SBA Loans are Misunderstood
From a coffee roaster to a $10 million development deal, the SBA's 504 loan program can work harder than you thinnk - it can even help create jobs
BY RANDALL WANKE
Located near Minnesota’s picturesque North Shore, Epicurean Cutting Surfaces may be one of the more unique small business success stories in Minnesota.
Born of the entrepreneurial spirit and the desire to protect the environment, this manufacturer got its start making skateboard ramps. But, the company’s founders discovered true inspiration in a pile of leftover materials from one of those ramps, which they used to create cutting boards. The cutting boards have become an international hit, and the organization’s founders were recently recognized as exporters of the year by the Small Business Administration (SBA).
Epicurean Cutting Surfaces is also one of a growing number of Minnesota manufacturers utilizing the SBA’s 504 loan program to grow their businesses and create more economic opportunities in their communities.
CEO Tony Ciardelli credits the 504 loan program with allowing his small business to expand into a new facility, which helped the organization to be more efficient by tailoring space in that facility to their needs.
“We added a whole office structure to the existing foundation, which we could design for what we needed, versus when we were renting, it was really difficult to use somebody’s existing space,” explains Ciardelli. Building their own office also helped the company increase its production and become more efficient.
Interest in the 504 loan program has grown, in part, as a result of changes made in 2004 that allowed for guaranteed loans of up to $4 million for small manufacturers to expand their businesses. This change also allowed small manufacturers more flexibility to invest limited working capital where it can do the most good— operating their businesses.
According to the SBA, Minnesota usually ranks in the top five nationally in the number of 504 loans provided to small businesses. In 2007, the SBA approved 427 SBA 504 loans in Minnesota, totaling nearly $209 million, which is up from more than $181 million in 2006. Even with this growth, many small manufacturers are failing to take advantage of the benefits of the 504 loan program.
Bremer Bank vice president Dale Peterson cites two reasons why this may be the case. First, he says, defining what a small business is and how that definition applies to utilizing a SBA loan program is not always easy. Second, many manufacturers assume SBA loan programs are for smaller transactions.
However, during these times of economic uncertainty, encouraging more small manufacturers to take advantage of the 504 loan program may help to create new jobs and economic opportunities in Minnesota.
GROWING MANUFACTURING IN MINNESOTA
According to Minnesota’s Department of Employment and Economic Development
(DEED), Minnesota had about 343,000 manufacturing jobs in 2004. DEED projects that number to grow by a scant 3,500 jobs or about 1 percent by 2014.
The SBA 504 loan program, which is designed to spur job creation, may provide an opportunity to help grow manufacturing jobs in Minnesota. “SBA 504 loans are unique in that they support activities of enterprising borrowers with strong entrepreneurial spirit,” says Lowell Collman, senior vice president at Anchor Bank.
A report released by the National Association of Development Companies (NADCO) in late 2007 found that about 62 percent of businesses that received SBA loans reported job growth in the two years following the loan funding.
HOW IT WORKS
The 504 loan program is designed to be an economic development tool that can help create jobs and financial opportunities within a community. With that goal in mind, in 2004, Congress passed and President Bush signed legislation which created a new loan category for manufacturers in the 504 loan program, with a limit of $4 million.
The loan can be used by small manufacturers for everything from construction of new facilities to purchasing long-term machinery and equipment. Under current SBA guidelines, in most cases, a manufacturing company is defined as a small business with 500 or fewer employees.
In a typical project that utilizes the 504 loan, the bank generally finances 50 percent of the project and the SBA offers 35 percent to 40 percent in debentures, while the owner—or a non-government lending source—provides 10 percent to 15 percent equity. For example, the 504 structure could be used for a $10 million commercial real estate transaction in which a private lender provides $5 million, the SBA provides $4 million and the owner provides the remainder.
Bremer Bank financed a roaster for a coffee distributor through the 504 loan program. Another business financed $1.5 million in capital equipment through the 504 loan program. According to Peterson, these bigger equipment purchases are a good example of utilizing the SBA financing structure with less money down and long-term fixed rates.
Manufacturers shouldn’t “let the fact that it’s a government program overwhelm them,” says Michelle Mueller, vice president of business development for Minnesota Business Finance Corp., one of six Certified Development Companies (CDC) in Minnesota. CDCs are licensed by the SBA to provide loans under the 504 loan program. “I sit down face-to-face and have them fill out the application. I explain it to them. We really try to make it as easy and painless as possible.”
Ciardelli and his colleagues found the SBA helpful and the 504 loan process to be smoother and easier than trying to find private funds on their own. “[The SBA] really allowed us to focus on growing our business and not have to focus on going out to find a lot of people to loan us money,” he says. “It wasn’t a very intense process. It was relieving.”
THE BENEFITS OF 504 LOANS
Advocates of the 504 loan program highlight the benefits of the program to manufacturers and lenders as well as Minnesota communities and taxpayers.
"Everyone wins with the 504 loan program,” Minnesota SBA Director Edward Daum says. “The small business owner obtains a favorable, fixed interest rate on a long-term loan. The lender is able to help the customer with a longer term loan as well as receiving a first mortgage position on the collateral.”
The NADCO report on the economic impact of the 504 loan program found that 77 percent of businesses reported increasing revenues within two years of their 504 loans.
Along with the potential for increased revenues, lenders also highlighted several benefits, including the fact that the 504 loan’s lower down payment allows manufacturers to invest more money into operations, which have a larger return on investment.
Peterson points out that business owners are often drawn to the 504 structure because it requires less money down. “Often the cash they have to put into the project is limited. Limiting the equity going into a real estate transaction is often preferable because the business owner gets a better return on equity by leaving the cash in the business,” he says.
According to Peterson, business owners also benefit from the longer terms that are available through 504 structures, which allow them to make the lowest possible monthly payment. The SBA offers a 20-year, fully amortizing loan on their portion of the deal, and at times banks will go out 25 years on their loan. Mike Ruether, president of Premier Bank— White Bear Lake, says that the program, in most cases, offers interest rates below market rate.
Along with the gains to manufacturers, lenders can also benefit from the 504 loan program. Ruether points out that participating in the program is good for lenders for one important reason: “it makes the loan less risky.”
With the 504 loan’s structure, banks are able to consider transactions that “they might not be comfortable with at an 80 percent loan to value,” explains Peterson. “Since they will have a first position at 50 percent of the transaction, banks might be more willing to work with a business with a shorter history of cash flow, finance cash flow off projections and look at industries they normally might not finance.”
“Lenders—whether in Minnesota or anywhere else—use 504 loans to finance equipment, fixed assets and real estate,” says SBA public affairs specialist David Hall. “On the 504 loans, the lender does indeed hold the favorable first mortgage position.”
“The local community gets a cash injection from the sale of the SBA 504 debentures in New York.” adds Daum. “And the program is not subsidized by the federal government, so the taxpayers win as well.”
Collman also notes, “The SBA 504 loan program is a catalyst for creating and retaining jobs, as well as expansion of commerce in Minnesota.”
ENHANCING THE LIVES OF OTHERS
With success stories like Epicurean, it is clear that the entrepreneurial spirit is alive and well in Minnesota. And during times when people are looking for hope in a tough economic climate, the 504 loan program can offer an opportunity for small manufacturers to expand their businesses and enhance the lives of their communities, employees and customers.