Here is a quick synopsis of the SBA 504 loan:
1) There is a “regular” commercial loan in 1st lien position that is made by a bank, and finances 50% of the project cost. This loan does NOT have an SBA guarantee, but the lender who is in 1st position is in a very strong collateral position (1st lien and a 50% loan-to-value at loan inception).
2) The SBA loan (originated through a CDC, or Community Development Corporation) is always in a 2nd lien position, and typically finances 40% of the project cost. This loan is 100% guaranteed by the SBA, so the CDC has minimal financial risk.
So what are the most commons error I see?
1) The first misconception is the belief that if the 1st lien holder forecloses, the SBA obligation disappears (hint: it doesn’t) While it’s correct that in a foreclosure scenario, the CDC/SBA 2nd lien could get wiped out, business owners always forget about that pesky personal guarantee that they signed. So in other words, if the 1st lien holder forecloses, it will eliminate the CDC/SBA security interest in the real estate, but it doesn’t mean that the personal guarantors are off the hook. In order to be released from the obligation, guarantors need to submit an Offer In Compromise.
2) The second misconception is that an Offer In Compromise (i.e. Release of your personal guarantee) can be negotiated before a short sale is completed (hint: it can’t). If you want to sell your building, but the value is less than the amount you owe, the SBA is usually pretty accommodating in terms of releasing their lien. What they won’t do, however, it release your personal guarantee in conjunction with the short sale. The short sale and the Offer In Compromise are two separate events. Many borrowers don’t like the idea of closing on a short sale without know how much they will be able to settle for, and I get that. All I can tell you is that until the liquidation of the real estate is complete, the SBA will not agree to an OIC. If you think threatening not to do the short sale will change their mind, thing again. I’ve seen deal blow up because the borrower thought the SBA would blink first (hint: they won’t).
3) The third misconception is that proceeds from a short sale can be used to make an Offer In Compromise. The purpose of the OIC is for the guarantors to make an offer in exchange for the release of their personal guarantee. In order to accomplish this, an offer needs to be made that pays the SBA a sum that is above and beyond the collateral they already have. In other words, sending the SBA the proceeds from the sale of collateral that was pledged for the loan (in most cases, this is the real estate) is not sufficient. The SBA already has a lien on the real estate, so if you offer them the proceeds from a short sale, you aren’t really offering them something they couldn’t get anyway by foreclosing. True, your short sale might fetch a price higher than what the SBA could sell if for in foreclosure, but unfortunately the SBA does not take that little tidbit into account.
Overall, the navigation through the short sale of your real estate, and subsequent settlement of your SBA debt can be daunting. There are many nuances that, if not fully understood, can really give you a major headache. Having the right advisors can make all the difference.