SBA loans are a popular choice for small business financing. But is an SBA loan the right choice for your small business? Well, that can be a complicated decision. In this blog, we will explore the SBA loans pros and cons so that you can make an informed decision about your small business loan.
SBA loans offer many benefits popular with small business owners, such as small business-friendly terms, a wide range of loan amounts, and capped interest rates. However, there are also some important drawbacks to consider, such as the strict underwriting criteria and long approval process. So, before you decide if an SBA loan is right for you, let’s dive into the SBA Loans pros and cons!
What are SBA Loans?
SBA loans are small business loans backed by the Small Business Administration, a U.S. government agency. The SBA does not directly lend money to small businesses; instead, they partner with lenders like banks and other lenders to provide financing.
In the SBA loan program, the loans are partially guaranteed by the government, which means that if you default on the loan, the SBA will reimburse the lender for a portion of the loss.
SBA loans were created to help small business owners get access to financing they might not otherwise qualify for. SBA loans generally have very small business-friendly, flexible terms, are available in a wide range of loan amounts, and have capped interest rates which make them an excellent choice for many small businesses.
What is the SBA?
The Small Business Administration (SBA) is a U.S. government agency that provides support to small businesses through business loans, SBA guarantees, contracting assistance, and counseling.
The SBA was created in 1953 as part of the Eisenhower administration’s response to the Great Depression. The mission of the SBA is “to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation.”
SBA Loans Pros and Cons: What Are the Advantages of SBA Loans?
There are many advantages to taking out an SBA small business loans, including:
Favorable Repayment Terms
SBA loans typically have more small business-friendly terms than other types of loans. For example, SBA small business loans often have favorable repayment terms, which can give you some much-needed breathing room when it comes to making the monthly payments on your small business loan.
Repayment terms vary depending on the use of proceeds, but typically range between 10 years (for most term loans) and 25 years (for real estate loans).
A Wide Range of Loan Amounts
SBA loans are available in a wide range of loan amounts, which can be helpful if you need a large amount of financing or a smaller loan. Small business owners can take out loans ranging in size from $500 (with microloans) to $5 million (with SBA 504 loans which finance fixed assets like the purchasing real estate), depending on the SBA financing involved and what they intend to use it for.
Set Maximum Interest Rates
Probably the biggest advantage of SBA loans at the competitive rates, which can be just a few points above the prime rate. SBA loans have capped interest rates, which means that the SBA sets limits on the maximum interest rate that lenders can charge on loans. For example, for variable rate loans, interest rates are capped at 2.25% to 4.75% above the base rate (e.g. the prime rate or LIBOR). For fixed rate loans, interest rates are capped at 5% to 8% above the base rate.
Please note though, that the specific interest rate that you will pay on an SBA loan is still negotiated between you and your SBA lending institution. As with all loans, a lot depends on your application and creditworthiness. A high credit score can be a big help at this time!
SBA Loans Pros and Cons: What Are the Cons of SBA Loans?
So clearly, there are a lot of pros to applying for an SBA business loan… but there are significant drawbacks as well. Let’s a closer look at the cons of SBA loans:
Strict Underwriting Criteria:
SBA loans have very strict underwriting criteria, which can make it difficult to qualify for a loan.
In other words, applying for an SBA loan can be a long slog, often a two month process involving A LOT of paperwork. SBA lenders typically require a credit score of 680+, a strong financial history, and more than 2 years in business. In addition, any SBA lenders that you apply to may have additional requirements of their own.
Long Approval Process
As mentioned, the SBA loan approval process can be lengthy, and it can easily take several weeks, if not months, to get approved for a loan. If you need to obtain financing quickly, you may want to consider looking into applying for a loan with an SBA Preferred Lender.
What Is an SBA Preferred Lender?
An SBA Preferred Lender is a lender that has been approved by the Small Business Administration to process and approve SBA-guaranteed loans on a streamlined basis.
SBA loans require typically a 2-step process. First, the lending institution must approve the application, and then it gets sent on to the SBA for approval. With SBA Preferred Lenders, the Preferred Lenders have been given the authority to make final credit decisions on SBA loan applications which can speed up the process significantly, sometimes to the matter of a couple of weeks
A Personal Guarantee or Down Payment May Be Required
An SBA business loan is not without risk, and depending on the SBA loan program you apply to, a down payment or personal guarantee may be required.
Many SBA loans require a down payment of 10%-20%, but the specifics will depend on the loan and the applicant’s financial profile. Of course, the stronger the financial history, the lower the required down payment will be.
Unfortunately, the down payment requirement is one of the leading barriers to small business owners receiving SBA funding. For small business owners that have not been in business for very long and/or does not have steady cash flow yet and/or do not have significant personal assets, it can be an impossible challenge to put together the money for the down payment required.
Required Fees
The fees associated with SBA loans can vary, but they are typically around 3% of the total loan amount. These fees can add up over time, so be sure to factor them into your budget when you are considering an SBA loan.
One fee that may be assessed is the SBA Guarantee fee, which is charged on SBA guaranteed loans. The SBA guarantee fee will depend on the type of loan, loan amount, and the term of the loan, and is determined by the portion of the loan that the SBA guarantees. Many SBA lenders simply pass on the cost by charging it agains the loan proceeds.
Types of SBA Loans
The SBA offers a variety of loan programs to small businesses, including:
SBA 7(a) loans
7(a) loans are the most common type of SBA guaranteed loan. 7(a) loans are term loans that can be used for a wide variety of purposes, including working capital, equipment financing, and business expansion.
In 2020, during the COVID crisis, the Paycheck Protection Program (PPP) was created under the SBA 7(a) loan program. The Paycheck Protection Program was designed to help businesses impacted by the COVID crisis, by offering business loans which were fully forgivable if used for specific expenses, mainly payroll. The Paycheck Protection Program has been closed to new applications since 2021.
SBA 504 loans
SBA 504 loans long-term, fixed rate loans of up to $5 million, designed for small businesses that need to finance the purchase of major fixed assets, such as purchasing real estate or to purchase equipment. Unlike 7(a) loans, these loans are not meant to be used at working capital.
SBA 504 loans are available exclusively through Certified Development Companies. Certified Development Companies at SBA-regulated, non-profit organizations focused on economic development within their communities.
SBA Express Loans
SBA Express loans are designed for small businesses that need financing quickly. An SBA Express loan can be used for the same purposes as a 7(a) loan (e.g. working capital), but has much faster turnaround time. The maximum amount available under the SBA Express Loan program is $500,000.
SBA Disaster Loans
SBA disaster loans are available to qualified businesses that have been affected by a federally-declared disaster. The SBA disaster loan program includes Economic Injury Disaster Loan program (EIDL). Economic Injury Disaster Loans are working capital loans which are meant to help small businesses and non-profits meet their financial obligations during a disaster
SBA Microloans
SBA Microloans are small loans (up to $50,000) that are designed for small businesses and entrepreneurs who are looking to start or expand a business and cannot get business funding elsewhere. Although the business funding does not come directly from the SBA, the SBA provides the funding to designated intermediary lenders, usually non-profits.
How Do I Qualify for an SBA Loan?
In the list of SBA loans pros and cons, it’s important to understand the requirements involved in an SBA loan. The specific requirements to quality for an SBA loan vary depending on the type of loan that you are applying for, but generally, here are the requirements to be eligible for an SBA loan:
Own a qualifying small business
Not every small business qualifies for an SBA loan and matters like size and length of time in business matter. To check if your business qualifies, visit the SBA Size Standards Tool at SBA.gov.
Operate a for-profit business located in the U.S. in an eligible industry
Not all for-profit businesses in all industries are eligible for SBA loans, and businesses in certain industries are definitely not eligible, for example businesses in the gambling industry. To check industries ineligible for SBA loans, visit SBA.gov.
Have good credit
As part of the approval process, all of the business owners with more than 20% ownership will have their credit checked, and the business’ credit may be checked as well.
Exhausted Other Funding Options
SBA loans are generally designed for small business owners who have not been able to obtain financing elsewhere. When you apply to your SBA lender, you will need to show how you have exhausted other funding options.
Demonstrated Investment Into the Business
SBA loans are not designed for businesses still in “idea stage.” They are meant to help an existing business continue its business growth, so business owners need to show that they have invested their own time and money into the business in order to be eligible for an SBA loan.
Show that you have the ability to repay the loan
In order to be eligible for an SBA loan, the application must be able to show that the business will be able to make the monthly payments and repay the business loan from future cash flow.
How Do I Find an SBA Lender?
If you are interested in applying for an SBA loan, you can find a lists of SBA-approved lenders on the SBA website. You can also talk to your local traditional banks or credit unions to see if they offer SBA loans.
A more convenient option for many small business owners, though, is to go through an online finance marketplace. These online finance marketplaces are not lenders themselves. Instead they partner with lending institutions, and match your loan application to the loans that you qualify for.
Some of the most popular finance marketplaces that work with SBA loans are Fundera, Nav, and SmartBiz.
How Do I Apply for an SBA Loan? What Do I Need for an SBA Loan Application?
To apply for an SBA business loan, you will need to fill out a loan application and submit it to an SBA-approved lender. Requirements will vary depending on the type of SBA loan you are seeking and the lending institution you are applying to, but generally, you will also need to provide the following information and documents:
-Historical tax returns, both personal and business,
-Profit and loss statement,
-Balance sheets, and
-A business plan with financial projections,
As we’ve discussed, the SBA loan application process can be lengthy, so be sure to allow yourself plenty of time to complete the application and assemble the paperwork!
What if an SBA Loan Isn’t for Me? What Business Financing Alternatives Are There?
If you don’t qualify for an SBA loan or if you decide that SBA funding is not right for your business, there are other funding options available, including:
-Traditional banks,
-Small business grants,
–Venture capital (Read more about How to Raise Venture Capital),
–Venture Capital Advantages and Disadvantages,
-An online lenders,
-Alternative lender,
-A business credit card,
-Merchant cash advances.
No matter what type of loan you decide to apply for, be sure to do your research before you make any decisions!
Final Thoughts on SBA Loans Pros and Cons
SBA loans can be a great option for small businesses, but they are not right for everyone. Be sure to carefully consider the pros and cons before you apply for an SBA loan.
