SOURCING A COMMERCIAL PROJECT – Part 1
by BPE Law Senior Attorney and Co-Manager, Keith Dunnagan
One of the first questions that comes up in any commercial transaction is who will lend the kind of money one needs to complete a commercial project. The answer naturally, is “that depends”. It depends on several factors, including but not limited to what type of project is being financed, how long has the business been operating, what is the solvency of the principal, what is the solvency of the guarantors, what is the required equity infusion from the borrower, and so on. But generally speaking at the end of the day there is a loan out there for every project. It is just a matter of finding the right source of funding for the project or business goal you need to fulfill.
One of the most common if not the most common source of funds sought in commercial finance is institutional money. That is a commercial loan from a commercial bank that is usually a large regional bank or a national bank. These institutions tend to be more flexible in providing the loans needed for businesses to operate. However, the lending structure on a commercial loan is significantly different from your everyday residential transaction. Commercial lenders tend to be fairly programmatic. That is they tend to approach each commercial loan like the last and the products don’t vary much from borrower to borrower. That means, the borrower, will likely incur a variable rate tied to one of the indexes (the most common seems to be tied to a treasury yield – commonly the 2-year treasury rate), the borrower will execute a standard form deed of trust, personal and corporate guaranties, environmental indemnity agreements (if the project is real estate related), security instruments and assignments affecting personal property, rents and the like and in some cases, will collateralize the loan against other non-related assets of the borrower or guarantor. While institutional money is readily available and rates are generally competitive, the lenders can pick and choose where they lend the money by creating draconian rules attached to the loan.
Another well-known source of funds is the SBA 504 program. The SBA 504 loan is an asset based financing mechanism. That means that these funds are generally only available for loans based upon real estate or tangible personal property (i.e. machinery or business equipment). The benefit of the SBA 504 loan is that it is designed for small businesses and can provide loans to its target market at below market rates. However, the SBA 504 loan is not for everyone. There are two issues involved with the SBA 504 loan, (1) generally speaking this type of loan will not provide all of the financing needed to complete a project. It is almost always secondary financing source, meaning that the first lender provides the majority of the financing (generally 50%), the borrower makes at minimum and equity infusion equal to 10% of the project cost and the SBA provides the financing in a secondary position for the remaining 40%. Second, the SBA is limited to small businesses and is restricted from lending to borrowers who exceed certain financial thresholds. So for the larger businesses out there, this financing option is likely not available.
There is also foreign money available. Under the United States Immigration Act of 1990, the US government created the EB-5 program. It is a loan that ties foreign investment to job creation in targeted employment areas and in return the investor obtains a green card. The investor has to put their money at risk for a certain period of time during which the funds are invested into the project and jobs are hopefully created. The Regional Centers, who raise the investor capital, provide the loans and handle all of the reporting requirements to complete the program and outside the requirements of a borrower’s specific loan documents, the borrower generally has not regulatory liability. The one thing a borrower must always be aware of in such a loan is the lock-out period or pre-payment penalty. Because the investor’s money has to be at risk for a certain period of time, the Regional Center maintains very strict terms on pre-payment.
These are just a few of the options available to source funds. Other sources that routinely come up are loans from state-chartered insurance companies, pension funds, mortgage REITS and investment trusts. All products designed to capitalize on the expanding commercial transaction world.
In the next article, we will continue to look at funding sources and look briefly at equity requirements and equity raises, security and other issues that come up in selecting a money source.
BPE Law Senior Attorney and Co-Manager, Keith Dunnagan, practices exclusively in the area of commercial transactions and finance. If you have any questions, you can reach him at 916-966-2260 or email@example.com.
For over 20 years, the attorneys of BPE Law Group, P.C. have been advising and representing business and property owners and investors in dealing with their legal needs. Check us out on the Web at: www.bpelaw.com. If you would like a consultation with us, please call our office at (916) 966-2260 or e-mail Keith Dunnagan at the above link.
This article is not intended to be legal advice, lending advice, or a specific recommendation of any particular lender or company, and should not be taken as such advice.