Congress will probably soon allow some borrowers to obtain a second PPP loan. Accordingly, I wanted to provide small business owners who need that help with additional detailed information above and beyond what’s available in most news reports.
This long blog post comes from the chapter in my “Maximizing PPP Loan Forgiveness” e-book that explains how PPP second draw loans work.
Note: If you bought a copy of that e-book because you’re an accountant or banker helping clients, we will send you an updated copy as soon as the final “Continuing Small Business Recovery and Paycheck Protection Program Act” legislation passes.
But for every else—folks who may need to move quickly to get in line for a second loan—I wanted to provide a detailed description of how these loans work.
A warning before we start… the PPP second draw loan rules are complicated and tricky…
Who is Eligible for PPP Second Draw Loan
A first thing to know: Only a subset of PPP first round borrowers qualify for a second draw loan.
First, for example, a second-draw-loan borrower generally needs to fall beneath specified size thresholds:
- 300 or fewer employees
- Less than the revenue threshold specified in section 121.201 of Title 13, Code of Federal Regulations (sometimes as low as $1,000,000 but often quite a bit more) or a size that falls under the alternative size standard established under Section 632(a)(5), which is a tangible net worth of the applicant of not more than $15,000,000 or average net income for federal tax purposes of not more than $5,000,000 excluding carry-over losses.
- private and not public.
Second, a firm needs to not fall into a typically ineligible-for-an-SBA-loan category from the lengthy bulleted list that appears here. But this note: If your firm falls into one of the “typically ineligible” categories but the PPP laws or rules have already allowed you to get a first PPP loan, you may be eligible for a second draw loan.
And then a handful of other excluded firm categories exist, too:
- An entity organized for research or for engaging in advocacy in areas such as public policy or political strategy or that otherwise describes itself as a think tank in any public documents;
- An entity that received a PPP loan already and which uses a North American Industry Classification System code that beginning with 52, the prefix for finance and insurance sector;
- Any business concern or entity primarily engaged in political or lobbying activities;
- Any entities affiliated with entities in the People’s Republic of China, the Special Administrative Region of Hong Kong, or that retains as a member of the board of directors a person who is a resident of the People’s Republic of China.
This idea: If you have an attorney, accountant or banker you work with, get their help to determine if you qualify for a second draw loan. And maybe do that ASAP since probably this second wave of borrowing will burn through the remaining PPP money fast.
Note: To provide second draw loans, the SBA will use the leftover money from the original PPP loans and then an additional $90 billion. But that will go really fast, I’m betting.
Qualifying for a Second Draw Loan
A borrower that’s small enough and then not otherwise ineligible due to its operating activities or connections to China must meet another requirement. Its revenues must have dramatically declined.
The simplest situation occurs when a firm’s gross receipts during the first or second quarter of 2020 fall to 50 percent or less than the same quarter’s gross receipts during 2019. I’m going to use some examples from our e-book to provide concrete details…
Example 1. Martha runs a preschool. In 2019, the preschool generated $100,000 in gross receipts both in quarter 1 and in quarter 2. Gross receipts fell due to the COVID-19 pandemic in 2020, however. In quarter 1, revenues equaled $50,000, for example. And then in quarter 2, revenues equaled $25,000. Martha can qualify for a second draw loan based on the drop in revenue in quarter 1 of 2020. That drop equals 50 percent. And she needs a drop at least that large. Martha can also qualify for a second draw loan based on the drop in revenue in quarter 2 of 2020. That drop in revenue equals 75 percent.
If an entity operated in neither the first or second quarters in 2019 but did operate during the third and fourth quarter, the entity qualifies for a second draw loan if gross receipts for the first or second quarter of 2020 fall to less than 50 percent of the gross receipts for the third or fourth quarter of 2019.
Example 2. Martha’s friend, Abigail, started a preschool in the fall of 2019 based, frankly, on the success she saw Martha enjoying. The timing could not have been worst. The third quarter revenue was slow due to the start-up—roughly $25,000. The fourth quarter, enrollment exploded and she recorded $100,000 of gross receipts. In 2020, however, she recorded receipts of $50,000 for the first quarter and $25,000 for the second quarter. Abigail qualifies for a second draw loan based on the 75 percent reduction in revenues that shows up when comparing the second quarter of 2020 to the fourth quarter of 2019.
The second draw loan statute provides a similar grace to someone who started a business in the fourth quarter of 2019. If an entity didn’t operate the first, second or third quarter of 2019 but did operate the fourth quarter and if gross receipts in the first or second quarter of 2020 fall to less than 50 percent of the fourth quarter of 2019, the firm qualifies for a second draw loan.
Example 3. Abigail’s daughter-in-law Louisa starts a preschool during the fourth quarter of 2019 and booked $40,000 of gross receipts for that quarter. For the first quarter of 2020, she booked $20,000 of gross receipts which isn’t enough of a drop to get her a second draw loan. For the second quarter, however, she booked $10,000 of gross receipts. The drop in revenue from the fourth quarter of 2019 to the second quarter of 2020—the $40,000 to $10,000 drop equals 75 percent—allows Louisa to qualify for a second draw loan.
Finally, if an entity began operations only in 2020 but was in operation on February 15, 2020 and gross receipts for the second quarter of 2020 fall to less than 50 percent of the gross receipts for the first quarter of 2020, the entity qualifies.
Accounting Method for Gross Receipts
One unanswered question left by the statute: How a borrower does the accounting used to determine gross receipts.
A quick first guess might be that a borrower simply uses the same accounting method as it does for its tax returns. So, either tax accrual basis or tax cash basis accounting.
One other factor to consider, however, is the borrower-friendly way the SBA has arranged the PPP loan terms. Given that for purposes of determining forgivable payroll and nonpayroll costs the SBA allows a borrower to use both cash basis and accrual basis accounting, a borrower may find the SBA allows them to use any reasonable accounting method that shows the required reductions in gross receipts.
This technical detail, then, bears close monitoring by accountants, attorneys and bankers.
PPP Second Draw Loan Amount Formulas
The second draw loan statutes provide three different loan amount formulas, each appropriate for a specific category of borrower. The formulas resemble the original PPP loan amount formula, and so will seem familiar to borrowers and their professional advisors. But subtle differences exist.
Default $2,000,000 Second Draw Loans
The default, most common second draw loan formula works nearly identical to most borrowers’ original PPP loans. That formula says a second draw loan equals the lesser of 2.5 times the average monthly payroll during the 1-year period before the date on which the loan is made.
Again, this language is nearly identical to the original PPP loan amount formula. The only difference? The second draw loan formula limits the loan amount to no more than $2,000,000. Presumably, the SBA will simplify and standardize the second draw loan formula, so it looks at the 2019 average payroll costs, just like it did for the original PPP loan formula.
Example 4. Dolley operates a women clothing store and qualifies for a second draw loan based on the $10,000 a month of payroll costs she paid or incurred 2019. The second draw loan amount equals $25,000. That amount matches her original PPP loan amount, which also equaled $25,000 and was also calculated as 2.5 times the $10,000 average monthly payroll in 2019.
Note: The original and still current PPP loan amount formula limits the loan amount to no more than $10,000,000. Note, however, that this $10,000,000 limit will be reduced as part of the Continuing Small Business Recovery and Paycheck Protection Program Act should it become law in it current form.
Seasonal Employer $1,000,000 Second Draw Loans
The second draw loan formula works differently for a seasonal employer.
For a seasonal employer, the second draw loan formula first calculates the average monthly payroll paid or incurred for a 12-week period (quoting the statute) beginning on February 15, 2019 or March 1, 2019, and ending June 30, 2019, or for a consecutive 12-week period between May 1, 2019 and September 15, 2019.
The formula then multiplies this average monthly amount for this 12-week period by 2.5, compares this product to $1,000,000, and sets the second draw loan amount to the lesser of the product or $1,000,000.
Example 5. James and Elizabeth own a wildly popular bar and restaurant in a seasonal tourist destination. They qualify as a seasonal employer and averaged $500,000 in monthly payroll costs over the 12-week period the seasonal employer second draw loan formula looks at. Their second draw loan amount however equals $1,000,000. Though 2.5 times $500,000 equals $1,250,000, the formula limits their loan to no more than $1,000,000.
New Employer $2,000,000 Second Draw Loans
The second draw loan program provides a special formula for new entities.
The statute defines a new entity as an entity that did not exist in the 1-year period before February 15, 2020. And for these folks, the formula calculates the average monthly payroll costs for the months in 2020 the entity operated, multiplies that average monthly amount by 2.5 to get a tentative loan amount, but the limits the loan to no more than $2,000,000.
Example 6. Stockly Donelson, a new law firm, started operations on March 1, 2020 and averaged $20,000 a month in payroll over the six months before it applied for a second draw loan. It qualifies for a second draw loan equal to $50,000.
Aggregate PPP Loan Limits
The second draw loan rules limit aggregate borrowing by an entity and its affiliates in three ways.
First, the rules say that a borrower receiving multiple second draw loans because it operates multiple locations (like a restaurant chain or a motel operator) can receive no more than $2,000,000 in total.
Second, the rules say that borrowers who have received a PPP loan may not receive another SBA loan that pushes their aggregate borrowing over $10 million.
Third, the rules say that within any 90-day interval or time, a borrower and its affiliates may not receive more than $10,000,000 of guaranteed loans.
Public Disclosures of Second Draw Loans
Probably a borrower won’t know whether the SBA will disclose borrowers receiving second-draw loans when applying. But borrowers and their professional advisors want to consider this wrinkle.
Publicly alerting competitors, employees, supplies and other stakeholders that a firm’s revenues have declined by 50 percent or more may cause significant damage in some situations. And the SBA’s current approach is to provide significant information about borrowers who take PPP loans larger than $150,000.
Second Draw Loan Forgiveness
Second draw loan forgiveness works like first draw loan forgiveness. A borrower potentially receives forgiveness equal to the sum of its payroll costs, mortgage interest, rent, utility payments, operations expenditures, property damage costs, supplier costs, and worker protection expenditures incurred before January 1, 2021.
Note: The “Continuing Small Business Recovery and Paycheck Protection Program Act” adds four new categories of forgivable spending: operations costs, property damage, supplier costs and worker protection expenditures.
As with first draw loans, at least 60 percent of the forgiveness must stem from spending on payroll costs.
Example 7. Stockly Donelson, the law firm mentioned in the preceding example, received a $50,000 original-version PPP loan and then a $50,000 PPP second draw loan. The firm may receive forgiveness for both loans. To receive full forgiveness, and assuming it will use the 24-week covered period, it needs to spend at least $60,000 on payroll and related costs and any remaining PPP loan money on mortgage interest, rent, utilities, operations expenditures, property damage costs, supplier costs, and worker protection expenditures.
Smallest Firms Targeted with Second Draw Loans
Understandably, perhaps, the statutory language that creates the second draw loan also tweaks the lending process to level the playing field for small borrowers and lenders.
The new loan sets aside $25 billion in funding for entities employing 10 or fewer employees, for example.
Also, it sets aside $10 billion in funding to be made by community financial institutions; insured depository institutions with consolidated assets of less than $10 billion; credit unions with consolidated assets of less than $10 billion; and farm credit system institutions with assets of less than $10 billion.
Finally, it directs the SBA to prioritize under-served communities and issue guidance addressing barriers to access to capital for under-served communities.
If a borrower does get another PPP loan, probably it makes sense to look at this blog post: How You Should Have Done Your PPP Loan. In retrospect, many borrowers should have handled their original PPP loans differently.
The proposed bill from Senator Rubio appears here: Continuing Small Business Recovery and Paycheck Protection Program Act.