Last month, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a $2+ trillion emergency fiscal stimulus package, with the intention to mitigate the economic damage created by the Coronavirus pandemic. For many individuals and small business owners who are facing financial hardship, including many financial advisors themselves, the Paycheck Protection Program (PPP), which originally authorized $349 billion in forgivable loans, is a compelling opportunity offered by the CARES Act providing much-needed financial relief.
While the initial round of funding was quickly depleted (as funds were exhausted only 2 weeks after applications were first accepted), Congress is now considering renewing PPP funds with an additional $310 billion. While the opportunity for relief with a loan (potentially one that is tax-free and forgivable, depending on how it is used) is attractive, the question for many financial advisors is whether or not they should take a loan in the first place, as there are many factors for advisors to consider.
First is whether the funds being requested are truly necessary to keep the business running, and whether the advisor really does need the funds as much as the next person in danger of losing their business. PPP funding is forgivable only if used for specific purposes (namely, payroll costs, mortgage interest, rent, utilities, and interest on other loans incurred prior to February 15, 2020); importantly, loans are not intended to serve as a ‘rainy-day’ fund or as reserves for future anticipated hardship.
Another important consideration that advisors should make is around disclosure requirements. As while PPP loans are not required to be disclosed in item 14K on FINRA Form U-4, they may need to be included in Item 18B of the Adviser’s ADV. Furthermore, while the ADV disclosure is not considered a derogatory mark against the advisor by regulatory agencies, clients (or potential clients) may feel otherwise. However, the manner in which the advisor chooses to present themselves to clients can influence their perception of the disclosure (e.g., some advisors who openly talk about the loan with clients have encouraged those who also need financial relief to apply for a loan; this approach has worked well to inspire some clients).
Ultimately, the key point is that the PPP has been (and, if more funding becomes available, can continue to be) a valuable resource that may help financial advisors in financial distress caused by the Coronavirus. While there are many considerations to make before choosing to apply for a loan, advisors should think quickly and be ready to apply for funding should more funds become available.
*** Michael's Note: Be sure to check out our brand new Advisor’s Guide To The Paycheck Protection Program resource page for a run-down of all the important PPP provisions!
- Advisor's Guide to the Paycheck Protection Program
- FINRA PPP FAQ
- Darla Mercado's article about advisors who took out a PPP loan
#OfficeHours with Nerd's Eye View Video Transcript
Hello, everyone. Welcome to this episode of "Office Hours," here at the "Nerd's Eye View." My name is Jeffrey Levine, the Lead Financial Planning Nerd for Kitces.com. Thanks for taking some time out of your schedules to join me today.
Now with our time together this afternoon, what I'd like to do is focus on a question I've been getting an awful lot lately, which is, "Hey, Jeff. Should I be taking a Paycheck Protection Program loan as an advisor?" In other words, "As an advisor, should I be actually going out and looking for myself, not just for my clients, but for myself or my firm, for a Paycheck Protection Program loan?"
What we're not going to do today is we're not going to focus on the nitty-gritty technical aspects of this program. If you want more information on that, such as what counts as payroll, how big your loan can be, how much is forgivable, all those sorts of things, we've got a great guide set up, and it's the Advisor's Guide to the Paycheck Protection Program. And I will include a link so that you can access that information if you want.
Again, today we're just going to focus on the bigger question, which is, "Should I be looking to get one of these loans in the first place?" Now notably, as I record this today, we should be looking at a vote in the House of Representatives to authorize another $310 billion for that program, on top of the $349 billion, which was already exhausted in less than a month, really in a matter of 3 weeks from the time that the program began accepting applications. So we should expect that to pass. We should also expect those funds to run out relatively quickly, so answering questions like this, such as, "Should I be looking to get one of these loans myself?" is really important.
What we are going to do today is focus on four different areas of the question, "Should I take a loan?"
First, we're going to focus on the "necessary aspect" that you need to certify as an advisor when applying for one of these loans, that the loan is necessary due to the current economic uncertainty. The next thing we're going to do is we're going to talk about the possibility of disclosure events for certain advisors. Third, we're going to talk about the potential impact this might have on clients, as well as potential clients in the future. And finally, we'll just touch on, again, an ethical question that is important to at least keep in mind.
Is A Paycheck Protection Program Loan Necessary For Your Advisory Business? [02:25]
With that said, let's start with the biggest issue here that I see, which is the necessary provision. One of the things that you have to certify when you're applying for a Paycheck Protection Program loan is that the loan is necessary due to the current economic uncertainty caused by the crisis. Now, certainly, there is economic uncertainty. No one is going to deny that, right? It's entirely unclear how long this will last, how many waves we're going to see how long people will be set at home. As we're talking today, there are some states looking to reopen, how successful those reopening campaigns will be. So, all of that leads to a tremendous amount of uncertainty.
What is less clear, however, is whether the loan is truly necessary for your business in the way that is intended under this law. Now I understand why everybody's looking to rush out and grab these loans. Is it free money? It's as close to it as we could possibly get when we're talking about money coming from the Federal Government. It is as close to free money as there can be, provided it's used to support employees' payrolls, for the most part.
Now that said, we're seeing more and more indication from the administration that they really want businesses to focus on the 'necessary' portion. Notably, on Tuesday of this week, Secretary Mnuchin was part of the White House briefing, and the issue of what was going on with Shake Shack and some other big companies came up.
And Secretary Mnuchin went out of his way to say that they are going to issue more FAQs in this area so that businesses are aware of who should be and who should not be looking at this. But he also wanted to emphasize the 'necessary' aspect, the 'necessary' provision.
Now obviously advisors are not Shake Shack, right? We're not talking about huge, publicly-traded corporations that probably also had access to a whole bunch of other debt facilities. That said, the necessary provision applies across the board. And here's an exact quote. I want to read this to you because I think it's pretty powerful. What he said was this:
We're going to give people the benefit of the doubt, but we're going to put out an FAQ on the certification, and if you pay back the loan right away you won't have a liability to the SBA or the Treasury.
So what this tells me is that they're taking this relatively seriously. If you're an advisor or anybody else and you've already accepted one of these loans and perhaps now, in retrospect, you realize you shouldn't have; you may want to take the Treasury and the Small Business Administration up on that and repay that to avoid potential penalties. Because what he said, and again, this is another direct quote from Mnuchin, he said, "But there are severe consequences for people who don't attest properly to this certification."
So does this mean that advisors can't get this unless they're dying? No, of course not. You just have to make a good certification that the loan is necessary. So one of the questions that you might ask yourself is, "If I didn't get this loan, would I be thinking or have to layoff people right now? Would I be cutting back hours or thinking about doing that in the immediate future at the very least? Would salaries be reduced? What would I do? Would I have to close locations if I'm a bigger firm?" I think this is really important.
Now what this is not, right, what this is not is, "Oh my goodness. If this continues for another three or four months, I'll have another quarter of down-billing, and then another quarter of down-billing, then I'm going to have to..." That is probably going to have a tough time dealing with the "necessary provision," right? It's not for padding one's own rainy-day fund, whether it be personal or business.
Now put that aside. Let's talk about probably another aspect of this that should be considered, which is the actual type of business. Now, sole proprietors, I think you're in a little bit of a tougher situation here, and the reason why is sole proprietors tend to run very healthy profit margins in this business. And so as a sole proprietor, if you were running a 70% or 80% profit margin before on, let's say, $400,000 or $500,000 of income, even if you saw that cut in half, I think you've got an incredibly difficult time looking to go and apply for one of these Paycheck Protection Program loans because you're running a really profitable business still. It may not be nearly as profitable as it was before, but you're still running a very profitable business.
Which, of course, leads to a question like, "Jeff, how much of a hit do I have to take before I should feel comfortable going out there and applying for a loan to potentially not only pay employees but, as a sole proprietor, maybe pay myself as well." Because that's also part of what this Paycheck Protection Program is meant for. It is clearly authorized for self-employed individuals to include their net earnings from self-employment. And what I would suggest here is that the rules clearly delineate a more than $100,000 cash compensation amount from a less than $100,000 cash compensation amount.
So I would say that if you're looking at this for yourself, right, and your income hasn't been cut, your net earnings haven't been cut below that $100,000 mark, that's probably a good indication that you, your own net earnings themselves, you should not be looking for a Paycheck Protection Program loan. I think that's a good guideline, right? Is it definite? No, we don't have definite guidance there, but I think that's a pretty good guideline. There's clearly a lot of legislative intent here to say we want to protect individuals' incomes up to this $100,000 mark, right? There's substantial legislative intent there that we can interpret it one way. So that's very critical.
The other thing I would mention here, obviously, is that if you're looking at employees, that is completely different, right? Now for larger firms, right, when I say larger firms, let's talk in the 5-to-100-employee range, right? Because if you're less than that, you're probably a small partnership, S corporation, or you're a sole proprietor. And again, it's probably largely your income that's going to suffer here, right? At bigger firms, however, when you're looking at dozens if not hundreds of employees, then we can really start to see those profit margins begin to compress, right?
So a healthy larger firm might only run profit margins of, say, 20%, 25%. And so if we see a contraction in the markets of 20% or 25%, all of a sudden, the entire profit of that firm is gone. There is zero profitability left, and layoffs or hours being cut, whatever you want to call it, are a lot more imminent than in situations where you have much higher profit margins for smaller businesses. So very important to consider that there. Again, is it truly necessary? That's the first question as an advisor I think you really need to ask yourself, is it truly necessary? And again, for your own compensation, if it's dropping below that $100,000 mark, I think you've got a pretty good argument here. If it's below, I think you leave yourself open to a little more of a gray area.
Is Taking A Paycheck Protection Loan A Disclosure Event? [09:53]
All right, so let's move on to our next potential issue, which is, is it a disclosure event? Now thankfully, for those of you out there who are regulated by FINRA, FINRA addressed this very quickly in a FAQ on its website. There was a question at first of, if you got this loan forgiven, would it result in a disclosable event on your U4? Notably, question 14K asks, "Have you compromised with a creditor recently?" And so FINRA said, "No, we're not going to deem this as a disclosable event." So that's good news for those of you who are regulated by FINRA.
However, for advisors… for the actual advisory firm itself… for an advisory firm that accepts its loan, a Paycheck Protection Program loan, there is a real possibility that the firm may have to disclose that loan on 18B of its ADV. Now notably, 18 ADV says if you have discretion or if you have clients prepaying more than $1,200, then in those situations, you have to disclose any financial condition that is “reasonably likely”... those are the words, "reasonably likely"… that results in you not being able to meet your obligations to clients.
I think if you're going to argue on one hand that this loan is so absolutely necessary that you had to receive it based on the economic uncertainty, then I think you have a really hard time at the same point arguing, "Well, it was really, really necessary, but we're also okay. Nothing to worry about here, right? No problems, but we really needed the loan," right? You're talking out of both sides of your mouth. So whether the SEC comes out with guidance, that would be great. That would be fantastic if we had a firm answer here, a firm answer for firms, if you will.
But until then, I think it's entirely reasonable that the SEC would require an advisory firm to answer that question in the affirmative, to answer, "Yes, there is something reasonably likely to impair our ability. In fact, it was so bad that we went out and took one of these loans from the Federal government that was part of the special program that could be forgiven to make sure that our employees could remain on payroll for the current time. Because we just don't know how bad this is going to get," right?
All of a sudden, if you have to lay off a lot of employees, clearly that could impair your ability to meet your obligations to clients. And so that is a really, really important element for us to think about here. Again, there's no clear guidance on this for advisory firms like there is for FINRA-regulated brokers. However, I think it is entirely reasonable to think that the way that that question is worded in 18B of ADV Part 2A, that the answer should be “yes”.
What Will You Be Signaling To Current Or Potential Clients If You Take A Paycheck Protection Program Loan? [12:50]
All right, let's assume that we've gotten past that hurdle. What's next? How about just what sort of impact will this have on your clients and your potential clients in the future? You should assume as an advisory firm that news of your taking a Paycheck Protection Program loan is going to become public at some point, right? You should assume that people will know who took these loans and who did not take those loans. If it doesn't happen, fine. But I would go under the assumption that it will occur. And you want to know, “how will your clients, or how will your potential future clients perceive that?”
And a lot of this comes down to how you present yourself as a firm and what sort of clients potentially you work with. There are some great examples of advisors who have very publicly said, "Hey, we're going for these loans ourselves." In fact, just last week, Darla Mercado, over at CNBC.com, she put out an article with advisors talking about how they went through this process themselves. And I think it's great if you're the type of advisor or advisory firm that is, like, "Hey, we're with you."
Well, maybe that's not the best way to say it. Really what I mean is, "We're just your regular type of people," right, "Just like you," the more down-to-earth-type-feel advisors, right? There are also other advisory firms that go out there, and they want to have this very elevated perception if you will. I hesitate to use some of the words you may be thinking associated with, sometimes the big firms, etc. But you want to make sure that you're talking to your clients where they are, right? And some clients, they want to go into the office and see the advisor in blue jeans, because that's what they wear. And there are other places and other firms where if you walked in and your advisor was in blue jeans, the client would walk out before they even talk to you.
So I think it's just important to know your client and to evaluate the potential impact here. Would your clients be upset? Would they be upset that you were taking this money from a government program that could've gone to other small businesses? Would they be upset that, frankly, you were in the position that you may need the loan, to begin with? Does that raise some level of doubt as to...even if it's not a disclosable event on your ADV, just to your own clients, does it raise some level of doubt or make them wonder and create some issues, or for potential future clients, etc.? Does it stop people from referring you right now? There are all these potential “what-ifs” that you may want to consider.
But for other advisors, that's fine. If you want to discuss this publicly with your clients, maybe you specialize in small businesses, and you want to say, "Look, I'm a small business, and I did this for myself, so I can help you out in this regard, too." So again, just know your business, know your clients.
Is Taking A Paycheck Protection Program Loan Ethical (If Your Advisory Firm Might Not Need It As Much As Other Small Businesses)? [15:38]
And then finally, the last item here is just the overall ethical question, which is, “Do you really need this money?” Even if you qualify, do you really need this money, potentially as bad as other businesses do? This is not an unlimited resource, right? Again, we saw the first $349 billion spent in a matter of weeks, in a matter of just two or three weeks. And so at this point, it's exceedingly likely that this new tranche of $310 billion that we expect to be passed into law today will likely run out relatively quickly, potentially, by some estimates, in as little as 2 days.
So there is an ethical question here whether you really need it as bad as other people. And frankly, that is not a question that I can answer for you. You have to answer that yourself, but it is, again, at least worth considering. And so bottom line here, though, is that if you've met and you're comfortable with all those things, you truly believe this loan is necessary. You’re okay with it being a disclosable event - if that even ends up being the case - or it’s just not something you have to worry about because you’re a broker who benefits from FINRA's existing guidance, or an IAR who is an independent contractor of a Registered Investment Adviser, but not the owner of the investment adviser, itself. You are not concerned about the impact on your clients, and you’re okay with the ethical choices of taking it, which frankly, again, no one would fault you if you qualify, and you truly need this.
As an advisory firm, you should not be treated differently than any other type of business out there. So if you're in need, it's certainly something where you should look to apply for this loan as soon as possible. Because, look, again, it's going to go away very, very quickly. This is like one of those commercials where they say, "Act now while supplies last." Well, act now while supplies last.
Thank you for joining us today. I hope this helps answer some of the key questions we've been getting around this, again, "As an advisor, should I be taking this loan?" Hopefully, this addresses a lot of the key questions or concerns that you may have had. I want to thank you for joining us. Tune back each and every day for updated guidance and information here at kitces.com. Thanks so much. Stay safe, stay healthy, and we'll see you soon. Bye-bye.