The EIDL May Not Be a Good Loan for the Practice

We are glad to hear that the SBA has been busy notifying loan applications that their Economic Injury Relief and Disaster Loan (EIDL) has been approved.  The question many of you have is whether or not to take the loan (please note the loan is different than the EIDL grant of up to $10,000 that many have already received).

Initially, the EIDL looked like an excellent loan and safety net for practices.  The loan is easy to obtain, and it does not require any level of documented loss to obtain the funds.  However, the SBA recently finished the final loan documents, and after reviewing the documents, we have several concerns.  Based on those concerns, we believe the loan may not be a good fit for many of you for the following reasons:

  1. The loan documentation has a provision that the borrower would need to provide reviewed financial statements if requested by the SBA.  There are three levels of financial statement services: audit, review, and compilation (Fluence provides compilations).  Reviews require additional scrutiny of financial information as compared to compilations.  If the SBA requested reviewed financial statements, it could result in a significant cost of $6,000 or more.

2. There are limits on how you can spend the EIDL.  The restriction that has us most concerned involves distributions and dividends.  Until the EIDL loan is paid back, owners cannot take distributions or dividends from their practice.  The SBA allows an exception if owners receive written consent from the SBA to take distributions or dividends.

a. For our S-Corporation owners, this is a significant restriction.  S-Corporation owners can still receive a salary, but they cannot take out money in addition to what they receive through payroll until the EIDL is paid back (without written consent from the SBA).

b. For LLCs and partnerships, the same basic rules apply, but members in these entities do not receive payroll; they receive distributions.  Members can be paid distributions that represent reasonable compensation (typically 30 – 40% of collections).  Members cannot receive more than that.

c. In either case, any unauthorized distributions could result in a penalty or worse.  Examples of unauthorized distributions include having the practice pay for a personal expense of the owner or accidentally using the business credit card for a personal expense.  The potential is high for accidentally breaking a provision of the loan agreement.

3. The intent of the EIDL is to provide necessary working capital to pay for operating expenses.  The loan is intended to help practices survive until they can return to normal operations following a disaster.  For practices with enough PPP loan money and/or with enough cash, this loan is likely not a good fit.  The EIDL is not intended to keep as an emergency cash reserve.

4. Accepting the EIDL may prevent you from receiving other government assistance in the future.  We are not sure how significant this restriction may be, but if there is another disaster, government assistance could be limited.

The Bottom Line:

  • Based on what we have learned about the restrictions of the EIDL, we believe it is not a good fit for many clients.
  • However, if you and your practice are truly in survival mode and you need this money to weather this storm, the EIDL is likely a good fit for you.  You will need to prevent personal expenses from being paid by the practice, and you cannot take distributions as outlined in #2 above.  If you need the EIDL to make it through this tough time, we do not think the concerns outlined in #1 and #4 above are strong enough reasons to prevent you from using the money.
  • If you have questions about whether the loan is a good fit for you, please let us know.  Also, if you have already accepted the EIDL and you now know it is not a good fit for you, we recommend you pay it back.  If you are unsure, please contact us and we can discuss the next steps to take.

Comments (8)

  1. Jennifer Gates says:

    I can’t find anyone else online interpreting as you do in #2 above. Nor can I find a copy of the loan closing documents, to see for myself. Indeed, the loan proceeds themselves cannot be used to make distributions. But after the loan proceeds have been appropriately used (and before the 30 year repayment period is finished) months will go by, and the business will become profitable again, at which point we want to distribute profit to our SCorp owner. We might not yet be capable of repaying the entire loan principle amount. In such a situation, can we at least increase the W2 salary paid to our owner/CEO??

    • sb says:

      (bump. Can we have input from fluence?)

      I received an EIDL, do have the paperwork, and can confirm I don’t see a restriction against any distributions/dividends while the loan is outstanding, just a restriction against using those funds for distribution/dividends.

      Now that the business has reopened, I am attempting to ensure I have liquid cash available in the business of the funded amount, less expenses paid during the shutdown/restart. After a few years and risk has abated, planning to repay balance.

      Also, there is a full personal guarantee on my loan due to amount, so moving to personal-side doesn’t keep anything from SBA.

  2. IL says:

    It is in the paperwork (see below). If you are set up as a S-corp where are required to draw a salary, then you can use the EIDL to pay it. However, if you want to take a distribution on top of the salary, you are required to make a written consent to SBA.

    LIMITS ON DISTRIBUTION OF ASSETS

    Borrower will not, without the prior written consent of SBA, make any distribution of Borrower’s assets, or give any preferential treatment, make any advance, directly or indirectly, by way of loan, gift, bonus, or otherwise, to any owner or partner or any of its employees, or to any company directly or indirectly controlling or affiliated with or controlled by Borrower, or any other company.

  3. Narayan Hegde says:

    Dear Sir,
    I have S-Corp and I am the owner and only employee. I have software consulting business.
    I take 50% of income as salary and remaining money as dividend distribution to Owner(my self)
    I applied for EIDL loan and got approved for 150K. Right now I am not short of cash.
    Should I go ahead and accept the loan?
    As you said in this discussion will the Dividend distribution be a problem?

    Thanks for your insight

    Narayan

    • SB says:

      Whether you ‘should’ is a judgement call. Couple thoughts:

      Based on what you wrote: “Right now I’m not short of cash” Do you expect you could be? As software consulting, assuming your overhead is minimal, so risk is probably a concentrated, client-based risk. Presuming you don’t see those clients / your contracts at much risk, otherwise you’d frame this less confidently.

      Noone knows how those SOP will updated/interpreted with this unprecedented expansion of EIDL that is so different from it’s original purpose: Cash-flowing unpredictable damage over a long-period of time vs recovering from a discrete event, would seem to necessitate a change in how these distribution provisions are applied

      Personally, since my businesses risk is mostly in 4Q – took an EIDL early to hedge against SBA running out of funding. I’m keeping EIDL amounts I didn’t use on the balance-sheet somewhere (cash/inventory/LOC payoff etc) in excess of net equity at time of loan, but still paying distributions as before, since current business justifies it; that seems operationally defensible if questioned. Then can make a decision after pandemic stabilizes next year (or year after) on if it is worth the interest or to pay-off.

    • NH says:

      Can you please remove my Full name and put my initial , thanks

  4. Jenna Owen says:

    If your compensation is customary and reasonable in reflecting your current efforts, then those distributions are kosher. One can disburse (distribute) to an owner to the extent directly related to performance of services for the benefit of the corporation. Found in 2018 SBA SOP manual, page 75: https://www.sba.gov/sites/default/files/2018-06/SOP%2050%2030%209-FINAL.PDF

  5. SB says:

    As a form of update, I did request from the SBA how to request approval for a distribution, and received this operative paragraph:

    “Please be advised, the “LIMITS ON DISTRIBUTIONS OF ASSETS” clause in your Loan Authorization and Agreement does not apply to any distribution of assets made in the normal course of business, including distributions to cover tax obligations, or distributions of net income in accordance with the bylaws or operating agreement of the company. It is unnecessary to obtain written consent of SBA for these types of distributions.”

    Surely, they’ve received that question thousands of times, and seems as suspected: they don’t want to deal with routine distributions, or even distributions of net income; rather the language is to leverage ability to claw back distribution of assets that the SBA has in good-faith issued to sustain the business.

    IMHO, if your business is profitable, keep your net equity equal to or larger than it was at the time of assistance; or if not profitable, than not taking anything out more than reasonable wages, and you should be clear.

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