How to Get an SBA Loan

Note that this article is one in a series of articles on small business how-to's.  Past series have covered how to buy a business, labor audits, sales taxes, and workers comp.

I recently went through the process of obtaining an SBA (Small Business Administration) loan.  These are loans that are what I call "cash flow" loans, secured more by the companies earnings rather than collateral (though collateral may be required, see below).  SBA loans are written by private banks to standards set by the government.  If these standards are met, then bank loans under this program get a partial guarantee from the US government.

Before I go on to describe the process, I feel compelled to note that as a libertarian who does not believe the SBA should even exist and who believes that such loan guarantees are a subsidy program that should be eliminated, I was obviously conflicted by whether to seek out such a loan.  What finally made the decision for me is that this government program has crowded out all other private options.  Banks get about the same rate for an SBA loan as they would for a commercial loan without the guarantee.  Since the guarantee is out there and doesn't cost the bank anything, the bank has no reason not to insist on it?  Therefore, as a small company in the SBA size range, there just are not any banks willing to lend without the SBA guarantee.  This does not mean that in a free market without the SBA there would be no loans - it just means that when such a free subsidy program exists, banks are going to take it.

Types of Loans

The following is a gross simplification, but for a small company, there are basically two types of loans: secured loans and cash flow loans.  Secured loans are by far the most common for small businesses.  I, like nearly every entrepreneur I know, have had to pledge my house at various times as collateral for loans.  While it is fairly easy in today's market for a small company to get an equipment loan (typically lease-finance of a purchase) secured by hard assets, few lenders will provide loans for general business and working capital needs unless they are secured by something tangible -- homes, vehicles, receivables, etc. 

However, most businesses need capital for more things than just to buy hard goods.  Seasonal businesses may need loans to pay the rent in off-seasons, retail businesses need money to grow inventory and pre-pay for new leases, while opening new divisions may require paying salaries well in advance of first revenues.  Unfortunately, most businesses that claim to be business banks have no desire or talent to understand a business well enough to make a cash flow loan.  I am not talking about just Ethyl's Bank, but large banks like Bank of America and Wells Fargo who were stumped when I wanted to discuss some unique financing needs in my business.  I know people with a half million dollars a year in free cash flow out of their business who have trouble getting bankers to make unsecured cash flow loans.  And, as mentioned above, those who do make cash flow loans typically insist on having the SBA guarantee.

How an SBA Loan Works

I will not pretend to be an expert on all the intricacies and rules.  The SBA has a number of programs, offering loans of different lengths of time and for different purposes.  The SBA has programs for both revolving lines of credit as well as standard 10-15 year loans.  Each of these programs has different under-writing criteria, fees, and limitations, which your banker will have to explain to you.  Most SBA loans, including mine, fall under the section 7(a) program.  The SBA site tries to explain some of this.

As stated in the intro, an SBA 7(a) loan actually is issued by a bank, but to SBA underwriting criteria and with an SBA guarantee.  The SBA only guarantees a portion of the loan, something like 50-75% depending on the exact loan type, with the bank taking the rest of the risk.  These loans are issued at a floating rate of prime plus a percentage, and the SBA has rules that caps the rates as well as fees the bank can charge.  The SBA charges a substantial fee, in the 2-3% of total loan value, up front to the borrower for the guarantee.

Banks participate in the program in one of two ways.  Most any bank can originate an SBA loan, collecting all the (very substantial) paperwork needed by the SBA and forwarding it to the SBA for approval.  In addition to the underwriting time at the bank, the SBA can take many weeks to complete this analysis.   A smaller subset of banks have been pre-approved by the SBA to act as their underwriting agent - called a preferred lender or PLP.  This means that they can do the SBA's analysis for them.  This often greatly accelerates the process.  My total time form the bank's first data request to the final loan closing was less than a month, which is very fast.

Choosing the Bank is Critical

From the section above, it should be obvious that you should strongly consider working through a bank that has the preferred lender status with the SBA.  Note that having  or not having this status does not necessarily correlate with bank size.  The "expert" I was hooked up with at Bank of America (my main bank) was useless, and told me in so many words that it would be impossible for me to ever get an SBA loan.  I ended up working with Silver State Bank, a relatively new business bank out of Nevada.  They had the whole process automated, and when combined with a very knowledgeable banker on the front end named Jerry Woods here in Phoenix, the process was as smooth as silk and very, very fast.  In fact, I got the whole loan done in less time than it took BofA two years ago to do my line of credit.

Costs and Other Considerations

SBA loans are not cheap, and I would strongly urge you to pursue secured asset-backed loans as far as you can.  My total fees, including the cost of the guarantee, ran to about 3% of the total loan value.  In addition, I STILL had to put up collateral to back the non-guaranteed portion of the loan.  In retrospect, I think I did a bad job of negotiating with my banker on this.  No matter how good they are, bankers are still bankers and are going to attach every asset that can sit still for collateral whether they really need it or not.  I should have pushed back harder on this issue.  Overall, though, I am excited that I now have the capital to continue to grow my business.

PS-  If you want to enjoy some of this capital at work, come to Lake Havasu and rent a jet ski for a day!  All those other entrepreneurs out there are investing money in dead-end stuff like microchips and improved manufacturing --  Ha!  There is nothing like being able to tear around a big lake on 110HP to really make America competitive!

  • http://www.22singersonemicrophone.blogspot.com Randy

    You must not be a praticing Libertarian if you indeed took the loan. Stop calling yourself one, if you won't make the "sacrifices" involved in changing this country.

  • http://valueprep.com/personal-loans/unsecured-personal-loan.html Brian unsecured personal loan guy

    Wow, seemingly childish to be so heated! I like when you call yourself that...so there.

  • http://www.achristianblog.com/ aaron

    I wish more people would blog about their SBA experiences, thanks!

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  • anna

    do you know what happens if you default on an sba loan

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  • notbaretto

    yours was a good overview. now, banks can make a loan and receive a 50% loan guaranty from sba, using their own documents, eliminating much of the paperwork previously required.
    a point of concern. under the regulations the bank is prohibited from obtaining collateral to secure the unguaranteed portion of the loan. all available collateral must be pledged to cover all of the loan; if there is a deficiency the sba covers its guaranteed portion after the liquidation of all collateral.
    i'm a libertarian too, and was pleased to see a 1993 study by price waterhouse, which documented sba is a net revenue generator for the public. the borrowers' guaranty fees, banks' fees to sba (paid to have the guaranty), and the taxes paid by the employees of small businesses which jobs/tax revenues would not have existed but for the financing provided due to the sba guaranties, far exceeded the total cost of the sba operations to the taxpayer. that's a result a libertarian can appreciate, especially recognizing the program does not displace non-guaranty loans; certainly one would not incur the higher transaction costs of a loan guaranty if cheaper non-guaranteed loans were otherwise available.

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  • Nathaniel Booker

    You failed to mention that because of the SBA guaranty banks will provide longer term financing than without the guaranty. For instance, most bank loans have shorter repayment terms 1 - 3 years for working capital financing. With SBA guaranty repayment terms are 7-10 years, more than twice as long. Obvioussly the longer repayment term makes the loan more affordable. With the SBA guaranty many businesses would not qualify with the shorter repayment term. Thus, it is not completely accurate to indicate or suggest the banks could provide similar financing withou the SBA guaranty.

    Also, SBA lenders provide up to 25 year financing for real estate loans without balloon payments. Most banks never provide this relatively length repayment term without the SBA program. Generally providing 10 - 15 years repayment and in many instances with a balloon payment (balloon payment results when the monthly payments made on the loan are lower than required to fully pay off the loan fully for the repayment term. The final payment is substantially more to pay off the remaining balance at the end of the repayment term). This could place a significant burden on the small business to come up with this finanl payment.

    Without the SBA program many small business deserving financing would be underserved by the banking community. Even you as "Libertarian" saw the practicality of obtaining a SBA guaranteed loan.

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  • http://www.504blog.com Robyn

    Mary Anne Martin said: "now, banks can make a loan and receive a 50% loan guaranty from sba, using their own documents, eliminating much of the paperwork previously required."

    What she's referring to is the SBA 504 Loan Program which provides 90% financing of commercial real estate. The main difference between this loan program and the more commonly known SBA 7(a) program (besides having a conventional first mortgage of 50% and a second mortage of 40% that is backed by the SBA) is that SBA 504 Loans have the option of fixing the rate at below market interest rates. Whereas 7(a)'s have floating rates tied to prime. Check out http://www.504blog.com or http://www.sba.gov or http://www.504experts.com.

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