A long-term financing tool designed to encourage economic development within a community

The U.S. Small Business Administration’s 504 loan program is available to all for-profit small businesses to help them purchase long-term fixed assets at a long-term fixed rate. These SBA 504 loans are 10 or 20-year notes with fixed rates for the life of the loan.

The program requires the participation of a bank to provide a business with up to 90% financing on an approved project. The bank is required to loan up to 50 percent of the financing, with the SBA providing 40 percent, leaving the borrower to inject just 10 percent into the project. This formula allows borrowers to conserve valuable working capital, along with improving their cash flow.

The loan has to be for hard assets such as land, building, building expansion/retooling, leasehold improvements or equipment. The business cannot have more than $15 million in liquid assets, nor can it have had net profits over $5 million in the last two years.

The principal owners of the business are the owners of the majority of the business assets. Any owner with 20 percent or more ownership will have to personally guarantee the 504 loan along with the operating company. Some soft costs can be included in the loan, such as attorney fees, interim interest, appraiser’s fees and engineer’s fees. An appraisal and environmental study is required for almost every loan, along with some SBA-specific paperwork.

If the business has been in operation for less than two years or is deemed “special-use,” additional owner equity is required. An example of a special-use business would be a car wash, as such a building would not be easily changed to house a different business if the borrower were to default on the loan.

Equity in the business’ assets can be counted as or toward the needed injection from the borrower. To give an example of this, say a business has owned a vacant lot for many years, and they decide to build a warehouse for their business on that lot. The value of the lot would be counted toward their 10-percent injection requirement, often resulting in no actual monies being required from the owners.

When the government passed the American Reinvestment and Recovery Act in 2009, certain provisions were put in place to allow for SBA refinancing of expanding business’ previous debt. This provision was not temporary, as some of the programs were. It allowed qualified businesses to finance current debt combined with a new loan with extended terms. A business undergoing a $200,000 expansion that had a current mortgage of $100,000 could up the project to $300,000 and extend the payments over 20 years; thus, instead of just adding a new payment, they would get the expansion done without increasing the debt load of the old mortgage.

The current debenture rate (July 2011) is 3.74 percent, which translates into an effective rate of about five percent. Hard to beat, when that is the rate you will pay for 10 or 20 years. No negotiating new terms every few years.

There is a prepayment penalty for paying off early. That would be prior to 10 years for the 20-year loan, or five years for the 10-year loan. You can, however, pay off the higher-interest first mortgage without being penalized by the SBA, thus saving you even more money. The prepayment penalty reduces each year you keep the loan, so if you pay it off after nine years, the penalty is quite small. The SBA loans are funded by selling bonds on the open market, not by using taxpayer monies.

An exciting new aspect of the 504 program is the availability to refinance some older debt without doing a total new project. If a business has a commercial loan at least two years old on assets that would have been 504-eligible at the time it was taken out, 40 percent of that loan could be paid off with a new 504 loan at a lower interest rate with longer terms.

Businesses that are speculative in nature do not qualify for 504 loans. This includes residential housing, apartment buildings and investment property. An assisted-living facility does qualify because of the services provided, whereas, a mini-storage facility does not, because the income is passive—the owner is providing space, but no real services. The operating company must occupy at least 51 percent of the space to qualify for a 504 loan, and no 504 monies can be used to improve the non-504 portion of the property. iBi

Illinois Business Financial Services is a Certified Development Company that works in partnership with the U.S. Small Business Administration. For more information, visit
ibfs.org.