What are SBA Loans?
The Small Business Administration (SBA) is an agency of the United States government that was created to support entrepreneurs and small businesses exclusively.
The most important thing to know about SBA loans is that the Small Business Administration isn't actually making the loans - they are guaranteeing the funds that banks lend under the program. This means that the government promises to pay the banks back for a portion of the loan if the business owner ends up defaulting. There are several types of loans available to business owners, with each focusing on a specific size or type of business.
The SBA loan program covers anything from disaster relief loans to loans designed to help refinance debt and purchase equipment. By alleviating much of the risk involved with lending to these businesses, the SBA can help make it easier to get funding where it may not otherwise be possible. Loans guaranteed by the SBA also have special fee structures for veterans, with many loans carrying no fees at all.
How To Apply for an SBA Loan
Loans are not issued directly by the Small Business Administration. Instead the SBA relies on a network of banks, non-profits, and other organizations to perform the applicant screening process. The application process itself looks and feels quite a bit like a traditional loan would, with the major exception being that the lenders are screening for specific guidelines set forth by the SBA for each loan program.
Current and potential business owners must present personal and business credit histories, financial statements, and must submit verification of their business industry and operational details. The lender will use North American Industry Classification System codes (NAICS) to determine the type of business that is applying for funding. The SBA has requirements on which types of business can obtain a loan through one of their programs. Some types of businesses are automatically disqualified such as pyramid/multi-level sales businesses, certain lending businesses, political or lobbying businesses, or businesses involved in pornography. Pawn shops, hotels/motels, nursing homes, and gambling facilities also face additional scrutiny and must prove the sources of their primary revenues in order to qualify for an SBA loan.
The Small Business Administration's individual loan programs each carry their own specific requirements and guidelines for applicants. In general, SBA loans carry looser credit and financial requirements than traditional commercial loans, making them ideal for new business owners or those with poor or limited credit histories. Since each of the individual loan programs have been created with the intention of supporting or stimulating growth in a particular sector of the economy, there are several application requirements to prove eligibility.
SBA Loan Process Checklist
The SBA application process may also include a checklist to assess the eligibility of the applicant. Many factors are covered, including:
Citizenship of owners/principals
If the owners of the business are not US citizens, the application may require the applicants to complete a separate form with additional information on their status in the country.
Owners' credit history isn't the only factor taken into consideration. If they have ever been arrested or had other issues in the past, the SBA requires a disclosure and may disqualify the applicant if they are currently under parole or indictment.
Strict disclosure of number of employees and revenues from the prior business year are required.
If the business owners have the ability to fund the project themselves or can obtain reasonable financing through some other means, the lender may not approve the loan under an SBA program.
Funds from the loan cannot be used to purchase assets that will be held for passive income (investments). Additionally, special forms may be required if the loan will be used to:
- Refinance Debt
- Fund change of ownership
- Purchase a building used for rentals
- Purchase a historic building
What Types of Loan Programs Are Supported By The SBA?
There are a few major types of SBA loans, each with different purposes and dollar limits.
SBA 7(a) Loans
SBA 7(a) are the most common type of loan covered under the SBA program. These loans can be used to refinance debt, buy a business, purchase real estate, or provide working capital, and are issued for up to $5,000,000. Terms vary depending on the purpose of the loan, and there are down payment requirements if the loan is used for a purchase.
The 7(a) program is regarded as more flexible than traditional loans because the terms are generally longer, down payments are lower, and rates can be lower as well. The SBA has created special sub-programs within 7(a) that include specialized funding for businesses that focus on:
- Exporting goods
- Underserved communities
- Active military- and veteran-owners
The SBA does want to see that the business owners have some degree of dedication to being successful and have invested some degree of their personal equity in the company.
Though the loans can be issued for up to $5MM, the 7(a) program will not guarantee 100% of the loan amount. When issuing loans up to $150,000, lenders can expect the SBA to guarantee 85%. Beyond that amount, the program covers 75%, not to exceed a total guarantee of $3,750,000. This means that lenders may additionally scrutinize applications for larger sums, as their risk increases.
Under the 7(a) program, the SBA charges lenders a participation fee, which may be passed on to the borrower, ranging from 3%-3.75%, depending on the dollar amount of the loan.
A CDC is a Community Development Corporation, which is a nonprofit designed to help bring investment to underserved, low income, or otherwise investment-starved areas. The 504 loan is designed to originate in partnership with CDCs, meaning part of the loan is funded by the nonprofit and the remainder is funded by a bank, and the SBA still guarantees a portion of the loan.
The 504 program has more specific purpose requirements than the 7(a) program does. Loan funds can only be used to:
- Purchase land
- Purchase existing buildings
- Purchase long-term machinery and equipment
- Build new facilities or renovate existing space
Under this program, businesses cannot have a net worth over $15MM and are required to have less than $5MM in revenues. Businesses also have to prove that they have the ability to pay back the money by projecting their revenues over the term of the loan.
SBA MicroLoans are issued for up to $50,000 and are designed to help women, low-income, veteran, and minority business owners. The SBA's MicroLoan program provides funding to nonprofit organizations that in turn lend those dollars back into the community. Loan terms max out at six years and rates vary. An important factor to note is that MicroLoans, while available to many underserved business sectors, generally carry higher interest rates than traditional loans - somewhere in the range of 7.5% on average.
The Small Business Administration offers disaster relief loans to individuals and businesses as well. When applying for a loan, a business must pledge assets to be at least partial collateral for a loan under this program, though the approval process may not depend completely on how much is pledged. This program also involves an assessment to determine the extent of damage and costs of repairs. Unlike some disaster relief programs, these SBA programs are issuing actual loans that must be paid back. There should be no fees associated with an SBA disaster loan and the application is filed directly through the agency.
During the application process, business owners will be required to disclose any past bankruptcy, legal or financial issues, personal criminal convictions, personal financial issues, and others. If any past issues exist, additional detail is required, and does not necessarily disqualify the applicant.
Is An SBA Loan Right For Your Business?
Loans issued under an SBA program generally require the borrower to have exhausted their other funding options prior to applying. Business owners may also find themselves ineligible to receive a loan through SBA for one reason or another. Though the loan programs created by the SBA are usually considered less burdensome than a traditional loan, other options may exist. This means that there may be a more viable alternative to an SBA loan, offering a more favorable term or interest rate to that business. Some local communities offer programs similar to an SBA loan that are designed to encourage specific economic growth in an industry or region.
Typically feature fast approval and loan amount offers. The forms are simple to complete and don't always require as thorough an application. Loans through these platforms are generally marketed to the small business market and feature a variety of repayment, term, and rate options.
Offered through chambers of commerce, local municipalities, or even banks in a particular area, and are designed to stimulate economic growth. Examples of loans issued under these programs would be farm and agricultural development loans, child development or childcare facility loans, and so on. These programs may be closely tied to an SBA program, and may have similar qualification requirements.
May be an option if no other lending solutions are available. Obtaining financing through online platforms can be a way to both publicize and fund a business, but fees and other requirements may make the process not worthwhile for some owners. Most crowdfunding sites require a percentage of the donated money to be paid in fees, which can sometimes add up to a much higher amount than any interest rate would. On top of fees, investors in many crowdfunded lending platforms can set their own repayment, term, and interest rate requirements, which means the business owner is at the mercy of that individual lender. These loans are also not regulated in the same way that the other loans listed here are, which can be troublesome if any issues arise during the funding process.