Why Lease When You Can Own?

Author: Christopher Crawford 
Source: Franchising World October 2004; www.franchise.org

When franchisees Brad and Risa May first began to explore the options available to them for their Goddard School franchises, they assumed they would be leasing their buildings.  Instead, they were delighted to find out they could finance and build their own facilities using long-term financing available through the U.S. Small Business Administration’s 504 Loan Program.

In spite of the advantages of the SBA 504 loan program, it is still one of the Federal government’s best kept-but fastest growing-secrets.  These special loans provide long-term (10-to-20 year) financing to small businesses for the purchase construction, renovation of buildings and can also be used to fund large equipment purchases.  504 loans are arranged by Certified Development Companies, funded by the sale of bonds on Wall Street, and guaranteed by the federal government through the SBA.

The Mays learned of the loan program through their bank and realized that with the low equity injection required, they could actually finance, and build, two franchises for which they received two 504 loans.  They were referred to CDC’s in Virginia and Oklahoma and built Goddard Schools in both states.  The Virginia 504 loan obtained Virginia Asset Financing Corporation funded the 2.5 million construction of a new 10,000 sq. ft. facility on 1.3 acres in Chantilly.  The Oklahoma 504 loan was financed through the Metro Area Development Corporation and funded the $1 million construction of an 8,000 sq. foot facility on 1.5 acres in Edmond.

The approval of the Mays' loan applications meant that they would be able to by the physical real estate for their franchises with 15 percent down payment (for a start up business), fixed interest rate and a long repayment period allowing for low monthly payments.

These terms made all the difference and gave the May’s the ability to pay for 3.5 million-worth of buildings and land for their businesses.  According to Brad May, “When we first looked into buying a franchise, I assumed we would be leasing a building.  In essence, by constructing our own buildings, we built our own retirement.”

CDCs partner with traditional commercial lenders, mostly banks, to provide these long-term, fixed-rate loans, however, borrowers work directly with the CDCs to apply, close, fund and service their loans.  The typical 504 loan represents 40 percent of project financing, with a 10 percent equity injection from the borrower and 50 percent from the commercial lender. 

Two-hundred, sixty five CDC’s, recognized by the SBA, are located throughout the United States to provide 504 loans.  In fact, the SBA no longer provides grants, or even directs business loans.  Today, it supports economic expansion by providing federal guarantees for the loans that CDCs make to small businesses. 

“SBA is in the business of servicing business, and we’ve come a long way in the last few years.  Our borrowers and lending partners are frequently impressed by our high level of service,” said James Rivera, SBA Associate administrator for financial assistance.

The huge advantage for small business owners if the 10 percent down payment for the borrower.  There are a couple of exceptions to the 10 percent down payment including a start-up business where a 15 percent down payment may be required.  Also a “special purpose building” such as a hotel, may require an additional 5 percent.  All in all, most borrowers save substantial up-front cash that can be used to fund the operating expenses of their business.

Brad May pointed out, “It helped to have Goddard Systems, Inc. on the SBA approved list of franchisors.  It made the loan applications much easier.  The financing worked very well for us, we were pleased with the whole process.  We would not have been able to own the building for one franchise-much two-without the 504 loan program.”

The Mays are doing very well with their new franchises, and both schools are already 95 percent full in the first year of operation.  Plus, as May put it, “There is a certain pride of ownership that can’t be beat.”

Is Your Franchise Eligible?

Many franchise businesses are eligible for 504 loans, with the exception of media and financial firms.  In fact, franchises are so important to the SBA that they will work with many franchisors to pre-approve their agreements, thereby speeding the process of obtaining loan approvals for franchises.

Since 504 loans must create jobs or retain jobs that are in danger of being lost.  Each project must create or retain one job for every $50,000 of 504 loan funding.  There are exceptions to enable 504 loans to provide additional assistance to women, minority, and veteran-owned businesses.

The 504 loan is reserves for “small” businesses-those having a net worth of less than $7 million, an average net profit after taxes for the last two years of less than $2.5 million.  Many franchises qualify.

The National Association of Development Companies financed only owner-occupied projects.  By law, the 504 loan cannot provide investor –owned project financing.  A business must be using the majority of the building or facility; however, unused space may be permanently leased to others.

How does it Work?

SBA 504 loans are “pooled” together and sold as 20 year bonds to large corporate and financial investors in the New York securities markets.  It is these bonds, carrying the guaranty of the U.S. government, that enable investors to accept a lower interest rate since they cannot lose their principle.  This is exactly the same way giant corporations borrow money from “the markets” rather than their local bank.  They do it to get better rates and more favorable terms through their strong credit ratings and Wall Street contacts. 

The 504 loan program does exactly the same thing for small businesses.  Our contacts are Merrill Lynch and CS First Boston.  These two global dealers pool, underwrite and sell out bonds, with pricing varying form month-to-month based on rates in the securities markets.  To keep the rates low, 504 bonds leverage the best credit of all: the US federal government guarantee.

Even when fees are added to the basic market interest rate to compensate SBA for the government’s guarantee is extremely attractive.  For example, the August 2004 effective interest rate for a 20 year 504 loan was 6.589 percent.  And interest rates are fixed, not tied, to the volatile bank prime rate. 

How to Begin

Start with the NADC Web site www.nadco.org.  There you will find a directory of our member CDC’s throughout the country by state.  Each listing includes complete contact information, and in most cases, links directly to each CDC’s Web site.  There are also more than 80 SBA offices that can refer you to a CDC, and SBA’s website, www.sba.gov, is a great source of information about the 504 loan program.

Another approach is to ask your banker about the SBA 504 loan program.  Chances are that he or she has heard about it, or may be one of our lending partners already.  If so, you will quickly be put in contact with a CDC loan officer for more information,

The 504 loan program was designed to give you the opportunity to get long term, fixed rate financing-with a low down payment-at a reasonable interest rate, to help you start or grow your business.