SBA Loans: What You Need to Know
Introduction to SBA Loans
Most small business owners consider a variety of funding and credit options at one time or another. If you run a small business, you may have already heard about or considered Small Business Administration loans, also known as SBA loans.
For many reasons, SBA loans are a great choice for some businesses. To help you decide if they’re the right choice for you, we’ve collected the benefits, drawbacks, application information, and other things you may need to think about when considering an SBA loan.
What is an SBA Loan?
Small Business Administration loan programs are drafted in agreement between lenders and SBA agencies. Borrowers use these programs when looking for lenders for their small businesses. Lenders appreciate SBA loan programs because the SBA shoulders some of the risk for the lender by guaranteeing a portion of the loan amount. Because of that guarantee, lenders are able to offer more flexible payment terms and lower interest rates than most small businesses would otherwise be able to get.
SBA loans and SBA Express loans are a useful option for many SMBs, but they do have several drawbacks that you should consider before applying. Here are some to think about before you make a decision.
Pros of SBA Loans
Designed Especially for Small Business
SBA loan and SBA Express loans target small businesses. The SBA, in partnership with lenders, created guidelines with the aim of aiding small business expansion and growth. Unlike traditional bank loans, SBA loans are aimed specifically at SMBs.
Multiple Uses for the Funds
SBA loans and SBA express loans can be used for a wide range of expenses. According to the SBA, you can use these loans for “most” business purposes, including start-up, expansion, equipment purchases, working capital, inventory or real-estate purchases.
SBA loans are secured, meaning, SBA agencies guarantee a percentage of the loan amount to the lender, reducing their risk. (In cases where you don't pay what you owe, the bank can still seize your assets.)
Because the federal government guarantees SBA loans, more lenders are willing to offer financing to small businesses through SBA loans. In fact, lenders lower their qualification criteria for small businesses that apply for SBA loans.
Cons of SBA Loans
Personal Credit Scores Required
In order to qualify for SBA loan and SBA Express loan, you must have a high personal credit score as well as good business credit. If either score is low, you may not be eligible.
2+ Years in Business
Your business must be at least 2 years old to qualify for an SBA loan. That can be a problem if you are one of the over 400,000 new businesses that appear every year in the United States and need operational capital just to get started.
Some Restrictions on Expenses
Some SBA loan programs have restrictions regarding the capital, meaning the money they provide can be used for specific purposes only. If your desired use doesn’t fall within SBA restrictions, this isn’t the right type of funding for you. The way you plan to use the funds may have an impact on your loan terms, so you’ll want to think about this before applying for the loan.
Specific Eligibility Requirements
Even though it’s generally easier to get approved for SBA loans than for traditional bank loans, the eligibility criteria can still prove to be tough for many small businesses to satisfy. The SBA determines eligibility based on criteria such as the nature of the business, where the business operates, and the character of the ownership. You can find more details about eligibility requirements for SBA loans <a href="https://www.sba.gov/funding-programs/loans">here on their official website.</a>
Do SBA loans actually work?
By now, you’re getting pretty familiar with SBA loans.
Next, you need to decide if these are the right choice for you. If you’re an entrepreneur looking for the best way to fund your growing business, you might be wondering if an SBA loan will help you get where you want to be.
Do SBA loans work? Have they helped others? For many businesses, the answer is yes.
We went right the source for more information and exchanged emails with with the SBA Office of Communications and Bill Manger, associate administrator for the SBA’s Office of Capital Access. Manger relayed a few impressive true SBA loan success stories:
- Chobani Yogurt, which had a valuation as high as $5 billion in 2016, used a 504 loan to start the company, according to Manger.
- Vidalia Denim Mills, a denim manufacturing company located in northern Louisiana, recently got a $25 million loan from the United States Department of Agriculture (USDA) and a $5 million loan from the SBA to grow their operations. The company “will be exporting its denim and employing more than 300 full-time workers thanks to its product and the partnership between the USDA and SBA,” Manger says.
- Laundry City, a laundry pickup and delivery service based in Baltimore, benefited from a $3.5 million SBA 504 loan. The loan allowed to company “to grow and increase the number of its employees,” Manger explains.
What Are the Different Types of SBA Loans?
There are several different kinds of SBA loans, so choosing the one that works best for your business can be a bit tricky. How do you find the right loan for your specific situation? You’ll want to understand the options before you decide what’s right for you.
“Small businesses seeking financing should speak with their lender about their individual needs,” Manger advises. “The SBA provides guarantees on loans that lenders would not make on a conventional basis."
To help make your decision easier, we’ve put together a list of eight of the more common forms of SBA loans at the time of this writing. That said, the SBA does change its offerings from time to time as the market dictates, so always check with them to be sure.
“The SBA modernizes its loan program periodically to reflect the current market,” Manger says.
When offerings change, the SBA provides updated information to lenders, who then provide it to the applicants, according to Manger.
“Applicants can reach out directly to one of our 68 field offices or find information available on the SBA.gov website, which has the standard operating procedures for our loan programs,” Manger explains.
To expedite your loan application, start with a look at the list of SBA-approved lenders here. For the fastest results, be sure to have all of the necessary documentation on hand before you apply.
1. SBA 7(a) Loans
The most common loan available through the SBA is a 7(a) loan which provides $30,000 to $5 million to small business owners. Qualified companies can use the funds to fund startup costs, purchase equipment, buy new land, repair existing assets, expand an existing business, acquire a new business, refinance debt, purchase inventory and supplies, and more.
To qualify for financing, business owners need to have good credit and good business history. In most cases, borrowers will have to put up collateral in order to secure financing.
Generally speaking, repayment terms do not exceed 10 years for most loans and 25 years for real estate loans. Interest rates can fall anywhere between 5–10 percent.
2. SBA 504 Loans
Small businesses that need long-term loans for fixed asset acquisitions—like buying property, buildings, or heavy equipment—can find the funding they need through the SBA 504 Loan program.
If approved, they can qualify for up to $5 million in financing. In most instances, owners are required to guarantee at least 20 percent of the loan.
“These loans are made available through Certified Development Companies (CDCs), which are the SBA’s community-based partners,” Manger explains. “The advantage of this program is that it provides terms of 10 years, 20 years, and 25 years, which helps free up cash flow for small businesses.”
To qualify for funding, businesses can not be worth more than $15 million and they must have an average net income of $5 million or less after taxes over the two previous years, according to the SBA. Nonprofits and businesses engaged in passive or speculative activities can’t get 504 loans.
SBA 504 Loans have fixed rates attached to them. You can use them in a variety of ways, including:
- Purchasing buildings
- Purchasing land and land improvements, which include grading, street improvements, utilities, parking lots, and landscaping
- Building new facilities or renovating existing ones
- Buying machinery or equipment that you intend to use over the long term
- Refinancing debt that stems from expanding a business through facilities or equipment
The 504 program, however, comes with some restrictions. You can not use these funds to buy inventory, consolidate debt, or as working capital.
According to the SBA, businesses usually need to create or retain one job for every $65,000 in financing they receive via 504 Loans; small manufacturers need to create or retain a job for every $100,000 in SBA funding.
In lieu of that, CDCs fund businesses that meet community development goals—like improving or stabilizing the economy, stimulating the development of other businesses, or bringing new income into the community. CDCs also fund businesses that help them meet their public policy goals, including revitalizing a community, expanding exports, increasing businesses owned by women, veterans, or minorities, and aiding rural development, among other things. What’s more, CDCs are more likely to approve loans that help them update facilities to meet health, safety, and environmental requirements.
3. SBA 8(a) Business Development Loans
Each year, the government aims to give out at least 5 percent of all federal contracting dollars to disadvantaged small business owners. One of the mechanisms they use to achieve that goal is the SBA’s 8(a) Business Development program.
Businesses approved for the program can earn sole-source government contracts of up to $4 million for goods and services and $6.5 million for manufacturing.
To qualify for 8(a) financing, small businesses must be at least 51 percent owned by a U.S. citizen entrepreneur who is socially or economically disadvantaged. Owners must have less than $4 million in assets and a personal net worth of $250,000 or less; their average adjusted gross income over the previous three years needs to be $250,000 or less, too. Owners must also manage day-to-day operations and their business needs to have a track record of successful performance.
To find out whether you’re eligible for an 8(a) Business Development loan, click here to visit the SBA’s “Am I Eligible?” page.
4. SBA Microloans
The SBA microloan program—which was created to help minority, veteran, women, and low-income entrepreneurs—awards qualified businesses with anywhere from $500 to $50,000. Borrowers have to sign a personal guarantee and may have to put up collateral to secure financing.
“The SBA’s Microloan program is designed to provide access to capital to traditionally underserved communities through mission-oriented not-for-profit lenders,” Manger says. “SBA regulators place a limit on the interest rates and fees that can be charged."
In 2017, the SBA approved nearly 5,000 microloans totaling almost $70 million; the average loan was $13,884 and carried a 7.5 percent interest rate. Repayment terms for microloans can’t exceed 10 years.
According to Manger, 8 percent of microloan borrowers return to the SBA when seeking larger amounts of capital.
5. SBA Community Advantage Loans
In 2011, the SBA launched its Community Advantage Loans program, which is designed to support businesses that operate in underserved communities.
Under the program, up to $250,000 is available to startups and established companies that wish to expand. Funds are relatively flexible and you can use them to cover working capital costs, buy inventory, acquire assets, and more.
Qualified businesses generally have between seven and 10 years to repay the loan, plus interest, which usually hovers somewhere between 7 percent and 9 percent.
6. SBA CAPLines
The SBA offers working capital loans to businesses that need to solve short-term cash flow problems or meet seasonal financing obligations.
The loans—which can reach as high as $5 million with a maximum maturity of 10 years—are perhaps best for businesses that need access to credit lines to ensure they’re able to meet their recurring operating costs and absorb unforeseen expenses.
“SBA CAPLines are a revolving asset-based line of credit,” Manger says. “Small businesses that buy and sell inventory or need to fund contracts would benefit from this type of financing.”
Today, there are four CAPLine programs:
- Working Capital CAPLine funds. You can use these funds to cover short-term working capital needs. You cannot use these funds to pay taxes.
- Contract CAPLine funds. Contractors typically use these to finance specific contracts—including general and administrative expenses. You cannot use these funds to buy assets, pay taxes, finance debt, or as working capital loans.
- Seasonal CAPLine funds. If your business needs to pay for inventory or offset high receivables during the busiest times of the year (for example, a house painting business), look in to Seasonal CAPLine funds. In some cases, you may also use the funds to absorb increased labor expenses that are seasonal.
- Builder’s CAPLine funds. You can use these to finance construction and renovation projects. Approved expenses include labor, supplies, materials, equipment, direct fees, landscaping, and utility connections, among other things.
While the cost of these loans will vary based on your specific financial situation, the lender you partner with, and how much money you take out, generally speaking, you can expect to pay somewhere between 7.25 percent and 9.75 percent in interest.
Since CAPLines are lines of credit, you only have to pay interest on the money you spend—not the entire credit line.
7. SBA Export Loans
The SBA also offers financing for companies that need working capital advances on export orders, receivables or letters of credit under its Export Working Capital Program.
Businesses can apply for these loans prior to finalizing an export sale. If approved, you can use the funds to finance supplies, inventory, and the production of export goods, cover foreign accounts receivable, and as working capital during long repayment periods.
Under this program, up to $5 million is available; loan maturities are generally one year or less. To secure financing, you’ll need to provide a personal guarantee from all owners (20 percent or more).
According to Manger, the SBA has a dedicated team of 21 regional export finance managers located across the country that can help with SBA Export Loans. The agency offers three programs designed to help small business exporters:
- The Export Working Capital Program provides exporters with up to $5 million. The SBA offers a 90 percent guaranty for short-term loans and lines of credit for export working capital.
- The Export Express Loans Program gives exporters up to $500,000 in short-term loans and lines of credit for export purposes. These loans are fast and flexible, as the SBA delegates authority to participating lenders.
- The International Trade Loan Program provides exporters with up to $5 million in long-term loans for facilities, equipment, and permanent working capital that will enhance export ability. Borrowers can also refinance existing debt under this program.
If you’re unsure about which program is best for you, talk to your lender or a trusted financial advisor.
8. SBA Disaster Loans
The SBA offers loans to businesses that have suffered from natural disasters. Typically, the SBA makes these comparatively low-cost loans available to replace or repair damaged property and offset economic losses in the wake of disasters.
If a natural disaster affects your business, you may be entitled to up to $2 million in relief to repair real estate, equipment, inventory and other fixtures. Loans can be issued of up to 20 percent more than the total loss if the funds are used to protect property against similar damages in the future.
Up to $2 million may also be available to businesses that lose revenue and are unable to meet financial obligations they would have otherwise been able to pay if the natural disaster did not occur.
In the event of a disaster, the SBA assesses damages to determine whether businesses are eligible for compensation under the Disaster Loans program. Interest rates won’t exceed 4 percent for businesses that don’t have credit elsewhere, or 8 percent for businesses that do. Repayment terms can extend to 30 years, depending on the finances of the business.
How Do SBA Loans Work? What's the Process?
Before you apply for a loan from the SBA, it’s worth getting familiar with the loan application process so you know what to expect moving forward.
First things first: The SBA itself doesn’t actually lend you the money. What they do is guarantee a business loan from a lender, like a bank. This gives additional assurance and encourages banks to finance businesses they otherwise might not approve for a loan.
To begin the loan application process, you need to establish a dialogue with an SBA-approved lender either directly or through a broker. The right lender will be able to walk you through a number of different loan options and recommend the financial vehicle that makes the most sense for your unique situation. You’ll have to submit a pile of documentation and financial information—your credit score, personal and business financial statements, several years’ worth of tax returns, resumes, business plans, authorization for credit and background checks, your completed loan application paperwork, and more—to determine your eligibility.
Over the next few weeks, the lender will assess your qualifications across five categories: your ability to repay the loan, your business experience, the equity you’ve invested in your company, how much debt you have and how likely you are to repay it, and whether or not you need to put up collateral to secure financing.
Let’s say the lender approves your application. Hooray! Once the lender has made an affirming decision, the loan closing process begins. Expect to sign a lot of documents once again—like a promise to pay, security documentation, insurance forms, and several SBA documents, and more. This process can last as long as three weeks.
The bottom line? Applying for a traditional SBA loan is often a long, time-consuming process with multiple steps that can take months to wrap up. Several entities are involved in the decision-making process and each step takes time. Unless you can afford to wait several months to secure financing for your small business, you are probably better off looking for financing elsewhere.
How to Apply For an SBA Loan
Now that you’re aware of the different kinds of SBA loans, it’s time to figure out how to increase the chances of approval if you apply, and how to get started with an application if you choose to move forward.
“SBA resource partners offer training courses on how to develop a comprehensive plan,” Manger says. “Business plans need to demonstrate how a small business will use the financing to support the business. It is also imperative that the small business owner can clearly demonstrate their ability to repay the loan. Projections of future cash flow are a necessary component of any business plan.”
If you decide to apply for an SBA loan, the best place to start is right where you are: the internet. Go to the SBA website and fill out the loan application form. To complete your application, you’ll need to provide documents and information verifying your identity, legality of your business, personal and business history, and creditworthiness.
This information includes:
- Your personal identification
- Certificate or license for the business
- Proof of business ownership
- Business financials, including financial projects
- Profit and loss statements
- 2 years of business tax returns
- 2 years of personal tax returns
- History of any past loan applications and decisions
For more information about what’s required, start here. You can also visit your local district SBA office in person to ask about approved lenders who deal with SBA loans. This page is a good starting place for locating a local SBA resources.
Usually, lending institutions have their own evaluation process and eligibility criteria to accept SBA loan applications, even for applications that follow guidelines drafted alongside the SBA agencies.
Be prepared to spend some time on this. The whole process, from application to loan decision, may take several weeks. In recent years, SBA agencies have introduced the SBA Express loan process which business owners can complete in days instead of weeks. As you might expect, this is very popular with small business owners looking to secure loans faster, but it is also harder to obtain. You must have high personal and business credit scores in order to qualify for the SBA Express process. Check with the lender before starting the application to find out which path is appropriate for your business.
Who Needs an SBA Loan?
Most small business owners use SBA loans and SBA Express loans to accomplish several goals. Here are some uses for which an SBA loan might come in handy:
- Running basic business operations.
- Marketing and advertising, with the goal of growing your business.
- Purchasing long-term assets, such as equipment and machinery.
- Buying furniture or supplies for your office.
- Meeting payroll to take care of your hardworking employees.
In short, many business owners will find uses for SBA loans. Borrowers can use the money from SBA Express loans and SBA loans for most legitimate business purposes, though there are some restrictions, making them less flexible than other funding sources.
Alternatives to SBA Loans
SBA Loans and SBA Express loans are great options for business owners to consider, but they aren’t for everyone. Luckily, there are many other alternatives that you can use to acquire funding for you small business besides SBA loans. Let's take a look at a few of these next.
Online platforms are available where borrowers can link their accounts and apply for loans. Direct online lenders and online marketplace lenders are two different types of online sources of funding.
- Direct online lenders request information about your business and credit history, according to the criteria of the specific lender. You can apply online, which means less time spent filling out forms than with a traditional bank loan.
- Online marketplace lenders (such as Lendio) are a little bit different. When working with an online marketplace lender, you would still provide your business and credit history information online. As with direct lenders, your information is analyzed to discover whether you could potentially qualify for the loan you seek. Next, there is an added step where your information is shared with a “marketplace” of lenders. Lendio, for example, shares your information with over 75 lenders who then evaluate your creditworthiness. If any of those lenders decide to offer you a loan, you are contacted by those lenders with their offers. You can then complete the application process with the lender of your choice and, if approved, receive your funding.
It Saves Time
Online loans can save you time, since you can complete your application on the web instead of filling out piles of paperwork. Their response times also tend to be faster than with a traditional or bank loan.
Get Multiple Options
With online marketplace lenders and fintechs, you can quickly compare different loan offers from multiple lenders before applying for the option you deem best for your business.
May Have Higher Interest Rates
Online loans can have higher interest rates than other types of loans. One reason for this is that online lenders and fintech firms aren’t banks, which means that they get their funds at higher interest rates than banks do. To make a profit, they then pass that cost along to you, the borrower.
The online lending market is still developing, which means there could be rapid changes in regulation. It’s also possible that online lenders may run into financial troubles of their own. Every business owner must determine their own tolerance for these risks.
Traditional Bank Loans
Whenever you think of loans, the first option that comes to your mind is probably “banks.” Yes, banks do provide conventional loans for small businesses. Here are a few of the pros and cons of working with banks.
At a major bank you can manage your checking account and loans all in one place sometimes through the same person, which can be convenient.
Lower interest rates
Since banks can borrow money from the Federal Reserve, they benefit from stable, low interest rates and can pass along that low interest rate to you, the would-be borrower.
Since you probably already use a bank for some things, like your regular savings and checking accounts, you probably feel used to working with one. Banks, being older and more established than the online options mentioned above, may have already built your trust.
Hard to Get
It is difficult to secure a loan from the bank. According to recent stats from the Biz2Credit Small Business Lending Index, large banks only approved <a href="https://www.biz2credit.com/small-business-lending-index">25%</a> of small business loan requests. Those aren’t great odds for doing the time-consuming and tedious work of applying for a loan.
You'll Need Collateral
Because banks offer secured loans, that means they demand collateral, which could be in the form of assets or a down payment. If you are unable to repay the loan, the bank could seize the collateral.
High Credit Scores
Banks typically want to see applicants with higher credit scores and will require personal credit information. Small business owners looking to separate their personal and business finances often dislike using personal credit to secure funding. If you’re late making a payment to the bank, the bank may report this delinquency to a credit bureau, tarnishing your personal credit because of a business issue. Others who bootstrapped their business with personal financing might have low personal credit scores but a healthy business. Banks punish these applicants by disregarding their business metrics in favor of personal credit.
If you invoice your customers on terms but need money while your customers are taking a long time to pay, then you can opt for invoice factoring. You can sell your invoices to the factor companies that will pay you a portion of the invoice value up front, and collect directly from your customers.
Want to learn more? Head over to our Guide to Invoice Factoring.
Pros of Invoice Factoring
You can get access to funds quickly. The application process is usually fairly simple and the approval requirements are not as strict as bank requirements.
Lower Credit Standards
You do not need a high credit score to become eligible for funds through invoice factoring, which makes it easier for business owners with poor credit to apply for a loan. Lenders usually only consider your invoice and account receivable values when assessing whether or not to offer you funding.
Cons of Invoice Factoring
Potential Damage to Customer Relationships
The factoring company collects directly from the customer. This could interfere with your customer relationships by making it appear your business and finances are unhealthy.
Sacrifice Invoice Value
Factors only pay a portion of the value of the invoices up front. It hurts to lose a chunk of your hard-earned payment just to get a bit of liquidity.
Lack of Choice
Factors often want to buy a huge chunk of your Accounts Receivable. You usually can't just choose to advance one invoice at a time when you need it. As a result, you end up essentially taking out a huge loan and paying interest on all of it, when you might have only needed a small portion of what you received. This lack of control and choice can be very frustrating.
What’s the difference between SBA loans and SBA Express loans?
As you begin your search for financing available through the Small Business Administration, you’ll quickly find out you have several options. Most commonly, business owners need to decide whether to apply for a traditional SBA loan or try their luck at securing an SBA Express loan.
As the name suggests, you can potentially secure SBA Express loans faster than traditional 7(a) loans. In fact, borrowers can expect a decision on their loan application within two or three business days—which sure beats the two- or three-month long process typically associated with traditional SBA loan applications. This speed of financing is due to the fact that the SBA tends to give participating lenders more flexibility when it comes to loan approvals.
Beyond that, there are several other differences between traditional SBA loans and SBA Express loans:
- Businesses can secure up to $5 million in financing through traditional 7(a) loans but only up to $350,000 through an SBA Express loan.
- Whereas traditional SBA loans have a maximum interest rate of prime + 2.75%, SBA Express loans carry interest rates of prime + 4.5%–6.5%, depending on the size of the loan. Smaller loans tend to have higher rates.
- The SBA guarantees up to 85% of traditional SBA loans but only up to 50% of SBA Express Loans.
Despite their speed, SBA Express loan applications still require a lot of paperwork and effort. They also tend to be much more difficult to obtain that a traditional SBA loan—particularly for young companies.
If all goes well, you may be able to secure fast financing with an SBA Express loan. But, due to lower odds of approval, it may not be worth your time to apply for an SBA Express loan unless your business has strong financials and a long track record of success.
SBA Loans vs Other Options: Analysis
SBA loans and SBA Express loans are especially designed for small business financing, making them attractive to small business owners. However, they do bring with them several potential issues that not every business owner will be able to overcome, such as high personal credit score requirements.
Yet, SBA loans are still a better option for many small business owners when compared to conventional bank loans, which require lots of paperwork and collateral before the loan is approved. The application and approval process can take many weeks--longer than many business owners want to wait. An SBA Express loan can allow you to get a loan decision in a matter of days or hours, but qualification is tricky and depends on several factors.
Factoring invoices is a reliable way to get funding quickly when you feel confident that your customers will pay, albeit at a slow rate. Online marketplace lenders are also worth considering because they process applications through convenient web platforms and can provide decisions relatively quickly. However, these online tools are also not always the first choice of many business owners due to their potentially higher fees and the risks associated with those fees.