Are You Eligible For a
Small Business Administration (SBA) Loan?
The US Small Business
Administration is devoted to helping startups succeed by assisting with
funding. Entrepreneurs should be aware of this opportunity and whether or not
they are eligible for the loans the SBA provides.
As a result of the
tremendous variety of loans offered by the Small Business Administration, the
different eligibility requirements are too numerous and too detailed to list
here. But there are some broad requirements that most or all potential debtors
must meet to receive this type of funding. All businesses must be operated on
United States soil, and certain types of industries are forbidden from
receiving funding. Gambling, pyramid schemes, investing/speculating, lending or
debt securitization, and all illegal activities are forbidden. Additionally,
nonprofits and religious organizations do not qualify. Additionally, the SBA
generally requires that the potential debtor already be personally invested in
the business from a financial perspective-they usually expect a one-fourth
contribution of owner's equity.
There are other
requirements that vary from loan to loan or industry to industry-the SBA has
standards for what size (in terms of employees and revenues) qualifies as a small
business. The SBA also has requirements for the proposed use of funds. For
example, the 7(a) Term Loan can be used for a great variety of purposes,
ranging from supplementing working capital to refinancing other debt. The
CDC/504 Term Loan, on the other hand, is used specifically toward heavy asset
purchases.
The Small Business
Administration's newest loan incarnation is the ARC loan, short for America's
Recovery Capital. This type of loan came about in response to the economic
crisis, and its eligibility requirements reflect its purpose. Businesses
seeking an ARC loan must:
(a) have been
profitable or cashflow-positive in the past two years
(b) currently be experiencing difficulty meeting short-term financial needs, and have proof, and
(c) not have any existing SBA loans.
(b) currently be experiencing difficulty meeting short-term financial needs, and have proof, and
(c) not have any existing SBA loans.
Most first-time
entrepreneurs are under the impression that SBA loans are an easy, viable route
to funding any startup. While the SBA is an
excellent government program to assist American small business, keep
in mind that it is a government program, with all that distinction
means - the process is slow, the restrictions are strict, and the hurdles to
approval are high. Before you commit countless hours and effort to pursuing an
SBA approval, be sure you understand the realities of the programs as well as
your alternative opportunities for financing your startup.
The SBA is
well-organized with distinctive programs to cover various sizes of businesses
at various stages. The most common SBA program for entrepreneurs is the 7a
Regular, which provides loan guarantees to approved businesses for startup or
expansion needs including working capital, equipment purchases and the like.
These guarantees are not actual loans but are intended to improve the chances
of obtaining a formal bank loan. After all, if the federal government is
promising to repay 75% or more of the loan if the borrower defaults then the
banks should be clamoring to provide the loans, right? Not so much. In fact,
banks are less and less inclined to service SBA-backed loans because of the
requirements (read paperwork) set forth in the SBA guarantee regulations
and the higher risk of helping out small business. Finding a bank to service an
SBA loan is even more difficult if you are trying to fund a startup. The SBA
requires a good personal credit score to even have a chance at a 7a guarantee,
and the banks will require excellent credit plus your personal guarantee and
collateral before they even think about lending the cash.
The 504 program
provides cash directly to Certified Development Corporations, local area
Not-For-Profits that are concerned with business development in disadvantaged
communities. This program is intended to provide up to 40% of the needed
capital for land and buildings for small businesses. The 504 money is borrowed
from the CDC, and the rest must be secured through a formal bank loan. The
requirements vary, but generally the company accepting the loan commits to job
creation at a certain level, such as one new job for every 50k in SBA dollars
or other specific economic development or public policy goal, such as minority
business ownership. Again, good personal credit, collateral (usually the
long-term assets purchased with the money), and the owners' personal guarantee
are required. The Microloan Direct program is probably the most viable option
for most startups. The SBA distributes around 20M per year to intermediaries
such as economic development NFPs throughout the country so they can provide
loans up to 35k to businesses in their areas. The NFPs set their own approval
processes with some guidance from the SBA. The average microloan is around 13k
and most intermediaries also require collateral and a personal guarantee.
The recent Stimulus
Plan includes incentives for banks to make more SBA-backed loans including
reduced fees and increased guarantees to 90% of the total loan amount. Still,
reports indicate that the banks aren't particularly swayed by these incentives
and loans to small businesses, and especially startups, remain limited. The
primary reasons are the high risk (one report indicates a failure rate of
nearly 12% in 2008), the high cost of servicing SBA loans (even with the
Stimulus Plan discount), and the little known fact that the SBA can back out of
the guarantees even after the loan has been made.
The reality of securing
an SBA loan is not as rosy as many startup gurus would have you believe, nor is
it necessarily an entrepreneur's best bet. At best, these loans should be a
backup plan if startup cash cannot be found elsewhere. SBA deals are expensive
-- even the microloan interest rates are between at least 8% and 13% - it is
time-consuming and tedious to qualify, and you will be required to support your
application with your personal guarantee anyway. This means that your assets
become fair game for the bank if the business doesn't work out for any reason.
In addition, the chances of approval are much slimmer than most people think.
Last year, just under 70,000 SBA 7a loans were funded, most of which were
likely for established companies. The Microloan program distributed over $20M
last year, but with an average loan value of $13,000, only around 1500 small
businesses (not all startups) enjoyed the fruits of this program. In
considering these numbers, keep in mind that over 600,000 new businesses with
employees are started each year. There are no reliable numbers on the
number of solo businesses that are also launched, but the estimates are that
the total is significantly over 1,000,000 startups each year. Add to that the
number of businesses seeking capital to grow and expand and the odds that any
one startup will be funded through an SBA program are pretty low.
If you are looking to
start your own business, don't make the SBA loan your first choice for startup
financing. Determine how much you can get done out-of-pocket and look to family
and friends investors to round out the funding. Financing your business
yourself and through people who know you and want you to succeed provides you
far more control and can be a stronger incentive to watch the pennies
throughout the life of your venture. However you decide to fund your business,
the first step is to develop a detailed plan, including financials, so you know
exactly how much you need and when. If the total is more than you can finance
yourself, the work you have put in to the planning can be easily organized into
a formal business plan to entice investors, including the SBA.
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