Small Business Administration (SBA) loans are typically considered to be the preeminent loan option for businesses operating in the United States. It’s true that these loans offer businesses a number of advantages, such as lower rates and longer terms, but they have drawbacks as well, including strict approval requirements and extensive paperwork. The application process can take weeks or months and most applicants are rejected.
If you have a strong personal and business financial history and the time to compile the documentation required to apply and wait for your application to be processed, SBA loans are a strong financing option. There are also circumstances in which SBA loans are not the best choice for your business—if you need funding quickly, for example, or your personal or business financial history doesn’t meet the SBA’s stringent requirements.
In this post, we’ll take a closer look at the pros and cons of SBA loans to help you determine if SBA funding is the best choice for your business. But before we dig into the pros and cons, it helps to understand how SBA loans actually work.
How Do SBA Loans Work?
SBA loans don’t actually come from the SBA. Instead, these loans are provided by SBA-approved lenders, such as conventional banks or microlending institutions, and are guaranteed up to a certain amount (usually 80-90%) by the SBA. This means that if you default on your loan, the SBA will reimburse the lender for part of the total loan value on your behalf. Guaranteeing the bulk of the loan value reduces the risk to the lender and can theoretically increase your chance of being approved.
Because SBA loans are actually provided by a bank or other lending institution, your loan application may be subject to two separate approvals: one from the lending institution, and one from the SBA. Whether your application requires two separate approvals depends on if your lender is considered an “SBA Preferred Lender”. Preferred Lenders can authorize loans on their own with no involvement from the SBA, which means approval may be quicker and you may not need to submit as much documentation to support your application.
If your lender is not a Preferred Lender, the lending institution will have to approve your application first before sending it to the SBA for a second approval. This will lengthen your approval timeline and can lead to significant delays in receiving approval and having your funds deposited.
Multiple types of SBA loans are available, including:
- 7(a) Guaranteed Loans: This is the most popular loan option offered by the SBA. Funding up to $5M is available and funds can be used to cover most business expenses. The SBA will guarantee up to 90% of the total value of your loan depending on your creditworthiness and financial history. Repayment terms can be as long as 25 years depending on what you plan to use the loan for, with fixed and variable interest rates available that are dependent on the federal prime interest rate.
- Express Loans: Express loans are smaller than 7(a) loans, up to $350,000, but with a faster approval timeline. They can be used for the same purpose as 7(a) loans.
- 504 Loans: The SBA partners with Certified Development Companies (CDCs) to provide up to $5.5M that can be used to finance the purchase of fixed assets such as machinery, buildings, or land. The funding is jointly supplied by the lender, the CDC, and the borrower. Repayment terms up to 25 years are available, with rates negotiated between the borrower and lender.
- Microloans: Small loan amounts up to $50,000 are called “Microloans”. These loans are primarily made available to borrowers in underserved markets, such as women-, veteran-, and minority-owned businesses. Microloans have a maximum term length of 7 years.
- Disaster Loans: SBA Disaster Loans are available to businesses impacted by natural disasters, including declared federal disasters such as hurricanes or floods as well as economic injury sustained during nationwide crises like the COVID-19 pandemic. Unlike other forms of funding, Disaster Loan funding is supplied directly by the SBA. Disaster Loans include two types of funding for businesses impacted by the COVID-19 pandemic: Economic Injury Disaster Loans provide up to 6 months of working capital to cover daily expenses repaid over a 30 year term, while the Paycheck Protection Program (PPP) provides forgivable loans to help small business owners cover payroll costs. Learn more about PPP.
Advantages of SBA Loans
SBA loans offer small business owners a number of advantages, including lower rates, favorable repayment terms, larger loan amounts, and forgivable COVID-19 support.
1. Lower rates
In addition to guaranteeing the bulk of your small business loan, the SBA sets a maximum interest rate that lenders may charge borrowers. The rate set by the SBA is tied to the federal prime rate—for example, if the federal prime rate is 3.25%, the SBA may charge an additional 2.0%-4.0%, resulting in an interest rate of 5.25%-7.25%.
Because the exact interest rate is tied to the federal prime rate, SBA loan rates are typically lower than the interest or fees you may pay on other funding options provided by both traditional and alternative lenders. However, the total cost of your funding—whether you receive an SBA loan or a non-loan form of financing from an alternative lender like a merchant cash advance—will always depend on your creditworthiness and your financial history.
Each SBA loan program has different approval requirements and therefore different rates. Fixed and variable rates are available, but the specific rate you will pay will be negotiated between you and your lender, and will depend on your creditworthiness as well as your personal and business financial histories.
2. Favorable repayment terms
Term lengths are negotiable with your lender and typically depend on what you plan to use your funding for, but in general, most SBA loans come with longer terms than other funding options.
SBA loans for real estate, for example, typically come with 25 year repayment terms, while terms are shorter—typically 7-10 years—for purposes other than purchasing real estate. These longer timelines in addition to the SBA’s repayment guarantee mean that SBA loans may have lower monthly payments than other loan options, which in turn means there will be less strain on your business’s cash flow.
On top of this, most SBA loans are fully amortizing, which means business owners won’t have to worry about making balloon payments at the end of their loan term. Your repayment terms may also include restructuring options, lower down payments, and more flexibility on your loan timeline.
3. Larger loan amounts
The SBA offers loans up to $5M depending on the specific needs of your business. Smaller loans, including microloans under $50,000, are also available.
4. Forgivable COVID-19 support
Loans issued under the Paycheck Protection Program are up to 100% forgivable if at least 60% of the loan is used to cover payroll and the remaining 40% is used to cover business-related expenses like rent and utilities.
While designed to cover payroll expenses, business owners are free to treat a PPP loan like a low-interest short-term loan and use their funding however they choose. In this case, you’ll pay a 1% interest rate on any non-forgivable portion of your PPP loan, which is still a significantly lower rate than 7(a) loans and other forms of traditional and alternative funding.
Learn more about PPP Round 2, including who is eligible to apply.
Disadvantages of SBA Loans
Lower rates and longer terms are compelling advantages, but these advantages come at the cost of strict underwriting requirements, extensive paperwork, long application timelines, and other drawbacks.
1. Strict underwriting requirements
SBA loans come with some of the strictest underwriting requirements small business owners can face. At a minimum, the SBA typically requires a credit score of 680+, along with strong personal and business financial histories, and no less than 2 years in business.
Ultimately, it is your lender who will decide whether you will be funded—not the SBA. Your lending partner may require you to meet or exceed other approval criteria in addition to these and other base requirements required by the SBA, and you may even need to apply for SBA funding through multiple lending institutions before you receive approval. Each lender will have their own application process and approval requirements.
Most businesses do not meet the lender or the SBA’s strict funding requirements, leaving many small businesses wondering how to get the funding they need to continue to succeed and grow. Businesses can still access the funding they need through non-bank lenders called “alternative lenders”. Learn more about the advantages and disadvantages of alternative lenders.
2. Extensive paperwork
The SBA requires small business owners to fill out an extensive application, as well as supply a significant amount of supplementary paperwork ranging from personal financial documentation to detailed paperwork about your business’s finances. On top of the lengthy standard application, you will likely be asked to provide:
- Historical tax returns for several previous years, including both personal and business tax returns
- Profit and loss statements
- Balance sheets
- Projected revenue and expenses
You may even need to provide a detailed plan for how you intend to use the loan.
Taking the time to compile this paperwork can be challenging for many small business owners, especially if they have a small team or are operating under COVID-19 restrictions.
3. Long application timelines
After you collect and submit your application paperwork, it can take weeks or even months for your lender to process your loan application. Non-preferred lenders can take even longer because there are two steps in the approval process—approval from the lender, and a second approval from the SBA.
This is a major drawback for businesses who need funding quickly to help cover an unexpected expense or seize a short-lived opportunity to grow.
4. Personal guarantee or down payment may be required
Many SBA loans require a down payment of 10-20%, but the specific amount will depend on what the loan is for and your financial profile. As a general rule, the lower your credit score, the higher your down payment will be.
The SBA typically requires a smaller down payment than other lenders, but it can still be difficult for small businesses to pull together enough funds, especially if they have a lukewarm financial history or have been operating under COVID-19 restrictions. Other lenders, including alternative lenders like Greenbox Capital®, don’t require a down payment.
5. Flaws with COVID-19 funding
With program requirements and rules constantly shifting, it’s hard for small business owners to keep up with changes to the SBA’s PPP program. Concerns like changing forms, technical difficulties, shifting guidance, and spending limits may discourage many small business owners from applying. Plus, unlike other SBA Disaster Loan funding, PPP applications must be submitted through another lending institution. This can make it difficult for business owners who don’t have an existing relationship with a lender to access these funds.
In addition to these challenges, all small business owners who receive PPP funding must apply for forgiveness, even if they don’t intend to use their PPP funding for forgivable expenses. This means that business owners will need to complete another application form, sometimes including detailed records for how their PPP funding was spent, regardless of whether they intend to apply for loan forgiveness. Because PPP funding only covers 8 weeks worth of expenses, many small business owners simply may not believe applying for funding and forgiveness is time well spent.
Other forms of funding exist to help small businesses navigate the ongoing challenges of the COVID-19 pandemic, including alternative lenders like Greenbox Capital®. Get our advice for what to do if you run out of PPP funding, or if you were never approved in the first place.
Is an SBA Loan Right for Your Business?
SBA loans offer a number of advantages for small business owners, including lower rates and longer terms, larger loan amounts, and forgivable COVID-19 support. However, these loans have the strictest approval requirements, require extensive paperwork, and can take weeks or even months to process, all with no guarantee of approval.
If you have a strong personal and business financial history and the time to navigate the process, SBA funding is often the best choice for your business. If you need funding quickly, a smaller loan, or don’t meet the SBA’s underwriting requirements, alternative lenders may be the a better option. With a simplified application, faster processing and approvals, and flexible approval requirements, these lenders offer a number of funding options from as little as $3,000 up to $500,000, including merchant cash advances, term loans, online invoice factoring, and business lines of credit.