So You Got a PPP Loan, Now What?

COVID-19 Coverage

At the time the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in late March, the S&P 500 index was off roughly 30% from its all-time high, and many RIAs had seen similar declines in AUM and run-rate revenue.  Since then, markets have recovered significantly, although due largely to Fed action rather than fundamentals.  There is still a great deal of uncertainty and a real possibility that there will be a significant revenue hit for RIAs.  With high fixed costs, that has the potential to cause a great deal of financial strain for many RIAs.

In order to mitigate the potential impact of the COVID-19 crisis, many RIAs applied for and received loans under the Paycheck Protection Program (PPP) established by the CARES Act.  These loans are intended to help small businesses keep employees on payroll during the COVID-19 crisis and may be forgiven if staffing levels are maintained and certain other requirements are met.

The disclosure requirements related to the PPP loans are an important consideration for RIAs—which typically pride themselves on transparency.  The SEC has released guidance stating, “If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance.”  The SEC considers using the PPP loan to pay staff providing advisory services to clients, a “ material fact” that requires disclosure.  Many firms that received PPP loans have already filed revised Form ADVs with PPP loan disclosures.

Many RIA owners are wondering what signaling effect the loans will have on clients.

Now that the loans have been received and disclosure is strongly advised (if not mandated), many RIA owners are wondering what signaling effect the loans will have on clients.  Will clients view PPP loans as a sign their advisor is experiencing financial strain or on the verge of financial insolvency?  Or will clients view it as a precautionary measure rather than a last-ditch effort to stay afloat financially?

We think that when properly explained to clients, there’s little reason for clients to be alarmed by their advisory firm receiving a PPP loan.  A candid disclosure and discussion with clients about the receipt of the PPP loan, its intended use, and its potential impact on the firm is likely enough to put clients at ease.

As a preliminary matter, it is worth putting the size of these loans in context.  The amounts we’ve seen disclosed range from a few hundred thousand to around a million dollars for firms with assets under management in the $1 to $3 billion range.  For firms of this size, this amounts to a month or so of revenue.  That’s not nothing, but it’s not life changing either.  A PPP loan is not likely to make a significant impact on a firm’s solvency.

For most RIAs, the PPP loans are a safety net, not a matter of survival.  Adding capital to the balance sheet makes a lot of sense in times of economic uncertainty for any business.  The balance sheet of an RIA is usually somewhat of an afterthought—money comes in and is quickly used to pay compensation and other expenses.  If there’s anything left, it’s distributed on a regular basis.  All that’s typically retained on the balance sheet is a few months of operating expenses.

Given the current economic uncertainty, it makes sense that RIA owners are paying more attention to their balance sheets.  Adding additional capital to ensure the RIA is able to continue to operate at the same level regardless of what happens in the financial markets is a prudent business decision.  It allows the RIA to protect its staffing level, provide security for its employees, and continue providing the same level of service.  That assurance directly benefits clients.

Many RIAs applied for PPP loans out of an abundance of caution and not desperation.

Many RIA clients are business owners themselves, and many have likely received PPP loans for their own businesses.  We think clients will recognize that in most cases RIAs have applied for PPP loans out of an abundance of caution and not desperation.

It’s also important to note that the economic situation seemed much more dire just a few months ago when RIAs and other businesses began applying for PPP loans.  At that time, the length of the shutdown was still indefinite and the path by which we would return to normalcy was much less clear.  Now that the uncertainty has abated somewhat, many RIAs have found that they didn’t need the funds from the PPP loan during the peak of the shutdown and don’t think they will in the future.  Some RIAs are considering returning the money because they haven’t needed it.

All of that is to say that we don’t view an RIA receiving a PPP loan as a sign for alarm, and we don’t think clients will either as long as the rationale is explained clearly.  The number of RIAs that have received PPP loans is (at least anecdotally) quite large.  At least seven firms on the Dynasty Financial Partners platform have received the loans, as have many of our clients.  While RIA’s profitability may suffer, we ultimately expect that most of the firms receiving PPP loans will weather the COVID-19 crisis with only minimal operational impact, and the PPP loans provide an additional level of assurance that this will be the case.