Eligible Passive Companies and the Paycheck Protection Program

  • Accracy
  • 26th Nov, 2023

If you're like most business owners right now in the U.S., you're probably scrambling to figure out what the Paycheck Protection Program is and how to take advantage of it. One term you might come across while learning about the program is "Eligible Passive Company."

Eligible Passive Companies and the Paycheck Protection Program

According to Small Business Administration (SBA) rules, the SBA normally doesn't loan money to "passive businesses." However, they make an exception for "Eligible Passive Companies."

Here's everything you need to know about Eligible Passive Companies and whether they qualify for Paycheck Protection Program loans.

What is a passive business?

Most small businesses are considered "operating" entities. They make money by selling a product or service.

Passive companies don't have a product or service. Instead, they make money from rental property or other investments, such as stocks or book royalties. For example, say Opportunity Real Estate Holdings purchases an office building and rents the space out to four different businesses. Opportunity Real Estate Holdings would be considered a passive business. That means they typically would not be eligible for an SBA loan unless it qualifies as an Eligible Passive Company.


What is an Eligible Passive Company?

According to the SBA, an Eligible Passive Company (EPC) is an entity that leases property to one or more operating companies for conducting the operating company's business.

Returning to our example above, say Opportunity Real Estate Holdings leases its space to a dentist, an accountant, an advertising agency, and a chiropractor. Because the company leases space to operating companies that use it to conduct their businesses, it may qualify for the Paycheck Protection Program.

However, the SBA has very narrow guidelines for which EPCs qualify for loans and how they may use loan proceeds.

Here are the conditions for qualifying as an Eligible Passive Company:

  1. Lease to an operating company: The EPC must lease 100% of its real or personal property to an operating company (OC). The OC must also be an eligible small business.
  2. Lease term: The lease must have a term equal to or greater than the term of the loan. For example, if there is only one year left on the tenant's lease with no option to renew, the EPC won't be able to get a loan with a two-year term.
  3. Lease payments: The EPC can't make a profit on the lease payments from the OC. In other words, the lease payments can't be more than the loan payment plus a reasonable amount to cover the EPC's costs of owning the property, such as maintenance, property taxes, and insurance.
  4. OC as co-borrower or guarantor: The OC must be a co-borrower on the loan if it receives any loan proceeds. Otherwise, each person with at least a 20% ownership stake in either the EPC or the OC must guarantee the loan.

Should an Eligible Passive Company apply for the Paycheck Protection Program?

Small businesses that apply for the Paycheck Protection Program (PPP) are supposed to use at least 60 percent of the loan proceeds to cover payroll and employee benefit costs. The remaining 40 percent can be used for covering mortgage interest payments, rent and lease payments, and utilities. As long as borrowers follow these guidelines, they can have 100% of the loan forgiven, essentially turning the loan into a tax-free grant.

The issue with EPCs applying for the PPP is that most EPCs don't have a lot of employees. Most holding companies just collect rent or other investment income, pay a small number of business expenses each month, and distribute profits to the owners. For that reason, EPCs with no employees may not be a good candidate for a Paycheck Protection Program loan.

Relief options for passive companies

Many passive companies depend on collecting rents from tenants to pay their mortgages. With the coronavirus pandemic causing a steep drop-off in rents, let's consider a couple options for passive companies.

Single-purpose entities

Many small business owners set up single-purpose entities to purchase real estate. For example, let's consider a fictional company, Matt's Plumbing Supply. A few years ago, when Matt wanted to purchase the building occupied by his plumbing supply company, his attorney recommended setting up a single purpose entity to own the building. Matt set up M1 Holdings LLC to purchase the real estate and lease the space to the operating company.

In the current economic climate, Matt's Plumbing Supply can't afford to pay rent to M1 Holdings because revenues are down. This makes it difficult for M1 to make mortgage payments to the bank. In this case, rather than have M1 apply for the Paycheck Protection Program, Matt may be better off applying for a PPP through the operating entity. Up to 25 percent of the loan's proceeds can be used to pay rent to M1 and still qualify for loan forgiveness.

Economic Injury Disaster Loans

Passive companies that don't have payroll and aren't affiliated with an operating entity might consider applying for an Economic Injury Disaster Loan (EIDL). EIDLs aren't eligible for loan forgiveness, but the SBA doesn't have strict requirements for how the business uses the loan proceeds.

If you are planning on applying for an EIDL loan, you will need to provide your gross revenue and cost of goods sold amounts for your business in the last 12 months. If you don't have those figures handy, you'll likely need retroactive bookkeeping to figure it out. If you don't have a reliable bookkeeping solution in place, Accracy can help.

You can learn more about applying for an EIDL by reading How to Fill out Your SBA Disaster Loan Application.

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