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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.
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.
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.
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:
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.
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:
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:
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.
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.
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:
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.
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:
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.
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.
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.
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.
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Derek Miller is the CMO of Smack Apparel, the content guru at Great.com, the co-founder of Lofty Llama, and a marketing consultant for small businesses. He specializes in entrepreneurship, small business, and digital marketing, and his work has been featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp.
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7 min read • Aug 08, 2022