Buying or Selling a Business with PPP or EIDL Loans
Problems with first and second draw Paycheck Protection Program (PPP) loans and Economic Injury Disaster Loans (EIDL) have come up in a number of transactions we’ve closed recently. In some situations, a PPP loan or EIDL has delayed closing or even caused the sale to fall apart.
So, I thought it would be a good idea to answer a few questions that have consistently come up in business transactions concerning these loans.
Do the Seller’s PPP Loans have to be paid or forgiven before the sale closes?
No. According to paragraph 2.b.ii. of the SBA procedural notice issued on October 5, 2020 (No. 5000-20057), if the seller’s PPP1 or PPP2 loan hasn’t been forgiven or paid by the closing, the seller can either:
- Request SBA approval to close the transaction,
- Pay off the loans, or
- Comply with the following process:
attestation depending on the amount each company received),
amount and interest for the period the loan was outstanding plus another six months or so).
It is important to note that PPP loans are unsecured – that is, there is no lien on the assets from these loans (this is different for the EIDL). Therefore, assets can be transferred free and clear despite the existence of the PPP loan.
However, if this process is not followed, then the seller/borrower could be in default of the PPP loans and lose the ability to have the outstanding PPP loans forgiven.
The following are my thoughts based on my experience dealing with PPP Loans and EIDLs in sale transactions:
- The buyer should absolutely have the seller’s PPP and EIDL notes reviewed by legal counsel as part of the buyer’s due diligence review of the seller to confirm the terms of those loans.
- In one of our prior transactions the lender, who was an SBA qualified lender, attempted to contact the SBA to secure approval to close the transaction without the lender controlled escrow in place (the seller’s PPP lender was extremely difficult to deal with) and was unable to get any response. So, I wouldn’t count on getting SBA approval. And, if SBA approval is the desired process, you must request it immediately after the purchase agreement is signed and leave sufficient time for the closing. Of course, there is no guarantee it will be forthcoming, so avoid this if at all possible.
- Some banks are charging the seller to set up the escrow agreement. In one transaction the lender demanded a $3,500 fee. So, get this part of the process started as soon as possible, especially if your PPP lender is a large bank.
- The buyer has to be cautious about closing the transaction where the seller has not followed the SBA mandated process and no post-closing escrow funds are being held that can be used to pay the seller’s PPP loans. The seller’s PPP loans might become the buyer’s problem. My guess is that, should the seller ultimately not repay its PPP loan (in the event it is not forgiven), the SBA might look to the buyer and make claims based on interference with contract or other ‘successor liability’ legal theory.
- The buyer’s lender may require the seller follow the SBA process for the PPP loan as a condition to close even though there isn’t a lien on the assets.
How do PPP loans affect adding a “partner” to a business?
The SBA treats adding one or more partners (co-owners) to a business as a sale if the total equity transferred to new partners since first PPP loan is more than fifty percent (50%).
However, paragraph 2.c. of the SBA procedure provides that “within 5 business days of the completion of the transaction” -without specifying the circumstances of those transactions – the PPP lender must give certain information about new owners to the SBA. In other words, the language is broad enough to require notice in the event of any ownership transfers. So, out of an abundance of caution, you may want to consider providing notice to the lender of any ownership transfers.
Does the Seller’s EIDL have to be paid in full before the sale closes?
Yes. EIDL loans are not forgivable (except for the grant portion of $1,000 per employee up to $10,000). The EIDL note contains a due on sale clause (section 4) that, in addition to other remedies, gives the SBA the right to declare the full amount of the loan due upon a transfer of the borrower.
For each EIDL in excess of $25,000, the borrower has granted the SBA a lien on the borrower’s assets and the SBA has probably filed a UCC-1 to record that lien. Therefore, to transfer the assets to the buyer free and clear from all liens, the EIDL must be paid in full at or before the closing.
To get the EIDL pay off letter, you will have to contact an SBA Disaster Loan Servicing Center. There is one in Birmingham, AL (800-736-6048), and one in El Paso, TX (800-487-6019).
As was the case with the PPP loans, make sure to request the payoff letter early in the process.
What if the Seller’s does not have enough cash to pay the EIDL or to set up the PPP loan escrow?
The EIDL will usually be paid at the closing based on the payoff letter from the SBA from the proceeds the seller is receiving from the sale. If the proceeds are insufficient, the seller will have to negotiate release of the EIDL lien and the due on sale provisions directly with the SBA. Because this can take quite a while, where this is the case the transaction often will not close.
For example, in one transaction the seller had spent the EIDL proceeds without being able to turn the business around and was trying to sell before the operation closed. The EIDL prevented the sale and the seller ultimately had to close the business.
The PPP loan escrow will also usually be set up using the proceeds the seller is receiving from the sale. If the proceeds are insufficient to set up the escrow, the parties can wait for the PPP loans to be forgiven.
What should you do as a seller regarding your EIDL and PPP loans?
First, apply for forgiveness of your PPP loans as soon as possible. This timing will be driven by when you spend the proceeds and your lender’s ability to accept the forgiveness application.
Once the application is filed, be sure to stay on top of the forgiveness process. I’ve seen applications processed and forgiveness granted quickly and other that have taken months. Be the squeaky wheel.
Second, don’t enter a listing agreement with a broker until you know that the listing price will cover all of your business’ debt obligations, including the EIDL. If you list the business for sale and the broker procures a ready, willing, and able buyer that you accept, your inability to pay the business debts won’t release you from having to pay the broker’s commission. Have the broker or your accountant or attorney prepare an estimate of net proceeds you’ll receive for your expected sale price after paying all debts and obligations to be sure the price at which you expect to sell (i.e., not just the listing price) is sufficient.
Third, keep your EIDL proceeds separate from your operating bank account – this will avoid using the proceeds without thinking about it and you’ll be able to keep an eye on the balance.
Finally, be sure to use EIDL proceeds only as permitted by the loan provisions – for working capital and normal operating expenses (rent, employee compensation, utilities, and certain debts). If the business isn’t able to repay the EIDL, you don’t want to complicate things with violation of the terms of the EIDL.
Of course, the above is general information and your situation may be different. Therefore, you should speak with an attorney before taking action on any of the above information. If you have any questions about your situation, please feel free to call me at 407-649-7777.
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