Why you may want to pay back your EIDL loan ASAP
Many borrowers aren't aware of the many restrictions and hefty penalties that come with the loan.
If you are planning on giving bonuses to your team this year-- or for the next 30 years-- and you have taken an Economic Injury Disaster Loan (EIDL), you had better think twice.
Back in March, when COVID hit and the government flooded the market with stimulus programs, it also rolled out a streamlined process for EIDL loans, saying that the borrower needed to show "substantial injury" due to COVID-19. Most companies, uncertain of the effects the pandemic would have on their businesses, assumed they would sustain substantial injury, and applied.
However, just because it was easy to apply and receive the money, doesn't mean it's a good idea to keep it. There are a number of reasons why we have concerns.
"Substantial Injury" is strictly defined
According to the SBA regulations, "substantial injury" is defined in very strict way-- that the business "would be unable to meet its obligations and pay ordinary and necessary operating expenses in the normal course of business."
So, if you happened to have cash reserves, an untapped line of credit or other money on the sidelines when you applied that could have helped you continue operations, you may run into trouble with your loan. But what about revenue declines or expense increases-- don't those count as "substantial injury?"
According to the SBA- a revenue decline or expense increase alone does not reflect "substantial injury." Most businesses have managed to continue operations, albeit at lower revenues and smaller staffs. Unless your business was severely impacted (think travel, entertainment, retail and hospitality industries), and you could have managed to continue operations without the loan by right-sizing your organization to the demand, it is likely you will have a hard time justifying "substantial injury."
Not being able to prove "substantial injury" is just the first of our concerns.
Disallowed Use of Funds
So if your business fared better than you expected after receiving the loan, there are a whole host of restrictions that many borrowers will have trouble complying with, including paying bonuses to employees and dividends to owners.
The loan documents you signed for your EIDL loan are very clear. EIDL proceeds cannot be used for:
• Payments of dividends or bonuses
• Distributions to owners – except when directly related to performance of services (salary)
• Repayment of stockholder loans/principal loans
• Expansion of facilities or acquisition of fixed assets
• Refinancing long-term debt
• Paying off other SBA or Federal loans
• Payments for non-compliance penalties
• Contractor malfeasance
You may already be out of compliance with your loan if you happen to pay some personal expenses through the businesses, have taken a draw, or gave bonuses to employees this year.
The SBA is very clear in it's wording: “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.”
That means for the next 30 years you will be unable to pay bonuses without written consent from the SBA. And it's pretty clear, even "indirect" bonuses fall under this restriction, so getting creative in how you bonus your team may also put you at risk.
Violations come with hefty penalties
So what happens if the SBA finds out you aren't in compliance with the terms of the loan? You could be subject to huge fines. According to the SBA, if the borrower violates any of the terms and conditions of the loan, the loan will be in default and you could face civil and criminal penalties up to 1.5 x original loan amount, in addition to having to pay the loan back So if you received the max loan amount of $150,000, your fine alone could be $225,00, on top of paying back the loan for a total out of pocket of $375,000! Add in criminal and civil penalties for being in default, we'd recommend taking a good hard look at keeping the loan.
So what do you do?
Claiming ignorance of the loan terms and restrictions won't fly with the government so if you don't meet the requirements, the best thing to do is to pay the loan back as soon as possible by going to this website. Even if you are found in violation of the loan terms, at least you can show you recognized the issue and returned the funds, which could help in negotiations with the SBA down the line.
What happens if you've already spent the money?
We recommend you pay back as much of the loan as you can, then assess how you may be able to pay back the rest over time, starting immediately. You'll need to make sure your cash situation can support it, and we (always) recommend having a 13 week and 12-18 month cash forecast in place to figure out how you can pay it back.
Unfortunately, the risks of keeping an EIDL loan outweigh the benefits of having the cash on hand. If your business fared better than you expected from start of the crisis, or if you have had to adapt your business to meet the demand and you are still managing to operate, we'd recommend taking a good hard look at keeping the EIDL loan. 30 years is a long time to be restricted, and the penalties are hefty.
If you need help figuring out how you are going to pay back your EIDL loan, contact us. We'll help you determine how to work in repayments to your cash plan.