Startup Business Loans: Know Your Options
Rates & Fees in this piece are accurate as of the date of publishing.
Starting a business requires money, but qualifying for funding is harder without revenue history. That’s why many budding entrepreneurs look for the unicorn of loans: the startup loan to get their business off the ground.
Startup business loans are generally for businesses that have been operating for less than six months, but are hard to come by. Many lenders aren’t keen on taking a risk on borrowers with a non-existent track record or very limited business credit history.
That’s where the Small Business Administration (SBA) comes in. “It’s truly the SBA that does startup loans,” said Ami Kassar, founder and CEO of MultiFunding LLC, an Amber, Pa.-based advisory firm for small- and medium-sized businesses.
Understanding a startup business loan
The SBA links entrepreneurs with lenders and funding to help them start and expand their business. Its guaranteed loan programs encourage banks and other lenders to make riskier loans that they otherwise wouldn’t. Both the 7(a) and microloan programs allow small businesses to use loan funds to get a new business into operation. The SBA’s 504 loan program is for existing businesses wanting to expand or modernize equipment.
For this reason, SBA loans have become synonymous with startup business loans and is often mistaken as a lender. The SBA doesn’t lend directly to small business owners. It sets guidelines and backs loans made by its partnering lenders.
What does it take to qualify?
To qualify for an SBA loan, your business must meet the following:
- Be for profit
- Meet SBA’s size standards
- Do business inside the United States
- Exhaust all other options for financing
Applicants should also have a very strong business plan and projections and a good understanding of how the borrowed money will be spent, Kassar said.
Don’t give up if one bank denies you for an SBA loan. “That’s not how it works,” Kassar said. “You really have to shop around and talk to many different SBA lenders out there to see if there’s one who would consider doing it for your startup loan.”
Startup business loans are risky for lenders, even for those partnered with the SBA, because new businesses often fail. This makes qualifying for an SBA loan difficult. “I don’t know the percentage but they’re not easy to find and they’re hard to get,” Kassar said.
Pros and cons of SBA startup business loans
An SBA loan doesn’t come without its challenges, but understanding the advantages and disadvantages of these loans can help you decide if it’s right for your small business.
Interest rates: SBA loans come with reasonable rates compared to other lending options for startups. The SBA caps rates on 7(a) loans, which can range between 2.25% and 4.75% plus prime. Rates on microloans come in between 7.75% and 8.5%.
Longer terms: Microloans have a six-year maximum loan term, while 7(a) loans generally run between five and 10 year terms. “It’s the best way because if you get it, you get the money and have 10 years to pay it back. So it gives you a lot of time,” Kassar said.
Keep control: Also, if approved, you don’t have to rely on selling shares of your company to an investor and can retain full control of it and its future, Kassar said.
Paperwork: Applying for an SBA 7(a) loan is a lot of work and can be very time consuming. “Sometimes people get really tired and frustrated by the paperwork,” Kassar said.
Fees: The SBA microloan comes with no fee. But the 7(a) loan has a guaranty fee that depends on the guaranteed portion of the loan as well as an ongoing fee. A prepayment penalty applies in specific cases.
Personal risk: If the lender typically requires collateral on loans between $25,000 and $350,000, then it must follow those requirements for 7(a) loans. At the very least, the lender must take a first lien any assets paid for by the loan. Microloan also require collateral and a personal guarantee from the business owner.
Is a startup business loan right for you?
SBA microloans are aimed at helping small businesses owned by women, minorities, veterans and low-income entrepreneurs who have difficulty accessing traditional loans. But other small business owners can qualify.
Lenders also view franchise businesses as good candidates for SBA loans because they tend to carry less risk, Kassar said. But other entrepreneurs shouldn’t be discouraged. Make an appointment with a counselor at your local SCORE office or visit the Small Business Development Center (SBDC) in your community to see which lending options are best for you.
“There’s hope for those who aren’t buying a franchise,” Kassar said. “It’s just going to be harder and you have to have the patience, the time and the discipline to find the right lender to get it done,”
Who/what type of business should avoid a startup business loan?
The SBA lists several types of businesses that are ineligible for its loans. They include:
- Businesses engaged in illegal activities
- Loan packaging businesses
- Speculative businesses, such as wildcatting for oil or trading commodities futures
- Multi-sales distribution businesses
- Gambling businesses
- Investment companies such as real estate investment firms
- Lending businesses such as banks, finance companies, factors, leasing companies and insurance companies
- Adult entertainment stores, strip clubs and non-profits.
- Dealers of stamps or rare coins
- Business with owners on parole
- Charitable, religious or other nonprofit institutions
Shopping for startup business loans
To avoid waste time, first determine whether a lender has a history of financing startup loans for small businesses, Kassar said. Use the SBA’s Lender Match tool to help narrow down your choices. Then, consider which type of SBA loan is right for your small business needs. Here’s how they compare generally.
|Loan Amount||up to $5,000,000||up to $50,000|
|Loan Term||5-10 years; 25 years for real estate||up to 6 years|
|Interest rate||prime + 2.25%-4.75%, dependent on size/term of loan||7.75%-8.5%|
|Guaranty fee||3% – 3.75% depending on guaranteed portion of loan; ongoing fee of 0.52% on loans over $150,000||None|
* The 7(a) program also offers a revolving line of credit up to $350,000 under its SBA Express option. This may be beneficial to a business who foresees ongoing cash needs, but doesn’t want to apply for multiple loans.
Applying for startup business loans
Generally speaking, qualifying for an SBA startup loan is determined by having a strong business plan, your credit score, personal income, whether you have a spouse that works who could support you early on and whether you have any assets that a lien could be placed on in case you falter on the loan.
“These that are the types of considerations that go into that calculation and every lender has their credit marks and their own different criteria for evaluating loans,” Kassar said, adding that it’s important for applicants to be disciplined and not give up during the process.
One of the biggest hurdles is getting the lender comfortable with your business plan. The lender also will review your personal credit, your personal financial statement, three years of your personal tax returns and revenue projections in your business plan.
The lender will likely have many follow-up questions for you, said Kassar, so It’s key that you are patient, feel good about your business plan and confidently address any lender concerns. He recommends buying a business planning software like Bplans to create a business plan that is complete before meeting with a counselor at the small business development center or an SBA lender.
Be prepared to spend some time gathering documents, starting with the following:
- Business plan
- Amount of funding you need
- Purpose of funds
- Your credit history
- Financial projections
- Available collateral
While it could take weeks or up to a month to perfect your business plan and gather the needed documentation, the approval process is thankfully shorter, according to Robert H. Nelson, the Massachusetts district director for the SBA. The current processing time is five days for small loans and 18 days for regular 7(a) loans.
“Most of our loans are done under expedited approval and obtain an instantaneous approval from SBA if eligible,” Nelson said. “Depending on the complexity of the transaction, the lender’s processing times can vary significantly and also can be affected by the delegated status of the lender.”
How much will startup business loans cost?
If it’s a startup loan and they’re using the SBA loan, it’s going to be, generally speaking, the highest tier of SBA prices.
7(a) loans less than 7 years:
- Prime plus 4.25% for $0 – $25,000
- Prime plus 3.25% for $25,001 – $50,000
- Prime plus 2.25% for over $50,000
7(a) loans 7 years or longer:
- Prime plus 4.75% for 0 – $25,000
- Prime + 3.75% $25,001 – $50,000
- Prime plus 2.75% for over $50,000
- Lender’s cost of funds plus 8.5% for 0 – $10,000
- Lender’s cost of funds plus 7.75% for over $10,000
*These rates are negotiable between lender and borrower.
While SBA microloans have no guaranty fee, 7(a) loans have a guaranty fee based on the portion of the loan backed by the SBA. 7(a) loans over $150,000 have an ongoing fee of 0.52%. Here’s how the guaranty fee on 7(a) loans are calculated:
- 3% for loans $150,001-$700,000
- 3.5% for loans $700,000- $1,000,000
- 3.75% on guaranty portion over $1 million
There is a prepayment penalty for 7(a) loans with terms of 15 years or more, if the loan is paid back early in the first three years. The penalties are assessed in the following way:
- 5% if prepaid in the first year
- 3% if prepaid in the second year
- 1% if prepaid in the third year
Other startup funding options
When you start a business and need capital to operate, there are generally three ways to get cash: use your personal savings, sell shares of your business or borrow money, Kassar said. Here are the other options, according to the SBA.
Commonly known as bootstrapping, self-funding includes capital from your personal savings, family members and friends and even your retirement savings plan. While you retain control of the business, your money remains at risk. You also may also face fees or penalties for tapping into your retirement plan early. You also make it harder to save for retirement.
These investors generally provide capital to startups and small businesses in exchange for an ownership share and an active role in the company. The funds venture capitalists offer are not loans so you don’t have to pay back the money, But you relinquish some control of your business. Venture capitalists are also particular about which businesses to invest in.
This method allows you to raise small amounts of funding from a large number of people known as crowdfunders, including your family, friends and others. Kickstarter and GoFundMe are among the well-known crowdfunding platforms used to raise capital. This is a low-risk method. Because crowdfunders aren’t investors, you retain control of the business. But crowdfunders typically expect a benefit in return for their contribution such as your product or service or formal recognition. You may also not raise enough money for your needs.
“In some cases, the business doesn’t really exist yet and there’s not much of a business to borrow from,” Kassar said. “So people may try to borrow money using their home equity line if they have a house or using their credit cards.”
But credit cards come with higher interest rates and you’re personally liable if you default. Home equity lines of credit are only an option if you own your house and have enough equity in it. You also risk losing your home if you default on a line of credit.
SBA investment programs
Small Business Investment Companies, or SBICs, are private investment funds that make equity and debt investments in small businesses using their own capital and funds backed by the SBA. The Small Business Innovation Research Program (SBIR) encourages small businesses to get involved in federal research and development that has the potential for commercialization. The Small Business Technology Transfer Program (STTR) provides funding opportunities that require small businesses to formally collaborate with nonprofit research institutions.
Choices are limited for a startup loan outside of those offered by SBA-partnered lenders. Fortunately, these small business loans offer reasonable interest rates and longer term repayment schedules, as long as you can suffer through the extensive documentation required. If you don’t have other – and cheaper – sources of funding available to you, it’s probably worth the headache to get this government-backed loan to get your business up and running.