Key Factors in Choosing Between an SBA 7(a) Loan and a Term Loan

Difference #1: Amount of Paperwork

The requirements and the application time are where a term loan from either a bank or an online lender may be preferable to a 7(a) loan. So generally, if a small business needs funds quickly, a term loan may be the better bet.

Because an SBA 7(a) loan is partially backed by the U.S. Small Business Administration, a borrower must have:

• Three years of tax returns (business and personal).

• A detailed business plan - a comprehensive, written document that serves as a roadmap for starting, managing, and growing a business. It outlines company goals, strategies for achieving them, market analysis, financial forecasts, and operational details. It is usually essential for securing funding, attracting partners, and guiding strategic decisions. If a small business owner is starting from scratch, they may want to start with a professional business plan template, which is offered by companies such as HubSpot.

• A comprehensive use-of-funds statement explicitly stating what the borrowed will be used for.

• Personal and business credit checks.

• Valid identification documents, including driver's license, Social Security number and employer identification number (EIN) for tax identification purposes.

• At least 2 years in business.

Due to the extensive paperwork required for a 7(a) loan, the application process can take up to a month, depending on the lender – a private entity approved by the SBA.

For a conventional term loan, every lender has different requirements. Term loans are offered by both traditional banks and online lenders, and the requirements between the two are often different. Generally, most term loan lenders will require:

• Identification: Valid driver's license, passport, or state-issued ID.

• Income Verification, usually in the form of 2-3 years of both personal and business tax returns.

• At least 2 months' worth of business bank statements to show cash flow history.

• A complete account of existing debt agreements (if any).

• Credit Report: Lenders will pull this, but it is advised to check your own first.

• Debt Information: Documentation of existing loans, leases, or debts.

• Almost all online lenders do not require a business plan, while some traditional banks do.

• A use-of-funds statement telling the lender what the borrowed funds will be used for.

The application time will differ among individual lenders. Online lenders generally fund more quickly than traditional banks .

Difference #2: The Cost of Capital

The interest rate on an SBA 7(a) loan could generally be less than a term loan, since a 7(a) loan is partially guaranteed by the federal government. When determining the rate for each, lenders consider:

1. Business and personal credit scores.

2. Loan duration. Generally, the longer the loan, the higher the rate.

3. SBA 7(a) loans use the WSJ Prime Rate as a base. Many term loan lenders use the federal funds overnight rate plus 3% to determine the prime rate (which is currently 6.75% as of the date of this article), although that might differ slightly among individual lenders).

4. Collateral. Both SBA 7(a) and term loan lenders accept collateral. Generally, providing collateral will lower the interest rate.

Generally, the interest rate charged gives SBA 7(a) loans an edge over term loans if the interest rate is the main consideration of the borrower.

Difference 3: Loan Durations

If the small business owner is seeking flexibility when it comes to loan duration terms, then conventional term loans have a clear advantage over 7(a) loans. 7(a) loans are generally meant for small business owners who are seeking assets to fund long-term growth plans, while term loans are probably better for those who are seeking funds for either short- or long-term plans.

With SBA 7(a) loans, the choice of loan durations is typically:

• Maximum of 10 years if the loan is being used to purchase equipment, increase inventory, stabilize cash flow, or fund long-term growth plans.

• Maximum of 25 years if the loan is being used to purchase real estate.

• With maturities of less than 15 years, there's often no prepayment penalty, but this may differ with each lender.

• Some SBA lenders may offer 7(a) with durations less than 10 years, but those cases are rare.

For conventional term loans, many lenders offer:

• Short term duration loans (3 to 24 months). These durations are mostly offered by online lenders.

• Intermediate duration loans (2 to 5 years)

• Long-term loans (5+ years, 10 years to purchase equipment and up to 25 years to purchase real estate)

• The prepayment penalty is different with each lender. Some lenders may offer discount penalties.

Loan Amounts -No Real Difference

The minimum and maximum amounts for both SBA 7(a) loans and conventional term loans are about the same, but there are some nuances to consider:

1. For most online lenders, the maximum amount of a term loan stays around $5 million (except in rare cases) since they mostly get their money from asset-backed offerings. Most traditional banks offer term loan amounts of up to $10 million, since they get their money through short-term borrowings from the Federal Reserve bank.

2. There is no official minimum amount for SBA 7(a) loans.

3. There are some traditional banks that offer term loan amounts exceeding $10 million, but it's very rare.

Which is the Best Choice?

In the end, choosing between a conventional term loan really comes down to the specific needs of the small business owner. A 7(a) loan may be preferable for small business owners that are:

1. Seeking to implement a long-term growth plan, as 7(a) loans, as 7(a) loans typically offer longer durations than term loans.

2. Seeking a lower cost of capital, as 7(a) loans usually offer lower interest rates.

3. Looking for a loan that does not have a significant drag on cash flow, as 7(a) loans have longer durations than term loans and therefore have lower repayment amounts than term loans.

On the other hand, a conventional loan may be the better choice for small businesses that:

1. Need funding quickly.

2. Are not in a position to produce a detailed business plan.

3. Are seeking short duration loans at a fixed rate.

4. Do not have strong enough credit scores for a 7(a) loan.

In the end, it's impossible to definitively say that one loan is better than the other.

What is clear, however, is that small business owners may want to carefully consider the key differences between both before deciding between a 7(a) loan and a conventional term loan.