Entrepreneurs can easily launch a new business by applying for a business loan, especially one that is backed by the Small Business Administration (SBA). SBA loans have long repayment terms, relatively low interest rates, and require less money and collateral up front.
However, there are a few things to think about because SBA loans aren’t right for every founder or business.
SBA loans versus standard commercial loans
There is one common misconception about SBA loans. The SBA does not issue loans of its own. A bank provides an SBA loan, which must be repaid in the same manner as any other bank loan. The fact that the SBA “guarantees” your loan to the lender as a means of encouraging business growth is the primary distinction between a standard commercial loan and an SBA loan.
It is essential to keep in mind that banks despise risk and that new businesses are by definition risky in order to comprehend why this program exists. Most of the statistics you hear about small business success are exaggerated; the most recent data show that one out of every five businesses fail within the first year. However, this indicates that four out of every five companies will survive for at least one year.
Therefore, even though the figures aren’t as bad as the skeptics would have you believe, a failure rate of 20% is still significantly too risky for banks. especially if you, as the borrower, want low interest rates and a low down payment. The SBA steps in to help with this. The SBA effectively informs banks that if your company fails, they will receive 85% of the money they borrowed back from the government through its loan programs.
However, even if you fail to make your payments, the lender will still pursue you. It also does not imply that banks are merely wasting money. Lenders whose portfolios do not perform well are kicked out of the program by the SBA, which monitors them. Therefore, even though the SBA protects the bank and makes it easier for founders to obtain loans, qualifying still requires a lot of effort.
SBA Loan Types
There are many different types of SBA loans, but the 7(a) and 504 loans are the most common. For the purposes of this article, we will primarily concentrate on these two programs.
SBA 7(a) Loans
The most common type of SBA loan is the 7(a) loan program, which allows for loans up to $5 million. It can be used for the most things, including:
In FY2022, the most recent year for which data are available, the SBA approved nearly 52,000 7(a) loans worth a total of $36.5 billion, or an average loan amount of nearly $705,000. Startup costs include equipment, inventory, real estate, construction, and working capital. These loans are typically repaid within seven to ten years. It is essential to keep in mind that 7(a) loans almost always have variable interest rates, which means that they change in line with the interest rate on Treasury Notes set by the Federal Reserve. For more specifics, refer to the SBA’s 7(a) loan terms and conditions.
SBA 504 Loans
The 504 loan is another popular SBA loan program. It is a little bit more rigid than the 7(a) loan, but it has longer payment terms and lower interest rates. The 504 loan can be used to acquire assets like:
Real estate, construction, and building enhancements are all examples of this.
The SBA approved just under 10,000 504 loans in the most recent fiscal year, totaling $8.2 billion, or approximately $850,000 per loan. 504 loans can be repaid in as little as 25 years. In contrast to 7(a) loans, 504 loans have fixed interest rates that are determined by the current market rate for the Treasury Note when the money is borrowed.
Eligibility Requirements for SBA
Loans To be eligible for an SBA loan, you and your company must meet the following requirements:
Be a for-profit business that has been officially registered and is located in the United States (or U.S. territories); Have enough cash for a down payment (at least 10%, but typically higher); Have a business plan with “reasonable” financial projections; Meet the SBA’s definition of a small business (varies by industry); Be a for-profit business that is located in the United States (or U.S. territories). If you want to learn more, read the SBA loan program’s terms and conditions.
What Kinds of Businesses Can Receive SBA Loans
Even if you meet all of the eligibility requirements, some kinds of businesses cannot receive SBA loans to fund them.
Companies that are not eligible include:
Real estate investment firms Futures trading (and other speculative investments) Dealers of rare coins and stamps Lenders and leasing companies Pyramid schemes Illegal activities Gambling (though businesses that make less than 1/3 of revenue from legal gambling, like selling lottery tickets, are eligible) Non-profits and religious organizations None of the aforementioned ineligible businesses should come as much of a surprise; however, there is one additional factor that must be taken into consideration when determining whether your company is eligible for an SBA loan. A company that receives an SBA loan is required to keep a Debt Services Coverage Ratio (DSCR) of at least 1.15, though the majority of lenders want it to be higher.
EBITDA (earnings before interest, taxes, depreciation, and amortization) divided by loan payments is your DSCR. For instance, if you have a $100,000 EBITDA and make $50,000 in loan payments in the same year, your DSCR is 2.0.
As a result, it will be difficult to obtain an SBA loan if your company, like a new invention or technology company, will take a long time to begin earning revenue.
Top Industries for SBA Loans
We thought it might be helpful to examine the most frequently funded SBA loans-funded industries to provide some context. The only purpose of this data is to provide information; You can still get an SBA loan even if your industry isn’t on this list. Also, just because your business is on this list doesn’t guarantee that you will get an SBA loan.
Top 20 Industries for SBA 7(a) Loans (2020–2022) Full-Service Restaurants Limited-Service Restaurants Hotels & Motels (excluding Casinos) General Freight Trucking, Long Distance General Freight Trucking, Local Fitness and Recreational Sports Centers Landscaping Services Residential Remodelers Other Specialty Trade Contractors General Automotive Repair Plumbing, Heating, and Air-Conditioning Contractors Gasoline Stations with Convenience Stores Insurance Agencies and Brokerages Offices of Dentists
We rely on these businesses to provide the goods and services that enable our communities to flourish.
An SBA loan might be a good option for you if you want to start a business of that kind.
This does not mean that you should disregard the SBA loan program if you have big goals. Every large undertaking begins as a small business. However, it is abundantly clear that businesses operating in the media and technology industries—the Facebooks, Amazons, Apples, Netflixs, and Googles of the world—do not typically meet the criteria for SBA loans. Angel investors and venture capitalists are better suited for funding these kinds of businesses.
It All Comes Down to the Details
Are you still unsure whether or not you or your company would be eligible for an SBA loan? Master plans has been preparing business plans for SBA borrowers for two decades, and we would be happy to talk with you about how we can help your new business get an SBA loan.
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