Consistent with the FAQs and the Interim Final Rule released by the Small Business Administration (SBA) with respect to the PPP, private equity firms themselves are ineligible for Main Street loans, and loans to their portfolio companies would be subject to the same type of affiliation rules that are used for the SBA’s PPP program, albeit with higher employee numbers (15,000 employees instead of the 500 for PPP loans), and that may make such loans inaccessible for many middle-market portfolio companies. Even for companies able to access the loans, the formula for calculating loan size based on 2019 EBITDA1 – and for secured loans requiring senior status and 200% collateral coverage – might make the size of the loan available unhelpfully small, especially after taking into account the accompanying business and operational restrictions. Restrictions of particular note are: (1) executive compensation caps2, (2) employee retention requirements3, (3) prohibitions on paying down prior debt4, and (4) restrictions on dividends, capital distributions and stock buybacks5.
Although not yet operational, we fully expect the Main Street program to have continual changes and updates similar to those that left many PPP recipients afraid to use PPP loan proceeds. Given the uncertainty, sizing and business restrictions, we would encourage companies and financial sponsors to consider their options, including private sector liquidity solutions.
In the early part of the cycle, private equity funds and their portfolio companies were focused on existing lenders and discussions around easing covenants, drawing on revolvers and incremental availability. In more recent weeks, we have seen a number of new creative liquidity solutions, including the use of new fund level leverage and opportunistic NAV facilities, asset transfers to unrestricted subsidiaries, specific asset class financings (including those focused on the value of intellectual property, inventory and unencumbered real estate), asset sales/M&A and infusions of preferred equity. We expect these trends to become more commonplace, but in order to get sponsors and their portfolio companies ready both for Main Street and private solutions, we would encourage businesses to consider the following questions:
- We are seeing many of the U.S. airlines taking a “wait and see” approach before taking government money and we expect that many other industries, including fitness, restaurants, hotels and retail, may do the same. As such, businesses should be thinking about the reason for capital; that is, is this a short-term liquidity issue or will the business be very different post-COVID? What are the costs in the near term with restarting the business? How will cash will be needed for the next 24 to 36 months? How much cash is on the balance sheet currently or is reasonably expected to be generated from operations in the relevant periods? Will that cash be sufficient to cover operations and service debt?
- If the business decides to apply for a Main Street loan, what is the maximum amount of money that would be available? Is it enough? If accepting the money limits the type of financings that will be available going forward, is the loan for enough money to allow the company to execute on its business plans?
- Does the company have existing debt? What consents would be needed from existing lenders to permit senior secured debt like the Main Street loan? From whom will the company need consents, how much time will they take, and how much will the consents/amendments cost? If the company elects to pursue a consent, should the business ask for other consents at the same time (for example, a maturity date extension, grace on interest payments or relief on financial covenants)?
- The Main Street FAQs provide for extensive quarterly and annual reporting, including unadjusted EBITDA, adjusted EBITDA and detailed collateral value reporting broken out by asset class, which goes well beyond what is required for typical middle market cash flow loans. A company considering applying for a Main Street loan should consider if it is able to provide the required information and if not, what would be required to prepare and provide such reporting (including estimates of the additional time, costs and labor involved).
- Accepting a Main Street loan requires the business to cap executive compensation, as detailed in Footnote #2 above. Although the cap on outflows might be acceptable immediately, the company should consider how a salary cap might hinder its business going forward: Will the company be able hire the right management team to turn around the business; and will the cap hinder its ability to attract top-tier talent in the future?
- How expensive is the funding versus other options, and will the financing create a longer-term price drag when the business (or any part thereof) is sold? What are the other options? How dilutive is the raise to existing holders?
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- For two of the Main Street programs (MSELF and MSPLF), the maximum amount of a Main Street loan is limited to an amount that, when added to the borrower’s existing outstanding and undrawn available debt, does not exceed six times the Eligible Borrower’s adjusted 2019 EBITDA. For the MSNLF, the maximum amount of a Main Street loan is limited to an amount that, when added to the Eligible Borrower’s existing outstanding and undrawn available debt, does not exceed four times the Eligible Borrower’s adjusted 2019 EBITDA. See Main Street Lending Program Frequently Asked Questions, dated April 30, 2020 (FAQ G.2).
- Depending on the borrower’s compensation structure, the limitations on compensation pursuant to Section 4004 of the CARES Act may present an issue. These limitations include: Officers and employees whose total compensation exceeded $425,000 in 2019 may not receive: (i) compensation that exceeds the total compensation received in 2019 (during any 12 consecutive months); or (ii) severance pay or other termination benefits that exceed twice the total compensation received in 2019. Officers and employees whose total compensation exceeded $3 million in 2019 may not receive total compensation over $3 million plus 50 percent of the excess over $3 million of total compensation received in 2019.
- While there is no explicit numerical employee retention requirement, the borrower must attest that it is making “commercially reasonable efforts to retain employees” and that it is making “good-faith efforts to maintain payroll.”
- Under the MSNLF and the MSELF, the borrower must certify that it will refrain from repaying the principal balance of, or paying any interest on any debt until the Main Street loan is repaid (unless such payment is mandatory and due). Under the MSPLF, the same certification is required, with the caveat that at the time of the origination of the Main Street loan, the borrower may refinance its existing debt, if owed to a lender that is not the Main Street lender. Under all three Main Street programs, the borrower is required to certify that it will not seek to cancel or reduce any of its committed lines of credit with any lender.
- These restrictions will apply to a company for a year after the Main Street loan is repaid. As such, these restrictions may impact the sale price a buyer is willing pay for a private equity portfolio company that is subject to these restrictions.
Client Alert 2020-359
