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Startup costs for small business entrepreneurs can be overwhelmingly expensive. The prospect of purchasing real estate, making land improvements, property renovations, or buying necessary equipment can bring a small business owner’s ambition to an early end if they’re unable to line up financing.
But there is a government program that can help small businesses get off the ground and contribute to the local economy's health at the same time.
It's known as the SBA 504 program for small business loans.
What Is an SBA 504 Loan?
SBA 504 loans are administered by the Small Business Administration. They have two primary aims:
- To help small business owners finance new commercial projects
- to spur local job growth
According to the SBA, 504 loans provide "long-term, fixed-rate financing of up to $5 million for major fixed assets.”
Small business loans created through the SBA 504 loan program may be used to fund:
- Real estate purchases, including buildings and land
- Land improvements, including landscaping, parking lots, and grading
- Facility construction or renovation
- Purchasing new, long-term equipment and machines
- Refinancing of debt incurred through any of the above
If you’re looking for small business loans, bad credit could get in your way, so keep that in mind as you consider your options.
Next, we’ll look at the advantages and disadvantages of a SBA 504 loan.
SBA 504 Loan Advantages
A SBA 504 Loan has several advantages.
Less Expensive
SBA 504 loans are generally less expensive than conventional loans.
Combined with the usual lower down payments, lower monthly repayments, and longer loan terms, small business loans through the 504 program may end up costing significantly less in the end.
Cover Business Expenses
They also cover a greater number of business expenses. Although conventional loan rates may be lower, SBA 504 loans usually cover a maximum of 80% of the total costs.
Fixed Interest Rate
The interest rate on an SBA 504 loan is fixed over the whole term. Other loans may be subject to variable interest rate fluctuations as set by the bank, and small businesses may find it harder to meet stiffer credit requirements over time. With an SBA 504 loan, those variables don’t come into play.
SBA 504 Loan Disadvantages
Even though a SBA 504 loan has several advantages, there are also disadvantages associated with it.
Must Stimulate Job Growth
A SBA 504 loan borrower must stimulate job growth.
For every $65,000 they get from the loan, they must either create or retain one new position.
If for some reason they can’t, they must meet certain public policy standards for local economic development.
Items that the Loan Can’t Cover
There are a few business necessities that the SBA 504 loan cannot cover.
For example, SBA loans can’t be applied toward inventory.
They also can’t be used as working capital or to consolidate pre-project debt.
6 SBA 504 Loan Requirements
Six of the most pertinent requirements for obtaining small business loans under the SBA 504 loan program are:
SBA Loan Requirement #1: Operating as a For-Profit Company
Your small business must be registered as a for-profit company in the United States.
Nonprofit organizations are ineligible for SBA 504 loans.
SBA Loan Requirement #2: Tangible Net Worth Less Than $15 Million
Tangible net worth equals the sum of your company’s physical or cash-convertible assets, minus its total debt liability.
To qualify for a SBA 504 loan, your net worth must be less than $15 million.
SBA Loan Requirement #3: Average Net Income Less Than $5 Million
Your average net income must be less than $5 million to qualify for a SBA 504 loan.
This figure is calculated after taxes for the two years immediately prior to your application.
SBA Loan Requirement #4: An Eligible Business
Your business must be considered an eligible business.
Disqualified businesses include ones that focus on:
- gambling
- speculation
- loan packaging
- investment
- multi-sales distribution
- and a few others
SBA Loan Requirement #5: Ability to Repay SBA Loans
You must be able to repay SBA 504 loans out of your company’s projected cash flow.
When it comes to these small business loans, bad credit is a non-starter.
If you need to improve your business credit score, or you are curious about how a business credit score is different from a personal credit score, click here.
SBA Loan Requirement #6: Strong Credit History and Good Character
The SBA solicits a “Statement of Personal History,” which is used to verify your past capability and compliance in repaying debts.
Like many other small business loans, bad credit can impact your eligibility.
What Are the SBA 504 Loan Rates?
As of June 2021, the interest rates on SBA 504 small business loans are between about 2.88% and 3.75%. Rates are set by the lending bank after the loan has been funded and can be either fixed or variable.
How to Use an SBA 504 Loan: An Example
Let’s look at an example of a SBA 504 loan. Say that a local restaurateur wants to turn an old auto garage into a café.
Acquiring the property costs $500,000.
Renovating the garage to accommodate a café costs $150,000.
New equipment and furniture cost another $100,000.
Setting up an electronic cashier station costs $20,000.
These expenses total $770,000.
If the restaurant owner meets all the qualifications and obtains an SBA 504 loan for 90% of the startup costs, they’ll receive $693,000 to put toward their business.
The SBA 504 Loan comes with requirements, though.
Along with repaying the loan, the owner will have to create at least 10 new job openings.
Alternatives to an SBA 504 Loan
There are alternatives to an SBA 504 loan. These include:
- Banks, institutional lenders, or credit unions
- Lines of credit or business credit cards
- Short-term business loans
- Financing using equipment as collateral
- Personal loans
- Venture capitalists, angel investors, or crowdfunding
- Business grants
- Traditional debt financing
Each of these options come with their respective risks, limits, requirements, and obligations.
Keep in mind that if you need small business loans, bad credit can impact the rates you receive, even if you aren’t using the SBA 504 program.
Applying for an SBA 504 Loan
To learn more about SBA loans through the 504 program, contact a financial institution, such as a major bank, that issues them.
If you’d like to apply for SBA loans, you can go to the Small Business Administration’s website and download a PDF form.
