Typically, small businesses encounter difficulties when looking for long-term financing at fixed interest rates. Recognizing this, the U.S. Small Business Administration (SBA) sponsors the 504 Loan Program which offers small businesses a financing alternative. In San Bernardino County, Enterprise Funding Corporation (EF), a Certified Development Company since 1984, offers the 504 Loan Program as one of its financing alternatives for small businesses. Working in conjunction with lenders, EF sells debentures guaranteed by the SBA to provide long term, fixed rate loans. A typical financing package utilizing the 504 program includes:

Generally, any project involving the purchase, construction, or improvement of fixed assets is eligible.
Examples include:

• Land and building acquisition
• Construction and renovation
• Purchase of heavy machinery or equipment
• Reasonable contingencies (up to 10 percent), furniture and fixtures
• Soft costs (such as professional fees and interest during construction)

1. EF lends up to 40 percent of the total fixed asset financing needed, to a maximum of $1,300,000.
   
2. A private lender, usually a bank, lends up to 50 percent of the project's total cost.
   
3. The business provides a minimum of 10 percent of the necessary funds. *
   *Start-up businesses and financing for special purpose buildings require an additional 5% equity injection each.
   

The principals (or others) may prefer to acquire title to real estate personally or through other entities and lease project assets to the operating company. This situation is possible in many instances, so long as a long-term lease exists and the principals and operating company guarantee the debt of the borrower.

The interest rate on EF's loan is fixed and generally one point above the the ten year treasury bond for a twenty year loan, and one point over the five year treasury bond for a 10 year loan. The interest rate on the companion bank loan is negotiated by the borrower and typically is floating.

This combination of fixed and floating interest rate financing provides an effective hedge against unfavorable interest rate fluctuations. If rates increase, the borrower is locked in the relatively low interest rate on up to 40 percent of the financing. If rates decrease, the borrower floats downward with the bank's loan. See our web site section entitled "Current rates" for more information.

Typical Project Funding
Use of Funds		Source of Funds Conventional Loan		Source of Funds 504 Program
Land	$500,000	Bank	1,440,000	Bank	$900,000
Building Construction	$1,000,000	504	-	504	$720,000
Machinery	$200,000	Equity	$360,000	Equity	$180,000
Furniture and Fixtures	$50,000	-	-	-	-
Soft Costs	$50,000	-	-	-	-
Total	$1,800,000	Total	$1,800,000	Total	$1,800,000

Example:

A manufacturer that has been leasing space wants to purchase a building and new equipment to facilitate business expansion. The financing package is as follows:

If a bank was willing to finance the project conventionally, it typically would lend up to 80% of the project cost at a floating interest rate, say prime plus one percent, for 10 years with an adjustment after that time periodically. Utilizing the 504 program, up to 90 percent of the project cost can be financed. The bank lends only 50 percent, thereby reducing its risk and corresponding interest rate. EF lends up to 40 percent at a fixed rate for 20 years.

As shown, the business' equity injection can be reduced by $180,000, thereby conserving cash and providing the necessary working capital to support growth. Additionally, cash flow is improved as a result of the longer maturity and potentially lower rates.

 

The conventional bank portion of the project has a few specific requirements including:

• Provide interim financing for the 40% debenture until funded
• Term:
  • a minimum of 10 years if requesting a 20 year term 504 loan;
    
  • a minimum of 7 years if requesting a 10 year term 504 loan
    
• The bank's note and lien instruments must not allow future advance clauses except advances for the reasonable costs of collection, maintenance, and protection of the bank's lien(s)
• Cannot be cross-collateralized with other financing provided by the bank
  

The borrower must contribute to the project cash (or property acceptable to SBA obtained with the cash) or land (that is part of the project property) valued at 10 % of the project cost. In some cases this equity injection can be borrowed. Examples of this are using an existing business line of credit or borrowing against unrelated assets such as a home equity loan. In all cases, credit and repayment issues must be addressed.

When an applicant is a startup business (less than 2 years old), the borrower must contribute at least 5% additional equity. Some types of buildings are considered special or limited purpose which also require additional equity (5%).

The borrower's contribution may be land (including buildings, structures and other site improvements, which will be part of the project property) previously acquired by the borrower. If the land has been held for at least 2 years, an updated appraisal can be used to determine the value of the contribution. Otherwise the basis for the value of the contribution is cost.

On projects involving new machinery and equipment, the allowance given as "trade in" on the old machinery and equipment may be used as part of the borrower's contribution..

The borrower may borrow its cash contribution from a third party. If any of the contribution is borrowed, the interest rate must be reasonable. If the loan is secured by any of the project assets, the loan must be subordinate to the liens securing the 504 loan, and the loan may not be repaid at a faster rate than the 504 loan unless SBA gives prior written approval

The following are some documents that may be used as evidence of the equity contribution:

• Copies of all documents evidencing the source and terms of any loans
  
• Receipts, canceled checks or other evidence satisfactory to SBA
  
• A bank's settlement statement evidencing the purchase of the property
  
• The "pay-out sheets" maintained by the interim lender

The SBA requires that the 504 loan must have a security interest in all project assets
We can recognize existing prior liens in the case of building expansions and renovations
Personal guarantees of all principals owning more than 20% of the company are required
If the business is a startup or the asset being financed is considered single purpose or the credit is unusually risky, additional collateral may be required

Key Man life insurance is typically required unless there is a strong management succession plan

Adequacy of collateral is a credit decision- additional collateral can be required by SBA

Most of the up front fees associated with the 504 Loan Program are included in the loan from EF. Total processing fees are approximately 2.75 percent of the amount of the EF loan, plus EF attorney fees ($2,200 maximum). A breakdown of the fees is as follows:

EF Processing Fee 1.5%
SBA Reserve Fee .5%
Colson Services Fee .25%
Bond Underwriter (20 year bonds) .5% (10 year bonds) .375%
Closing Costs (estimate) $2,000
EF Attorney $2,200

A borrower's monthly payment will include principle, interest and a loan servicing/guarantee fee. Ask EF for a specific example regarding the fees and total amount

Monthly fees added to the debenture rate
	CDC Service	.625%
	CSA	.1
	SBA Guaranty	.410 ***
	Total:	1.135%
*** current as of October 2002

The effective interest rate that is quoted at the time of closing and which is in the mortgage calculator section of this web site includes all fees. In each loan transaction there will be a note rate (5.3854% as of 8/2002) and an effective interest rate including fees (6.751% as of 8/2002).

This effective interest rate includes all these fees and is quoted.

Upon issuance of a final commitment (SBA Loan Authorization), EF shall be deemed to have earned an application processing fee of $1,000, which is considered a part of the loan processing fee, and will be charged to the borrower if the loan is not funded because the borrower declines to proceed with the 504 loan.

The first mortgage loan generally can be prepaid according to terms negotiated between the bank and borrower.

The EF loan also may be prepaid. It must be prepaid in full and there is no penalty if prepayment occurs in the second half of the term (e.g.,years 6-10 for a ten year loan, years 11-20 for a 20 year loan). During the first half of the loan term, the prepayment penalty declines over time, beginning after one year's interest. EF can prepare a prepayment schedule for your review at your request.

The borrower cannot make partial payments of principal in any given month.