SBA Loans Can Be Complex: A Practical Guide
The Small Business Administration (SBA) is a federal agency that works with lending institutions to provide loans to small businesses. The term “SBA Loan” can be a little confusing because the agency itself does not lend money directly to small business owners. Rather, it works with its lending partners – usually banks, community development organizations, and micro-lending institutions – to make it easier for business owners to secure capital. The funding for SBA loans comes from the lenders themselves, while the agency provides government-backed loan guarantees that mitigate lenders’ exposure to risk, thereby making it easier for business owners to get loans.
For instance, when Jeff Meier wanted to take full ownership of his grocery business, he approached six different banks for help with the acquisition. All of them refused.
Meier then decided to take a different route. He contacted Rappahannock Economic Development Corporation (REDCO), a certified nonprofit commercial lender, to obtain an SBA 504 loan that allowed Meier to buy out his former business partner, free up the store’s cash flow, and diversify debt.
Meier’s Battleground Country Store in Fredericksburg, Virginia, opened in 2016 with 18 employees. Today, the store has 29 employees and continues to expand its range of services. While Meier credits his experience in the U.S. Air Force and National Guard for honing his leadership and management skills, he also says that the success of his store wouldn’t have occurred without his SBA loan.
Meier’s case is similar to that of many small business owners who have secured SBA loans to expand their businesses. The loan he qualified for is one of 13 different loan types that the SBA packages in six loan programs. In all, the SBA helped issue more than $5.4 billion in loans in 2018 and, through August, was on pace to top that figure in 2019.
SBA LOANS VS. BANK LOANS
“Helped” is the operative word since the SBA doesn’t lend money directly to small businesses, with the exception of its Disaster Loan program. The SBA guarantees a portion of the loan, which reduces risk for lenders. This lower risk to the lender makes it easier for small businesses to get loans, especially businesses that would normally not qualify for a loan. Examples of this are businesses with insufficient down payments for collateral for traditional bank loans.
The typically lower SBA loan interest rates and term lengths make repayment less complicated. Simply put, borrowers have less money to repay over a longer period of time.
All SBA loans are similar in purpose and share characteristics, but they are each designed for different needs and different borrowers.
The SBA doesn’t have one narrow definition of a small business. Rather, different criteria are set according to industries. There are other factors that separate an SBA loan from a commercial one.
SBA LENDING PROGRAMS
The SBA has six loan programs that offer 13 different loans. These loans are designed to accommodate a variety of needs.
The programs are as follows (All SBA interest rates are current as of August 2019):
- SBA (7a) Loans
This is the SBA’s most popular program. It’s ideal for small businesses that need working capital, and can provide up to $5 million. In addition to the standard 7(a) loan, the SBA offers three other loans of this type.
- 7(a) Small Loan. This is a (7a) loan that can provide up to $350,000 and is typically faster to fund.
- SBA Express Loan. The 36-hour turnaround is the advantage of this offering. But interest rates can be higher, since the SBA guarantees a maximum of 50 percent for SBA Express Loans.
- Community Advantage Loan. These are 7(a) loans designed to provide financing to businesses in underserved areas. Borrowers may not meet standard SBA 7(a) loan criteria for a variety of reasons. These loans offer the same expedited approval of an SBA Express loan, but with 85 percent of the loan guaranteed up to $250,000.
SBA Interest rates for 7(a) loans can range from 7.5 to 10 percent. They also come with a number of fees, such as an origination fee of 0.5 to 3.5 percent, an SBA guaranty fee of two to 3.5 percent and a loan packaging fee of $2,000 – $4,000.
How Can I Use Money from an SBA 7(a) Loan?
The SBA has rules on how you can and cannot use proceeds from an SBA-guaranteed 7(a) loan. Typically, the use of loan proceeds is very general. However, there are some limitations and restrictions on the use of funds.
Acceptable uses of SBA 7(a) Loan Proceeds
Financing for long and short term assets used in normal business operations. Acquisitions and refinances are eligible, and may include real estate and business goodwill. Working lines of credit are available:
- To purchase equipment, machinery, furniture, fixtures, supplies or materials
- To purchase real estate, including land and buildings
- To construct a new building or renovate an existing building
- To establish a new business or assist in the acquisition, operation or expansion of an existing business
- To refinance existing business debt, under certain conditions
- SBA CDC/504 Loans
This is the SBA version of a commercial real estate loan. To qualify for a CDC/SBA 504 loan, applicants need a credit score of at least 680 and a down payment of at least 10 percent. The upper range of loan amounts can be between $14 – $20 million. The SBA interest rate for this type of loan is approximately 3.76 percent fixed for a 10-year loan and approximately 4.08 fixed for 20 years.
- SBA CAPLines
These loans serve as business lines of credit. There are four SBA CAPLines that can help businesses with short-term, seasonal or cyclical working capital needs. All of them can extend up to $5 million in credit. The CAPLines are:
- SBA Seasonal. To qualify, a business must have been in operation for at least one year and needs to demonstrate a pattern of seasonal activity.
- SBA Contract. This version can be used for materials and labor associated with contracts. Interested businesses need to prove experience, profitability and ability to do the work associated with the contract. They must also complete the contract or purchase order.
- SBA Builders. Contractors and home builders who build or renovate residential or commercial buildings can qualify by demonstrating experience, profitability and the ability to complete the project.
- SBA Working Capital. This SBA line of credit allows small businesses to convert short-term assets – like pending invoices – into cash. To qualify, businesses must generate accounts receivable or have inventory.
The SBA interest rates for all of the CAPLines range from 7.5 to 10.0 percent. The SBA loan payment terms are 10 years, except for Builder CAPLines, which is five years. A credit score of at least 680 and short-term collateral, such as invoices or contracts, are required.
- SBA Export Loans. These are SBA loans that provide financing for businesses that need to finance their export activity. Export loans are best suited for businesses engaged in international commerce and are looking to expand in that area. The SBA interest rate on the SBA Working Capital loan typically ranges from six to 10 percent and can fund up to $5 million. The maximum term for repayment is three years.
- An SBA Export Express loan is also available for up to $500,000 at an interest rate of 9.75 to 11.75 percent. SBA loan payment terms are up to seven years for a line of credit, and the standard SBA 10-25 years for a term loan.
- SBA International Trade loans are also available for businesses that want to enter or expand their presence in international markets. The terms for these loans are the same as the SBA 7(a) loan program. They can provide up to $5 million at an SBA interest rate ranging from 7.5 to 10 percent. The SBA payment terms of the loan range from 10 to 25 years.
A credit score of 680 is required, and the business must already be involved in exporting goods or services to foreign countries. For Export Express, the business must be at least one year old.
- SBA Microloans. This is the ideal loan for startups. Microloans can offer up to $50,000 are a good fit for SBA Microloans. They are issued through non-profit, community-based organizations. They can’t be used to refinance debt or purchase real estate. No business history is required, so they can be used to start a business. They are also a perfect fit for home-based businesses and the self-employed.SBA interest rates on microloans range from eight to 13 percent. SBA payment terms are up to six years. A credit score of 640 and some collateral are needed.
- SBA Disaster Loans. This group of loans consists of the only SBA loans funded directly by the agency itself. SBA Disaster Loans help companies that have been impacted by a declared natural or economic disaster. These loans are used mainly to fill gaps in the funding of a business once other resources, such as reserves and insurance, have been exhausted. There are three types of SBA Disaster loans:
- SBA Business Physical Disaster Loans. These are long-term, low-cost loans for businesses that have been physically damaged by a disaster that occurred within a declared disaster area. The loans cover physical losses and damages, and can replace or repair uninsured property up to $2 million.
- SBA Economic Injury Disaster Loans. Businesses that have suffered substantial economic injury as a result of a disaster and cannot meet their normal operational expenses may be eligible for these types of loans. They provide short to medium-term working capital loans up to $2 million.
- SBA Military Reservists Economic Injury Disaster Loans. This is an option for a business that has had a key employee called for active military duty. If the employee’s absence has resulted in the business not being able to meet normal operating expenses, these short to medium-term working capital can provide up to $2 million.
SBA interest rates on Disaster loans range from four to eight percent, with SBA payment terms that can stretch up to 30 years. A credit score of 660 and an ability to repay the loan are required.
SBA LOANS FOR VETERANS
The Military Reservists Economic Injury SBA Disaster Loan is one of several SBA loans for veterans. According to the SBA, veteran-owned businesses comprise 9.1 percent of the 30 million private sector businesses in the United States that employ nearly 60 million workers.
The SBA report also notes that veteran-owned business employ more than five million workers and contribute $1 trillion to the U.S. economy. As more veterans returned home and discharged, the SBA Veterans Advantage loan has been created to keep fueling this important economic sector.
The SBA Veterans Advantage loan is similar to a standard 7(a) loan. It can provide working capital of up to $5 million to start or grow a small business with no guaranty fees up front for loans of $125,000 or less. For loans of greater than $125,000 veterans can benefit from a 50-percent reduction of guaranty fees up to $5 million.
There are no guaranty fees for all SBA Veterans Advantage Loans under the SBA Express loan program. Under this program, veterans can borrow a maximum of $350,000. This figure was chosen because of all SBA loans that go to veterans, 73 percent are for $350,000 and less.
In addition to loans, the SBA also provides counseling and training to give veterans the support they may need in business.
To qualify for an SBA Veterans Advantage loan, at least 51 percent of the business must be owned and controlled by individuals in at least one of the following groups with the appropriate accompanying documents:
- Veterans (other than those dishonorably discharged)
- Copy of Form DD 214, which is routinely provided for discharge veterans;
- Service-disabled Veterans
- Copy of Form DD 214 or document from the Department of Veterans Affairs confirming the veteran’s service-connected disability;
- Active Duty Military service member participating in the military’s Transition Assistance Program (TAP)
- DD Form 2 (“U.S. Armed Forces Identification Card (Active),” or DD Form 2 (“Armed Forces of the United States Geneva Conventions Identification Card (Active)” and DD Form 2648 (Active Duty Military member) or DD Form 2648-1 (Reserve Component member);
- Reservists and National Guard Members
- DD Form 2, Armed Forces of the United States Identification Card (Reserve);
- Current spouse of any veteran, active duty service member, reservist or National Guard member or widowed spouse of a service member who died while in service or as a result of a service-connected disability.
- The veteran’s Form DD 214 and proof of current status as spouse. For spouses of TAP participants, reservists or National Guard members, other appropriate documentation from the Department of Defense of Department of Veterans Affairs that proves spousal status is acceptable.
Veterans and their spouses who apply for the SBA Veterans Advantage Loan must meet all the requirements of the SBA 7(a) loans. These include a credit score of at least 680, personal collateral and good credit. Two years of operating as a business is preferred, but startups are eligible should the owners have enough experience in the industry and a good business plan.
SBA LOANS FOR WOMEN
The SBA doesn’t have a loan program specifically targeted for women-owned business. The 8(a) Business Development Program is designed to help small businesses compete in the marketplace. The 8(a) program is a key component in the federal government’s plan to award at least five percent of all federal contracting dollars annually to small businesses owned by socially and economically disadvantaged people or entities.
The 8(a) program is also a good option for minority-owned businesses. Business owners can get certified as an 8(a) business through the certify.SBA.gov website. Applicants will also need to have a profile at SAM.gov before they can use the certification website. The Office of Women’s Owned Business Ownership (WBO) is a good resource for women-owned businesses. It helps women business owners through programs coordinated by SBA District offices. These programs include business training, counseling, federal contracts and access to credit and capital.
Most SBA loans for women and SBA loans for minorities are standard SBA 7(a) loans. The terms and requirements for these loans are the same for women-owned businesses and minority-owned businesses.
APPLYING FOR AN SBA LOAN
While the SBA offers a variety of loan options – and is accessible to businesses that may not typically qualify for a loan – an SBA loan application still has strict eligibility requirements. The most general requirements are that all major owners of the business must have good or excellent credit. The owners also must have a reasonable amount of equity in the business, and cannot have delinquencies or defaults on other government loans. This includes student loans.
The business must be at least two years old and meet the SBA’s definition of a small business. It has to prove that it tried and failed to get funding from other lenders. The business must also operate as a for-profit entity based in the United States and in an eligible industry. Loan packaging and vice industries such as gambling are examples of industries that typically don’t qualify.
The lender and the type of SBA loan that is being applied for may have additional requirements. If a business fails to meet the age or credit score requirements, it could qualify for an SBA startup loan through the 7(a) program.
Other reasons why an SBA loan application may be rejected is if any of the business owners has a criminal past, or if the business has too many assets.
Applicants may have to provide documents such as:
- A comprehensive business plan;
- Resumes of key personnel;
- Articles of incorporation and bylaws;
- Business certificate or license;
- Business credit report;
- Business tax returns;
- Current profit-and-loss statement;
- Current debt schedule;
- Projected financial statements;
- Business lease agreement;
- Personal financial statements for owners who own at least 20 percent of the company;
- A written valuation for any asset used as collateral to secure the loan.
Since the SBA guarantees the repayment of the majority of the loan, it’s not uncommon for lenders to ask for collateral to cover the balance. For instance, if the SBA guarantees 80 percent of the loan, the lender may ask for personal collateral to cover the remaining 20 percent.
Businesses that are interested in applying for an SBA loan should find a lender that’s not only knowledgeable about these loans, but also originates many of these loans. Such a lender will save time and increase the chances of getting funded.