So, the Small Business Administration (SBA) has created a solution for small business owners who need financing through SBA loans. These loans give business owner better access to financing through approved lenders who can offer reasonable terms. Let’s learn more about the pros and cons, so you can determine if SBA loans are the right solution for your financial needs.
What Are SBA Loans?
The SBA works with various financial institutions to create funding guidelines that reduce the risk for the lender and increase a small business’s chance at getting a loan. These loans are funded from SBA-approved or preferred lenders and are guaranteed up to 90% by the SBA. The SBA agrees to pay up to the guaranteed amount if the loan goes into default, creating lender security. However, the business owner still needs to repay the defaulted amount, so the SBA could, for example, liquidate collateral and or put a lien on your income or tax return. Eligibility varies based on the loan type, business structure, and use of funds, but generally, you need to meet these base requirements:
Be a for-profit businessFit the SBA small business size standardsDo business in the U.S.Have invested equity (time or money) as the business ownerExhaust financing options (use no other financing sources)
Types of SBA Loans
SBA loans provide small businesses with up to $5.5 million to cover the purchase of fixed assets or provide working capital. Knowing the use of the funds is crucial to apply for the most appropriate SBA loan. Loan types include:
7(a) Loans
The 7(a) loan program is the SBA’s most popular loan program. It provides a revolving loan of up to $5 million in funding for most business expenses, including the purchase of new equipment, acquisition costs, or real estate. The SBA guarantees up to 90% of the loan based on loan amount and creditworthiness. 7(a) loans have a 5- to 25-year maturity rate and fixed or variable interest, depending on the lender.
504 Loans
The SBA works with CDCs (Certified Development Companies) to provide up to $5 million for the purchase or improvement of major fixed assets, such as land, new or existing buildings, and machinery. 504 loans offer fixed rates and 10- or 20-year maturity terms.
Microloans
Microloans provide business owners up to $50,000 to cover start-up costs. They are available through community-based lender organizations that often focus on underrepresented founders. The SBA sets a maximum repayment of six years, and the interest rates are generally 8% to 13%.
Disaster Loans
The Disaster Loan program provides funds to businesses located in declared disaster zones to cover operating expenses and losses not covered by insurance. Unlike the other programs, these loans are issued by the SBA.
Pros and Cons of SBA Loans
SBA loans make financing more accessible for small businesses that are often turned away from traditional loans. These programs have several advantages, including favorable terms. However, there are some disadvantages to keep in mind as well, such as a lengthy application process.
SBA Loan Pros Explained
Favorable Terms
SBA loans tend to be more affordable for small business owners because of their favorable terms. First, the SBA caps the interest rate that lenders can charge with a base rate connected to the federal prime rate or LIBOR. Second, maturity tends to be longer than traditional loans, up to 25 years, which makes repayment easier.
Loan Amount Variance
SBA loan programs give business owners a way to purchase fixed assets or add working capital. So the amount needed can vary greatly, and SBA loans offer a wide array of funding. The smallest loans are often $5,000 via a microloan program. Larger 504 loans can fund up to $5.5 million. But you’ll want to ensure you apply for the proper program based on how you will use your funding.
Business Mentorship
Some SBA loans give business owners access to business counseling and mentorship. You can obtain guidance on topics from submitting a loan application via an SBA program to developing management skills. Underserved communities have the option for additional support through business centers working with the SBA.
SBA Loan Cons Explained
Specific Fund Use
Each SBA loan comes with specific rules on how funds can be used to support your business. 7(a) loans cover fixed assets and working capital, making it the loan option with the most variety in accepted uses. 504 loans specifically cover fixed asset purchases or improvements, and microloans can’t be used for real estate or debt restructuring. This could limit the type of loan you go after or hinder your ability to use funding as needed.
Lengthy Approval Processes
One of the biggest downsides of SBA loans is the lengthy application timeline, which can take from a few weeks to a few months. For any non-SBA-preferred lender, the approval process is twofold, as both the lending institution and the SBA need to accept the application. This could also mean you’ll have to provide additional paperwork for each organization.
Personal Guarantee Requirements
The SBA wants to see that you, as the business owner, are serious about the repayment of the loan. First, you must have invested equity to be eligible for an SBA loan. Second, you need to put a personal guarantee down to share the risk with lenders and the SBA. For example, a loan may require a 10% or higher down payment or have a collateral requirement such as the asset being purchased with the loan.
SBA Loan Alternatives
A review of the pros and cons of SBA loans may have you looking into other funding options. Here are a few alternatives that may better suit your business structure and funding needs:
Crowdfunding: With crowdfunding, average consumers invest in your business without expecting a return on their investment. Crowdfund contributors often expect a “gift” in return for their investment, such as a product or promotion, but you are not obligated to repay them.Bootstrapping: Bootstrapping is when you use your own resources, including money in savings or retirement accounts, then you develop strict budgeting. You may also turn to family and friends for contributions.Business credit cards: A credit card allows you to build a business credit score, receive the card benefits, and showcase a reliable financial history when making timely payments.
Is an SBA Loan Right for You?
SBA loan programs come with a variety of advantages, including longer repayment periods, lower interest rates, and a wide loan amount offering. Yet they do come with disadvantages, including long approval timelines, a required personal guarantee, and specific fund use. For some small business owners seeking to buy major assets or grow working capital, SBA loans are affordable options. Review SBA loans pros and cons and your own financial situation to see if an SBA loan could potentially work in your favor. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
