Small firms can use the special financial product known as an SBA 504 loan to finance large purchases like equipment and real estate. A bank or credit union gives 50% of the capital for SBA 504 loans, a certified development corporation (CDC) provides 40%, and the borrower pays the remainder, or 10%, as a down payment. This makes SBA 504 loans special.
Since these loans can be used to improve or buy long-term fixed assets, they are crucial for small enterprises. An SBA 504 loan can be used by small enterprises for land, equipment, furniture, buildings, and parking lots; however, it cannot be used for simple real estate investments or inventory purchases.
Although SBA 504 loans are limited to $5 million, certain projects may qualify for more than one loan from the Small Business Administration (SBA). About 5,900 SBA 504 loans worth $6.4 billion were issued by the SBA in 2023.
Understanding SBA 504 Loans
For small businesses trying to fund the purchase of significant permanent assets such as real estate and equipment, knowing SBA 504 loans is essential. The goal of the SBA 504 loan program is to promote job development and business expansion. It provides long-term fixed-rate financing made possible by an alliance between participating lenders and certified development corporations (CDCs).
There are two loans associated with the SBA 504 loan. A SBA-guaranteed Community Development Center (CDC) may provide up to 40% of the loan amount, compared to up to 50% from a regular lender. Generally speaking, the borrower must provide an initial deposit of 10% equity. An increased equity contribution can be required for newly established companies or those purchasing assets for specific uses. Normally, the maximum amount that can be borrowed is $5 million, but for qualified energy-related initiatives and small industries, it can go up to $5.5 million.
Essential components of SBA 504 loans consist of:
- Loan sums between $25,000 and $5.5 million
- Ten years for technology and twenty years for real estate are the set repayment terms.
- Interest rates with a competitive edge that are based on US Treasury rates
The SBA 504 loan program, which was established to promote economic growth, has been essential in achieving this goal. Specifically, the program requires businesses to create or maintain one job for every $75,000 in SBA financing. Beyond employment figures, the program supports modernization initiatives that boost production, boost local economies, and increase competitiveness. Examples of these initiatives include the use of robotics and the renovation of buildings to comply with health and safety regulations.
SBA 504 Loan Fundamentals
The Small Business Administration (SBA) guarantees SBA 504 loans, and it collaborates with certified development corporations (CDCs) to provide these special loans to small firms.
How an SBA 504 Loan is Structured
Three parties are involved in the 504 loan program: the borrower, a Certified Development Company (CDC), and a lender certified by the SBA. The SBA certifies and regulates the CDCs as nonprofit organizations, and they collaborate with eligible lenders to guarantee the loan. Typically, the loan bundle is composed of three parts:
Conventional first Mortgage: The planned asset will be used as collateral, and the CDC and an outside lender will each provide 50% of the loan’s funding.
Second Mortgage: as much as forty percent of the loan’s funding will come from the SBA, which will accept a second mortgage as collateral.
Equity Investment: Generally, a deposit of ten percent is required from your company. In case your company is new or you’re creating special-purpose assets, the SBA might demand a down payment of up to 20%.
What Can I Use an SBA 504 Loan For?
In general, only expenses that meet specific requirements are eligible to receive SBA 504 loans.
Extended Period: An SBA 504 loan may be available for projects like constructing a new parking lot or buying a large piece of equipment, but short-term costs like marketing and inventory are typically not eligible.
Fixed: Generally speaking, fixed assets are physical, long-term investments that bring in money for the company. In layman’s words, fixed assets are the tangible, long-term items that a firm employs daily, such as a warehouse or a piece of production equipment.
Assets: Payroll and rent are examples of expenses, not assets, even if small firms do from time to time look for loans to cover them. To put it another way, SBA 504 loans are typically meant to be investments in long-term tangible assets rather than just to pay bills.
Who is Eligible for an SBA 504 Loan?
To be eligible for an SBA 504 loan, companies need to fulfill seven requirements:
Be a company that is in operation: These loans for investing in a running business are guaranteed by the Small Business Administration.
Make money via operating: Loans under SBA 504 are not available to nonprofit organizations.
It exists in the United States: Since the SBA is a U.S. government initiative, companies with operations abroad are not eligible.
Fulfill SBA guidelines for business size: Section 121 of Title 13 of the Code of Federal Regulations establishes standards for the SBA’s definition of a “small business.” These prerequisites include having a typical net annual income of less than $5 million and a net value of no more than fifteen million.
Not be a type of business that is excluded: Certain exceptions aren’t qualified for SBA 504 loans; these include casinos and multiple-level marketing firms.
Not eligible for credit from any other source: Stated differently, the SBA extends SBA 504 loans exclusively to companies unable to secure equivalent conditions from another lending source.
Have a good credit history and prove that you have the means to pay back the loan. For a business to be eligible, it needs to be able to make payments on the loan.
SBA 504 Loan Parties
The majority of conventional loans are made between a lender and the recipient. The reason SBA 504 loans are special is that they involve a certified development corporation, or CDC, as a third party. Each party’s role is as follows:
- Participating Financial Institutions: These are outside lenders who consent to take part in SBA 504 loans; they are usually banks or credit unions. They typically provide 50% of the loan’s capital, but because the borrower and the CDC provide the remaining 50%, their risk is slightly reduced compared to a conventional loan.
- CDCs: CDCs usually contribute 40% of the total capital. The SBA’s cooperation with these approved development enterprises ensures their loan participation. The loan terms can be adjusted to determine the percentages that each organization contributes.
- Borrowers: The small firms that apply for the loan and use the funds for long-term fixed-asset renovations are the borrowers. Typically, they deposit 10%.
The SBA. Although they are not a party to the loan, the SBA is nevertheless involved. They are both the loan’s guarantors and overseers as they establish the regulations that govern SBA 504 loans and guarantee the CDC’s share of the loan, which may be greater than 40%.
SBA 504 Loan Structure and Terms
Certain terms of SBA 504 loans are prescribed by the SBA, but the borrower, the bank or credit union, and the CDC can negotiate other terms.
Interest percentages: Although there is no fixed interest rate for SBA 504 loans, participants also usually do not negotiate interest rates because rates are determined by the current market rate.
Loan Total: Individual loans are limited by the SBA to $5 million, or $5.5 million for suitable energy projects; however, certain projects may qualify for multiple loans.
Loan Duration: SBA 504 loans are offered with maturity terms of 10, 20, or 25 years; however, the borrower, CDC, and the financial institution can work out details like early repayment penalties.
Benefits and Drawbacks of SBA 504 Loans
The main advantage of an SBA 504 loan for borrowers is that it enables them to acquire or enhance a long-term asset. They get the advantageous rates that the SBA sets and SBA 504 loan terms are inherently better than those they can get from other lenders.
Because SBA 504 loans carry less risk than conventional commercial loans, lenders prefer to work with them. After all, the SBA provides a sizable portion of the funding through the CDC.
SBA 504 loans have the disadvantage of being time-consuming to obtain. A lot of paperwork is needed for SBA loans, but FileInvite makes the process simple.
Documents Needed for the SBA 504 Loan
A 504 loan application needs a lot of supporting documentation because it’s a federal government loan. However, there are actions you can take to speed up the procedure and improve the competitiveness of your application.
- Prepare Financial Documentation
- Financial documents must be ready once you’ve decided a 504 loan is the best option for your company. This comprises:
- Statements of business finances
- The proprietors’ financial statements
- Returns of business taxes
- Assess Your Business’s Creditworthiness
Although there isn’t a minimum credit score required by the SBA, your lender probably will. Lenders often want a minimum score of 680. However, a lower score does not automatically rule out your company. Your credit score is only one of numerous considerations your lender will take into account, just like with every other loan application. Recall that the lender is only concerned with the credit score of your company, not your score.
Gather Additional Required Documents
Apart from the standard financial records mentioned above, you will additionally have to send in a:
- Plan of business
- Statement of Fund Use
- A document that adequately details the collateral
- Debt timeline
- Analysis of cash flow
- A list of all outstanding payments and receivables
- For building loans, a contractor’s estimate; for equipment loans, cost documentation
- Evaluation of real estate and/or machinery
How to Apply for an SBA 504 Loan
The steps involved in qualifying for an SBA 504 loan are as follows:
Step 1: Gather Documentation
The bank, credit union, and CDC will require a great deal of paperwork to validate your SBA loan. This paperwork will include business debt schedules, financial statements for both the business and the individual, personal tax returns for the last three years, and other documents specific to your loan.
Step 2: Find a CDC
SBA 504 loans, in contrast to conventional loans, necessitate the participation of a certified development corporation, or CDC. Locate a certified CDC to proceed with the next round of application preparation. Upon connecting with a CDC, they will assist you with the remaining steps of the application procedure. In the US and its territories, the SBA recognizes more than 200 CDCs.
Step 3: Submit an Application
You may submit your final SBA 504 request for financing with the assistance of your CDC in completing the necessary documentation and papers. Your application should contain the documentation you acquired in the first phase as well as an explanation of the project and the intended use of the funds.
Completing plenty of paperwork and keeping track of a lot of documents are necessary when qualifying for an SBA 504 loan. FileInvite’s industry-leading document-gathering software speeds up this procedure by up to six times.
How to Qualify for an SBA 504 Loan
Three requirements must be met to be qualified for an SBA 504 Loan. To operate in the United States or its territories, your company must first be a for-profit enterprise. You must also have less than $15 million in total tangible net assets. Third, during each of the two years before your application, your average net revenue on a post-tax basis must be less than $5,000,000.
Additionally, applications where the company has shown managerial expertise are more likely to be approved by the SBA.
For a business to qualify for an SBA 504 loan, they need to:
- Function in the United States or its territories as a for-profit enterprise.
- Possess an actual net worth of less than $15 million.
- Have, over the two years before the application, a median net income of under five million dollars after federal taxation on income.
- Avoid doing anything inactive or speculative.
- The suggested business plan can be implemented.
- Both the company and its executives have excellent morals.
- The company can return the debt.
Businesses that engage in speculative, passive, or nonprofit operations are not qualified for the 504 loan program.