Business LoansSBA Loans

A Basic Guide to Microloans

Microloans

You’re a startup founder. You’ve just started Widgets Incorporated and don’t need much money to get started. You’ve tried going to your local bank for a loan, but your banker says $15,000 is too small an amount to be profitable for them.

If only you could find a lender willing to lend $15,000, you could get the equipment you need and inventory to get your business up and running.

In fact, you already have “skin in the game” and have invested your own money into the venture.

Have you considered the benefit of applying for a microloan?

If you’re looking for a small investment and are a new or existing business in need of funding, a microloan could be for you.

Microloans help start and grow a lot of small businesses, said Sandy Headley, vice president of Access to Capital for Entrepreneurs (ACE), which assists businesses through loans and business development services.

Continue reading to learn about microloans and if they could be a viable option for funding your business.

Understanding microloans

A microloan is a loan disbursed in a small amount. For example, the Small Business Administration, whose goal is to promote U.S. small businesses, has a microloan program that lends up to $50,000 to startups and nonprofit child care facilities.

Microloans also play a role in community development. It is an important part, especially in building a community because communities need small businesses, Headley said. They fill in space with larger businesses and make a community attractive, drawing more business, she said.

Another use of the microloan, popularized by microlenders such as the nonprofit organization Kiva, is to assist entrepreneurs internationally and promote business ownership in particular regions of the world.

How do they work?

Microloans can be used in many ways, including purchasing inventory and supplies, working capital, machinery or equipment. Each lender will have its own set of requirements, with some lenders having requirements as specific as region or state of a business, or the business owner’s gender. Main Street Launch, for example, provides loans to businesses in San Francisco or Oakland, Calif. Grameen America lends only to women entrepreneurs.

Rates will also vary and may be higher than those of a traditional bank.

How likely are you to qualify for one?

Even though a microlender might offer a small business more flexibility with credit history, a business owner should still present a competitive application in order to apply.

Here are three main items to pay attention to when applying for a microloan:

Credit: Each lender will have its own credit requirement, so review both business and personal credit by requesting reports from credit bureaus such as Dun & Bradstreet, Experian, TransUnion and Equifax.

Business plan: A business plan will help others see the the vision that you have for your business. The Small Business Administration’s website offers a great deal of information on writing business plans.

Collateral: A lender will likely require collateral to secure the microloan.

Pros

Microloans can offer a number of benefits to a borrower. They offer:

  1. An alternative lending option for businesses that don’t meet qualifications of traditional bank loans.
  2. Loans in small amounts. Not all businesses require large amounts of capital to thrive. Some businesses might need less than $50,000, in which case a microloan would be an option.
  3. A start to building a positive lending history. Microloans help businesses to build credit so that when they need their next loan a couple of years down the road, hopefully they’ll be able to qualify for a bank loan, Headley said.
  4. Additional training. A microlender may also offer additional services such as business development or consulting.
  5. A focus on underserved populations. The SBA Microloan Program, for example, targets entrepreneurs from underserved groups such as low-income, women and minority entrepreneurs.

Cons

Before applying to a microloan, here are three additional points to consider:

  1. Limitations: A lender might lend to individuals for certain regions or social demographics. As you research options, review each lender’s requirements.
  2. Amount of capital your business needs: Microloans provide lending for small sums of money, usually up to $50,000. If you need more capital for your business, you will need to consider other financing options. Or use the microloan to build and develop a lending history to get a larger loan.
  3. Interest rates: Interest rates for microloans tend to be higher than those of traditional banks, but are for lower amounts so they will be repaid more quickly.

How they stack up

Microloans are just one of many possible options for financing a business. Let’s take a moment to look at how microloans stack up to a few other options for financing, starting with traditional loans.

Traditional loans: Traditional small business loans will also be secured with collateral, but lend in larger amounts and are more strict on credit requirements.

Business credit cards: If a balance isn’t repaid on a credit card, it will be transferred each month, causing the cardholder to incur more debt. Microloans have repayment terms with the goal of the loan being repaid in full.

Merchant cash advance: Also referred to as MCAs, a cash advance company will advance a certain amount and recoup the fund through future credit card sales. Interest rates are typically higher than those of microloans.

Is a microloan right for you?

While microloans are open to any business that meets the eligibility requirements of a particular loan, there are certain entrepreneurs who would be a good fit for consideration for microloans as a form of business financing.

The following businesses and business owners can benefit from a microloan:

  • Startups or early-stage businesses that require little capital
  • Businesses that want to use a microloan to build credit for a larger loan in the future
  • Low-income entrepreneurs

Who/what type of business should reconsider a microloan?

Any business in need of large sums of money, or an amount larger than $50,000 should seek other forms of financing for their business. Microloans focus on smaller loans for businesses.

Shopping for microloans

Look for lenders who will fit what you’re looking for.

As you search for microlending matches, compare the following:

    • Interest rates: Interest rates vary from lender to lender and will impact the overall amount that you repay.
    • Maximum amount: Review the amount maximum to make sure that the loan amount will cover the cost of your business’s financing needs.
    • Transparency: Is a website clear in presenting the information and easy to understand? Is all information presented up front, including additional fees? Can you trust the lender?

Small business owners have many options when it comes to microlenders. Because so many options exist, we’re going to list a few here. Then we urge you to head over to Google or a local business center to learn more.

SBA Microloan Program:

The SBA Microloan Program provides loans up to $50,000 to small businesses and not-for-profit childcare facilities. This program is ideal for a business that needs a smaller amount of capital to get up and running, or to grow. SBA microloans can be used on supplies, furniture, fixtures, machinery equipment and as working capital. The average interest rate for this loan is 7.5% and has a repayment term of up to six years.

Grameen America:

Since starting in 2008, Grameen America has disbursed nearly $1 billion in microloans, helping women escape poverty by way of entrepreneurship. First, one woman finds a group of women she trusts. She then receives financial training for one week and opens a savings account. Grameen America then lends each woman $1,500 for her small business. Grameen America is active in 13 U.S. cities and has created 190,000 jobs and invested $935 million in women to date.

LiftFund:

LiftFund offers lending options for businesses and startups that don’t qualify for traditional sources of lending. It is a community development financial institution (CDFI) that works to create economic growth in communities throughout the U.S. LiftFund has loans between $500 and $1 million and serves 13 states.

Valley Economic Development Center (VEDC):

VEDC offers loans between $500 and $500,000 to small businesses in California, New York and Illinois. The Microenterprise Loan is between $500 and $2,500, and the VEDC Microloan is between $2,500 and $50,000. Valley Economic Development Center is a CDFI as well, and administers loans and microloans with a community-centric approach. Microloans start with an interest rate of 7.75%. Uses for loans include working capital, inventory, furniture, fixtures, business acquisition and expansion. VEDC also offers educational courses and one-on-one counseling services.

ACCION:

A non-profit lending network that provides loans between $300 and $1 million with fixed rates from 7 percent to 24 percent. Some of its goals are to help businesses create jobs, increase the amount of assets and thrive financially. ACCION serves businesses in various regions in southern California, Arizona, Colorado, New Mexico, Nevada, Texas, Illinois, Indiana and the U.S. East Coast.

The U.S. Small Business Administration also has a list of participating intermediary lenders in various states. Download here.

Eligibility for microloans

Each microlender has its own criteria to determine lender eligibility. In most cases, the borrower must be at least 21 years old and the owner of the organization intending to use the borrowed funds for business purposes. A sole owner can apply alone for a microloan, while co-owners must apply as co-borrowers.

Generally, credit requirements are less stringent than they are for other types of business loans, since they are designed for growing companies that might not have had the chance to build up much credit. Credit scores for the business and its owners are reviewed. However, they are considered in the overall context of the loan application. Therefore, things like a strong business plan or the management team’s past success might offset less-than-ideal credit. Serious financial issues like recent bankruptcies or tax liens will likely disqualify an organization from achieving these loans.

Some microlenders require that the company resides in the same state where it operates. Others give priority to certain types of owners, including minorities, veterans, women, and those that meet low-income requirements, in order to boost entrepreneurship in underrepresented groups.

The SBA’s microlending program does not have many requirements for borrowers. It specifies that the funds must go towards working capital and materials such as supplies, furniture, fixtures, and equipment. You cannot use SBA microloans to buy land or property. The SBA notes that its program does not take borrowers’ creditworthiness into account unless they are looking to obtain more than $20,000.

Applying for microloans

Before beginning the process of applying for a microloan, do some research and figure out exactly how much you want to borrow. You should be prepared to back up that request with facts and figures, including how much the items in which you want to invest cost and how making those purchases will help your company meet its growth goals. You should also review your finances to determine how large of a payment you can afford to make each month and what length of terms you’ll need to complete your payments.

Borrowers can find potential microlenders that service their area by searching online, referring to the SBA’s list, or visiting a local resource that assists small businesses such as a nearby college’s center for entrepreneurship. You can reach out to the lender over the phone or fill out their online form for potential applicants.

Application Process to Get a Microloan

After answering a few preliminary questions, you’ll likely receive more comprehensive application forms via mail or e-mail. Depending on the lender, you might need to provide documentation with your application, such as:

  • Detailed business plan
  • Business registration and licenses
  • Proof of ownership
  • Recent balance statements
  • Tax returns
  • Cash flow analysis
  • Valuation on intended collateral

Some microlenders require that you undergo training before they will consider your application. This can include courses or sessions with a counselor that cover topics like financial management, marketing, and customer service. A microlender might also have specific requirements regarding your business plan and the level of detail it covers. Certain lenders mandate these things to improve the likelihood of success for your company, thereby upping the probability that you’ll pay back your loan responsibly.

Sometimes, a microlender will require the borrower to provide collateral to secure a loan. This can be personal property like real estate or items that the company owns, such as commercial machinery and vehicles. Microlenders might also ask owners to contribute a certain amount of the company’s money towards the loan’s intended purchase to prove their company has some skin in the game. For example, if your company needs money to purchase a piece of manufacturing equipment that costs $10,000, the lender might provide $8,000 and ask that you put the other $2,000 down. Before you apply, think about whether or not you’re able to put down money or collateral to secure your loan. Know what you can afford and make sure you have an accurate valuation on your property.

Once your application has been reviewed by the microlender, they will let you know if it’s been approved or denied. If you receive an approval status, they’ll outline the rates and terms. Depending on whether you believe the terms are amenable to you, you will sign a contract and the loan will be funded. If your application is denied, you can continue to apply with other lenders.

How much will a microloan cost?

The cost of a microloan will include principal and interest, in additional to any fees (i.e. origination fees and closing expenses). Interest rates will vary relative to the loan. A number of factors can impact repayment terms such as the amount of the loan, plan for the funds, lender’s requirements and the unique needs of a borrower.

The bottom line

In short, microloans can serve as an alternative to traditional financing through a bank loan. It is for less money and can also serve as an introductory loan for a business to move onto financing options for larger amounts.

If you have a new or existing business with minimal capital needs and are looking for financing to assist in its growth, microloans are a valid option.

It can be difficult for smaller businesses to get access to capital because the banks don’t want to do loans below $50,000, and the businesses don’t want to borrow more than what they need, Headley said. Microloans serve a phenomenal niche in that respect — a microloan can be the difference in these businesses staying in business, or not.

 

Compare Business Loan Offers