Venture-backed startups line up for U.S. government stimulus loans after weighing risks

By Jane Lanhee Lee and Krystal Hu

(Reuters) – The COVID-19 pandemic arrived just as Respond Software CEO and co-founder Mike Armistead was trying to sell automated cyber security software to new clients. Most of them are no longer in a buying mood. So Respond Software, a 50-employee, venture-backed startup, applied for about $1 million in government support.

Respond Software, which last year raised $20 million from investors including Foundation Capital and CRV, is one of more than 1.5 million U.S. companies that have applied for the nearly $350 billion in Paycheck Protection Program. The PPP, launched in early April, dispenses low-interest loans that can be forgiven.

But the program, a key piece of the federal government’s stimulus efforts to help small businesses and their employees, has run out of money. The U.S. Small Business Administration, which doles out the loans, said on Thursday it was unable to accept new applications.

For venture-backed startups, deciding whether to apply for an SBA loan is tricky. While the loan is meant to protect jobs and startups are key to job creation, critics say venture-backed startups should be bailed out by deep-pocketed investors, not the government. U.S. venture capital firms invested over $136 billion last year alone, according to data firm PitchBook.

Respond is one of seven startups that told Reuters they applied for the funds after weighing what they acknowledge are legal and reputational risks of seeking support from a program aimed at saving jobs at small and midsized companies, some which have nowhere else to turn, amid the virus-imposed shutdowns of their businesses.

But some venture capitalists and founders who looked at the program said they concluded they could not or should not apply. Applicants have to certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations” and there is no clear guidance on what that means.

Kathleen McGee, a lawyer at Lowenstein Sandler in New York City, said if companies have cash in the bank that will sustain them for a year, then “it’s probably going to be a flag raised for regulators who are combing through these applications at another time.”

In most circumstances, a startup would need to get its board to approve applying for loans, giving some investors de facto veto power.

Companies that have applied include GrowthPlug Inc, a healthcare software startup that raised $1 million late last year and Zammo.ai, a voice command platform that plugs into services like Amazon.com Inc’s <AMZN.O> virtual assistant, Alexa. Zammo.ai has spent a third of the $3 million it raised last year.

“We’re kind of the classic Silicon Valley startup where we’re fighting to get a new kind of category of software that we think is going to be really valuable, started,” said Respond Software’s Armistead. “But that takes time.”

SECOND THOUGHTS

The venture capital industry fought to make sure startups could qualify for the loans. But then, many of the startups have had second thoughts.

Stephen Hyndman, chief financial officer at global venture capital firm GGV Capital, said very few of GGV’s U.S. portfolio companies have applied.

“Many companies that initially were excited about the low interest rate, the expedited process for applying, the potential for forgiveness of the loan, things like that, found it pretty attractive,” said Hyndman. “But then after going through the full consideration of what’s involved here, many are opting out.”

Some startups that have applied, which still have some cash in the bank, say without the loans, they would be laying off workers to make that cash last longer, and they believe the goal of the program is to protect employment.

“My personal opinion is we need to make decisions based upon what’s the right thing to do for the company and the employees,” said Michael Brown, general partner of Battery Ventures. “And if we get it wrong and there’s a bad headline, I’m willing to take that risk.”

Ed Zimmerman, who chairs the tech group at Lowenstein Sandler, said some of his clients have pushed back when he advises against applying. “One thing that I have said to one or two clients is you might not like me very much today or in three months, but I think you’ll like me four years from now when you’re reading about investigations and private lawsuits in the paper and you don’t have this in your background.”

Brett Hellman, founder of tech company MatterApp, a platform for peer feedback, said he thought about applying but decided the program was not meant for a venture-backed company like his, with enough cash in the bank to last two years. Instead he took a 25% pay cut and laid off one of 14 employees.

Startups that need money now can look to venture capital firms for additional investment, he said. “But small businesses, they have literally nowhere else to go.”

Venture capitalists say they cannot pour more money into all their struggling investments.

Jag Puttanna, EmpInfo Inc’s founder and CEO, had never used government loans to fund his employment and income verification startup during the eight-plus years of running it. But he applied for Paycheck Protection Program loans, thinking it is better than turning to investors for cash.

“I’m afraid they may lowball us right now because the revenue is going down,” said Puttanna.

(Reporting by Jane Lanhee Lee in Sedona, Ariz., and Krystal Hu and Chibuike Oguh in New York; Editing by Greg Mitchell and Matthew Lewis)