How to Qualify for an SBA Loan

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One of the most popular financing sources for small businesses in the US is securing an SBA loan. In fact, during the fiscal year 2022, the SBA approved over $43 billion in annual small business funding. However, these loans are known for their stringent eligibility criteria, and the challenges in loan qualification requirements make it imperative for businesses to have alternative plans for funding.

If you’re planning to apply for an SBA loan, understanding its ins and outs and knowing its requirements is the first step towards loan approval. In this article, we will look at navigating the complexities of SBA loan qualifications, aiming to provide clarity on the path to securing funding.

The 5 C’s of SBA Loan Eligibility

Lenders take into account the 5 C’s of credit—character, capacity, capital, collateral, and conditions—when evaluating eligibility for an SBA loan.

Capital

In the context of SBA loans, capital refers to the money business owners are willing to invest personally. This down payment demonstrates a commitment to the venture. Most SBA lenders require borrowers to front a portion of the loan amount, typically expecting a down payment ranging from 10% to 30%.

Conditions

SBA-approved lenders also factor in the economic and market conditions prevailing across industries to determine a borrower’s risk profile. A business operating in an industry hit by recession might have trouble repaying the loan.

Capacity

Capacity assesses a business’s ability to repay a loan, examining current income, future financial projections, and cash flow. Lenders use this to ensure the business can sustain regular loan payments over the loan term.

Character

Banks scrutinize the character of both the business owner and the business itself. They consider the owner’s history with personal credit score, loan repayments, any criminal record, and overall money management capabilities. A business’s character is gauged by its market longevity, business credit score, cash flow management, and competitive standing, reflecting its reputation and reliability.

Collateral

Even though the SBA secures a part of the loan, lenders typically require additional collateral to safeguard the unguaranteed portion. Acceptable collateral includes tangible assets like equipment, real estate, and other valuable business assets.

SBA Loan Qualifying Requirements

1. Business Credit Score

A business credit score reflects a company’s creditworthiness, akin to a personal credit score for a business. It’s provided by credit bureaus like Dun & Bradstreet, Experian Business, and Equifax Business, typically ranging from 0 to 100. SBA lenders often look for scores above 75.

2. Financial Statements & Documents

For an SBA loan application, businesses must compile several financial statements: Personal and Business Income Tax Returns, Income Statements, Bank Statements, and Balance Sheets. Additionally, lenders may require business licenses, lease agreements, and existing loan contracts to fully understand the business’s financial obligations.

3. Personal Credit Score

Personal credit scores like FICO and VantageScore are important for SBA loans as they reflect the business owner’s financial reliability. Credit bureaus like Equifax, Experian, and TransUnion issue these scores ranging from 300 to 850. SBA lenders typically prefer scores above 680. Enhancing your personal credit score can also involve paying bills on time, reducing debt, and avoiding new credit inquiries in a short period of time.

4. Collateral & Personal Guarantee

Collateral is a tangible asset that secures a loan, whereas a personal guarantee is a commitment by the business owner to repay the loan personally if the business cannot. SBA loans often require both, ensuring lenders have a way to recoup funds if the business defaults. For them, it can significantly reduce the loan risk to the borrower, making them more willing to lend the funds out.

5. Business Plan & Overview

A strong business plan should include detailed financial forecasting, cash flow projections, and a clear explanation of how the loan will be used. Lenders evaluate this alongside the business’s repayment strategy, current market position, and growth trajectory. A thorough plan can significantly enhance the lender’s confidence in a borrower’s capability to repay thus improving loan approval chances.

6. Location

SBA loan eligibility mandates that a small business must be owned and operated within the United States. This requirement ensures that the economic benefits of the loan, such as job creation and community development, are confined within national borders, fulfilling the SBA’s mission to bolster the domestic economy.

7. For-Profit Business

SBA loans are exclusively available to for-profit businesses. This stipulation aligns with the SBA’s aim to support businesses that contribute to the economy through taxable revenue. Non-profit entities are directed to other federal or state grant programs designed to support their organizational missions.

8. Need for financing

An applicant must demonstrate a genuine need for financing that cannot be met through other financial means. SBA lenders typically require proof that the business has sought financial assistance elsewhere, like traditional bank loans or business lines of credit, before applying for an SBA loan.

9. Business size

The SBA’s definition of a small business varies by industry but generally includes revenue and employee count considerations. Lenders will verify that a business fits within these parameters to qualify for SBA loan programs, ensuring that the assistance is directed to genuinely small enterprises.

10. Time in business

The time a business has been operational is a key consideration for loan qualification. Established businesses with at least two years of operations are preferred by lenders, though some SBA programs are also accessible to qualified startups.

11. Nature of Business

The SBA restricts loan eligibility to businesses that operate within certain ethical and legal boundaries. Industries typically excluded from SBA loan programs include gambling, speculation, lending, and any investment-based business whose primary purpose is to generate returns from passive income rather than traditional business activities.

Comparing Requirements of Different Types of SBA Loans

The table below compares the requirements of three primary SBA loan programs: 7(a) loans, 504 loans, and microloans. Each has unique criteria that cater to different business needs:

Requirement SBA 7(A) Loans SBA 504 Loans SBA Microloans
Purpose General small business loans Fixed assets and real estate Small-scale financing
Maximum Loan Amount $5 million $5 million $50,000
Repayment Terms Up to 10 years (25 years for real estate) 10 or 20 years Up to 6 years
Interest Rates Variable, pegged to prime rate Fixed, below-market rates Fixed, generally higher than 7(a) and 504
Down Payment As low as 10% Typically 10-20% None required
Collateral Required for loans over $25,000 Secured by the assets financed Varies, but often not required
Personal Guarantee Required Required Required
Eligibility Criteria Operate for profit, meet SBA size standards, demonstrate need Operate for profit, meet SBA size standards, tangible net worth under $15 million Must be a for-profit business, unable to get credit elsewhere

The table provides a high-level comparison, but specific details can vary by lender and the individual circumstances of the borrower. Prospective applicants should consult with an SBA-approved lender to understand the full scope of requirements for each loan program.

FAQs

What Disqualifies You From Getting an SBA Loan?

The three primary disqualifiers for an SBA loan include a poor credit history, insufficient collateral or equity investment, and lack of a solid business plan. These factors can signal to lenders a high risk of default, making loan approval less likely.

What Credit Score Is Needed for an SBA Loan?

SBA lenders generally look for a personal credit score above 680 and a solid business credit history, indicating reliability in repaying debts.

How Much Collateral Does the SBA Require?

The SBA doesn’t set specific collateral thresholds, but SBA loans typically require sufficient collateral for loan amounts over $25,000. The exact amount varies by lender and is based on the loan size and the borrower’s financial situation.

What are the alternatives to SBA loans for small business funding?

Apart from SBA loans, business owners can utilize small business loans from alternative lenders, business credit lines, angel investments, crowdfunding, venture capital, and government grants to fulfill their financing needs. Each option varies in accessibility, cost, and terms, suitable for different types of businesses and financing needs.

 

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