An SBA loan is usually your best choice for small business funding for buying a franchise or for improving it. One reason is that they generally have much lower rates of interest and terms in comparison with conventional loans because they are secured by the SBA. There are two primary kinds of SBA loans that are utilized for small business funding. These are the SBA 7(a) and SBA 504 loan programs. Normally, SBA 7(a) loans are preferable over SBA 504 loans for financing your franchise\franchise outlet. The following are a number of the reasons why a SBA 7(a) loan is better than a SBA 504 loan:
1. SBA 7(a) loans are far more flexible than 504 loans concerning what the funding can be used for when you are purchasing a franchise or when you are improving it.
7(a) loans may be used to purchase real estate, equipment, inventory and goodwill when purchasing a franchise outlet. It can also be used for construction and remodeling of your franchise. Franchisees can also use an SBA 7(a) to supply working capital. SBA 504 loans, by contrast, are mainly used for obtaining or improving commercial real estate or for buying machinery and equipment. It’s important to note that any equipment that is obtained with a 504 loan is required to have an anticipated life-span of 10 years or longer. The Small Business Administration doesn’t permit SBA 504 loans to be used for purchasing inventory, goodwill or for working capital.
2. SBA 7(a) loans usually have much better interest rates.
Since the Small Business Administration guarantees up to 90% of an SBA 7(a) loan and only 40% of an SBA 504 loan, lenders are a lot much more likely to offer lower rates on SBA 7(a) loans. You can get an SBA 7(a) loan with either a fixed or a variable interest rate. The specific interest rate for an SBA 7(a) loan is negotiated between the applicant and the lender. However, the SBA sets a maximum limit to the interest that your loan provider can charge for an SBA 7(a) loan. The highest interest rate on a 7(a) loan is calculated 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 a 7(a) loan; a prime rate posted in a US daily newspaper, the London Interbank One Month Prime Rate plus 3% or an SBA Peg Rate. The Small Business Administration places limits on the additional spread which loan providers can add to this the base rate. For loans with maturities of less than seven years, the Small Business Administration allows a maximum spread of not more than 2.25 percent. The highest possible spread for loans with maturities of seven years or more, is 2.75 percent.
The interest rates on 504 loans are generally more in comparison with SBA 7(a) loans. This is because fifty percent or more of the funding is a private conventional loan. The Small Business Administration does not get involved in the private conventional loan that’s combined together with the SBA 504 loan. Consequently, the terms, the rates, the fees and whether or not the loan has a fixed or a variable rate is entirely up to the discretion of the private loan company. The good news is that lenders are more inclined to offer lower rates of interest on these loans because there’s reduced risk when compared to a 100% conventional loan. The reason why their risk is lowered is because the SBA 504 loan is subordinated to the private loan. Because of this, they’ll be paid first from the proceeds of the liquidation of collateral in the event the borrower defaults on the loan.
Certified Development Companies (CDCs) provide the SBA 504 loan financing which is guaranteed by the SBA. The rate of interest on this a part of the loan is usually ¾ percent above the current market rate for 5-year and 10-year U.S. Treasury bonds.
3. A 7(a) loan typically has lower fees when compared to a 504 loan.
On loans under $150,000, the fees for SBA 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. The fee jumps up to 3% for 7(a) loans that are providing between $150,000 to $700,000 of financing and have terms that are more than one year. A 3.5% loan fee is charged on loans for over $700,000. An additional 0.25% is added to the fees on the portion of the loan that exceeds $1 million.
For 504 loans, the fees are typically three percent for the 40% portion of the funding that is guaranteed by the Small Business Administration. The loan fee charged for the traditional loan is set by the private loan company. The SBA does not specify a maximum fee for this part of the financing.
4. 504 loans specify that the financing fulfill specified SBA-defined policy goals. SBA 7(a) loans don’t have these kinds of .
The SBA requires that SBA 504 loans be used to fulfill certain employment creation or community development objectives. Normally, a 504 loan is expected to retain or create one job for every $65,000 provided by the borrowed funds. Small manufacturers, on the other hand, need to produce or retain one job for every $100,000 of 504 financing received.. These conditions are not specified for SBA 7(a) loans.
In conclusion, an 7(a) loan is normally the recommended option for business financing that can be used for purchasing a franchise outlet or for improving it. The reason why an SBA 7(a) loan is superior to a 504 loan is because it provides a much better rate of interest and superior loan terms. The other advantage of SBA 7(a) loans is that you don’t have to meet SBA-defined policy goals.
When you apply for an SBA loan to fund your franchise, you need to understand that you don’t fill out an application directly to the SBA. SBA loans are instead supplied by banks and other special finance companies. Previously, the primary providers of SBA loans for small businesses were neighborhood community banks. This source of SBA loans has substantially declined as a consequence of many community banks going out of business during the last twenty years. Concurrently, the large banks that now dominate the banking industry do not want to bother with small business loans. Fortunately, this void in small business lending has been quickly filled by non-bank SBA loan companies. One example of these non-bank SBA lenders is Newtek, the small business authority. Founded in 1994, Newtek has become the largest non-bank SBA loan provider in the US. In 2013, the Small Business Administration ranked Newtek as the 6th largest SBA 7(a) lender of all loan providers in the United States. In most situations, Newtek can get you pre-qualified for as much as five million or as little as fifty thousand dollars within 48 hours. The application process is simple. Newtek fills out all of the loan documents for you.
Written by: Erik Krupp, Cofounder of NewBusinessCreator.com