What You Need to Know About SBA Loans for Business Startup

The U.S. Small Business Administration is one avenue you might take if you’re trying to find ways to fund a small business startup. 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. We’ve outlined 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, or SBA, 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.

What are SBA loans?

SBA loans are funded by lenders that partner with the SBA. The SBA itself does help guarantee the loans, offering a guarantee of up to 85 percent 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.

* 504 loan programs provide up to $5 million for use in purchasing machinery, facilities or land.

* Microloans provide up to $50,000 for use starting a business.

* SBA disaster loans provide up to $2 million for use 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 inventory and equipment. 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.

The benefits of SBA loans

One of the biggest benefits of any loan backed by 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. You might also be eligible for an SBA loan when you failed to obtain a traditional business loan because of the SBA guarantee.

Aside from competitive terms and potentially easier access to capital, SBA loans afford some unique perks. Some loans ensure complementary 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 a lender match tool to help potential business owners find a financial partner that can meet their needs.

Who qualifies for SBA loans?

The requirements for SBA loans very depending on:

  • The type of loan
  • The size of loan
  • The lender funding the loan
  • Other factors

At 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
  • Partially funded by owner investment

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.

Disadvantages of SBA startup loans

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, the SBA isn’t going to back your play.

Typically, SBA lenders require that owners invest around 20 percent 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 percent 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.

The bottom line about SBA startup loans

The terms of SBA loans depend on how much you borrow and what you use it 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 percent of the total from your own pocket, they may not be the right choice for you. But they 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.