What’s a Debenture? Understanding SBA 504 Financing for Small Business Owners

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When you’re applying for an SBA 504 loan, there’s a term you’ll hear frequently: debenture. The debenture plays an important role in the SBA financing process – in fact, it’s how you’ll get your funding at closing! And it’s a key difference between a traditional commercial mortgage and using an alternative business loan option like the SBA 504 program.

Learn everything you need to know about debentures below including how it impacts your SBA 504 loan.

An overview of the SBA 504 loan program

To answer the question, “What’s a debenture,” you should understand how SBA 504 loans differ from traditional commercial mortgages.

The U.S. Small Business Administration (SBA) was created to help more small business owners gain access to financing. While the SBA doesn’t make loans directly, they do work with banks, credit unions, and other financial institutions to help small business owners like you get the funding you need. Among their various loan programs, the SBA 504 loan program is the preferred program for purchasing commercial real estate, major assets, and debt refinance.

It offers excellent terms, including down payments as low as 10% (compared to 30% or more for conventional commercial mortgages); competitive, fixed-rate financing for the life of the loan; and a longer repayment period (up to 25 years), which make your monthly payments more manageable.

Project financing through the SBA 504 program includes three components. You’ll work with your bank on a first mortgage for part of the cost of the project, that bank will partner with a certified development company (CDC), like Pursuit, for the 504 portion, and then you’ll add in your equity (your down payment) as the borrower.

While there may be scenarios that could impact the financing structure (such as buying a special-use property, like a gas station or an auto repair shop, for example), here’s a typical SBA 504 structure:

  • You, the owner, provide the down payment (10% of the project total).
  • Your bank provides a first-mortgage loan for 50% of the project.
  • The CDC provides a second-mortgage loan for 40% of the project total through the SBA 504 loan program. The 504 program can finance $25,000 to $5 million, or $5.5 million for manufacturing companies or green-energy projects.
  • There is also an interim loan, commonly referred to as a bridge loan, that bridges the gap from closing to funding of the SBA 504 loan.

What’s a debenture and how is it different?

Simply stated, a debenture is similar to a bond. They can be bought and sold on financial markets between two different groups of investors. Buying and selling debentures doesn’t require either of the groups to pledge collateral.

Here’s how debentures are used to finance the SBA 504 portion of loans for small businesses:

When a bank or credit union lends money, they provide loans to customers using the funds they have from deposits by other customers. The bank or credit union makes money on the loans through the interest charged to the borrower, and customers who have savings and other deposit accounts may also earn a return through interest on their accounts.

Unlike traditional lending institutions, CDCs don’t have funds available through deposit accounts. Instead, for CDCs to finance SBA 504 loans, they use a debenture to raise the funds needed for the SBA-guaranteed portion of the loan.

Institutional investors (such as pension funds, insurance companies, and large banks) purchase these debentures through monthly sales of SBA 504 loan debt. SBA 504 debentures are 100% guaranteed by the federal government, so they’re considered a safe and desirable part of an overall investment portfolio.

In addition, investors receive interest on the debenture, which is fixed for the life of the debenture (10, 20, or 25 years). This is part of the interest that you pay on your SBA 504 loan.

What’s a bridge loan and why is it necessary?

It’s important to understand the difference between a bridge (interim) loan and debenture because of its impact on the overall loan process.

SBA 504 debenture sales only happen once per month based on a set schedule.  Depending on the timing of your loan closing, you may need an interim loan to bridge the gap between your loan closing and when your debenture is sold.

The bridge loan ensures that you’re able to pay the agreed-to purchase price and any closing costs or related fees at closing.

The actual funds for an SBA deal aren’t available until after the debenture sale, so there are essentially two steps to the SBA 504 loan closing process.

First, there’s the closing. For a commercial real estate transaction, this is where the property/title changes from the seller to the buyer. The funds at closing come from the bank’s first mortgage, your down payment or equity, and the remaining portion that will ultimately be funded by the SBA 504.

The SBA loan is then submitted into the next available debenture sale which typically occurs 30-60 days after closing.  This is why the 504 portion is covered by a bridge loan, which allows the SBA 504 transaction to close prior to the debenture financing.  

After the debenture sale’s funds are received by the CDC, the bridge loan is paid off in full and the permanent SBA 504 loan is financed.

Will you need a bridge loan for an SBA 504 loan?

Yes. In fact, the SBA will not approve the SBA 504 debenture, and your CDC will not issue a commitment letter, without knowing who the interim lender will be.

Without bridge loans (sometimes referred to as “interim second loans” or “interim seconds”), SBA 504 deals would be stuck in limbo. For this reason, when you apply for an SBA 504 loan you should also start applying for a bridge loan at the same time. Many times, the first mortgage lender will provide the bridge loan, and if you’re working with Pursuit, our team will help to facilitate this for you.

Once the underwriting process is successfully completed, you’ll receive three loan approvals – the first mortgage, issued through the partnering financial institution; the second mortgage, issued by the CDC; and approval for the bridge loan.

The interim loan is paid off by the money from the debenture sale as part of the permanent SBA 504 loan financing. This usually occurs within 60 days after the initial closing for most deals.  Some SBA 504 projects that include construction or extensive renovation may have an extended bridge loan term.

Pursuit helps with every step of the SBA 504 loan process

Whether you’re new to small business loans or have past experience, the SBA 504 loan process can be complex. But you can count on Pursuit to be with you every step of the way.

We’ve helped thousands of small business owners get the financing needed to launch, grow, and thrive, and we’re one of the most experienced CDCs in the country. When you’re ready to apply, get in touch with us. We look forward to working with you!

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