SBA Microloan: What Is It and Is It Right for Your Business?
Learn more about the Small Business Administration’s Microloan program.
- April 6, 2020
- 6 min read
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The U.S. Small Business Administration (SBA) is among the primary places small business owners turn to when considering small business loans and new business loans. SBA loans have long terms, low interest rates and can be used for a variety of purposes. But there is more than one type of SBA loan, a point which many small business owners may not be aware. One of the lesser-known loans from the SBA is the SBA Microloan program. This is a versatile loan program with some key differences from the general small business loans offered through the SBA’s 7(a) loan program. Read on to find out what an SBA Microloan is and whether it could be an ideal solution for your business.
When most people think of an SBA loan, they’re likely thinking of the SBA’s flagship 7(a) loan program, which is its general small business loan program. In that program, the SBA works with banks nationwide to extend to you small business loans. With the SBA Microloan program, the SBA works with nonprofit community-based organizations with experience in lending to extend to you small business loans. In both types of SBA loans, the SBA does not actually provide you with the loan, but rather guarantees the loan on behalf of a bank with SBA 7(a) loans and on behalf of nonprofit lending organizations for the SBA Microloan. These nonprofit organizations serve as designated intermediary lenders and they each have their own lending and credit requirements. Through the SBA Microloan program, business owners can borrow up to $50,000 with repayment terms of up to six years. When it comes to applying, you’ll need to find an approved microlender in your area.
Related: SBA Loan Rates of 2020
The SBA leaves much of the specific qualifications, requirements and terms up to the individual microlenders. However, the SBA does restrict the length of the repayment terms for microloans to a maximum of six years. Ultimately, the loan repayments terms come down to the discretion of the lender, which are determined by key factors such as:
- Loan amount
- Planned use of the funds
- Requirements stipulated by the intermediary lender — the microlender
- Needs of the small business borrower
Other important loan characteristics such as the interest rates, fees and collateral requirements are determined by the individual microlender. Interest rates are set by using the five-year treasury bill rate in effect at the time funds are loaned. According to the SBA, interest rates on microloans are typically between 8% and 13%.
Unlike with the SBA’s 7(a) loan program, the SBA doesn’t lay down specific eligibility requirements such as time in business or minimum revenue. With microloans, the individual microlender provides their own eligibility standards for the business loan. However, businesses generally must meet the following criteria:
- Be a for-profit small business or certain non-profit childcare centers
- Business must be located in the microlender’s approved area of operations
- Business must meet the SBA’s small business size standards
- Neither the business nor owner have been debarred from receiving federal funds
- Have sufficient income to support loan repayment
- No owner of more than 50% of the business is more than 60 days delinquent in child support payments
SBA microloans are sometimes colloquially known as SBA startup loans. This is due in part to that fact that SBA microlenders will lend to businesses that do not fulfill most bank’s eligibility criteria. Thus, businesses with little time in existence, businesses that have limited credit or financial records and business owners who have limited or below average credit can borrow funds through SBA microloans.
One of the appeals of SBA microloans is that many microlenders do not have minimum credit score requirement or minimum revenue requirements. Also, depending on the microlender, borrowers might not need to put up collateral either. But it again all comes down to the individual microlender’s discretion. Since microloans are limited to areas in which there are microlenders, you may not have a lot of options if you only have one or two approved lenders near your business. This is why it’s best to reach out to your nearest microlender directly to get more information about qualifications and requirements.
Unlike a general business loan, with the SBA Microloan program, there are some restrictions on what you can use the funds for. For example, microloans can only be used for certain business purposes, which include:
- Working capital
- Inventory or supplies
The SBA explicitly points out that you cannot use an SBA microloan to pay existing debt or to purchase real estate. Considering that the maximum microloan amount is $50,000, these stipulations are understandable, not arbitrary. For SBA loans that do allow refinancing debt or buying real estate, check out other SBA loan programs, such as a 7(a) loan or 504 loan, the latter of which is designed for commercial real estate and equipment.
The initial step for the application process is to track down a microlender in your area. Depending on the lender, you may be able to apply for a microloan online or you may be required to make a visit to their offices to apply in person. Many may require that you connect with their lending specialists via phone to start the process. In the end, it’s all dependent on the lending organization.
When you apply, you’ll typically go through a pre-application process, which makes sure you’re located in the approved area, that your funding needs are within $50,000 and similar basic qualifications. Once you move on to the actual application, you will generally be asked for some or all of the following information and respective documentation:
- Description of the business
- Business structure
- Business location
- Written business plan
- Business and personal tax returns
- Years of business experience
- Financial reports, budget, balance sheets and profit and loss statements
- Personal financial statements and credit report
- Articles of incorporation
- Applicable business licenses and permits
Depending on the lending institution, the application might not require all of these documents, but it’s important to be prepared. The whole application and funding process typically takes between a couple of weeks to a couple of months. Microlenders also offer training and technical assistance to businesses they fund. This could be optional, but sometimes training is required as part of the application or to get approved. Whether training is optional or not, if you’re a borrower, you should take advantage of the microlender’s additional services, like classes, workshops and mentorship on many different topics related to business.
Microloans are, by design, smaller than most traditional business loans and are approved for businesses who normally may not meet bank requirements. Therefore, SBA Microloans are already in some ways an alternative to most business loans out there. That said, if you don’t qualify for an SBA Microloan, but need comparable amounts of funding — meaning, a maximum of $50,000 — there are alternatives to microloans:
- Personal and business credit cards
- Business lines of credit
- Invoice factoring
- Business grants
- COVID Relif loans
With these forms of financing, you could definitely get funding to the amount of $50,000, equal to the maximum SBA Microloan. Term business loans from a bank naturally have higher funding amount potential, but they also have stricter qualifications than these alternative solutions.
SBA Microloans aren’t designed for everyone or for general use. The SBA 7(a) loan program is more geared towards that. Instead, the SBA Microloan program has a narrower focus and small funding amounts, with limitations on the ways you can spend the loan money. Some business owners might be put off by these restrictions. For others who can’t meet typical bank criteria to be eligible for a business loan, the SBA Microloan can be very useful — if you’re approved, of course. Microlending organizations are experienced in working with startups and local businesses that are viable yet can’t get financing through other financial means. These loans, with a maximum of $50,000, are best for business owners who need money to cover business expenses like working capital, inventory or supplies and equipment, which are precisely the costs you can pay for with microloan funds.
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