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Exponential News

Paycheck Protection

May 18, 2020 11:58:20 AM / by ExIM Team

The Coronavirus Aid, Relief and Economic Security (CARES) act included a $349 billion loan program called the Paycheck Protection Program (PPP) as a lifeline for small businesses desperate for cash during the COVID-19 pandemic lockdown. We believe that a payroll tax holiday is a better solution to ensure that Small Medium Enterprises (SMEs) receive the economic support that they need.


The importance of helping American SMEs cannot be understated. Sole proprietors and contractors account for around 80% of the 30 million U.S. small businesses. 51% of small business owners will only be able to continue to operate for another 0–2 months, according to a recent Goldman Sachs study.


Payroll Tax Forgiveness Could Be A Better Solution


A payroll tax holiday and/or rebate are better ways of reducing costs to companies in direct proportion to actual payroll. In most states, total payroll taxes (FICA and FUTA) paid by the employer is around 12%.


FICA deductions mostly affect lower and middle-class wage earners, as social security taxes are limited to the first $137,700 of annual salaries. By eliminating this tax altogether, lower and middle-class workers, who are more susceptible to market downturns and unemployment, are better protected as companies receive a higher net expense benefit to keeping them on the payroll.




By directly attributing tax cost reduction to payroll as opposed to through a complicated lending process, small businesses would benefit without letting intermediaries, such as banks, put their hands in the cookie jar and subsequently slow down the process of relief.


Payroll tax holidays have also historically been successful in reducing unemployment faster during an economic recovery. Businesses are much more willing to hire back employees if the cost to do so is lower by 12%. In 2010, with bipartisan support, payroll taxes were reduced by 2 percentage points, which helped reduce unemployment rates from a then high of 9.6% to to 8.1% 2 years later when the scheme ended. At an estimated 21% unemployment, a much bolder tax holiday will be needed.


Freelancers, Gigsters, And Independent Contractors


The PPP attempts to assist those most in need but it still doesn’t affect many essential industries.


Almost 30% of the US workforce are independent contractors rather than W-2 employees, which doesn’t qualify their employers for a tax holiday benefit. However, this group of people work in many essential jobs such as nurses, physicians, truck drivers, and construction workers.


The Brookings Institute recently reported that approximately 10% of the workforce in the US has alternative employment arrangements for their main job. Freelancers pay about 15% in self-employment taxes at the federal level, so seemingly, a payroll tax holiday may not help them keep their jobs. However, if self-employment taxes are forgiven for 1099 employees, they may negotiate their contracts to pass their savings on to their employers.


Problems With The Payroll Protection Program (PPP)


The key factor in the trickle-down economics scheme for PPP is that a portion of the loan that is forgivable is equal to the amount spent on payroll, rent, mortgage, insurance, utilities in the 8 weeks following receipt. Small businesses can receive loans of up to $10 million as long a 75% of the money is spent for payroll and the businesses retain employees or rehire those laid off; i.e. if they receive $100, they need to spend at least $75 on payroll and a max of $25 on non-payroll related items such as an office lease.


Loans originally designed to help the nation’s mom-and-pop shops keep employees on the payroll are instead going to a very different set of companies. Many small businesses that did not receive these loans were forced to close.




Who Didn’t Miss Out on SBA loans?


Large chain restaurants such as Ruth’s Chris steakhouse ($20 million loan, $468 million in sales last year, approximately 5,600 employees), Potbelly ($10 million loan, sales of $410 million last year, 6,000 employees — and, the same day that loan came through, the company paid a $100,000 signing bonus to a new executive), and Shake Shack ($10 million loan, sales of $574.6 million last year, 6,101 employees). Morgan Stanley reported that $243.4 million of the total $349 billion has already been allocated to large, publicly traded companies.


Even a Luxury hotel conglomerate exploited loopholes and was able to receive $59 million in funding through 3 separate entities.


Shake Shack, in a face-saving move, is returning its PPP loan, “so that those restaurants that need it most can get it now,” said CEO Randy Garutti, even as he argued that Shake Shack, with about 45 workers per restaurant, “could and should apply to protect as many of our employees’ jobs as possible.”




The SBA issued new guidance on April 23rd which makes it more difficult for larger, publicly traded companies to access the next round of PPP funding. The update was released after much public criticism over the failures and inefficiencies of the program, as laid out above.


The Big Banks Are The Winners


According to Bloomberg, Banks received an origination fee of 1–5% for these loans that mostly went to large businesses. The origination fee would be $100,000 on a $10mm loan as opposed to $5,000 on a $100,000 loan.


Therefore, banks are incentivized to favor and front-load applications with higher loan amounts because they receive higher fees per application. In a recent NPR investigation, banks issuing the PPP loans have made more than $10 billion in fees. This is because the banks took in the fees while processing loans that required less vetting than regular bank loans and had little risk for the banks. It is important to note that taxpayers are providing the money for the loans, which were guaranteed by the SBA.


Banks are the biggest winners and have prioritized applications that make them the most money. All applications go through a bank, who earns origination fees for taking zero risk.


The next winners are larger corporations that receive favorable treatment from banks and Congress. These are the same businesses that have a larger cushion to weather the losses.


At last, capital does make it to the employees, which is the lifeblood of keeping our economy as stable as possible during this tumultuous time.


But What About The Small Business Owners?


Only about 9% of companies that applied for the PPP loan actually received their loan before funds ran out, per the site COVID Loan Tracker. Small businesses did not quite make it into the queue to save their employees. These are the individuals who the PPP is supposed to be targeted to help. However, small business owners often do not even take a paycheck, rather they receive dividends from their businesses. In doing so, they do not qualify for the rigid PPP requirements for funding and as such may have trouble weathering the economic downturn.




While the original $349 billion was depleted in a matter of less than two weeks, the government has passed a second bill replenishing the PPP with an additional $310 billion. Coupled with the new guidance which limits larger companies from taking advantage of the program, we are hopeful that more small businesses will be able to access PPP funds. But those in need of these loans should act fast — choose the right bank and move quickly.



Resources for Small Businesses Impacted By The Coronavirus Outbreak:


Centers for Disease Control and Prevention — Guidelines for Small Businesses

SBA — Coronavirus (COVID-19): Small Business Guidance & Loan Resources

Treasury Dept. — Assistance to Small Businesses

Dept. of Labor / OSHA — Resources for Small Businesses

Internal Revenue Service — Coronavirus Tax Relief

U.S. Senate — Small Business Owner’s Guide to the CARES Act

On a happy end note, a few organizations (Facebook, Goldman Sachs, and Google) are also seeing the need to assist small businesses and are devoting funds to the cause.


Note:  This article was originally posted on April 27, 2020 on Exponential's Medium page



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Tags: Investor Letters

ExIM Team

Written by ExIM Team

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