When you don’t have the personal or investment capital necessary to start a business that requires a good chunk of it, the logical answer is to look into a business loan. And although just about any loan involves receiving a lump sum of cash and paying it back over a period of time, not every loan program is created equal. Out of all the business loan programs out there, many entrepreneurs tend to enjoy the accessibility and simplicity of SBA loans.
But how do you qualify for an SBA loan? The current economy is volatile, and following the financial losses caused by many coronavirus-related closures, more and more businesses are competing for precious capital. Here’s how to get in on what’s available.
Ensure your business meets the basic requirements
The SBA doesn’t actually give out loans; instead, it works with individual lenders to distribute loans to small businesses by setting guidelines set by its partnering lenders and community development organizations. As such, it’s crucial that your small business meets these “hard guidelines” in order to even be in the running for an SBA loan. The SBA requires that businesses are for-profit, based in the United States, and “small” (per its size standards) to start. Founders need to have invested time and money into the business, exhausted other lending options, and established the ability to repay the loan over a reasonable period of time. The SBA’s lending partners do not consider businesses that don’t meet these criteria, so if your business is technically an enterprise or you’re legally a nonprofit, you may be out of luck. (Other less common characteristics can disqualify a business as well, such as being faith-based, gambling- or marijuana-focused, or discriminatory, like any business that focuses its resources on clients of a certain gender or race.)
Iron out your credit
Like with any other loan, the SBA will examine a founder’s credit score and history to determine their likelihood and ability to pay back the loan amount. As such, SBA loans aren’t available to business owners whose credit scores are under 670, or whose credit histories recently show delinquent payments. Try retrieving a copy of your credit report prior to applying for an SBA loan, and if your credit score is on the lower end, take steps to improve the score over time.
Prepare everything on the loan submission checklist
Applying for a loan is a lot more complicated than just asking for it. The SBA requires that any business looking for a loan completes an extensive loan application, a credit memo, a cash projection document and more. Some of these items are dependent on the amount of the desired loan, the age of the business or the number of borrowers on the loan application. Although less common, 504 loans (which are used for major fixed assets that frequently involve construction or long-term machinery) require different application items, so make sure to look out for the appropriate checklist for your desired loan.
The SBA generally requires that business owners offer up some type of collateral to secure a loan. This is required of anyone who owns 20 percent or more of the business. Collateral can include assets such as real estate or office equipment, and can also cover things like accounts receivable, inventory and an owner’s second mortgage on their home. In the SBA’s own words, this is a founder’s way of proving that they have “skin in the game.”
Similar to any financial decision, taking on an SBA loan also comes with its risks. Offering up collateral can result in personal consequences if you can’t make your payments. SBA loans often have relatively high interest rates as well, which means more money paid back over the long-term (even though those interest rates do have a cap). And just like mortgages, SBA loans often come with origination and appraisal fees that tack onto the down payment before you can receive the actual cash you’ve applied for. All of these factors are important to consider before biting the bullet.
If you do ever take out an SBA loan, remember that they can be put to use in a variety of different ways, including recovering from the impact of Covid-19, hiring new staff, investing in new technologies and even purchasing another business. As your business continues to grow, it is worth considering how this type of loan might best benefit your business.