SBA loans cap interest rates and long terms, making them ideal for small business funding. However, they can be challenging to apply for. They require patience and adherence to strict criteria. Do you know how to tell if they are suitable? This article will help you decide.
SBA loans are small business loans issued by lenders and partially guaranteed by the U.S. Small Business Administration, or SBA. They can come with tight lending rules and regulations. Some also have long, flexible terms and capped interest rates, making them a great way to fund a small business venture.
Are these loans a good idea for your business? Which pros and cons should you consider? Here is what you need to know.
Table of Contents
SBA loans are loans provided by commercial lenders but with the benefit of a guaranty provided by the U.S. Small Business Association (SBA). That guarantee is provided to incentivize lenders to loan funds for small businesses to entrepreneurs that commercial lenders would otherwise see as too much of a credit risk.
Upon securing an SBA loan, the borrower can then use the funds to acquire fixed assets and provide working capital for its business, among other things. Because these loans are guaranteed by the SBA, there is reduced lender risk, which allows the lender to extend the loan on more favorable terms than would otherwise be available.
“The SBA isn’t the one doing the lending. Instead, it works with a network of approved institutions to lend money, which is, in turn, partially guaranteed by the SBA.”
If the business can’t repay the loan, the bank first looks to the small business owner through a personal guaranty, but with the assurance that anything that remains uncollectible will be covered by the SBA.
DID YOU KNOW: A partial guarantee on an SBA 7(a) loan can cover 85% of a loan up to $150,000 and 75% of loans over $150,000? Without this guarantee, it would be harder for small businesses to get the funding they need because traditional banks often see small businesses as too risky.
Because SBA loans involve a government entity, the application process is comprehensive and can be restrictive and hard to navigate. To get an SBA loan, you should first determine the type of loan that fits your business situation best. Then find a lending institution in your area, like a bank or credit union. Apply for the SBA loan through that lender.
Depending on your business’s qualifications and the lender’s criteria, the terms of your SBA loan may vary. There are various SBA loans to apply for, each of which can have its own criteria. However, there are some basic eligibility requirements to meet, including:
- Be an officially registered for-profit business in an eligible industry
- Must be physically located and doing business in the U.S. or its territories
- As the owner, you must have invested equity in the business, like time or money
- Must demonstrate a need for funds
- Must be a small business as defined by the U.S. SBA
- No delinquency on any existing government debts
- No one with 20% or more ownership in the business can be currently incarcerated or on probation or parole, or be a defendant in a criminal proceeding.
Applying for a U.S. Small Business Association loan can take several weeks. Required paperwork and the slow speed of bureaucracy can delay the process. Because of this, an SBA loan may not be the best option for you if your small business desperately needs capital.
Note that all SBA loans have to be approved by the U.S. Small Business Association. That process can take anywhere from 5-10 business on top of the time it takes your SBA lender to underwrite the loan. However, certain lenders meeting strict criteria of the SBA can qualify for “preferred lending partner” (PLP) status, which allows the lender to determine the loan eligibility for the SBA guarantee without SBA review. Thus, working with a PLP lender can cut up to two weeks off your lending timeline to obtain funds.
PLP lenders such as, to name a few, also usually extend a higher volume of these loans than non-PLP lenders and, therefore, have more robust back office functions and underwriting teams which can eliminate a lot of the headaches that come with obtaining an SBA loan.
An SBA loan can come in various sizes. They range from $500 to $5.5 million, with five to 25-year repayment plans. However, ten years is typically the standard. Each loan type has unique requirements for eligibility, such as:
- Two years of business experience
- The business owner has a 640+ personal credit score
- The business has $100,000+ in annual revenue
Meet those criteria, and your small business is in a good spot. The best SBA loan for you will depend on the requirements you meet and what you’re planning to use the funds for. The most common types of SBA loans include these:
- SBA 7(a) Loans
- SBA CDC/504 Loans
- SBA Microloans
- SBA Disaster Loans
- SBA CAPLines
- SBA Export Loans
SBA 7(a) loans are the most common because of the low-interest rates, long repayment periods, and flexible terms. The 7(a) loan is the darling of the entrepreneurship through acquisition community! Existing small businesses can certainly use a 7(a) loan to refinance existing debt, buy commercial real estate, or update equipment. But entrepreneurs can also use a 7(a) loan to fund the acquisition of an existing business, making this an ideal choice for small business buyers – especially first-time buyers! The 7(a) loan has a $5 million upper limit, making the possibilities virtually endless for small business entrepreneurs.
The CDC/SBA 504 loan is a project-based loan to fund major fixed assets and is available exclusively through a Certified Development Companies (CDC). The loan can be for up to 90% of the project value, with 50% coming from an SBA lender (coordinated by the CDC) and the other 40% directly from the CDC. This leaves the borrower responsible for a 10% down payment. Unlike a 7(a) loan, however, 504 loans are available for 10, 20, or even 25-year terms, depending on the project.
An SBA microloan is not guaranteed by the SBA. It can only be provided by non-profit small business lending institutions. The maximum loan amount is just $50,000, hence the name. Because the SBA doesn’t back microloans, they have much higher rates than other SBA loans. Despite the limited applications, SBA microloans are ideal for self-employed individuals, solo entrepreneurs, startups, and non-profits with limited capital needs.
SBA disaster loans are available to businesses, non-profit organizations, homeowners, and even renters that have evidence of physical or economic impact due to a disaster, as defined by the SBA. This could be a natural disaster or an economic recession. This SBA loan can be used to rebuild inventory, repair assets, and handle other operating expenses. It’s a wise option for borrowers needing to bounce back from a disaster without taking on too much debt.
SBA CAPLines are actually extended through the 7(a) program described above but are lines of credit rather than direct loans. There are four different CAPLines to choose from. Each one is geared toward various industries and is often bundled with SBA 7(a) loans.
CAPLines are ideal for businesses with cyclical finances. For example, retailers looking to maintain cash flow during an offseason or contractors with significant upfront expenses before revenue is earned can use CAPLines to help.
Export loans are for businesses with experience with exportation and are looking to use the money to develop business abroad. It’s a loan targeted to specific small businesses and ideal for U.S. manufacturers looking to bring their products overseas. SBA Export Loans are also suitable for those already exporting but need capital to continue expanding.
With all the information on SBA loans and the available types, you may wonder if applying for an SBA loan is right for you. There are certainly several advantages to getting an SBA loan. Let’s explore these:
- Broad Requirements
- More Opportunity
- Large Loan Amounts
- Long Terms
“The owner must also invest time and money into the business and exasperate all other funding sources.”
In general, to qualify for an SBA loan, the eligibility requirements are pretty broad. Essentially, a business must be legally registered and operating for profit in the U.S.
Because they have a partial guarantee from the SBA, there’s a safety net that forms that reduces the lender’s risk. This makes it easier to qualify and get approved for an SBA loan, especially for those who may not be eligible or get approved for traditional loans.
You can acquire quite a bit of money with these loans, ranging from $500 to $5.5 million. The amount you can get from an SBA loan is also more considerable than what is typically provided by other lenders or banks.
With SBA loans, you have plenty of time to pay them back. The term of your SBA loan will depend on how you plan to use the money but typically ranges from 10 to 25 years. Longer terms make it easier to use the funding without worrying about quickly paying off the loan.
Unfortunately, despite how great applying for an SBA loan may sound, there are significant disadvantages when determining the best move for your business. Some of the cons of these loans include the following:
- Slow Approval Process
- Require Personal Guarantee
- Hard to Qualify
- Low-Credit Applicants Not Approved
The SBA loan application and approval process can take weeks or months. It’s a very detailed process with a long paper trail. It also takes a while to submit the documentation and even longer to get it approved. Then you might have to wait to access the funds while your business starves for capital. For example, you can expect a typical 7(a) loan to take up to eight weeks to pass through underwriting and funding.
In many cases, these loans require an unlimited personal guarantee from anyone who owns 20% or more of the borrowing business. That often includes a second (or third) mortgage on the primary residence of the guarantors. This means you’re responsible for repaying the debt if the loan defaults and your family’s home is at risk if the borrower’s assets can’t satisfy the loan. This can be highly stressful and is often the point in the process where many people panic and reach for a business lawyer.
“Even with flexible requirements and a partial guarantee from the SBA, getting approved for an SBA loan is tricky.”
There are other strict criteria to meet. You typically need years in business, strong finances, and good credit to qualify.
One of the strict eligibility requirements for these loans is good credit history. Even with one loan guarantee and long loan terms, lenders aren’t likely to provide this loan to borrowers with a low credit score. Those interested in receiving this loan should aim for a personal credit score of 680.
When you default on a loan or have business trouble with a legal undertone, looking for a professional to help you handle the situation is normal. Business lawyers are legal professionals who focus on issues affecting businesses like taxation, business transactions, intellectual properties, and other operations. Business lawyers are your go-to throughout any business-related legal process, whether preparing documents or overseeing trials and hearings.
If you’re in the business world, it’s a good idea to have a business lawyer in your back pocket from the very beginning.
“Issues can arise at any stage, and it’s crucial to have knowledgeable legal help to turn to if and when you need it.”
Many business lawyers have a solid understanding of how these loans work, including the rules and regulations. They also know what to do if you are in loan default. In a case like this, business lawyers can analyze your financial situation and help you determine the best course of action.
Some of the other reasons why you may need a knowledgeable legal professional include the following:
- You Want to File for Bankruptcy
- You Need an SBA Loan Debt Settlement
- You Need to Negotiate Loan Modifications
- You Need to Sign a Legal Document
U.S. Small Business Association loans are small business loans issued by lenders and partially guaranteed by the U.S. Small Business Administration, or SBA. They can come with tight lending rules and regulations. However, they have long, flexible terms and capped interest rates, making them a great way to fund a small business venture.
Several loans are available, each with its terms and conditions. The best SBA loan for you will depend on the criteria you meet and what you’re planning to use the funds for. There are several advantages to receiving these loans but also many disadvantages. Weigh the pros and cons for the best possible outcome, and speak to a business lawyer if you have questions.