A Look at Small Business Planning During COVID-19

The American College of Financial Services
July 16, 2020

In this time of unprecedented market and societal uncertainty, small business owners across the nation are experiencing stressed balance sheets and hearing bleak financial projections. If you're an advisor working with business owner clients, there's never been a more important time to ensure you're putting forward a financial plan that considers not only the current negative effects of the COVID-19 pandemic, but one with a business plan template that will navigate and withstand the turbulent waters of recovery in a post-COVID world.

One of the key concepts to understand is how the business owners you work with have been supporting their businesses during the pandemic, through public and private lenders alike. Both have their benefits and drawbacks, but the federal government's twin Paycheck Protection Program (PPP) loans and Economic Injury Disaster Loans (EIDLs) are overwhelmingly the resources business owners have turned to in this time of crisis. 

However, both programs come with strings attached, and while they may have saved your clients' small businesses in the short term, it's up to you to ensure they maintain a successful business in the long term. To help, here's an overview of the two programs and the elements advisors should take into account.


Paycheck Protection Program (PPP) Loans


The PPP has been a key federal effort to support small businesses and sustain their employees and owners during the worst of the COVID-19 crisis. The loans, issued by lenders from private banks, are meant for business owners with fewer than 500 employees, as well as some nonprofits, veterans organizations, and different kinds of self-employed and startup workers. While the PPP expired originally at the end of June, Congress extended the program's licensing until August 8 to account for popular need and demand.

Business owners can get PPP loans for up to 2.5 times their average monthly payroll, with a limit of $100,000 yearly per employee and a $10 million overall limit. Small business owners are usually required to prove their need to get and keep one of these loans; however, the Small Business Administration (SBA) has said loans under $2 million are unlikely to be targeted for review. PPP loans have a 1% interest rate, mature after two years, and require no collateral: in turn, lenders are expected to defer fees and repayments for between six months to one year. Finally, PPP loans are okay for use on any kind of business expenses, and many could possibly be forgiven in their entirety.

Sound too good to be true? Well, it might be if advisors and their clients aren't careful.

There are important PPP loan restrictions business owners need to understand going in. First off, only the portion of the loan spent on specifically-designated eligible expenses is forgivable: those include payroll costs, mortgage interest, and rent and utility payments. In addition, only 40% of the proceeds of the loan can be used for non-payroll costs. To have any chance at their loan being forgiven, business owners need to maintain the number of employees on their payroll and their wages, which in troubled economic times can be difficult to do: this includes paying employees at least 75% of their normal salaries during the weeks after the loan is granted. If your client's small business has had to lay off workers or reduce salaries due to COVID-19, an unforgiven PPP loan could be a heavy burden to bear as they're trying to recover.

There's also tax implications to consider. While forgivable PPP loan proceeds won't be subject to taxation, the IRS says expenses paid from those forgiven proceeds are. The rule is meant to prevent claiming tax benefits for already tax-exempt income, but with salary and wage costs no longer tax-deductible like normal, it can be an unpleasant surprise for business owners come tax time. For advisors, it's important to consider whether a PPP loan makes sense for the client's business from a strategic perspective, as well as think about the speed and extent of the economic recovery and how much the business can count on an increase on their future cash flow statements.


Economic Injury Disaster Loans (EIDLs)


While the SBA usually only offers direct loans, or EIDLs, in very specific and narrow circumstances of disaster, the federal CARES Act expanded access to the loans by naming all 50 U.S. states as disaster areas. Because of this, most small businesses now qualify for EIDLs.

However, advisors and clients should once again be careful when considering going to a government lender for an EIDL. Some of the terms are more favorable than PPP loans, including a long-term 30-year timeframe for payback and the possibility for an emergency grant advance of $10,000 (taken from the loan total and does not need repayment provided it's used to fund payroll, mortgages, lease payments, and paid leave). Loans below $25,000 also don't require any collateral, but this is balanced out by a 3.75% interest rate and a capping of loan value at $2 million maximum.

Proceeds from EIDLs can be used for ordinary operating expenses, but they can't be used to replace lost revenue or profits, or for business expansion, putting many more preconditions on what can be done with the money. It's also likely that those applying for an EIDL may get less money than they'd hoped for, as the SBA continues to report it's overwhelmed with applications and processing has been delayed in many cases. SBA lenders also judge the amount of loan relief doled out by its subjective analysis of the economic severity of the injury and the borrower's ability to repay, both of which could be affected by changes in the ongoing crisis. EIDLs have long terms and low interest rates that may make them seem like a dream come true for borrowers, but with the exception of their grant portion, they are not forgivable, meaning if the business runs into trouble, borrowers could be buried under the weight of their repayment debts.


Why Not Use Both?


While there's no rule that state’s small business owners can't apply for both a PPP loan and an EIDL, in many cases the two are like oil and water: they just don't mix as well as you'd hope. PPP loans and EIDLs can't be used to pay the same expenses, and taking both requires the willingness to take on a debt burden potentially double that of one of the loans alone and a careful repayment plan based on all potential outcomes.

However, there are some ways the two can work together. EIDLs can be refinanced using forgivable PPP loans. If a small business owner applies for a PPP loan, having already received and exhausted an EIDL that was used for payroll expenses, the EIDL balance can be carried over into the PPP loan and may be forgiven, providing the criteria are met. This would require, however, that the advisor and client agree on applying for a larger PPP loan and using the additional funding to repay the EIDL. Remember that with larger loan amounts comes more government scrutiny: before getting started with any loans, advisors and clients should try to use their best judgment about how favorable economic conditions are likely to be in the future and how that affects their ability to pay off the loans.


Navigating a Crisis with Confidence


At The American College of Financial Services, our expert faculty and thought leaders are working to bring you the most accurate and up-to-date information on the state of the markets, economy, and loan availability for you to best serve your small business owner clients.

To learn more about PPP loans, EIDLs, and other factors critical to leading clients to business success in a post-COVID world, download our free white paper, “Helping Your Small Business Clients Plan in the COVID-19 Era."