Business Financing: The Next Step

The Next Step

Are you thinking about buying a business?  Or, do you own a business, but are leasing the space?  Are you ready for the next step?  Before going to see your community banker, here are a few things you should be aware of: 

Loan to Value

The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased.

For example: if someone borrows $870,000 to purchase a business worth $1,000,000, the LTV ratio is $870,000 to $1,000,000 or $870,000/$1,000,000, or 87%. The higher the LTV ratio, the riskier the loan is for a lender.

Loan to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage. From the perspective of a lender, borrowers with a lower LTV, and thus more equity in their business, are less likely to default on their mortgage. 

Equity Investment

If you are a small business owner and are considering purchasing or renovating commercial real estate or purchasing equipment to grow or expand a business, you also need to consider your investment (equity).   What can you invest in the business?   Business loan applicants must have a reasonable amount invested in their business, for typical commercial loans this amount can be 20-30% of the loan package. 

Strong equity investment shows the lender that you are fully committed and serious about the business.  Weak equity or nonexistent equity can make obtaining a loan more difficult or impossible. 

Other Options:

Both LTV and equity investment can act as deterrents for the small business owner.  However, there are programs that assist with these issues.  The U.S. Small Business Administration’s (SBA) 504 Loan Program provides specific assistance on both of these issues while providing the same benefits of conventional commercial loans. 

Most types of businesses are eligible for 504 financing, including manufacturing, wholesale, service, professional services or retail.

A 504 loan may be used to purchase fixed assets such as: land and improvements,   construction of new facilities, or to purchase long-term machinery and equipment with a useful life of at least 10 years. Other costs such as legal fees, environmental studies, and the cost of appraisals can also be financed in the loan.

A typical 504 project is structured with fifty percent of the project costs provided through a private-sector lender.  Forty percent of the project costs are financed with a fixed-rate debenture secured with a junior lien from a SBA Certified Development Company (CDC). The debenture is backed by a 100 percent SBA-guaranty. And the final 10 percent of the project cost is provided by the purchaser.

The Advantages of the SBA 504 Loan

Consider the following advantages of the SBA 504 program versus conventional commercial loans:

  • In most cases, the company is required to inject just 10 percent of the total project cost, which includes renovations and soft costs. This allows the business to preserve cash for working capital. (equity investment)
  • The lender has less risk because the SBA 504 loan is in second position
  • A lower loan to value ratio for the lender (LTV)
    • Fixed rate on the SBA 504 portion. Small businesses don't have to worry about the prime lending rate going up and can calculate the exact amount of their mortgage payments for 20 years.
    • Long term  504 loans are for 10 or 20 years. Because the CDC is in second lien position, the lender doing the 50 percent first lien loan is willing to lend at a longer term. Longer terms reduce monthly payments
    • Low interest rate. Even with fees and closing costs included in the rate, the 504 program offers a low fixed rate for a subordinate mortgage loan. The blended rate between the lender portion and the SBA’s 504 portion makes the project very affordable, particularly for small businesses.

When you are ready to take the next step for your business, be sure and ask about the SBA 504 program.  It could be the right tool for you to expand, acquire and grow your business. 

Have additional questions about the 504 program?  Contact EMDC at 207.942.6389 or bizservices@emdc.org