SBA 504 and 7a | What Each Programme Actually Funds

Definition

SBA 504. A programme for long lived fixed assets, principally owner occupied commercial real estate and heavy equipment with a long useful life. It is delivered as two loans, not one: a conventional first mortgage from a bank or credit union, and a second position debenture issued through a certified development company with an SBA guaranty behind it. The borrower contributes equity on top. The debenture carries a long term fixed rate set at a periodic bond sale.

SBA 7(a). The SBA's general purpose programme. A single loan made by a participating lender, with the SBA guaranteeing a portion of it, capped at a statutory maximum of $5,000,000. Its defining feature is breadth of use: working capital, business acquisition, partner buyouts, refinancing eligible debt, equipment, and real estate all sit inside it.

The simplest way to hold the distinction: 504 is a structure built around an asset. 7(a) is a loan built around a business.

The Two Programmes Side by Side

The differences that actually decide which route a file takes are structure, use of funds, rate character and the tests attached.

The Occupancy Requirement

SBA real estate financing exists for businesses that use their property. It is not a route to investment property, and this is the requirement that disqualifies more enquiries than any other single rule.

Existing building. The operating business must occupy at least 51 percent of the rentable space. The balance may be leased to third parties, and that rental income can generally be counted in the analysis.

New construction. The threshold is higher. The business must occupy at least 60 percent immediately, with a defined path to occupying more of the building over time, and limits on how much space may be permanently leased to others.

Two practical points that follow from this:

Mixed use works, within the rule. A business occupying most of a building and leasing the remainder is a normal and financeable SBA profile.

An affiliated operating company arrangement is standard. It is common and accepted for a holding entity to own the real estate and lease it to the affiliated operating business, provided the ownership and lease arrangements meet SBA requirements. The occupancy test looks through to the operating business.

What does not work is buying a property to rent out. No amount of structuring changes that under either programme.

The Job Creation and Public Policy Test on 504

This is the requirement unique to 504, and it exists because of who delivers the programme.

A certified development company is a mission driven entity whose purpose is local economic development. The debenture portion of a 504 project is issued through one, so every 504 project has to satisfy an economic development objective. There is no equivalent requirement anywhere in 7(a).

The primary route is job creation or retention, measured against a defined amount of certified development company funding per job created or retained. A project that will add or preserve enough employment relative to the debenture size clears on this basis.

Where the job test is not met, a project can still qualify by satisfying one of the programme's community development or public policy goals. These cover categories such as rural development, expansion of exports, reduction of energy consumption, businesses owned by veterans, and revitalisation of a defined business district, among others.

What this means in practice for a borrower: a 504 project with modest employment impact is not automatically out, but the economic development case needs to be identified early and evidenced, rather than discovered late. Whether a specific project satisfies the test is determined by the certified development company and the SBA.

Thresholds That Decide SBA Files

Three SBA underwriting points come up constantly, and they are where otherwise clean files get stuck.

Minimum 10 percent post close liquidity. A borrower is not permitted to empty themselves of cash to fund the closing. Liquidity has to remain after the deal is done. Sponsors who plan to fund the entire equity contribution from every available dollar find this out late, and the fix at that point is either less leverage or more cash from somewhere else.

Maximum 90 percent against appraised value. Note the denominator: appraised value, not purchase price. When an appraisal lands below the agreed price, the gap comes out of the borrower's pocket on top of the planned contribution. On a property agreed at $3,000,000 that appraises at $2,800,000, the financeable base fell by $200,000 and the borrower's cash requirement rose accordingly.

The lender orders the appraisal. Not the borrower and not the broker. An appraisal a borrower commissioned independently, however competent, will not substitute for the lender's own instructed report. Commissioning one privately in the hope of setting the number is spent money.

Sitting behind all three is the equity contribution itself. The conventional 504 structure has the borrower at around 10 percent, but that rises where the project involves a special purpose property, and rises again for a start up business, with both conditions together producing the highest requirement. Hotels, restaurants, car washes, bowling centres and similar single use assets fall into the special purpose category.

Which Route Fits Which File

A working rule, with the caveat that real files are frequently decided by details rather than by rules.

504 deserves serious evaluation when: - The use of funds is owner occupied commercial real estate or heavy, long lived equipment - The business can meet the occupancy requirement and has a credible economic development case - A long term fixed rate on the majority of the debt is worth structuring around, which given the recent gap between roughly 5.90 to 6.20 percent on the debenture and roughly 9.50 to 11.75 percent on 7(a) is very often the case - The project is large enough that the two loan structure justifies its extra moving parts

7(a) is normally the practical route when: - Working capital is part of the use of funds, which 504 cannot cover - The deal is a business acquisition or a partner buyout - The purposes are mixed and will not sit neatly in a fixed asset structure - Speed and simplicity matter more than optimising the rate, since one loan and one closing is a materially lighter process

The mistake worth avoiding is defaulting to 7(a) on an owner occupied real estate purchase because it is the programme the borrower has heard of. On a real estate heavy file the pricing difference compounds over a long term and is worth the evaluation.

PeerSense is a capital advisory. We position a file and place it with lenders whose credit box already fits it. We do not lend, fund, price or approve anything, and programme eligibility is determined by the lender, the certified development company and the SBA.