How SBA Loans Work
With a traditional loan, you directly approach a lender and request financing. If the lender approves, they’ll give you the money. The SBA, on the other hand, serves as a mediator between you and a lender. You’ll work through the SBA to find a potential lender, who will then consider your request.
The kicker is that once you’re approved, the SBA guarantees a sizable portion of the loan, reducing the lender’s risk. Because they know they’ll get paid even if you were to default, lenders are much more willing to be generous with you. The SBA’s incentive means lenders will even compete for your business.
Because SBA loans are so beneficial for borrowers, they’re increasingly popular with entrepreneurs. Securing a loan with monthly payments, fixed interest rates, and generous repayment terms is rare indeed. And the process of paying off an SBA loan builds your credit, which improves your options when you need to pursue additional financing in the future.
A Few SBA Basics
Although SBA loans offer a bevy of benefits, don’t think for a moment that getting one is a walk in the park. Applying for these loans takes a lot of effort. First off, there’s a legendary amount of paperwork. If you dread the idea of filling out massive forms, you probably won’t love the SBA application process.
Second, all that paperwork takes a long time to process. While some mainstream loans can get approved and funded in a couple of days, SBA loans easily take a couple of months (or more) to get the green light. This difference is important to note because there are times when speed is of the essence for entrepreneurs. And in those times, an SBA loan is definitely not a good option.
However, as long as you’re comfortable with the quirks of SBA loans, you’ll find they’re an excellent way to obtain financing. Because each type of SBA loan has unique requirements and benefits, here’s a breakdown of what you can expect…
SBA 7(a) Loans
In the world of SBA financing, these loans are definitely the rockstars. Because these loans have remained popular for decades and have actual worth, they’re much more like the Eagles than Nickelback. Each year, more entrepreneurs use the 7(a) program than any other offering from the agency.
These loans are tailor-made for those who have been turned down for loans in the past, providing generous rates and terms. Another benefit is their flexibility, as they can be used for diverse purposes, including purchasing machinery, acquiring a new business, or buying real estate.
The good news is that most small businesses meet the SBA 7(a) loan requirements:
- Must operate for profit
- Must do business in the US or its territories
- Must have reasonable owner equity to invest
- Must use other financial resources, such as personal assets, before applying
Your business won’t qualify if it’s involved in loan packaging, investment or lending, multi-sales distribution, speculation, gambling, or if the owner is on parole. Other excluded businesses include dealers of rare coins and stamps, charitable or religious nonprofits, and government-owned corporations.
To apply for an SBA 7(a) loan, you’re required to provide a business license, 2 years of business tax returns, 2 years of personal tax returns, a YTD balance sheet, a YTD Profit & Loss (P&L) statement, and a debt schedule.
You’ll need to submit a strong business purpose for the funds and be able to articulate your business need. Also, you should use the SBA’s size standards to prove your business meets the definition of “small” within your industry.
SBA Express Loans
While 7(a) loans offer many stellar benefits, there are times when they’re not quite fast enough for your needs. As stated earlier, SBA loans are like the molasses of the financial world. So if you need capital fast, they’re probably not a good fit for the situation.
The SBA is aware that small business moves fast, so they’ve created the SBA Express Loan to better fill that void. These loans have a lot in common with the 7(a) program but are on a streamlined timeline. Less paperwork is needed and the waiting period is shorter. As is often the case with expedited loans, the maximum dollar amount is lower than with other programs.
Of course, this loan is still through the SBA, so don’t be overly optimistic and think the money will appear in your bank account overnight. If approved, it’ll still probably take a month or so for you to receive the money.
You’ll most likely qualify for an SBA Express Loan if you own a business and have a credit score of 680 or higher. You’ll need to gather all the necessary documents ahead of time if you want to make the application process smoother.
The following will be required:
- Business license
- Business tax returns
- Personal tax returns
- YTD P&L statement
- YTD balance sheet
- Debt schedule
To meet the SBA loan requirements for usage, you’ll need to apply the funds toward increasing working capital, financing equipment, or debt consolidation. As long as your plan lines up with those uses and adheres to the program’s other requirements, you should be in great shape.
SBA 504 Loans
These loans are intended for small business owners who want to expand their operations. In a nutshell, 504 loans (aka Certified Development Company loans) are 7(a) loans that are laser-focused on real estate.
Here are the uses approved for an SBA 504 loan:
- Purchasing existing buildings
- Purchasing land and land improvements such as grading, street improvements, utilities, parking lots, and landscaping
- Constructing new facilities
- Modernizing, renovating, or converting existing facilities
- Purchasing long-term machinery
- Refinancing debt as part of an expansion of your business through new or renovated facilities or equipment
The terms for these loans depend on what exactly you’ll be spending the money on. If you are purchasing land or structures, the term will be in the neighborhood of 20 years. If it’s machinery or equipment you’re buying, the term will often be half that.
To qualify, your business must have a tangible net worth above $15 million. Additionally, you’ll need to prove that in the past 2 years you’ve had an average net income of $5 million or less. If your business is engaged in nonprofit, passive, or speculative activities, you probably won’t qualify. And, as always, use the SBA’s size standards to ensure you are eligible.
SBA Disaster Loans
Coming off what was a record-breaking year for wildfires and storms in many areas of the country, it’s nice to know the SBA is looking out for small business owners. An SBA disaster loan is a low-interest way to recover from the physical and economic damage caused by declared disasters. These loans are open to a more diverse range of businesses than other SBA programs. There are no size restrictions, and private nonprofit organizations, homeowners, and renters can qualify.
You can use a disaster loan for repairing or replacing personal property, real estate, equipment, machinery, inventory, and business assets. Basically, these loans are meant to help you get your operation back where it was before the disaster struck. You’re not allowed to use the funds to try expanding your business beyond where it was pre-disaster.
Here are the 4 main types of disaster loans:
1. Home and Personal Property Loans
To qualify for one of these loans, you aren’t required to own a business. Instead, this program is meant to help a wide variety of victims of a disaster.
2. Business Physical Disaster Loans
For times when a business or organization sustains damage during a disaster, these loans offer up to $2 million to assist in replacing and restoring damaged property. To qualify, you must live in the declared disaster area.
3. Economic Injury Disaster Loans
Not all damage from disasters is of the physical kind. These loans are meant to assist those who may not have experienced physical damage but have still been negatively impacted. If you qualify, you’ll get as much as $2 million to pay for expenses you would’ve been able to handle if not for the disaster.
4. Military Reservists Economic Injury Loans
These loans are meant for business owners who are employing one or more military reservists called to active duty. The SBA provides financing that makes it possible to continue your business operations.
If you have questions about whether or not you are in a presidential and SBA declared disaster area, you can search by state and territory with the SBA’s online database. Common examples of disasters added to the database include fires, tornadoes, flooding, earthquakes, and drought.
For those who qualify, it’s important to follow the SBA loan requirements as carefully as possible. The first step is registering with the Federal Emergency Management Agency (FEMA). You can do this by calling FEMA at 1-800-621-3362 or visiting DisasterAssistance.gov. Once you’ve received a FEMA registration number, you’ll be eligible to fill out the SBA online application.
Before starting the application, make sure you have this additional information on hand:
- Contact information for all applicants
- Social Security numbers for all applicants
- Employer Identification Number for business applicants
- Deed or lease
- Insurance information
- Business income
- Business account balances
- Business monthly expenses
Once you’ve clicked submit on the application, you’ll need to sit back and wait for the SBA to review your documents and dispatch an inspector. Following an on-site evaluation from the inspector, the SBA will have an estimate for the cost of your damage. You should know that the SBA considers disaster loans a priority, so if you qualify, you’ll get the good news in as little as 3 weeks.
SBA Express Bridge Loans (EBLs)
The Express Bridge Loan (EBL) Pilot Program was created to complement the other disaster loans provided by the SBA. It empowers 7(a) lenders to provide financing on an emergency basis. Of course, the only way to qualify is if the need is tied to a disaster-related purpose.
The key words in the name are “express” and “bridge.” Essentially, these loans provide expedited money to businesses hurt by presidentially-declared disasters. These loans are smaller than most, tapping out around $25,000. The idea is that they help you bridge the gap between the disaster and the arrival of more substantial loans.
This SBA loan program requires that you are located in a primary county or contiguous county that’s been presidentially-declared a disaster area, your business had established a banking relationship with the lender as of the date of the disaster, the funds are used for the survival or reopening of your business, and that the application process must be concluded within 6 months of the qualifying disaster.
Defaulting On an SBA Loan
As long as you consistently make the required payments on your loan, the topic of default isn’t even relevant. But if you fall behind on your payments, it’s helpful to know what to expect.
First, the lender would contact you to discuss the situation and offer possible solutions. If you’re unable or unwilling to make the necessary payments, the lender will initiate the collection process as described in the SBA loan agreement.
After the lender has exhausted their recovery options, they will submit a claim to the SBA. This stage is when the federal government’s guarantee comes into play, and the SBA will repay a significant portion of the loan for you.
At this point, the lender will move on to greener pastures, and you’ll be dealing directly with the SBA. The agency will contact you and request the remaining balance. They will also allow you to make an offer in compromise, which means you suggest an amount smaller than what is owed. If your financial situation is compelling enough, they may accept your offer.
Even if the SBA rejects your offer, you’ll typically have the chance to submit another (more substantial) offer in compromise. Be aware, however, that the SBA also has the right to send your account to the Department of the Treasury. Unlike the SBA, the Treasury has the power to begin collection through actions such as wage garnishments and claiming your tax returns.
While there’s often a chance you can settle with the Treasury, the process isn’t for the faint of heart. For this reason, you should always try your best to resolve payment issues with the original lender, rather than letting the issue reach the highest levels of the government’s financial world.
SBA Loans Aren’t Your Only Option
While SBA loans are undeniably great, always account for the fact that they take extra time and effort to obtain. You can’t simply stroll along and expect positive results. Do your homework to find the best option, then meticulously gather all the required documents.
Ultimately, the biggest SBA loan requirement is patience. If time is limited and you don’t want to wait for the lengthy SBA approval process, there are other excellent loans you may want to consider. These alternatives include short term loans, merchant cash advances, equipment financing, and accounts receivable financing.
Each loan product has its pros and cons, which is why it can be helpful to get an expert’s opinion. If you have questions specific to SBA loans, reach out to the advisors at your nearest District Office. For questions about a broader range of loan products, including short term loans and other non-SBA options, feel free to talk to the experts at Lendio. We can answer any questions you have and guide you to the best choice for your needs.