Small Business Financing 101: SBA Loans

Katie Fleming

Katie Fleming

Co-founder and COO of Owner Actions

An entrepreneur applies for an SBA loan for her startup venture.

SBA loans are one of the most commonly used ways to cover early-phase costs. Named after the Small Business Administration that guarantees them, these loans enable small business owners to finance up to 90% of their early costs, working capital expenses, equipment needs, and building acquisition or improvement costs. Businesses need to demonstrate at least one year of performance before being eligible for this category of loans, but an SBA loan can be an option for late-stage startup companies.

 

What are 7(a) loans?

The SBA offers loans to small business owners for an assortment of purposes. Some use them to cover early-phase costs, working capital, and equipment needs, while others use it to finance a small business acquisition. Depending on your needs and the level of financing that you require, you may consider one of three types of 7(a) loans that the SBA offers:

Standard 7(a) loan

Maximum loan amount $5,000,000
Collateral requirements Loans that are $350,000 or more are collateralized to the maximum extent possible. If a business’s fixed assets can’t fully secure the loan, lenders may include trading assets and will take the available equity in the owner’s personal real estate as collateral. Any shortfall may be covered by a life insurance policy that names the lender as the beneficiary.
Maturity terms
  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory
Other terms and conditions The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days.

 

7(a) small loan

Maximum loan amount $350,000
Collateral requirements Loans between $25,000 and $350,000 are generally collateralized through a lien on the assets being financed with the loan proceeds and a lien on the applicant’s fixed assets.
Maturity terms
  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory
Other terms and conditions The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days.

 

SBA express loan

Maximum loan amount $350,000
Collateral requirements Loans between $25,000 and $350,000 are generally collateralized according to the lender’s policy.
Maturity terms
  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory
Other terms and conditions The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the lender. The loan turnaround time is 36 hours or less.

 

The SBA also offers 504 loans to cover the purchase of existing buildings, the purchase of land or land improvements, the construction of new facilities, the renovation of existing facilities, and the purchase of long-term machinery. Unlike 7(a) loans, 504 loans must be used for a specific purpose, which cannot include working capital or inventory or consolidating debt.

While 7(a) loans are provided by SBA-approved lenders, 504 loans are granted through a collaborative effort from participating lenders, SBA-regulated certified development companies (CDC), and borrowers. In most 504 arrangements, the SBA lends 40 percent of the total project costs. Lenders provide 50 percent of the total project costs, and borrowers provide the remaining 10 percent.

 

504 loan

Maximum loan amount $5,000,000; however, business owners are generally required to create or retain one job for every $65,000 the SBA guarantees
Collateral requirements The project assets being financed are often used as collateral, and personal guarantees from owners who have a 20 percent or greater in the business are required.
Maturity terms 10-, 20-, and 25-year terms
Other terms and conditions Interest rates align with the current market rates for 5-year and 10-year U.S. Treasury issues and are fixed for the life of the loan.

Which loan program is right for me?

Whether you choose one of the 7(a) options or the 504 loan will depend on what you plan to do with the funds you raise. If you’re planning to raise capital for a specific real estate project, such as buying land or engaging in renovations, then you’ll likely choose a 504 loan. If you plan to fund other startup costs or working capital needs, you’ll choose a 7(a) loan or another financing option.

It’s important to note that some SBA loans include additional fees and prepayment penalties. You should speak with a lending officer before proceeding with an SBA loan to make sure that it’s a suitable choice for your needs and that your business is eligible for SBA funding.

 

What are the qualifications for SBA loans?

To qualify, you must be operating a small, for-profit business that’s based in the United States. You must be able to make a down payment, equal to 10-20% of the value of the business, and have exhausted other options for financing. Additionally, you and the business you’re acquiring should be on solid financial footing. Applicants should have a credit score greater than 640, and most bankers require businesses to demonstrate one to two years of profitability and growing annual revenues. Lenders may also require a debt service coverage ratio of at least 1.15 to ensure that the business has enough cash on hand to service debt, interest, and lease payments.

At present, some types of businesses are ineligible for SBA loans. You can study the current list of ineligible businesses at SBA.gov.

You can find additional requirements for the 7(a) loan options here and the 504 loan here.

 

Where do I go to attain one of these loans?

Many commercial, regional, and community banks issue all three forms of 7(a) loans, and they can guide you through the steps you’ll need to take to start the 504 loan process. Most will direct you to the appropriate contact at a certified development company (CDC) in your region.

Some online banks also offer these loans. GoKapital and Commercial Loan Direct are two popular lending services many business owners use to access SBA financing.

 

What should I do before applying?

There are four steps you should take before applying for an SBA loan for your startup:

1

Make sure your finances are in good order.

You and any partners who will hold at least a 20 percent ownership share in the business should gather three years of tax returns, determine your net worth, and ensure that your credit scores are 650 or greater.

2

Develop a plan for covering the down payment.

As a borrower, you’ll be expected to make a down payment that equals at least 10 percent on any items for which you’re attaining financing. In most circumstances, the SBA loan will cover the remaining 90%. You may choose to dip into your personal savings, stock accounts, home equity accounts, or retirement funds to accumulate the cash that’s needed, or you could consider leveraging the assets of another business you might own.

You may wish to speak with a certified public accountant (CPA) or financial planner who can help you understand the risks of using each of these sources of funding.

3

Select an SBA loan provider.

You can work with any commercial or community bank that offers this service. You may want to choose one that has a team dedicated to serving small businesses and offers favorable terms and competitive interest rates. GoKapital and Commercial Loan Direct are popular SBA lenders.

If you need help finding a lender, visit SBA.gov and use their Lender Match tool.

4

Gather the documents you’ll need to complete the application.

You’ll need to gather or create personal and business documents to demonstrate your business’s viability, your creditworthiness, and your ability to run the business effectively. Key items include:

  • Three years of personal tax returns for you and any partner with at least a 20% ownership share in the business
  • Documentation of your personal assets and liabilities
  • Up to three years of your business’s tax returns
  • Up to three years of your business’s financial statements, including profit-and-loss statements, balance sheets, and cash flow statements
  • A debt schedule that lists your business’s debts and liabilities
  • Proof of the business licenses and registrations that are required for you to conduct business, which may include articles of incorporation, franchise agreements, copies of contracts that you hold with vendors and key customers, and leases on the property
  • A third-party valuation of the business
  • A business plan that describes the company, the target market it serves, its competitive positioning, and its plans and projections for the future
  • A resumé or other proof of your experience or ability to manage a business

How do I apply?

Your lender will provide you with a loan application and SBA forms specific to the loan you’re seeking. You will complete SBA Form 1919 and SBA Form 413 for the standard 7(a), 7(a) small loan, and SBA express. You’ll also complete SBA Form 1920 for the standard 7(a) and the 7(a) small loan. For the 504 loan, you will complete SBA Form 1244.

Important note: Your lender may ask you to purchase creditor insurance, which provides assurance that the loan will be repaid in the event of your death or incapacity. Learn more about creditor insurance in our Small Business Financing 101 article, What Is Creditor Insurance?.

 

Once you complete the required forms and show that you can provide collateral for the loan, the lender will begin the underwriting process. During this time, the lender will evaluate your assets, liabilities, and managerial experience and assess the business’s financial positioning.

If your lender is an SBA-preferred lender, the team you’re working with will decide whether to approve the loan. Others will need to work through the SBA for loan approval. Once your SBA loan is approved, the lender will work quickly to distribute the funds you need for startup.

 

How can I boost my chances of being approved?

Here are some strategies you can use to boost your odds of approval:

 

What's next?

An SBA loan isn’t your only funding option for startup. Learn about term loans, asset-backed financing, 401(k) options, portfolio loans, and other options, including angel investors and venture capital, in our article, Your Go-to Guide to Raising Capital for an Acquisition.

 

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