Small businesses are the backbone of the American economy. More than 50% of the working population works in the sector. While the statistics may romanticize the idea of small business ownership, the reality does not. Over half of all small businesses close down just 5 years after conception.
One of the major reasons for this high rate of failure is lack of capital. It’s hard enough to come up with a great business idea, but proving its profitability to potential investors can be a challenge in itself. To prevent such situations, the Small Business Association came up with several loan options for potential business owners. This article will help you understand them better while also outlining several funding alternatives that can be used.
How are SBA Loans Different from Other Small Business Loans?
For the most part, SBA loans are quite similar to commercial loans. You borrow an amount, secure it with collateral and pay it later with an interest premium. There’s one big difference, the SBA guarantees a significant portion of the repayment. The SBA itself does not provide the loans, sourcing it from different lending institutions. This reduces a lot of the borrower’s liability, with some loans being guaranteed up to 80%. The down payment required on such loans is also lower compared to conventional loans, a good option for those with lower investment capital.
Before you consider applying for a SBA loan, you need to understand some of the downsides as well. Since the SBA guarantees repayment, the selection criteria can be quite narrow. It would be quite difficult to acquire a business loan for individuals with bad credit. While it is a business loan, the SBA may ask for personal guarantees from owners or even setting interests as high as 20%.Finally, the application may take a long time to process, so immediate capital may not be possible.
Types of SBA Loans
1. 7a General Small Business Loans
7a small business loans are the most commonly used loans among individuals looking for a way to start a small business. Used for a variety of purposes such as purchasing machinery, equipment and other working capital, the loans have a maximum borrowing limit of $5 million and borrowing period from 10 to 25 years. Typical interest rates vary from 6-8% depending on the nature of the business.
General SBA loans are a good option for first time business loans. However, a credit score of over 670 and above is generally required along with a 10% down payment. The applications might also take a fair bit of time to be processed. Express loans work around that by guaranteeing application processing within 36 hours, but the capital transfer might not occur as quickly. Interest rates are higher on the latter as well, averaging around 9%.
2. Microloan Program
Microloans are targeted towards non-profit childcare centers, but can be acquired by business owners as well, particularly those that fail to qualify for the 7a. The borrowed amount may be used for investing in working capital but cannot be used for the purchase of property. While there is no particular eligibility criteria, you will have to put down an asset as collateral. Microloans also have a much lower cap of $50,000, a higher interest rate and a maturity period of 6 years.
3. CDC/504 Loans
If you’re looking to expand by investing in an office building or real estate, 504 loans may be right for you. These loans have a much higher borrowing limit of $13 million with a maturity of 20 years. Interest rates are also lower than microloan programs, ranging from 3-5% on average. The SBA is quite selective when giving out CDC loans. The business should be eligible under SBA rules and require a 10% down payment. The applicant must also have a sound credit history and at least 50% of the property has to be owner occupied.
4. CAPLines Loans
If you’re expecting a lot of working capital injections in the future, the CAPLines program might provide you with a fair bit of liquidity. This lending option provides a credit of up to $5 million for a 10 year period. Interest rates are the same as 7a loans, but with one big advantage; they are only applicable for the amount that’s used. For example you use $10,000 of the $100,000 provided as credit at 3%, you’ll just be paying $300 instead of $3000.
On the flip side, small business loans without collateral cannot be acquired as the SBA requires applicants to pledge a certain amount or assets. They are usually coupled with the above three as complementary products, so getting a stand alone loan might prove to be difficult.
Besides SBA loans, business owners may also choose to acquire loans from institutions such as banks and lending institutions. There are several different loan types offered for people with differing needs, such as:
1. Merchant Cash Advance
Businesses with high credit card sales, such as retailers, have a higher chance of running into a liquidity crunch. A merchant cash advance allows the business to get cash in advance for a percentage of future credit card sales for a set period of time.
2. Gender Based Loans
Some institutions such as banks and the SBA have also opened up specific loan programs for providing small business loans for women.
3. Working Capital Loans
Used for short term capital injections, these loans come with higher interest rates and shorter maturity periods.
Besides banks and SBA loans, there are a few other alternatives as well. Credit unions offer small business loans to their members, but the borrowing limit is generally lower compared to other financial institutions. Alternative funding firms, such as Carter Funding Corporation, are also increasing in popularity due to the lower cost of financing as well as the flexibility offered by them. These firms provide cash in return for accounts receivable. This is a good option for businesses that are low on cash but have large numbers of outstanding invoices.