What do Ben & Jerry’s Ice Cream, Intel, Nike, Apple Computers, Under Armor and Chobani Yogurt all have in common? In addition to revolutionizing their industry and the world, each of these companies experienced rocketlike growth and relied upon the support provided by the Small Business Administration (or SBA). In this 2-part series we are going to explore the SBA 504 program in order to provide you a program overview, the benefits provided to rapidly growing companies, and the costs associated with the program.
I have helped hundreds of rapidly growing companies define and achieve their strategic goals. With each one I ask three questions:
Q: What does your business absolutely need to succeed? (A: Cash)
Q: What is the goal when you are setting an expense budget? (A: Predictability of expenses)
Q: What is the most critical thing to manage when expanding or exploring a new venture? (A: Risk)
Seeing into the mind of an entrepreneur that is leading a rapidly growing company is like peering into the future. These are all critical questions that entrepreneurs ask themselves, but they are also reasons why strong companies utilize the SBA 504 program, even if they qualify for traditional financing.
What is the SBA 504 Program?
The SBA 504 program was designed by the Small Business Administration to help banks support companies that need cash to purchase real estate or non-titled equipment. (Titled vehicles, airplanes, and working capital loans cannot be financed with this program but are eligible for other SBA programs.)
An SBA 504 loan has 3 components:
- The cash (down payment) provided by the borrower.
Normally, the entrepreneur must inject 10% of the project as a down payment, but there are exceptions that may increase the down payment up to 20%. For example, if the company that is borrowing the cash is a start up (defined as being in operation less than 2 years), then the SBA will require an additional 5% down payment. Also, if an entrepreneur is purchasing (or constructing) a special purpose property (roller rink, hotel, gas station, etc.) then the SBA will require an additional 5%.
2. The bank loan provided by the lead bank.
Typically, the first bank loan is for 50% of the project cost. The structure of the loan follows typical bank structures. This means that the bank has the option of charging an origination fee (most banks do charge an origination fee for this loan, as they are charged a ½% fee by the SBA), and there may be a balloon term that is shorter than the amortization. The amortization is typically set depending upon what the entrepreneur is purchasing. Equipment and machinery, which may be obsolete within 10 years normally get a maximum amortization of 10 years, while real estate may get a 20- or 25-year amortization.
3. The bank makes a 2nd loan which is typically called a debenture (or bridge) loan.
This loan is normally 40% of the project cost, and usually does not have a maturity longer than 36 months. While banks can require principal repayment on this loan, I have seen these loans to be interest only with the expectation that they will be paid off by the SBA long term loan.
It is important to note that the SBA does not handle construction loans, which is why the bank provides an interest only period to allow for the construction of the new property. If the project is equipment only, or no construction is involved, then the SBA will work to have this loan paid off much faster (usually within 90 days).
To help with the refinance process, the SBA uses a Certified Development Company (or CDC). There are many CDCs throughout the country, and a bank is not required to deal with any specific one.
Technically (sorry for the following bank-nerd speak) the SBA long term loan is financed through a bond (called a debenture) that is generated to pay off multiple bank loans. These bonds are issued once a month (usually around the 15th), and all the associated fees for administering this process are rolled into the bond.
The SBA loan has a unique structure. It is fully amortizing for 10, 20, or 25 years, with the interest rate fixed for the entire time.
As you can see, the SBA 504 program is somewhat complex, but for the right entrepreneur it has tremendous benefit, specifically:
Minimal cash injection
Remember when I asked the entrepreneur what their business needed to survive, and they told me “cash”? With the SBA 504 program, they may be able to inject as little as 10% of the project cost in cash. This is critical to companies that must maintain a significant amount of cash to support their operations or entrepreneurs that want to keep their personal cash reserves as strong as possible.
Long term fixed rates
While the first bank loan is subject to balloons or rate adjustments, the SBA rate is set when the bond is issued and is very competitive. I have seen a 25-year loan with a fixed rate below 5%. This not only eliminates the interest rate risk, but it also provides predictability in the repayment expenses for the life of the loan.
Flexibility
The SBA allows for a refinance of the bank loan at any time (loan 1). This means that if there is another bank that is willing to give better rates or terms, a refinance can be done without interrupting the long-term fixed rate of the SBA loan. Additionally, if the entrepreneur sells their business, the SBA will allow the purchasers to take over payments for the SBA loan, as long the purchaser is eligible for SBA financing. This potentially can be a point of negotiation in the sale of the company, as the SBA loan may have a long-term fixed rate that is below the market. This flexibility allows entrepreneurs to de-risk their expansion plans.
Up to $5,000,000 in SBA guaranty
This program can be used in conjunction with other SBA programs to the point of $5,000,000 in guaranty. What that means to entrepreneurs is that they can have projects that cost up to $12,500,000 and still participate in this program.
By now I am sure you are asking “What’s the catch? All of this seems too good to be true. Why would anyone do anything other than an SBA loan?”
Be on the look-out for part 2 of my SBA 504 overview, coming soon, as I explore the potential risks and costs associated with SBA 504 loans.
One amazing caveat to this is for manufactures. If you are a manufacturing company, you may be eligible for up to $5,500,000 of SBA guaranty per project! So if you have an expansion project this year that takes up $4,000,000 of the guaranty, and in 2 more years you want to expand again….. That’s right – you may qualify for anther $5,500,000 of an SBA guaranty.
Being an entrepreneur is one of the most difficult and demanding things you can do. The good news is that entrepreneurship today is a team sport. Hit the connect button on LinkedIn or Facebook NOW and together we will start maximizing your profit, strengthening your leadership skills, controlling your business finances, and using your bank as a strategic advantage. When we connect, tell me if you have every had an SBA 504 loan and what you thought of the experience.
Greg Martin is an entrepreneur’s insider to the banking industry and passionately believes that every person was uniquely designed for a higher purpose and calling. Greg guides entrepreneurs in defining and achieving their purpose and calling. His deepest passion is living life with his wife of 17 years and their wonderful son.
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