SBA 504 Loans Explained
What is an SBA 504 loan?
The SBA 504 loan is a loan provided by the Small Business Administration for the purpose of buying fixed assets such as real estate and equipment.
In addition to the borrower and the bank, a third party is also involved in 504 loans: an SBA-approved certified development company (CDC). A CDC is a nonprofit company that works with conventional financial institutions to provide funding for businesses that would otherwise have less access to high-quality financial resources.
How does the SBA 504 loan work?
504 loans consist of three parts: 50% from the bank, 40% from the CDC, and the 10% down payment from the borrower.
While both the bank and CDC work closely together to issue your 504 loan, only the CDC component is regulated by the SBA. This means the CDC portion of the loan will have SBA-set standards whereas the banks set their own eligibility requirements and terms for the bank portion of the loan.
SBA 504 Loan Amounts
The maximum loan size of the CDC portion of the loan is $5 million, with a $5.5 million extension for green energy companies and manufacturers. The bank portion of the loan can double or even triple the CDC’s portion, which means that the total possible funding through a 504 loan could be $20 million or more.
As the borrower, you will have to put down at least 10% of the loan amount, with start-ups and special purpose properties having to potentially pay more. However, this down payment is usually around half of what banks require for conventional loans.
Down payment can also come from personal funding and assets.
SBA 504 loans have long repayment terms with monthly repayment. Purchasing machinery and equipment has a 10 year repayment period; purchasing/converting land or buildings has a 20-25 year repayment period.
SBA 504 loans are designed for the purchase of major fixed assets, as listed below:
Purchasing equipment or machinery
Purchasing existing buildings
Purchasing of land and land improvements (e.g. street grading, utilities, parking lots, etc.)
Building new facilities
Renovating, remodeling, or converting existing facilities
Refinancing existing debt that relates to an expansion of your business through new or renovated facilities or equipment
The SBA’s rules for how the 504 loan proceeds can be used are quite specific. For example, SBA 504 loans cannot be used for working capital or inventory. In addition, equipment purchased with the 504 loan must have a 10-year estimated life.
To qualify as a business for an SBA loan, you must meet the general requirements:
Your business is officially registered as a for-profit business in an eligible industry and operates in the US.
Your business meets the SBA’s definition of a small business.
You, the business owner, have invested your own time and/or money into the business.
You are not delinquent on other government loans
You have strong personal credit
Requirements specifically for the 504 loan would include:
Your business has a tangible net worth of no more than $15 million and an average net income of $5 million or less after federal income taxes for the two years prior to application
You meet owner occupancy requirements
Your business must create or retain jobs or promote other public policy goals
The application process for the SBA 504 loan is also quite extensive, with a lengthy application form and plenty of required financial documentation.
The SBA 504 loan is one of the best financing options when a business needs to purchase fixed assets. The 10% down payment is lower than other traditional financing options and coupled with a low interest rate makes the 504 loan one of the most affordable loans available.