Growing businesses also make purchases from vendors, suppliers, and contractors throughout the region. These purchases fund more local businesses, families, restaurants, and so on in the same manner. Money that comes into a community through jobs created or retained through economic development circulates around and around through that community, touching other people’s lives.

The tax base is also increased through the growth of local companies. As a start, the companies themselves pay taxes. In addition, the newly created jobs translate into new income for local families, which is also taxed. Growing incomes also lead to more purchases throughout the local community, which means a larger amount of sales tax is collected.

The increased tax base then funds more services supporting the community. From more police, to better schools and libraries, to repaved roads, this cycle of economic development impacts life for all community members. The entire community wins with a 504 loan.

CDC’s are non-profit entities with a mission to support the growth and economic stability of a specific region. A key part of achieving this mission is stimulating the expansion of local businesses. As companies grow, they create more local jobs, re-invest cash into the region through local contractors and suppliers, and provide a larger tax base that in turn supports improved services for local communities.

But how do CDC’s help local companies to grow? One clear path would be investing in these local businesses and supporting them with financing. But most CDC’s (which are often smaller nonprofits) don’t have hundreds of millions of dollars sitting around in their bank account to invest. So this is where the SBA steps in.

The SBA guarantees 100% of the portion of the loan provided through the CDC. If the borrower defaults on the payment, the full credit of the United States government will be used to cover the debt. As a result, investors see 504 debentures as extremely secure investments. Either the borrower or the federal government will pay the debt off in full. Either way, the owner of the note will make a steady, safe return on their investment. As a result, 504 loans become low risk investments that can easily be packaged and sold to private investors.

The SBA facilitates this sale on a national level. In fact, the CDC portion of the loan isn’t funded until it has been purchased by private investors. This means that the CDC achieves its mission of supporting regional development by financing local businesses, but it doesn’t use its own cash for the loans. Instead, it simply funnels money from investors around the country directly into the local community. That is a huge win for the CDC.

The SBA is a federal agency tasked with the mission to aid, counsel, assist and protect the interests of small business concerns; preserve free competitive enterprise; and maintain and strengthen the overall economy of our nation. The 504 Loan Program achieves this mission by promoting private sector investment in fixed assets, which in turn increases productivity, creates new jobs, generates additional tax revenue, and strengthens the economy as a whole.

The 504 program offers similar benefits to the SBA as it does for CDC’s. The SBA does not need to fund the loans itself. Private investors provide 100% of the money being loaned. The SBA is leveraging private investors in order to promote economic growth on a national scale.

But what about the costs? Who pays when a borrower defaults on a loan?

The SBA charges a Guarantee Fee to borrowers. This fee is typically 0.5% of the amount funded through the CDC. This fee is minimal, but it is the cornerstone of the SBA program. Through it, the 504 program has remained self-funded without the need for tax payer dollars to support it!

But the 504 program changes the risk profile for the lender. They provide only 50% of the financing, yet they are the first lienholder on the asset. This means that in case of default, the lender is highly protected. As a result, the bank is willing to lend to businesses it would otherwise decline.

As an example, consider a business applying for financing in order to purchase a $10M property. Suppose this applicant has a credit score of 680 and their monthly profit is only 25% more than the monthly payments would be on the loan. (That’s a DSCR of 1.25.) Most banks would be very hesitant to extend credit to this company. Their credit history reflects prior failure to repay debts, plus a few small setbacks in the business could easily leave them unable to make their monthly loan payment.

The 504 program changes the bank’s risk calculous drastically. The bank would only need to lend $5M, but they would still be the primary lienholder. This means that if the client doesn’t make payments on time, the bank can foreclose on the property which is worth $10M. Best case scenario, the client pays their debt on time and the bank profits. Worst case scenario, the bank spends $5M to acquire a $10M property. It then turns around and resells the property, again making a handsome profit. Thus the 504 program is a win for banks, or traditional lenders. It allows them to safely serve more clients and boost their profits.