How to Secure A Small Business Administration (SBA) Loan
in Debt Financing for Small Businesses
The U.S. Small Business Administration (SBA) is a United States government agency that provides support to entrepreneurs and small businesses. The agency's activities can be summarized as the "3 Cs" (i.e. capital, contracts, and counseling). The chief means through which the SBA helps to provide access to capital to U.S. small business owners is through its lending programs. The SBA’s major loan programs are as follows:
- Disaster - The SBA provides low-interest disaster loans to help businesses and homeowners recover from declared disasters such as the California wildfires and some of the hurricanes which have devastated the continental US in recent years such as Hurricane Harvey, Irma, and Michael.
- 7(a) Business Loan Guarantee - The SBA 7(a) Loan Guarantee program is one of the most popular loan programs offered by the agency. A 7(a) loan-guarantee is provided to lenders to make them more willing to lend money to small businesses with weaknesses in their loan applications. If the loan is for less than $150,000, then the SBA will guarantee up to 85 percent of the loan, but if the loan is for more than $150,000, they will only guarantee 75 percent of the loan. Interest rates are based on the prime rate (currently 5%), the size of the loan, and the maturity of the loan. Interest rates for a 7(a) loan currently range from between 7.25% to 9.75%. In addition, the SBA themselves charge a premium for the guarantee. The SBA fees range from 2% of the guaranteed amount for loans of $150,000 and less, to 3.75% on any guaranteed amount over $1 million making the final interest rate payable by the SBA loan recipient between 9.25% and 13.5%.
- 504 Certified Development Companies - The SBA 504 loan program is designed to provide financing for the purchase of fixed assets (i.e. real estate, buildings and machinery) at comparatively low rates. It works by distributing the loan among three parties. The business owner puts a minimum of 10%, a conventional lender puts up 50%, and a so-called Certified Development Company (CDC) puts up the remaining 40%. Effectively there are two loans in place, potentially at different rates of interest. The CDC portion of the loan is priced based upon the current rate for 5-year and 10-year US Treasury bonds. To those rates, you must add a spread for investor returns, as well as fees that the CDC and SBA charge. By the time you add these up based upon current rates, the SBA CDC/504 loan rates between approximately 3.72% and 7.145%. The bank, on the other hand, is free to charge whatever interest rate they choose to offer to you but it would typically be at an interest rate lower than 10%.
- Direct Micro Loans - Through their Direct Microloan Program, the Small Business Administration (SBA) loans money to intermediary nonprofit lenders. These lenders then provide business loans of up to $50,000 to startups and small businesses, many of them run by women, minorities, or veterans. Interest rates on microloans are typically slightly above market rate because the borrower profile is a bit riskier. Interest rates currently range from 8% to 15% for most microloans.
These SBA loans are amongst the best business funding options available to entrepreneurs due to their comparatively low-interest rates, long terms, and manageable monthly payments. However, they are heavy on paperwork and detail so it is important to understand what the requirements are for these loans in order to maximise your chances of securing an SBA loan. We will detail below what the requirements are for an SBA loan:
- U.S. For Profit Business in Eligible Industry- The first SBA loan requirement is that you must have a US-based, for-profit business in an eligible industry. Non-profit businesses aren’t eligible for SBA loans, and certain industries are barred from receiving SBA loans, including life insurance companies, companies involved in lending, companies involved in gambling and passive income businesses. On the top of the SBA’s requirements, lenders might also have their own list of industries that they are willing to support.
- Small Business - The SBA is dedicated to helping small businesses so you’ll need to verify that you meet the size requirements for an SBA loan. There are three ways in which you can meet the SBA size requirement: number of employees, business revenue and business net worth. The SBA often changes what “small business” means, but the average local business is almost certain to meet the definition. If in doubt, please check the SBA size standards at the SBA website.
- Time in Business - Lenders will want to know how long you’ve been in business before they approve your SBA loan. The longer your business has been operating, the more likely you are to get approved for the loan. When you’re applying for an SBA loan, many lenders will require a minimum time in business of two years
- Personal Background Checks - As a part of the SBA loan qualifications, you’ll need to submit information about your personal background, including previous addresses, your citizenship status, and your criminal record. The SBA requires anyone who owns 20% or more of the business to sign a personal guarantee on the loan so any significant shareholder will need to submit themselves to full personal background checks.
- CV's of Leadership Team - A CV is a requirement for any SBA loan but it is particularly important if you require your small business loan to start your business, so make sure you’ve prepared this document fully and professionally. A resume is a great opportunity to show how you are prepared to run your company successfully.
- Personal Credit Report - In your SBA loan application, you’ll provide your social security number and sign a credit authorization, which will allow the lender to obtain your personal credit report. Great personal credit gives the lender reassurance that you’ll be trustworthy with your business’s finances and be able to pay back the loan.
- Business Credit Report - Unless you’re seeking a loan to launch a brand new business, your business credit report will also be part of the SBA loan requirements. There are several business credit reporting agencies, but FICO Small Business Scoring Service (SBSS) is most important for SBA loans. The SBA uses the SBSS score to prescreen 7(a) loan applications and will reject your application if your score is below 140, whilst most lenders set their minimums even higher (usually at least 160).
- Personal & Business Income Tax Returns - Personal tax returns are another important SBA loan requirement for income verification purposes. Similarly, lenders use business tax returns to verify your business’ income. Lenders typically ask for the past three years of personal and business income tax returns.
- Business Financial Statements - The SBA will require a copy of all recent financial statements, including a profit and loss statement and balance sheet. Obviously the stronger the balance sheet and more profitable the business, the more likely that the SBA loan will be approved.
- Bank Statements - Most lenders will ask to see a year’s worth of personal and business bank account statements along with all the rest of the documents required for an SBA loan application.
- Business Debt Schedule - A business debt schedule is document required by the SBA that breaks down your debt by monthly payments and shows the interest and principal due each month.
- Legal Documents - There will no doubt be legal documents that are required as part of the SBA loan application. Examples of the types of legakl documents that will need to provided include business licenses and registrations allowing you to conduct business such as Articles of Organization for LLCs, contracts with third parties such as clients and suppliers, Leases for commercial real estate or business equipment and franchise agreements.
- Evidence of Collateral - The SBA requires lenders to obtain “adequate collateral,” when available, to secure an SBA loan. Whether that’s real estate, equipment, or inventory, this collateral will need to be adequately documented.
- Personal Guarantee - Anyone who owns 20% or more of the business must sign a personal guarantee for an SBA loan. If a business defaults on an SBA loan, the lender will first seize any collateral or business assets to repay the debt. If those aren’t available, then the personal guarantee authorizes the lender to seize personal assets as well, such as your car, personal bank accounts, or even your home in some cases.
- Business Plan - The quality of the business plan that accompanies any SBA loan application is a critical factor in securing a loan. This business plan is your big chance to prove to the lender that investing in your small business is a smart decision.
Once you have your SBA loan requirements in order and your application submitted, the underwriting process with the SBA can take as few as 30 days but as long as several months. Compared to other small business loans, SBA loans tend to take longer to process. However, if you’re looking for a low-cost loan, an SBA loan is worth the wait.
Most entrepreneurs fund their own business through the start-up stages but, when they eventually exhaust their initial personal resources, they eventually tend to either want or need to tap into other funding sources to enable their business to continue to survive and grow. Whilst the proceeds of such a loan often help accelerate business growth, this comes with significant risk for the business owner as they will be personally responsible for repaying, whether or not the business ultimately proves to be a success.
Given that the stakes are so high for the business owner, it is critical that they have a solid, well-researched business plan that meets the SBA loan requirements as well as banks’ highest standards. A business plan written for a bank loan differs from other types of business plan by its focus on the financial aspects, such as the specific use of the loan proceeds, important financial ratios such as your debt to asset ratio, debt to service ratio and interest coverage ratio and the potential return on investment (ROI).
If you’ve already been through an SBA Loan Calculator and want to move to the next step, call us or send us a message today to move one step closer to obtaining the insight and the finance that will take your small business to the next level.