Updated: Jan 24
When your small business needs additional capital to expand, take on new workers, purchase new equipment to develop new and additional products. You’ve reached a critical milestone in any small business’s life cycle. Although you may have been able to start your small business and get to a certain level of success without having to take outside financing, every small business comes to a point where it needs to seek external funding to thrive. Without obtaining external financing, many small businesses are either stuck in neutral, unable to grow and meet the increasing demand for its products/services or slowly wither like a plant that's without water.
When the time comes for a small business to obtain outside financing to jump to the next level, securing funds that are guaranteed by a federal agency through the Small Business Administration’s loan guarantee program is often the safest bet for an entrepreneur or small business owner. While big banks can still be and are resources, it's helpful to know that they approve roughly 25% of loan applications and ask for more documents during the process. With that being the case, we will focus on the other options.
The Small Business Administration (SBA) is a federal government agency that was created with the express goal of nurturing small business creation and growth in the United States. SBA loans can be used to provide small businesses with working capital, for the purchase or lease of real estate or fixed assets, refinancing existing debt or several other purposes. Through financing programs offered by the SBA, specific lenders can provide financing at lower interest rates and for a longer duration than what a new business typically would have access to under a typical bank loan or other forms of funding.
Financing a Small Business with an SBA Loan
The SBA does not lend money directly to small businesses or their owners. Instead, the SBA sets guidelines for loans made by its partnering lenders, community development organizations, and micro-lending institutions. The lenders do the actual lending, but the SBA provides a guarantee for the loans. The SBA reduces the risk for lenders, in turn making it easier for them makes it easier for them to access capital. SBA loans are available through a wide variety of different SBA-approved lenders.
Additional Help Regarding Applying for Small Business Financing
The SBA’s loan programs
SBA loans come with unique features, advantages, and terms that may not be available for other types of financing. The government guarantee that comes with SBA financing means that rates for SBA financing typically end up being lower than the comparable loans that can be obtained through banks and other financial institutions that do not carry the same government-backed guarantee. The term over which SBA financing can be obtained also is typically longer than comparable bank loans or other forms of funding. This is a win on several fronts for an SBA loan borrower because he or she has a longer window to pay back the loan and ends up paying a lower interest rate than if he or she had obtained some other form of financing. The SBA guarantee means that the lender making the loan or extending financing to a small business will get paid back one way or another, whether by the small business borrower or by the SBA if the borrower defaults and fails to pay the lender back. It also enables the lender to take more risks and lend to businesses it may not otherwise give to if the financing did not carry with it a government guarantee.
The SBA also offers assistance to small business borrowers in their local communities.
The Service Corps of Retired Executives (SCORE) is an official partner of the SBA. SCORE was first launched under President Lyndon Johnson in the 1960’s. Its members are current or retired business owners and corporate executives who provide consulting services and advice to entrepreneurs and small business owners. SCORE has offices throughout the United States but also offers the majority of its services online as well as in person.
One of SCORE’s signature programs is providing entrepreneurs and small business owners with an experienced mentor in the same geographic locale who can offer guidance, coaching, and expert insights to small business owners and entrepreneurs. Local chapters of SCORE also feature seminars and workshops in addition to one on one coaching that SCORE is known for.
SBA Loan Requirements
To obtain an SBA loan, no matter which lender you choose to go through, the requirements for applying for the financing are generally the same. They are set by the SBA and may differ slightly from lender to lender, but most material terms of the SBA will not differ markedly from one lender to another. This makes it easier for potential borrowers because they can assemble one set of materials that they can then use to apply to multiple different lenders that offer an SBA financing to obtain funding that closely meets their needs. The main requirements associated with most SBA financing are that the small business owner must have:
An excellent personal credit score
The business must have solid financials
Future prospects as reflected in its business credit score and business plan
The small business owner must make a personal guarantee or pledge adequate collateral, or both
Personal guarantee: Many times, an SBA or another form of a small business loan or financing will require the small business owner to sign a personal guarantee. This means that the small business owner agrees that he or she is personally responsible for the repayment of the loan if the business proves unable to repay it for whatever reason. If the company fails to repay the loan, then the lender can look to the small business owner to satisfy the outstanding debt. Whether a personal guarantee is required can depend on the lender, but most lenders that require a personal guarantee will do so for any individual that owns more than 20 percent of the business.
Time in business: Many lenders will require that a small business must have been in operation for a minimum period of time before the lender will even consider extending financing. Some lenders will require a minimum of two years in business, while others may require three years. Regardless of which period of time the lender requires, what they will be looking for is that your small business is established and has been profitable enough to pay back the financing that is being sought.
Adequate collateral: collateral refers to the assets that are pledged to secure repayment of the loan. This can consist of the business’s equipment, its bank accounts, its real estate or equipment and/or the personal assets of the business owner or other corporate or personal assets. The purpose of requiring adequate collateral is that the lender needs to know that if something goes wrong, they will have some way to recoup the money that’s being lent to the borrower. If a small business borrower has significant personal assets, then the lender will have some recourse if the small business ends up defaulting on the loan.
Other Information used to Apply for an SBA Loan
Credit score (both personal and business)
Small business owners are required to have excellent personal credit (675 or above through most lenders) to obtain SBA financing. A personal credit score is a measure of how likely it is that an individual borrower can pay back financing that he or she takes on. If a business owner has excellent personal credit, then lenders are likely to look more favorably upon lending to that individual’s business.A business credit score is exactly like a personal credit score that is assigned to a business that rates the creditworthiness of the business, or ability to pay back money lent to a company. It measures the ability of a business to pay back money that is lent to it. Having as high a business credit score is necessary for a small business owner to qualify for SBA financing.
Every business that applies for SBA financing is required to have a written business plan. It should set forth the problem your business is attempting to solve or the need it is helping your clients or customers to meet as well as how your business will help them to meet that need. A business plan is not required to run into the hundreds of pages, but it also cannot be too short; a simple paragraph with no detailed explanation is not enough. A lender is going to be interested in determining whether you will be able to pay back the funds that the lender may extend to your small business. The business plan is how the lender will assess your business’s future prospects.
Bank statements enable a lender to track the cash flow in and out of your small business. A bank statement will allow the lender to map out exactly how much money is coming in and out the door of your business and what your business is spending its money on.
FAQ: SBA Financing
What if my small business has a limited track record?
The lack of an established track record comes with the territory for new or young businesses. A lender understands that a small business generally will not have a long track record of success, particularly if the small business is seeking financing to enable it to expand or take on new orders or clients.
Can I apply to more than one SBA-approved lender for SBA financing?
Absolutely. Given how competitive it can be to obtain SBA financing, borrowers increase their chances of qualifying for financing by applying to multiple lenders. Different lenders put different emphasis on various factors and sources of information, so a borrower may find that one lender considers the borrower and his business to be a reasonable credit risk, whereas another lender may feel differently.
What can I do to increase my chances of being approved for SBA financing?
Obtaining SBA financing is competitive. Given that its terms are traditionally very favorable, SBA financing is not a sure thing; many potential small business borrowers apply for financing but are unsuccessful at doing so.
Besides applying to multiple lenders, focusing on fundamentals is an important way to ensure you seek to obtain financing when you need it. This means ensuring that your business is operating lean, that your customers are satisfied, and ensuring efficiencies in all parts of your business. Lenders will take a very detailed look at your business and proactively ensuring that your business is operating with maximum efficiency at every level is key to success in obtaining SBA financing.
Best Practices for Paying off an SBA Loan
Ensuring you properly manage your small business’s cash flow
Small businesses can struggle with uneven cash flow as a result of their relative youth and not yet having a solid toehold in the marketplace and the reliable stream of business that often results from such an established track record. Given the very nature of a small business is that it is new and revenue is not always going to come in regularly, having access to financing to tide you over during the slow periods or to upgrade your business’s capacity to meet existing orders is essential. However, having a reserve to tide your business over during the lean times when business is slow is essential to proper planning and ensuring your business can meet its obligations to employees, customers, suppliers, and lenders.
Being realistic about your business’s financing needs
Many entrepreneurs are the type of people that are comfortable assuming the risk. That is often what enables a small business owner to succeed in the dangerous world of starting a new business, where failure is the norm, not the exception. However, when obtaining financing, it is essential not to be too aggressive and attempt to do too much too quickly. As an example, if your business is in its third year of operation and is just becoming steadily profitable for the first time, it probably is not the best time to rush out and try to develop an entirely new product line. Investing millions of dollars upfront without having an idea as to whether there is a market for that particular product line isn't a best practice.
Consider seeking assistance
Small business owners can sometimes feel isolated. They may spend every waking hour building their business, leaving very little time to take a step back and assess how they are doing. Taking the time to stop, obtain a mentor through SCORE, or a similar mentoring/networking program can be a vital source of trusted advice and insights from someone who has been building a growing business before.
Merchant Cash Advances - How They Can Help Your Small Business...
SBA financing is competitive, slow, and can be very difficult to come by. However, even for small business borrowers who get turned down for SBA financing, there are other options in the form of alternative financing. A comfortable and pain-free alternative to SBA financing is utilizing a merchant cash advance (MCA). A merchant cash advance operates much like a loan or other form of traditional funding in that a lender provides a set of financing to a small business borrower, but much faster. It can be looked at as a fast business loan. The lender and the borrower agree on an amount of funding that will be advanced, the period over which the funds will be paid back, and the terms according to which the MCA will be paid. The proceeds from the MCA can then be used by your small business for equipment financing, hiring new employees, provide working capital or other purposes.
However, unlike a traditional loan that is paid back through a series of fixed payments made at regular intervals, a merchant cash advance is paid back through the lender, by taking an agreed-upon percentage of your business’s receivables. For example, your agreement with the lender that extended MCA financing to your business may be that the lender will receive 10% of your business’s receivables over a period of 12 months until the financing is paid back. If you borrow $100,000 over a period of 12 months and 10% of your receivables in each of the first ten months equates to $10,000, then you would have paid back the financing in ten months. Similarly, if 10% of your business’s receivables in the first eleven months were $9,100, then you would pay back the loan in roughly eleven months. An MCA offers flexibility in that there is not a fixed payment each month that your small business has to worry about making no matter what its revenue is in a given month. Instead, the fees are a percentage of your business’s receivables, whether that is $10 or $100,000 in a given month. They can be excellent to get some much-needed working capital, and can even substitute traditional working capital loans.
The Speed & Comfort of a Cash Advance
Unlike SBA loans, the process of obtaining an MCA requires less documentation, and you’re able to receive funding much faster. It can be thought of as a quick business loan. For example, at Velocity Capital Group, we’re often able to provide fast small business financing. We can have same-day funding options for businesses that have completed our quick application. It can take anywhere from 3 – 6 months waiting to receive an SBA loan after being approved. We help reduce the time and effort being spent searching for financing options so that your focus is on your enterprise.
The MCA comes with a bonus of not having to put up collateral for the advance. The agreement is purely a stake in future receivables.