What the Second Round of the Paycheck Protection Program Means for Factors

With the second round of the Paycheck Protection Program in full swing, what do factors need to be aware of in terms of its effect on current and potential clients?

BY PHIL NEUFFER, MANAGING EDITOR, COMMERCIAL FACTOR

A slew of new acronyms became household names in 2020, but one of the most bandied about relates to the Paycheck Protection Program. In the financial services industry, in particular, it has become unnecessary to spell out the program’s full name due to its impact in combating the economic fallout of the COVID-19 pandemic.

According to the U.S. Small Business Administration, since it was passed as part of the CARES Act last spring, the PPP has reached more than 5 million loan approvals and more than $500 billion in dollars lent. In 2021 alone, the program has already yielded more than $35 billion in loans, according to the SBA, with 65.6% of those loans going for $50,000 or below. Some of the industries that have been most reliant on PPP funds include accommodation and food services, construction and manufacturing.

During the back half of 2020, as the pandemic accelerated, discussions about a second round of the PPP heated up, ultimately leading to the renewal of the program in early January. This second round will continue to get liquidity to businesses, but what does it mean for factors?

To understand the impact of the second round, looking back at the first round can provide some insights.

The First Round

“The first round of PPP money kept many borderline companies from falling over the edge and creating workout situations for factors, although many factors saw a drop in business from the competing source of cheap money,” Jason Medley, Esq., a member of Clark Hill, says. “A positive byproduct was that our MCA fights have almost all but ceased, so it seems the PPP money may have dealt a severe blow to that industry.”

Dan Tortoriello, executive vice president and COO of North Mill Capital, echoes this assessment, describing the program as both a “blessing and a curse.”

“The blessing in that clients did not suffer or request over-advances and our loan to collateral positions were improved,” Tortoriello says. “The curse was that outstandings were down and business was off.”

This impact to new business has been the primary negative effect of the program from factors’ perspectives, and this has been made all the more difficult to deal with as factoring companies, like all other financial institutions, are excluded from the program.

“This was a myopic and sweeping judgment made by bureaucrats on the false assumption that private commercial finance companies have unlimited access to cheap capital,” Medley says. “Instead, many factoring companies are run not much differently than the clients they provide capital to.”

Versant Funding, a factoring company based in Boca Raton, FL, never planned on utilizing the PPP even before discovering it wasn’t an option. However, new business inquiries for the company slowed down once the program was enacted. Some of that new business may have been further cut by companies that potentially took PPP funds without really needing them.

“It is quite obvious that businesses wouldn’t be looking for money with a cost when they can get it for free and have no obligation to repay it,” Mark Weinberg, president and CEO of Versant Funding, says. “It was clear to us that many businesses took advantage of the program that had not been negatively impacted by COVID-19.”

The first round of the PPP created additional challenges for factors as well as general asset-based lenders, according to Medley, who says factors have had to consider waiving or making a reservation of rights to any “additional indebtedness” covenant, often extending to the “negative pledge” covenant when the PPP loan was accompanied by an Economic Injury Disaster Loan. Medley also says that how PPP money was treated both by lenders and borrowers has created some issues, particularly as some borrowers have failed to segregate PPP money in a separate payroll account. However, for some factors, many of the positives of the program have outweighed the negatives.

“While the rollout of the PPP was bungled pretty badly the first time around, I do think it helped our clients quite a bit. There was so much uncertainty during that time, so being able to ‘freeze in time,’ so to speak, was the right move for most of our clients and allowed them to regroup in order to restart,” Ryan Jaskiewicz, CEO of 12Five Capital, says. “From a volume and new business perspective, it certainly slowed things down, but I still believe that was the right tradeoff given the circumstances.”

The Second Round

With all this in mind, what does the second round of the PPP mean for factors? As a reminder, the renewed PPP allows for new and previous borrowers to use the program, with returning borrowers applying for a second draw PPP loan. Weinberg does not expect any of Versant Funding’s current clients to make a second draw, while Jaskiewicz believes many of 12Five Capital’s clients won’t qualify for a second round. Conversely, Tortoriello anticipates that many of North Mill Capital’s clients will receive funds from the second round.

Regardless of what current clients do in relation to the program, factors believe that the second round will emulate the first in deteriorating the need for new business — at least in the short term.

“I think it will be very similar to the first round, with funds used in lieu of borrowings,” Tortoriello says. “As we work through the current year and stimulus funds decrease, we believe additional borrowing will come back in some industries versus others.”

“[The second round of the PPP] will probably slow down new business once again and many will, again, take advantage of the free money,” Weinberg says.

However, as was made evident during the first round, even with additional government programs like the Economic Injury Disaster Loan, these funds may not be enough to carry businesses through a pandemic that continues to ravage the country. Factors and other capital providers will just need to work with the intricacies of these government loans to help continue liquidity.

“As long as the SBA continues to be willing to subordinate their position in the A/R, we are happy to factor companies that have PPP loans that need to be repaid or are in the process of being forgiven,” Weinberg says.

The subordination process was a thorny issue throughout 2020 and the first round of the PPP, but Medley says that it has “improved to some degree,” although he still recommends that factoring companies issue a reservation of rights notice to their clients for good measure.  

Regardless of the hoops through which factors need to jump, Tortoriello believes factors will still be a part of financial solutions for borrowers in need of capital to both survive during the pandemic and succeed on the other side.

“Our advantage to our clients is to be there through good and bad. They come to realize that what we offer has a direct and immediate effect on their working capital,” Tortoriello says. “If this leverage is utilized properly, it can add to taking advantage of future opportunities.”

The key, according to Jaskiewicz, will be for factors to focus on creating tailored solutions and not just on who has the lower rate. 

“This really is a time where not all things are created equal. Too often in our space, the value of a factoring company is tied to a discount rate,” Jaskiewicz says. “The real experience of life shows a very different picture. This is where forward-thinking finance companies can really shine for their clients and set themselves apart from the average.”