For small businesses looking to expand, manage cash flow, or invest in new opportunities, securing financing can be a critical step. The U.S. Small Business Administration (SBA) offers two primary loan programs to support small businesses: the 7(a) Loan Program and the 504 Loan Program. Each of these programs serves different purposes and comes with its own set of requirements and benefits. At Got Biz Loans, we are committed to helping you navigate these options and secure the financing that best fits your business needs. In this article, we will explore the differences between SBA 7(a) and 504 loans, how they work, and the criteria for obtaining them.

What is an SBA 7(a) Loan?

The SBA 7(a) Loan Program is the SBA's most popular loan program. It provides financial assistance to small businesses with special requirements. The 7(a) loans are versatile and can be used for a variety of purposes including:

• Working capital
• Equipment purchases
• Refinancing existing debt
• Real estate acquisition
• Business expansion

Key Features of SBA 7(a) Loans:

1. Loan Amounts: SBA 7(a) loans can provide up to an aggregate amount of $5 million in funding. This means you can access multiple loans as your business grows and your funding needs increase, as long as the total amount borrowed does not exceed $5 million.
2. Terms: Loan terms can vary based on the use of funds. Typically, terms are up to 10 years for working capital and up to 25 years for real estate.
3. Interest Rates: Interest rates for SBA 7(a) loans are typically variable and are tied to the prime rate, plus an additional margin that is negotiated between the borrower and the lender.
4. Guarantee: The SBA guarantees up to 85% of loans under $150,000 and up to 75% of loans over $150,000.‍
5. Debt Service Coverage Ratio (DSCR): To qualify for SBA loans, a Debt Service Coverage Ratio (DSCR) of 1.15 or higher is typically required. This means your business should generate enough operating income to cover 115% of your debt obligations, indicating strong financial health and an ability to repay the loan.

Calculating the Debt Service Coverage Ratio (DSCR).

The Debt Service Coverage Ratio (DSCR) is a key metric used by lenders to assess a business's ability to repay its loans. It compares a business's operating income to its debt obligations. A DSCR of 1.15 or higher is typically required for SBA loans, indicating that the business generates sufficient income to cover its debt payments with a comfortable margin.

DSCR Formula:

DSCR = Net Operating Income (NOI) ÷ Total Debt Service

Where:

• Net Operating Income (NOI) is the business's income after operating expenses but before interest, taxes, depreciation, and amortization (EBITDA).
• Total Debt Service is the total amount of current debt obligations, including principal and interest payments.

Example Calculation:

Let's say your business has the following financials:

• Net Operating Income (NOI): $230,000
• Total Debt Service (Annual debt payments including principal and interest): $200,000

Using the formula:

DSCR=230,000 ÷ 200,000 = 1.15

In this example, the DSCR is 1.15, which means the business generates 115% of its debt obligations in operating income, meeting the typical requirement for an SBA loan.

Steps to Calculate DSCR:

1. Calculate Net Operating Income (NOI):

1. Start with your business's earnings before interest and taxes (EBIT).
2. Add back non-cash expenses such as depreciation and amortization.
3. NOI = EBIT + Depreciation + Amortization

2. Determine Total Debt Service:

1. Sum up all annual debt obligations, including principal repayments and interest expenses.
2. Total Debt Service = Annual Principal Repayments + Annual Interest Payments

3. Calculate DSCR:

1. Divide the NOI by the Total Debt Service.
2. DSCR = NOI ÷ Total Debt Service​

By following these steps, you can determine your business’s DSCR and assess its ability to meet debt obligations, an essential factor in securing financing, particularly for SBA loans.

How SBA 7(a) Loans Work:

To apply for an SBA 7(a) loan, businesses need to work with an SBA-approved lender. The lender will submit the loan application to the SBA, which will review the application and decide whether to provide a guarantee for the loan. The guarantee reduces the lender's risk, making them more willing to provide financing to small businesses.

What is an SBA 504 Loan?

The SBA 504 Loan Program is designed specifically for economic development and job creation. It provides long-term, fixed-rate financing for major fixed assets such as real estate and equipment. This program is ideal for businesses looking to:

• Purchase or renovate existing buildings
• Construct new facilities
• Purchase long-term machinery and equipment

Key Features of SBA 504 Loans:

1. Loan Amounts: SBA 504 loans can provide up to $5.5 million per project, with a total project cost typically ranging from $125,000 to $20 million or more.
2. Terms: Loan terms are generally 10, 20, or 25 years.
3. Interest Rates: Interest rates for SBA 504 loans are fixed and are based on current market rates for 5- and 10-year U.S. Treasury issues, plus an additional spread.
4. Structure: The 504 loan is structured with three parts:
   • A loan from a private-sector lender covering 50% of the project cost.
   • A loan from a Certified Development Company (CDC) covering up to 40% of the project cost, backed by a 100% SBA-guaranteed debenture.
   • A down payment from the borrower of at least 10% of the project cost.

How SBA 504 Loans Work:

To apply for an SBA 504 loan, businesses need to work with a Certified Development Company (CDC) in conjunction with a traditional lender. The CDC submits the loan package to the SBA, which reviews and approves the loan. The SBA then guarantees the debenture that backs the CDC portion of the loan.

Differences Between SBA 7(a) and 504 Loans.

While both loan programs are designed to support small businesses, they have distinct differences:

1. Purpose:
   • 7(a) Loans: Versatile and can be used for a wide range of business needs including working capital, debt refinancing, and real estate.
   • 504 Loans: Specifically for purchasing fixed assets such as real estate and equipment.
2. Loan Amounts:
   • 7(a) Loans: Up to $5 million.
   • 504 Loans: Up to $5.5 million per project.
3. Interest Rates:
   • 7(a) Loans: Variable rates based on the prime rate.
   • 504 Loans: Fixed rates based on U.S. Treasury rates.
4. Terms:
   • 7(a) Loans: Up to 25 years for real estate, up to 10 years for working capital.
   • 504 Loans: 10, 20, or 25 years.
5. Structure:
   • 7(a) Loans: One loan provided by an SBA-approved lender with an SBA guarantee.
   • 504 Loans: Combination of a traditional lender loan, CDC loan backed by an SBA-guaranteed debenture, and borrower down payment.

Credit Criteria for SBA Loans.

To qualify for either SBA 7(a) or 504 loans, businesses must meet certain credit criteria:

1. Time in Business: Generally, businesses must be operational for at least 2 years.
2. Personal Credit Score: A personal credit score of 650 or higher on Experian.
3. SBSS Business Credit Score: A Small Business Scoring Service (SBSS) credit score of 160 or higher.

Additional Requirements:

• Business Size: Must meet SBA's size standards for small businesses.
• Profitability: Demonstrate the ability to repay the loan from cash flow.
• Owner's Equity: Owners should have invested their own time and money into the business.

How Got Biz Loans Can Help.

At Got Biz Loans, we specialize in helping small businesses secure the financing they need through SBA 7(a) and 504 loans. Our experienced team understands the intricacies of these programs and can guide you through the application process to increase your chances of approval.

Why Choose Got Biz Loans?

• Expert Guidance: Our team has extensive knowledge of SBA loan requirements and can help you prepare a strong application.
• Streamlined Process: We simplify the loan process, from gathering documentation to submitting your application.
• Wide Network: We work with a network of SBA-approved lenders and CDCs to find the best financing options for your business.
• Tailored Solutions: We understand that every business is unique, and we provide personalized solutions to meet your specific needs.

SBA 7(a) and 504 loans offer powerful financing options for small businesses looking to grow and thrive. By understanding the differences between these programs and meeting the necessary credit criteria, you can secure the funding needed to achieve your business goals. At Got Biz Loans, we are committed to helping you navigate the SBA loan process and find the best financing solution for your business. Apply today to learn more about how we can assist you in securing an SBA loan.