SBA Startup Loans Explained

Find out if your new business qualifies for a Small Business Administration loan.

The U.S. Small Business Administration is one avenue you might take if you’re trying to find ways to fund a startup or new business. The administration itself doesn’t make loans, but it does partner with lenders to pave the way for qualified small businesses to receive funds they need to launch. New businesses, however, don’t typically qualify.

Read on to find out how SBA startup and small business loans work, so you can decide if this is an avenue you want to pursue for funding.

What Is the Small Business Administration?

The Small Business Administration is an agency of the federal government that works to provide small businesses with the resources and knowledge they need to succeed. The SBA is not a bank or a lender, which means it doesn’t actually give out loans. It does provide financial and other business counseling, publishes a wealth of resources on small business management and connects small businesses and entrepreneurs with partners, including lenders.

Read: How to Safeguard Your Small Business For the Next Recession

What Are SBA Loans?

SBA loans are funded by lenders that partner with the SBA. Rather than funding the loan itself, the SBA helps guarantee the loans, offering a guaranty of up to 85% of the amount borrowed. That means if the loan goes unpaid, the SBA agrees to be responsible for that portion of the principle.

The SBA works with businesses and startups on several types of funding.

  • 7(a) loan programs provide up to $5 million for use as working capital, purchasing equipment or expanding business operations.
  • 7(a) Small Loan programs provide up to $350,000 for use as working capital, purchasing equipment or expanding business operations.
  • 504 loan programs provide up to $5 million for use in purchasing machinery, facilities or land.
  • Microloans provide up to $50,000 for starting a business.
  • SBA disaster loans provide up to $2 million for recovering after a natural disaster or emergency.

While most of these loans are meant for use by existing small businesses, microloans can be used to fund a new startup. You can use the funds as working capital to run a new business or to buy equipment and inventory. The funds may also be used to cover expenses associated with starting a new business, such as legal or marketing fees.

In some cases, the 7(a) loan programs may also be used to start a business, though borrowing larger amounts will require passing more due diligence. Microloans tend to be funded by nonprofits and charities seeking to assist specific types of business owners or businesses; the 7(a) loan programs are funded by more traditional lenders.

Read: How to Get a Business Loan

Who Qualifies for SBA Loans?

Qualifying for SBA loans depends on a variety of factors. One primary factor is which SBA loan program you’re applying for, such as a standard 7(a) loan versus an SBA Express loan versus a 504 loan. The requirements for SBA loans vary depending on:

  • The type of loan
  • The size of the loan
  • The lender funding the loan
  • The credit standing of your business

At a minimum, most loans require that the borrower be a for-profit business, based in the United States, unable to obtain necessary financing from other sources and partially funded by owner investment. Again, these are general basic requirements, and you should check out the SBA’s webpage on the different types of loans it offers.

Not everyone who meets these basic requirements ends up with an SBA loan, though. Since the federal government guarantees some portion of these loans, lenders must conduct serious due diligence when approving them.

You’ll need to be able to show personal financial statements and credit histories, appropriate business documents — including licenses and leases if you have them — and company financial statements. New startups may need to present viable business and marketing plans. The process can be time-consuming and demanding — though you do get the benefit of SBA counseling and assistance as you go through it, which you don’t always get with traditional lending.

Benefits of SBA Loans

One of the biggest benefits of any loan through the SBA is that it’s backed by the SBA. That substantially reduces the risk taken on by the lender, which means you can benefit from more favorable terms. This is one of the main reasons why SBA loan rates almost always beat non-government-backed business loans from both traditional and alternative lenders.

Aside from competitive terms and potentially easier access to capital, SBA loans afford some unique perks. Some loans ensure complimentary access to financial and business education and counseling from the SBA, which can help you overcome hurdles in running your small business — especially in that critical first year.

You may also benefit from perks such as more flexible income and expense requirements, reduced or no collateral requirements and a potentially lower down payment than might be required with a traditional business loan. The SBA provides its Lender Match tool to help potential business owners find a financial partner that can meet their needs.

Find Out: 5 Steps to Take After Being Rejected for a Small Business Loan

Drawbacks of SBA Loans

The main drawbacks of SBA loans are less about the substance of the loan than about the strict requirements for qualifying. The SBA maintains requirements on minimum time in existence as a business, as well as minimum requirements for revenue generation.

These criteria present a conundrum to startup businesses and companies who need funding but haven’t launched the business yet and therefore haven’t generated revenue. This is a major reason why companies who are just starting out need to find alternative sources of funding instead of pursuing an SBA loan.

Beyond the stringent requirements, perhaps the biggest disadvantage of SBA startup loans is that they do require owner investment. Partly, this is to ensure the owner is invested in the success of the business. If you don’t believe in your business enough to invest it in, then the SBA isn’t going to back your play.

Typically, SBA lenders require that owners invest around 20% of the total from their own pockets. That means if you want a $100,000 total capital investment in your new business, you’ll have to come up with $20,000 of it before you can borrow $80,000 via the SBA loan process.

Another potential disadvantage is that SBA loans require a personal guarantee. Everyone who owns 20% or more of the business must put up a personal guarantee, which means those people are personally responsible for the loan if the business defaults. That’s not an odd risk with most startups, though — unless you incorporate and are able to borrow money through the corporation, you’ll probably face some type of personal guarantee requirement in the early days of funding your business.

See: How to Find Investors – 7 Steps to Raising Business Capital

The Bottom Line

The terms of SBA loans depend on how much you borrow and what you use the funds for. Usually, startups must pay the loans back in either seven, 10 or 25 years, depending on the reason for borrowing. Interest rates and fees are often less than you might experience with traditional lending, thanks to the SBA backing.

SBA loans are never a starting point for any business, and since you have to invest around 20% of the total from your own pocket, they may not be the right choice for you. But SBA loans do offer potentially large funding with favorable terms for those that can qualify, so they’re worth keeping in mind as you plan financially for your new company.

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