Cheap, overlooked long-term financing for tax cuts

For the second time in two years, our lawmakers have created federal tax cuts designed to spur business investment. However, despite record-low interest rates, affording the funds many veterinarians require in order to acquire the property and equipment to take advantage of those tax cuts has never been harder. Into the breach has stepped the U.S. Small Business Administration.

Yes, the Small Business Administration, or SBA, long known as the lender of last resort, has an underused program that gives many veterinarians the means to expand, modernize and compete in today's economy - as well as acquire the business property needed to truly benefit from recent tax cuts. Under the SBA's 504 Certified Development Company Program, veterinarians can purchase land and land improvements, including existing buildings, construct new facilities, modernize, renovate or convert existing facilities, purchase equipment and make leasehold improvements to practice property under a long-term lease.

According to the SBA, their 504 program enables a veterinarian to borrow up to 90 percent of the money needed for covered expansion needs.

This way, the veterinarian must come up with only 10-percent of the project's cost instead of the 20-percent usually required by lenders. This frees additional cash for working capital needs. Unfortunately, the 504 program cannot be used for working capital or inventory or for consolidating, repaying existing debt or refinancing.

The key to the SBA's 504 loan is a so-called certified development company (CDC), a non-profit organization sponsored by private interests or by state or local government. These local community experts have access to SBA loan programs through certification from the Office of Rural Affairs and Economic Deveopment at the SBA. There are more than 400 CDCs across the nation.

What is a certified development company?

The CDC organizes the financial package, completes all SBA paperwork, processes, closes and services loans and brings new business and long-term customers to the participating bank or other financial institution. The veterinary practice's banker or the local office of the SBA usually maintain lists of CDCs.

A typical 504 financial package usually has three separate components. The SBA-guaranteed 504 loan, the bank or financial institution's loan and the veterinarian's equity injection.

Since the 504 program is permanent financing, the private lender typically provides interim financing on a conventional basis during any construction period.

The SBA offers four key advantages. First, because the SBA assumes most of the credit risk, commercial banks are generally more willing to consider riskier deals that might normally not be considered "bankable." About 25 percent of all SBA loans, for example, are extended to start-up entities, which are rarely eligible for conventional commercial funding.

Why SBA financing?

Second, the terms of repayments are generally more favorable than those offered with conventional commercial financing. For real estate loans, the term can go up to 25 years. This might be just the ticket for a veterinarian-or his or her practice- needing additional capacity, but who can't work a loan payment into existing cash flow on the 15-year payback of a conventional commercial real estate loan.

Third, most SBA programs are inclusive. While there are some restrictions in terms of how a small business is defined, the SBA estimates that more than 90 percent of all businesses in the U.S. qualify for SBA financing. And, there is no minimum loan amount, with a maximum guaranty amount of $750,000. In other words, a loan could be as high as $1 million with a 75 percent SBA guaranty-and even larger under the 504 program.

The fourth key advantage is the relatively low-cost of financing.

The SBA charges a guaranty fee for term loans based on a sliding scale of 3 percent on the first $250,000; 3.5 percent on the next $250,000, and 3.875 percent on the remaining guaranty amount.

Surprisingly, less than half of the $2.5 billion approved by Congress for 504 loans in 2002 was actually used. This year, 2003, more businesses seem to be taking advantage of the program, applying for the $4.5 billion available. This may, in part, be due to the economy. Banks use 504 loans to minimize risk during a recession, but when the economy is healthy, they have less need for subsidized lending.

SBA wants your business

Many critics blame the program's heavy bureaucracy and localized processing, saying that can drag out the approval process for weeks or months. The SBA has acknowledged that processing times are too varied. They are now conducting a pilot program to see whether centralized loan processing - which its had for years in its Preferred Lender and SBA Express programs-will improve service.

While each state currently has its own loan processing site, the pilot program directs all 504 loans from Arizona, North Carolina, Sacramento, California and South Florida, to the processing center in Sacramento, Calif. If successful, the pilot program will be expanded, a few district offices at a time.

Many experts blame poor education for the low volume of loan requests under the 504 program. Not enough lenders and borrowers understand the benefits. Few veterinarians, for example, understand the SBA's loan programs, often dismissing them as strictly for independent businesses-or for small businesses-failing to realize how broad the definitions actually are.

To be eligible for the 504 loans, the veterinary practice must be operated for profit and fall within the program's size standards.

A practice or business qualifies as "small" if it does not have a tangible net worth of $7 million and does not have an average net income in excess of $2.5 million after taxes for the preceding two years. Any business engaged in speculation or involved with rental real estate is not eligible.

For every $35,000 in 504 funding from the CDC, veterinary practices/borrowers must be able to show that they have created one job or retained one that would have been lost without the project. Often it can be enough to show that the project will have an alternate impact on the local economy.

Other restrictions

If, for instance, the loan enables a veterinary practice to update equipment and increase its ability to better serve a community-but that modernization makes it necessary to let some employees go-the veterinary practice may still get credit for the jobs retained, since those jobs would have been lost if the veterinary practice had gone out of business.

Practices where the facilities are not owner-occupied (such as real estate investment in rental housing,) are not eligible for 504 funding although a veterinary practice can lease out a portion of the building during the expansion period.

If the funds are to be used to build a new building, the practice must occupy 75 percent of it; if the veterinarian is using the funds to purchase an existing building, the practice must occupy 51 percent of it to start.

It should be noted that while a 504 loan can be used to purchase a new building, it is not a construction loan. The veterinary practice must get a regular construction loan and the 504 loan is funded after the project is completed.

And remember, if you are planning to pay your 504 loan back early, be aware that there is a sliding-scale repayment penalty for the first half of the loan period.

If you plan to sell your veterinary practice during the term of the loan, the loan is assumable, but only if the person assuming the loan qualifies and is approved by the SBA. This keeps veterinarians from selling their practices to people with little or no business experience who are not likely to be successful.

Fifty percent of the 504 financing comes from the participating financial institution.

Getting the money

That lender's investment is generally secured by a first security interest (a lien) on the facility or equipment. The remaining 40 percent comes from CDCs, local public/private partnerships organized as nonprofits. CDC loans are typically fixed-rate loans secured by a second lien and guaranteed by the SBA. The remaining 10 percent, of course, is the veterinarian's responsibility.

There are a few basic financial requirements every lender must meet.

For existing operations, the SBA generally looks for a debt-worth ratio (total liabilities/total assets) of not more than three to one subsequent to the loan being made. A start-up must have at least 30 percent in equity invested by the principals under most SBA guaranty loan programs.

In addition to the capital requirements, the SBA looks closely at cash flow (both historical and projected) and the background and competence of those involved.

With 504, as with most SBA programs, the veterinarian works with his or her banker in filling out the paperwork to apply for the loan. Finding a bank that has some experience in SBA lending is essential as well as an excellent first step towards tapping into this underused, SBA financing program.

Mr. Battersby is a financial consultant in Ardmore, Pa.