The Pros and Cons of an SBA Loan

Small Business Administration (SBA) loans are typically considered to be the preeminent loan option for businesses operating in the United States.

The biggest misconception about these loans is that the SBA lends directly to small businesses.  In reality, the SBA Loan Program partially guarantees loans made by banks or other direct lenders to eligible small businesses. The program aims to promote economic growth by encouraging lenders to partner with small businesses that may be struggling to secure financing on reasonable terms. Because of the guaranty, SBA loans tend to have lower monthly payments than other types of loans.

Multiple types of SBA loans are available, including:

7(a) Guaranteed Loans: This is the most popular loan option offered by the SBA. Maybe it’s popular because you can borrow up to $5 million or maybe it’s because of its low-interest rate and long repayment terms (up to 10 years). And the SBA will guarantee up to 90% of the total value of your loan depending on your creditworthiness and financial history.

Express Loans: SBA loans generally take a long time to work through, but SBA Express speeds up the process. 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. These loans are only for backing fixed assets. 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”. If you’re a freelance, home-based small business owner, this could be an option for you. You can generally use the money to do most anything for your business, with the exception of purchasing real estate or paying existing debts. Microloans have a maximum term length of 7 years.

Disaster Loans: While hopefully you never need to use this type of loan, it is available in the event of a natural disaster, 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. You can receive up to $2 million in financing with very low rates as long as you can prove your business has suffered in a declared disaster zone. Disaster Loans include two types of funding; Economic Injury Disaster Loans which provide up to 6 months of working capital to cover daily expenses repaid over a 30-year term, and the Paycheck Protection Program (PPP) which provides forgivable loans to help small business owners cover payroll costs.

Pros 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.

  • Low Interest Rates

As opposed to online short-term loans which tend to have high rates, the SBA sets maximum interest rates that lenders can charge on 7(a) loans. 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.

The SBA guarantees between 50 and 90 percent of the loan in the event that you can’t pay it and the loan goes into default. This makes banks and other lenders eager to work with you and to give you favorable rates for paying them back.

  • 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. The program offers fully amortizing terms up to 10 years on non-real estate transactions like working capital, equipment, or inventory purchases. Longer maturities result in drastically lower monthly payments and conservation of cash flow, creating an opportunity to grow your business faster. In addition, the program allows you to refinance existing debt that may be too expensive.

  • 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. This wide range provides you the buying power and flexibility you need as a business owner to launch the project of your dreams. 

  • No Collateral Requirements

The SBA guaranty helps offset risk, giving financial institutions the flexibility to consider transactions not fully collateralized by business or personal assets. When applying for a traditional bank loan, lenders often require a loan to be fully collateralized by real estate or other tangible assets.

  • Flexibility

Just as your business offering differs from the one down the street or across the internet, your financial needs and structure are different, too. Small business loans can accommodate many needs, whether you’re looking to purchase real estate or expand your current location and you need capital for construction costs.

  • Combined Financing

The ability to combine SBA with other funding options, such as ROBS or Portfolio loans, for the down payment makes it one of the most flexible financing options available for small business owners. This allows a small business to increase their borrowing power beyond the cash they have in the bank, if your global cash flow can support the repayment.

  • Forgivable COVID-19 support

Loans issued under the Paycheck Protection Program (PPP) 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.

Cons 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.

Although SBA 7(a) loans require investment of time and effort, the overall benefits of the program outweigh the costs for many small-business owners.

  • 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. 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 alternative lenders.

  • Collateral

Even though the SBA guarantees most of the loan for the lender, collateral is still (almost always) required to secure the loan. As the borrower, you’ll be required to put up your most valuable assets as collateral for the loan. SBA loans are not easy to obtain, so you’ll need to put in work. Be ready to roll up your sleeves and prove your worth to your lender through a lengthy process that encompasses providing a solid business plan and a large down payment.

  • 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 drawback for businesses who need funding quickly.

  • Personal guarantee

Lenders will require you to sign a personal guarantee if you own 20% or more equity in the business. If you’re unable to make payments down the road based on the original agreed-upon terms, you’ll need to pay back the lender from your personal accounts or assets.

  • High Denial Rate

The stark reality is that most SBA loan applications are rejected. Navigating the inconsistencies with lenders and completing different applications both contribute to a low approval rate for entrepreneurs who are seeking SBA funding. However, those working with an SBA consulting service have a much higher approval rate. The trick is to find a company you trust with multiple years of experience, and one who will refund your consulting fee if your loan isn’t approved.

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’re searching for the least expensive and most flexible option, 7(a) loans should be on your radar. While factors like timing and the amount of paperwork matter, extended maturities and lower interest rates tend to have the most profound impact on your business long-term.

If you need funding quickly, a smaller loan, or don’t meet the SBA’s underwriting requirements, alternative lending may be the better option. With a simplified application, faster processing and approvals, and flexible approval requirements, we offer a number of other funding options including merchant cash advances, term loans, and business lines of credit.

To see if SBA financing is the right option for your business, contact Omni Capital at 800-418-9458 to speak with one of our experts today.