You’re in a sitch - you need a loan to help pay for new equipment, refinance old debt, or to acquire a business. Chances are, very few of us have thousands, if not hundreds of thousands lying around ready to be spent on these big-ticket purchases.
Enter the SBA Loan. Back in 1953, the U.S. Small Business Administration (SBA) was created to help Americans start, build, acquire and grow businesses. With it, the SBA provides small businesses with various financing options ranging from microlending to more substantial equity and debt investment capital through something called ‘SBA Loans.’
What is an SBA Loan?
SBA loans are in many ways different from other lending sources one may apply for in that a portion of SBA Loans are guaranteed and backed by the government- in some cases up to 85% of the loan amount.
It’s important to note that the SBA itself does not lend money directly to consumers; rather, the loan is issued by lenders such as banks. This ‘government guarantee’ is beneficial for lenders should a small business ever default on their loan. It is, therefore, appealing for SBA lenders as this gives them a reduced level of risk.
But what’s in it for a small business owner? Is there the same level of appeal? Yes. SBA loans have some of the most favorable loan terms for small businesses. They offer flexible and manageable repayment options, longer terms, and lower down payments. These great terms enhance the appeal, however, the application is time-consuming and the competition is high - more on this subject will be provided later.
There are various SBA loan programs that small businesses can apply and borrow money. SBA loans are suitable for a wide range of business activities such as:
- Adding to working capital
- Purchasing inventory
- Refinancing old debt
- Buying real estate
- Funding a purchase of an existing business; specifically titled the SBA 7(a) Loan.
Individuals looking to purchase a small business will likely be interested in applying and pursuing the SBA 7(a) loan. The SBA 7(a) is the most common SBA loan that small businesses apply for.
It is important to know that the SBA sets guidelines that govern the 7(a) loan program. From there, it is up to the lender and the borrower to negotiate the specific terms. Here’s a look at the general terms:
- Loan Amount: A small business can borrow up to $5 Million in capital.
- Maturity Term: The maximum maturity of loans used to fund an acquisition is 25 years.
- Interest Rate: Ranging from 2.25-8.00%, these rates are comparatively much lower than other forms of loans. Of course, the rates vary depending on the loan amount, maturity, and if it is variable or fixed.
- Down Payments: 10-20% is required.
In the case where a buyer has enough capital to purchase a business without the help of the loan, they can still apply for SBA 7(a) to leverage cash flow and pay for the business with relatively inexpensive, borrowed capital- as interest rates are fairly low.
Who Qualifies and are They Hard to Get?
There are over 30.2 million small businesses in the U.S. and a reported 10,312 of them were sold in 2018. Taking these two numbers into consideration, it is safe to assume the competition for getting your SBA 7(a) loan is high.
So, how do you convince the lender that you are a good fit and capable of running a successful business? Well, business owners need to be experienced, have good character, demonstrate their ability to repay the loan, and have sufficient equity invested in their business.
But that's only a glance at the qualifications. Both the SBA and the lender have specific requirements that are in place to select the best applicants. Different lenders have different qualifications and the SBA itself has set guidelines for a business to be approved, which are:
- Small Business - The business meets the SBA small business size requirements that change depending on the industry.
- US Business - The business is physically located in the U.S. or the U.S. territories.
- For-profit - The business is registered and operates legally in the U.S.
- Invested Equity - The business and its owner(s) have invested their capital.
- Exhausted alternative loans - The business has attempted to apply for other financing options but have been turned down.
As an owner, having strong financials for your business does not stop there, your personal financials are also taken into consideration. Your chances of getting approved by a lender are far greater if both your personal and business financials are in good standing. Notable personal qualifiers include a credit score greater than 640. Business qualifiers include profitability for 2 or more years and growing annual revenues.
How to Apply
Due to the SBA being a government agency, the loan application and approval process can be rigorous and thorough. Applying for the SBA 7(a), as well as other SBA loans can be a lengthy process. If you are in dire need of money with a limited timeframe, you may want to consider other options. The application and approval process together can take weeks, even months.
Step 1: Qualify for SBA 7(a) Loan
Before you even start your application, make sure you meet the requirements set by the SBA. Your lender may also require different terms, so keep in mind which banks or programs you can apply to when searching. In short, you do not want to spend hours upon hours working on an application to learn that you won’t qualify.
Step 2: Look for the right SBA Lender
Shop around to find a lender right for you and your business. If you are unsure where to start, consider using the SBA Lender Match tool to find an approved lender.
It’s helpful to choose a lender that has a department that focuses on small businesses, or a Preferred Lender who can approve applications more often as they can make in-house final credit decisions.
Determining which lender to go with can be made easier when you ask questions on qualifying requirements such as minimum credit score, collateral, cash flow requirements, etc and if they have approved a loan similar to your business. It’s also good to get an understanding of the prepayment penalties, grace periods, interest rates, and repayment of the loan principal.
Step 3: Gather Necessary Documents and Submit your SBA 7(a) Loan Application
You have chosen your lender, now it’s time to organize your loan application. It requires various documents that will be scrutinized by the lender to determine if you are approved.
Here’s a general list of documents that may be required by the lender:
- Basic Information: Company name, number of employees, etc.
- Personal Background Information: Such as previous work experience that makes you qualified to run your business and logistical details such as address.
- Use of Funds: Specify the loan amount and what it will be used towards.
- Business Plan: An explanation of what your business does and what your goals for the business are.
- Personal and Business Financial Statements: This is to verify that you and your business are in good financial standing. Statements required to include: balance sheet, cash flow, debt schedule, profit & loss statement, bank statements.
- Tax Returns: Personal and business tax returns for the previous 3 years to verify your and the business’s income.
- Collateral: Personal and/or business assets used to ensure the lender has a secondary source of payment should payments default.
- Legal Documents: Business licenses, leases, lawsuits, etc.
It’s an exhaustive list and it will take an average of 60-90 days for the SBA and the lender to review all your documents. Make sure to work closely with your lender to see if additional information is needed. The more timely you can provide this information, the quicker the lender can approve your loan.
Following the 2008 financial crisis, it has become more difficult for small business owners to secure financing as the willingness for banks to lend money has decreased. But, with SBA loans guaranteed by the government, it gives a reason for lenders to support small businesses like yours.
As a common theme mentioned throughout this blog - the process to apply for an SBA loan is neither quick or easy. It can take weeks if not months from the day you check your eligibility to when the money is in your hands. Therefore preparation and organization are key. In the end, an SBA will more than likely be worth it. With one of the longest repayment terms, highest loan amount, and lowest down payments, the SBA loan is one of the best options for small businesses.