An SBA loan is normally your best option for business funding for buying a franchise or for improving it. One reason is because they will often have much lower interest rates and terms when compared to conventional loans because they are guaranteed by the Small Business Administration. Currently, two of the most widely used SBA loans offered by the Small Business Administration are the SBA 7(a) loan and the SBA 504 loan. In most situations, an SBA 7(a) loan is a better option compared to a 504 loan for funding your franchise. The following is a list of advantages that 7(a) loans possess over 504 loans:
1. SBA 7(a) loans have fewer restrictions when compared to 504 loans regarding what the financing may be used for when you’re purchasing a franchise business or when you are improving it.
SBA 7(a) loans are very flexible regarding what the funds may be used for. In addition to being used for buying and improving real estate and for acquiring equipment for your franchise outlet, a 7(a) loan may also be used to buy goodwill and inventory. Franchisees can also use an SBA 7(a) to supply working capital. In contrast, uses of a 504 loan is more restricted. SBA 504 loans are only supposed to be used to obtain long-term fixed assets such as commercial real estate. You can use a 504 loan to acquire equipment. Bear in mind, anything you buy will need to have an anticipated life expectancy of at least 10 years. The Small Business Administration also allows SBA 504 loans to be utilized for construction, renovation, landscaping and installing utilities. 504 loans are not to be used for purchasing goodwill, inventory or for working capital.
Because the Small Business Administration guarantees up to 90% of an SBA 7(a) loan and only 40% of an SBA 504 loan, loan providers are usually more likely to offer lower rates of interest on 7(a) loans. There are SBA 7(a) loans that have either a fixed or variable rate of interest. The specific rate of interest on an SBA 7(a) loan is negotiated between the applicant and the loan provider. However, the SBA sets a limit to the rate of interest that a loan company may charge for a 7(a) loan. The highest possible rate of interest on a 7(a) loan is established by the addition of a base rate to an allowable spread. There are three published rates which can be used to figure out the base rate of an SBA 7(a) loan; a prime rate publicized in a US daily newspaper, the London Interbank One Month Prime Rate plus 3% or an SBA Peg Rate. The SBA places limits on the additional spread that loan providers can add to this the base rate. The Small Business Administration permits a spread of not more than 2.25% for any SBA 7(a) loans which are shorter than seven years. The highest spread for loans with maturities of seven years or longer, is 2.75 percent.
The interest rates on 504 loans are almost always more than SBA 7(a) loans. This is because fifty percent or more of the financing is a private conventional loan. The SBA doesn’t place any regulations upon these private loans. As a result, the private lender is free to set the rate of interest, the terms, along with other conditions of the loan, including whether or not it has a fixed or variable rate. However, because there’s lower financial risk concerning these loans, loan companies usually charge a lesser interest rate when compared to a 100% conventional loan. The reason that the private lender’s risk is minimized is because the SBA 504 loan is in second position. Consequently, they will be repaid first from the proceeds of the liquidation of collateral in the event the borrower defaults on the loan.
With SBA 504 loans, 40% of the funding is from Certified Development Companies (CDCs) and is guaranteed by the SBA. Generally, the rate of interest charged on these loans is ¾ percent above the current 5 or 10 year U.S. Treasury bond rate.
3. The fees are usually less for SBA 7(a) loans in comparison with 504 loans.
On loans under $150,000, the fees for 7(a) loans are zero percent. On loans which are for more than $150,000 which have a maturity of one year or shorter, the fee is 0.25 percent of the guaranteed portion of the loan. SBA 7(a) Loans for between $150,000 and $700,000, that have terms that are longer than one year, carry a fee of 3%. A 3.5% fee is charged on loans in excess of $700,000. An additional 0.25% is charged on any financing that goes over $1 million.
With 504 loans, a three percent fee is normally charged on the 504 financing. The fees on the 50% portion of the funding supplied by the private conventional loan is entirely up to the loan company’s discretion and does not have an upper amount specified by the SBA.
4. 504 loans require that the funding satisfy specified SBA-defined policy goals. SBA 7(a) loans don’t have these kinds of conditions.
The Small Business Administration requires that SBA 504 loans be utilized to achieve specified job creation or community development objectives. Typically, the SBA requires companies to create or preserve one job for each $65,000 supplied by an SBA 504 loan. Small manufacturers, on the other hand, have to produce or preserve one job for every $100,000 of 504 funding obtained.. These conditions are not stipulated for 7(a) loans.
In conclusion, an SBA (7a) loan is usually the preferred alternative for small business funding that can be used for buying a franchise business or for improving it. The key reason an 7(a) loan is better than a 504 loan is because it has a much better interest rate and superior terms. The other benefit of 7(a) loans is you don’t have to meet SBA-defined policy goals.
When you apply for an SBA loan to fund your franchise, you need to realize that you don’t submit an application directly to the SBA. You need to approach banks or other special loan companies for SBA loans. Previously, the leading providers of SBA loans for small businesses were neighborhood community banks. Unfortunately, a large number of community banks have gone out of business over the last twenty years. As a consequence, this source of SBA loans has drastically diminished. At the same time, large banks are taking over a larger part of the banking marketplace. This is not a good trend, because big banks aren’t that enthusiastic about small business lending. The good thing is that non-bank SBA loan lenders are rapidly filling the void in small business lending. One example of these non-bank SBA lenders is Newtek, the small business authority. Newtek was initially launched in 1994. Since then, it has grown to become the largest non-bank SBA lender in the United States. In 2013, the SBA ranked Newtek as the 6th most active SBA 7(a) lender of all loan providers in the United States. Newtek can usually pre-qualify you for a 7(a) loan for as much as $5 million or as little as fifty thousand dollars within two days. Completing the application is easy. Newtek completes all of the SBA loan application paperwork for you.
Written by: Mark J. Krupp, Cofounder of NewBusinessCreator.com