Startups are racing against time for stimulus funds — and Washington’s efforts are falling short
Some VC-backed startups are considering modifying deal terms to get around vague stimulus guidance.
Despite a mad dash by dozens of members of Congress and a lobbying frenzy by Silicon Valley, many venture-backed startups still don't have a cut-and-dry answer on whether they qualify for the billions of dollars earmarked for small businesses in the coronavirus stimulus package. So startups are making do with what little information they have.
Late on Monday, the Small Business Administration and Department of the Treasury released new guidance that clarified some of the rules that have tripped up startups and prevented some from applying. Now, investors Protocol spoke with said they're receiving requests from a large number of startups to change their voting and control terms to make them eligible for the grants.
Get what matters in tech, in your inbox every morning. Sign up for Source Code.
"I think most startups are comfortable moving forward with applications based on last night updated SBA/Treasury guidance, although many startups are still evaluating the true level of their need [and] associated ethics of applying," said Trevor Loy, an investor at FlyWheel VC.
Even so, many banks and lenders are still reluctant to accept applications from VC-backed startups, citing the scattershot guidelines for the $350 billion loans program.
"The guidance from last night still seems to be insufficient, and lenders are still hesitant to make these loans," one Democratic congressional aide told Protocol.
Over 30 members of Congress have written letters, sent emails and set up meetings to encourage the administration to include VC-backed startups as it doles out funds from the SBA program, according to a count by Protocol. Speaker Nancy Pelosi and House Minority Leader Kevin McCarthy have gotten personally involved.
Congressional staffers involved in the process said their efforts have picked up in recent days. The small-business loans program, called the Paycheck Protection Program, officially opened up Friday.
Venture capitalists have seen the program as a way the government can help preserve jobs at companies affected by COVID-19 in a way that their own checkbooks cannot. In the last week, venture firms have scrambled to hold conference calls, send out guidance and host webinars to help educate their startups on how to apply.
There is increasing concern that the small-business funds will be depleted by the time there's more clarity about whether VC-backed firms are eligible for the money. Congress is starting to mobilize to potentially infuse more funds into the program through a standalone appropriations bill, but the path forward is unclear so far.
"The overall sentiment has been that the funds will go quickly … and there's going to be a huge shortage of companies that don't get what they need," Brad Luttrell, the co-founder of a hunting app called GoWild, told Protocol. GoWild, a VC-backed company, applied for the federal loan through Chase Bank on Friday, but has not yet received word on the status of the application.
Luttrel said he has received template communications from Chase but nothing substantial, and the clock is ticking.
"My office has been inundated with calls, emails and letters from small startups who cannot access this critically important economic lifeline," Rep. Anna Eshoo, D-Calif., said in a statement to Protocol. "I hope the SBA takes immediate action because this assistance is needed right now."
Lawmakers, hearing from startups and companies in their districts across the country, have made a number of requests, including that SBA waive its rules for VC-backed startups or that the agency put out specific and helpful guidance clarifying its stance. At issue are the SBA's affiliate rules, which generally indicate that startups with investors who can "control" actions — whether through owning the majority of stock or having voting shares that can block transactions — have to count investors and their other affiliates to the employee headcount, potentially pushing them over the small-business limit (typically 500 employees). Given the extraordinary situation, many have argued that the rules shouldn't apply now.
Despite McCarthy's promise that it was "going to be solved" last week and Silicon Valley's Rep. Ro Khanna's work to press the issue, the treasury department hasn't gone so far as to waive the rules entirely or draw a clear bright line that would make startups unquestionably eligible.
In one relevant addition to the guidance, the SBA confirmed that minority investors may still be considered affiliates if they hold certain control rights. But there are still many outstanding questions about the affiliates issue.
"There's obviously a lot of frustration in the startup community," said Scott Brovsky, the director of the Small Business Development Center at UC Riverside, which helps mentor tech startups in Southern California. Brovsky said most startups he has worked with have avoided applying so far because they aren't sure how to navigate the affiliates question.
Ed Zimmerman, a lawyer who specializes in venture capital and startups at Lowenstein Sandler LLP, said his firm has been working overtime to convince banks to accept applications from VC-backed startups. He said he has been in communication over email and over the phone with three separate banks who were reluctant to offer the loans, but have chosen to open up the process, particularly in light of the guidance released this week.
"Guidance is coming out in an unsteady way," Zimmerman said, noting that far more startups are likely eligible for loans than previously understood, but the chaos and confusion has led even potentially eligible firms to "take a step to the back of the line."
To get around it, some startups are now asking venture capitalists to amend their deal terms to relinquish specific control in order to meet the eligibility requirements. In a blog post, Upfront Ventures partner Mark Suster said getting investors to agree to the amended terms may be easier for companies that have a larger number of investors who all own around the same size of the company. But earlier-stage startups that may have one lead investor who does have more control may be less willing to agree to a change, he warned.
"If your company is in dire straits (let's say you're a transportation company or a hospitality company), then you're likely to find an amenable investor," he wrote. "If you're in a company where the investor views your application as more of a 'gray area,' then you may not easily receive consent for changes."
Zimmerman said he has heard from a slew of startups hoping to amend their deal terms at this point. "We are spending plenty of time reading venture deal documents to see if there are offending provisions and to ensure those provisions are irrevocably waived or amended out of those deals," he said.
Many startups are opting to try their luck and apply, instead of waiting for new guidance, due to escalating concerns that the money won't be there within days.
Wells Fargo had already stopped taking applications as of Monday morning, announcing that it reached the $10 billion cap it had set for loans. The administration on Monday said it had approved 130,000 loans worth $38 billion, amounting to about 10% of the program.
There's already been talk of expanding the loans program. Sen. Marco Rubio, R-Fla., who authored the PPP, said in a tweet that his office is working with the treasury department to "make a formal request for additional funds ASAP & with Senate leadership to get fast track vote ASAP."
And several lawmakers said they will likely try to ensure that the next economic stimulus package includes a fix to clarify the role of startups.
"We have been in contact with the Small Business Administration about these concerns, and we hope to get them addressed through fixes to phase 3 or possibly in phase 4," Rep. John Carter, R-Ga., said in a statement to Protocol. "It is my hope that the Treasury will rectify a number of these eligibility issues in their guidance."
Despite the rush by many VC-backed startups to try to get funding, there's a growing worry that some startups are applying for the loans without actually needing them, and investors are starting to push back against the frenzy. "This misconception that it's a free two months of payroll is bizarre to me," said one startup CEO, who decided not to go ahead with the application and spoke to Protocol on the condition of anonymity to discuss their company's finances. Some peers the CEO has spoken with applied to the program to stave off layoffs, but there are also companies who aren't in as dire of need who have also applied. "I think it's incredibly reckless of founders," the CEO said.