The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is a $2 trillion economic relief package enacted to help individuals and businesses in the United States weather the severe financial impact of the COVID-19 pandemic.
A key feature of the relief package is the creation of the Paycheck Protection Program (PPP), which will be administered by the Small Business Administration (SBA). PPP loans will be made by participating commercial lenders between February 15, 2020, and June 30, 2020, subject to certain eligibility requirements, and will be 100% guaranteed by the SBA.
Who is eligible for a PPP loan?
In addition to small businesses, any business, nonprofit, veterans organization or Tribal organization is eligible if it employs not more than the greater of:
Additionally, to be eligible an applicant must have been in operation on February 15, 2020, and certify that:
How do I count my total employees?
Applicants will count their own employees (including anyone employed on a full-time, part-time or other basis) and employees of their “affiliates”, and will exclude independent contractors.
Applicants that are deemed to be “affiliated” with other entities (including their investors) must include affiliates’ employees into their headcount for purposes of the PPP eligibility determination. Subject to certain limited exceptions, the SBA’s method of determining “affiliation” will potentially make loan eligibility challenging for venture capital (VC) and private equity (PE) backed companies because "affiliation" is often determined by stock ownership.
For companies for which the primary NAICS code begins with a 72 (accommodation, food services and drinking places) and for which there is more than one location, the company will be eligible if no one location has more than 500 employees. Additionally, if the company’s primary NAICS code begins with a 72 and the company has no more than 500 employees, the business has been assigned a franchise code by the SBA, or the company receives financial assistance from an SBIC licensed company, the company need not aggregate “affiliates” employees with its own.
For all other companies, the applicant’s employee head count will be aggregated with that of any “affiliates” and of any affiliates of an affiliate.
What if I have access to credit elsewhere?
The PPP waives the ordinary requirement that a 7(a) business loan applicant be unable to obtain credit elsewhere.
What amount can I apply for?
The PPP loans may not exceed 250% of the applicant business’s average monthly “payroll costs” from the year prior to the loan, up to a total maximum of $10 million.
How can the loan be used?
During the period from February 15, 2020, to June 30, 2020 (the covered period), the loans can be used for payroll costs, health care benefits, mortgage interest, rent, utilities and interest on any other debt obligation that was incurred before February 15, 2020.
Does the loan need to be repaid?
Recipients can apply for and receive forgiveness of all or a portion of a PPP loan. Generally forgiveness will be equivalent to the amounts the applicant can document that it paid in the eight weeks following origination of the loan for payroll, mortgage interest, rent and utilities. No amounts paid outside of the 8 weeks are forgivable.
No personal guarantee or collateral is required.
The loans are fee-free, and payments of principal and interest are deferred for at least six months and up to a year.
Any remaining balance on the loan after forgiveness will remain fully guaranteed by the SBA and subject to a maximum interest rate of 4% and maturity of 10 years.
How and when should I apply?
The act authorizes the SBA to guarantee up to $349 billion for this and its other lending programs, meaning that once that monetary threshold is reached, absent further Congressional action, no further loans could be guaranteed. Because the covered period for loan uses ends on June 30, 2020, and the maximum forgiveness period is eight weeks, any loan obtained after May 5 may not enjoy the full forgiveness period.
For this reason, companies should begin discussing potential applications with their lender and collecting documentation and information related to its employee headcount, average monthly payroll costs and other permitted loan costs for the past year, and SBA Form 1919, which the SBA may modify specifically for the PPP. If a company’s existing lender does not plan to offer PPP loans, companies can contact other banks in their area that are SBA loan program participants. Existing participating lenders are listed on the SBA website for the district in which the company is located, and the SBA is authorized to add additional lenders for this program.
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A force majeure clause is a paragraph that appears in most contracts relieving one or both parties from their obligations if they are unable to perform due to some massive and unforeseen event beyond their control. It's often phrased as an "Act of God."
Most force majeure clauses do NOT excuse payment obligations so rent, operating expenses and loan payment contracts are still enforceable.
It is still to be determined, and will vary greatly by jurisdiction and the actual language written in your specific contract, whether the COVID-19 pandemic constitutes an "Act of God." If the pandemic is not considered to be force majeure by the courts, performance by one or both sides may still be excused under other legal doctrines like frustration of purpose, hardship or changed circumstances.
Start.law attorneys are reviewing contracts impacted by COVID-19 pro bono. Please email us us if you would like a review.
CaliforniaAB5 is now in effect and someone can only be considered an independent contractor if:
They control how they work.
The work done falls outside the hiring company’s usual course of business.
They customarily engage in an independent trade.
This is a big deal for startups as it's more expensive to hire employees. Things like sick leave, workers comp, and unemployment benefits generally don't apply to independent contractors but do apply to employees. Failure to comply with the law change could subject companies to worker misclassification lawsuits, which can now be brought by both local cities and the state.
While it's unclear if the law will last long (Uber, Lyft and DoorDash have pledged to spend $30 million each on a 2020 ballot initiative to reverse AB5), there is a nationwide trend towards limiting independent contractor agreements and startups should be prepared to make more employee hires for the foreseeable future.
Valuation is determined by negotiation between the investor and the startup.
The startup’s valuation immediately before the investment is called “pre-money valuation” while the startup’s valuation immediately after the financing is closed is called the “post-money valuation.”
The pre-money valuation is determined by the following equation:
Pre-money Valuation = Post-money valuation – Investment
The post-money valuation is determined by the following equation:
Post-money Valuation = Investment/Ownership Percentage
It works like this. An investor comes to you and offers to invest $3 million into your startup for 30% of the company.
To determine the post-money valuation
$3million/.30 = $10million
and to determine the pre-money valuation
$10million – $3million = $7million
I say that valuation is determined by negotiation because the terms of the investment can, and likely should be, negotiated. It may be better to take less money and give up a smaller percentage of your company or it may be better to take a lower valuation from a more reputable investor.
Some founders have to work a day job during the initial stages of their startup. It's a common way for co-founders to pay their bills prior to a seed round of financing. However, precautions must be taken to ensure the company you work for can't steal your startup's IP. Prior to launching a startup, each co-founder should review their current employer invention assignment to see if the IP they are developing for their startup could possibly be claimed by their current employer.
Employer Invention Assignments Are Common in Tech
If in the technology field, a co-founder’s day job likely requires their employees to sign an invention assignment in conjunction with or as part of their employment agreement. In a nutshell, the employer invention assignment defines parameters that an employee assigns intellectual property to its employer. (And for what it’s worth, a startup should have such an invention assignment with each of their co-founders.) If your day job isn’t related to the development of technology or your employee is not a technology company, you may not have signed and invention assignment.
Check the Scope of Your Employer Invention Assignment
Some employer invention assignments are broad in scope while others are very narrow in scope. Regardless of what the contract says, you should note that certain jurisdictions like California place boundaries on how broad employers can make their employer invention assignment. For what it’s worth, the general trend is that employer invention assignments are somewhat fair and do not try to assign every thought you have ever had over to the company (although we’ve seen a few companies try).
The broader the scope of the invention assignment, the greater the potential problem for the founder and his or her startup, as the founder may be unknowingly assigning intellectual property to the day job rather than the startup. If the startup or the technology involved is in any way related to the day job or if the founder is using the equipment of the day job while working on the startup, the risk of such an assignment increases.
Quite often founding teams breakup and having a former founder own a large portion of your company is not a scenario VCs want to see. To avoid this problem set up a vesting schedule in your Stock Purchase Agreement.
The standard vesting schedule for startup companies is four years with a one year cliff and monthly vesting thereafter until the founders reach 100%. The one year cliff means that the founders do not get vested with regards to any common stock until the startup’s first anniversary. Thereafter, the founders get vested every month at an amount equal to 1/48th of their total common stock.
If a founder leaves before the startup’s first anniversary, the founder leaves without any common stock.If a founder leaves after 15 months, the founder will have 31.25% of his common stock vested (25% after the first year, plus the 2.083% vesting each month for 3 months). Thus, the missing founder leaves the startup with much less shares than if the founders stock had vested immediately. This makes it easier to get the necessary approval (and other issues) to go forward with an acquisition or venture capital financing and allows you to spend that repurchased equity on new hires or founders.
There are two methods of calculating the Delaware franchise tax, and the bill you get in the mail defaults to the Authorized Shares Method, which is by far the more expensive of the two.
The Authorized Shares Method bases the tax bill on the number of shares authorized.
Thus, if your startup authorized 10 mil shares, your franchise tax bill would be almost $85,000, which is, of course, outrageous.
Thankfully, there is an alternative way to calculate Delaware franchise taxes — and one that is very likely to lead to a much lower tax bill- the Assumed Par Value Method.
The Assumed Par method is calculated based on all issued shares, authorized shares, and total gross assets in the following manner:
Step 1: Divide Total Gross Assets by Total Issued Shares (“Assumed Par Value”)
Step 2: Multiply Assumed Par Value by Total Authorized Shares (“Assumed Par Value Capital”)
Step 3: The franchise tax is calculated at $400 per every $1 mil or portion thereof of
Here’s an example of a calculation of a startup with total gross assets of $250,000, 5 mil issued shares and 10 mil authorized shares:
Step 1: $250,000/5 mil shares = $0.05 Assumed Par Value
Step 2: $0.05 * 10 mil shares = $500,000 Assumed Par Value Capital
Step 3: Since the startup has less than $1 mil in Assumed Par Value Capital, their tax bill will be $400. (Plus the $50 annual filing fee.)
(Please note: This example assumes the actual par value listed in the startup's Charter is lower than the assumed par value. Otherwise, the actual par value is used in place of the assumed par value in Step 2 above)
You'll pay your taxes online with a credit card by March 1st. The online form defaults to the Authorized Share Method, but if you fill in gross assets it will use the Assumed Par Value method.
If a company owes more than $5,000 in franchise taxes, then it must make quarterly tax payments:
40% due on June 1st
20% due on September 1st
20% due on December 1st
and the remainder due on March 1st.
Any positive balance goes towards next year. Failure to file by the deadlines will cause a company to fall out of good standing with the state, which can complicate, delay or even prevent a range of possible transactions, including funding transactions.
The lines between the rounds have blurred, but this is the general fundraising path.
Friends and Family/Pre-Seed/Accelerator
This is the least formal round of investing and as such there are no real guidelines. It's important to remember that while accelerators provide capital, their real contribution to a startup is industry contacts and mentorship.
Funding at this stage may come from angel investors, targeted funds, and accelerators and incubators, who may provide $10,000 to over $100,000 in startup capital.
These funds are often used for further research, testing product-market fit, key hires, and product development.
Seed investors take risks, because of the higher risk at this stage, convertible notes are often used.
Making it to this stage typically requires having gained some proof of concept. Investors are beginning to look at real data to see what the startup has to show for the money previously invested. This may not be revenue, but they want to know what key metrics are being improved.
Capital from this round is typically about optimizing what has been done and discovered so far. It is for honing the business model into something which can then be scaled.
Earlier investors may participate. Though at this stage startups will begin to require the partnership of investors who can really help with taking the venture to the next level.
Series A investors are usually venture capitalists or angels.
By a Series B round startups are definitely looking for VC level participation. This stage is about building out the company and building on existing success. Capital may be used for expanding teams, geographic expansion into new markets, and general scaling.
A Series B round probably involves a raise in the tens of millions of dollars range. Profits may still be scarce, though the startup should be firing on all cylinders and demonstrating traction and a business model that works. Investors at this stage need to be chosen carefully in order to make the leap to enterprise levels. Potential acquisitions are probably already being eyed.
Series C or more
If you make it to this stage you are probably really getting to the big time. You likely have a company valued in excess of $100 million. You’ll probably be raising in the range of $50 million-plus.
From here it is likely going to be a sprint to an exit. At this point, you will be working with the biggest venture capital firms and maybe even corporate level investors. However, this can also be one of the toughest rounds for founders. Investors are likely to be demanding and the due diligence process intensive.
When bootstrapping, it is common for founders to not pay themselves any cash compensation. This approach is sometimes also applied to other service providers, who receive just stock option compensation. Despite the prevalence of this practice, certain rules must be followed or the company will be setting itself up for liability and investors avoid liability.
Liability issues most often arise with the severance of minority co-founders or independent contractors.
A minority co-founder, who has not been paid any cash compensation is not working out and is let go. If this co-founder feels aggrieved, she might sue the company, and the other founders personally, for failing to pay the minimum wage. The minority co-founder may face an uphill battle to prove her claim, but this situation would be a thorn in the side of any startup, with the potential to grow into a costly lawsuit. You can avoid this entire scenario by simply paying the individual at least the minimum wage in cash.
You classify a service provider as an independent contractor, and you do not pay them cash. Instead, you pay them in equity subject to a vesting schedule. The person works for a while, but their work is unsatisfactory so you terminate them. Their equity is unvested, and so it all reverts to the company. This person may not only sue you for failure to compensate them, but they might also assert that they own the IP they created while working for you because you didn’t pay them anything for it. It is obviously in a startup’s best interest to steer clear of these issues. So, it is important you handle paying people correctly. (A payroll service like Gusto is affordable and automates all the documentation required.)
What are the Laws?
For founders acting as corporate officers, it is generally difficult to escape “employee” status and the minimum wage and overtime requirements. Under the federal income tax law, an officer of a corporation is defined as a “statutory employee” which leads to a similar classification under the wage and hour laws. Admittedly, the federal Fair Labor Standards Act has an exception to the minimum wage for 20% or greater equity owners, but many states, including California, Washington, New York, and Maryland do NOT have similar provisions. Because the state minimum wage levels are higher than the federal standard, these are the applicable rules to startups with workers in those states.
The risk with not paying your employee co-founders (and if they are an officer of the company, then they are likely an employee) at least the minimum wage is that they might sue you personally if things don’t work out. This is one reason investors usually want to know if a company has severance plans in place before they invest. Failure to pay severance when a company runs out of cash is another potential source of troubles for directors and officers of the company.
Here are the Startup Rules
If you are the majority founder, you are probably not going to sue the company. So, you can probably not pay yourself in the early days. But this situation will change as your company grows, particularly when you begin to solicit investment funding. Investors are going to want to have the assurance that there is zero potential for outstanding wage claims.
Pay minority co-founders and independent contractors at least the minimum wage to avoid the risk of a lawsuit.
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