The world of small business financing is complex and multifaceted, with one of its most crucial elements being government loans. Often misunderstood, these lending mechanisms are designed to support the growth and stability of small enterprises, empowering them to overcome financial hurdles and attain their objectives. This article seeks to demystify government small business loans, elucidating their nature, potential beneficiaries, and the diversity of options open to entrepreneurs.
Understanding Government Small Business Loans
Despite popular misconception, in most cases, the federal government doesn’t lend money to small businesses. Instead, a government small business loan is a loan through an approved lender backed by the government. The government sets guidelines for these loans, and the main benefit is that it reduces the risk for lenders, making it easier for small businesses to get the funding they need.
Traditional lenders often view small businesses, especially new ones, as high-risk borrowers due to their lack of collateral or established credit history. In contrast, government-backed loans are designed to support these businesses, even when they do not meet conventional lending standards. This isn’t to say that all businesses can get funded because of these government programs. A feasible business idea, good business plan, and the owner’s credit history will be taken into consideration.
Related: Do SBA loans affect personal credit?
Types of Government Loans
There are several types of small business financing options, but I will go over the more popular ones, including the SBA 7(a), SBA 504 loan, SBA microloans, and the USDA B&I program.
SBA 7(a) Loan
The 7(a) Loan Program is the Small Business Administration’s (SBA) most popular loan program. It’s especially handy when a business purchase involves real estate, but it can be used for several other purposes, including:
- Short and long-term working capital
- Refinancing existing business debt
- Purchasing and installing machinery, equipment, furniture, fixtures, and supplies
The highest amount you can borrow with a 7(a) loan is $5 million. Eligibility for this loan depends on what your business does, your credit history, and where your business operates.
To qualify, businesses must:
- Operate for profit
- Be classified as a small business according to the SBA
- Conduct or plan to conduct business in the U.S or its territories
- Prove a need for the loan
- Use the funds for a valid business purpose
- Be up-to-date on any existing debt obligations to the U.S government
- Have a good credit standing and be able to repay the loan
The 7(a) loan can be used for:
- Long and short-term working capital
- Revolving funds based on the value of existing inventory and receivables
- Purchasing equipment, machinery, furniture, fixtures, supplies, or materials
- Purchasing real estate, including land and buildings
- Constructing or renovating buildings
- Starting a new business or helping with the acquisition, operation, or expansion
- of an existing business
- Refinancing existing business debt under certain conditions
When you’re ready to apply for an SBA guaranteed loan, you’ll need to work with an approved commercial lender to determine which documents are needed. Generally, you’ll need to fill out the Borrower’s Information Form (SBA Form 1919). Depending on your business’s circumstances, your lender will also ask for financial statements, proof of the existence of the business (ex. formation paperwork, business license, etc.), income tax returns, and possibly more.
SBA Express Loan
For a small business owner that needs swift funding, the SBA Express loan is an ideal solution. While technically a modified 7(a) loan, the SBA Express loan provides an expedited approval process, but loans are limited to $500,000. Applicants can expect a response within 36 hours and funding within seven business days if approved.
SBA 504 Loan
The SBA 504 Loan Program is a Small Business Administration program that is designed to support business growth and job creation by providing long-term, fixed-rate financing for significant assets.
These loans are managed by Certified Development Companies (CDCs), which are community-based partners of the SBA that work toward improving local economic development. The maximum amount you can borrow under the 504 loan program is $5.5 million, although certain energy-related projects may qualify for more.
To be eligible for a 504 loan, your business must:
- Be a for-profit company operating in the U.S or its territories
- Have a tangible net worth of less than $15 million
- Average net income of less than $5 million after federal income taxes in the last two years
- Meet other SBA size guidelines, have qualified management, a feasible business plan, good character, and the ability to repay the loan.
However, businesses engaged in nonprofit, passive, or speculative activities cannot qualify for this loan.
You can use a 504 loan to buy or construct existing buildings, land, new facilities, or long-term machinery and equipment. It can also be used to improve or modernize land, streets, utilities, parking lots, landscaping, and existing facilities. However, the loan cannot be used for working capital, inventory, debt consolidation, repayment, or refinancing, and it cannot be used for speculation or investment in rental real estate.
SBA microloans cater to small business owners who need small, short-term loans. Like the other SBA loans, the microloan program is not a direct loan from the SBA. Instead, the SBA provides funds to intermediary lenders. These lenders then provide microloans to small businesses. While each intermediary lender has its own lending and credit requirements, they generally require some type of collateral as well as the personal guarantee of the business owner.
In addition to providing financial assistance, most microloan lenders also offer business counseling and training, which can be particularly helpful for newer businesses.
SBA microloans are available for up to $50,000 and interest rates typically range between 8% and 13%. Funds can be used for various purposes, including working capital, inventory, supplies, furniture, fixtures, machinery, or equipment. However, they cannot be used to pay existing debts or to purchase real estate.
USDA Business & Industry (B&I) Loan
Not as popular as the SBA programs, the United States Department of Agriculture (USDA) B&I Loan Program offers financial support to rural businesses, providing them with loan guarantees. Like the SBA, this program is managed by banks with guarantees by the USDA. Some lenders specialize in these loans, assisting rural businesses in understanding the process and requirements.
USDA B&I loans are designed to assist rural businesses that operate in regions with typically under 50,000 residents. See the USDA eligibility map to see if your business can apply. Both for-profit and non-profit businesses, cooperatives, and federally recognized tribes can qualify for these loans.
The B&I loans can be used to start or expand a business, including as working capital, buying commercial real estate, machinery or equipment, business acquisitions, and debt refinancing if it improves cash flow and generates jobs.
Businesses can borrow more through the B&I program than in SBA programs, which provide up to $25 million. The maximum term is 30 years for commercial real estate, up to 15 years for machinery and equipment, and 7 years for working capital. Interest rates, either fixed or variable, are set by the lender. The USDA’s loan guarantee varies on the amount being borrowed.
- Loans of $0-$5 million: 80% guaranteed
- Loans of $5-10 million: 70% guaranteed
- Loans greater than $10 million: 60% guaranteed
While there are eligibility requirements and application processes to navigate, the potential benefits make these loans a worthwhile consideration for any small business owner. It’s important to note that despite their higher costs and the paperwork required to apply, government-backed loans can be beneficial for businesses that might not qualify for traditional financing. The government guarantee reduces the risk for lenders, which allows them to provide loans to businesses that they might not otherwise lend to.
Government Small Business Loan FAQs
Why would a small business want a government-guaranteed loan?
Small businesses may want a government small business loan because they offer competitive interest rates and flexible repayment terms 2. Additionally, some loans come with continued support to help start and run a business 1 These loans are structured to help small businesses navigate financial challenges and achieve their goals, featuring several key characteristics and benefits.
Is an SBA loan cheaper than a traditional business loan?
There is a common belief that SBA loans are less expensive, but that isn’t the case. While a government-backed loan can often be spread out over more years than a traditional business loan, making the monthly payment cheaper, there are costs to consider.
SBA Guarantee Fee: One of the reasons why SBA loans are more expensive is due to the SBA guarantee fee. The SBA charges this fee to lenders for the loan guarantee provided by the government. It’s essentially an insurance premium for the lender in case the borrower defaults on the loan. This fee, which varies based on the size and maturity of the loan, is often passed along to the borrower, increasing the cost of the loan.
Interest Rates: While the SBA sets a maximum cap on interest rates, the rates can still be higher than conventional loans. The rate usually includes a base rate (like the prime rate) plus an allowable spread that the lender can charge. This spread accounts for the risk of lending to small businesses, which are typically considered riskier borrowers.
Packaging and Other Fees: SBA loans can come with other fees such as packaging fees (for preparing and submitting the loan application), servicing fees, closing costs, and possibly other fees.