Every small business will get to the point when they need additional capital to grow the business, fund payroll, buy inventory, or for working capital. Sometimes, finding a good source of funding leads to stress. Little do some small business owners know that the Small Business Administration (SBA), a United States federal agency, can offer them other financial products and loan opportunities.
Credit card companies, on the other hand, can provide quick review and approval of applications and fast funding, but high-interest rates make them unappealing to many business owners. Additionally, some card companies won’t extend credit to people with low-to-no or bad credit or permit credit card balances up to the hundreds of thousands of dollars that some business owners need to achieve success.
These scenarios and others prompt many business owners to believe that their only option is to apply for a conventional business loan through a bank, credit union, or other lending institution.
The Small Business Administration maintains partnerships with certain financial institutions, such as banks, commercial lenders, and micro-lenders, to provide approximately a dozen different small business loan program options to existing and startup for-profit business owners with little-to-no credit or some history of bad credit. Loan approval amounts range between microloans for a few thousand dollars and multi-million-dollar options. SBA loans offer low interest. Borrowers can negotiate rates with some lenders and typically pay no more than up to 13 percent interest. The repayment term can range between five months and 25 years.
The loans are backed by a federal guarantee that protects the lender. In the event that a borrower defaults on their loan, the SBA pays the lender a certain percentage of the total loan amount so the lender can recoup their losses. For example, SBA pays 85 percent for loans up to $150,000 and 75 percent for higher loans. This is the main reason SBA banks are more likely to offer SBA loans and accept applications from risky borrowers.
Borrowers commonly learn of three specific SBA programs:
– Microloans – Through non-profit, community-based organizations, borrowers can take out small loans up to $50,000, which makes the loan payments easier to manage than conventional loans. The average loan is $13,000. The SBA makes these loans available to all business owners, including established ones with better credit, to “rebuild, re-open, repair, enhance, or improve” a small business.
– SBA 7(a) – These loans provide an approved borrower with up to $350,000 to cover costs related to starting a business, including the purchase of equipment or inventory, obtaining capital, or expanding a business that already exists. Lenders might offer revolving lines of credit with these loans or not require collateral for loans up to $25,000.
– SBA 504 – Borrowers who want to construct, improve or modernize, or purchase “fixed assets” as buildings can apply for up to $5 million. These loans can also be used to purchase equipment and land, including commercial properties, at rates below the market value. The loans are long-term with a fixed rate. To apply, a business must have a tangible net worth of at least $15 million and an average two-year net income after taxes of less than $5 million.
How to Apply for an SBA Loan
The SBA provides a lending connection tool at SBA.gov called the “SBA Lender Match” form. Although the form only takes approximately five minutes to fill out, you might not receive a response for two or more business days. If the SBA believes that you meet borrower requirements, it sends you a list of SBA-approved financial institutions. You must then independently contact each institution to discuss available SBA loans and application processes. You probably won’t receive approval for an SBA loan if you have few assets, poor cash flow, or dips or voids in your income over a several-year period.
When you finally narrow down your list of potential lenders, you can usually apply in person or online. You must supply a lot more information about your business than you might need with a conventional bank loan. Beyond the loan application, you typically need to provide at least your business certificate or license, proof of ownership, documentation of any affiliations, personal background and financial statement, a business overview, and history, and a business financial statement for at least the past year, two-to-three years of personal and business tax statements, loan application history and business building lease or purchase information.
Small business owners often mistakenly believe that they can’t apply for these types of loans because of a past history of financial losses or too much current debt. Although it’s true that a bank, credit union, or similar financial institution might turn you down because of your credit and financial histories, many lenders are just as interested in current cash flow and collateral when reviewing applications. They want to know if either meets or exceeds value-wise the loan amount. They might also allow you to take out a loan if you have a long, positive history with them and recently hit a rough patch.
That said, lenders don’t receive any federal assurances or repayment for conventional loans if a borrower defaults, which is why most borrowers must normally have great personal and business credit scores, good standing, and a lengthy, positive financial history. You also can’t have a lot of debt since lenders calculate an applicant’s debt-to-net-worth ratio as well.
Conventional loan lenders typically approve high dollar amount loans of $250,000 and higher so those small business owners can use the money to consolidate their current business debts, secure working capital, buy business-related equipment or pay for other business-related necessities. Loan programs can include standard loans, lines of credit, real estate loans, and financing for machinery. Application review and approval can take up to four months. That said, non-SBA financial institutions often finish their reviews and decisions a lot faster. Loan interest typically doesn’t go above 10 percent. Some lenders approve a loan repayment term of up to 20 years, but they normally approve 10 years or less on average.
How to Apply for a Conventional Loan
Most small business owners start with their current bank, credit union, or other financial institution. They then compare any offer they receive with offers by local and online lenders and attempt to negotiate. When you apply, the lender is likely to ask you to supply a business certificate or license, proof of ownership, current statements from other financial institutions where you have accounts or other loans, if applicable, several years of personal and business credit reports, and tax returns, proof of current outstanding debts, relevant lease or other business-related contracts, details about unpaid business-related invoices, proof of outstanding money owed to you, a business future forecast and a business growth plan. With the latter, you must successfully argue how you plan to repay the loan in time.
Advantages and Disadvantages
In summary, SBA loans and conventional loans each have pros and cons. They’re both considered the best overall financial resources for small businesses because they offer borrowers better deals, such as reasonable fees and repayment flexibility than other options like business credit cards that tack high-interest rate amounts to balances. With both options, the lender often delays funding for months unless the borrower agrees to pay higher interest.
The advantages of an SBA include options for business owners who have little-to-no credit or one or more instances of financial instability in their credit history. Given the guarantee provided by the government, the capital and collateral requirements aren’t as high as with conventional loans. An SBA lender may even approve a loan if the applicant has an inadequate amount of collateral. They also offer lower loan amounts and longer repayment terms than non-SBA banks, which gives borrowers a lower monthly amount and more time to pay. The advantages of conventional loans include a faster application review turnaround time, higher loan amounts, and more flexibility with how borrowers can use the money.
One of the disadvantages of SBA loans is the requirement that borrowers prove that they tried other options. They must often supply more documentation than a conventional loan and the review process can take up to six months. Depending on the type of loan, the borrower might face restrictions related to how they can spend the funds. Microloans, for example, can’t be used to buy real estate or pay debt. With non-SBA banks, borrowers often have to agree to a loan amount that is higher than the amount of money they actually need, which results in them paying more interest over time. They must also typically have enough collateral to cover the loan total unless the borrower and the bank have a long-standing positive relationship.
As you can see, the best business loan option depends on a wide range of factors, including your financial and credit history, the current state of your cash flow, capital and collateral, your intended use for the loan, and the lender’s rules. Each option also presents application review challenges.
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