Bradley Partner Frederic Smith Quoted in BBJ on How PPP Loans Are Affecting M&A Deals

Bradley attorney Frederic Smith was quoted in the Birmingham Business Journal on why the Small Business Administration's Paycheck Protection Program (PPP) loans are causing issues in M&A activity. 

Smith said PPP loans are already affecting M&A by delaying or even ending deals.

He explained one issue businesses have been experiencing during transactions is addressing change of control, which requires consent from the SBA and the lender when an acquirer purchases a company that took out a PPP loan. 

“Lenders have very little guidance from the SBA on how to handle a borrower’s request for a consent to a change of control, and it can trigger a default under the PPP loan if the borrower doesn’t obtain consent from the lender before the transaction closes,” he said. “Trying to go through that process while you’re working on a closing and getting it done on a tight timeframe is very difficult and can cause delays in getting transactions closed.”

Another issue, Smith noted, is some buyers are concerned about potential unknown liabilities and future government enforcement actions surrounding a target company that obtained a PPP loan and how they obtained it – properly or maybe improperly but in good faith — as guidance from the SBA was slow to materialize. 

“Some buyers view the PPP loan more as a liability than as an asset,” Smith said. “Some buyers are simply taking the position that they will not close an acquisition unless the target company repays the loan as a condition of closing.”

While it may add some complications to a transaction, Smith said there are ways for parties to close a deal without waiting until a PPP loan is forgiven or paid off.

He said some parties are negotiating how to allocate the risk between the buyer and seller with purchase price adjustments, escrows or holdbacks. 

Smith said parties also need to be aware that a company that received a PPP loan is not entitled to claim the employee retention tax credit, which is a separate payroll tax credit for employers that experience significant disruptions in their business due to the pandemic.

He said if a company is planning to claim that potentially very valuable tax credit and it acquires a company that obtained a PPP loan, the company may become ineligible for that claim, which could be a significant loss in value for the buyer. He said the same issue exists on the flip side.

Under current law, another tax issue that could be a pitfall in M&A deals is payroll deductions. Smith said expenses paid with a PPP loan are not deductible for income tax purposes, whereas under normal circumstances, payroll would be deductible. He said this increases the target company’s income tax liability, and that is being factored in as part of the deal.

Parties also need to be aware of PPP loan forgiveness eligibility in an asset sale in which a buyer is acquiring substantially all of the target company’s assets, Smith said.

He said employees are typically terminated and then immediately hired by the acquirer after closing day. In the PPP loan scenario, Smith said if a seller obtained a loan but then terminated all of its employees in connection with the sale before applying for forgiveness, eligibility for forgiveness is reduced.

Smith said he has been dealing with these different issues every week with clients engaged in transactions, and he offers two pieces of advice: apply for forgiveness or repay the funds.

“We’re advising people, if this is an all-asset sale, they need to try to spend all of the PPP loan funds on eligible expenses and apply for forgiveness before they close their transaction,” Smith said. “The target company may not be happy about repaying the loan, but if the transaction is large enough, it may be worth it to them to repay the loan in order to get the deal done.”

Despite hurdles, Smith said he hasn’t seen a deal fall through yet because of PPP issues.

“It adds a layer of complexity to the transaction, and usually one or more of these issues I’ve mentioned comes up … so it may take a little longer. It may introduce some uncertainty to the deal,” he said. “But, ultimately, I haven’t seen a deal fall apart solely because of these issues. I’m sure there are some out there that have. I just haven’t seen one.”

The original article, "Why PPP Could Create Challenges for Birmingham M&A Deals," appeared in the Birmingham Business Journal on July 30, 2020. (Login required.)