While the CARES Act and its Paycheck Protection Program (PPP) helped many independent businesses struggling under the COVID-19 pandemic, restrictions on the types of companies eligible for relief prevented private equity (PE) portfolio companies from accessing much-needed capital. The new Main Street Lending Program (MSLP) removed many of those restrictions, but capital access for PE portfolio companies is still a challenge.
How PPP’s affiliation rule restricted PE portfolio companies from loans
COVID-19 slammed the brakes on the global economy in March 2020, which resulted in a huge leap in America’s unemployment rate. That rate went from 3.6% in January 2020 to a spike of 14.7% in April, and a slight easing to 13.3% in May.
To combat this unprecedented brick wall blocking economic growth, the U.S. government provided $2 trillion in relief through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, so businesses with less than 500 employees could keep their doors open, continue to pay employee salaries, and stave off even more layoffs and bankruptcies.
However, as executives at New York-based PE firm Lincolnshire Management noted, “the PPP had affiliation rules that essentially grouped employees from a private equity provider’s portfolio companies under one umbrella, causing their collective headcount to cross 500 in many cases, thereby making them ineligible for PPP loans.”
$600 billion Main Street Lending Program may provide some relief
On April 9, a few weeks after CARES was signed into law, the Federal Reserve unveiled the Main Street Lending Program (MSLP) to “support lending to small and medium-sized businesses”.
Under the MSLP, the Federal Reserve plans to purchase up to $600 billion in loans from lender banks and financial institutions, thereby giving them additional liquidity to make more loans. This funding window opened on June 15, 2020, and runs through September 30, 2020.
In its original version, the MSLP offered four-year loans to companies with revenues of less than $2.5 billion or no more than 10,000 employees. Consequently, companies with more than $2.5 billion but fewer than 10,000 employees would still be eligible for MSLP loans. Borrowers also got relief through deferrals in principal and interest payments for the first year.
TJ Maloney, CEO of Lincolnshire Management, said there are more adjustments to be made.
“This easing from PPP’s 500 employee limit to MSLP’s 10,000 employee limit did provide some relief to small and medium enterprises that have previously received private equity investments, but more needs to be done.”
Under the original MSLP, the Federal Reserve required that companies applying for loans “commit to make reasonable efforts to maintain payroll and retain workers. Borrowers must also follow compensation, stock repurchase, and dividend restrictions that apply to direct loan programs under the CARES Act. Firms that have taken advantage of the PPP may also take out Main Street loans.”
While most of Lincolnshire’s portfolio companies were conservatively managed and not over-leveraged, to be prudent the company dedicated a two-person team to look into PPP and MSLP borrowing options.
Even with new MSLP rules, challenges remain
Lincolnshire Management noted that while the original MSLP provided welcome relief, it wasn’t all smooth sailing. In response to the MSLP’s shortcomings, on April 16, 2020, the Association for Corporate Growth (ACG) compiled a list of recommendations for improvement and requested clarification on technical ambiguities that made loan applications confusing.
Another issue with the MSLP is that it is open to the 1.6 million businesses that applied for loans under the PPP. This has created a rush for money as businesses, including PPP recipients, desperately try and get their hands on all the money they can. This has overwhelmed banks, and will likely influence how they prioritize new loan applications.
For instance, banks will find it easier and quicker to give loans to long-term customers and companies they had already vetted during the PPP process. Consequently, new loan applicants, especially firms with no prior banking relationship with MSLP-approved lenders, could have their loan applications pushed to the bottom of the stack.
Out of an abundance of caution, banks may also increase due diligence guidelines, which will significantly burden private equity-backed mid-market companies, such as those in Lincolnshire Management’s portfolio, that are new loan applicants.
Fed revises MSLP to further ease restrictions on lending
After public comment and input on the original MSLP, and seeing the sharp jump in unemployment and business distress, the Federal Reserve further eased restrictions on MSLP loans on June 8, 2020. The new rules:
- Increased the term from 4 years to 5 years
- Reduced the minimum MSLP loan amount from $500,000 to $250,000
- Increased the maximum loan size for new loans, priority loans and expanded loans
- Held interest payment deferrals to one year
- Extended principal payback deferral by another year (from 33.33% payable in years 2, 3
and 4 to 0% payable in years 1 and 2, 15% payable in years 3 and 4, and 70% principal
balance payable in year 5)
- Held the interest rate at LIBOR + 3% irrespective of company-specific risk.
Lincolnshire Management’s Maloney welcomed the Fed’s stepping in to provide real relief to all of America’s small and medium employers.
“In particular, I appreciate that the Fed favorably expanded the types of companies that can apply for loans,” Maloney said. “The revised MSLP guidelines also give borrowers greater relief on principal repayment, which will vitally help businesses conserve cash and increase their chances of successfully bouncing back from the Covid-19 crisis.”