If you are looking to launch a business or grow a company but don’t have adequate funds, there are a number of financing options you can consider.
The number-one source of funding for businesses are conventional bank loans. For younger firms with less credit history or businesses that don’t qualify for traditional loans, however, loans backed by the Small Business Administration (SBA) are a good choice. Here’s what you need to know to determine which type might be right for your business.
What’s the difference between the loans?
Both SBA and conventional loans are usually issued by banks. SBA loans, however, come from banks that participate in the SBA loan guaranty program. Under these loan programs, the SBA promises that if your business fails and you default on the loan, it will buy a portion of the loan back from the bank. An SBA guaranty typically ranges from 50 percent to 85 percent of the loan amount up to $3.75 million.
Pros and cons of conventional loans
When seeking financing, most business owners turn first to conventional loans. These loans, which are not backed by the government, may carry a lower interest rate, and the approval process is generally faster than it is with SBA loans.
There are no caps on the amount a business can request, and the loan can be structured in many different ways, with varying terms lengths and either floating or fixed interest rates. Payment schedules are also flexible, ranging from monthly to even annual payments, depending on how the business owner and bank structure the agreement.
The downside is that conventional loans generally require high business and personal credit scores, and qualifying businesses are usually well-established In fact, 58 percent of firms from zero to two years old report difficulty with credit availability, compared with just 39 percent of mature firms, according to a recent study by the Federal Reserve Bank of New York.
Try an SBA loan program
That’s where the SBA comes in. By guaranteeing loans, the SBA eliminates some of the risk banks take on when funding young businesses. Although SBA loans may require more paperwork and take longer for approval, they offer businesses a variety of loan types. The three biggest are:
- The 7(a) loan program: The SBA’s most popular loan program, it helps businesses finance startup costs, buy equipment and inventory and obtain working capital in amounts up to $5 million. It can be used to launch a business, buy an existing business or expand a business. To qualify, the business must operate for a profit in the U.S., and the owner must have an equity stake.
- The 504 Loan Program: This program provides small businesses with long-term, fixed-rate loans to buy assets for expansion and modernization. The loans are offered through Community Development Companies, which are nonprofit corporations that promote economic development and are regulated by the SBA. The loans typically require the borrower to contribute 10% of the project’s cost.
- SBA Microloans: The SBA provides funds to intermediary lenders—typically nonprofit, community-based organizations—to manage smaller loans of up to $50,000. Businesses can use the loans for working capital or to buy inventory, furniture and equipment, but they cannot use the loans to pay debts or purchase real estate. The average microloan is $13,000.
Keep in mind that just as no two conventional lenders are the same, neither are SBA lenders. It’s a good idea to shop around and choose a lender that understands your business goals and needs.