We are now a good three months into the chaos brought about by COVID-19 and while many middle- and lower-middle market deals have been put on hold or even died, some M&A activity has continued unabated. That said, the deals and the associated risks look very different today than they did four months ago when there were only a few confirmed COVID-19 cases in the USA, the unemployment rate was ~3.5%, and Major League Baseball was beginning spring training. Now deals are generally taking longer to negotiate and close from a diligence, underwriting (if financing is involved) and logistics perspective. In addition to assessing the human and economic risks associated with COVID-19, buyers, sellers, lenders and their respective advisors are having to navigate the federal and state stimulus packages, including the Paycheck Protection Program (PPP) established by the CARES Act in late March. 

This alert seeks to assist relevant stakeholders as they navigate the M&A process before, during, and after PPP loans are received and (potentially) forgiven. The questions we address include: 

  • What is the “present effect rule” and how does it impact PPP eligibility? 
  • How might an M&A transaction impact the PPP loan and the ability of the borrower to participate in forgiveness?  

Overview of PPP 

As most readers know, the two primary requirements to participate in PPP are the applicant must (i) meet the eligibility requirements and (ii) be able to certify the loan is necessary to support ongoing operations. In addition to being unsecured 1% loans with a six-month deferral before any payments are required, borrowers are eligible to seek forgiveness for all or a portion of the loan if the loans are used to pay for certain specific expenses (such as payroll).    

In general, most applicants are eligible for PPP loans if they: (i) qualify as a “small business concern”;1 (ii) have fewer than 500 employees, including employees of all affiliates, and are not, as per the SBA’s guidelines, an ineligible business listed in 13 CFR 120.110(b)-(j), (m)-(s) or in bankruptcy at the time of the business’ application,2 or (iii) meet the SBA’s employee-based size or revenue standards (including the “alternative standard”).3 Businesses receiving PPP loans that are otherwise ineligible may be subject to criminal and civil fraud claims. See our Client Alerts titled “The Paycheck Protection Program in Action: Questions About Loan Application Risks” and “The Price of PPP – Guidance for Management & Boards on Mitigating PPP Risk” for more information on these potential claims. 

Additionally, borrowers must certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” This certification must be made in good faith and companies are asked to consider other sources of funding available. As per the SBA’s most recent guidelines,4 borrowers, who together with their affiliates, received less than $2 million in PPP loans are “deemed to have made the required certification concerning the necessity of the loan request in good faith.” For loans in excess of $2 million, if the SBA determines the applicant did not make the above certification in good faith, the SBA’s remedy will be to first seek repayment of the loan in full.

There are a number of other certifications borrowers must make during the application and forgiveness process, including certifications related to the use of funds, the borrower’s organizational structure, and the information provided to support the borrower’s forgiveness application. Any mis-certifications are also subject to criminal and civil fraud claims.  

PPP and M&A Considerations 

Application Stage of PPP: Present Effect Rule & the Affiliation Test 

The affiliation test is one of the key components of assessing an applicant’s eligibility. While most of the attention on the affiliation rules has been focused on reviewing the applicant’s ownership and management structure and any negative control a minority owner may have over an applicant, one of the less discussed rules is the SBA’s “present effect rule.” 

Under this rule, the SBA will give “present effect” to agreements concerning the ownership or control of an applicant as though the rights granted in the agreements have already occurred.5 The agreements typically include options, convertible notes, or other equity agreements that have not been exercised or vested. But the rule also gives present effect to any binding purchase, merger and other buy/sell agreements. If the present effect rule is triggered, the PPP affiliation rules will apply to the applicant and, depending on the consequences, the applicant may be ineligible to participate in the program.  

1. Does a Letter of Intent (“LOI”) Create a Present Effect? 

A non-binding LOI signed by the applicant and a buyer is considered an agreement to negotiate or an opportunity to evaluate and does not trigger the present effect rule. However, a binding LOI or similar agreement does create a present effect. For example, if an applicant has entered a binding LOI to be acquired in the future by a company that is ineligible to participate in PPP, the applicant would also be ineligible. Whether or not an LOI is considered binding or non-binding depends on a number of factors and circumstances. The below table provides a summary of some of the factors to consider when determining whether an LOI is binding or non-binding.6

Binding Non-Binding
There is a firm purchase price in place.  Purchase price is conditioned on meeting certain financial targets. 
Simple confirmatory diligence must be completed prior to closing.  Broad diligence must be completed prior to closing. 
Negotiations began long before the execution of the LOI.  There is an ability of either party to withdraw from the deal. 

Ultimately, if the agreement and the deal are contingent on other factors occurring, the LOI is almost certainly considered non-binding. 

2. Does a Signed Purchase Agreement Create a Present Effect? 

Similar to a binding LOI, an executed Purchase Agreement for an M&A transaction that has not closed as of the time of the PPP application triggers the present effect rule and the affiliation rules must be considered for eligibility purposes. 

Period between Applying and Signing Loan Documents

The applicant typically has up to ten days between the time the SBA approves their application and when the applicant is required to sign the PPP loan documents. If the applicant is near the final stages of closing a transaction during this period, we generally advise clients to wait as long as possible to sign the loan documents with the aim of closing the deal prior to the SBA deadline. The rationale behind this approach is the deal could fall apart (there is significantly greater deal risk in this environment) and the applicant may require the funds to operate. 

Period Between Receiving the Loan and Forgiveness

The period between when an applicant receives a loan (now, a borrower) and applies for forgiveness is the period in which many borrowers are operating right now. Most companies that are eligible and have decided to participate in PPP have already received their funds. The primary challenge sellers and buyers face at this time is assessing how an M&A transaction may impact a borrower’s ability to participate in forgiveness. The issue is, under the SBA’s current rules, the borrower must wait eight weeks before applying for forgiveness and the lender has up to sixty days to then certify the forgiveness amount (some lenders are saying the certification process should not take that long). What happens if a borrower would like to close an M&A transaction during that time? Is all or a portion of the loan eligible for forgiveness? Should the PPP loan be treated as a bridge loan to be repaid at closing? 

During the period after disbursement and before forgiveness is applied, the CARES Act and the SBA’s guidelines are generally not as relevant as the loan documents (typically consisting of a promissory note and one or two consents or certifications) the borrower entered into with its lender. Those documents are where you would find any change of control provisions and prohibitions on change of ownership, the nature of business, assigning the loan documents or the obligations arising thereunder, or selling assets outside the ordinary course. 

The parties to the M&A transaction should carefully review the loan agreement for language such as the following: 

  • An event of default occurs if the borrower “reorganizes, merges, consolidates or otherwise changes ownership of business structure without lender’s prior written consent.”
  • The borrower “will promptly notify lender in writing of change in the management or in members of the company, change in the authorized signors.”
  • The borrower “will not, without lender’s prior written consent: (i) change the ownership structure or interests in the business during the terms of the loan; (ii) sell, lease, pledge, encumber, or otherwise dispose of any of borrower’s property or assets except in the ordinary course of business.”

Typically, PPP loan documents will require the lender’s consent before entering into a transaction resulting in any of the above events. If the consent is not obtained, the borrower will almost certainly not be eligible to participate in forgiveness and the loan should be repaid at closing. If it is not repaid, the consummation of the transaction may result in an event of default under the PPP loan, triggering default remedies for the lender, including default interest and immediate repayment.7

Unfortunately, neither the SBA nor the lenders have issued any guidance on when they may consent to a borrower engaging in any of the above M&A activities. There is also no guidance on whether a borrower can continue to participate in forgiveness after obtaining the lender’s consent and consummating a M&A transaction. 

In the absence of any specific guidance, we are left somewhat in the dark but some of the factors they may consider include: 

  • Would the borrower have otherwise qualified for a PPP loan on a post-closing basis from an eligibility and necessity perspective? 
  • Is the deal structured as an equity transaction where the borrower continues to operate separately from the purchaser? Lenders consenting to equity transactions seems more likely since the borrower continues to operate separately from the buyer and it is easier to account for the use of the PPP funds. 
  • Is the deal structured as an asset transaction where substantially all the assets and employees are transferred to the buyer? For an asset transaction, lender consent may be less likely since (i) the borrower is a separate legal entity from the purchaser entity and (ii) if the borrower’s business is being combined with the buyer’s (instead of being held as a separate subsidiary owned by purchaser) it is more difficult to account for the use of the PPP funds.

Based on the above and until there is further guidance, borrowers and potential buyers should be prepared to treat PPP loans as any other indebtedness that should be repaid in full at closing. This is irrespective of whether the transaction closes in week one or week eight of the eight-week period. 

To protect against the uncertainty around forgiveness, purchasers should require additional diligence, fundamental representations, and/or special indemnity provisions from the seller/borrower entity.   

Period After Applying for Loan Forgiveness

As mentioned above, lenders have up to sixty days after the borrower applies for forgiveness to confirm the amount to be forgiven under the loan. If a borrower elects to keep its PPP loan and participate in forgiveness, this confirmation period should be taken into consideration when determining when closing an M&A transaction can likely occur. As reflected in our recent FAQ on PPP Loan Forgiveness, the forgiveness application is not straightforward and, especially during the first few weeks, lenders will face both a learning curve and flood of applications from borrowers all over the country. 

For now, we are recommending the parties to an M&A transaction apply the lender consent analysis outlined above to this period. Meaning, if no lender consent is obtained prior to the consummation of an M&A transaction, the parties should expect PPP loans to be fully repaid at closing without taking into consideration any amount that may be eligible for forgiveness.  


Until additional guidance is issued, the lender will ultimately have wide discretion to determine whether they will consent to a PPP borrower entering into an M&A transaction that is prohibited under the loan documents. This impacts the borrower’s ability to keep the loan in place post-closing, as well as the borrower’s eligibility to participate in forgiveness.  Ultimately, the borrower should work closely with its legal counsel, the potential acquirer and its loan provider when assessing how a PPP loan may impact an imminent M&A transaction. 


1 As defined in Section 3 of the Small Business Act, 15 U.S.C. 632.
2 The affiliation rules are waived for (i) businesses in the hotel and food service industries with NAICS codes beginning with 72, (ii) any business concern receiving financial assistance from a small business investment company (SBICs), (iii) franchises assigned a franchiser identifier code, and (iv) religious organizations.  In addition, prior to May 5, 2020, applicants were only required to count employees of affiliates whose principal place of residence is in the United States. The number of employees is calculated by taking the average number of employees per pay period over the preceding year and adding the average number of employees of the applicant’s affiliates over the same period.
3 Additional qualifying applicants include casinos, churches, 501(c)(3)s, veteran organizations, and Tribal business concerns. 
4See SBA FAQ #46. 
5 13 C.F.R.121.301(f)(2).
6See Size Appeal of Telecommunications Support Services, Inc., SBA No. SIZ-5953 (2018) and Size Appeal of Enhanced Vision Systems, Inc., SBA No. SIZ-5978 (2018).
7 See Signapori v. Jagaria, 2017 IL App (1st) 160937, ¶ 8, 84 N.E.3d 369, 372.  In this case, failure to notify the bank of the ownership change triggered an event of default.