SBA 504 Loan
A Certified Development Company (CDC) is a nonprofit corporation set up to contribute to the economic development of its community. CDCs are located nationwide and operate primarily in their state of incorporation (Area of Operation). CDCs work with SBA and private-sector lenders to provide financing to small businesses through the CDC/504 Loan Program, which provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings.
Typically, a 504 project includes:
- A loan secured from a private sector lender with a senior lien covering up to 50 percent of the project cost;
- A loan secured from a CDC (backed by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the total cost;
- A contribution from the borrower of at least 10 percent equity.
Interest rates are competitive and usually below market. The rate is fixed for the term of the loan. The loan by the CDC uses the 10 year Treasury note as a benchmark.
The rate on the loan from the private lender can be fixed or variable and is typically indexed to Prime, Libor or Treasury.
A borrower’s rate on the 504 portion of the loan is set when the project is completed and a debenture is sold on Wall Street. At this time the rate is fixed for the term of the loan. The rate tracks the 10 year treasury. With a 504 loan,business owners never worry about a rate increase.
Expenses can be accurately projected since the amount of the mortgage or equipment payment is fixed.
The rate from the 1st position lien holder is determined by the lender and can be fixed or variable. Lenders vary in the benchmarks used to set their rates and are not limited to which index they use. Lenders can use Treasury notes, Commercial paper, Libor or Prime. The CDC always uses the least volatile rate as it’s benchmark, which is the 10 year treasury.
CDC 504 loans are for terms of 10 or 20 years and seek to bring debt service in line with the cash flow generated by the asset. Loans for real estate, either an existing building or new construction are for a 20 year term. Loans used for the purchase of equipment are based on the life of the asset, usually 10 years. An appraisal must support the useful life of the equipment if being financed for 20 years.
All CDC loans are fully amortizing and have no balloon or call features. Longer terms permit lower monthly payments.
The term on the bank’s first mortgage is determined by the lender. Because the bank or other lender doing the 1st lien loan is only at a 50% risk exposure; lenders are usually willing to extend longer terms at favorable rates.
If the CDC loan is a 20 year term, the 1st lien holder must have at least a 10 year term. That loan can have a longer amortization. Most lenders will do a 15-20 year term with a 20 year amortization. Lenders can go out as far as 25 or 30 years on their first lien note. If a CDC does a 10 year loan, the 1st lien lender must have a term of at least 7 years. Most lenders match the CDC’s ten year term.
The borrower provides as little as 10% of the project cost as equity. This allows a borrower to keep more of their cash for working capital or for expansion. An additional 5% is required for any start up business; an additional 5% is required for a single purpose property.
A start up business is defined as having been in business for less than 2 years (documented by tax returns). An example of a single purpose property would be a hotel, a gas station, a water theme park or movie theatre. A start-up, single use property would require an equity injection of 20%.
A borrower may be asked by either the bank or the CDC to bring in more cash if the business has a lack of historical debt service coverage.
Subordinated debt or seller carry back notes can be used towards equity injection; providing the third party lender approves.
To be eligible for an SBA 504 loan, a borrower must be a for-profit business. The business can be organized as a corporation, partnership, sole proprietor, or limited liability company.
The business, and its affiliates, must have a NET worth not greater than $15MM. Average after-tax net profits during the previous 2 years cannot exceed $5MM per year.
The principals (owners) of the business must be US citizens or registered aliens with a green card. Owners must be of good character. Anyone who owns 20% or more of the operating company must personally guarantee the loan.
Liquid assets of the principals are taken into account in determining eligibility. If an owner has enough liquidity to finance the project without the assistance of an SBA 504 loan, the request may be deemed ineligible. If you are unsure of your eligibility, please contact our office and we will help to determine it.
Another lender must be willing to participate in the financing.
The owner-user of the project being financed must occupy 51% of an existing building; 60% of a newly constructed building (with the intent of occupying 80% within the following 3-10 years).
The loan must stimulate the economy through job creation or job retention. Apartment buildings, strip shopping centers, and other real estate investments are not eligible.
Use of Proceeds
The loan proceeds from an SBA 504 loan can be used for the following:
- Acquisition of vacant land for the construction of a building
- Purchase an existing building or construct a new building
- Modernization or renovation of a building including leasehold improvements
- Purchase of machinery and equipment
- Soft costs associated with the project such as title insurance, survey, attorneys fees, appraisals, environmental reports, architects, permits, engineering fees, installation of machinery, and points on bridge loans
NOT Permitted are mortgage broker fees, points on permanent financing, franchise fees, inventory, or working capital
Refinancing is NOT permitted except to take out interim loans and for the next 2 years, it will be permitted to refinance balloon notes on owner-occupied real estate.
The CDC takes a subordinate (second mortgage) to secure its portion of the financing. Other assets of the business or principals are generally not required to secure the loan. Additional collateral may be required if the business is a start-up, if the credit has unusual risk, or if the asset being financed is considered a single-purpose asset or does not appraise high enough.
For its 50% participation in the project, the private lender will have a first lien on all of the project assets. The first mortgage loan from the private lender is not guaranteed by the SBA.
All fees and closing costs related to the SBA 504 loan are added to the loan amount. This lets a borrower amortize their cost over the term of the loan. Alliance Lending and SBA fees are based on the 504 loan amount and cover the costs of packaging and processing the loan application and for selling the underlying bond issue. The fees total approximately 2.16% of the CDC portion of the loan.
Bank or third-party lender fees can include the cost of interim interest and/or a loan origination fee. These costs are determined by the 1st position lien lender.
Alliance Lending does not charge upfront packaging fees. A loan application deposit is collected prior to submitting the package to SBA for a Loan number. The deposit is refunded to the borrower when the debenture funds. If the borrower fails to close the loan, the deposit is not refunded.
A servicing fee is built into the effective rate of the loan. It applies to the declining balance of the loan and is adjusted every 5 years. As the loan is paid down, the fee amount decreases.
A pre-payment premium exists for the first ten years of the loan. The premium declines each year. If you do need to prepay the loan; you can minimize the interest due by pre-paying your loan the month before your semi-annual anniversary.
The long-term fixed rate passed on to a borrower is financed by selling a bond to investors. Investors, such as pension funds, need to know their funds will continue to earn a predetermined rate. Investors are willing to give a fixed rate to a borrower, in return for the promise of a long-term payout.
If you sell your building, a qualified buyer can assume the CDC portion of the loan and pay an assumption fee. In this case, the prepayment penalty would not apply.
The prepayment premium on the first lien is negotiable.