In their book Start Your Own Business, the staff of Entrepreneur Media Inc. guides you through the critical steps to starting your business, then supports you in surviving the first three years as a business owner. In this edited excerpt, the authors offer a brief description of the different type of loans you can obtain from the SBA.
Where can you go when private financing sources turn you down? For many startup entrepreneurs, the answer is the U.S. Small Business Administration (SBA), whose loans often have less stringent requirements for owner’s equity and collateral than commercial loans, making the SBA an excellent financing source for startups. In addition, many SBA loans are for smaller sums than most banks are willing to lend.
Of course, that doesn’t mean the SBA is giving money away. In fact, it doesn't actually make direct loans; instead, it provides loan guarantees to entrepreneurs, promising the bank to pay back a certain percentage of your loan if you're unable to.
The SBA can help you prepare your loan package, which you then submit to banks. If the bank approves you, it submits your loan package to the SBA. Applications submitted by lenders are generally reviewed by the SBA within a span of several days to two weeks.
The SBA offers a wide variety of loan programs for businesses at various stages of development. Here’s a closer look.
1. 7(a) Loan Program.
The primary and the most flexible SBA loan program is the 7(a) Loan Program. For this loan, the SBA provides maximum guarantees of up to $5 million or 75 percent of the total loan amount, whichever's less. The average loan in 2012 was $337,730. For loans that are less than $150,000, the maximum guarantee is 85 percent of the total loan amount. SBA policy prohibits lenders from charging many of the usual fees associated with commercial loans. Still, you can expect to pay a one-time guaranty fee, which the agency charges the lender and allows the lender to pass on to you. Fees for smaller loans can be as little as zero percent.
A 7(a) loan can be used for many business purposes, including real estate, expansion, equipment, working capital, and inventory. The money can be paid back over as long as 25 years for real estate and equipment, and 10 years for working capital. Interest rates vary with the type of loan you apply for.
The 7(a) Program also offers several specialized loans. One of them, the SBA Express Program, promises quick processing for amounts less than $350,000. SBA Express can get you an answer quickly because approved SBA Express lenders can use their own documentation and procedures to attach an SBA guarantee to an approved loan without having to wait for SBA approval. The SBA guarantees up to 50 percent of SBA Express loans.
For businesses that need working capital on a short-term or cyclical basis, the SBA has a collection of revolving and nonrevolving lines of credit called CAPLines. A revolving loan is similar to a credit card, with which you carry a balance that goes up or down, depending on the payments and amounts you borrow. With nonrevolving lines of credit, you borrow a flat amount and pay it off over a set period of time.
CAPLine loans provide business owners short-term credit, with loans that are guaranteed up to $5 million. There are four loan and line-of-credit programs that operate under the CAPLines umbrella:
1. Seasonal line of credit: designed to help businesses during peak seasons, when they face increases in inventory, accounts receivable, and labor costs
2. Contract line of credit: used to finance labor and material costs involved in carrying out contracts
3. Builders line program: provides financing for small contractors or developers to construct or rehabilitate residential or commercial property that will be sold to a third party. Loan maturity is generally three years but can be extended up to five years to facilitate the sale of the property.
4. Working capital line of credit: a revolving line of credit (up to $5 million) that provides short-term working capital. Businesses that generally use these lines provide credit to their customers or have inventory as their major asset.
3. Pre-Qualification Program.
The SBA’s Pre-Qualification Loan Program helps pre-qualify borrowers in underserved markets, including women business owners. Under the program, with the aid of private intermediary organizations chosen by the SBA, eligible entrepreneurs prepare a business plan and complete a loan application. The intermediary submits the application to the SBA.
If the application is approved, the SBA issues you a pre-qualification letter, which you can then take, along with your loan package, to a commercial bank. With the SBA’s guarantee attached, the bank is more likely to approve the loan.
4. MicroLoan Program.
The MicroLoan Program helps entrepreneurs get very small loans, up to $50,000. The average loan in 2012 was for $13,000. The loans can be used for machinery and equipment, furniture and fixtures, inventory, supplies, and working capital, but they cannot be used to pay existing debts or to purchase real estate. This program is unique because it assists borrowers who generally don't meet traditional lenders’ credit standards.
MicroLoans are administered through nonprofit intermediaries, which receive loans from the SBA, then turn around and make loans to entrepreneurs. Small businesses applying for MicroLoan financing may be required to complete some business-skills training before a loan application is considered. The maximum term for MicroLoans is six years, and interest rates vary.
5. CDC/504 Loan Program.
The 504 Loan provides long-term, fixed-rate loans for financing fixed assets, usually real estate and equipment. Loans are most often used for growth and expansion. 504 Loans are made through Certified Development Companies (CDCs)—nonprofit intermediaries that work with the SBA, banks, and businesses looking for financing.
If you're seeking funds up to $1.5 million to buy or renovate a building or put in some major equipment, consider approaching a CDC. Typical percentages for this type of package are 50 percent financed by the bank, 40 percent by the CDC, and 10 percent by the business.
In exchange for this below-market, fixed-rate financing, the SBA expects the small business to create or retain jobs or meet certain public policy goals. Businesses that meet these goals are those whose expansion will contribute to a business district revitalization, such as an empowerment zone; a minority-owned business; an export or manufacturing company; or a company whose expansion will contribute to rural development.
If your business has the goal of job creation, the SBA program will lend up to $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, according to the guidelines for the program.
6. 8(a) Business Development Program.
The SBA’s 8(a) Program is a small-business set-aside program that allows certified socially and economically disadvantaged companies to enter the federal procurement market as well as the economic mainstream. The 8(a) Program is a starter program for minority businesses, which must leave the program after nine years.
Entrepreneurs who participate in the 8(a) Program are eligible for the 7(a) Guaranty Loan and the Pre-Qualification Programs. Businesses must be owned by a socially and economically disadvantaged individual. Socially disadvantaged categories include race and ethnicity. Participants can receive sole-source contracts, up to $4 million for goods and services and $6.5 million for manufacturing. To qualify as economically disadvantaged, you must have a net worth of less than $250,000, assets under $4 million, as well as two years’ worth of tax returns. There are other qualifications, including that the firm must be at least 51 percent owned by the program applicant and owners must show good character.
7. Export Working Capital Program.
If you're planning to export, you should investigate the Export Working Capital Program. This allows a 90 percent guarantee on loans up to $5 million. Loan maturity is one year; funds can be used for transaction financing. The exports financed must be shipped and titled from the U.S. The loans are typically processed quickly.