United States

Family offices, portfolio companies may qualify for CARES Act loans

INSIGHT ARTICLE  | 

The CARES Act is a $2.2 trillion fiscal policy response to help American citizens and businesses struggling with the severe impact from the coronavirus pandemic.

The law created several important programs to help provide liquidity to small and midsize businesses to cover payroll or other business expenses. The programs all have a different purpose. To qualify, each program carries its own set of restrictions based on employment size and other variables. Here are three of the biggest:

  • Small Business Administration Economic Injury Disaster Loan Assistance
  • Paycheck Protection Program
  • Emergency relief funding: Midsize businesses

The intention of the new law is to help businesses operating on Main Street, and in some cases that might include some family offices that have a vested interest in developing these communities.

What qualifies as a family office?

Family offices can range from a few single-generation members of a wealthy family with common investment and philanthropic goals, to a multi-generational family with contrasting interests and individual investment objectives. Most family offices combine asset management, cash management, risk management, financial planning, tax, accounting, lifestyle management and other services.

Then there is the question of what constitutes a family office. A couple of years back, the commissioner of the Internal Revenue Service challenged the business expenses taken by a family office named Lender Management, LLC.

The IRS argued that the expenses taken were nonbusiness because the company was only managing family wealth. The case went to tax court, and the family office won the ruling. The court said that the family office was determined to be in a trade or business based on its activities, compensation of employees and family relationship.

Ever since that landmark case, a number of existing or newly created family offices have restructured to act like an advisory firm where revenues are driven based on helping to manage the business portfolio for members of the family or unrelated investors. As investment sophistication increased, the result required employing more people to manage investments, handle investor relations or to just pick up the phone at the front desk.

Coronavirus and its fallout

With the downturn in the economy, these office roles may be most vulnerable to any business slowdown. The progression of the coronavirus has disrupted financial markets and slowed down many operating businesses. Companies managed by family offices, like the rest of the economy, are struggling to pay their employees and cover their weekly expenses.

Adding to the difficulty is that some family offices have not invested in technology that allows for working remotely. As states move to stay-in-place policies, these firms are scrambling to work with outside technology consultants to upgrade systems which is eating through working capital.

It all makes for a challenging environment, and portfolio companies must now decide how to manage their payroll, rent, utilities and other ordinary expenses.

That’s where the stimulus loan measures come in. Now, in terms of annual revenues and employment count, some portfolio companies might be classified as a small business under the Small Business Administration. And they could be eligible for loans under the CARES Act.

Counting employees

A critical measure comes down to who is considered an employee, especially with the rise of direct investing by family offices in recent years. These offices are now acting as if they are private equity funds, where they perform the due diligence and sourcing without using an outside adviser.

For a diversified family office with investments in operating businesses, the SBA requires applicants to aggregate their operations with those of any affiliates. An affiliate relationship exists when one business controls or has the power to control another. Companies owned by family offices may be considered affiliated when all the other operating companies and employee numbers are combined.

If the total employee threshold is exceeded – in the case of the Paycheck Protection Program, that number is 500 employees — the family office or operating companies may not qualify for the SBA lending options. Unless policy makers come up with another option, this will be one tough uphill climb.

Other financial services participants like private equity, venture capital and hedge funds are facing similar issues. There are reports that Nancy Pelosi, the speaker of the House, is pushing to remove these restrictions.

A careful analysis of the small business size standards according to the SBA and associated affiliate rules will need to be completed by legal counsel and a qualified lender to confirm eligibility to apply for these loans.

The takeaway

Family offices that are struggling to manage and grow their business portfolio in local communities should consider applying for the SBA loan programs under the CARES Act as a way to help to keep the boat afloat in choppy waters.

This article was originally published on The Real Economy Blog.

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