504 Loan Underwriting Considerations

These are the top five questions we ask when we are looking at financing a particular 504 loan request. If you have a client that fits the program but falls short in answering these questions give us a call and we will be glad to work through underwriting the loan on a case by case basis.

How well can the business cash flow debt?

• Cash flow coverage is the single most important criterion in getting a loan approved.
• Plus 1: 1 debt coverage in existing financials is a great way to start.
• We can underwrite on financial projections if they make sense and fit the business model.How strong is the company’s balance sheet?

How strong is the company’s balance sheet?

• We want to see business owners that are invested in their businesses.
• We want to see a post project pro forma debt/worth ration 6:1 or less is considered very good; we can go higher but we will need compensating factors.

What are the company’s operating trends?

• We like to see solid growth or the potential for growth.
• We do not like to see a company relying on just one or two business clients for revenue, the more the better.
• We are looking for a solid accounts receivable and accounts payable by the business indicating good strong business health.

How strong are the company’s owners?

• We like to see some net worth outside of the business.
• Solid credit is important and credit must be acceptable.
• Borrowers must show that they have their down payments seasoned and sourced.

How solid is the project collateral?

• We need to have an appraisal that equals project costs

If you have a question that you would like to ask concerning the SBA 504 loan program please use the form below

[faq ask SBA 504]

Common Questions Concerning SBA 504 Loans

What down payment is required for my project to get financed?

• 10% is required as the down payment. Funds should be seasoned and sourced.
• Special Use properties will require an additional 5% extra and we will help you determine that.
• Any new business will require 5% extra.

How do I know if my project is considered a special use project?

• Best way to determine is can your property be used for multiple purposes? If not, then its considered Special use.
• A car wash, a restaurant, funeral home are examples of special use properties.
• When in doubt an appraiser can normally determine.

What is considered a “new” business?

• Key criteria is ownership experience  and not the life of the business that is being financed.
• Experienced owners can get lower down payments if starting a new business unit in a field in which he/she has ownership experience.
• Inexperienced owners require higher down payments, even if acquiring an existing business.
• People with strong management experience  may qualify for a lower down payment when starting a new business if they hard profit and loss responsibility over a comparable business.

How many jobs am I required to create by using an SBA 504 loan?

• 1 job within the first two years of completion for every $50,000 of SBA financing.
• Waivers do exist for public policy goals; minority owned; women-owned; veteran owned and rural locations are major qualifiers.

Can my business be too big for a 504 loans?

• Maximum net worth of the business should be less than or equal to $7.5 million.
• Average net profit after taxes for any business should be less than or equal to $2.5 million.

Can my business not be eligible for an SBA 504 loan?

• Standard SBA exceptions include finance companies, speculative mining, gambling establishments, etc.
• Some franchise businesses are ineligible for financing because they are overly controlled by the parent corporation which is  common among insurance agents, real estate agents, and financial advisors.

What are the requirements for owning a building with an  SBA 504 loan?

• If acquiring an existing building, the owner can lease up to 51% of the property.
• If the owner is building a new building, the owner must occupy 60% at completion and can lease out an additional 20% for 5 years but then they must occupy 80% the building and can only lease out 20% during the life of the SBA 504 loan.

If you have a question that you would like to ask concerning the SBA 504 loan program please use the form below

[faq ask SBA 504]

SBA 504 Project Structuring Guides

You ready to submit a 504 loan request but before you do use our project structuring guide as a valuable resource.

Hard costs for fixed-asset acquisitions that are eligible with a 504 loan:

• Land
• Acquisition of land and existing building
• Construction and upfit
• Eligible equipment: 10 year useful life, no rolling stock

Soft costs that can be included in an SBA 504 loan are:

• Design Fees
• Appraisal
• Environmental review
• Closing Costs
• Lender Origination Fee
• Interest during construction/interim period
• Contingency reserve (as needed for project)

What exactly is an “equity injection” in a 504 loan?

• Cash invested by business owner is standard source of down-payment
• Owners cannot pledge outside collateral, i.e, lien on vacation home-in lieu of investing cash into the project
• Owners can count previous expense on project, i.e., land down payments and initial architectural drawings–toward the needed down payment.
• If owner has owned project land or building for 2 years or more, the 504 loan program can use the existing appraised value as “base” value for project structure

Typical Limitations for a CDC in a 504 loan program:

• $1.5 million 504 loan maximum for most customers
• $2 million maximum for customers that meet SBA public-policy goals
• $4 million maximum for manufacturers
• They must factor in any other existing SBA debts in determining maximum eligibility of any one borrower

If you have a question that you would like to ask concerning the SBA 504 loan program please use the form below

[faq ask SBA 504]

Conventional Loan vs SBA 504 Loan

SBA 504 Typical Loan Structure

A bank or other lender finances 50% of the project cost and takes a first mortgage (lien) position on the assets financed.  The CDC, through the SBA 504 loan, finances 40% of the project cost up to a cap and takes a second mortgage position. The borrower then contributes a downpayment of as little as 10%.

Typical Project

When you compare a typical bank loan vs the SBA 504 loan you will notice that the conventional bank loan will require an additional $226,500 in order to do the same loan. By using the SBA 504 program a business owner will get the best terms possible with the lowest down payment.  Please note:  an additional 5% down payment is required for certain projects like special purpose buildings (ie. car wash, hotels) or for start up businesses.  For both a new business and a special purpose building, the down payment is 20%.   The seller can provide the 50% permanent financing but, under current regulations, the seller must be co-equal to or subordinate to the SBA 504 loan. The 50% first mortgage can come from a variety of nonfederal sources such as banks, nonbank institutions or government agencies.

Typical Rates and Terms

SBA 504 loans are for terms of either 10 or 20 years.  The interest rate on the SBA 504 loan is set when the SBA sells the bond (debenture) to fund the loan, and the interest rate is then fixed for the duration of the term.  The small business owner’s monthly payment includes program fees and a loan loss subsidy fee which are financed as part of the loan.    SBA 504 debentures are fully amortized securities and have no baloon payments. There is a penalty for prepayment during the first half of the loan term on an SBA 504 loan.

Collateral

The SBA takes a subordinate (second mortgage) to secure its 40% portion of the financing and takes a security interest in assets financed.  Other assets of the business or principals are generally not required. (unless the company is a startup or the credit is unusually risky or the asset being financed is considered a single purpose asset or doesn’t appraise high enough).

Fees and Payments

All of the fees on an SBA 504 loan are added to the loan amount so they are amortized over the loan term and do not represent any “out of pocket” expenses for the small business owner.
Payments on the SBA 504 loan are made by ACH debit from the small business owner’s designated checking account on the first of each month after the loan closes. Payments on the SBA 504 loan are separate from payments on the 50% first mortgage loan.

Are you a candidate for an SBA 504 loan?

You should consider the SBA 504 program any time you want to get financing for an owner-occupied property. Be sure to ask the following questions when considering such funding:

Let’s consider Brett, the owner of a successful local tire store. Brett has a five-year lease on his building.  Although his monthly lease payments are $8,000, they are scheduled to increase $500 per month each year.  Brett, therefore, decides to buy the building for $1.4 million using SBA 504 financing.  He makes a $140,000 down payment and gets 20-year, fixed-rate financing on the balance at 6.5 percent.  His monthly loan payments now total $9,394 ($5,219 for his bank-financed $700,000 loan and $4,175 for his SBA $560,000 loan).   Over the 20-year life of the loans,  Brett will make a total of $2,254,560 in payments.  If he had continued to lease, his monthly payments for 20 years (assuming rent increases of $500 per month per year) would have totaled $3,060,000.  Brett’s net total savings of $805,440 works out to $3,356 per month throughout the life of the loan; in just three-and-a-half years, his net savings will be equal to the amount he spent on the down payment.  In addition,  Brett will reap the benefits of equity appreciation on the property and a possible tax write-off of the depreciation and interest expense. Plus, he will own the property free and clear in 20 years. Quite a winning deal.

SBA 504 financing is not a perfect solution. Some of its downsides include:

SBA 504 Insight!

SBA 504 Loan Program Highlights

• Buy land and build a building
• Build on leased ground with lease being longer than 20 years
• Renovate/expand building already own
• Purchase building currently occupying
• Purchase machinery & equipment with 10 years useful life
• Purchase machinery & equipment with less than 10 years useful life is not allowed
• Lasehold improvements is possible
• Working Capital is not available under this program
• Finance Inventory is not available under this program
• Finance Receivables is not available under this program
• Consolidate Debt is not available under this program
• Restructure Debt can’t be done
• Refinance Debt is limited

Typical SBA 504 Business Profiles

• Start Up Business can be financed
• Franchise’s are acceptable
• Not a franchise, management experience and sufficient cash is acceptable
• Not a franchise, no management experience, no cash is not acceptable
• For Profit Business
• Non-Profit Business can’t be financed
• Radio/TV/Newspaper/Publishing Companies
• Gambling Establishments can’t be financed
• Lending Investment Companies can’t be financed
• Academic Schools can’t be financed
• Trade/Technical/Preschools/Nursery Schools can be financed
• Investor Financing can’t be financed

Ideal Conditions  For A Business Needing An SBA 504 Loan:

• In business at least 2 years
• History of increasing sales
• History of profitability
• History of re-investing profits
• Less than $3,000,000 profit, after taxes
• Less than $8,500,000 tangible net worth
• Negative Net Worth Is Possible
• Will create  jobs as a result of expansion is preferred
• Will not create jobs as a result of expansion can still be financed
• Business will occupy 100% of building
• Business will buy existing building, occupy at least 51% or more
• New Construction-business wants to sublease part of the space

SBA 504 Inside Tips

1. The down payment/equity injection on SBA 504′s could be as low as 10%, preserving needed cash for working capital.
2. Interim financing costs including points, fees, and construction interest maybe included in SBA 504 loan.
3. Appraisals, architect costs, engineering, environmental, and your construction title insurance maybe included in SBA 504 loan.
4. Impact and permit fees; as well as utility hook-up fees are eligible costs in a SBA 504 loan.
5. Equipment and machinery can be financed with a SBA 504 loan.
6. Site improvement costs can be included in a SBA 504 loan.
7. Banks can have as low as 50% Loan to Value Ratio with a SBA 504 loan.
8. Contracts for Deed are eligible for new financing under a SBA 504 loan.
9. Land acquired prior to application for a SBA 504 Loan can be part of the required equity injection, if the land has been acquired within the last 3 years.
10. Change of ownership and purchase of a company is eligible for an SBA 504 loan.
11. For profit golf courses are eligible for SBA 504 financing.
12. A building on leased land can be financed by a SBA 504 loan as long as the lease is longer than the maturity date of the SBA 504 loan.
13. If there is pre-existing debt already secured by Project Property, the debt may be wrapped in bank’s first mortgage as a non-project cost along as there is adequate DSC and LTV.
14. Refinancing of existing debt, not to exceed 50% of the cost of the project, can be done with a SBA 504 loan if the business is expanding, acquiring land, expanding their building, or purchasing equipment.

Now is the time to take advantage of the SBA 504 program. Contact us today!

Small Business=SBA 504

Accessing the 504 Page

The 504 Objective is to achieve community economic development through job creation and retention by providing long term fixed asset financing to small business concerns.  SBA 504 loans provide small business owners with the same sort of attractive, long-term, fixed rate financing available to larger businesses. Funds can be used to buy a facility, to buy land and build a new building, to renovate or expand an existing structure, and / or to purchase equipment and machinery for a business.

The SBA 504 program is a cooperative effort between Community CDC, the SBA and private sector lenders (i.e., banks and some non-bank lenders), as well as the small business concern.

What Businesses Are Eligible For SBA 504 Loans?

The program is intended for small and medium-sized businesses. Large businesses, those with a net worth of more than $8.5 million and / or an average income, after taxes, of more than $3 million for the last two years, may be too big.

What Is The Loan $$$ Limit?

Normally, the 504 loan is limited to 40% of the total project up to a maximum of $1,500,000. However, “under-served” business categories (i.e. rural based, women-owned, veteran or minority-owned businesses; projects located in an enterprise zone; and businesses that export), can secure up to $2,000,000 in SBA 504 funds, and manufacturing firms can apply for up to $4,000,000 in SBA 504 loan program assistance.

What Are The Interest Rates, Terms and Costs?

Interest rates on the 504 portion are fixed at below market rates, set by the market each month when a 504 bond is sold in New York.  The term of the 504 loan may be either 10 years (machinery and equipment loans) or the more common term of 20 years (used on real estate loans). Partner lenders / bankers who provide approximately 50% of the total financing project, will charge their own market interest rates.

What Collateral is Required?

Generally, the assets of the project being financed are adequate collateral for the purposes of the 504 Loan Program. Personal guarantees of the principal owners of the business will be required. In rare and exceptional cases, personal assets may be attached.

Financing

Projects are financed through a unique public/private partnership that involves the small business concern, Community CDC, and private sector lenders. In the 504 loan structure, the small business concern (applicant) puts up a minimum of 10% of the total funds for a project.  Single purpose type facilities could require up to an additional 5% down, and new/start-up businesses another 5%.  Community CDC provides up to 40% or $1,500,000 ($2.0 to 4.0 million in certain circumstances), whichever is less, and the private sector lender provides the balance of the money.  The Community CDC/SBA portion of the loan is at a fixed rate for a term of 10 or 20 years.  The bank portion of the loan is at market rates and terms, negotiated between the small business and the bank.

The Community CDC/SBA portion of the financing is actually funded by the sale of a 100% federally guaranteed debenture on the open market.  The SBA 504 program is a take out financing program.  Community CDC/SBA offer an up-front commitment to finance a project.  The participating private lender provides interim financing, advancing up to 90% of the total project funds during the construction/acquisition period.

After the project is complete, proceeds from the debenture sale reimburses or “takes out” the participating private lender (by the net debenture amount of the original SBA authorization).

Eligibility

Typical candidates for 504 loans are businesses that are for-profit, healthy and have a track record of growth.  The company must be a small business, with a net worth of less than $8.5 million, and an average annual net income after taxes of less than $3 million.  New jobs must be created (or in some instances, job retention will suffice) as a result of the new fixed assets being financed. The rule-of-thumb is that a project must create one new job for every $50,000 of debenture.  However, projects with a high community impact and low direct job impact may be considered when achieving a  Community Development or Public Policy goal (for further definition of these goals please contact us).  Start-up businesses may also be eligible, if, the small business concern can demonstrate that it has:

• Qualified management with related industry experience,
• A strong business plan backed by thorough research and well-based financial protections,
• Access to an adequate amount of working capital, and a 15% (or greater) equity contribution.

So, to be eligible for SBA 504 financing, a business must satisfy four general requirements:

• It must be organized for profit;
• It must be located in the US;
• It must be “small”; and,
• It must be able to demonstrate a need for the desired credit

With regard to the latter point, if funds are otherwise available to the business “on reasonable terms and conditions” from alternative, nonfederal sources, including personal resources, without a 504 Loan, then the business may not be an eligible business. For example, if the total personal liquid assets of anyone who owns 20% or more of the business / businesses are “excessive” then these owners will have to inject more of their own resources into the project and reduce the 504 portion of the financing package proportionately.

Liquid assets include: cash or cash equivalent; savings accounts, CD’s, stocks, bonds; and, the cash surrender value of life insurance policies. IRAs, real estate and other personal property are NOT considered liquid assets.

The “Liquidity Test” used by the SBA to determine whether or not the total of the liquid assets are “excessive” or not, varies with the size of the total financing package associated with the project. When the total financing package is:

• $250,000 or less, each 20% owner must inject any personal liquid assets which are in excess of two times the total financing package or $100,000, whichever is greater.
• Between $250,001 and $500,000, each 20% owner must inject any personal liquid assets which are in excess of one and one-half times the total financing package or $500,000, whichever is greater.
• Exceeds $500,000, each 20% owner must inject any personal liquid assets which are in excess of one times the total financing package or $750,000, whichever is greater.

Use of Proceeds

Eligible Uses of the Proceeds from a 504 Loan:

A small business can only use proceeds from an SBA 504 loan for “sound business purposes” where that phrase is defined as including direct expenditures to acquire, construct or convert a facility for company expansion, such as:

• Land, where the value of the land is determined at cost, if acquired within the last two years, or at the appraised fair market value, if owned for more than two years.
• Site Improvements, such as grading, paving, landscaping, curb and gutter, etc., although, no more than 5% of total project costs can be for “community” improvements.
• Purchase of one or more existing building(s). The Operating Company must occupy at least 51% of the total square footage of the four walls of the project building(s).
• Conversion, expansion, or renovation one or more existing building(s), although the cost of improving a tenant spaces / spaces to be leased out can NOT be included in the SBA 504 financing.
• Construction of one or more new building(s). The Operating Company must occupy at least 60% of the project, with projections indicating that the Operating Company will need some additional space within 3 years and a reasonable intent that the business will occupy 80% of total space within 10 years. SBA 504 financing can NOT be used to improve tenant space with specialized improvements. A contingency reserve for construction cost overruns, not to exceed 10% of construction costs, may be included in the calculation of total project costs for the purposes of a 504 Loan application.
• Acquire and install machinery and equipment, where these assets have a useful life of at least 10 years AND are at a fixed location. Furniture, fixtures and equipment with a useful life of less than 10 years CAN be included in mixed use projects where these are “essential to and a minor part of” the total SBA 504 financing project.
• Professional Fees directly attributable and essential to the project, such as: title insurance fees; architect fees; engineering fees; any required environmental studies or audits; the cost of a project appraisal; any municipal charges; electricity / gas / water hookup charges; the cost of any survey required to provide clear title; and, related legal and accounting fees.
• Repayment of interim financing costs, such as points charged or interest paid to a lender during the interim or construction phase of the project.

Any expenses incurred toward the total cost of a project, other than a land purchase, must be made within nine months of the date that a completed loan application package is received for consideration by a certified development company like Community CDC.

Terms and Rates

SBA 504 loans carry a fixed rate of interest, which is determined at the time the debentures are sold.  10 year terms are allowed for equipment purchases and 20 year terms for real estate; loan terms are based on the type of assets financed, with the requirement that the useful life of the assets must equal or exceed the loan term.

The private lender’s loan must carry a minimum term of 7 years for projects involving machinery and equipment, and 10 years for projects involving real estate.

In either case, the private lender must provide a “comfort letter” to Community CDC/SBA that any balloons on the bank’s portion of the financing will be refinanced, barring any late payments or adverse change in financial condition of the small business concern.

The private lender’s loan may be fixed or variable, with a rate that is “legal and reasonable.”

SBA is great for small business!

When a business is looking for a long-term, fixed rate loan for major asset purchases, a good financing vehicle for that is the SBA 504 loan program. Proceeds from these loans must be used to purchase fixed assets such as land and improvements to buildings, streets, utilities, parking lots and landscaping. The loan can also be used to construct a new building and purchase machinery and equipment. If new equipment is bought, it has to have a useful life and for at least ten years.

The 504 SBA Loan operates as a partnership between a third party lender, a certified development company and the borrower. These types of loans offer many benefits to business owners, including low down payments, below market fixed interest rates and long-term financing.

There are several criteria for qualifying for a loan, including the fact that the business must be a for-profit company with a net worth of less than $8.5mm. The SBA also sets cap on annual earnings of the business at $3mm.The business applicant has to be the primary user of a facility, with a minimum percentage of 51 percent for an existing building, and 60 percent for a new building. A new job has to be created for every $35,000 provided by a Certified Development Company. Passive investment companies, non-profit companies, lending institutions and real estate development companies are not eligible for the 504 SBA Loan.

There are three parts to an SBA 504 Loan. The first part is a mortgage provided by a commercial lender, which can take up to 50 percent of the cost. This carries its own interest rate, terms and conditions. The second part is a loan through a certified development company, which can take up to forty percent with a maximum debenture amount of $1,500,000 for most businesses, $2,000,000 when meeting defined public policy goals, and $4,000,000 for eligible small manufacturers. This term can be as long as twenty years, with ten years for equipment. The interest rate for this is fixed and usually below market. The third part of the payment comes from the borrower, at around ten percent of the total cost. If the business is new, or a new facility is being built with the loan, the borrower may have to contribute as much as twenty percent. The down payment can be cash, equity in land, a building or existing equipment.

As the SBA 504 program can only be utilized to finance fixed assets, it is not the most ideal program if a prospective buyer wants to finance the purchase of an existing business. Goodwill, working capital, and other intangible assets are typically not eligible under the 504 program. This is also a program for “new money” and it cannot be used for refinance. If someone needs to refinance or needs to do a highly leveraged loan that is short on collateral, the SBA 7a program may be a viable alternative.

SBA 504 Debt Refinancing

We have received a lot of questions concerning the new SBA 504 provision that went into effect June 2009  that allows clients to refinance their existing loans by using the SBA 504 loan program. Here are some of the highlights with the new program.

• Any small business planning an expansion may refinance existing eligible debt as long as the amount being refinanced is 50 percent or less of the total cost of the expansion.  The key word is expansion. If they are not expanding operations then they are not eligible for SBA 504 refinancing.
• Eligible debt for this program includes debt that was used to finance fixed asset purchases such as land, buildings, building expansions, or equipment.
• The debt being refinanced must be related to the expansion with fixed assets as collateral. Debt may be refinanced at a different location other than the Project expansion as long as the operation at the other location is a similar operation (with the same NAICS code) as the operation at the Project location. In other words a client can’t take money out of his subject property (hotel) to use towards the use of another type of property (gas station).
• The borrower must have been current on all payments of debt being refinanced for one year prior to the date of refinancing. No exceptions. A verification of mortgage and a paper trail must demonstrate.
• The terms and interest rate must be better than those of the existing indebtedness.
• The business must create or retain a job for every $65,000 guaranteed by the SBA 504 loan.
• These changes are effective for loan applications received on or after June 23, 2009, the effective date of the regulations.

Selling Points of the new SBA 504 refinance program:

• Since 1986 the SBA 504 program has created over 2 million jobs in the United States.
• With the new refinancing provision, small business owners will be able to improve their debt structure and improve their cash flow helping them weather the recession.
• Small businesses can combine two existing mortgages and refinance both into a new 504 structure, even if those debts are for different buildings or assets.
• Lower interest rates than conventional bank loans with higher LTV’s are available through the SBA 504 loan program.
• No balloons. SBA loans have long term amortizations so you do not have to refinance anymore.
• SBA loans are assumable.
• If 2,000 SBA loans are provided in a given year, the annual interest savings will be over 72MM and 15,000 jobs can be created.

If you have a question that you would like to ask concerning the SBA 504 loan program please use the form below

[faq ask SBA 504]