The ongoing COVID-19 pandemic has precipitated an economic slowdown not seen in over a decade. In response, the federal government has enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), taking unprecedented steps to address the concerns of small and medium-sized businesses, with the new Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans being the centerpiece of those initiatives. However, small businesses should keep in mind the other government-guaranteed lending options available to them. Most have heard of the SBA’s 7(a) loan program, to which the PPP loans are an addition, but fewer are familiar with the SBA’s 504 loan program, which helps borrowers acquire and maintain fixed assets.
504 Loan Program Overview
Unlike the 7(a) loan program, in which a small business borrows from an SBA-participating lender, the 504 program involves a small business borrowing from both an SBA-participating lender and a certified development company (“CDC”). CDCs are nonprofit corporations certified by the SBA and designed to promote community development. A 504 loan is structured so that a CDC covers 40% of project costs, a participating lender covers 50% of project costs, and a borrower covers 10% of project costs. The CDC’s 40% financing is guaranteed by the SBA. Generally, 504 loans can be used only for fixed assets and related soft costs, including:
- purchase of land, and land improvements
- purchase of existing structures
- construction of new facilities or renovation/conversion of existing facilities
- purchase of long-term machinery
- refinancing of debt associated with the above projects
Benefits to the Borrower
The 504 loan program is attractive to many small businesses because of the 90% financing offered by the lender and the CDC. Beyond this, 504 loans provide for longer amortizations and fixed interest rates, currently about 5%, and they do not require balloon payments. Both 10- and 20-year maturities are offered for 504 loans.
The major distinction between the 504 and 7(a) loan programs is the involvement of CDCs. A project can be eligible for a CDC’s 40% financing only if it creates jobs or serves certain community development or public policy objectives. If a project is eligible, the CDC will fund its portion of the project cost through the sale of a debenture to institutional investors. CDC debentures have a maximum amount of $5 million and are fully guaranteed by the SBA. Borrowers should keep this in mind, as it limits the amount that the CDC may put into a project to $5 million.
Applicants for the 504 loan program must meet the SBA’s small business size requirements set out in the North American Industry Classification System (NAICS) codes. Applicants must also have a maximum tangible net worth of $15 million and a maximum average net income of $5 million after federal income taxes for the preceding two years. Potential borrowers are encouraged to discuss eligibility for the 504 loan program with the SBA originators at their trusted lenders, a regional CDC or with us and we can introduce you to a CDC and a participating lender. The application for a 504 loan is much more involved than the application for a PPP loan.
Debt Relief for 504 Loan Program Borrowers
In addition to the establishment of PPP loans, Section 1112 of the CARES Act also provides relief to SBA 504 and 7(a) loan program borrowers. Effective immediately, the SBA has been instructed to pay the principal, interest, and related fees for all outstanding 7(a) (other than PPP loans), 504, and SBA microloans for a six-month period. The SBA also pledges to pay principal, interest, and related fees for all new 7(a) (other than PPP loans), 504, and microloans issued prior to September 27, 2020, for a six-month period. This represents a significant opportunity for small-business borrowers considering SBA financing to weather the uncertainty brought on by the COVID-19 pandemic. Although Section 1112 is to be self –executing by the SBA, we suggest any business with any of these SBA loans should follow-up with their SBA lenders.
Steps for Borrowers Going Forward
1. Contact an SBA-participating lender about the possibility of obtaining a 504 loan for your qualifying project or, alternatively, reach out to a CDC authorized to lend in the region where your project is based. The SBA offers a search tool for borrowers seeking out CDCs here.
2. Alternatively, contact McCarter & English as we can help you find the right lender and CDC for your needs and assist you through the entire process.