March 29, 2022
Guest Post by Katie Fleming, Co-founder of Owner Actions
SBA loans are one of the most common forms of financing for owners of small and growing businesses, and for a good reason. These loans are relatively easy to qualify for, offer favorable rates and terms, and provide capital that can be used for a wide range of purposes.
SBA loans may already be on your radar, but if you’re like many owners, you likely have some questions on whether you can qualify for them and how they can be used. In this post, I’ll help you navigate the essentials.
Let’s start with the basics.
What is an SBA loan?
An SBA loan is a form of financing banks can offer to small business owners who are willing to repay it in moderate monthly increments.
Unlike other loans, this option is guaranteed by the Small Business Administration (SBA) rather than a bank itself. This guarantee makes the loans a lower-risk lending option for banks. Here’s why that matters: When the risk is minimized, banks are more willing to approve lending applications. Many owners find it easier to access funding through an SBA loan than through non-collateralized loan options.
Are there multiple kinds of SBA loans?
There are, but when many owners consider SBA loans, they’ve focused on 7(a) loan products. The 7(a) loans can be used for a wide range of purposes. Many use them to cover early-phase costs, working capital, equipment or machinery needs, real estate, or even small business acquisitions.
SBA 7(a) loans come in three forms:
- The standard 7(a), which offers a maximum loan amount of $5 million
- The 7(a) small loan, offering a maximum loan amount of $350,000
- The SBA express loan, which provides up to $350,000 in a faster time frame (typically less than 36 hours)
All three loans options are typically collateralized and have maturity terms of 25 years for real estate and 10 years for working capital, inventory, or equipment.
SBA 7(a) loans aren’t the only option available to small business owners. The SBA also guarantees a 504 loan product. This kind of loan can help you cover the costs of acquiring existing buildings, buying land, investing in land improvements, constructing new facilities, renovating existing facilities, or purchasing long-term machinery. Importantly, owners can’t use a 504 loan to cover other costs such as working capital, inventory, or long-term debt.
With 504 loans, borrowers can access up to $5 million with maturity terms of 25 years for real estate and 10 years for working capital, inventory, or equipment, but there is an important condition: You’ll need to create or retain at least one job for every $65,000 the SBA guarantees. Further, the project assets that the loan covers are often used as collateral, and owners with a 20 percent or greater interest in the business will need to provide a personal guarantee of the loan, which is a legally-binding promise to repay it.
Another category of SBA and SBA-related loan products that are typically smaller but worth mentioning, are SBA microlenders, SBA Community Advantage lenders, and Community Development Financial Institutions (CDFIs). SBA microloans are not SBA guaranteed loans but are typically low rate loans up to $50,000 that have terms of 1 to 6 years. SBA CA loans are SBA guaranteed loans up to $250,000 that are very similar to the 7(a) loans mentioned earlier, but only a handful of lenders that are actually nonprofits can provide them. Lastly, CDFIs, which are often times SBA microlenders are non-traditional financing options that operate using grant money from different sources including the United States Treasury, SBA, and other municipal, private, and public financing or grant sources. Check out the links to find out if there are any of these lenders operating in your area:
Which loan program is right for my business?
Whether you choose one of the 7(a) options or the 504 loan will depend on what you plan to do with the funds you raise. If you’d like to finance a specific real estate project, such as buying land or taking on renovations, a 504 loan might be a good option. If you plan to cover other startup costs or working capital needs, you could explore one of the 7(a) loans or another financing option.
Beyond use of the funds, there are a few other factors you’ll need to keep in mind to determine if an SBA loan is a smart choice for your business.
First, recognize that these funds may involve fees not covered here. You’ll need to work with a banker to sum up these costs and an accountant or financial advisor to ensure you can cover them and the monthly loan payment that will be required.
Second, loan terms could include some prepayment penalties. Here again, your banker can help you understand the added costs involved in the early repayment of any SBA loan you sign for.
Third, some businesses don’t qualify for SBA loans, or they may need to cover costs that make the SBA loan products an unsuitable choice. Let’s explore what this might mean for your business.
Will my business qualify for an SBA loan?
Many do, though there are quite a few qualifications to meet.
First, you must be operating a small, for-profit business in the United States, and your business must be eligible for financing according to SBA terms. At present, some of the businesses that aren’t eligible include those involved in loan packaging, speculation, pyramid sales, gambling, investment, or lending. In addition, the SBA states that the owners seeking funding cannot be on parole. You can review the full list of ineligibilities here.
There are also some financial qualifications. You and any significant partners in your business must have a solid credit score, generally 640 or higher. You must also be able to make a down payment, which typically equates to 5-10 percent of the cost of your project. And importantly, you must have exhausted all other forms of financing to accomplish your objective.
A final qualification is that your business must be growing and profitable. This is typically measured in the following three ways:
- Your business must be able to demonstrate at least one year of profitability.
- Your business must have growing annual revenues.
- Your business must have a debt service coverage ratio of at least 1.15 to ensure it has enough cash on hand to cover its outstanding debt, interest, and lease payments.
How do I apply for an SBA loan?
You can apply for an SBA loan by following four simple steps:
- Make sure your finances are in good order and build projections that will help you demonstrate where your business is headed or how you expect it to perform realistically if you are a startup. ProjectionHub can help if you need some creating projections!
- Form a plan for covering the down payment, which is often 5-10 percent of the asset or project you need to cover. Many owners use personal savings, stock accounts, home equity accounts, retirement funds, or the assets of another business they own to cover this requirement.
- Select an SBA loan provider using the SBA’s Lender Match tool. Pro tip: Here at Owner Actions, we recommend choosing a bank that offers competitive interest rates and has a team dedicated to serving small businesses.
- Gather the documents you’ll need for your application. You can find a summarized list of those document requirements here.
How can I boost my chances of approval?
There’s no getting around the core requirements your lender or the SBA sets, but there are steps you can take before applying for an SBA loan to ensure you’re on the right track.
First, take time to review the SBA’s full list of requirements (you can find the list here). Your preferred lender can walk you through any other criteria they’ve set for approval.
Second, check your credit score—and the credit scores of any significant partners—before applying. Remember, a score of 640 or greater is usually a must-have for approval. You can certainly look into score-boosting strategies with the help of a financial advisor, but these tend to work best for owners who are looking for small score boosts rather than significant jumps.
Third, work proactively to build a sound business plan. Services like Masterplans can be tremendously helpful in forming a plan that will impress lenders (and, of course, help you guide your next steps in running your business) or you can use a template like the SBA’s for creating a business plan. And, certainly, ProjectionHub can help you create the projections your lenders will need to understand your trajectory.
What if an SBA loan isn’t right for my business?
There are many other forms of financing to consider. Visit us at owneractions.com, and we’ll walk you through some other popular ways to raise the capital you need.
About Owner Actions
Owner Actions is a free, all-in-one resource that can help you start your business, set it up for growth, and navigate its day-to-day operations. With articles, product and service recommendations, and a free action guide curated specifically for your business, you’ll find the resources—and the support you need—to go after your business goals.