Leveraging loans: SBA's 504 program helps small businesses grow, while preserving cash flow
Photo / Tim Greenway
Field Rider of Pine Tree State CDC, pictured near his office in Portland, cites the importance of business cash flow.
Field Rider, president of Pine Tree State CDC, a Portland-based nonprofit certified by the U.S. Small Business Administration to provide financing under its 504 loan program, knows how important cash flow is to small business owners seeking financing to grow their companies. If too much up-front cash is required to get the loan, he says, it sometimes reduces the working capital cushion they'll need to easily manage their short-term debts and operational requirements.
“The big lesson I learned was just how important cash flow is to most small businesses,” Rider says of his almost two decades as a bank lender, director of the business assistance division of the Finance Authority of Maine, C-level positions with two Lewiston-Auburn region businesses and as senior loan and investment officer (a position he still holds) with BDC Capital, the oldest business development corporation in the United States. Those diverse experiences are now coming together at his three-year-old company, which besides offering SBA 504 funding, also provides access to lines of credit; term loans; senior short- or long-term debt; subordinated debt; and mezzanine or private equity financing.
While each option has its merits, he says, the SBA's 504 loan program is particularly well suited for start-ups and established businesses looking to grow and to acquire assets such as real estate, machinery and equipment. That's because its comparatively low 10% down payment requirement helps those borrowers preserve cash for working capital.
“It's meant to be a job-creation program,” he says. “The way it gets there is by reducing the amount of working capital that an expanding business has to put into fixed assets.”
How the SBA 504 loan program works
SBA's 504 program offers long-term, fixed-rate loans that currently have an interest rate of under 5%. In the typical 504 project, a bank funds 50% of the cost with a loan secured by a first lien, an SBA-licensed Certified Development Company (commonly referred to as a CDC) funds 40% through a loan secured by a second lien and the borrower provides the remaining 10%. Borrowers don't have to pledge all available assets as collateral, just collateral associated with the project (although additional collateral might be required if the asset value of the equipment purchase or real estate is insufficient to attain a 1:1 coverage ratio for the loan amount).
Like any SBA program, there are certain eligibility requirements and conditions on how the 504 loan proceeds can be used. Borrowers must be for-profit businesses with a tangible net worth of $15 million or less and posting an average profit of less than $5 million over the two most recent fiscal years. While there is no maximum project size, the maximum SBA loan amount is $5 million — although small manufacturers or certain types of energy projects may qualify for a $5.5 million loan.
Rider says the 504 program typically requires the borrower to create one job for every $65,000 guaranteed by the SBA (or one job for every $100,000 for manufacturers), but it does allow alternative metrics if the business qualifies as meeting certain community development or public policy goals. Among them:
• Improving, diversifying or stabilizing the local economy.
• Stimulating other business development
• Bringing new income into the community.
• Assisting businesses in labor surplus areas.
• Expanding exports.
• Expanding small businesses owned and controlled by women or veterans or minorities.
• Aiding rural development.
• Increasing productivity and competitiveness.
Rider says Maine banks are as much his customers as the small businesses that decide to use the SBA 504 loan program. The advantage of the SBA 504 loan program for banks, he says, is that it helps them to mitigate credit risk, stay within their overall lending limits and manage liquidity while also gaining the opportunity to cultivate a small business owner as a long-term customer.
SBA's perspective
Pine Tree State CDC had built a $7.5 million loan portfolio in Maine in the three years since being licensed by SBA to handle 504 loans, Rider says. This spring, the portfolio got a big boost when the SBA transferred an $18 million portfolio from Coastal Enterprises Inc. to Pine Tree — a change Rider says was driven by CEI's decision to relinquish its 504 license in order to focus on the SBA's 7(a) loan guarantee program under a new wholly owned subsidiary, CEI 7(a) Financing LLC. SBA then selected his company to oversee and service the loans for nearly 80 Maine companies within CEI's 504 portfolio.
The average 504 loan amount in that portfolio, he adds, is $275,000.
“Practically speaking, those borrowers will see no difference” in the handling of their accounts, Rider says. “For me, it allows me to work with the lenders who had worked with CEI to make those 504 loans. I'm hoping to have them use me in future deals. It jumpstarts my 504 portfolio and allows me to add staff to do the servicing of those loans.”
Diane Sturgeon, deputy district director and lender relations specialist at SBA's Maine district office, says for the current fiscal year ending Sept. 30, SBA so far has made 24 loans in Maine under the 504 program, with SBA's portion totaling $10.52 million and a total transaction value (i.e., including the third-party lenders' portion of the loans) of $24.84 million.
From October 2012 to this April, she adds, SBA has approved 163 loans in Maine under the 504 program having a total transaction value of $162 million, with SBA's $70 million leveraging $92.1 million of third-party lender dollars. Here's the breakdown of SBA 504 loans in Maine for each fiscal year of that time-frame:
2014: 49 loans approved, for a total value of $49 million, with SBA's $21.3 million leveraging third-party loans.
2013: 48 loans approved for a total value of $51.9 million, with SBA's $22 million leveraging third-party loans.
2012: 42 loans approved for a total value of $36.24 million, with SBA's $16 million leveraging third-party loans.
Sturgeon agrees with Rider that one of the 504 program's greatest benefits to a small business is that it enables borrowers “to inject a much lower down payment into a large real estate transaction, allowing them to retain those funds for working capital and expenses.” The program's relatively low fixed interest rate on the SBA's portion of the financing, she adds, gives the small business owner “predictable payments at a fixed rate for the life of the loan rather than a loan structured with a variable rate and/or a balloon payment, which is more the norm for a commercial real estate purchase when fully financed through a traditional lender.”
Sturgeon also says third-party lenders participating in a 504 loan “are more likely to make a loan they otherwise wouldn't be able to make and at more favorable terms to the borrower” due to their “first lien position with a very favorable loan-to-value [ratio].”
Although she acknowledges SBA 504 loans can take longer to close than a traditional commercial real estate loan simply because they involve more than one lender, Sturgeon notes that if banks involve a CDC familiar with the SBA's underwriting standards early in the process, the loan's closing can be competitive with the time-frame of a traditional commercial real estate loan.
“The 504 loan program is a hidden gem for small business owners trying to purchase, build or expand commercial real estate,” she says. “It's a wonderful tool a small business owner can use to purchase or build the real estate to house their business, to expand their existing real estate or to build equity in something rather than paying rent. They retain cash for working capital by not having to inject a full 20% to 25% down on the project, they get a fixed-rate loan for 30% to 40% of total project costs for 20 years that they'd never get from a traditional lender, and the bank or credit union serving as the third-party lender gets a much lower loan-to-value [ratio], allowing them to be involved in projects they couldn't otherwise finance.”
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