How to Finance a Business: SBA Loan

Welcome to the How to Finance a Business series! This series explores different ways to get the financing your for business, regardless if you’re financing your own startup or buying a business already on the market. For many people, money is the only thing standing between them and their goal. You’ve got the business plan to make it work and the drive to see it to the end: all you need is someone who shares your entrepreneurial spirit.

Part Two: SBA Loans

Last week we talked about two of the most conventional methods people use to buy and start-up businesses: credit cards and conventional bank loans. Today we’re looking at one of the most sought-after loans, a Small Business Administration loan. There are a lot of misconceptions about these kinds of loans, not only their cost, but also their origin. This week’s article is focused on taking you through the basics of the different types of SBA loans, as well as how they generally differ from conventional loans.

Small Business Administration Basics

The Small Business Administration is a government agency that specifically focuses on providing support to small businesses and those entrepreneurs who are seeking to start or buy them. Their mission statement is “to maintain and strengthen the nation’s economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters.” Their services can be broken down into three “Cs,” that is funding capital, offering contracts, and providing counseling.

The SBA doesn’t directly provide loans. These aren’t government grants, no-interest loans, or “free money.” The loans are actually made through conventional banks, credit unions, and other lenders who partner with the SBA. Instead the SBA backs these loans, guaranteeing repayment of part of the loan if the borrower defaults. Under the Recovery Act/Small Business Jobs Act, the SBA now guarantees up to a record 90% of the loan. This makes the lender more willing to lend to small businesses and risky startups.

SBA Loans Programs

While the SBA works through other lending institutions, they provide very specific loan programs, that have certain characteristics regardless of which bank, credit union, or lender provides them. Here are two of the most popular types (more can be found on their website):

  • The 7(a) Loan Program: Currently the most popular loan program, the 7(a) can get a small business owner up to $750,000. This is through a local lender, with a partial backing guarantee from the SBA. These loans are typically used for working capital, asset purchases, and leasehold (landlord or tenant) building improvements. All owners who own a 20% equity stake or more have to personally guarantee the loan.
  • The 7(m) Microloan Program: The SBA’s Microloan Programs are designed to provide small loans to start up or grow a business. While microloans go up to $50,000 and have an average of $13,000, the 7(m) provides up to $35,000. This loan is unconventional (and under government scrutiny) because the SBA provides these funds though through non-profit intermediaries who are actually responsible for them.

CDC/504 Loan Program Eligibility 

Lastly there’s the CDC/504 Loan, designed for expanding a company. To be considered for Certified Development Company (CDC)/504 loan, applicants must meet these eligibility requirements:

  • Operate as a for-profit company
  • Do business (or propose to) in the United States or its possessions
  • Has a tangible net worth less than $15 million and an average net income less than $5.0 million after taxes for the preceding two years.
  • Loans cannot be made to businesses engaged in speculation or investment in rental real estate.
  • Be an eligible type of business. While the vast majority of businesses are eligible for financial assistance from the SBA, some are not. Check this list of eligible and ineligible types of businesses to see if your company qualifies.
  • Under the 504 Program, Plan to use proceeds for an approved purpose. CDC/504 loan proceeds may be used for the financing of fixed assets like real estate or equipment. This list explains Eligible and Ineligible Use of Proceeds.
  • Not have funds available from other sources. SBA does not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the financing. Both business and personal financial resources are reviewed as part of the eligibility criteria. If these resources are found to be excessive, the business will be required to use those resources in lieu of part or all of the requested loan proceeds.
  • Ability to repay the loan on time from the projected operating cash flow of the business
  • Good character. SBA obtains a “Statement of Personal History” from the principals of each applicant firm to determine if they have historically shown the willingness and ability to pay their debts and whether they have abided by the laws of their community
  • Relevant management expertise
  • Feasible business plan

SBA Loans vs. Conventional Loans

There are certain advantages and disadvantages of a SBA loan verses a conventional loan. Due to the guarantee provided by the SBA, they have advantages, but additional government oversight and qualifications can make getting (and filing) SBA loans difficult. In general SBA loans have:

  • With lower risk due to governmental guarantees, SBA loans typically have a lower interest rate.
  • Both SBA and conventional loans usually require collateral, SBA loans allow for personal assets as collateral.
  • Not all businesses are eligible: in general residential property holding, non-profits, and lobbyist companies are exempt.
  • SBA loans usually take much longer to process, in addition to paperwork due for the banks actually processing the loan.

At George & Company we’ve seen and made a lot of businesses happen, including help getting people the financing they need to succeed. If you’re interested in buying or selling a business, or getting the assistance you need to make that happen, please contact us and we’ll put our skills in M&A, brokerage, and appraising to work for you.