The Government to the Rescue? SBA's 504 Program - BodyShop Business
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The Government to the Rescue? SBA’s 504 Program

Donnie Jones had always dreamed of building a state-of-the-art body shop. But he faced major obstacles. Every banker he tried to get a business loan from wanted 25 to 30 percent in cash equity, with rates and terms that would have been a major stretch for his cash flow.

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Then Jones met a banker who suggested the Small Business Administration’s 504 long-term fixed asset financing program. With only 10 percent down and an affordable monthly payment, Jones was able to construct a new 5,400-square-foot building.

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"I was certainly pleased with the down payment part of the package," says Jones. "And we got an excellent rate compared to our other options at the time – and with a lower monthly payment."

Within a year and a half of completing the new facility, Jones Body Shop had doubled its annual sales rate and had increased its employee base from four to 10.

A Fixed Asset Financing Program
Since its inception in 1981, the 504 program has generated loans in excess of $15 billion. The fiscal period ending Sept. 30, 1999, was a near record year for 504 loans – with 5,280 loans totaling $2 billion extended on a national basis.

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Even with these impressive numbers and growth, most shop owners are unaware the program even exists. And many of those who have heard of 504 loans tend to be scared off by the dreaded "g" word – as in "government" program.

But don’t let that deter you. The program is designed to provide small businesses with long-term fixed asset financing – specifically for land, buildings and equipment – so it’s something worth considering.

There are four key players in every 504 deal – the borrower, the bank, the SBA and a Certified Development Corporation (CDC). The borrower is generally required to inject a down payment of only 10 percent. The CDC provides an SBA-guaranteed fixed rate debenture bond for 40 percent of the project, and the bank agrees to provide permanent financing for the remaining 50 percent. For example, in a $500,000 project, the borrower puts up $50,000, the CDC provides an SBA-guaranteed debenture bond in the amount of $200,000 and the bank extends a loan of $250,000.

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It usually takes four to eight weeks from the beginning of the application process to the approval by the CDC/SBA, according to Mark Barbash, executive director of the Columbus Countywide Development Corporation in Columbus, Ohio.

"We encourage our banks to call us early in the process," Barbash explains. "That way we can begin some preliminary evaluation before the package gets here, which expedites the approval process."

Many CDCs report that SBA 504 loans are ideal for body shops, thanks to the capital-intensive nature of building a shop and installing new equipment. "We just recently closed [a deal] and funded a body shop and there’s another one in the pipeline waiting to close," says Linda Harden, a loan officer with the Centrolina Certified Development Corporation in Charlotte, N.C. "With a body shop, we can finance most anything, including the real estate, the framing equipment, the spraybooths and any other equipment with a useful life of at least 10 years."

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Barbash agrees that the SBA 504 program is an excellent fit for shop owners looking for capital expansion funding. "The nice thing about the program is that it’s primarily for existing businesses," says Barbash. "And while some banks aren’t comfortable with automotive assets, we are because we’re cash flow lenders. We probably do six or eight automotive-related projects each year out of 65 or so loans."

Eligibility Requirements
A few basic eligibility restrictions are imposed by the SBA.

1. For every $35,000 of the SBA-guaranteed debenture, the project must create at least one employment position.

2. Machinery and equipment financed must have a useful life of at least 10 years.

3. For construction of a new building, the borrower must plan to occupy at least two-thirds of the space.

4. For purchase or remodeling of an existing facility, the borrower must plan to occupy at least 50 percent of the space.

5. The borrower must qualify as a small business.

An applicant is considered a small business if the firm’s net worth doesn’t exceed $6 million and net profits after taxes have averaged less than $2 million during the previous two years. According to the SBA, 98 percent of all U.S. companies meet the agency’s definition of a small business.

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Barbash says that nearly all body shops would be eligible for SBA 504 loans. In fact, some body shops have taken advantage of the program more than once. 3-C Body Shop in Columbus, Ohio, for example, has tapped into the 504 program on three separate occasions for projects totaling $1,671,000. The loans were used for a new facility in 1993, the expansion of that facility two years later and the construction of a satellite location in 1998.

Jobs, Jobs, Jobs
With its requirement that at least one job be created for every $35,000 in SBA-guaranteed debenture bonds sold, the 504 program should continue to receive strong support from the national government. "The basis of the 504 program always comes back to the creation of jobs," says Mike Stamler, an SBA spokesman in Washington, D.C. "The overall emphasis is on creating jobs and meeting needs of local communities."

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According to Stamler, CDC annual reports reflect that 504 loans have assisted in creating and retaining more than 1 million jobs since 1981. Stamler also cites that the program has created one job per $9,000 of CDC debenture bonds sold, an extraordinary level of efficiency for a federal government initiative.

But is it right for you?

Ten Need-to-Know Facts About the 504 Program
1. The underwriting criteria – The SBA imposes a few basic underwriting restrictions on each prospective borrower. First, the funds must not be otherwise available. Second, the business owners must demonstrate good character and management ability. Third, the collateral must be acceptable. Fourth, the borrower must display adequate cash flow to repay the loan. And fifth, the borrower must reflect a sufficient equity position.

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For existing body shops, the "sufficient equity" requirement generally translates into a debt/worth ratio (after accounting for the proposed loan) of no higher than four to one. Start-ups must contribute at least 30 percent equity to the total start-up.

The equity requirement prohibits many new ventures from qualifying for the 504 program, says Barbash. "Most start-ups need as much working capital as possible in the early stages. Under the 504 program, it just doesn’t make sense for a borrower to tie up so much in fixed assets when they must also meet the 30 percent equity requirement."

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2. Types of candidates and projects – The ideal 504 candidate falls into one of two categories: a business owner who’s currently leasing and doesn’t have the down payment typically required for conventional financing, or an entrepreneur in a high-growth mode in need of additional capacity.

The 504 program can be used to finance three types of real estate projects: the purchase of land and construction of a new building, the acquisition of an existing facility, and the renovation or expansion of an already owned edifice. Soft costs, such as professional fees, surveys and interim interest, can also be included in the financing package.

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"Most of the deals we see, probably over 80 percent, involve real estate," says Barbash. "It’s the only place I know of where you can get 20-year fixed rate subordinate financing."

3. Limitations on project size – The SBA places size limitations only on the CDC debenture portion of the project. The minimum amount for a 504 debenture is $50,000, while the maximum is $1 million. Given that the 504 debenture usually provides 40 percent of the overall project amount, this results in a total range for 504 projects of $125,000 to $2.5 million. However, some banks are willing to finance more than 50 percent of a 504 project, which means total project amounts could hit $3 million and higher.

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4. Loan terms – The SBA will allow a term of up to 20 years for a 504 real estate loan and up to 10 years for equipment financing, which are both more favorable than most conventional commercial bank loans. The participating bank is required by the SBA to extend a term of at least 10 years for real estate projects (most will go 15 years on the amortization schedule) and at least seven years for equipment loans.

5. Interest rates and fees – The interest rate for the debenture bond is fixed for the entire 10- or 20-year term of the loan. Both the 10-year and 20-year 504 loan (most are 20 years since real estate is usually involved) are fixed at the five-year U.S. Treasury Bill rate plus a spread. In October 1999, that spread was 1.15 percent for the 10-year loan and 1.27 percent for the 20-year loan. That translated to loan rates of 6.95 percent and 7.20 percent, respectively. The borrower can negotiate a rate with the participating bank on a fixed or variable rate basis.

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An upfront fee of about 3 percent is charged for all 504 debentures with annual fees also charged for servicing the loan. The bank typically will charge a 1 to 2 percent fee on its portion of the financing package.

6. Preparing for the application – The borrower must submit several documents to the bank and CDC to begin the application process. Historical financial statements going back at least three years should be included in the package. Personal financial statements on all the principals in the business are also required, since personal guaranties are mandated.

For new real estate projects or renovation, construction estimates and a set of completed plans with specifications must be submitted with the package. An offer to purchase should accompany the package if you plan to purchase an existing structure. An equipment loan request should include estimates on the total cost of the machinery to be purchased.

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7. The role of the bank – The local bank is the starting point for all 504 loan requests. It’s important to find a lender familiar with the program because of the close working relationship among the bank, CDC and SBA. The respective bank will analyze the feasibility of the request based on its standard set of lending criteria. Underwriting components such as credit history, management strength, the business’s track record, collateral, cash flow and the company’s level of equity are considered.

For construction of new facilities, the bank not only extends a 50 percent first mortgage permanent loan, but it also provides a 90 percent interim construction loan for the project once the 504 request has been approved by the CDC and the SBA.

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8. The role of the CDC – Paul Herringshaw, executive director of Centrolina Development Corporation, Inc. in Charlotte, N.C., appropriately refers to the CDC as "the catalyst" for the 504 process. Once the bank has initially approved a 504 request, the prospective borrower is turned over to the CDC. "The CDC works with the applicant and assists in preparation of the package," says Herringshaw, whose CDC has helped create more than 5,800 jobs since the formation of Centrolina 16 years ago.

After the CDC Board of Directors (made up of local bankers and other local business people) approves the loan, the CDC officer then recommends the package to the SBA. The SBA denies few requests once they have passed muster with the bank and the CDC.

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"Our CDC tries to make the whole process as painless as possible for the borrower," says Barbash. "We play a major role in helping the borrower put together the loan package that will ultimately be submitted to the SBA."

9. The role of the SBA – By guaranteeing the 504 debenture, the SBA provides the glue that seals each deal. Without that guarantee on the debenture, there would be no market to sell the bond. Without the debenture bond, there would be few banks willing to provide a 90 percent loan.

The SBA has done an excellent job of leveraging its resources. Federal funds aren’t actually advanced unless a 504 loan goes bad. Stamler reports a charge-off ratio of only one-half of 1 percent. So the SBA essentially has achieved a 200-to-1 leverage of its dollars in the 504 program.

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10. It’s not for everyone – The 504 program has many benefits, but it’s not for every small-business owner. Pre-payment penalties are attached to the debenture bond portion of the financing, so a borrower thinking of refinancing or relocating only a few years after construction or expansion would be well-advised to avoid a 504 loan.

With the requirement that one job be created for every $35,000 in debenture money, the program also will not work for a business owner looking to add equipment that will reduce the number of employees.

There are also some inconsistencies in the level of competence on the part of banks, CDCs and SBA offices in certain parts of the country. In fact, finding a good bank/CDC/SBA partnership is essential to the timely completion of the 504 approval process. For instance, even though Donnie Jones was pleased with his new body shop facility, his CDC officer left in mid-stream and his package took several months to be finalized. Herringshaw, however, says this isn’t the norm.

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"All of the CDCs strive for quick turnaround now," says Herringshaw. "The process has been streamlined to cut down on the time involved and to improve responsiveness."

Nothing to Lose
The SBA’s 504 program is a diamond in the rough in the intricate world of corporate finance. And while the program may not be appropriate for all shop owners, 504 loans can provide valuable capital for entrepreneurs looking to make new capital improvements or expand an existing facility.

Sound like something you’re planning to do? Then perhaps your plans should include learning more about the 504 loan. And don’t let the fact it’s a government program scare you off. Your home and business are already wiretapped and under 24-hour surveillance anyway, so you’ve got nothing to lose.*

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Writer Tol Broome Jr. is a financial expert who’s been in the lending business for 15 years. He’s also a contributing editor to BodyShop Business.


* We’re just kidding. If, for some reason, your business really is wiretapped and under 24-hour surveillance, it’s purely coincidental.

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