The SBA's 504 program, promotes economic development through financing capital assets. Lenders should consider the potential benefits to high net worth professional clients of trust ownership in these SBA-financed assets.
The SBA 504 program allows the financing of capital assets--buildings, equipment, related soft costs, and the like--with low down payments ranging from 10-20% of the total project cost. The balance of the funding comes from a private-sector lender and a certified development company (CDC), generally in proportions of 50% and 30-40%, respectively. The private-sector lender enjoys a first-position mortgage and security interest in financed assets, with the CDC/SBA in a second position. Given the relative security of the private-sector lender's collateral position, very competitive pricing and loan terms are generally available. The second-position loan is priced at a fixed rate for a fully amortizing 20-year term with assumption allowed. In sum, it is a very attractive financing package. (1)
The benefits of the 504 loan structure can be even more distinct for high-net-worth professionals--for example, surgeons, lawyers, and accountants. The low down-payment requirement preserves working capital for the future growth and development of a practice without resorting to other debt. The ability to broadly define project cost to include many types of soft costs or build-out requirements--whether structural or related to equipment needs--further assists in the preservation of working capital. Finally, cash flow--for the funding of planned investment patterns for retirement or for family needs--is preserved by the structure of the debt, a long-term amortization in the 504 portion, and the opportunity for a longer term and amortization in the lender's first-position loan.
The benefits to a lender of this product are equally apparent. In preserving the availability of cash flow, as well as in creating a superior collateral position, the lender has structured an especially secure credit exposure. This can either accrue to the general benefit of the portfolio or be more immediately recognized through a specific lower loan-loss reserve allocation. The lender also has created a much more marketable credit product mix through the availability of long-term, fixed-rate financing. The 504 program's limited restrictions on the structure of the first-position mortgage also can be turned to good account by offering the full spectrum of engineered credit offerings to tailor a loan uniquely suited to the borrower's needs. (2) Finally, the specific loan structure, discussed herein--placing the title to the acquired capital asset into a trust environment--inherently lends itself to the cross-selling of investment products and other financial services.
The placement of significant financial assets under the legal separation of a trust may benefit high-net-worth professionals. Examples could range from protection of assets in litigation to the more universally needed benefits of trust status in estate planning. In certain circumstances, these protections also could be of value to lenders, as in the case of keeping an asset outside of probate.
Trusts are a relatively complex topic, given the considerations particular to an individual client's situation. The objective of this article is not to review overall trust strategies but rather to view how the varied benefits of trust asset protection can be used within the requirements of the SBA regulatory environment.
SBA regards the question of trust ownership of financed assets as a subset of the regulations that determine the eligibility of a borrower. The key regulatory issues are that a borrower is determined to be a "small business" and that any assets financed meet the requirements of being more than an investment. SBA's perceived mission and the legislative intent of the program are to assist the operations of a small business, not the speculative or passive real estate investments of a small business's principals. (3) There are, however, clear advantages to a small business owning its place of operations, as well as distinct legal benefits to owning these premises outside of the operating entity of the business. This has led to a long debate as to how and when SBA could, or should, assist in the financing of real estate purchases for an otherwise eligible small business. The eligible passive company rule is the result of this debate. As it specifically relates to trusts owning an SBA-financed capital asset, regulations require the following limiting conditions:
1. The trustor must be eligible by SBA standards.
2. All donors to the trust are considered trustors.
3. All trustors must guarantee the loan.
4. The trust must represent and warrant that it will not be substantially amended or revoked for the life of the loan. (4)
Luckily, eligibility under the 504 loan program is far less complex than for the 7(a) program. As it relates to the issue of business size, any business with a tangible net worth of less than $7 million and after-tax net income averaging less than $2.5 million over the preceding two years is eligible. Principals and the immediate family of the borrowers or the "eligible passive company" also must meet an excess liquidity test. (Principals include anyone owning 20% of a project.) The test relates the size of the total project being financed--using a very broad definition--to an upper limit for liquidity, net of exemptions, as either a flat-dollar amount or a multiple of the total financing package. The relationship is outlined in the following table:
Total Financing Allowable Maximum Liquid
< $250,000 2 x total financial package or
$100,000, whichever is greater.
$250,001-$500,000 1.5 x total financial package or
$500,000, whichever is greater.
> $500,001 1 x total financial package or
$750,000, whichever is greater.
Liquid assets are defined as "cash or cash equivalent, including savings accounts, CDs, stocks, bonds, or other similar assets." Specifically excluded are real estate equity, closely held nonmarketable stocks, IRAs, 401(k)s, Keogh plans, or other established retirement plans subject to withdrawal penalties and restrictions. (5) Given the relative liberality of this definition, most successful professionals will still qualify as eligible borrowers.
The balance of eligibility issues relate to prohibited business lines, citizenship or legal residence issues, and moral and ethical considerations. These regulations can be summarized in fewer than two pages. Outside of citizenship or legal residence status issues, these should rarely constitute an eligibility issue for most professionals. As citizenship or legal residence issues are beyond the scope of this article, a local CDC or the local SBA district office can provide answers to situation-specific questions.
In sum, while all donors to the trust must be determined eligible, there are limited obstacles to eligibility and the determination is relatively straightforward. However, all trustors must be guarantors of the loan, which may in certain circumstances present administrative or marketing issues. It must also be noted that the 504 program has a specific and definite job-creation requirement that, while important in the overall program, can be less of an issue in certain transactions because of the manner in which performance under this requirement is measured.
The current regulations also clearly define two other issues that serve to increase the attractiveness of this ownership structure. The first is that the trust itself does not have to meet eligibility requirements, either in size or in the business lines it is engaged in. This could radically enhance the benefit of the 504 program to a high-net-worth professional who has or is contemplating transferring significant assets to a trust environment as part of an estate-planning process. Given an application lead time of at least six months due to other regulatory issues, prospective borrowers' financial situations could be reasonably structured to render them eligible for the benefits of a 504 loan by placing assets into a trust as part of legitimate estate-planning moves. In an environment involving the new construction of a practice facility, this is not an unreasonable time frame.
Finally, beneficiaries of the trust do not have to guarantee the loans made under the 504 program if the asset is titled in the name of the trust. This provides the "icing on the cake" for a planned asset-transfer environment.