Borrower Equity for the 504 Loan Program

When it comes to how much a borrower needs to contribute to a 504 project, there are two questions:

1.)  How much equity does a borrower need to contribute?

2.)  What is the source of that contribution?

One of the major advantages of the 504 program is that in most cases the required equity contribution is just 10% of the eligible project costs. However, the SBA does require a higher amount in four different cases.

  1. If the business is considered a start-up, that is it has been generating revenues for less than 24 months, or if it’s an existing business, but the project property is considered limited or special purpose like a gas station, hotel, or bowling alley, the equity requirement is 15% and the SBA portion is limited to 35%. The Third Party Lender, usually a bank, provides 50% of the project costs.
  2. If the business is considered both a start-up and the property is limited use, the equity requirement is 20%. In that case the SBA loan is limited to 30% of the project cost.
  3. For any business that has an outstanding 504 loan for a project involving a limited or special purpose property, for each subsequent project involving a limited or special purpose property the borrower must contribute 20%. This new rule applies even if the 504 loan is to related affiliate business.
  4. There is a special case when the appraised value of the project is less than 95% of the project costs. Then the equity requirement is whatever is required, 10%, 15% or 20%, plus the difference between the appraised value percentage of the project costs and the minimum 95% appraised value required. So if the regular equity requirement is 10%, but the appraisal was just 92% of the project costs, the equity required is 10% plus 3% or 13%. The additional 3% is subtracted from the SBA portion making the project structure in this example 50% Third Party Lender, 37% SBA and 13% equity.

Each 504 project requires cash to complete.  Most of the cash needed to pay for the project assets and other eligible expenses is borrowed cash from the Third Party Lender and the SBA. But a business must be prepared to contribute cash into the project and provide proof at the application stage that this cash is available to contribute.

However, the SBA does allow the equity contribution to be borrowed cash as well. The borrowed equity can be some or even all of the required equity contribution. If the borrowed equity is collateralized by assets other than part of the 504 project, such as in the case of a home equity loan, the borrower must just be able to demonstrate repayment of the loan from the cash flow of the business or other sources. Only in situations where the equity loan is collateralized by the project property, the lien must be subordinate to the 504 loan and the loan may not be repaid at a faster rate than the 504 loan, without SBA permission.

In some cases, the equity is not cash but contributed land or other property acceptable to SBA obtained with cash. If the project involves construction on land or renovations/addition to a building already owned by the applicant, the existing equity in the property can count towards the required equity contribution. If owned less than 2 years, the value is the cost of the land or building. If owned for more than 2 years, the value is a current appraised value.

The SBA does allow an applicant can contribute a greater amount than the minimum required, if they so choose.

If there are any questions on the equity required, or anything else about the SBA 504 Program, give us a call for the answers.

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