Funding is a key part of starting a small business. After securing a loan, you can find an office space, open a storefront, order inventory, launch an e-commerce website, and pay for the services needed to get your small business off the ground.
Starting and growing your new business doesn’t necessarily mean draining your personal bank account. Instead, look for funding opportunities to supplement your financial needs.
The cost to start and run a successful company varies greatly depending on the business model, industry, location, and the owner’s goals. According to the Small Business Administration (SBA), most microbusinesses with 1–2 employees only need $3,000 to start. Most home-based businesses are launched with just $2,000.
Obviously, the funding needed to launch a franchise or an innovative tech startup could stretch into the hundreds of thousands, but a lot of small businesses only need a little extra capital to get their business running.
Small business owners looking for funding solutions to cover startup expenses should consider microloans. While smaller in nature, microloans can provide entrepreneurs—especially minority entrepreneurs or those in low-income communities—access to the capital needed to launch their business.
This guide takes a deep dive into microloans and answers frequently asked questions while assessing the value of this financing option. Keep reading to determine if microloans are the right funding solution for your business.
What Is a Microloan?
A microloan is a smaller loan with fewer stipulations issued to business owners, typically disadvantaged entrepreneurs. A business can use a microloan for a variety of purposes but will have to pay it back faster than traditional loans.
Microloans typically cover smaller loan amounts with flexible requirements and terms. There’s no set amount for what constitutes a microloan, but according to the SBA, a microloan is any loan amount falling below $50,000. The average microloan amount is around $13,000. However, some organizations issue microloans for a little as $500—especially if they want to support community businesses or help entrepreneurs struggling to secure other funding.
While microloans are usually available to anyone, some financial institutions will limit applicants to certain demographics. More organizations are specifically developing microloan programs to help disadvantaged business owners access the funds they need but have been unable to receive through traditional financing.
Microloans Were Built to Help Disadvantaged Business Owners
The modern microloan has its roots in 1970s Bangladesh, where economics professor Mohammed Yunus loaned $27 to local women who wove bamboo stools. Yunus saw how these women were exploited by money lenders and decided to offer a better alternative.
With his loan, these women were able to buy their own materials and begin selling their stools in their own shops. This small loan helped them launch their businesses, and they were able to quickly turn a profit even as they paid back their loans—helping to break the cycle of poverty and debt.
Yunus went on to start the Grameen Bank Project, which strived to provide funding to poor and disadvantaged business owners. Yunus and his bank were awarded the Nobel Peace Prize in 2006.
In the modern era, several organizations provide similar services through microloans. In the United States, the SBA offers microloans to qualifying businesses to help them establish themselves and grow.
Local governments offer small business microloans to foster job growth. Even private organizations have microloan arms that are meant to support lower-income and disadvantaged people. By giving these entrepreneurs the support they need, these microlenders can have a significant impact on communities with minimal capital risks.
Of course, there are plenty of microloan funding options for business owners who don’t come from disadvantaged communities. However, microloans are rooted in creating opportunities for people with poor credit and limited resources.
As many minority small business owners experienced during COVID-relief funding, financing isn’t always equal. Programs like microloans can balance the scales and give disadvantaged business owners access to additional funding.
What’s a Microloan Used For?
Most microloans aren’t limited to a certain type of purchase and can be a flexible way to access the funds you need to open and run your new business. Along with providing a boost to startups, more established businesses apply for microloans when they need to rebuild after a natural disaster or when they want to expand their current operations. Companies of all sizes, shapes, and industries can use the capital from microloans to cover short-term business expenses.
A few examples of common ways small business owners might use microloans include:
- Working capital: this refers to the liquid cash you have on hand to cover daily costs. Working capital can pay for miscellaneous expenses and protect your business if you go over budget for any reason.
- Inventory: a crucial part of many small businesses, from e-commerce stores to local product-based companies. You can purchase items for sale or invest in materials that can be used to manufacture your products.
- Supplies: your supplies can cover everything from safety equipment to office items for your staff. You’re likely going to need to invest more in supplies at the front end of your business but will always need to consider these expenses as you grow.
- Furniture and fixtures: if you have an office or storefront, you’ll need desks, couches, lighting, and other furniture or fixtures to help improve comfort and productivity. You can use a microloan to cover these costs.
- Equipment and machinery: this includes everything from your POS systems to large-scale manufacturing equipment. Like supplies, you will invest more at the start of your business on these expenses, so securing a microloan can give you the capital needed to make these purchases before launching.
- Employee wages: microloan borrowers can use the funds to cover employee wages and salaries. This financial relief can keep your staff covered during a struggling period or while you wait for outstanding client payments.
Some organizations might set restrictions on how you can and can’t utilize microloans, so always review and discuss the requirements with your lender. For example, the SBA states that microloans can’t be used to pay existing debts or to purchase real estate.
Other microlenders create loans to cover equipment costs or to promote hiring growth, which means you’ll need to use those funds for specific purposes. However, for the most part, you’ll have complete flexibility to use your microloan however you’d like.
What Are the Pros and Cons of Microloans?
Like any funding decision, a microloan has pros and cons that could determine whether this financing option is best for you. Just because microlending worked for another organization doesn’t mean it’s right for your needs. Consider a few of the pros and cons of microloans as you weigh this funding option.
Some common advantages to microloans include:
- Microloans tend to have fewer requirements than traditional loans.
- They usually have lower credit score requirements, which means you’ll still qualify if you don’t have the best credit.
- They are often approved faster than larger loans, giving you access to necessary funds quickly.
- They are easier to pay off, which means your business can become debt-free faster.
- They are less expensive. Smaller loans typically mean lower interest rates, so you owe less on the money you borrow.
- You may not need collateral. Some microloans won’t require any collateral to prove that you’ll repay the money.
These benefits have a significant impact on small businesses that need startup funding to open their doors or need a short-term loan to cover emergency costs. However, there are some drawbacks to opting for a microloan.
Some common disadvantages to microloans include:
- The amount is limited. Microloans are inherently small, which means you may not have access to the full amount needed to make a significant difference in your business.
- The term might be shorter, which means you will need to pay back your loan faster and could have a higher monthly payment than a traditional loan.
- Some microloans have restrictions on what you can spend the money on—like equipment financing or building remodeling.
- You may not qualify if you don’t meet certain demographic requirements. Some microlenders support specific demographics (like women-owned businesses), disqualifying entrepreneurs who do not meet those requirements.
As you start to research microlending, consider what amount you’d need to borrow, how you plan to pay it off, and the timeline needed to return the amount borrowed. Answering these questions will help you to determine whether the terms of the loans you find are reasonable and to decide if a microloan is the right option.
Who Issues Microloans?
There are several organizations that specialize in providing microloans to small businesses. The SBA is one of the most common sources of microloans, so we’ll start there.
SBA Microloan Program
The SBA is a popular funding resource for small businesses, and they also facilitate microloans throughout the country. You won’t deal directly with the SBA to apply for and receive these microloans.
Instead, the SBA partners with intermediary lenders—nonprofit community-based organizations with lending and management experience—to review, approve, and distribute microloans to borrowers.
Small businesses looking to secure a microloan from the SBA’s microloan program should know the following details:
- Borrowers will need to contact their local SBA district office to begin the application process.
- Each intermediary lender has its own lending and credit requirements, which can vary.
- The maximum repayment term on an SBA microloan is 6 years.
- The maximum amount a borrower can receive is $50,000.
- Interest rates on the microloan are determined by the intermediary lender but typically fall between 8 and 13%.
- SBA microloans cannot be used to purchase real estate or pay off current debts.
Other Microloan Lenders
Beyond the SBA’s microloan program, you can also find microloan opportunities from private lenders or nonprofit organizations like Accion USA or Kiva.
To find a lender who can help you secure a microloan, check out the curation lender services from Lendio. You can fill out a few basic forms and compare lenders to see which ones offer the most favorable terms. To start, answer a simple question: how much money do you need?
If you don’t want to work with a new lender, consult your bank or credit union about their small business funding options. Some banks offer discounts to existing customers, which means you could save by taking out a loan where you already have an account. However, it pays to compare rates, and you could save a significant amount of money by shopping around for loan providers.
What Do You Need to Apply for a Microloan?
Preparation is the best way to increase your odds of getting approved for a microloan and receiving your funds faster. Gathering the right information before you start the application process will streamline your approval.
A few basic items you will likely need for the microloan application include:
- The loan amount you need and what you plan to use it for;
- Your business bank account routing information;
- Your LLC documents and IRS Employer Identification Number (EIN);
- Applicable business licenses; and
- Relevant information about your business (size, employees, annual sales, etc.).
Additionally, you’ll need to be ready for the lender to pull a business credit report and potentially a personal credit report. While you’ll be able to self-report on the application, most lenders will confirm your credit scores on their own. Microloans tend to have lower credit score requirements, but most lenders will still use your credit history to determine your eligibility and interest rates.
Keep in mind that different lenders will set different requirements for loan approval. While this list provides a basic guide for what you should gather, you may need certain documents or statements to confirm your eligibility.
If possible, review the requirements for your microloan before beginning the application process and talk to a lending specialist. They can help you to create a checklist of items to gather before you apply.
What Are Some Alternatives to Microloans?
If you decide that microloans aren’t the best option for you, there are other funding alternatives to consider. These options can provide the same flexibility and similar funding amounts to microloans. Consider what’s available to you and whether these choices are better for your business.
- Business credit cards. Like a personal credit card, a business credit card lets you spend money on anything you want. Your credit provider will set a limit for how much you can spend, but you can keep charging the card as long as you stay below that limit and pay it off. Credit cards have several benefits—namely their cashback rewards—but they might not be available if you have poor credit. They also might have annual fees and high interest rates that drive up their costs.
- Crowdsourcing. Crowdsourcing is the ultimate microloan. Instead of seeking a lump sum of money from 1 person, you ask many to give you a few dollars each—like asking 200 people for $10 to raise $2,000. Websites like Kickstarter are popular for small businesses to raise funds, and you might not even have to pay the loan back. However, crowdsourcing is unpredictable, and you may not get all the funds you need if your goals aren’t met.
- Peer-to-peer lending. P2P lending is like crowdsourcing, but it tends to occur on a larger scale. Through P2P sites, investors and entrepreneurs can donate a few thousand dollars as a loan that you’ll pay back once your business starts to grow. Like crowdsourcing, the main drawback is that you don’t know if people will want to loan money to you. You might also have to follow strict repayment terms.
- Small business grants. Grants are like loans, except you don’t have to pay them back. Some local governments and nonprofit foundations offer microgrants to small businesses to help build up their communities. While these grants are free, they often require a complex application process because so many companies apply for them. Plus, you may need to use the grant for specific projects—like investing in clean energy or job creation.
At Lendio, we have several business funding choices for your needs. Learn more about equipment financing, merchant cash advances, and other ways to secure small and large amounts of money to start your business.
Let Us Help You Secure a Microloan
If you only need a few thousand dollars to launch your new business venture or help cover inventory costs, then a microloan might be right for you—especially if you’re a marginalized business owner. These smaller loans are a great way to get the working capital you need without taking on a lot of the risk or financial burden that comes with larger funding options.
Whether you hope to secure $500 for a short-term upgrade or need a $50,000 investment, our team at Lendio is here to help you. Use our guides to research different funding types and opportunities for small businesses. You can find a potential microlender or an alternative option to increase the cash flow of your business.