When seeking financing, many small business owners work with their bankers to pursue loans from the Small Business Administration (SBA). The SBA offers a number of loan options to help start, build or grow a business, one of the most popular of which is the SBA 504, a program used to finance fixed assets like commercial real estate and industrial equipment. A benefit of the SBA 504 loan that’s most attractive to business owners is that this particular loan type requires as low as 10% equity down, compared to 25% or 30% typically required for conventional financing allowing the borrower to preserve capital for other business needs.
If your small business is looking into building or renovating a facility or purchasing equipment needed to expand or improve your operations, an SBA 504 may be a good option for financing.
What criteria are used to qualify for an SBA 504 loan?
There are a number of criteria that must be met in order to secure SBA 504 financing. First, the type of business you run will determine eligibility. There are a few that are not eligible; visit SBA’s website here to see the guidelines.
If a business meets eligibility criteria, there are still a few restrictions regarding how you’re able to use the loan proceeds. For example, a 504 loan cannot be used by a business to purchase inventory or to infuse general working capital. (We will cover SBA products for those situations in an upcoming post.) Here are a few more guidelines set by the SBA specifically for a 504 loan:
- Established businesses must have a tangible net worth of less than $15 million, and an average net income of less than $5 million after taxes for the preceding two years.
- The SBA does not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the financing. Both business and personal financial resources are reviewed as part of the eligibility criteria. If these resources are found to be excessive, the business will be required to use those resources in lieu of part or all of the requested loan proceeds. If the money is to be used to build a facility, the borrower (or borrower controlled LLC) must occupy at least 60% of the building.
- Both established and startup organizations also must demonstrate the ability to repay the loan based on projected operating cash flow of the business. Startups must go further to show evidence of relevant management experience and a sound business plan that indicates growth potential.
Benefits of the SBA 504
One reason so many small businesses take advantage of the 504 loan for buildings and equipment is because of the interest rate protection. With a long-term fixed rate on 40% of the debt, borrowers are protected against rising interest rates. This gives business owners peace of mind as they have more control over their long-term interest expenses.
SBA loans have helped small businesses of all types build and continue to thrive. There are additional SBA loan types, and if the 504 isn’t aligned with your situation or needs, we’ll discuss alternatives in the following paragraph.
In the meantime, if you have questions about financing for your business, don’t hesitate to reach out to Investors Community Bank. Our small business experts would be happy to share their insights!
Other SBA Loan Programs
There are a number of situations in which other types of loans are more appropriate. Below is an overview of some of the financing avenues available to small and medium-sized businesses for the situations when a 504 loan might not align with the business or its owner’s needs.
SBA 7a: The 7a is available to both startups and established businesses for a variety of uses, including the acquisition of another business, working capital (something an SBA 504 loan cannot be used for), FF&E (furniture, fixtures and equipment) refinancing and for improvements made to a leased building by the lessee (called leasehold improvements).
The maximum loan amount for this program is $5 million, but the average loan amount in FY 2018, according to the SBA, was $420,000. Interest rates for the 7a are established by negotiations between the applicant and the lender, with both fixed and variable rate options available. Rates for the SBA 7a are based upon the risk profile of the client and would have a shorter lock-in period than a 504 loan.
SBA 7a Express: The SBA offers a “fast track” version of the popular 7a known as the SBA 7a Express and may be either a term note or a line of credit. Banks may recommend a 7a Express when the borrower may not have adequate collateral. This expedited loan is appealing to borrowers because it can provide a way to obtain financing that may not have been available with conventional bank financing. The loan limit of the SBA Express program is $350,000, which may be inadequate for small businesses in industries that are more capital intensive.
SBA CAPLines: This program helps small businesses meet short-term working capital needs with a standard asset-based line of credit (also known as Working Capital CAPLine).
This is generally used by businesses to support their working capital needs, using accounts receivable and inventory as collateral. These facilities typically finance growth with principal repaid as the borrower converts short-term assets into cash. These lines require regular servicing because of the nature of the collateral, and the extra monitoring may result in additional fees.
While SBA loans are widely used by small businesses across the country, conventional loans are still a common type of financing for small businesses, primarily because of their ability to accommodate a wider range of needs. Conventional loans can be used for short-, medium- and long-term needs, and loan limits are higher than SBA programs. Approvals are based on the company’s cash flow, collateral support, credit history, and economic outlook.
So, what’s the right loan for your small business – an SBA or conventional loan? When evaluating the needs of a small business, a lender will typically:
- Look first at SBA financing if the business is a startup, as new entities often represent a higher risk than established businesses and SBA mitigates the bank’s risk. Also, if the business is experiencing growth, SBA financing’s ability for a longer term may better meet the company’s cash flow and working capital needs.
- Look first at conventional loans when risks are mitigated, as in the case of established businesses and businesses with strong cash flow and a solid collateral position, because of the flexibility they offer to be customized to the situation and needs of the business.
- Pursue a combination of SBA and conventional financing when an established business is looking to finance growth or to acquire another business, depending on the type of business and that of the business being acquired.
There are other considerations that may influence the type of loan a lender recommends to a small business owner. Because conventional loans are not guaranteed by the federal government as SBA loans are, lenders may prefer to offer a conventional loan to small businesses that have demonstrated the ability to service the debt and that have adequate collateral to cover the loan in case of default. More detail about the differences among the SBA loan types and conventional loans is provided in the comparison chart below.
The most appropriate loan for your small business will depend both on your needs and on the health and potential of your company. A healthy cash flow, your collateral, the size of your down payment, and the size of the project all factor into identifying which loan type will best suit you, today and in the future. Sit down with a banker with experience in your industry and knowledge of the options available to you; he or she will be able to make the most practical recommendation, and help you through the loan application process.