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Catch-22 and Financing Too

  1. It is important, especially during the early stages of start-up, for small business owners to preserve capital for ongoing operations and future expansion.
  2. During times of growth, many small businesses will attempt to secure additional funding from lending institutions.
  3. Securing a loan for a new small business location or expansion often requires the owner to contribute 20%-40% or more of the amount needed.
  4. The money contributed will likely come from the operating capital the business sought to preserve.

Do you see the issue?

The business can grow, but sometimes, only by sacrificing the capital needed for ongoing operations.  I’m told that Joseph Heller originally intended his classic novel to be about small business financing, but opted to write Catch-22 about government bureaucracy because it was less nonsensical.

It’s natural to have a smirk on your face as it is suggested that a solution to the problem above may exist in the form of a government program, but an SBA 504 Loan does offer the opportunity for small businesses to acquire the financing necessary to purchase commercial real estate or expand an existing location while preserving capital for operations even if it does come with a little bureaucracy. Here’s how:

How It Works

A 504 Loan is a relatively simple concept involving three parties—the lender, the Certified Development Company (CDC), and the borrower. This creative combination of public and private financing has successfully provided $100 billion to over 130,000 small businesses since its inception in 1986.

The process starts by approaching a bank that is a participating SBA lender (there are many in the area). The progression of activity is very similar to applying for any other type of commercial financing. A series of loan documents, ranging from an application to financial statements, will need to be completed. The lender will provide 50% of the financing requested, assuming approval.

Community Development Companies are SBA authorized and regulated not-for-profit corporations that provide the “504” portion of the loan. That is, they provide the 40% of the loan amount that is guaranteed by the SBA leaving only 10% to be provided by the borrower.  Borrower approval is similar to the criteria found in traditional financing, but because banks are largely insulated from losses, standards are generally a little less stringent. This is most readily illustrated through greater flexibility in approving borrowers with lower credit scores (600) and higher debt ratios (1.0), though you must still document the ability to repay the loan.

Benefits of a SBA 504 Loan

The SBA 504 Loan Program offers two primary benefits to eligible businesses (most small businesses are eligible) purchasing commercial real estate or expanding an existing location including low down payments and long-term fixed rate financing, but there are other “hidden” benefits for savvy borrowers.

10% Down Payment—Why bury the lead? The most obvious benefit of a 504 is the limited capital contribution required from the borrower. The low down payment allows borrowers to retain operating capital and retain liquidity while securing a new or expanded business location. By comparison, most conventional loans will require a minimum of 20% (sometimes 30% or more) down, which translates to an additional $50,000-$100,000 needed on a $500,000 transaction.

Fixed Rate 20 Year Financing—In an environment of variable interest rates with 3-5 year loan terms (meaning a loan renewal is required after that period), an offer of a fixed interest rate (currently 5.68%) for a period up to 20 years should be a welcome one for small business owners.  The long-term nature of the financing enables the small business to preserve capital by maintaining lower monthly payments and avoid potential risk associated with traditional loan call provisions (if the traditional loan is not renewed, the balance becomes due).

Flexible Structure—The program permits small businesses to take possession and hold real estate in their own name, the business name, or a real estate holding company (generally a LLC). Every situation is unique, but this can create the opportunity to maximize owner or business tax benefits.

What You Need to Know

There are limitations to the program, particularly regarding what are eligible and ineligible uses of the loan funds. Loan proceeds must be used for commercial real estate that will be occupied by the borrower. The rule is 51% of an existing building purchased and 60% of a newly constructed structure must be owner occupied. Funding cannot be used for working capital, refinancing existing debt (most of the time), or investment real estate beyond the occupancy standards stated above.  If you’re seeking funds for working capital, consider looking into the SBA 7a program.

Most small businesses are eligible for the program, but must have operated for two years or more (less than two years requires additional equity), have a net worth less than $15 million and net income less than $5 million after taxes, and not have other reasonable sources of funding for the loan.  Again, businesses engaged in speculative investment in real estate, coins, oil; pyramid sales; and, oddly enough, illegal activities, are not eligible.

Loan amounts are capped at $5 million for regular projects and $5.5 million for manufacturing projects. Technically, the loan amount is also tied to the number of jobs created or retained. The general rule of thumb is $65,000 loaned for each job created or saved, but this can be adjusted if the project meets another economic development goal.

What’s the Rub?

The SBA 504 Loan program offers a big solution for many small business owners that have limited capital or are seeking to preserve existing capital for operations. It would be reasonable to expect a program of this nature to come with some drawbacks. Surprisingly, the disadvantages are relatively minor. SBA loans do take a little (sometimes, a lot) longer to close and the process can seem redundant. Occasionally, the SBA/CDC will require additional collateral and this is often in the form of equipment or inventory, which can tie up the collateral available to offer another lender. The most restrictive is reserved for the prepayment penalty, which starts at 10% in year one and declines by 1% each year until exhausted in year eleven.

Each business financing decision is different and while the shortcomings are minimal, it is worthwhile to research and compare the 504 Loan Program to other conventional loan products.


Tim Reamer provides commercial real estate brokerage and consulting services with Cottonwood Commercial and specializes in investment property (multifamily | commercial | NNN), retail/restaurant site selection, and commercial buyer/tenant representation. Learn more at