Perhaps the main worry of every entrepreneur is getting enough funds to make his business grow. The worry is not unjustified because conventional sources of finance like banks and credit unions are usually extremely reluctant to extend loans to startups because of the absence of a track record. Typically, small business owners try to manage with personal savings, or credit cards or personal loans that tend to be quite expensive. However, most are perhaps not aware that the government offers various kinds of less expensive business loans through banks as well as direct lenders partnering with the US Small Business Administration. A low-down on the most common SBA government small business loans:
Why Does the Government Extend Business Loans?
Even though conventional commercial lenders like banks extend business loans at reasonable rates of interest, they normally do not fund small businesses and startups because they are riskier. According to studies, less than half of them survive the initial five years and are thus likely cases of default. While the SBA does not itself extend any loans, they offer a guarantee of up to 85% of the amount of the loan that protects the bank from default by the business. Due to this guarantee, the SBA partner banks become more willing to extend loans to small businesses.
Who Is Eligible to the Government Business Loans?
As attractive the SBA loans are, not every small business is eligible for one because, in case of default, the SBA has to pay the lender back, and a large portion of this has to come from taxpayer dollars. To prevent wastage of tax money, the SBA requires the loan applicants to have a strong credit score, proof of having invested personal money and time in the business, and lack of success in getting funds through other options. The business needs to be at least two years old and profitable. The eligibility is more relaxed for SBA microloans, however, the need for a good credit score remains.
The 7(a) Loan Program
The 7(a) Loan program, perhaps the most popular SBA program, provides term loans that need to be repaid over a fixed period together with the interest. While the loan is capped at $5 million, the average disbursement is a little over $400,000. Apart from the interest, SBA 7(a) loans are also subject to fees charged by the SBA, which is typically passed on by the lender to the loan recipient. The fee, as well as the rate of interest, depends on the loan amount and the tenor. Loans under $150000 do not attract fees while the maximum fee of 3.75% applies to loans in excess of $1 million. The rates of interest are negotiated between the borrower and the lender and tied to the prime rate. Loans for less than seven years are priced at a maximum of Prime rate + 2.25% and for over seven years at Prime rate + 2.75%. Loans under $50,000 and expedited loans carry higher rates. These terms are comparable to the finance available from leading private lenders like https://www.libertylending.com/ .
The CDC/504 Loan Program
The CDC/504 Loan Program offers loans for specialized purposes to small businesses. Typically, loans are available for purchasing or upgrading commercial facilities like real estate, warehouses, equipment, production lines, heavy machinery, etc. Three different parties are involved in CDC/504 loans; a Certified Development Company (CDC) that is essentially a non-profit lender approved by the SBA for improving community economic development that extends 40% of the loan amount and also guarantees it. While the bank gives 50%, the borrower has to contribute the remaining 10% as margin money. Depending on the type of business and if it is a startup, there could be a need for a larger down payment by the borrower. The loan is capped at $13 million and can be more depending on the type of industry and number of jobs being created. CDC/504 loans entail origination and processing fees that amount to around 3% of the loan amount. While the interest rate of the CDC component of the loan is tied to 5-year and 10-year Treasury notes, the interest rate charged by the bank is negotiated mutually. Since collateral in the form of property is available, the bank also charges less interest, which, however, may be variable instead of being fixed for the entire tenor. While CDC/504 loans are ideal for capital-intensive requirements, the loan processing can take a lot of time and the number of applications that are accepted is also limited.
SBA Microloan Program
As the name suggests, SBA Microloans provide up to $50,000 to small businesses who find it very difficult to access capital because either they have just been established or are engaged in activities that lenders shy away from due to their riskier profiles. In this program, the SBA funds community-based non-profit organization that determine eligible borrowers and provide microloans in the range of $5,000 - $50,000; the average is around $14,000. The longest period for the repayment is, however, only six years. The interest rate, terms of repayment, and the fees are negotiated by the non-profit disbursing the loan and the borrower; the interest is typically in the range of 8%-15%. The main criterion used to qualify the loan application is the ability to repay, not the borrower’s credit history. SBA Microloans work out very well for business owners requiring a small amount of capital either to buy equipment or for working capital.
While the most popular government loans for small business owners are the SBA 7(a) loan, CDC/504 loan, and Microloan, there are some other specialized loan programs of the SBA that may be more suited to the special needs of the business owner. These include SBA disaster loans that provide funds for the long-term to businesses that have been affected by a natural disaster, SBA import/export loans that provide funds for production, inventory, or supply of goods meant for export, and SBA CAPLines for working capital, seasonal lines of credit, and contract loans. Apart from the SBA, small businesses can also get funds from other state and local government agencies.