What is an SBA 504 loan?
The SBA 504 loan program is a partnership program between a Certified Development Company (CDC), such as SPEDCO, and a lender. The SBA 504 loan program is an economic development program that promotes growth and job creation in American small businesses by providing fixed-rate, long-term financing for land, buildings and manufacturing equipment or machinery.
What is the job creation ratio required with an SBA 504 loan?
The job creation requirement is one job per $65,000 of SBA loan funds received.
Are there any special programs or exceptions to the job creation requirement?
Yes, the SBA 504 program has established Energy Efficiency/Public Policy goals that recognize the importance of ‘green’ initiatives by allowing special exceptions to the job creation requirements. Projects that meet one of the following new energy goals are eligible for SBA 504 loans without needing to create or retain jobs:
- Reduction of energy consumption by at least 10%
- Increased use of sustainable designs that reduce the use of greenhouse gas and non-renewable resources and minimize harmful environmental impact.
- Installation of equipment and/or upgrades that will process renewable energy sources.
Eligibility & Restrictions:
How does the SBA define “small business”?
For purposes of an SBA 504 loan, a business qualifies as “small” if it is a for-profit enterprise; is independently owned and operated; does not dominate in its field; does not have a tangible net worth in excess of $15 million, and does not have an average net income in excess of $5 million, after federal taxes, for the two preceding years. The SBA will make loans to sole proprietorships, corporations, partnerships, limited liability companies and combinations thereof. For example, a common loan structure is to have a Limited Liability Company own the real estate, and lease it back to an Operating Company, which is an S-Corp.
Do “start-up” companies qualify for an SBA 504 loan?
Because the eligible uses for an SBA 504 loan are limited to real estate and machinery/equipment (excluding office equipment and computers), the loan program is primarily geared towards existing businesses which are seeking to expand. Start-up companies are not excluded from using an SBA 504 loan, however, the SBA will require a higher level of injection from the company than the 10% minimum.
Is an applicant with personal liquidity disqualified from receiving funds through the SBA 504 loan program?
A three-level test based upon the size of the total financing package is used to calculate when liquid assets must be used by the borrower to reduce the SBA portion of the package. Liquid assets include: cash, savings accounts, CDs, marketable securities, and cash surrender value of life insurance. Assets that are NOT considered liquid include: real estate, closely-held non-marketable stocks, IRAs, 401(K) or Keogh Plans or other retirement accounts. The SBA requires personal resources that exceed the maximum amount be injected into the total financing package when the owner’s liquid assets exceed the amounts below:
The amount of Personal Liquid Assets that must be injected into the project is the amount exceeding:
- $250,000 or less: 2x the total financing package, or $100,000, whichever is greater.
- $250,000 – $500,000: 1.5x the total financing package, or $500,000, whichever is greater.
- $500,000 or more: 1x the total financing package, or $750,000, whichever is greater.
Is an applicant automatically ineligible if they have had a prior bankruptcy?
If the bankruptcy was more than five years ago, and if there is a satisfactory explanation for it, the applicant may still be eligible for the SBA 504 loan program.
What ongoing restrictions and loan covenants will the SBA require?
Some typical covenants include the following:
- A change in ownership or control of the business must obtain prior written consent of the SBA.
- Each May and October the business must furnish evidence that real estate taxes have been paid.
- The business must provide evidence of hazard insurance on business property on an annual basis in an amount equal to the SBA loan.
- Corporate tax returns or annual financial statements prepared by an accountant on at least a compilation basis must be provided.
- The business must get SBA consent in writing in order to incur any additional encumbrances on the collateral securingthe SBA loan.
- Life insurance is generally required on all key individuals.
It is unusual for the SBA to impose covenants referring to cash flow coverage or other financial ratios, although it is acceptable for the bank to do so.
Loan Amounts & Rates:
What is the maximum loan amount available under the SBA 504 program?
For typical projects the maximum SBA loan amount is up to 40% of the total project costs with a maximum dollar limit of $5,000,000. An exception to this rule exists if the applicant meets some public policy goal. In these cases up to $5.5 million may be obtained if the company meets at least one of the following criteria:
- Business facility is located in a rural area.
- Business facility is located in a business revitalization district.
- Operating Company is majority-owned by either a woman or a veteran.
- Operating Company is defined as a small manufacturing company with its primary NAICS code being in sectors 31, 32 and 33, and all of its production facilities are located in the United States
- Business facility meets certain specific environmental or energy efficiency “green” goals
Another exception to the Size Standard is that up to $5,500,000 may be obtained for:
- Each Project for Small Manufacturers
- Each Project that reduces the Borrower’s energy consumption by at least 10%; or
- Each Project for plant, equipment and process upgrades of renewable energy sources such as the small-scale production of energy for individual buildings or communities’ consumption, commonly known as micropower, or renewable fuel producers including biodiesel and ethanol producers.
Can there be more than one Project funded with an SBA loan?
There can be more than one Project (for small manufacturers and eligible energy projects) for the same applicant or for its affiliates. The $5,500,000 per Project is not reduced by other prior SBA loan amounts outstanding because the $5,500,000 is a limit per Project, not a limit for each small business concern.
Note: SBA504 loans made for Projects for small manufacturers or eligible energy loans as described above do not reduce the $5,000,000 limit for each small business concern for regular SBA 504 loans and loans for Public Policy Projects.
What determines the SBA interest rate and when can I lock into the rate?
The interest rate for 10- and 20-year SBA 504 debentures is loosely based on a “spread” or premium over the 5- and 10-year U.S. Treasury rates, respectively. This spread will vary from offering to offering, reflecting current market conditions.
The interest rate is set approximately six weeks after the project is totally complete, a Certificate of Occupancy is issued, all construction funds have been fully advanced and lien waivers have been collected for the project.
Loan Structure & Projects Costs:
Can seller-subordinated financing be used as the equity portion of the project?
While technically eligible, seller financing is considered a credit decision that is made on a case-by-case basis. If accepted, the seller must agree to subordinate his/her interest to the bank and SBA, and agree to sign a Subordination Agreement disallowing principal payments on the loan. If project assets are used to secure the seller’s Note, the term of that Note must match the term of the SBA loan. However, if the seller’s Note is secured by a non-project asset, the term need not match the SBA loan term.
Are SBA 504 loans assumable?
Yes, as long as the SBA/SPEDCO have an opportunity to review both corporate and personal financial information on the proposed borrower(s) in advance of the sale. One note of caution: the release of the original borrower’s personal guaranty is NOT automatic with a loan assumption.
Is it possible to purchase both real estate and equipment at the same time using an SBA loan?
Yes – in two possible ways. It is possible to prepare “companion” SBA504 loans – one 20– year loan for the real estate, and another 10–year loan for the equipment. Or, if the weighted useful life of the equipment does not “drag” the overall life of the project below 20 years, we can prepare a single application that includes both real estate and equipment.
Equity, Leaseback & Rental:
I bought land several years ago that is worth much more now than I originally paid for it. Can I contribute the land to my building construction project as equity? Will it be valued at cost or market value?
Land may be used as the equity injection in the project. The appraised value may be used if the land was acquired more than two years prior to the application date and the appraisal is accompanied by a title report covering the sale history for the past five years. Otherwise, the lower of cost or market value must be used.
The borrower’s contribution may include the buildings and site improvements on the contributed land as long as they are used in the project.
I am buying a building at less than market value. Can I use the equity in the property as my 10% equity injection?
No, the project value will be based on the lower of cost or appraised value. However, an exception to this rule is that a “land write-down” on unimproved land DOES qualify as equity.
My accountant told me that there are tax advantages to me if I own the real estate personally and lease it back to my company. Is this practice permissible to the SBA?
Yes, however, anyone who owns 20% or more of either the real estate OR the company will be required to sign a Personal Guaranty for the entire amount of the SBA loan.
An Employee Stock Ownership Plan (ESOP) owns a portion of the stock of the corporation and I own the remainder. I plan to own the real estate personally and lease it to the corporation. Must the ESOP provide a guaranty for the loan?
If the ESOP owns 20% or more of the corporation at the time of application, then a guaranty would be required. If the ESOP cannot provide such a guaranty, then a beneficiary must do so.
The SBA may occasionally waive the requirement for a guaranty from an ESOP if the 504 loan has been made to the operating company. Please contact a SPEDCO loan officer with specific details for a more in-depth ruling.
Is it permissible for two or more owners (such as two doctors each owning his/her own practice) to jointly purchase a building using the SBA 504 loan program and then lease back space to their individual businesses?
While it IS permissible for two (or more) unrelated owners to purchase or construct a building together, then each lease back a portion, borrowers should keep one important fact in mind: in order to qualify, each person who owns 20% or more of either the building OR either of the operating companies must offer a full personal and corporate guaranty on the entire project.
Another possibility would be for the two owners to turn the building into a condominium, with separate legal descriptions. In this way, each person will be asked to guaranty own his/her own portion of the building.
Because I expect my company to continue to grow rapidly, I would like to construct a building larger than what I will need at first. Is it possible for me to rent out some of the space for a few years?
For new construction, the SBA permits rental of up to 40% of the space in the short term; however, by viewing the company’s projections, the SBA expects that the borrower’s company will occupy 80% of leased space within 10 years of the loan. Only 20% of the total area may be leased out permanently.