At an already anxious time for many entrepreneurs and investors, the venture capital (VC) and startup community has recently added a major new worry: a debate over whether many startups will need to change their Charters in order to qualify for SBA Section 7(a) loans under the Paycheck Protection Program.
We believe that amending a Charter is one of several ways to achieve the desired goal, but it’s the most cumbersome and expensive way, and there are better solutions. Please read on for a brief explanation and a request for others in the startup community to accept this position. Please stay tuned for a subsequent longer, more detailed article expanding our analysis.
It’s not news that the Federal small-business program got off to a rocky start. There’s confusion around which “protective provisions” trigger “control” under the applicable rules – an important distinction, because a finding of “control” would mean that a startup would have to add together its employee headcount with that of its venture capital investor(s), as well as the many other startups funded by that same VC. If aggregated in this way, most VC-backed startups would likely be ineligible for these loans.
We’ve written repeatedly about which rules apply (“Forbes: Section 301(f) Article,” and “Lowenstein Sandler SBA Section 7(a) Paper,”  to name a few) and more recently, about the analysis of “protective provisions” in the context of SBA Section 7(a) loans under PPP for venture-backed startups (“Forbes: Treasury Clarifies Affiliation Rules”). The remainder of this column will make much more sense if you first read those articles, which interpret and apply the law. By contrast, this column argues for a position we’d like to encourage the community (and regulators) to take.
For those familiar with the interplay between startup/VC financing documents and the “affiliation rules” issues under the PPP’s SBA Section 7(a) loans, here is the position we are advocating and encourage others to adopt: The market and the regulators should endorse multiple paths that will permit VC-backed startups to override protective provisions by (1) a simple agreement between the minority stockholder controlling the veto and the startup, OR (2) a proxy irrevocably empowering other holders of the same security to SHARE control of the veto (for purposes of Section 301(f)(1)), OR (3) to amend or restate the Company’s Charter to remove the problematic provision(s). We request the startup and venture community to support this position and to not assert that the only path is to amend/restate the Charter. This is because, of the three foregoing methods, amending/restating the Charter:
- is by far the costliest,
- is the most time consuming,
- requires multi-party negotiations (which could incent investor misbehavior/holdups)
- requires specific technical legal work (which lends itself to inadvertent technical “foot faults”)
- requires a filing (and a filing fee) with the Secretary of State of the relevant jurisdiction
- entails delay before the filing can “go effective,” and thus before the startup can certify and apply for the loan, and
- should NOT be required by the law applicable to the PPP loans at issue (we note that both the Delaware General Corporation Law (DGCL) and the Model Charter from the National Venture Capital Association (NVCA) should generally authorize waiving a minority stockholder’s preferred stock consent rights outside the Charter).
In short, to argue that the cleanest path to a protective provision override is through Charter changes would subvert the intention of the CARES Act, which is designed to deliver rescue funding to employers who need it with as little friction, cost and delay as possible. This is neither the time nor situation to cause more incurrence of fees, delays and logistical hurdles than is absolutely necessary.
In order to support this position, we will very soon publish an article discussing (1) what a protective provision is, (2) why protective provisions matter, (3) how to amend/eliminate them, and (4) how we’d like people to think about amending or eliminating them.
A Note About Certifications/Liability/Doing Right:
Startups should consider whether they need the funding (see Albert Wenger’s great post about that). The loan application requires the startup’s authorized representative to certify that “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” If your startup has a comfortable cash cushion in the bank and has not been hard hit by the pandemic, reconsider proceeding with a loan application. Further, the person signing the application form, under penalty of law (personally), should carefully consider the statements to which they are certifying, which include:
- “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
- “I understand that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.”
That’s a big deal! If your startup needs the money, please carefully and in good faith, diligence the information needed and complete the application, as required. This is, however, a pause point.
We’re providing analysis in real time, in response to a deluge of new law, new guidance and new commentary. We’ve provided footnotes so you can see what we’ve relied on. We may possibly get this wrong and if we do, the footnotes are there to encourage people to check our work and let us (and others) know if you’re reading it differently. We’re all in this together and want to come up with practical and helpful answers for entrepreneurs and small business owners as swiftly as we can. Please check back soon for the longer analysis and continue to let us know, as so many already have, what you are finding valuable and what you’d like to hear more about. Twitter handle here or email us.
DISCLOSURE: I’m a partner at the law firm Lowenstein Sandler LLP. While we serve as counsel to many startups, growth companies and funds, this column is NOT intended to be legal advice, so do speak with your counsel. Also, this column is NOT intended to encourage applicants to complete the application in any way that is untruthful/inaccurate.
 A corporation’s certificate of incorporation is also called a “Charter.” It’s a publicly available document filed with the Secretary of State in the State in which the corporation has incorporated.
 Ed Zimmerman, “Venture-Backed Startups Can Access SBA 7(a) Loans – What The Experts Aren’t Telling You!,” Forbes (April 1, 2020).
 Lowenstein Sandler SBA Section 7(a) Paper by Matthew J. Moisan, Ed Zimmerman, Lowell A. Citron, Kimberly E. Lomot, and Raymond P. Thek, “SBA Section 7(a) Loans for Venture Capital Backed Growth Companies/Startups Under the CARES Act” (March 31, 2020).
 Ed Zimmerman, “Wait What?! Treasury Clarifies ‘Affiliation’ Rules For SBA Section 7(a) Loans (& Startups Are…),” Forbes (April 1, 2020).
 The NVCA has provided a great open source resource in its Model Legal Documents for Venture Deals (NVCA Model Documents) and you can review the model protective provisions in the currently available term sheet (Model Term Sheet) and related model Charter (“NVCA Model Charter”), though there are other “negative controls” elsewhere in the documents.
 DGCL Section 228 prescribes the ways in which stockholders can consent to action and deliver those consents. That section expressly permits “unless the Charter provides otherwise,” action of the stockholders by written consent (including by email) of a sufficient percentage of holders to approve the change.
 The NVCA Model Charter (last updated January 2018) provides that a set percentage of the preferred can waive the rights of the whole series (or class). That waiver would not require filing an Amendment or Restatement of the Charter. Here’s the NVCA’s language:
“Waiver. Any of the rights, powers, preferences and other terms of the Series A Preferred Stock set forth herein may be waived on behalf of all holders of Series A Preferred Stock by the affirmative written consent or vote of the holders of at least [specify percentage] of the shares of Series A Preferred Stock then outstanding.
Article Fourth Section 8, page 39. This provision ends with the following footnote: “The percentage of shares of Series A Preferred Stock required for a waiver is generally fixed at the percentage (typically set forth in Subsection 3.3) required to amend the Series A Preferred Stock terms.” Subsection 3.3 is entitled “Series A Preferred Stock Protective Provisions” and appears on page 15.
8] As of April 5, 2020, this was the right loan application for SBA Section 7(a) Loans under PPP, though the forms have not been clearly date/time stamped and there were several iterations so we have observed people using outdated applications – that were released within the last week. The one we believe to be currently in force at April 5, 2020 is stamped “OMB Control No.: 3245-0407 Expiration Date: 09/30/2020.”