Entrepreneurs are looking for the most economical, sensible, and affordable ways to finance their business ventures. For many business owners, they find able to meet all those goals with funding options made possible by the U.S. Small Business Administration (SBA). These small business funding solutions offer favorable interest rates and repayment terms, flexibility, and opportunity. Understanding the possible options, requirements, and ways to apply can help you get a jump start on business financing.
Here, then, is the quintessential guide to SBA loans.
How Do SBA Loans Work?
The federal agency does not provide loans directly to business owners. Instead, it works with a nationwide network of lenders that do provide the loans. The advantage to financial institutions is that in most cases the SBA lowers the risks of lending. The agency guarantees a portion of the loan and will pay back the lender if the business owner defaults on the loan.
The guarantee amounts are significant. The SBA guarantees up to 85 percent of loans valued at $150,000 or less and 75 percent for larger loans. The maximum amount in SBA loan programs is $5 million.
The federal investments and confidence in small business owners are among the reasons the SBA loans program has been so popular and successful.
What Are the Types of SBA Loans?
The SBA provides a litany of options for lending. Here is a closer look at each product.
7(a) Loan Program
The SBA’s flagship and most popular program offers federally guaranteed loans at amounts up to $5 million. While there are several types of 7(a) loans, they all can be used for equipment purchases, business expansion, short- and long-term working capital, construction and renovation projects, business acquisitions and, in some circumstances, refinancing other business debt. The loans are provided by partner banks, credit unions, and other specialized lenders.
504/CDC Loan Program
These programs make available guaranteed funds up to $5.5 million. They can be used to buy facilities, equipment, land or machinery, build new buildings, and renovate or refurbish buildings. They are processed via non-profit organizations called Community Development Companies and private lenders, each of which provides a portion of your loan.
These small loans (up to $50,000) are intended to cover business startup costs, working capital, and the purchase of inventory, furniture, fixtures, machinery, or equipment. Community-based nonprofit organizations and community lenders, rather than larger financial institutions, issue and manage the loans.
CAPLines Lines of Credit
This program, a type of 7(a) loan, helps businesses that need to replace working capital or have cyclical changes in cash flow. They are intended to pay recurring operating expenses, cover seasonal cash flow gaps, provide short-term financing for contract fulfillment, and pay for construction or renovation expenses.
SBA Disaster Loans
Small business owners who have been adversely affected by a natural disaster or other emergencies can access loans, processed via the SBA, for up to $2 million. These low-interest, long-term loans can be used to repair or replace items damaged or destroyed in a declared disaster zone, or for businesses that have suffered economic damage due to a declared disaster.
What Interest Rates Are Applied to SBA Loans?
The SBA sets the interest rates its partners can charge. While the rates may be fixed or variable, they are based off of the prime rate. In 2018, prime rose 5 times, from 4.5% in January 2017 to 5.5% by year end.
For 7(a) loans, the rate is calculated based on the amount being borrowed and the length of repayment terms. The longer the repayment term, the higher the rate. Conversely, the more that is borrowed, the lower the interest rate.
The repayment terms are under two groups, one for loans of fewer than seven years and one for seven years or longer. The loan amount windows are up to $25,000, up to $50,000 and $50,000 or greater.
The longer repayment terms are a major advantage to the SBA loan programs. Loans for working capital and operating expenses can be extended up to seven years. For purchases of new equipment, loans can stretch to 10 years and for real estate acquisitions, the loan can be spread out over 25 years.
A CDC/504 loan rate is established using two types of loans: a bank loan and a CDC loan. The CDC loan rates are based on the Treasury rate, a fixed rate and an ongoing fee percentage. The longer the loan, the higher the maximum interest rate.
With Microloans, interest rates vary by lender, but in general the rates in 2019 are between 8% and 13%. In addition to the interest, additional fees and closing costs may be incurred by the borrower.
Are Personal Guarantees Required with SBA Loans?
Every owner who has at least a 20 percent stake in company ownership is required to provide a personal guarantee. The same goes for top management position holders. That means that owners and executives have skin in the game and need to put up personal assets as collateral in case the loan is unpaid.
How Do I Know if My Business Is Eligible for SBA Loans?
The federal agency has established eligibility guides for its loan programs. These guidelines are:
- The business must be physically located within the United States.
- The business needs to be for-profit and in an eligible industry. Excluded businesses include those primarily engaged in lending, politics, lobbying, life insurance, gambling, religious education, bail bonds, pawn shops, speculation (such as real estate development, mining, drilling or medical research) and passive income.
- The borrower has an equity stake in the business.
- The business meets size standards for its industry set by the SBA for revenue and employees.
- The borrower’s loan history and ability to borrow capital with reasonable terms from elsewhere.
Are Franchises Eligible for SBA Loans?
Franchises are eligible for 7(a) loans, as long as the franchise owner is allowed to profit from the work commensurate with ownership. The franchisor cannot retain operational control such that the franchisor is essentially working under an employment contract.
Franchises must be listed on the SBA Franchise Directory before franchisees can qualify for loans. An updated list can be found here.
What Do I Need to Prepare to Apply for SBA Loans?
The preparation for applying for an SBA loan depends on how you plan to get your application submitted. You can opt to do it on your own, or you can enlist the assistance of SBA loan specialists, like the in-house SBA experts at Benetrends.
If you do choose to do the work on your own, as a borrower you need to provide detailed documentation according to SBA guidelines that demonstrate the business is legitimate and stable. Lenders are allowed to add additional guidelines that are more stringent than the SBA standards. The documentation includes:
- A thoroughly developed business plan
- Resumes for key employees
- Bylaws and articles of incorporation
- Business license or certificate
- A lease agreement
- Business tax returns
- Personal tax returns
- Business credit report (Some lenders may also require a personal credit report.)
- A verified and current business profit-and-loss statement
- Financial statements showing projections
- A schedule of current business debt
- Financial statements for anyone with an ownership stake of 20 percent or more of the business
- Written valuations for any asset that will be used as collateral for the loan
How Do I Start an SBA Loan Application?
The best place to start is on the SBA website. There you can access information about the 7-page Borrower Information Form (for 7(a) loans). You may also want to use a checklist to ensure you have all the required information to prepare for an application.
Once you are ready to apply, you can look for lenders in your area. The SBA emphasizes knowing answers to key questions before starting, including how much capital you will need and how it will be used. Any firsthand industry experience is also helpful to lenders.
Once you reach out to lenders and answer a few questions, the SBA reports you will be matched within two days with lenders interested in your loan request.
Note that filing a loan application does not mean you will automatically be approved.
How Can Businesses Compare Lenders?
The SBA encourages borrowers to ask questions of each potential lender, including:
- What are your interest rates, cash flow requirements, grace periods, and minimum credit scores?
- Are there any prepayment penalties?
- Under what conditions can you demand full repayment?
- How many SBA loans do you provide?
- What is your approval rate for SBA loan applications?
- What experience does your staff have in working with SBA borrowers?
- What are the dollar ranges for your SBA loans?
How Is My SBA Loan Application Evaluated?
In a recent U.S. News & World Report article, an SBA official noted that lenders are likely to look at the following criteria when assessing your loan application:
- The credit history and reputations of the borrower, business, and associates
- How much management experience the applicant has
- How strong the business is
- Future prospects, projected cash flow, and past earnings
- The viability of repaying the loan using business earnings
- Enough equity invested in the business for it to have a sound financial basis
- The potential for long-term business success
- The type and value of provided collateral
- The impact of affiliates on the applicant’s ability to repay the loan
What Help Is Available to SBA Loan Applicants?
Sorting through the details, complexities, and options available for SBA loans can be confusing. There are many resources available for entrepreneurs, including local SBA district offices, Women’s Business Centers, Veteran’s Business Outreach Centers, and Score mentoring programs.
If you're looking to simplify the application process, turn to Benetrends. At Benetrends, we have helped entrepreneurs apply for and obtain SBA loans for more than 35 years. We have had a 97 percent approval rate during that time. Our experienced staff experts work with our ever-growing network of lenders to give you choices when it comes to your financing needs. It is part of our ongoing commitment to success for small businesses, including 401(k) loans and support services such as retirement fund and payroll management, business insurance, and credit card processing.
For more information, schedule a consultation with one of our SBA funding specialists today.