I'm interested in buying a building to house my growing business. Would it be possible to get an SBA guaranteed loan for this purpose?
Moving Up in Memphis
Dear Moving Up in Memphis,
An excellent question about an excellent source of funding. The SBA 504 Loan Program does indeed provide long-term, fixed rate financing for investment in fixed assets. This type of loan is handled through what's known as a CDC (Certified Development Company) and, although this financing has a few strings attached, it's often a win-win deal for borrower, lender, and the local community.
The program is intended to help small and medium-sized businesses avoid large down payments and floating interest rates that are typically associated with the purchases of "bricks and mortar" fixed assets. Section 504 is also aimed at aiding local economies by increasing employment opportunities—therefore the loans are tied to certain job creation mandates. Typically a borrower is required to either create or retain one job for every $50,000 of total project cost.
The loans are extended through an SBA-approved CDC—a private nonprofit corporation set up to contribute to the economic development of its community or region. Typical CDC-financed projects range in size from $500,000 to $2 million, with an average cost of $1 million. The total size of projects using CDC financing is unlimited, but, as with SBA loan guarantees, the maximum amount of CDC participation in any individual project is $1,000,000 or $1.3 million for some public projects.
Participants in a CDC may be banks, utilities, professional organizations, community groups, and private investors. For banks in particular, lending through a CDC is an opportunity for them to meet their bank regulatory requirements for community lending while spreading the risk from those investments among the separate CDC corporate members.
The bank also need not consider its CDC participation against its loan loss reserves. CDCs can also minimize risks by selling 100% SBA-guaranteed debentures to private investors in amounts up to 40% of a project or $750,000, whichever is less. Finally, CDC investing by banks creates an attractive loan-to-value ratio; the bank usually contributes only about 50% of the CDC loan proceeds, yet is given a priority claim against the value of the project or collateral.
The purposes for which a 504 loan can be obtained are "bricks and mortar" type expenditures, including:
- purchasing existing buildings
- purchasing land and land improvements such as grading, street improvements, utilities, parking lots, and landscaping
- modernizing, renovating, or converting existing facilities
- purchasing machinery and equipment that will have a useful life of at least 10 years
- financing a construction contingency fund
- paying interest on interim financing
- paying professional fees directly attributable to the project, such as surveying, engineering, architect, appraisal, legal, and accounting fees.
But be aware that CDC loan funds cannot be used for working capital or inventory, short-term needs, consolidating or repaying debt, refinancing, or financing a plant not located in the U.S., its territories, and possessions.
Eligibility for a 504 loan requires, in addition to the general eligibility requirements for a SBA Section 7(a) loan, that the small business be a for-profit corporation, partnership, or sole proprietorship, have a net worth of less than $7 million, and have after-tax profits averaging less than $2.5 million for the past two years.
Typically, a 504 loan from a Certified Development Company (CDC) requires some financial contribution from the small business before the CDC will provide funding. Contributions to a CDC loan are usually structured as follows:
- Approximately 50% of total funds will come from a bank or other private lender. The borrower will typically have to secure this loan with collateral such as a first mortgage and possibly a personal guarantee of at least the principal amount.
- Approximately 40% will come from an SBA loan instrument. The borrower will typically have to secure this instrument with a second mortgage and personal guarantee.
- 10% to 30% of an equity contribution will come from the small business. The small business's claim must be subordinated to the above two priority lenders.
In addition to this capital contribution, the borrower is also required meet the general criteria for SBA loan guarantees, pledge that at least one job is to be created or retained for every $50,000 of loan funding, show evidence of an existing cash flow sufficient to repay the additional debt, and pay a variety of processing and legal fees.
While this program sounds complicated, and in some ways it is, it would be well worth it for you to investigate it as financing alternative for your business expansion. There are about 270 CDCs operating in specific geographic regions as of this writing. You can learn much more about CDCs by going to the SBA's CDC detail page.