The U.S. Small Business Administration (SBA) is the go-to resource for small business financing needs. Working through traditional financial institutions like banks, the SBA offers several loan programs specifically designed to meet the unique funding needs of businesses. For many of these businesses, qualifying for an SBA loan can be the difference between staying in or going out of business.
“A banker experienced in SBA loans offers much more than loan documentation,” said Dell Duncan, First Federal Lakewood vice president of commercial lending and SBA specialist. “The best will advise borrowers, help set expectations, foresee potential pitfalls and continuously communicate to ensure the borrower is well-informed throughout the loan process.”
Working through a financial partner to understand and apply for the most appropriate SBA loan program is the best way to ensure a timely process and increase the likelihood of approval. The commercial banker will work with the SBA directly to make the process smooth for the borrower and the lending institution.
The SBA’s 7(a) loan program and the 504 loan program are the SBA loans most widely sought and used by small businesses. The two programs have similar eligibility requirements, usage criteria, amortization schedules, interest rates and funding limits., but there are some unique differences.
The 7(a) SBA Loan Program
Offering help for small businesses, this loan program is the most common SBA loan program, and has a number of loan types. The variety of acceptable uses makes 7(a) loans attractive to many businesses seeking loan options. Loan funds can be used for any sound business purpose, including real estate purchase (land and buildings), construction, business acquisitions, working capital, refinance of existing debt, and the purchase of furniture, fixtures, and supplies.
7(a) loans can be up to $5 million and traditionally carry a 75% SBA guarantee. In order to provide greater funding for small businesses during the pandemic, the guarantee has been increased to 90% through the end of 2021.
Eligibility requirements include meeting the SBA’s small business definition, operating for profit, operating a legal business purpose and operating in the United States or U.S. territories. The business owner must have some equity in the business and demonstrate a need for the funding.
A 7(a) loan is usually repaid in monthly installments of principal and interest. Rates can be fixed or variable. The lender establishes the interest rate based on the borrower’s payment history, collateral, credit score, and other factors.
A type of 7(a) loan, the Express Loan offers faster approval time, generally within 2-3 days from completed application, and can be approved for amounts up to $1 million with 75% SBA guarantee through the end of September 2021. Small businesses like that the loan can be initially funded as a line of credit, with advances as needed, then termed out over a five to seven year period.
“The SBA guarantee allows us to take a closer look at applications that may not qualify under stricter conventional business loan standards,” said Duncan. “It opens the door a little wider for businesses that need financial help, and would otherwise be declined.”
504 Loan Program
The 504 loan program continues to grow in popularity due to the low interest rate environment. These loans, up to $5 million, are funded by the bond market, backed by the SBA, and give small businesses access to more attractive fixed rate terms – 10, 20 or 25 years – and fixed rates that are often ½% less than other funding sources. The flip side is that 504 loans can only be used to fund fixed assets such as machinery and equipment; owner-occupied real estate, including new facilities or existing real estate; and commercial property improvement. Loan funds cannot be used for working capital or inventory, consolidating, speculation or investment in rental real estate.
Eligible 504 loan borrowers must have a tangible net worth of less than $5 million, average net income of less than $5 million after federal income taxes for two years before application, operate as a for-profit company in the United States or its possessions. In addition to SBA size guidelines, eligibility requirements include qualified management expertise, a feasible business plan, good character and the ability to repay the loan.
The SBA was established to help small businesses prosper by making credit available to businesses that for various reasons would not qualify for conventional commercial loans. These can include less than perfect credit, short, or no operating histories, or those operating in certain industries that are considered riskier to traditional lenders.
For SBA loan borrowers, under temporary guidelines established by the recent economic stimulus package, the SBA will make the first three months of loan payments, up to a total of $9,000 per month. In addition, the SBA guarantee fee, usually about 2.3% of the loan amount and passed along to the borrower, is waived until funding runs out later this year. These temporary cost-savings are intended to help more small businesses reduce financing expenses during the impacts of COVID-19.
Other criteria appeal to SBA borrowers. Industry eligibility for SBA loans is broader than traditional banks provide. SBA loans generally require a lower equity infusion from the borrower. The SBA may require owner equity as low as 10% instead of a bank’s 20-25% equity requirement. The SBA will not decline a loan due to lack of collateral. Inconsistent debt service capacity is acceptable if there is a valid reason (like the COVID pandemic). The SBA has a little more flexibility in weighting a borrower’s credit score. A longer repayment period, resulting in lower monthly payments, also make SBA Loans attractive to businesses that need to conserve cash.
The SBA doesn’t expect small business owners to decipher hundreds of pages of programs, guidelines and regulations to apply for its loan programs. Instead, business owners work with a local banker who will take time to understand the business and the financing request and work with the borrower and the SBA throughout the entire process to generate the most useful financing arrangement in the most efficient manner.
Not all banks and commercial bankers are active or dedicated to the SBA programs, so business owners may need to talk with more than one institution until they are comfortable with the banker’s SBA knowledge and ability to recommend and facilitate the right SBA financing option for the business’s best interest.