The Small Business Administration (SBA), started in the U.S. in 1953, is designed to help small business owners pursue their business aspirations. A go-to resource and advocating voice for business owners, the SBA is the only cabinet-level agency dedicated to small businesses. Not only do they provide counseling, contracting, and expertise, but they also offer SBA loans.
To help provide a better understanding of this unique kind of loan, we spoke to an SBA Loan Expert at Blueacorn. Unlike conventional loans, the SBA tailors these loans specifically for small businesses, ensuring access to funds that would otherwise be unavailable. These loans are unlike the Paycheck Protection Program (PPP) which was administered via the SBA and lent directly to borrowers. PPP loans were a unique loan program in response to the pandemic authorized by the CARES Act. Traditional SBA Loans are primarily commercial and are approved and funded by both banks and non-bank financial companies.
Q: What Makes an SBA Loan Different from Conventional Loans?
A: A lot of conventional lenders do not want to do small loans. It’s a lot of work for the lender based on the revenue opportunity. Just being able to get a lender to look at your business plan, and hear your project, or whatever you are trying to finance is probably the first big difference.
One of the best features is a longer-term fully amortized loan. That means lower monthly payments so a borrower can keep more cash in the business. SBA loans carry no or very short prepayment penalties so they are very flexible for paying them off. SBA loans can include all the closing costs in the loan, and often do not require a down payment so the barrier to entry on a project is quite a bit less. They also often have “no covenants,” which means as long as payments are made the loan can’t be called back by the lender before the term ends.
Q: Who Offers SBA Loans?
A: SBA loans are offered by both non-bank finance companies and chartered banks. Every SBA lender must be licensed to do SBA lending. There are tens of thousands of licensed SBA lenders, but only a couple thousand who have actually made an SBA loan over the past 12 months, and even fewer who are active. Those are the lenders that small businesses want to work with.
What are the Different Types of SBA Loans?
SBA loans fall into a few different categories. The two primary types are the 7(a) program and the 504 program. These loans are facilitated through third-party organizations like banks and non-bank financial institutions. Disaster loans (EIDL) are dealt with directly through the SBA.
We will focus primarily on the 7(a) and the 504 programs as they are the most commonly utilized programs. The 7(a) has many subspecialty loans that are part of the program, each of them built for specific business purposes.
SBA 7(a) Loan Program
The 7(a) loan program is the most commonly used because of its flexibility as a general-purpose loan. That means, there are more acceptable uses for the loan’s proceeds. These loans accounted for over half of the loans guaranteed in 2019 alone.
There are certain things you can’t use the loan for, and it is important to be aware of these before applying. You aren’t allowed to use your SBA loan to pay delinquent taxes or reimburse a business owner for outstanding expenses. You aren’t allowed to buy out one of your business’s owners with these funds either.
You can use it for:
- General working capital
- Purchasing a building or equipment
- Paying your employee’s salary until you turn a profit
- Purchasing inventory or general supplies
- Refinance debt
In general terms, most business expenses can be covered with one of the 7(a) loan sub-programs (there are 6 types of sub-programs). These different sub-programs are tailored to different industries, financial needs, and demographics. This flexibility makes it the default choice for many small businesses seeking loans.
It is important to note that interest rates are not standardized by the SBA. Your interest rate is based on your lender as well as the size of your loan and repayment schedule. The SBA does set maximum interest rates to ensure they don’t become too much for a borrower to handle. In addition to interest rates, fees can apply as well. Depending on the size and purpose of the loan, SBA loan payment can last anywhere between 7 and 25 years.
504 Loan Program
The 504 program is focused on financing fixed assets. That means the program provides funds for purchasing or renovating land, buildings, or equipment. Its terms, qualifications, and application process is a little more complex than the 7(a) program. Getting approval for the 504 program is more time-intensive since these loans cover extremely expensive projects and have no set maximum.
When a loan is approved, a bank funds up to 50% of the project costs. Another 40% is funded by a nonprofit certified development company (CDC) and the final 10% comes from the borrower as a downpayment.
Because the bank portion of the loan is not regulated by the SBA, banks can charge their own interest rate on their contribution. The CDC can only charge fixed interest rates set by the SBA. The interest rates usually range from around 5% to 6% and can take from 10 to 25 years to repay.
Microloan Program
Businesses that don’t need large loans, but do need some cash flow to help growth can apply for the microloan. Most banks that don’t feel comfortable lending to small businesses definitely won’t do small loans under $50,000. The SBA microloan was created to help businesses partner with local nonprofits for small loans. Microloans do have shorter terms (up to 6 years) and much higher interest rates.
Pros and Cons of SBA Loans
During the conversation with the SBA loan expert, we asked a few questions to help people understand the loans better.
Q: Which loan is the most recommended to apply for?
A: It depends on the need of the borrower; evaluate how much you need, how long you need, and why you need the loan.
Q: What are the biggest pros and cons of SBA loans?
A: The Pros include:
- More flexible terms (lower credit scores can qualify)
- Lower monthly payments
- Lower out-of-pocket
- No or very low prepayment penalties
- Borrowers with less collateral can still be approved depending on the strength of the total request
- Loan costs are almost always built into the loan (depending on the lender)
- Allows for lower personal credit scores
- Don’t need existing relationship with a bank
Cons:
There are lots of specific rules and regulations so it can get complicated fast. Having a trusted partner to assist along the way is important.
Interest rates can be slightly higher than conventional loans due to the added risk of loans with less collateral, less equity, and lower credit scores
Q: What are common issues people encounter with these loans?
A: The paperwork required to apply for an SBA loan can be more than a conventional loan.
Be prepared to provide your lender with answers to questions, additional explanations, paperwork, etc. Understand your business, understand exactly what it is you want to accomplish, and be able to explain that to your lender. Understand the timing of the process so there are no surprises.
Q: How do businesses benefit from these loans?
A: Access to capital when other sources won’t lend; longer, more flexible terms. Structuring a loan that accomplishes what the small business needs allows that business owner to grow his business and accomplish his business goals.
To summarize the benefits:
1) Lenders are specifically targeting small- to medium-sized borrowers and loans
2) Longer term
3) Lower monthly payments
4) Businesses with collateral shortfalls can get approved (ex: service businesses)
5) Owners with lower credit scores accepted
6) Zero or very short pre-payment penalties
7) Will finance all loan closing costs
8) Lower out-of-pocket costs
SBA Loan Application
The application process begins with the SBA lender. The lender manages the entire process and the borrower does not work with SBA directly. To qualify for a loan you must:
- Be a small business as defined by the SBA
- Be a for-profit business
- Must be owner operated
- Occupy the real estate at least 51% (for real estate loans)
Each of the different types of loans has its own requirements, though some may overlap.
The Documentation required for approval includes but is not limited to:
- Business tax returns for the past 3 years
- Personal tax returns for all 20% or more owners for the past 3 years
- Interim balance sheet and income statement for the business
- Personal Financial Statement for all 20% or more owners
- SBA Form 1919 (loan application)
- Several other forms depending on the type of loan desired
For small business owners, SBA loans are a great way to start or grow a business without getting a conventional loan. The SBA recognizes that small businesses are the backbone of the American economy. They have designed these loans especially to ensure business owners have access to the funds they need. If you are considering a loan, be sure to speak to an SBA lending expert. They will help you decide what kind of loan you need and walk you through each step of the process.