How to really help small business through COVID-19

When the Paycheck Protection Program was conceived, the prevailing expectation was that the economy would be shut down for a few months at most. The PPP’s mission was to avert layoffs by covering small businesses’ payroll costs for that short time, and once the coronavirus was contained, the economy would reopen, employees would return to work and businesses would bounce back.

Had that scenario played out, the PPP would have been largely successful. In reality, it’s a reasonably well-designed bridge over a canyon much wider than its engineers planned for.

The PPP’s challenges include structural and obsolescence issues that have emerged as the COVID-19 economic crisis has progressed. The structural issues have limited the number of borrowers that were able or chose to participate, while the obsolescence issues limit the program’s effectiveness even for PPP loan recipients.

Structural issues:

• Chaos and confusion: Limited guidance at the launch of the program and constantly changing guidance thereafter led many potential borrowers to not apply due to concerns about whether they would be eligible to receive a loan or have it forgiven.
• Unclear and lax eligibility standards: A primary qualifying criterion for the PPP is that borrowers are able to certify that “COVID has created economic uncertainty” for their businesses. The ill-defined “economic uncertainty” standard opened the door for many to use PPP funding as a working capital hedge, even though their revenues have not been significantly diminished. This crowded out borrowers with more urgent needs.
• Use of funds restrictions: The standard that 75 percent of PPP funds be used for payroll expenses (later reduced to 60 percent) made the program impractical for industries with high fixed or inventory costs relative to payroll.

Obsolescence issues:

• Lockdown periods: Economic restrictions have persisted far longer than projected when the PPP was conceived.
• Phased reopenings: Contrary to hopes of an economic snapback, many industries are reopening in stages and are subject to capacity restrictions. In addition, consumer concerns about health and safety continue to depress revenue. These factors have mutated the key issue for which the PPP was designed (covering payroll costs during the shutdown) into a new problem for many businesses: costs will likely exceed revenue for an extended period.
• New costs: Many businesses face increased costs, none of which is offset by the PPP. Examples include renovations to accommodate social distancing, increased cleaning costs, and personal protective equipment purchases.

These factors lead to increasing expectations of further economic damage. According to a recent NFIB report, about one in seven PPP recipients anticipate layoffs after their PPP funds are used. Even more significantly, nearly a quarter of small business owners have considered the need to close permanently. Clearly, something more needs to be done.

A productive path forward

Policymakers recognize these challenges and proposals to address them are gaining steam. In mid-June, a bipartisan group of lawmakers introduced the RESTAURANTS (Real Economic Support That Acknowledges Unique Restaurant Assistance Needed To Survive) Act in both the House and Senate.

Key facts about the RESTAURANTS Act:

• It would provide $120 billion in grants (maximum of $10 million per recipient, based on certification of need) to restaurants and bars through 2020 that would make up the difference between their full-year 2019 revenue and projected 2020 revenue.
• Funds would be administered and disbursed directly by the Treasury Department.
• Grants can be used for a broad list of expense categories, including payroll, rent/mortgage, utilities, maintenance and payments to suppliers. The act appears to contemplate a true-up process, where recipients would be required to partially repay grant amounts if their actual revenue exceeds the projections on which their applications were based.

The act addresses many of the PPP’s limitations. In certain respects, however, it does not go far enough, while in others, it arguably creates new problems while exacerbating some of the same issues plaguing the PPP. Points to consider include:

• Expanding the scope beyond restaurants and bars is necessary to address other industries severely impacted by COVID-19.
• Tying the provisions more closely to operating expenses, with the aim of preserving payroll. Business owners should have incentives to improve operational results, which are missing in the proposed structure that guarantees a given level of revenue. An exit bonus, or “earn-out,” once revenue is restored to a certain level could address this.
• Eliminating a separate provision that requires unused grant funds to be repaid if a recipient goes out of business before year-end. A better model would be a series of periodic payments that could be adjusted over time based on economic conditions and business results.
• Relying on the infrastructure built for the PPP, rather than setting up an entirely new process.

Although well-intentioned and supported by tireless efforts on the part of bankers and the SBA, the PPP faced inherent limitations.

Creative ideas are now emerging for the next round of support for small businesses, but careful consideration of unintended consequences and strategic alternatives is needed to address the continuing crises our small businesses face.

Michael Brauneis is managing director and U.S. financial services industry leader at Protiviti.

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