Cashing in on 504 loans: a Small Business Administration program has enabled thousands of companies to borrow at favorable rates and expand

Nation's Business, Dec, 1993 by J. Tol Broome, Jr.

Donnie Jones of Greensboro, N.C., had always dreamed of expanding his auto body shop business, but financing posed a major obstacle. The banks he visited wanted a 25 to 30 percent down payment in cash plus monthly loan payments that would not have been affordable.

Then Jones met a banker who suggested that he apply for a loan under the U.S. Small Business Administration's Section 504 program. With a 10 percent down payment and an affordable monthly payment, Jones found that he was able to buy land and construct a 5,400-square-foot body shop.

"I was certainly pleased with the down payment part of the package," Jones says. "We got an excellent interest rate compared to our other options at the time, and a lower monthly payment."

Within a year and a half of completing the new facility, Jones Body Shop had doubled its annual sales and added six employees, bringing the total to 10.

Since its inception in 1981, the 504 program has generated more than $4.6 billion in loans. The program reached a new high in the 1993 federal fiscal year that ended Sept. 30, with 2,454 loans totaling $813 million.

Even with this record of impressive growth, many owners of small businesses are unaware that the program exists. And some others who have heard of 504 loans steer clear of them because of the program's association with the federal government.

To help you determine whether you should explore the 504 program, here's an explanation of how it works:

Fixed-Asset Financing

The program is designed to provide long-term, fixed-asset financing to small businesses, specifically for land, buildings, and equipment. There are four key players in every 504 deal: the borrower, the bank, the Small Business Administration (SBA), and a certified development company (CDC).

The borrower is generally required to make a down payment of only 10 percent. The CDC provides 40 percent at a longterm fixed rate, with an SBA repayment guarantee if the borrower defaults. The bank, meanwhile, agrees to provide longterm financing for the remaining 50 percent. It should be noted that the bank, not the borrower, initiates contact with the local CDC.

"Our bank has utilized the program a great deal in recent years," says David Trautman, a vice president with Park National Bank, in Columbus, Ohio. "The borrower is able to preserve working capital for other uses, and the program offers an attractive rate structure and favorable repayment terms." He adds that prospective borrowers are often "surprised to find that a 504 application does not involve mounds of paperwork."

The entire application process usually takes from four to eight weeks, according to Mark Barbash, who is executive director of the Columbus Countywide Development Corp. "We encourage our banks to call us early in the process," he says. "That way we can begin some preliminary evaluation before the package gets here, which expedites the approval process."

Eligibility Requirements

There are several basic eligibility restrictions imposed by the SBA:

* For every $35,000 loaned by the CDC, the project must create at least one new job.

* Machinery and equipment financed must have a useful life of at least 10 years.

* The borrower must plan to occupy at least two-thirds of a building constructed with the loan.

* For purchase or remodeling of an existing facility, the borrower must plan to occupy at least 50 percent of the space.

* The borrower must qualify as a small business. An applicant is considered a small business if the firm's net worth does not exceed $6 million and if after-tax net profits have averaged less than $2 million during the previous two years. According to the SBA, 98 percent of all U.S. companies meet the agency's definition.

* Strict equity requirements usually prohibit start-ups from participating in the 504 program.

Jobs, And More Jobs

Since its inception, the 504 loan program's principal mission has been job creation, says Martin Orr, chief of the development company branch of the SBA, in Washington, D.C. "The overall emphasis [of the 504 program] is on creating jobs and meeting needs of local communities."

According to SBA records, loans made under the 504 program have helped create more than 314,000 jobs since 1981.

To better evaluate whether your company might qualify for a 504 loan and to learn how to proceed, consider the following points:

Underwriting Criteria

The SBA imposes several basic underwriting restrictions on each prospective borrower:

* The borrower must have been turned down for bank loans.

* The business owner must demonstrate good character and management ability.

* The collateral must be acceptable.

* The borrower must show adequate cash flow to repay the loan.

* The borrower must own a substantial stake in the business.

Types Of Projects

According to Trautman, of Park National Bank, ideal 504 candidates include business owners who are growing quickly and need additional capacity, who are leasing their place of business, and who lack the 20 to 25 percent down payment typically required for conventional financing.