504 Loans: Big Benefits for Smaller Businesses

Financing the growth of a business may be easier than you think. The U.S. Small Business Administration’s 504 Program-administered in North Dakota by the Dakota Certified Development Corporation-provides affordable financing to help healthy, expanding small-and medium-sized businesses grow.

The 504 Program is a powerful tool for community economic growth. Its goal is to create and retain jobs through long-term financing of real estate and equipment at a fixed below-market interest rate.

Often businesses have difficulty qualifying for traditional financing because of the difficulty of coming up with down payments of 20 percent or more. Loans through the 504 Program can finance 90 percent of a project’s cost for qualifying businesses, conserving valuable operating capital.

In addition to generally lower down payments, 504 loans offer other advantages to borrowers:

• Fixed interest rate financing — avoiding the uncertainties of future market fluctuations.
• Longer repayment terms that bring debt service in line with the cash flow generated by the asset.

A complete 504 financing package is a combination of at least three sources: the Dakota CDC, borrower equity and a local bank, savings and loan or credit union.

• Through the Dakota CDC, the SBA may guarantee up to 40 percent of the total project cost, or from $50,000 to $5.0 million (up to $5.5 million in certain cases and manufacturing).
• SBA financing consists of a debenture, a type of bond. Pooled with other debentures, it is sold publicly to investors.
• The business receiving the financial assistance must inject at least 10 percent of the total funds for any project (up to 20% for startup & special purpose).
• The balance, 50 percent, is usually provided by a local financial institution, although other SBA-qualified lenders may also provide the 50 percent.

More on 504

The portion of these 504 financing packages provided by the SBA may be used to assist with a variety of fixed-asset projects:

• Plant acquisition, construction, renovation or expansion, including the purchase of land.
• Land and site improvements, including grading, streets, parking lots, utilities or landscaping.
• Purchase and installation of machinery and equipment.
• Interest on interim financing.
• Professional fees directly attributable and essential to the project, surveying, engineering, architectural or legal.
• Refinancing is not allowed.

504 Eligibility

If financing is not available from nonfederal sources on reasonable terms, a business may qualify for 504 assistance by meeting several criteria.

It must be a for-profit corporation, limited liability company, partnership or proprietorship, and must have a sound business purpose.

Certain businesses are not eligible for the 504 financing. These include nonprofit organizations, investment companies, gambling facilities and lending institutions.

The net worth of the business and its affiliates must not exceed $8.5 million. Its average net income (after taxes) must not exceed $3.0 million for the last two years.

The project being financed must demonstrate economic impact on its community, primarily through job creating or retention.

Collateral and Security

The borrower must provide collateral to secure the loan. This may include a mortgage on the land and building being financed; liens on machinery, equipment and fixtures; lease agreements, and personal guarantees from individuals with 20 percent or more ownership in the company (or limited guarantees from those with less than 20 percent ownership). The participating bank receives the first lien on the collateral; SBA holds the second lien.

Terms

The 504 Program offers terms of 10 years for loans that finance machinery and equipment, and 20 years for real estate loans.

Interest

The interest rate is determined at the time the 504 loan is funded, usually within six weeks to two months after the project’s completion.

Assumability

504 loans are fully assumable with SBA approval.

Repayment

Loan repayment begins on the first day of the month following the sale of debentures.

Prepayment

A prepayment penalty applies during the first half of the loan term, starting at 10 percent and declining to zero at the mid-life of the loan.

Interim Financing

Funding of the 504 portion of the loan package usually takes place within two months after the project is completed. This means that interim financing is required, usually by the local financial institution that hold the first mortgage or lien; the banker advances capital as the project begins and is repaid from the proceeds of the SBA debenture.

Fees

The 504 program requires payment of a fee of 2.75 percent of the SBA portion of the loan package, plus a closing fee for recording fees, and a legal fee of approximately $950 (financed). The participating bank pays an up-front fee of 0.5 percent of its loan to the Dakota CDC, which transfers the payment to the SBA.

Application and Approval

Contact the Dakota CDC or your local bank to find out more about project eligibility and establish preliminary feasibility. If the initial meeting is positive, the applicant will meet with the Dakota CDC and his or her local banker; or the Dakota CDC will send a loan application to the potential borrower on request.

Once the Dakota CDC has all the information requested in the application, approval usually takes two to three weeks.