The Paycheck Protection Program (PPP) was created by the CARES Act to encourage small business owners to maintain their workforce or rehire previously laid off or furloughed workers. For more information, see our previous posts here and here.
But does the program really incentivize employers to hire workers back, even when a business has been forced to shut down? In other words, does it make sense for a business owner to take out a PPP loan and hire employees back even if there is nothing for them to do?
The answer is yes. The program encourages employers to hire back employees because it also makes other expenditures such as rent, utilities, and owners pay eligible for forgiveness.
Furthermore, an employer who uses PPP to rehire employees needs to hire them all back, otherwise, the outcome may be worse than doing nothing. The following example demonstrates why.
[Note that the following example is an approximation and does not include all program details and options. In addition, this example only applies to the eight-week period following the receipt of loan proceeds where certain expenditures are eligible for loan forgiveness.]
Consider a business owner who takes a salary of $150,000, and has 10 employees with the following salaries:
Based on this payroll (and assuming no benefits), the business is eligible for a PPP loan of approximately $138K.
In addition, the business pays rent of $5,000 per month and utilities of $500 per month. Along with payroll costs (both owner and non-owner), these two items are eligible for loan forgiveness.
The owner is considering applying for PPP, but he is unsure about whether to use the funds to 1) just pay himself, 2) hire half of the employees back, or 3) hire all of the employees back.
Option 1: Just Pay Owner
If the owner only pays himself back, the amount eligible for loan forgiveness is restricted in two ways. First, non-payroll costs must not exceed 25% of total costs eligible for forgiveness. This reduces the amount of the rent and utilities eligible for loan forgiveness.
Second, by only hiring back himself, the business owner has reduced his FTEs by 91%. Therefore only 9% of the expenditures eligible for loan forgiveness are allowed.
By multiplying 9% by the tentative amount eligible for forgiveness, we arrive at a figure of only $1,865 for loan forgiveness, leaving the business owner with a net benefit of $1,865.
Option 2: Partial Rehire
If the owner were to rehire only the first five employees on the employee roster, this would cost the business $61,538 in pay for the eight-week period. The tentative amount eligible for loan forgiveness includes this amount (capped at an annualized rate of $100,000), the rent and utilities, and the owner’s salary (also capped). This totals $84,077.
However, because only 6 of the 11 employees have been rehired, only 55% of that amount is eligible for forgiveness, or $45,860. This is less than the out of pocket costs to pay the employees. The business owner comes out worse off by more than $15K.
Option 3: Hire Back Everyone
If the owner were to hire all employees back, the cost of that payroll would be $90,769. However, there would be no reduction in the amount of the loan that is eligible for forgiveness, which includes employee payroll costs, rent, utilities, and owner’s pay.
With a loan forgiveness amount of $113,308, and non-owner payroll costs of $90,769 the owner is left with a net benefit of $22,538.
In conclusion, the PPP program design seems to work as intended, encouraging employers to rehire employees that have been laid off or furloughed. Furthermore, the program encourages employers to hire all employees back by making them worse off with a partial rehire. When it comes to PPP, it’s all or nothing.