What is an SBA loan?

Every day as a small business owner is an adventure. Sometimes, opportunities arrive unexpectedly, or your need for resources changes. If you're looking for financing for your small business, you may have heard about SBA loans. What is an SBA loan, and how are they different from traditional business loans? Because SBA loans are backed by the U.S. Small Business Administration (SBA), they can help to make funding available to younger companies or to businesses needing to establish a credit history.

SBA loans are designed to meet the unique needs of small businesses looking for funds for a number of purposes, from assistance with working capital needs, to company expansion, debt refinancing or the purchase of real estate and equipment.

How does an SBA loan work?

While the SBA itself does not directly lend to small businesses, the agency does guarantee loans made by approved lenders or financial institutions. This guarantee eliminates some of the risk to its lending partners. The SBA also sets the guidelines for their loan program, including loan terms, maximum borrowing amounts and interest rate caps. In addition to the SBA's guarantee, lenders participating in this program may also require individuals owning 20% or more of a business to provide a personal guarantee or collateral for a portion of the loan.

SBA loans offer larger maximum amounts and longer terms compared to traditional business loans for small businesses. Lenders may use their own credit guidelines when performing a risk assessment of the business applicant. Based on the credit history of the business and its owners, a lender may approve an applicant for one or more types of SBA loans.

Eligibility determination for an SBA loan

To apply for an SBA loan, companies in the U.S. must meet certain eligibility requirements in terms of size and type of business. Business owners will need to prepare a loan proposal that proves they meet the SBA's criteria. The proposal will also document the company's current and future business plans, the reason for their loan request and any collateral offered to support the loan. Lenders may also want to review company financial statements, several years' worth of tax returns and proof of collateral, if needed.

Types of SBA loans

The SBA offers several types of loan programs designed to support the diverse financial needs of small businesses. Whether you're looking to purchase real estate, access working capital or recover from a disaster, there's likely an SBA loan tailored to your situation.

SBA 7(a)

A standard 7(a) SBA loan offers borrowers between $500,000 to $5 million. These loans are approved to help small businesses meet a variety of needs, including:

• Funds for working capital
• Purchases of equipment, furnishings or real estate
• Refinancing existing debt
• Facilitating a change in ownership
• Any combination of these approved purposes

The SBA will guarantee up to 75% of the balance of an SBA 7(a) loan. Interest rates charged by the lender may not exceed the maximum amount set by the SBA for this program.

SBA express

Express loans are the quickest and most flexible borrowing option of all SBA loans. Express financing is available through a line of credit or term loan in amounts of up to $500,000. No collateral is required for express loans of up to $50,000. For amounts over $50,000, the SBA guarantees 50% of the loan. Interest rates may not exceed the SBA maximum rate.

SBA 504

An SBA 504 loan offers long-term, fixed rate financing for owner-occupied real estate purchases or company expansion. This type of loan may also be used to acquire machinery and equipment or for some types of debt refinancing. SBA-approved Certified Development Companies (CDCs) work with lenders to originate loans of up to $5.5 million through the 504 program. Eligibility is limited to for-profit companies with a net worth under $20 million and average income of less than $6.5 million annually.

EIDL

Small businesses affected by disasters such as fires, floods or severe storms may apply for a low-interest Economic Injury Disaster Loan (EIDL) through the SBA. Funds may be used for working capital needs and to pay ongoing business expenses during the recovery period. This loan may not be used to purchase new assets or to fund company growth. Borrowers are able to defer their first payment for 12 months and will not accrue interest for the first year. EIDL loan applications are submitted directly to the SBA.

SBA loans vs. traditional business loans

Both SBA loans and traditional business loans provide financing for small companies. Understanding what is an SBA loan vs. a traditional business loan and comparing the pros and cons of each can help you decide which option is the best fit. For both SBA and traditional loans, ask your lender about interest rates and fees to help determine the total cost of borrowing.

Pros of SBA loans

• Favorable interest rates: The SBA sets a maximum rate that lenders may charge.
• SBA guarantee: Limits risk to lender, which opens an avenue to financing for newer businesses or companies with a limited credit history.
• Longer repayment terms: Longer payback periods of 10 or 25 years translates into lower monthly payments, as well as additional time to pay off the loan.
• Larger funding amounts: Average SBA loan sizes are typically larger than general business loans. The average SBA 7(a) loan is approximately $434,000 and average 504 loans are over $1 million.

Cons of SBA loans

• Personal guarantee or collateral: Business owners may be asked to personally guarantee a portion of an SBA loan or offer collateral.
• Strict eligibility and credit requirements: SBA size and eligibility requirements limit the number of qualifying businesses.
• Additional documentation required: Applicants should plan to submit a proposal about their company, their collateral and how they plan to use the funds.
• Longer processing time: Generally, SBA loans take longer to approve compared to traditional business loans.

Pros of traditional loans

• Fast approval process: Loan applicants typically receive a quick yes or no decision.
• No personal guarantee: Some business loans do not require a personal guarantee or collateral.
• No size or industry requirements: Borrowers do not need to meet SBA's eligibility criteria.

Cons of traditional loans

• Higher interest rates: Lenders may charge a higher rate for non-guaranteed business loans.
• Shorter terms: Payback periods are closer to five to seven years.
• Lower amounts: Maximum borrowing amount caps out at a lower threshold, generally $250,000.

Common SBA Lender loan terms and acronyms

Below are some of the common terms and acronyms associated with SBA loans that you may need to be aware of before you apply:

• SBA: The U.S. Small Business Administration is a government agency that was created on July 30, 1953, and works with organizations and private lenders such as Citizens to guarantee loans, assist with contracts, provide counseling sessions and offer other support to small businesses.
• SBA Small Loans (up to $500K): The SBA's most popular loan program is designed to help existing small businesses with financing for a variety of business purposes.
• SBA Standard Loans (from $501K up to $5,000,000): Businesses can utilize these loans for multiple purposes such as working capital, equipment and bulk inventory purchases, debt refinance, real estate purchase and improvements and business acquisitions.
• Small business: The SBA determines whether or not a business is classified as "small" by examining its industry, employment or business receipts for a comprehensive look at size. If your business classifies as "small," you most likely are eligible for SBA loan programs.
• Bank prime rate: The base rate that contributes to the interest rate at which banks will lend money to customers.
• Revolving line of credit: A flexible method to borrow funds for your small business, which allows you to borrow up to a certain amount, make payments on the line, then borrow again during the draw period. Also, the borrower is only required to make interest-only payments during that draw period.
• Term loan: A more structured method to borrow funds for a small business, a term loan carries a fixed-interest rate with amortized monthly or quarterly payments and defined loan terms.
• Underwriting process: Handled by your chosen SBA lender, the underwriting process ensures a business owner can meet a business loan's expectations. The process may address the borrower's character, personal and company finances, business plan, resumes and more.

Take the next step: Apply for an SBA loan

Based on the size of your business and your current financing needs, one or more SBA loans may work for you. Speak with an approved SBA lender to learn more about the application process and find out what type of documentation is required. Check out the SBA loan offerings from Citizens today.

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