Your SBA Lending Questions Answered: Eligibility, Refinancing, Appraisals and More
Our small business lending experts receive numerous questions everyday related to SBA 504 loans and other SBA financing, and we’re happy to provide guidance to ensure all parties involved are well-informed on what’s expected. We’ve compiled some of the most common and interesting questions we’ve received to help you and your small business clients better navigate the SBA process.
1. What’s the difference between a new business and an extension of an existing business?
A big benefit of the 504 program is that a borrower can qualify for up to 90% financing. That is, the borrower’s equity contribution is as little as 10% of the project cost. However, if the applicant business is a “new business,” the 504 provides up to 85% financing and the equity contribution is 15%. The SBA’s definition of a “new business” is nuanced.
Let’s take a look at an example. A 504 request comes in which includes building financing for the fourth location of a restaurant. The existing three locations are each organized into separate entities with the same owner. The fourth location includes a new owner as a 50% partner.
Due to the difference in ownership, the SBA will usually require a 15% equity contribution for the purchase of the building as the applicant business is a “new business.” If the fourth location had identical ownership to any one of the prior locations, and the prior locations had been in operation at least two years, then a 10% equity injection would have been permissible.
On the other hand, SBA requires a “change of ownership” to be considered a new business unless the change of ownership does not result in changed management.
2. Can you refinance a 7(a) loan with another 7(a) loan?
According to the SOP, refinancing an existing 7(a) loan has the same eligibility requirements as any other term debt, with one additional requirement. The new lender needs to demonstrate that the current debt is on unreasonable terms (i.e 10% cash flow savings, balloon payment). Additionally, if the loan to be refinanced is a 7(a) loan, then the existing lender must be unwilling to modify existing loan terms and the new lender's file must document the existing lender’s unwillingness. Proof of the existing lender’s unwillingness to modify or extend the loan terms must be provided with the loan application.
3. How long does a business have to meet 504 occupancy requirements?
Small businesses will often purchase an existing building with tenants that have lease agreements that expire after the buyer takes possession of the building. For existing buildings, the SBA requires that the Operating Company (OC) occupy at least 51% of the space. However, the SBA allows the OC up to 12 months after the 504 loan closing to meet the occupancy requirements, assuming the circumstances are justified.
4. How is the term of a 504 loan determined?
The term of the 504 relates to the useful life of the fixed asset being purchased. Real estate is financed using a 20- or 25-year 504 loan and equipment is financed using a 10-year 504 loan. Other assets that can be included as part of a 10-year 504 loan include furniture and leasehold improvements, so long as the blended useful life of the project qualifies for longer terms.
5. If your project includes both real estate and equipment, do you apply for multiple 504 loans?
Not necessarily. We can use a "blended useful life" calculation to complete one 504 loan transaction. If the "blended useful life" of the project exceeds 15 years, the entire project is eligible for a 25-year 504 loan. In the example below, the blended useful life exceeds 15 years so the $280,000 504 loan could be financed at a 25 year term.
6. Is it advisable to amortize equipment over a 25-year loan?
The ability to stretch the term of your financing lowers your monthly debt service payments dramatically. If your company is growing, the 25-year term financing allows you to better manage cash flow to support growth in the short term. Cash flow from the company can be used to help generate more sales (more employees, inventory, etc.) rather than be used to retire shorter-term debt. Since most borrowers seeking 504 financing are undergoing an expansion, it’s a good idea for them to amortize debt for equipment over as long a term as possible.
7. What options are there if a real estate appraisal is less than the total project size?
The SBA will often accept an appraisal so long as it comes within 95% of the required value. For example, if you have a $1,000,000 project, the financing will be approved conditionally on having an appraisal of $1,000,000. If the appraised value is $950,000 or more, the SBA will often accept the appraisal.
If you have a question or deal you’d like to discuss, get in touch with one of our loan officers today.