A Business Owner's Guide To:
SBA Loans

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Quick Overview

  • Repaid in regular monthly payments over time
  • Usually secured by some type of collateral
  • Interest rates vary depending on the loan amount and term
  • Available from SBA-affiliated traditional lenders

The SBA is not a lender, but rather guarantees small business loans offered by traditional lenders like participating banks and credit unions to encourage lending to small businesses across the country.

What Makes SBA Loans Different From a Traditional Bank Loan

SBA loans come from participating banks, credit unions, and licensed non-bank lenders but they are partially guaranteed by the U.S. Small Business Administration (SBA), a federal agency that promotes small business ownership in a variety of ways.

Small businesses are viewed as higher risk for lenders. The SBA loan guarantee program encourages lenders to work with small businesses. In return the lenders adhere to specific lending terms, interest rate caps, and other criteria set out by the SBA.

The loan guarantee is in effect credit insurance – typically, it means that the SBA will cover a portion of any loan losses incurred by the bank, up to 90%. Note: these programs don’t mean that a business owner who defaults on his loan won’t be expected to eventually pay off his or her balance.

The sharing of risk is what makes SBA loans attractive for banks, who are in turn asked to provide loans to a sector of the economy that is higher risk: small businesses.

SBA loan terms can be more flexible, meaning borrowers can be approved even if they have fewer assets than required by commercial lenders. So if you are just starting out and don’t own a home or other big ticket asset to offer as collateral, you still have a good chance at getting a loan.

Note: SBA guaranteed loans are based on a working arrangement between the SBA and the bank. The SBA doesn’t lend money, and it doesn’t interface with borrowers. Banks and other participating lenders decide whether or not to approve loan applications, and then they apply directly to the SBA for the guarantee. Note: not all banks participate with the SBA.

The Types of SBA Loans

There are several types of SBA loans. Here’s an overview of the options:
 
Capitol-building-sba-loansThe (Almost) All Purpose 7(a) Loan

The most popular SBA loan program is the 7(a) loan, designed to provide funds for a broad list of businesses. These loans target “small” companies, defined according to the North American Industrial Classification System (NAICS), which determines whether a company is small by its annual revenues or number of employees.

The maximum loan amount available under the 7(a) program is $5 million.

The 7(a) loan is a general purpose loan, and the funds may be used for almost any business need, including:

  • Starting a new business
  • Funding working capital
  • Buying land and a building
  • Acquiring another company
  • Refinancing existing obligations of your business.

Most 7(a) loans are used to purchase assets, such as real estate and equipment, due to favorable terms that let you repay the loan over the useful life of the asset: up to 25 years for real estate and 10 years for equipment. These longer repayment terms keep payments lower, meaning more capital stays in your business to fund operations and growth.

SBA loans do have some restrictions on how they’re used.  Funds guaranteed by the SBA can’t be used to fund an investment, or any passive business activity, like purchasing a building that will be leased to another business. They also can’t be used to reimburse a business owner for money previously invested, or repay any money owed to the government, such as taxes.

How to Know If a 7(a) Loan Is Right For You

If you can answer, “yes” to any of the below, a 7(a) loan may be right for you.

  • Are you a small business? (For a list of the SBA criteria for small businesses, click here.)
  • Is your business based in the U.S. or its territories?
  • Do you have capital to invest in the business?
  • Are you current with all debt payments to the U.S. government, including income taxes?

The Types of Businesses Not Eligible for 7(a) Loans

There are a number of businesses that are not eligible for a 7(a) loan, including the following:

  • Businesses that focus on teaching or spreading religion
  • Businesses focused on politics or lobbying
  • Businesses primarily focused on anything deemed of an “indecent sexual nature”
  • Life insurance or lending businesses
  • Businesses domiciled outside the U.S.
  • Businesses that limit membership for any reason other than capacity
  • Businesses that get over 1/3 of revenues from legal gambling
  • Businesses owned by persons who are currently in jail, under indictment, or on parole
  • Businesses in speculative industries, such as oil exploration
  • Businesses involved in multi-level marketing
  • And of course, businesses engaged in illegal activity

You can find a full list on the SBA.gov website here.

How to Apply

Like any loan, before you go to your local lender to discuss a loan application, you need to get together some documentation, including:

  • A business plan
  • Business financial statements for the last three years, including balance sheets and profit and loss statements (P&L)
  • Tax returns for the business and its owners over the past three years
  • Detailed information on any other business loans you have
  • Personal financial statements on all owners who hold more than 20% of the business (using the SBA form–see below)
  • The lease for the business premises, if applicable
  • Financial projections for three years showing what you expect revenue and expenses to be, and demonstrating that operations will be able to repay the proposed loan
  • Resumes for the business owners and any key employees

While the lender will run a credit report on you and your business, it is a good idea to have already checked both your personal and business credit profile ahead of time, to ensure its accuracy and to be prepared to answer any questions.

There are three SBA forms for borrowers to complete. To get a head start and speed up your application process:

  • Download and fill out the borrower information form–you can find it here.
  • Download and fill out personal background and financial statement forms.
    • Personal background—here.
    • Financial statement—here.

You may be required to provide additional information related to the specific purpose of the funding you are requesting. For example, if you’re planning to use the loan to buy another business, you need to provide a copy of the purchase contract, the target companies’ financial statements, tax returns, and other details about them.

How Long it Takes to Get an Answer

There are two loan approvals you’ll need to obtain. First, your bank must review your application and decide whether you meet their qualifications for funding, subject to SBA approval. Banks are obligated to observe the “credit elsewhere” rule, meaning that if your company is qualified for a loan from any other source without the credit insurance provided by SBA, you should be sent there.

Once the lender has agreed to the loan, they must seek the SBA’s approval of the guarantee.

Processing 7(a) applications by the SBA can take two to three weeks, or may be turned around in the same day, depending on whether your bank has delegated authority with the SBA.

If approved, it might take between 30 and 60 days to close the loan and receive funds. The length of this time requirement will be determined by the use of funds and what collateral is required.  If you’re using the loan to buy real estate or a business entity, your loan closing will coincide with the purchase closing.

Interest Rates, Fees, and Terms

While the maximum 7(a) loan is $5 million, the average loan amount is in the $330,000 range. There is no minimum loan amount, and roughly 2/3 of loans are for less than $150,000.

Borrowers pay a one-time up-front fee, depending on the size of the loan and guarantee. Smaller loans (under $750,000) have lower fees. The SBA does not allow other fees to be assessed by the lender unless there are extreme circumstances, such as higher-than-normal servicing required by your loan.

The loan terms are negotiated with the lender that provides the loan, within a few parameters:

  • Fixed and variable interest rates are available
  • Lenders are limited to how much they can add to the prime rate based upon the size of the loan
  • Maximum loan terms are determined by the use of loan funds, like:
    • 25 years for real estate and improvements
    • 10 years for equipment
    • 7 years for working capital
  • Personal guarantees are required for all owners of 20% or more of the business
  • Monthly loan payments are required
  • Borrowers will have to pay for all costs associated with the lender’s due diligence on collateral – this may include attorney’s fees, appraisals, environmental assessments, etc.

 SBA Express Loans

SBA Express Loans are another option under the 7(a) program. They give lenders the flexibility to offer a revolving loan structure for a specified period. What this means: you can draw funds out for a certain amount of time, say 1-2 years, paying only interest and treating the funds as a line of credit, before beginning to repay the loan through monthly payments of interest and principal. The maximum term on these loans is seven years.

Express Loans are available for up to $350,000, although there are a few options that provide for loans up to $500,000 for certain applicants.

For more details on program functionality and eligibility, click here.
 
504 Real Estate and Equipment Loans

If you need a loan to purchase real estate or machinery, a 504 loan could be a good option.

A 504 loan works differently from 7(a) loans. With 504 loans, applicants must provide equity contributions as low as 10% of the asset’s purchase price (or at least 15% for startup companies).

Most 504 loans are structured as follows: a nonprofit organization called a “Certified Development Company” (sanctioned by the SBA) will work in tandem with your lender and provide up to 40% of the project funding. Meanwhile, a traditional lender, like a bank or credit union, provides at least 50% of the financing.  The process is slightly more complicated than other forms of financing since there are two participating lenders who must collaborate. The maximum 504 loan can be for $5 million, meaning that project funding can total up to $12,500,000 (or higher if the senior lender agrees to contributing over 50%).

Interest rates for 504 loans are fixed for 20 years (10 for equipment) and the asset you purchase serves as collateral for the loan. Personal guarantees are required.

How to Know if You Qualify

To qualify for a 504 loan, you’ll need to show that your business is creating jobs or helping to meet one of 14 different public policy goals provided for under the program.

The SBA requires that 504 recipient businesses must create or retain at least one job for every $65,000 provided by the SBA loan, though for small manufacturers, the number is lowered to one job per $100,000.

The 504 program eligibility is more relaxed. Applicants must have a maximum business net worth of $15 million and an average income of less than $5 million for each of the past two years. Other restrictions described in the 7(a) program also apply.

The full list of qualifications can be found here.

Interest Rates and Terms

504 loans can have a 10-year (for equipment) or 20-year (for real estate) maturity, giving borrowers enough time to repay them according to the useful life of the collateral assets.

All 504 loans are fixed-rate, so you don’t have to worry about your interest rate suddenly going up.  The loans come with a fee, which can be financed with the loan, spreading it out over a longer period.

How to Apply

The same paperwork that is required for the 7(a) loan is also required for a 504 loan. A list of Certified Development Companies in your state can be found here. Whether you first approach the senior lender or the CDC is up to you.

As with all loans, having all your paperwork and financial information prepared in advance will help speed up the process.  If approved, receiving the funds make take between 30 and 60 days, though some lenders are willing to cover immediately to close your loan.
 
SBA Micro Loans: An Overview

A microloan is just what it sounds like: a very small business loan. The average microloan is around $13,000, though you can borrow up to $50,000.

These loans are an option if you need a smaller sum of money to get your business started or to expand it, but don’t need the larger sums of a 7(a). For example if you need to buy a new oven for your bakery — a micro loan could be a good fit.

However, microloans can’t be used for paying debts or buying real estate.

Unlike 7(a) and 504 loans, which are only offered to for-profit businesses, microloans can also be used for not-for-profit childcare centers, though other types of not-for-profit companies are ineligible.

Another important distinction is that while 7(a) and 504 loans come from third party lenders, microloans come directly from government funds, which are administered by local nonprofits in each community. Collateral and a personal guarantee are still required.

Microloans are less standardized than 7(a) and 504 loans, so each community lender administering the loan has their own eligibility requirements.

Some factors to keep in mind with microloans:

  • The application process may require you to participate in business training conducted by the nonprofit organization that administers the funding.
  • While the loan amount is smaller than that of a 7(a) or 504 loan, it also has to be repaid faster, with a maximum repayment period of six years.

The interest rates of microloans vary depending on the nonprofit that administers the loan.

You can find a list of nonprofits that administer microloans here.

To Sum Up

The SBA is a unique organization designed to assist small businesses with a variety of financing options and other needs. While it’s important to research each type of loan offered to ensure that it’s right for your situation, there are many instances in which an SBA loan could be a wise bet for obtaining a business loan.

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