Connect with us

Finance & Accounting

SBA 504 vs. 7(a) Loan Comparison: What Are the Differences?

Published

on

SBA 504 loans and SBA 7(a) loans are both types of business loans that are guaranteed by the U.S. Small Business Administration (SBA). The loan amounts, terms, and permissible uses vary for each of these programs. You’re more likely to use an SBA 7(a) loan for working capital or business expansion, and an SBA 504 loan to finance the purchase or improvement of commercial property or equipment.

SBA 504 loans vs. SBA 7(a) loans: Key differences

SBA 504 Loan

SBA 7(a) Loan

Loan Amounts

$50,000 to $5 million, $5.5 million for small manufacturers or specific energy projects

$5,000 to $5 million

Permissible Uses

• Construction

• Working capital

• Purchasing property

• Starting or expanding a business

• Property improvements

• Business acquisitions

• Equipment finance

• Equipment finance

• Debt refinance

• Debt refinance

Maximum Repayment Term

10, 20, or 25 years

• 10 years for working capital and equipment

•25 years for real estate

Interest Rate

• Approximately 4% to 7%

• Prime Rate + 2.25% to Prime Rate + 4.75%

• Fixed interest rate

• Variable interest rate

SBA guarantee fee, CDC fees, and bank fees

SBA guarantee fee and bank fees

Down Payment

10% (higher for startups or special use properties)

10% to 20%

Collateral

• The assets being financed serve as collateral

• Collateral required for loans over $25,000, personal residence might need to be pledged

• Personal guarantee required

• Personal guarantee required

Eligibility

• Have a business net worth of $15 million or less, and an average net income of $5 million or less

• Meet the SBA’s definition of “small”

• Be a for-profit business in the U.S. or U.S. territories

• Be a for-profit business in the U.S. or U.S. territories

• Provide a 10% down payment (more for startups or special use properties)

• Invested own money in the business

• Meet job creation/retention or public policy goals

• Attempted to use alternative financial resources

While there are some grey areas, it’s usually quite clear which loan—the SBA 504 or the 7(a)—is right for a small business. Keep reading to dig further into the differences between an SBA 504 vs. 7(a) loan to find out which one to choose for your business.

SBA 7(a) loan: Best for general business financing

For most small business owners who are trying to select among the different types of SBA loans, the 7(a) loan is the best option. The SBA 7(a) loan is a flexible, low-interest-rate business loan that’s suitable for a variety of business needs.

SBA 7(a) loan structure

The SBA itself is not in the business of lending. Rather, the SBA partially guarantees business loans made by banks and other private SBA lenders. The partial guarantee lowers a lender’s risk of extending capital to small business owners and incentivizes lenders to approve applicants that they might otherwise reject. A bank or other direct lender will underwrite and issue your SBA 7(a) loan.

SBA 7(a) loan uses

Along with the above uses, any of the following are also eligible uses for an SBA 7(a) loan:

  • Purchasing, constructing or renovating a commercial property (most investment property is excluded, however)

  • Acquiring fixed assets, such as equipment, fixtures, or furniture

  • Working capital, such as purchasing inventory or supplies

  • Purchasing land for a business

SBA 7(a) loan eligibility

The bank issuing the 7 (a) loans has the discretion to set its own eligibility criteria. In most cases, SBA lenders require a strong personal credit score (650+) and a demonstration of your ability to repay the loan, evidenced by historical business revenue or documented cash flow projections. They’ll also require a down payment of 10% to 20%.

SBA 7(a) loan amounts and terms

There’s technically no minimum loan amount set by the SBA, but obtaining loan amounts at the very low end of this spectrum can be hard because lenders don’t earn much profit from small loans.

The repayment time frame depends on what you’ll use the loan funds for. If you’re using an SBA loan for working capital, then the term is up to 10 years. Working capital encompasses uses like business expansion and buying inventory. A 10-year term also applies to equipment and machinery, but the term can’t exceed the expected useful life of the tool that’s being financed. If you’ll be using a 7(a) loan to purchase, construct, or make improvements to real estate, you’ll enjoy up to 25 years to repay your loan.

SBA 7(a) loan interest rates and fees

The typical SBA 7(a) loan has a variable interest rate and monthly payments of principal and interest. The latest SBA loan rates always represent a spread over the Prime Rate, which is a market rate that fluctuates based on how the economy is doing. SBA 7(a) loan rates are similar to the rates on conventional bank loans and represent some of the most affordable options for small businesses. That said, since the interest rate is variable, rates can go up or down while your loan is outstanding.

The primary fee on an SBA 7(a) loan is the SBA guarantee fee. The SBA charges the guarantee fee to ensure that the government has money to reimburse the lender if the business can’t pay back the loan.

Currently, the SBA guarantee fee is as follows:

  • Loans of $150,000 or less: 2% fee on the guaranteed portion

  • Loans of $150,001 to $700,000: 3% fee on the guaranteed portion

  • Loans of $700,001 to $5 million: 3.5% fee on the guaranteed portion on amounts up to $1 million, plus 3.75% fee on the guaranteed portion over $1 million.

Note that this fee is charged on the guaranteed portion of the loan. For example, if you get a $150,000 loan, the SBA will guarantee up to 85% of that loan—or $127,500. That means you’ll owe a guarantee fee of 2% on that latter amount—or $2,550. There’s also a small service fee that you have to pay annually.

Keep in mind that your bank will likely charge additional fees, such as loan packaging fees and closing fees. Such fees will increase your overall borrowing cost.

SBA 7(a) loan collateral

Most SBA 7(a) loans require collateral of some sort. For larger loans, the SBA requires the lender to place a lien on all assets that are financed with the loan, as well as any existing fixed assets of the business.

If the loan isn’t fully secured at that point, the bank might also place a lien on the business owner’s personal residence or other personal property.

In addition to collateral, anyone who owns 20% or more of the business must sign a personal guarantee. By signing a personal guarantee, you are making a personal promise to pay back the loan if your business’s assets don’t sufficiently compensate the lender.

SBA 504 loan: Best for financing fixed business assets

The SBA 504 loan, more formally called an SBA 504/CDC loan, is a more specialized loan than the 7(a) loan. The 504 loan is designed for business owners who need to finance the acquisition or improvement of fixed assets—such as land, buildings, or equipment—and whose projects promote economic development or other public policy goals.

SBA 504 loan structure

The SBA 504 loan has a more complicated structure than the SBA 7(a) loan, comprising three parts:

  • Bank loan (50%): A bank or other direct lender extends 50% of the loan amount

  • CDC loan (40%): An SBA-approved Certified Development Company (CDC) extends 40% of the loan amount

  • Borrower down payment (10%): The borrower puts up 10% of the loan as a down payment

Owners of startups and special use properties must put up higher down payments. CDCs are local nonprofit lenders that promote economic development in their communities by participating in SBA 504 financing. The SBA certifies and regulates CDCs.

SBA 504 loan uses

The funds from a 504 loan can only be used for properties that are at least 51% owner-occupied (for existing facilities; 60% for new construction). In other words, if your building has 1,000 square feet, your business must occupy and use at least 510 square feet. You can lease out the remaining space to other businesses. In contrast to an SBA 7(a) loan, an SBA 504 loan cannot be used for working capital or for buying inventory or supplies.

SBA 504 loan eligibility

The job creation/retention or public policy requirement is unique to the SBA 504 loan program. For every $75,000 that the CDC lends, the applicant business must create or retain at least one job (small manufacturers have to meet a higher job creation/retention goal). Three-quarters of the jobs created or retained must be in the local community. If you’re not able to show that you meet the job creation or retention requirements, there are other public policy goals that you can meet instead, such as furthering the growth of minority or women-owned businesses or reducing energy consumption.

The typical business owner has to put just 10% down on an SBA 504 loan. However, if you have a startup (fewer than two years of consecutive operating history) or a special use property (such as an amusement park or gas station), you’ll have to put down 15%. If your business is classified as a startup and a special use property, the down payment increases to 20%.

On top of the requirements detailed above, the bank and the CDC issuing the loan can set additional requirements. As with 7(a) loans, SBA 504 lenders require strong personal credit and a demonstration of your ability to repay the loan, evidenced by historical business revenue or documented cash flow projections.

SBA 504 loan amounts and terms

The SBA 504 loan is ideal for large business investments. There’s no limit on the bank portion of the loan, so 504 loans technically have been funded for upward of $20 million.

Your repayment term on an SBA 504 loan will be 10, 20, or 25 years. If financing equipment, the term depends on the expected useful life of the equipment. The term will be 20 or 25 years for other uses, so you can expect low monthly payments.

SBA 504 loan interest rates and fees

Whereas the SBA 7(a) loan is a variable-rate loan, SBA 504 loans are fixed-rate loans. The advantage of fixed-rate financing is that your rate is locked in for the life of the loan. This is one of the biggest benefits that the SBA touts for 504 loans.

SBA 504 loan rates are among the lowest interest rates you can find on small business financing, even lower than SBA 7(a) loans. The interest rates on SBA 504 loans are pegged to the rates on U.S. Treasury bonds.

There are a few more fees on SBA 504 loans compared to 7(a) loans. SBA 504 loans come with four main fees:

  • SBA upfront guarantee fee – The SBA charges a 0.5% upfront fee to the borrower.

  • SBA annual service fee – The SBA charges an annual service fee of 0.368% to the borrower, which is applied to the loan’s outstanding principal balance.

  • CDC processing fee – The CDC charges a 1.5% upfront processing fee to the borrower.

  • CDC servicing fee – The CDC also charges an annual servicing fee between 0.625% and 2% per year, assessed on the loan’s outstanding principal balance.

Keep in mind that the CDC or bank can charge additional fees, such as loan underwriting fees and closing fees. These fees will increase your overall borrowing cost.

SBA 504 loan collateral

Most SBA 504 loans are self-secured, meaning that the underlying fixed assets serve as collateral. There’s typically no need to provide additional collateral above and beyond what you’re already acquiring with the funds.

Anyone who owns 20% or more of the business must sign a personal guarantee on both the CDC and bank portion of the 504 loan. Remember, even business owners with a solid credit history and excellent financials will have to sign a personal guarantee for the lender’s security. If your business defaults and cannot compensate the lender, the personal guarantee permits the lender to pursue loan repayment directly from the business owner’s personal assets.

SBA 504 vs. 7(a) comparison: Which loan is right for you?

Choose the SBA 7(a) loan if:

  • You need working capital to buy inventory, supplies, or fill cash flow gaps

  • You need less than $5 million in financing

  • You prefer a faster SBA loan application process

The SBA 7(a) loan program also has sub-programs that might be suitable for your business, such as Community Advantage Loans designed for women, minorities, and other underserved entrepreneurs. To get started with an SBA 7(a) loan, apply here.

Choose the SBA 504 loan if:

  • You need financing to purchase, lease, renovate, or improve commercial real estate, buildings, or equipment.

  • You’re making a large investment in your business.

  • You’re able to show that you meet job creation, job retention, or public policy goals.

  • You’re okay with a slower loan application process.

  • You can only afford a 10% down payment.

To get started with an SBA 504 loan, use the SBA’s Lender Match tool. This can help you find a bank and a CDC that participate in SBA 504 financing.

The bottom line

When you are considering a small business loan, there are several options to choose from. The SBA 7(a) loan fits a wide variety of business needs and is an especially good option if you are looking for working capital. The SBA 504 loan is more niche and designed for real estate investments and other fixed assets. Whichever you end up choosing, both the SBA 504 loan and 7(a) loan are excellent opportunities for small business owners searching for affordable financing.

Advertisement

This post was originally published on this site

Continue Reading

Banking

How to Get a Loan to Buy a Business

Published

on

Not everyone wants to take on the challenge of building a business from the ground up. An attractive alternative can be to step into a business that’s already up and running by purchasing it from the current owner. Some advantages of buying a business may include easier financing, an established customer base and an existing cash flow.

Buying a business is different from buying a franchise. Franchises have a set business model that’s proven to work. However, when you buy an independently operated business, it’s important to show the lender that you, your previous business experience and the business you want to buy are a winning combination.

What lenders look at when you want to buy a business

Because lenders can view the performance record of an existing business, it’s typically easier to get a loan to purchase an existing business compared with startup funding. However, your personal credit history, experience and details about the acquisition business still matter.

Your personal credit and experience

Through credit reports and credit scores, lenders are able to assess how you’ve managed debt in the past and potentially gain insights into how you will handle it in the future. Your education and experience will also be evaluated.

Solid credit history: Lenders look to see if you have a history of paying your debts. Foreclosures, bankruptcies, repossessions, charge-offs and other situations where you haven’t paid off the full amount will be noted.

Business experience: Having worked in the same industry as the business you want to purchase is helpful. Related education can also be viewed as a positive.

Other businesses you’ve owned

Having a track record of operating other successful businesses can have a positive influence on lenders when it comes to buying a new operation.

Record of generating revenue: Business financial statements can help a lender document that your current or past businesses were well-managed and turned a profit.

Positive credit record: Lenders review business credit scores and reports to verify creditworthiness and to identify liens, foreclosures, bankruptcies and late payments associated with your other businesses.

The business you want to buy

Just because a business is operating doesn’t mean it’s a good investment. Lenders will ask for documentation, often provided by the current owner, to assess the health of the operation.

Value of the business: Like you, your lender will want to ensure that you’re buying a business that has value and that you’re paying a fair price.

Past-due debts: Lenders will be interested in the business’s past-due debts, which may include liens, various types of taxes, utility bills and collection accounts.

Documentation

Most lenders will let you know what they want included in the loan application package, but there are some personal documents that are typically requested, as well as ones related to the business you want to purchase.

Personal documents

The following documents are used to evaluate your personal finances, business history and plans for operating the business after its purchase:

  • Personal tax returns.

  • Personal bank statements.

  • Financial statements for any of your other businesses.

  • Letter of intent.

Business documents

Documents from the current business owner will also be evaluated. Some common ones requested by lenders include:

  • Business tax returns.

  • Profit and loss, or P&L, statements.

  • Business balance sheet.

  • Proposed bill of sale.

  • Asking price for inventory, machinery, equipment, furniture and other items included in the sale.

Where to get a loan to buy a business

Compared with finding a loan to start a business, getting funding to buy an existing business may be easier. Here are three popular funding options to check into for a business loan:

Bank loans

Banks generally offer the lowest interest rates and best terms for business loans. To qualify for this type of loan, you’ll typically need a strong credit history, plus the existing business will need to be in operation for a certain minimum of years and generate a minimum annual revenue amount set by the lender.

SBA loans

If borrowers don’t qualify for a traditional bank loan, then SBA loans, ones partially guaranteed by the Small Business Administration, may be the next option to explore. Because there is less risk to the lender, these loans can be easier to qualify for. Banks and credit unions frequently offer SBA loans in addition to traditional bank loans.

Online business loans

Another option to consider is online business loans. Online business loans may offer more flexibility when it comes to qualification, compared with bank and SBA loans. Minimum credit score requirements can be as low as 600, and in a few cases lower. Generally, interest rates are higher than what’s available with a traditional bank loan.

Advertisement

This post was originally published on this site

Continue Reading

Banking

Accounts Receivable Financing: Best Options, How It Works

Published

on

Accounts receivable financing, also known as invoice financing, allows businesses to borrow capital against the value of their accounts receivable — in other words, their unpaid invoices. A lender advances a portion of the business’s outstanding invoices, in the form of a loan or line of credit, and the invoices serve as collateral on the financing.

Accounts receivable, or AR, financing can be a good option if you need funding fast for situations such as covering cash flow gaps or paying for short-term expenses. Because AR financing is self-securing, it can also be a good choice if you can’t qualify for other small-business loans.

Here’s what you need to know about how accounts receivable financing works and some of the best options for small businesses.

How Much Do You Need?

with Fundera by NerdWallet

How does accounts receivable financing work?

With accounts receivable financing, a lender advances you a percentage of the value of your receivables, potentially as much as 90%. When a customer pays their invoice, you receive the remaining percentage, minus the lender’s fees.

Accounts receivable financing fees are typically charged as a flat percentage of the invoice value, and generally range from 1% to 5%. The amount you pay in fees is based on how long it takes your customer to pay their invoice.

Here’s a breakdown of how the process works:

  1. You apply for and receive financing. Say you decide to finance a $50,000 invoice with 60-day repayment terms. You apply for accounts receivable financing and the lender approves you for an advance of 80% ($40,000).

  2. You use the funds and the lender charges fees. After receiving the financing, you use it to pay for business expenses. During this time, the lender charges a 3% fee for each week it takes your customer to pay the invoice.

  3. You collect payment from your customer. Your customer pays their invoice after three weeks. You owe the lender a $4,500 fee: 3% of the total invoice amount of $50,000 ($1,500) for each week.

  4. You repay the lender. Now that your customer has paid you, you’ll keep $5,500 and repay the lender the original advance amount, plus fees, $44,500. You paid a total of $4,500 in fees, which calculates to an approximate annual percentage rate of 65.7%.

Because accounts receivable financing companies don’t charge traditional interest, it’s important to calculate your fees into an APR to understand the true cost of borrowing. APRs on accounts receivable financing can reach as high as 79%.

Accounts receivable financing vs. factoring

Accounts receivable financing is often confused with accounts receivable factoring, which is also referred to as invoice factoring. Although AR financing and factoring are similar, there are differences.

With invoice factoring, you sell your outstanding receivables to a factoring company at a discount. The factoring company pays you a percentage of the invoice’s value, then collects payment directly from your customer. When your customer pays, the factoring company gives you the rest of the money you’re owed, minus its fees.

With accounts receivable financing, on the other hand, your invoices serve as collateral on your financing. You retain control of your receivables at all times and collect repayment from your customers. After your customer has paid their invoice, you repay what you borrowed from the lender, plus the agreed-upon fees.

Invoice factoring can be a good financing option if you don’t mind giving up control of your invoices and you can trust a factoring company to professionally collect customer payments. If you’d rather maintain control of your invoices and work directly with your customers, AR financing is likely a better option.

Best accounts receivable financing options

Accounts receivable financing is usually offered by online lenders and fintech companies, many of which specialize in this type of business funding. Certain banks offer AR financing as well.

If you’re looking for a place to start your search, here are a few of the best accounts receivable financing companies to consider.

altLINE

A division of the Southern Bank Company, altLINE is a lender that specializes in AR financing. AltLINE offers both accounts receivable financing and invoice factoring, working with small businesses in a variety of industries, including startups and those that can’t qualify for traditional loans.

AltLINE offers advances of up to 90% of the value of your invoices with fees starting at 0.50%. To get a free quote from altLINE, call a representative or fill out a brief application on the lender’s website. If you apply online, a representative will contact you within 24 hours.

AltLINE’s website also contains a range of articles for small-business owners, covering AR and invoice financing, payroll funding, cash flow management and more. AltLINE is accredited by the Better Business Bureau and is rated 4.7 out of 5 stars on Trustpilot.

1st Commercial Credit

1st Commercial Credit offers accounts receivable financing in addition to other forms of asset-based lending, such as invoice factoring, equipment financing and purchase order financing. The company works with small and medium-sized businesses, including startups and businesses with bad credit.

With 1st Commercial Credit, you can finance $10,000 to $10 million in receivables with fees ranging from 0.69% to 1.59%. You can start the application process by calling a sales representative or filling out a free quote form on the company’s website. After your application is approved, it typically takes three to five business days to set up your account, then you can receive funds within 24 hours.

1st Commercial Credit is accredited by the Better Business Bureau and has an A+ rating.

Porter Capital

Porter Capital is an alternative lender specializing in invoice factoring and accounts receivable financing. The company also has a special division, Porter Freight Funding, which is dedicated to working with businesses in the transportation industry.

With Porter Capital, you can receive an advance of 70% to 90% of your receivables and work with an account manager to customize a financing agreement that’s unique to your business. Porter funds startups and established businesses, offering fees as low as 0.75% monthly.

You can provide basic information about your business to get a free quote and receive funding in as little as 24 hours. Although Porter Capital isn’t accredited by the Better Business Bureau, it does have an A+ rating; the company also has 3.7 out of 5 stars on Trustpilot.

Additional options

Although AR financing and factoring are distinct, many companies blur the lines between the two. As you compare options, make sure you understand the type of financing a lender offers.

If you decide that invoice factoring may be a fit for your business, you might consider companies like FundThrough, Triumph Business Capital or RTS Financial.

Find and compare small-business loans

If accounts receivable financing isn’t right for you, check out NerdWallet’s list of the best small-business loans for business owners.

Our recommendations are based on the market scope and track record of lenders, the needs of business owners, and an analysis of rates and other factors, so you can make the right financing decision.

Advertisement

This post was originally published on this site

Continue Reading

Finance & Accounting

SBA Loan Collateral vs. Guarantee: What’s the Difference?

Published

on

Personal guarantees and collateral are both ways of promising a lender that you’ll make good on your debt. You may have to offer both to get an SBA loan.

Collateral ties a loan to a specific asset, like your business’s inventory or your home, which the lender can seize if your business can’t repay the loan. A personal guarantee promises the lender that you will repay the debt using your personal assets, but may not specify how.

In general, SBA lenders require anyone who owns 20% or more of a business to provide a personal guarantee. SBA loans larger than $25,000 usually require collateral, too.

Do SBA loans require a personal guarantee?

SBA loans usually require unlimited personal guarantees from anyone who owns more than 20% of a business. Lenders may ask for limited or unlimited personal guarantees from other business owners, too.

Unlimited personal guarantee: This is a promise that the guarantor (the business owner) will pay back the loan in full if the business is unable to. The lender doesn’t have to seize collateral or seek payment from any other source before going straight to the loan applicant for loan repayment.

Limited personal guarantee: If you own less than 20% of a business, you may have the option to sign a limited personal guarantee instead. The limited personal guarantee caps the amount you’ll have to pay the lender, either as a dollar limit or a percentage of the debt.

Limited personal guarantees can be secured by collateral, which means the lender will seize those assets when they recoup payment instead of asking you to pay back a certain dollar amount.

Who has to personally guarantee an SBA loan?

The SBA requires personal guarantees from:

  • Individuals who own more than 20% of a business.

  • Spouses who own 5% more of the business, if their combined ownership interest is 20% or more.

  • Trusts, if the trust owns 20% or more of the business.

  • Trustors, if a revocable trust owns 20% or more of the business.

SBA lenders may require additional personal guarantees.

Do SBA loans require collateral?

For SBA 7(a) loans of between $25,000 and $350,000, SBA lenders have to follow collateral policies that are similar to the procedures they’ve established for non-SBA loans. Banks and credit unions are usually the intermediary lenders for SBA 7(a) loans.

If you use an SBA loan to finance specific assets, like an equipment purchase, the lender will take a lien on those assets as collateral. The lender may also use your business’s other fixed assets as collateral, and you may have to offer personal assets, too.

For SBA 7(a) loans larger than $350,000, SBA lenders need collateral worth as much as the loan. The lender will start with your business assets. If they need more collateral, the SBA requires them to turn to the real estate you own personally, as long as you have at least 25% equity in the property.

Live Oak Bank is the largest SBA 7(a) lender in the U.S. by volume. Its loans may require collateral in the form of:

  • Personal residences.

  • Retirement accounts.

  • Commercial real estate.

  • Equipment.

  • Commercial vehicles.

  • Accounts receivable.

  • Inventory.

What if I can’t provide collateral or a personal guarantee?

If you’re seeking any type of SBA loan, there’s a good chance you’ll have to provide both collateral and a personal guarantee. Even SBA microloans usually require collateral and a personal guarantee. Without them, you’ll have trouble getting an SBA loan.

Some online lenders offer unsecured business loans, which don’t require collateral. But you may still have to sign a personal guarantee.

Advertisement

This post was originally published on this site

Continue Reading

Trending

SmallBiz Newsletter

Join our newsletter for the latest information, news and products that are vital to running a successful SmallBiz.