SBA vs. conventional loan: What you need to know

Starting a business can be an expensive endeavor. For business owners looking for funds to grow or launch their business.

Many major financial institutions offer conventional business loans, a common source of funding for businesses. However, younger businesses may not qualify for conventional business loans, as newer businesses tend to have less credit history. 

U.S. Small Business Administration loans are specifically designed for smaller, newer businesses, and could be a great option for those who can’t or don’t want to take out a conventional business loan. Here is what you need to know when deciding between conventional and SBA loans.

What’s the difference between an SBA loan and a conventional business loan?

Two of the main differences between a conventional business loan and an SBA loan is that an SBA loan typically has a longer repayment term and a lower interest rate than a conventional loan.

Both SBA loans and conventional loans for businesses can be issued by banks or alternative online lenders. SBA loans come from lenders that participate in the SBA loan guarantee program. The program promises that the SBA will buy back a portion of your loan from the lender if your business fails and you default on the loan. 

An SBA guarantee typically ranges from 50 to 90 percent of the loan amount up to $5 million, depending on the loan program.

What is an SBA loan?

The SBA is a government agency that partners with SBA-approved lenders to offer a variety of loans for businesses that can’t get conventional loans. Depending on the type of loan you get, the SBA eliminates a percentage of the risk banks take on when funding young businesses. The SBA also puts limits on lender interest rates for SBA loans. 

One SBA loan option is the 7(a) loan program. As the SBA’s most popular loan program, 7(a) helps businesses finance startup costs, buy equipment and inventory, buy or expand existing businesses or obtain working capital.

If you want to fund a new asset for your business or upgrade an existing one, you may qualify for a 504 SBA loan. These loans can be used to purchase new land, facilities, and equipment that help a business grow. A 504 loan may also be used to improve existing facilities. The SBA also offers microloans for up to $50,000.

Requirements of an SBA loan

There are four main requirements for an SBA loan. 

1. Your business must be for-profit
2. You must operate in the U.S.
3. The business owner must have invested equity in the business
4. You must have exhausted other conventional loan options

You may face other requirements based on the type of loan you’re applying for. For instance, to be approved for a 7(a) loan, you must have used alternative funding (such as personal assets) to fund your business in the past and must not be delinquent on any debts to the U.S. government.

SBA also limits how you can use the funds for your loan. For 7(a) loans, acceptable uses include long- and short-term working capital and the purchase of real estate. 

Your small business must also meet SBA size standards. Depending on your industry, you will need to be under a certain annual revenue or have a finite number of employees to qualify. 

Key aspects of an SBA loan

• Range of loan amounts: The SBA’s 7(a) Small Loan provides business loans of up to $350,000, while the Standard 7(a) Loan offers funding up to $5 million.
• Longer loan terms: SBA loans have repayment terms of up to 25 years for real estate and 10 years for other fixed assets and working capital, which could make monthly payments more manageable. Conventional loans typically have terms of up to 10 years.
• Interest rate limits: The government places a cap on the maximum interest rate for these types of loans. It’s equal to a base rate, such as prime, plus a percentage.
• Longer wait times: Because a conventional loan only has to be reviewed by an institution’s internal underwriting team, approval times are often faster than SBA loans. SBA loans require more paperwork and approval from SBA before the lender can fund the loan. 
• Ideal for businesses with no credit or bad credit: SBA loans were designed for small businesses that wouldn’t qualify for a conventional loan at a bank.
• You must meet SBA and lender requirements: The application process and approval can take longer, and businesses must meet eligibility requirements from both the lender and the SBA.

How to apply for an SBA loan

The first step to applying for an SBA loan is visiting SBA.gov and filling out the SBA lender match form. The form takes about five minutes to complete and asks applicants to describe their businesses and their needs.

Within two days, the applicant will receive an email with a list of lenders they’ve been matched with. The business can then contact the private lenders individually to compare rates, terms and other details before making a decision. Once a business decides on the SBA-approved lender they want to move forward with, they’ll submit an application directly to the lender. 

It may be easier to apply directly with a lender in the SBA’s Preferred Lenders program, which can expedite the approval process. 

What is a conventional business loan?

Conventional loans are typically offered by banks, credit unions and other financial institutions. Online lenders are increasingly likely to offer business loans as well, and they may work with startups and businesses with lower credit scores that struggle to work with larger banks. 

Lenders provide approved businesses with funding and the businesses repay the loans (plus interest and any applicable fees) over an agreed-upon term.

Depending on your loan agreement, business loans can be used to expand your business, buy business-related equipment or consolidate business debt. The loan can also be used as working capital.

Unlike with SBA loans, the bank shoulders 100 percent of the risk if your business defaults. Since conventional business loans have high stakes for private lenders, banks often require borrowers to have good credit.

Requirements of a conventional business loan

A business looking for a conventional loan will need to demonstrate its ability to repay the loan. Your lender may use a debt-to-equity ratio, debt-to-total assets ratio, or debt service coverage ratio to assess how likely you are to repay your loan on time. The latter is calculated by dividing your EBITDA (earnings before interest, taxes, depreciation and amortization) by the interest and principal required to pay the loan. 

You may also need to provide the lender with a business plan that outlines its details and financial projections.

Financial institutions also require a good business credit score, as well as a strong personal credit score from the individual who’s representing the business. Your lender will consider your outstanding debts, annual revenue and the information on your tax returns. 

The number of years your business has been in operation will also be taken into account, as will your industry. If you operate in a stable, profitable industry, you may see a faster approval or higher approval amount. 

Key aspects of a conventional business loan

• Requires strong business and personal credit scores: Because the lender absorbs all risks if a business fails and defaults on the loan, it will typically require strong credit scores to qualify. However, some lenders do work with credit-challenged companies.
• May offer competitive rates: Because approval is highly dependent on credit, some conventional loans offer lower interest rates for businesses with high credit scores.
• Difficult for no-credit or bad-credit borrowers: Young businesses without established credit or those with bad credit might face challenges getting approved. If they’re approved, the conventional loan rates will likely be high.
• Variety of loans available: Private lenders offer conventional business loans in various amounts and with different terms and payment schedules. For instance, a line of credit is ideal for anyone who needs revolving credit, while equipment loans are good for buying new physical assets that grow your business. 
• Faster approval process: Lender approval is based on the bank’s underwriting criteria, meaning less paperwork and less time needed to make a decision.

How to apply for a conventional business loan

A business can apply for a conventional loan directly with their preferred lender. Many lenders accept applications in person at branch locations, over the phone and online.

Conventional loan application processes depend on the lender. You can streamline the process by investing time and energy in preparation. 

First, determine which loan type is most appropriate for your needs. Next, get your credit score in the best shape possible to increase your chances of approval. 

Once you’ve compared lenders and decided where to apply, gather all necessary documents. Filling out an accurate loan application can help you avoid unnecessary delays.

Loan review and approval timelines vary from bank to bank.

SBA loan vs. conventional loan: Which is best?

If you’re looking for business funding and deciding between an SBA loan and a conventional business loan, you’ll want to explore both options before making a final decision.

Consider the stage of your business (e.g., a startup versus an established business), your credit history and overall financial health to help determine which option is best for you. You should also calculate the cost of a business loan to see which is the most affordable for you.

SBA loans and conventional business loans come with their own pros and cons, and no two lenders are the same regardless of which type of loan you choose. It is important to understand how both loan types and the individual lenders you consider will work for your business’s specific needs.