What are SBA Loans? The Most Detailed Guide for All Business Owners

How SBA Loans Work

Here's brief outline of how lending with an SBA loan works:

1. Startups and entrepreneurs with innovative business ideas select an SBA loan program and apply for the loan. These borrowers usually don't have business history and credit scores required to qualify for traditional bank loans, and SBA seems to be a reliable option.

2. SBA finds and connects the borrower with a certified community development financial institution (CDFI), who then screens the loan application against various parameters to verify business potential and repayment capabilities. They may evaluate personal credit scores, business plans, revenue streams, market size, and growth

3. The CDFI may offer the funds, while SBA guarantees a certain portion of the loan. Certain CDFIs may also ask borrowers to guarantee a small percentage, make upfront downpayment, or keep a collateral.

What Type of Businesses Can Qualify for an SBA Loan?

A wide majority of small businesses and startups may qualify for an SBA loan. These can include businesses from the following sectors:

• Food & Beverages
• Consumer Packed Goods
• Information Technology
• Hospitality
• Retail and Wholesale Businesses
• eCommerce and Other Digital Startups
• Rental Businesses
• Electronic Appliances
• Hardware Tools
• Oil and Gas
• Construction and Heavy Equipment
• Automobile, and many more

However, certain businesses, like non-profit organizations and those into gambling, money lending, pyramid schemes, and adult entertainment cannot apply for SBA loans.

How To Apply for an SBA Loan?

1. To apply for an SBA loan, current and aspiring business owners must present personal and business credit histories, financial statements, and submit verification of their business industry and operational details. The lender may use North American Industry Classification System codes (NAICS) to determine the type of business that is applying for funding.
2. The SBA has requirements through which borrowers can find eligibility for 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.
3. The Small Business Administration's individual loan programs each carry their own specific requirements and guidelines for applicants.
4. If an SBA lender qualifies a business for a loan and shares approval, SBA proceeds with the loan agreement and acts as guarantor to secure the loan.

Since each of the individual loan programs has 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.

What Do I Need for an 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:

1. 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.

2. Personal History

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.

3. Business Size

The application may ask owners for strict disclosure of the number of employees and revenues from previous business ventures.

4. Personal Resources

If a business owner has 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.

5. Loan Purpose

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 owner intends to use the loan for:

• Refinancing Debt
• Fund change of ownership
• Purchasing a building used for rentals
• Purchasing 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 financial ceilings.

1. SBA 7(a) Loans

SBA 7(a) loans can be used to refinance debt, acquire 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 may be some 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 smaller, and interest rates are typically lower than market standards for qualified applicants. 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 prefers business owners to 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 $5 million, 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 up to 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.

The SBA 7(a) program also includes several other types:

• Standard 7(a) Loans: These loans are greater than $350,000 and processed through the Preferred Lender Program (PLP) delegated authority or non-delegated authority like Loan Guaranty Processing Center (LGPC).

• Small 7(a) Loans: These loans are under $350,000 and processed through LGPC.

• SBA Express Loans: Under these loans, the evaluation and loan disbursement are faster. However, the SBA may not guarantee a high portion of the loan. This 7(a)-loan option is ideal for businesses owners trying to capitalize in time-sensitive markets.

• SBA Export Express Loans: These loans offer term loans or revolving line of credit for businesses looking to develop export side of their businesses. Decisions are faster under SBA Export Express loans, and SBA may guarantee up to 90% of the loan.

• SBA Export Working Capital Loans: These loans are suitable for businesses that are already into export but need more working capital and cash flow to expand and grow their business.

• International Trade Business Loans: These SBA loans are especially designed to help businesses involved in international trade. Owners can use the funds secured to acquire, construct, or improve facilities. SBA can guarantee up to 90% of the loan amount.

• Manufacturers' Access to Revolving Credit (MARC) Loans: These refer to SBA-guaranteed business line of credit. From their eligible credit line, business owners can withdraw as much amount as they want and only need to pay interest on the amount withdrawn.

• CAPLines: These are short-term loans to help small businesses meet their seasonal or demand-based financing requirements.

2. CDC/SBA 504 Loans

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 $20 million and are required to have less than $6.5 million 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.

3. SBA Micro Loans

SBA Micro Loans are issued for up to $50,000 and also provide 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 micro loans, while available to many underserved business sectors, generally carry higher interest rates than traditional loans.

Here's an in-depth article that explains what you need to know about SBA Microloans as a small business owner.

4. Disaster Loans

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.

SBA Loan Alternatives

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. In this case, they can look forward to the following SBA loan alternatives.

1. Term Loans

Various banking and non-banking financial organizations offer term loans. These include a lump sum amount given at a certain interest rate. Borrowers can negotiate their repayment terms like interest rates, loan tenure, loan amount, and more. Term loans are also multi-purpose loans. Owners can use them freely for equipment purchases, inventory, building a logistics network, and more.

2. Business Line of Credit

Private business line of credit is still useful for startup businesses. You can apply for any loan amount within that credit line and expect to receive faster decisions. With monthly repayment, business owners can free up portions of their credit line and borrow again as per business requirements.

3. Commercial Real Estate Loans

These loans are used for making commercial real estate purchases, like retail stores, warehouses, and offices. To establish creditworthiness, lenders may require business owners to make an upfront downpayment. However, the real estate property itself secures the loan, decreasing monthly payments and freeing up cash flow.

4. Equipment Financing

To secure costly equipment, owners can opt for equipment financing at private lenders. As the equipment secures the loan, business assets of the owner remain protected. Moreover, because of reduced risk, borrowers may be able to secure competitive rates for the loan.

5. Regional programs

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.

6. Crowdfunding

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 up 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.

Final Thoughts

With the wave of entrepreneurship, SBA stands as an organization aimed at helping startups fuel growth. It offers multiple loan programs in collaboration with non-profit community developers and even guarantees the loan. Startup business owners who are not able to secure financing through some other financing options can look forward to SBA loans. Also, for innovative ideas, SBA loans might be better because of their competitive interest rates. Owners can use the funds secured for multiple purposes and pursue business growth.