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What is an SBA 504 loan?
An SBA 504 loan provides long-term, below-market, fixed-rate financing to small businesses for construction and renovation of facilities or to acquire real estate, machinery, or equipment. The loans are administered by Certified Development Companies (CDCs), such as Souris Basin Certified Development Company. 504 loans are typically financed 50 percent by a commercial lending institution such as a bank, 40 percent by the CDC, and 10 percent by the business itself.
In exchange for this below-market, fixed-rate financing, the SBA expects the small business to create or retain jobs or to meet certain public policy goals.
Basic Eligibility for 504 Financing:
- Be an operating business or an “eligible passive concern” (leases real or personal property to the operating company for use in the operating company’s business)
- Be organized for profit
- Be located within the United States
- Be “small” under the program size standards: Tangible Net Worth ≤ $7MM and Net Profit ≤ $2.5MM (2 year average). Can use 7a size standards as an alternative
- Demonstrate the need for desired financing (credit not available elsewhere)
- Meet an “Economic Development Objective” of the program
Economic Development Criteria:
- Jobs – create or retain one Full Time Equivalent job for every $65K of SBA guaranteed dollar in the project. Job creation within the first 2 years after project placement. Retained jobs are jobs that could be lost, but not for the project AND/OR
- Community Impact – Improve the local economy, bring new income into the area, assist manufacturing firms, etc. AND/OR
- Public Policy Goals – National objectives such as rural development, expanding exports, expanding opportunities for veterans and woman, revitalize a business district, etc.
Ineligible Types of Businesses:
- Non-profit institutions
- Finance businesses: banks, finance companies, insurance companies, etc.
- Real estate development and other speculative businesses
- Business located in a foreign country
- Pyramid sales distribution
- Businesses deriving more than 1/3 of revenue from legal gambling
- Businesses that limit their membership for reasons other than capacity (women only gyms, etc.)
- Government owned entities (except Tribal)
- Businesses principally engaged in teaching religion or religious beliefs
- Those that have previously defaulted on a Federal loan
- Those involved with illegal activity, prurient sexual nature, etc.
Maximum Loan Amount:
- Eligible entity may borrow up to 40% of the project or a total SBA guaranteed portion of:
- $1.5MM if the objective is job creation or community development
- $2.0MM if the objective is a public policy goal other than manufacturing
- $4.0MM if the economic development objective is manufacturing (NAICS 31, 32, 33)
Credit Criteria:
- Repayment ability, cash flow coverage of 1.25:1 or better is desirable
- Collateral generally limited to the asset financed, additional collateral may be required if cash flow or other credit criteria is inadequate, may also require additional equity
- Personal guaranty required of any 20% or more owner
- Life insurance may be required if management succession is an issue, environmental issues, appraisals.
Eligible Uses of Proceeds:
- Acquisition of land
- Land improvements
- Purchase one or more existing buildings (Must occupy 51%, cannot make tenant improvements)
- Remodel, convert, expand, or renovate existing buildings
- Construction of a new building, owner company needs to occupy at least 60% with plans to occupy 80% in 10 years. Can lease up to 20% indefinitely
- Acquisition of machinery and equipment with a 10 year or more useful life
- Construction related costs such as a contingency reserve, professional fees, and repayment of interim points, fees and interest
Ineligible Use of Proceeds:
- Working capital
- Debt refinance (except for eligible interim financing)
- Franchise fees
- Incorporation or other organizational costs
- Commitment fees, origination fees, brokers fees, counseling fees
- Rolling stock (autos, trucks), boats, airplanes
- Equipment/furnishings with less than a 10 year useful life
Typical Financing Structure:
- Bank 50%
- 504 program 40% - maximum – subordinates to bank
- Equity 10% equity may increase to 15% to 20% if asset financed is “limited use” or if the company is a start-up or both, equity can be in the form of cash or equity in real estate
Advantages for Borrower:
- Low down payment
- Fixed interest second mortgage
- Long term financing
- Collateral usually limited to assts being financed
- Rate of private sector financing usually more favorable
- Loan is assumable
Advantages for Lender:
- Excellent loan to value ratio
- U.S. Government as subordinate lender
- May participate in project that would exceed their lending limit
- Less red tape than a 7 (a)
Advantages for Community:
- Jobs
- Capital investment
- Greater access to capital
- Stimulation of development
Disadvantages for Borrower:
- Prepayment penalty for first half of the term of the 504 loan
- Limited to financing of fixed assets
- Some reporting requirements (job creation/retention notes)
- Restricted methods of payment ACH Payment ONLY!
Disadvantage for Lender:
- Participation fee ½ point, passed on to the borrower.
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