SBA Loans- an Overview, Types, How to Apply, Pros and Cons
If you are a small business entrepreneur in the United States, SBA loans are a great choice for your business. SBA loans are an effective source of finance for small businesses in the US to grow your business. SBA loans have tight lending standards, but their flexible terms and low-interest rates can make them one of the best ways to fund a business.
What is an SBA Loan?
SBA loan is simply a small business loan that is partially guaranteed by the US government’s Small Business Administration (SBA). The SBA loan eliminates some of the risks for the financial institution that is issuing the loan. SBA-guaranteed loans are made by a private lender and guaranteed partially by the SBA, which helps reduce the lender’s risk and helps the lender provide financing that’s otherwise unavailable at reasonable terms.
There are three parties involved in an SBA loan transaction, they are:
- The borrower who borrows money under the SBA loan scheme
- The SBA, provide a substantial portion of the guarantee to the lender on behalf of the borrower.
- The lender who lends the money to the borrower based on a guarantee by the SBA.
How does SBA help small businesses get loans?
The U.S. Small Business Administration helps small businesses get funding by setting guidelines for loans and reducing lender risk. SBA guarantees encourage private lenders to provide funding to small businesses. These SBA-backed loans make it easier for small businesses to get the funding they need.
What is an SBA loan guarantee?
The SBA loan guarantee works as a substitute for the needed collateral and provides the lender with satisfactory security to support the loan. The SBA will guarantee repayment of a substantial percentage of the loan amount if the borrower defaults on the loan. If the borrower fails to repay the loan, the lender can recover up to 85% of the outstanding loan principal from the SBA.
The concept of a limited guarantee
The concept of limited guarantee can be well understood by analysing the Standard 7(a) Loan as below.
The maximum loan amount for a Standard 7(a) SBA loan is $5 million. Loan guarantee is limited to 85% for loans up to $150,000 and 75% for loans greater than $150,000. So, the maximum amount of loan guaranteed by the SBA under Standard 7(a) loan is $3.75 million. (Updated Aug 2022)
Obtaining an SBA loan guarantee is not an easy task as it requires a lot of effort and formalities.
Is there any requirement for owner’s equity under the SBA loan?
There is no such fixed legal requirement that exists in the SBA loan system. However, the SBA prefers an owner’s equity investment of at least 25% of the total cost of the project. The SBA (and the lender) may ask for proof that the project will be funded with at least 25% sponsor equity. This is basically to ensure a serious approach and accountability from sponsors in case of trouble in the business. The specific amount of an owner’s investment can often be negotiated so that a lesser percentage of financing may come from the owner.
Do a personal guarantee required for an SBA loan?
SBA loans typically require an unlimited personal guarantee from anyone who owns 20% or more of the business. Lenders may also ask for a limited or unlimited personal guarantee from other business owners as well.
You may also need to put up physical collateral or offer a down payment — in addition to signing a personal guarantee — to secure your SBA loan.
What are the assets that can be used as collateral for SBA loans?
You can use the following assets as collateral for an SBA-guaranteed loan:
- Land and/or buildings
- Machinery and/or equipment
- Real estate and/or chattel mortgages
- Warehouse receipts for marketable merchandise
- Personal endorsement of a guarantor (a friend who is able and willing to pay off the loan if you are unable to)
- Accounts receivable
- Savings accounts
- Life insurance policies
- Stocks and bonds
What are the types of SBA Loans?
SBA financing programs vary depending on a borrower’s needs. Each loan has its own terms and conditions. The selection of the loan depends on your purpose and the plan for which the funds are raised.
Here’s a summary of the most common types of SBA loans.
1) SBA 7(a) Loans
7(a) loans are the most common loan programs for SBA which includes financial help for businesses with special requirements. The 7(a) Loan Program includes financial help for small businesses with special requirements. This is the best option when real estate is part of a business purchase, but it can also be used for:
- Short- and long-term working capital
- Refinance current business debts
- Purchase furniture, fixtures, and supplies
Types of 7(a) loans
2) SBA 504 Loans
The CDC/504 Loan Program provides long-term, fixed-rate financing for major fixed assets that promote business growth and job creation. The loans are administered by Certified Development Companies (CDCs) through commercial lending institutions. 504 loans are typically financed 50% by the bank, 40% by the CDC, and 10% by the business.
504 loans are available through Certified Development Companies (CDCs), SBA’s community-based partners who regulate non-profits and promote economic development within their communities. CDCs are certified and regulated by the SBA.
The maximum loan amount for a 504 loan is $5 million. For certain energy projects, the borrower can receive a 504 loan for up to $5.5 million per project, for up to three projects not to exceed $16.5 million total.
Use of 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 programs, however, come with some restrictions. You cannot use these funds to buy inventory, consolidate debt, or as working capital.
3) SBA Microloans
Established in 1992, the SBA’s Microloan Program offers anywhere from a few hundred dollars to $50,000. The Microloans are provided for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment to businesses. Normally such microloans cannot apply to traditional lenders because the amount they need is too small. Proceeds may not be used to pay existing debts or to purchase real estate.
These loans are not guaranteed by the SBA. SBA provides funds to specially designated intermediary lenders, which are non-profit community-based organizations with experience in lending as well as management and technical assistance. These intermediaries administer the Microloan program for eligible borrowers.
What are the eligibility criteria for SBA Loans?
To be eligible for SBA loan assistance, businesses must:
- Operate for profit
- Be considered a small business, as defined by SBA
- Be engaged in, or propose to do business in, the United States or its possessions
- Have reasonable invested equity
- Use alternative financial resources, including personal assets, before seeking financial assistance
- Be able to demonstrate a need for a loan
- Use the funds for a sound business purpose
- Not be delinquent on any existing debt obligations to the U.S. government
If your business fulfils the following minimum requirements, then you should seriously consider applying for SBA funding:
- 2+ years of business history under your belt
- A 640+ personal credit score for the business owner
- $100,000+ in annual revenue for your business
You can find more details about eligibility requirements for SBA loans here on the official government website.
How to Apply for an SBA Loan?
Make sure your eligibility. You need to make sure that you are eligible for the SBA loans. The typical lender criteria that you can expect include a minimum of 2 years in business, strong annual revenue and a good credit score, which starts around 640.
a. Lender Match
As the first step towards applying for an SBA loan, you should start with a Lender Match. SBA website provides a convenient Lender Match tool to match potential borrowers with lenders within two days. The lender Match page will help you with the following:
- Describe your needs: Answer a few questions about your business in as little as five minutes. These are the basic details that help the lender to take a decision.
- Get matched in two days: Receive an email with the contact information of lenders who express interest in your loan.
- Talk to lenders: Compare rates, terms, fees, and more.
- Apply for a loan: Submit loan applications and paperwork. You’re well on your way to securing a business loan!
Before selecting a lender, you need to make sure that:
- The lender is actively participating in the SBA loan programs. You can check the list of active lenders on the SBA website.
- The lender should have enough prior experience in handling SBA loans
- The average loan processing time to disburse a loan by the lender should be known.
- The normal interest rate and other charges of the lender
- Other lender terms and conditions.
b. Get your application completed online
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
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 resource.
c. Wait for the feedback
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.
Pros of SBA Loans
Custom designed for small business
SBA loans basically target small businesses. The SBA, in association 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.
Use of funds
SBA loan proceeds can be used for multiple purposes including fixed capital, working capital, export assistance, real estate etc.
SBA Loans are structured in such a way that the interest rate limits are already well defined. The interest on SBA loans is charged a prime rate plus a markup rate known as the spread. This restricts the lenders from charging exorbitant rates to borrowers for SBA loans.
Fees for SBA loans usually consist of an upfront guarantee fee, based on the loan amount and the maturity of the loan, and a yearly service fee — based on the guaranteed portion of the outstanding balance. The SBA reassesses its fee structure each year.
Fees for SBA 7(a) loans of $350,000 or less are currently being waived
Another perk of SBA loans is that you get more time to repay them, which means you’ll have more money available for other business needs. The loan term will depend on how you plan to use the money. The current maximum maturities are:
Working capital or inventory loan: 10 years.
Equipment: 10 years.
Real estate: 25 years.
Cons of SBA Loans
Higher credit scores
In order to get qualified for an SBA loan, you need to have a higher personal credit score and business credit score. If the score is low in any, you may not be eligible.
Your business must be at least 2 years old to qualify for an SBA loan. So if you are a startup owner with less than 2 years of operations, you may not be eligible for the loan.
Slow to fund
Depending on your lender and the type of SBA loan you apply for, it can take anywhere from one to three months to access funds. Plus, the SBA loan application process is detailed and requires extensive documentation.
Personal guarantee required
SBA loans typically require an unlimited personal guarantee from anyone who owns 20% or more of the business. Lenders may ask that other business owners provide a limited or unlimited personal guarantee as well. You may also need to put up physical collateral or offer a down payment – in addition to signing a personal guarantee – to secure your SBA loan.
Restrictions on Expenses
Some SBA loan programs have restrictions regarding 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.