The SBA is not a lender, but rather guarantees small business loans offered by traditional lenders like participating banks and credit unions to encourage lending to small businesses across the country.
What Makes SBA Loans Different From a Traditional Bank Loan
SBA loans come from participating banks, credit unions, and licensed non-bank lenders but they are partially guaranteed by the U.S. Small Business Administration (SBA), a federal agency that promotes small business ownership in a variety of ways.
Small businesses are viewed as higher risk for lenders. The SBA loan guarantee program encourages lenders to work with small businesses. In return the lenders adhere to specific lending terms, interest rate caps, and other criteria set out by the SBA.
The loan guarantee is in effect credit insurance – typically, it means that the SBA will cover a portion of any loan losses incurred by the bank, up to 90%. Note: these programs don’t mean that a business owner who defaults on his loan won’t be expected to eventually pay off his or her balance.
The sharing of risk is what makes SBA loans attractive for banks, who are in turn asked to provide loans to a sector of the economy that is higher risk: small businesses.
SBA loan terms can be more flexible, meaning borrowers can be approved even if they have fewer assets than required by commercial lenders. So if you are just starting out and don’t own a home or other big ticket asset to offer as collateral, you still have a good chance at getting a loan.
Note: SBA guaranteed loans are based on a working arrangement between the SBA and the bank. The SBA doesn’t lend money, and it doesn’t interface with borrowers. Banks and other participating lenders decide whether or not to approve loan applications, and then they apply directly to the SBA for the guarantee. Note: not all banks participate with the SBA.
The Types of SBA Loans
The (Almost) All Purpose 7(a) Loan
The most popular SBA loan program is the 7(a) loan, designed to provide funds for a broad list of businesses. These loans target “small” companies, defined according to the North American Industrial Classification System (NAICS), which determines whether a company is small by its annual revenues or number of employees.
The maximum loan amount available under the 7(a) program is $5 million.
The 7(a) loan is a general purpose loan, and the funds may be used for almost any business need, including:
- Starting a new business
- Funding working capital
- Buying land and a building
- Acquiring another company
- Refinancing existing obligations of your business.
Most 7(a) loans are used to purchase assets, such as real estate and equipment, due to favorable terms that let you repay the loan over the useful life of the asset: up to 25 years for real estate and 10 years for equipment. These longer repayment terms keep payments lower, meaning more capital stays in your business to fund operations and growth.
SBA loans do have some restrictions on how they’re used. Funds guaranteed by the SBA can’t be used to fund an investment, or any passive business activity, like purchasing a building that will be leased to another business. They also can’t be used to reimburse a business owner for money previously invested, or repay any money owed to the government, such as taxes.
How to Know If a 7(a) Loan Is Right For You
If you can answer, “yes” to any of the below, a 7(a) loan may be right for you.
- Are you a small business? (For a list of the SBA criteria for small businesses, click here.)
- Is your business based in the U.S. or its territories?
- Do you have capital to invest in the business?
- Are you current with all debt payments to the U.S. government, including income taxes?
The Types of Businesses Not Eligible for 7(a) Loans
There are a number of businesses that are not eligible for a 7(a) loan, including the following:
- Businesses that focus on teaching or spreading religion
- Businesses focused on politics or lobbying
- Businesses primarily focused on anything deemed of an “indecent sexual nature”
- Life insurance or lending businesses
- Businesses domiciled outside the U.S.
- Businesses that limit membership for any reason other than capacity
- Businesses that get over 1/3 of revenues from legal gambling
- Businesses owned by persons who are currently in jail, under indictment, or on parole
- Businesses in speculative industries, such as oil exploration
- Businesses involved in multi-level marketing
- And of course, businesses engaged in illegal activity
You can find a full list on the SBA.gov website here.