Politics

Startups are struggling to get PPP money. Now a Fed rule may freeze them out of loans, too

Lawmakers are pushing for changes to the Main Street Lending Program.

The Federal Reserve building in Washington, D.C.

The Federal Reserve's Main Street Lending Program offers the promise of $600 billion in loans -- for those who can get them.

Photo: Olivier Douliery/AFP via Getty Images

A growing number of midsize startups say they're likely to be locked out of the Federal Reserve's $600 billion loan program, and lawmakers are lining up behind them to change the Fed's rules before it's too late.

The Fed's Main Street Lending Program, which was created by the $2 trillion stimulus package, is geared toward midsize businesses that need a fast influx of money due to the coronavirus crisis. But the Fed's formula effectively means money will be doled out only to businesses that can prove they were operating profitably, or "EBITDA-positive," in 2019, leaving many midsize tech startups in a no man's land of being too big to qualify for other relief measures, like the Payment Protection Plan, but still locked out of loans.

A group of 41 lawmakers, including members of Congress representing startup hubs Silicon Valley and Austin, asked the Fed Thursday to adjust its guidelines before the program officially launches.

"Without changes to the Main Street Lending Program, many emerging midsize businesses will be ineligible for both programs, which could have devastating effects on the employees of many otherwise successful companies," the lawmakers wrote in a letter to Fed Chairman Jerome Powell and Treasury Secretary Steve Mnuchin. Rep. Anna Eshoo took the lead on the letter, with sign-ons from Reps. Will Hurd, David Cicilline and Jackie Speier, among others.

"We can't afford [to] let a generation of startups fail just because government programs didn't account for their needs and business models," said Rep. Mike Doyle, who heads the House Energy and Commerce technology subcommittee. "Startup companies are focused on growth at this stage in their development, not profit. That's what they should be doing. They shouldn't be penalized because they're trying to create something new."

In some ways, the situation mirrors the chaos around the PPP, a loan program for small businesses that startups say they cannot access because of quirks in its guidelines; both programs have bipartisan groups of legislators clamoring for change.

The Fed's Main Street loans are substantially different than the PPP loans, however. They are not forgivable, making them attractive only to companies that can take on debt amid coronavirus. And they are aimed at businesses with head counts between 500 and 10,000 employees.

Lightspeed Venture Partners' Amy Wu, who has been advising startups on PPP and other lending programs, said a number of its portfolio companies had hoped to qualify for the Main Street lending program. But she said that the EBITDA-positive requirement, and the way the program favors larger companies, means many will be shut out unless there are changes. "Most likely we'll be sitting out of this one," she said.

Alon Rotem, general counsel for online retail startup ThredUp, told Protocol that his company has been looking into the Fed's Main Street program as an alternative to the PPP because it's too large for the small business loan but could benefit from a boost as the economic downturn hits the retail industry particularly hard. He said the company recently had to furlough some of its employees.

"As we go through the high level terms [of the Main Street lending program], virtually everything lines up and looks like we would qualify — but for the EBITDA component," Rotem said.

There is serious money at stake. Rotem said it is "within the ballpark" for midsize businesses to be asking for loans between $10 million and $20 million. (For new loans, the maximum is about $25 million; it is significantly higher for the Fed's expanded loans program.)

Another general counsel for a midsize tech startup, who requested anonymity to speak candidly about his company's financials, told Protocol there is a "real possibility" that companies like his will "fall through the cracks."

"For companies like ours and others that didn't contemplate COVID but have been negatively impacted by it, the EBITDA requirement puts this money out of reach and could have draconian ramifications," he said. His company applied for a loan through the PPP but did not hear back before the money ran out last week. The Senate on Tuesday passed a bill to pour $320 million more into the program, though that is expected to dry up within a matter of days as well.

The Fed did not immediately respond to Protocol's request for comment on the EBITDA requirement. But the program's contours are still in flux. The central bank announced the lending program's guidelines on April 9 and accepted comments from outside stakeholders until last week. The issue has attracted a wave of advocacy from startup trade associations and advocacy groups including TechNet, the National Venture Capital Association and Engine, with TechNet in particular beginning to press members of Congress on it.

Justin Field, the senior vice president of government affairs at the National Venture Capital Association, told Protocol that he recognizes that the program is "probably still only going to work for a small percentage of the later-stage companies," even if the Fed updates its rules. But he said it could still be a "helpful program" for a significant number of startups.

"They gotta do something. You can't enact a program and cut out, arguably, the most valuable, high-growth companies," said Cooley lawyer Ron Hopkinson, who has been advising many companies on the lending program. While tech startups are one sector that may be boxed out, he said that R&D-focused, publicly traded life sciences companies or private-equity-owned companies could also come up short.

Banks already lend to many of these kinds of high-growth companies and use other metrics, from market caps to internal valuations, to make lending decisions. The same could be done for the Fed's program, he told Protocol. "I think they drew the box too narrowly. EBITDA is one metric, but they're going to have to come up with another metric or another program," Hopkinson said.

In its comments to the Fed, TechNet suggested that the program set loans at a fraction of 2019 gross profit. Other groups and companies have floated their own specific proposals for addressing the issue without using EBITDA in 2019 as a metric. The lawmakers suggested allowing lenders to use a recent month's EBITDA or month-over-month growth of revenue.

ThredUp's Rotem said he understands that the Fed is trying to strike a balance — even if he wishes it were doing it differently.

"On the one hand, they want to support medium-sized businesses," he said. "On the other hand, they need to do what's in the public's interest, and that's not to fund companies that are going to go out of business."

It's unclear when the Fed will officially open up the Main Street program, but it's possible more guidelines are coming that could clarify the role of startups and even tweak the EBITDA requirement. Until then, "lobbying efforts are ramping up," said NVCA's Field. And lawmakers have pledged to keep pushing.

"The Main Street Lending Program should not only ensure that today's thriving businesses survive," the lawmakers wrote in their letter to the Fed, "but also support those businesses with the potential to drive expansion when the economy recovers."

Correction: An earlier version of this story incorrectly reported that Rep. Jeff Van Drew signed a letter urging changes to the Main Street Lending Program. This story was updated on April 23, 2020.

Image: Yuanxin

Yuanxin Technology doesn't hide its ambition. In the first line of its prospectus, the company says its mission is to be the "first choice for patients' healthcare and medication needs in China." But the road to winning the crowded China health tech race is a long one for this Tencent- and Sequoia-backed startup, even with a recent valuation of $4 billion, according to Chinese publication Lieyunwang. Here's everything you need to know about Yuanxin Technology's forthcoming IPO on the Hong Kong Stock Exchange.

What does Yuanxin do?

There are many ways startups can crack open the health care market in China, and Yuanxin has focused on one: prescription drugs. According to its prospectus, sales of prescription drugs outside hospitals account for only 23% of the total healthcare market in China, whereas that number is 70.2% in the United States.

Yuanxin started with physical stores. Since 2015, it has opened 217 pharmacies immediately outside Chinese hospitals. "A pharmacy has to be on the main road where a patient exits the hospital. It needs to be highly accessible," Yuanxin founder He Tao told Chinese media in August. Then, patients are encouraged to refill their prescriptions on Yuanxin's online platforms and to follow up with telehealth services instead of returning to a hospital.

From there, Yuanxin has built a large product portfolio that offers online doctor visits, pharmacies and private insurance plans. It also works with enterprise clients, designing office automation and prescription management systems for hospitals and selling digital ads for big pharma.

Yuanxin's Financials

Yuanxin's annual revenues have been steadily growing from $127 million in 2018 to $365 million in 2019 and $561 million in 2020. In each of those three years, over 97% of revenue came from "out-of-hospital comprehensive patient services," which include the company's physical pharmacies and telehealth services. More specifically, approximately 83% of its retail sales derived from prescription drugs.

But the company hasn't made a profit. Yuanxin's annual losses grew from $17 million in 2018 to $26 million in 2019 and $48 million in 2020. The losses are moderate considering the ever-growing revenues, but cast doubt on whether the company can become profitable any time soon. Apart from the cost of drug supplies, the biggest spend is marketing and sales.

What's next for Yuanxin

There are still abundant opportunities in the prescription drug market. In 2020, China's National Medical Products Administration started to explore lifting the ban on selling prescription drugs online. Although it's unclear when the change will take place, it looks like more purely-online platforms will be able to write prescriptions in the future. With its established market presence, Yuanxin is likely one of the players that can benefit greatly from such a policy change.

The enterprise and health insurance businesses of Yuanxin are still fairly small (accounting for less than 3% of annual revenue), but this is where the company sees an opportunity for future growth. Yuanxin is particularly hoping to power its growth with data and artificial intelligence. It boasts a database of 14 million prescriptions accumulated over years, and the company says the data can be used in many ways: designing private insurance plans, training doctors and offering chronic disease management services. The company says it currently employs 509 people on its R&D team, including 437 software engineers and 22 data engineers and scientists.

What Could Go Wrong?

The COVID-19 pandemic has helped sell the story of digital health care, but Yuanxin isn't the only company benefiting from this opportunity. 2020 has seen a slew of Chinese health tech companies rise. They either completed their IPO process before Yuanxin (like JD, Alibaba and Ping An's healthcare subsidiaries) or are close to it (WeDoctor and DXY). In this crowded sector, Yuanxin faces competition from both companies with Big Tech parent companies behind them and startups that have their own specialized advantages.

Like each of its competitors, Yuanxin needs to be careful with how it processes patient data — some of the most sensitive personal data online. Recent Chinese legislation around personal data has made it clear that it will be increasingly difficult to monetize user data. In the prospectus, Yuanxin elaborately explained how it anonymizes data and prevents data from being leaked or hacked, but it also admitted that it cannot foresee what future policies will be introduced.

Who Gets Rich

  • Yuanxin's founder and CEO He Tao and SVP He Weizhuang own 29.82% of the company's shares through a jointly controlled company. (It's unclear whether He Tao and He Weizhuang are related.)
  • Tencent owns 19.55% of the shares.
  • Sequoia owns 16.21% of the shares.
  • Other major investors include Qiming, Starquest Capital and Kunling, which respectively own 7.12%, 6.51% and 5.32% of the shares.

What People Are Saying

  • "The demands of patients, hospitals, insurance companies, pharmacies and pharmaceutical companies are all different. How to meet each individual demand and find a core profit model is the key to Yuanxin Technology's future growth." — Xu Yuchen, insurance industry analyst and member of China Association of Actuaries, in Chinese publication Lanjinger.
  • "The window of opportunity caused by the pandemic, as well as the high valuations of those companies that have gone public, brings hope to other medical services companies…[But] the window of opportunity is closing and the potential of Internet healthcare is yet to be explored with new ideas. Therefore, traditional, asset-heavy healthcare companies need to take this opportunity and go public as soon as possible." —Wang Hang, founder and CEO of online healthcare platform Haodf, in state media China.com.

Zeyi Yang
Zeyi Yang is a reporter with Protocol | China. Previously, he worked as a reporting fellow for the digital magazine Rest of World, covering the intersection of technology and culture in China and neighboring countries. He has also contributed to the South China Morning Post, Nikkei Asia, Columbia Journalism Review, among other publications. In his spare time, Zeyi co-founded a Mandarin podcast that tells LGBTQ stories in China. He has been playing Pokemon for 14 years and has a weird favorite pick.

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