Commercial Lending
How Do SBA 504 Loans Work?
Discover the advantages of SBA 504 loans, enabling small businesses to seize growth opportunities through shared capital partnerships.
Discover the advantages offered by an SBA 504 loan and obtain the essential funds that will drive your business growth in the year 2024.
The Small Business Administration (SBA) assists small business owners throughout the development process. One of the most valuable services the SBA provides is financing for business expansion and asset procurement.
You may be familiar with the 7(a) loan, but the SBA also provides other funding known as the 504 loan. The 504 loan program generally caps the funding at $5 million but eligible energy-efficient or manufacturing projects may qualify up to $5.5 million each. The SBA provides small businesses with long-term financing that may also be used to purchase major fixed assets.
As you prepare your business for 2024, consider applying for an SBA 504 loan.
How Does the SBA 504 Loan Program Work?
To obtain a 504 loan, you must show that the asset you want to purchase promotes job creation and business growth. Because the 504 loan is a community-based program, your business is more likely to be successful if you can clearly tie the proposed asset to the community.
How an SBA 504 Loan is Structured
The 504 loan program involves three parties, the borrower, an SBA-qualified lender, and a Certified Development Company (CDC). The CDCs are nonprofit entities certified and regulated by the SBA, which in turn work with qualified lenders to underwrite the loan. The loan package is typically structured with three components:
- Conventional first mortgage: The CDC and a third-party lender will provide 50% of the loan’s funding, with the proposed asset serving as collateral.
- Second mortgage: The SBA will take a second mortgage in the collateral and provide up to 40% of the loan’s funding.
- Equity investment: In most cases, your business must provide a 10% down payment. If your business is a startup or you are developing a special-purpose property, the SBA may require up to 20% down.
How to Qualify for an SBA 504 Loan
To be eligible for an SBA 504 Loan, the SBA imposes three requirements. First, your business must be a for-profit company located in the United States or its territories. Second, your total tangible net worth must be less than $15 million. Third, your average total net income must be less than $5 million on a post-tax basis for each of the two years preceding your application.
In addition, the SBA is more likely to approve applications where:
- The company has demonstrated expertise in management.
- The proposed business plan is feasible.
- The business and its leaders are of good character.
- The business can repay the loan.
Companies that perform nonprofit, passive, or speculative activities are not eligible for the 504 loan program.
How Can I Use an SBA 504 Loan?
The SBA sets strict parameters for the use of a 504 loan. The agency considers the purchase or construction of long-term machinery and equipment, new facilities, and existing buildings or land to promote job creation and business growth. In addition, you may also use a 504 loan to improve or modernize existing facilities, land, parking lots, landscaping, and streets.
However, you may not use a 504 loan:
- As working capital
- To purchase inventory
- To consolidate, repay, or refinance business debts
- To speculate or invest in rental real estate
Once you’ve identified a proper asset and business purpose for your loan, you’ll need to apply to the SBA.
Documents Needed for the SBA 504 Loan
As a loan provided by the federal government, a 504 loan application requires extensive documentation. Nonetheless, there are steps you can take to streamline the process and make your application more competitive.
1. Prepare Financial Documentation
When you’ve determined that a 504 loan is right for your business, you’ll need to prepare financial documentation. This includes:
- Business financial statements
- The personal financial statements of the business’s owners
- Business tax returns
2. Assess Your Business’s Creditworthiness
While the SBA has no minimum credit score requirement, your lender likely will. Usually, lenders look for a minimum score of 680. But that doesn’t mean a lower score will automatically disqualify your business. Like with any other financing application, the credit score is just one of several factors your lender will consider. Remember, the lender only cares about your business’s credit score, and not your individual score.
3. Gather Additional Required Documents
In addition to the basic financial documents listed above, you will also need to submit a:
- Business plan
- Use of funds statement
- Document sufficiently describing the collateral
- Debt schedule
- Cash flow analysis
- Listing of accounts receivable and accounts payable
- Contractor estimate (for construction loans) or cost documentation (for equipment loans)
- Real estate and/or equipment appraisal
Finding an SBA-Approved Certified Development Company (CDC)
To obtain your 504 loan, you will have to work with a Certified Development Company (CDC) to procure financing. The CDC that you select will work with your lender to underwrite the loan and establish the necessary terms and conditions. Similar to the CDC, the SBA must approve the lender with whom you want to work. You can save time by choosing a lender with a preexisting SBA-approved CDC.
To choose the CDC most suited to your business’s needs, you’ll want to consider several factors. These include:
1. The Working Relationship Between the CDC and its Lenders
To obtain a 504 loan, the CDC will play a critical role, from underwriting to processing and servicing the loan. The lender will work with the CDC along the way.
2. The Responsiveness of the CDC
You’re bound to have questions during the process. It’s also possible that your business or the lender will encounter unforeseen or unexpected circumstances. When that happens, a responsive CDC is more likely to keep your application on track and provide peace of mind.
3. The Projects that the CDC has Facilitated
The fact that a given CDC is new does not necessarily mean that it cannot handle your proposal. However, those CDCs with an established history are more apt to handle your unique requirements. Such a CDC will also have longer-standing relationships with lenders.
The SBA’s website can help you find CDCs in your state that will meet your requirements.
Completing the SBA 504 Loan Application
How to apply for an SBA 504 loan involves four steps.
1. Prequalify Your Business
The CDC you select may have a prequalification process. This will require you to submit your personal and business tax returns, personal financial statements, and interim financial reports. Prequalification will save you time by determining your eligibility, providing a range of expected loan disbursements, and determining your down payment.
2. Complete the SBA’s Application
Once pre-qualified, you will complete the application documents. This includes SBA Form 1244. The CDC will help you complete the application and then underwrite the loan with your lender. Depending on your project proposal, the SBA may require an appraisal and environmental review.
3. Obtain Approval
Once completed, the CDC will send your application packet to the SBA for review. This generally takes about one week. However, the SBA will also conduct a background check. If the background check shows any irregularities, processing and approval could be delayed.
4. Close the SBA 504 Loan
At this point, your CDC and lender will prepare your loan documents. Once in the possession of the escrow officer, you will designate a time to sign the final documents and close escrow. It can take from 30 to 90 days to complete the closing process.
Common Pitfalls to Avoid in Your Application
To ensure that your application is processed smoothly, you’ll want to avoid some common pitfalls:
- Establish a profitability history. Before applying, your business should have a demonstrated history of profitability. Ensure that all revenue is deposited into your business accounts and avoid overdrafting the accounts.
- Develop a comprehensive business plan. Your business plan should be thoughtful and strategic. You are asking for up to $5.5 million, after all. The business plan should clearly articulate the need and expected use of the funds, an explanation of the products or services offered by your business, and a detailed financial projection for the near term.
- Prepare for the application process early. Completing the SBA 504 loan process requires substantial due diligence. You must provide years of financial information for yourself and your business. You’ll also need to demonstrate your business’s creditworthiness. If you expect that you’ll need additional time to complete your application, begin early.
How FileInvite Can Help with the SBA 504 Loan Process
FileInvite's secure file sharing and document collection platform can substantially streamline the SBA 504 loan application and approval process for lenders. By automating the document collection process, FileInvite reduces the administrative workload involved in manually collecting, tracking, and storing documents. It enables lenders to send automated requests for documents and receive real-time updates when documents are submitted by applicants, ensuring no delays in the application process.
And that’s where FileInvite can help streamline the application process. FileInvite’s software enables businesses to fund their SBA loans up to six times faster. Experience a more secure document collection with FileInvite.
Importantly, FileInvite enhances compliance through its secure portal, which is designed to handle sensitive financial documents, providing both encryption and access control. This is crucial for maintaining the security of the applicant's personal and business information. By integrating with existing lender systems and offering a single portal for document management, FileInvite minimizes the potential for errors and omissions, leading to a more efficient approval process.
To learn more and request a demo, visit FileInvite today.
