capital is typically used to pay for regular expenses, such as utility bills, employee payroll, rent, inventory, and marketing costs.”
The SBA has also published a list of ineligible uses for EIDL loan proceeds. These include repayment of stockholder/principal loans, expansion of facilities, acquisition of fixed assets, repair of physical damages, refinancing long term debt, paying down other SBA loans, paying down any federal debt except IRS obligations, legal penalties, or relocation.
In addition, the funds cannot be used to pay any dividends or bonuses, or disbursements to owners, partners, officers, directors, or stockholders, except when directly related to performance of services for the benefit of the applicant. This caveat seems to indicate that EIDL funds may be used by small business owners like sole proprietors who compensate themselves for their work by way of owner distributions. This would be consistent with the spirit of the CARES Act, which explicitly indicates that sole proprietors and independent contractors are eligible. Borrowers would be well advised, however, to verify this with the SBA.
Borrowers are also required, “to the extent feasible”, to purchase only American-made equipment and products with the proceeds. Misuse of funds is subject to penalties including repayment in full at 1.5 times the loan value, as well as fines, imprisonment, and civil penalties.
Receipt Retention. Borrowers are required to obtain and itemize receipts (including paid receipts, paid invoices, or cancelled checks) and contracts for all spending of loan funds. These records must be retained for three years after the full loan proceeds are received and must be provided to the SBA whenever the agency requests them.
Books and Records. Borrowers are required to maintain “current and proper books of account in a manner satisfactory to the SBA” for the most recent five years and until three years after the loan is paid off. These include financial and operating statements, insurance policies, tax returns and related filings, records or distributions, dividends, and other compensation to owners. The SBA may audit these records at any time and may require inspection and appraisal of the borrower’s assets. The SBA must be provided financial statements annually, and it can require borrowers to provide an Accountants Review Report prepared by an independent CPA.
Compensation from Other Sources. Eligibility for the loan is limited to losses not compensated by other sources, such as insurance proceeds, grants and loans from other government agencies or private organizations, civil liability claims, or salvage of damaged property. Any such compensation must be handed over to the SBA up to the full amount of the EIDL loan. This provision will be of particular interest to borrowers who took advantage of state and local government programs, as well as programs provided by private companies like Amazon, Facebook, and Verizon.
Collateral. All EIDL loans over $25,000 come with collateral terms. To secure these loans, borrowers must grant the SBA security interest in all company property, including inventory, equipment, loans, letters of credit, healthcare insurance receivables, credit card receivables, deposit accounts, and commercial tort claims. These collateral items may not be sold or transferred (except for normal inventory turnover), nor can they be used as collateral for any superior liens, without SBA approval.
Hazard Insurance. Borrowers who are required to put up collateral must provide proof of an active hazard insurance policy covering at least 80% of its insurable value. Coverage must be maintained throughout the entire term of the loan.
Default Terms. Default under the EIDL program is broadly defined, and includes failure to make an EIDL loan payment, default on other SBA loans, transfer of collateral, withholding material information or lying to the SBA, defaulting on loans from other creditors in a manner that impacts their ability to repay the EIDL, failure to pay taxes, bankruptcy, and change of ownership with SBA’s prior consent, among other provisions.
In conclusion, the EIDL program is a boon to small businesses affected by the pandemic. It is a very inexpensive source of working capital, with a 30-year term that keeps monthly payments low. However, with those benefits come many requirements that must be met thoroughly and consistently. Business owners who receive EIDL loans should ensure they have the right team of professional support lined up to ensure compliance.
Sources: SBA EIDL loan documentation; SBA Disaster Assistance Program Standard Operating Procedure (https://www.sba.gov/sites/default/files/2018-06/SOP%2050%2030%209-FINAL.PDF)