The BizQuest Team Published Nov 28, 2023
How to Use an SBA 504 Loan to Buy a Business
The BizQuest Team
When a small business acquisition includes commercial real estate or major equipment, an SBA 504 loan can be a strong financing option. It offers a low down payment, fixed interest rates, and long repayment terms, which can make a deal built around physical assets more affordable and predictable over time.
What Is an SBA 504 Loan?
The SBA 504 is a loan program backed by the U.S. Small Business Administration and delivered through Certified Development Companies (CDCs). It helps small business buyers finance major fixed assets, especially owner-occupied commercial real estate, heavy equipment, and related property projects.
CDCs are community-based nonprofit partners certified and regulated by the SBA. They work with traditional lenders to structure and fund 504 loans.
How the Three-Party Structure Works
The SBA 504 loan uses a three-party financing model that splits the project costs among a lender, a CDC, and the borrower.
- Lender (bank or credit union): 50% of the project cost, provided as a conventional first mortgage
- CDC: 40% of the project cost, funded through an SBA-guaranteed debenture
- Borrower: 10% down payment (equity injection)
This structure keeps the borrower's out-of-pocket costs low and gives the lender and CDC clear roles in the financing. In some cases, such as startups or single-purpose properties, the borrower contribution may increase to 15% or 20%.
What Can You Finance With a 504 Loan?
The 504 loan program is for major fixed assets and certain related property improvements. Eligible uses include:
- Purchasing owner-occupied commercial real estate or land
- Constructing new facilities
- Improving or modernizing land or existing facilities
- Buying long-life machinery and heavy equipment
- Consolidating or refinancing qualifying debt in some situations
The 504 loan cannot be used for working capital, inventory, or intangible assets like goodwill. For business acquisitions that include real estate, buyers sometimes pair a 504 loan with an SBA 7(a) loan to cover both parts of the deal.
Loan Amounts, Terms, and Interest Rates
The SBA 504 loan offers long repayment terms, and the CDC portion carries a fixed rate for the life of the loan. That structure can make monthly costs more predictable for buyers who plan to hold the property or equipment long term.
- Maximum CDC loan amount: $5 million for most projects; up to $5.5 million for small manufacturers and certain eligible energy-related projects
- Repayment terms: 10, 20, or 25 years
- Interest rates: Fixed for the CDC portion and tied to U.S. Treasury rates; the lender's portion may be fixed or variable
Borrowers lock in the CDC debenture rate at closing, protecting them from future rate increases over a 20- or 25-year term.
Eligibility Requirements
Both the business and the use of funds must meet SBA criteria to qualify for a 504 loan.
Business Requirements
- Must be a for-profit business operating in the U.S.
- Must meet SBA size standards: tangible net worth under $20 million and average net income under $6.5 million after federal income taxes for the prior two years
- If real estate is part of the loan, the property must generally meet SBA owner-occupancy requirements: at least 51% of an existing building or 60% of a newly constructed one
Loan Requirements
- Must be used for eligible fixed assets
- Must create or retain jobs, or meet a community development or public policy goal
- Startups may qualify but typically require a higher borrower contribution
Key Benefits of the SBA 504 Loan
The 504 can lower upfront costs and make long-term borrowing more predictable than most conventional business loans. In practice, that means:
- Low down payment preserves cash flow for operations
- Fixed rate on the CDC portion removes long-term interest rate risk
- Longer repayment terms reduce monthly payment pressure
- Below-market debenture rates, often lower than commercial real estate loans
- Property ownership builds equity over time
SBA 504 vs. SBA 7(a): Choosing the Right Loan
Both programs are backed by the SBA, but they serve different purposes. Here's how they compare for business acquisitions.
| Loan Type | Down Payment | Terms | Use of Funds | Best For |
|---|---|---|---|---|
| SBA 504 | As low as 10% | 10, 20, or 25 years | Fixed assets: real estate and equipment only | Acquisitions that include commercial real estate or heavy equipment |
| SBA 7(a) | As low as 10% | Up to 10 years (25 with real estate) | Purchase price, working capital, inventory, equipment, real estate, refinancing | Most small business acquisitions without significant real estate |
A 504 loan usually makes the most sense when real estate or equipment is a major part of the deal and the buyer plans to own the property long term.
When a 504 Loan Is the Right Fit
The 504 is a strong fit when a business deal is anchored by real property or major equipment. Common examples include:
- A restaurant acquisition that includes the building
- A manufacturing business with a factory or production facility
- A car wash with the land and physical plant
In each case, the buyer benefits from owning the real estate long term. Compared with conventional commercial financing, the lower down payment of an SBA 504 loan makes small business ownership more accessible.
SBA 504 loans can take longer to close because both the lender and CDC have to approve the deal, and real estate often adds extra documentation. Buyers should start the SBA loan application process early and work with an experienced team to help keep the deal on track.
For buyers acquiring a business where real estate or equipment is a core asset, the SBA 504 loan program can make ownership more affordable. It can be a practical way to finance business property and preserve cash flow available during the early ownership transition.
If you're looking to purchase a business or prequalify your business for sale, visit BizQuest's Finance Center. Discover financing options for your business goals and secure the funding you need.
