Congratulations! You’ve decided to build your own business. Now it’s time to find capital to fuel your growth, and you’ve likely heard the words “SBA Loan” ad nauseum. Well, what is an SBA Loan? How does an SBA Loan work? In this article, we will explore in detail a few of the SBA’s most popular loan products, including the SBA 7(a), the SBA CDC/504, and . We will also discuss the SBA application process, eligibility, and the realities of actually accessing these loans.
What is an SBA Loan?
The Small Business Administration (SBA) is a government agency tasked with helping America’s small businesses operate and thrive. In addition to providing educational resources, government contract opportunities, and professional counseling, the SBA offers a loan program to provide small businesses with affordable financing.
The SBA Loan Program is one of the most attractive and favorable forms of financing for small businesses. Rather than funding small businesses directly, the SBA “guarantees” a percentage of the loans issued by affiliate banks and lending institutions, thus allowing qualified small businesses to borrow at more favorable terms than the broader market.
While the SBA offers a wide array of loan products catered to specific purposes, the SBA 7(a) and the CDC/504 programs are the largest and most flexible.
SBA Loan Features
Before we jump into specific SBA loan programs, let’s take a moment and review the key features that should be considered when shopping for an SBA loan. Here we will answer questions like: Why is an SBA loan so good? Do SBA loans require collateral? How many SBA loans can I have? How long are SBA loan terms? Are SBA loans personally guaranteed?
Why is an SBA loan so good?
Simply put, an SBA loan is one of the most borrower-focussed financial instruments on the market. It has the following components that make it more flexible and easier to repay than most other lending instruments. The SBA provides a general list of eligibility requirements, however you will also need to refer to each specific program’s requirements as well.
Annual Percentage Rate (APR)
The APR represents the total cost of the loan. It is comprised of the interest rate and fees.
For those considering an SBA loan, it is important to understand that the SBA provides the structure and standards by which affiliate lending institutions must operate as they lend to borrowers applying for an SBA loan. As it relates to interest rates, the SBA provides a maximum rate that the lender cannot exceed. The maximum rates quoted by the SBA are made up of a base rate plus a spread. Without getting into the complexities of financial markets, there are three acceptable sources from which the lender can derive the base rate (all of which are approximately the same):
The prime rate
The London Interbank (LIBOR) One Month Prime plus 3%
SBA Peg Rate
The spread chosen is up to the discretion of the affiliate lender so long as it does not exceed SBA maximums. The SBA also offers both fixed and variable interest rates.
While affiliate lenders typically charge miscellaneous fees for underwriting a loan, the SBA charges a single “guarantee fee” to cover the percentage of the loan being guaranteed by the federal government. The fee is based on the loan’s maturity and the dollar amount guaranteed, not on the total loan amount. The affiliate lending institution pays the guarantee fee to the SBA with the option to pass the expense on to the borrower at closing. There may be other third party fees, including an appraisal, business valuation, environmental reviews, and filing fees.
The loan term is the period of time in which the loan is in effect and to be paid down. The SBA 7(a) and CDC/504 have terms ranging between 5 and 25 years.
A prepayment penalty is a fee charged by the lender for paying down the loan at a faster rate than that scheduled in the loan agreement. While most SBA loan products allow borrowers to make prepayments without a penalty, there are circumstances and conditions in which a prepayment fee will be levied.
Collateral & Personal Guarantee
Collateral is the asset or assets used to secure the loan. If the borrower defaults on the loan, the lender has the right to take possession of the collateral as payment. Because collateral provides a level of security to the lender in the case of default, loans backed by collateral often have lower interest rates than loans that are not.
On the same lines of collateral, a Personal Guarantee is an unsecured (not backed by explicit assets) promise by the borrower to pay back the loan with his or her personal assets should (s)he default on the loan. Nearly all SBA products require some form of a available collateral as well as a Personal Guarantee from individuals with ownership of 20% or greater.
Can I have multiple SBA loans?
The short answer is, yes, you can have multiple SBA loans simultaneously. Since the maximum loan amount under the 7(a) program was increased to $5 million, many lenders have started splitting larger loans into smaller loans. Therefore, there has been an increase in multiple 7(a) loans to the same borrower at approximately the same time. When lenders make multiple loans to one borrower, which are to be approved within 90 days of each other, the loans will be treated as if they were one loan when determining the guaranty percentage and the amount of the guaranty fee. (1)
Popular SBA Loan Products
Now that we have a broader understanding of the purpose and function of the SBA, let’s discuss a few of the agency’s most popular loan products: the SBA 7(a), the CDC/504, the Disaster loan programs.
SBA 7(a) Loan Program
The SBA 7(a) program is the agency’s primary and most popular loan program. The program focuses on helping start-ups and existing small businesses by providing a financing guarantee for a broad array of business purposes.
One of the benefits of the 7(a) program is its exceptional broadness, providing flexibility for both short-term and long-term financing needs. In addition, the federal guarantee and the longer terms allow borrowers to keep greater cash flow within the business. Another benefit of the 7(a) program is that it is fully amortized, eliminating the need for a giant balloon payment at the maturity date. Finally, the 7(a) program has no prepayment penalty for loans with terms less than 15 years and a reduced prepayment penalty for loans with terms greater than 15 years.
In order to qualify for the SBA 7(a) program, the borrower must:
Operate as a for-profit business
Meet SBA size requirements (refer to SBA Definition of Small Business section) Show good character, credit, management competency, and the ability to repay Do business (or propose to) in the United States or its territories
Plan to use proceeds for an approved purpose (7(a) loan proceeds may be used to establish a new business or to assist in the operation, acquisition or expansion of an existing business)
Not have funds available from other sources (SBA does not provide financing to businesses when the individual owners or the company itself has sufficient or partially sufficient capital)
Have a feasible business plan
Maximum of $5 million
(Average Amount: $371,628 as of 2015) (2)
The interest rate is negotiated between the borrower and the SBA-approved lender, subject to the SBA maximums. Both fixed and variable interest rates are available.
Maturities less than 7 years: Base + Max Spread of 2.25%
Maturities of 7 years or greater: Base + Max Spread of 2.75%
The spread on loans of less than $50,000 and loans processed through SBA 7(a) Express have higher maximums
All loans are fully amortized (meaning that the borrower’s periodic payments will consist of both interest and principal such that the entire loan will be paid by the final maturity date)(i.e. No balloon payments)
- For loans under $150,000: Guaranty Fee is 0% (No Fee)
- For loans greater than $150,000 with a maturity of one year or shorter: Guaranty Fee of 0.25% (of guaranteed portion)
- For loans between $150,000 and $700,000 with a maturity greater than one year: Guaranty Fee of 3.00% (of guaranteed portion)
- For loans greater than $700,000 with a maturity greater than one year: Guaranty Fee of 3.50% (of guaranteed portion)
- Note: There is an additional Guaranty Fee of 0.25% on any guaranteed portion greater than $1 million
Percentage Guaranteed by SBA
- Up to 85% for loans for $150,000 or less
- Up to 75% for loans greater than $150,000
Maximum exposure the SBA will undertake is $3,750,000
- For Real Estate: Up to 25 years
- For Equipment & Business Acquisition: Up to 10 years
- For Working Capital: Between 5 and 7 years
For loans with a maturity of 15 years or greater, a prepayment penalty applies when:
The borrower voluntarily prepays 25% or more of the outstanding balance of the loan, AND
The prepayment is made within the first three years after the date of the first disbursement of the loan proceeds.
During the first year after disbursement: 5% of prepayment amount. During the second year after disbursement: 3% of prepayment amount. During the third year after disbursement: 1% of prepayment amount
There is a first lien on the assets acquired with the loan proceeds as well as a Personal Guarantee of all principal owners with 20% or more ownership.
Use of Funds
Long-term working capital to pay for: operational expenses, accounts payable and/or to purchase inventory
Short-term working capital to pay for: seasonal financing, contract performance, construction financing and exporting
Revolving funds based on the value of existing inventory and receivables (under special conditions)
Purchase equipment, machinery, furniture, fixtures, supplied, or materials
Purchase real estate (including land or buildings)
Construct a new building or renovate an existing building
Establish a new business or assist in the acquisition, operation, or expansion of an existing business
Refinance existing business debt (under specific conditions)
Restriction of Funds
Proceeds cannot be used to buy an asset to hold for its potential increased value (speculation) or to reimburse an owner for the money previously put into the business
Proceeds cannot be used to refinance existing debt where the lender is in a position to sustain a loss and the SBA would take over that loss through refinancing
Proceeds cannot be used to implement a change to business ownership or for a change that will not benefit the business
Proceeds cannot be used to permit the reimbursement of funds owed to any owner
Proceeds cannot be used to repay delinquent state or federal withholding taxes or other funds that should be held in trust or escrow
Proceeds cannot be used for purposes that are not considered to be a sound business purpose as determined by SBA.
SBA 7(A) Express Loan Program
The SBA 7(a) Express loan falls under the SBA 7(a) loan umbrella. The 7(a) Express program is focused on a quicker application and funding process. The SBA achieves this by providing affiliate lenders with more control over the approval process. Essentially, the SBA defers to the affiliate lender’s underwriting process and simply performs a high-level review of the loan before providing final approval. The trade off for a quicker approval process is a lower maximum loan amount, higher interest rate, and a smaller federal guarantee.
The program offers the simplest and quickest application and approval process while maintaining very favorable terms.
Refer to SBA 7(a) Loan Program
Maximum of $350,000
- Up to 6.5% over the base rate for loans of $50,000 or less
- Up to 4.5% over the base rate for loans over $50,000
Refer to SBA 7(a) Loan Program
Percentage Guaranteed by SBA
Up to a Maximum Guarantee of 50%
- For Working Capital: Up to 7 years
- For Equipment: Up to 10 years
- For Real Estate: Up to 25 years
- For Revolving Lines: Up to 3 years
- Lenders are not required to take collateral for loans up to $25,000
- Lenders may use their existing collateral policy for loans over $25,000 up to $350,000
Use of Funds
Refer to SBA 7(a) Loan Program
CDC/504 Loan Program
A Certified Development Company (CDC) is a nonprofit corporation tasked with contributing to the economic development of its local community. With over 252 entities nationwide, CDCs work with both SBA and non-SBA lenders to provide financing to small businesses. The CDC/504 Loan Program provides businesses with long-term, fixed-rate financing for large fixed assets, such as buildings and property. The 504 loan program provides banks with a unique financing tool for small businesses looking to either create jobs or meet specific public policy goals. Under the CDC/504 Loan Program, an independent lender partners with a CDC to finance a small business loan request.
One of the greatest benefits of the CDC/504 loan is the low down payment. The loan is structured such that the partner lending institution will provide a portion of the loan, the CDC will provide another portion, and the borrower will provide at least 10% as a down payment. With the CDC/504 loan, however, the borrower can borrow the 10% down payment from another lending institution so long as it is not from another SBA loan. In addition, the associated fees from the loan can also be financed as well. Other benefits include a longer loan term, which preserves cash flow, and full amortization, which eliminates balloon payments.
In order to qualify for a CDC/504 Loan, borrowers must:
- Operate a for-profit company
- Do business (or propose to) in the United States or its territories
- Have 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
- Be an SBA-eligible type of business (click here)
- Satisfy Use of Funds requirements
- Not have funds available from other sources
- Have the ability to repay the loan on time from the projected operating cash flow of the business
- Have 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)
- Possess relevant management expertise
- Have a feasible business plan
Note: Loans cannot be made to businesses engaged in speculation or investment in rental real estate.
Maximum loan amounts are determined by how funds will be used based on which goal they support from the list below:
The maximum loan amount is $5 million for meeting the job creation criteria or a community development goal. Generally, your business must create or retain one job for every $65,000 provided by the SBA, except for small manufacturers, which have a $100,000 job creation or retention goal.
The maximum SBA loan amount is $5 million for meeting the public policy goals of energy reduction or alternative fuels. Examples of public policy goals include:
Business district revitalization
Expansion of exports
Expansion of minority business development
Increasing productivity and competitiveness
Restructuring because of federally mandated standards or policies
Changes necessitated by federal budget cutbacks
Expansion of small business concerns owned and controlled by veterans (especially service-disabled veterans)
Expansion of small business concerns owned and controlled by women
The maximum loan amount for small manufacturers is $5.5 million. A small manufacturer is defined as a business with its primary business classified in sector 31, 32, or 33 of the North American Industrial Classification System (NAICS), and all of its production facilities located in the United States. To qualify for a $5.5 million 504 loan, your business must meet the definition of a small manufacturer and accomplish one of the following:
Create or retain 1 job opportunity per $100,000 guaranteed by the SBA
Achieve one of the community development or public policy goals
Set to a spread above the current market rate for 5-year and 10-year U.S. Treasury bonds.
Equal to approximately 3% of the debenture (the portion guaranteed by the CDC/SBA) and may be financed with the loan.
Percentage Guaranteed by SBA
The CDC’s portion of the loan is backed by a 100% SBA-guarantee (a maximum of $5 million for most businesses and $5.5 million for small manufacturers or specific types of energy-efficient projects). The borrower contributes equity of at least 10% of the project’s cost.
Terms of either 10 years or 20 years.
There is no prepayment penalty after 10 years on 20-year term loans. The prepayment penalty declines in an accelerated fashion over the first 10 years and is eliminated in year 11.
The prepayment penalty is calculated based on the loan debenture (the portion funded by the CDC/SBA) rate. If you have a 10-year-term loan, the same principles apply; the penalty declines at an accelerated pace over five years.
The project assets being financed are used as collateral. The affiliate lender’s loan is secured by a first lien covering 50% of a project’s cost (The SBA does not provide a loan guarantee for the bank-funded portion of the financing). The CDC’s loan is secured by a second lien for up to 40% of the project’s cost. Personal guarantees of the principal owners are also required.
Use of Funds
The purchase of land, including existing buildings
The purchase of improvements, including grading, street improvements, utilities, parking lots, and landscaping
The construction of new facilities or modernizing, renovating or converting existing facilities
The purchase of long-term machinery and equipment
Restriction of Funds
Working capital or inventory
Consolidating, repaying or refinancing debt
Speculation or investment in rental real estate
SBA Disaster Loan Program
As a small business owner, the possibility of a natural disaster has surely crossed your mind. What would you do? How would you recover? Whatever your contingency plan may be, you can take comfort knowing that the SBA provides resources for exactly such events.
Types of SBA Disaster Loans:
Business Physical Disaster Loans
Home and Personal Property Loans
Economic Injury Disaster Loans
Military Reservists Economic Injury Loans
To learn more, check out our article on SBA Disaster Loans.
The SBA Application Process
So we have an understanding of the SBA and its most popular loan products. Now let’s dive into the crux of the matter: the application process. Below, we will cover broad steps and considerations you should be mindful of as you pursue an SBA loan.
Step 1: Determine Eligibility
More often than not, small business owners expect and rely on obtaining an SBA loan only to realize that the process is daunting or that they aren’t eligible. In order to qualify for an SBA loan, small businesses must not only satisfy eligibility requirements for the SBA, but also the general eligibility requirements of the affiliate lending institutions making the actual loans. For more detail on specific SBA Eligibility requirements click here.
Again, borrowers must also qualify with the individual affiliate lender as well. This final hurdle is different for each lender and will include analysis of personal and business metrics, such as credit score, years in business, industry classification, etc.
SBA Definition of Small Business
The SBA uses the North American Industry Classification System (NAICS) to determine size standards. You can find the classifications that apply to your business on the NAICS website. Furthermore, you can use the SBA Size Standard Tool to determine if your business is eligible.
Generally, the SBA considers businesses with fewer than 500 employees or annual revenue of less than $7.5 million as small businesses. With that said, there are countless subtle differences and conditions depend on the specific industry.
General Borrower Eligibility
Small businesses must also satisfy general eligibility standards required by the SBA-affiliated lending institutions that will actually be providing the SBA loan. While these standards often vary and depend heavily on the type of lending institution (traditional bank, alternative lender, etc.), there are common metrics that most lenders focus on when determining eligibility.
680+ FICO score: The FICO score is your personal credit score. Why does this matter? Simply put, lenders reference the personal credit history of you and your business partners to help assess the potential of your business to manage and pay back your loan. Your FICO score is based on:
Amount of Credit Card and Other Debt
Length of Time you have had credit
Types of Credit in Use
Recent Credit Inquiries
2+ Years in Business: The length of time your business has been in existence is important for two reasons. First, the length of time your business has been in existence offers insight into how stable your business is and will be moving forward. In addition, the more experience you and your business partners obtain in your given field, the more confidence lenders will have in your ability to understand and navigate the market. Both of these reasons ultimately impact your ability to pay back the loan over time.
Debt Performance: Borrowers require that you have no delinquencies or defaults on debt obligations to the U.S. government (including student loans).
Business Factors: There are many metrics lenders use to measure the performance and health of your business. These factors especially come into play if your personal credit is subpar. The key areas that lenders will focus on are:
Revenue (Sources of Revenue, Growth Projections)
Cash Flow (or how much net cash your business produces after operating expenses)
Existing Debt (Debt Service Coverage Ratio, Debt-to-Asset Ratio, Quick Ratio)
Use of Funds: It is very important to have a clear understanding for what exactly you intend to use the loan proceeds. Lenders like to see that you are allocating resources to projects and investments that will grow the business and thus your ability to repay the loan.
Collateral: Develop a thorough understanding of what capital you are willing to put up as collateral. Often lenders require small businesses to put up collateral or provide a personal guarantee, regardless of credit score and business performance.
States of Incorporation: Different lenders have different state and legal lending requirements
Step 2: Prepare your Financial and Corporate Documents
We suggest that, before you even begin your search for SBA Loan Providers, you take the time to gather and prepare all of the necessary financial and corporate documents. Not only is this a very difficult and time-consuming process that can often hold up the SBA loan application process, but it is also extremely beneficial to develop a comprehensive understanding of your business as you advocate on its behalf to loan officers and lending institutions. Furthermore, by going through this process first, you can save yourself months of back and forth with lending institutions only to find out that you are not eligible or competitive for an SBA loan. Nearly all lending institutions require the following documents:
Personal and business income tax returns
Balance sheet and income statement
Personal and business bank statements
A photo of your driver’s license
Articles of incorporation
A resume that shows relevant management or business experience
Financial projections if you have a limited operating history
In addition, lenders often require a business plan that spells out the nature of your business and your projected ability to repay the loan. A business plan often includes:
Product or service description
Industry and competitive analysis
Marketing and sales strategy
Plan for loan proceeds
The actual approval decision focuses on largely five things:
Character (i.e. credit history)
Capacity (i.e. your ability to pay back the loan)
Capital (i.e. down payment)
Conditions (i.e. terms and intended use of the loan)
Step #3: Find an SBA Loan Provider
Now it’s time for the rubber to meet the road: finding an SBA loan provider. What is an SBA loan provider you might ask? You might remember that earlier we said that the SBA does not actually lending any money itself. Rather, affiliate SBA-approved institutions lend the funds. While all SBA loan providers offer SBA products, they all differ in their application process, eligibility requirements, loan terms, etc.
The first thing to understand when shopping around for SBA loan providers is that not all of them are the same. In fact, each SBA provider will have one of three statuses: SBA Standard, SBA Certified, and SBA Preferred. An SBA Standard Lender is qualified to make an SBA loan, however the lender must submit transactions for review and receive SBA approval in order to receive a guarantee on the credit. As the lender demonstrates an ability to follow guidelines and produce adequate loan volume, it can become an SBA Certified Lender, which allows deals to be prioritized for review and approval. Finally, SBA Preferred Lenders have the authority to decide whether the SBA guarantee can be used or not and, often, the loan can been approved on the same day. Overall, with standard and certified lenders, the SBA checks both the borrower’s eligibility and the lender’s application to ensure the loan is correctly underwritten. With preferred lenders, the SBA only checks the lender’s justification of eligibility for the borrower, not their underwriting.
Next, you want to compare each provider individually. This will allow you to develop a personal relationship with each lender and allow you to ask more direct questions that will help you get a read on your competitiveness as an SBA applicant. You can either go straight to your preferred SBA lender (usually, but not always, a bank), or you can go to sba.gov and use their tool to connect SBA borrowers with SBA lenders.
The final option is to work with an SBA Loan Broker. SBA Brokers shoulder most of the heavy lifting, providing their relationships and experience to offer insight on which lenders are most suitable for your application and how best to present your loan application. While you certainly lose control of how your application is presented, ultimately, brokers can save you time.
Step #4: Fill out SBA Application & Submit
It’s now time to submit your application. While many of the forms should be self-explanatory, there are additional resources out there that can guide you through each step. We have some great resources on completing specific forms for the SBA application.
SBA Application Turnaround Time
If you’ve already submitted your application, you’re probably wondering how long it will take to get approved and receive the funds. One of the greatest disadvantages of the SBA loan process is that it takes a decent amount of time. In fact, it can take as much as three months from application submission to funding. It is very important to get an accurate understanding of the application timeline as you shop around for SBA loan providers.
With new players entering the space, however, the market is changing and application turnaround times are coming down. One such play is SmartBiz , an alternative lender that uses technology to offer SBA loans through SBA Preferred lending partners. While SmartBiz is largely for highly qualified borrowers, they have take massive strides in reducing the application and processing times (averaging two weeks on the high end).
Access to an SBA Loan
I would be remiss if I did not mention this one final point. Obtaining access to an SBA loan is not an easy or quick process. The sheer number of documents and approval processes required before you ever see a penny of growth capital can be daunting. Furthermore, at the end of the day, the SBA is a government agency. As such, they are subject to economic events and the volatile whims of Congressional policy.
Currently, regardless of the lender, you have on average a fifty percent chance of approval. Therefore it is critical to keep other financing options open. If you’re curious about ways to receive some of the benefits of an SBA loan through traditional financing means, take a look at our blog post SBA Loans Are Great, But Can You Recreate Them On Your Own?