What Contractors and Their Financial Partners Need to Know Related to PPPAnchin Alert February 25, 2021
Now that calendar year contractors are in the midst of preparing their financial reports for 2020, it is time to understand how banks and sureties will evaluate the PPP loans that may be included as liabilities on the contractors’ balance sheets at December 31, 2020. How will banks and sureties view PPP loans in light of an entity’s equity value and loan covenants?
Many contractors, unless they were working on projects deemed essential, experienced a significant decrease in revenue in 2020 as a result of the COVID-19 pandemic. For many of these companies, the PPP loans were crucial to their ability to maintain payroll and pay critical expenses. Further, to the companies’ benefit, many contractors will be able to have some or all of the loans forgiven to the extent that they were able to maintain employment levels for a specified period and used the loan proceeds for qualified expenses during the covered period as specified under the law. Thanks to the recently passed legislation, not only will the loan forgiveness not be taxable, but the related expenses paid with the loan proceeds will be deductible. In effect, the loan to the extent forgiven, is tax-free money from the government.
However, because of the logistics involved in applying for forgiveness and the approval process needed by the banks and SBA, many loans extended during 2020 will not be forgiven until 2021. For the most part, generally accepted accounting principles (“GAAP”) require that the loans remain on the company’s balance sheet until actual forgiveness is deemed to be complete. Many companies will be faced with a situation where their balance sheet at December 31, 2020, will reflect a liability that will be fully or partially forgiven in 2021.
How will this liability be evaluated by the banks in determining covenant compliance? Many companies may already have issues related to complying with covenants for 2020 because of the adverse impact of COVID-19. How should sureties evaluate this liability when determining bonding capacity for their contractor clients? Will banks and sureties be in the position of having to evaluate the likelihood of the loan being forgiven to determine covenant compliance and bonding capacity? Or will they simply treat the loan as a liability not to be discounted in any way until it is forgiven? Will the banks and sureties’ experience with any particular contractor impact their decision-making process?
As you can see, there are many factors to consider and the answers may not be so straight-forward. A good relationship among the contractor, CPA, bank, broker, and surety is critical to ensure that the parties involved can make informed decisions for the benefit of all – particularly for the contractor who is struggling during these trying times. Timely communication is key. If you are faced with the above situation regarding your PPP loan, we recommend meeting with your bank and surety early to understand how they plan on evaluating this liability for purposes of determining covenant compliance and bonding capacity. Do not wait until the financial report is ready to be issued to address these matters.
Please contact Joseph Zeller, Phillip Ross, or your Anchin Relationship Partner with any questions you may have. We look forward to providing you with further guidance and advice on these critical matters.