5 Major Problems With SBA Loans
Small Business Association (SBA) loans have helped countless entrepreneurs launch and grow their businesses. That being said, roughly only about 50% of small businesses that apply are approved.
That means that roughly half of those small business owners who apply have to find alternative lending or funding.
The SBA currently offers 4 types of loans:
- 7(a) loan program of up to $5 million (Processed through banks, credit unions, other lenders)
- 504 loan program of up to $5 million (Processed through private-sector lenders and nonprofits)
- Micro Loans of up to $50,000 (Processed through community-based nonprofits)
- SBA disaster loans of up to $2 million (Processed through the SBA)
None of these loans are particularly easy to get. If your business is in need of financial help, your best bet may be to save time, skip the SBA loan application process and go directly to exploring alternative options.
Here are 5 reasons why.
1. Stringent Lending Standards
Even if your business has a strong credit history, you’re still not guaranteed to get approved for an SBA loan.
Generally, they are looking for businesses with annual revenue numbers over $180,000. You should have a minimum credit score of 680, and your business should be in operations for a minimum of four years. If you’re short on any one of those 3 numbers, your odds are very low of getting approved.
If you foresee any of this being a problem, you are probably better off looking into alternative funding assistance with Payvant Capital to help your business. They can offer you a merchant cash advance (MCA), which has more favorable qualification criteria for small businesses. It is not subject to traditional lending standards because it is not a loan – it’s a form of funding.
You may be able to qualify if you:
- Have been in business for 6 months or longer
- Have at least $10,000 in monthly transactions
The advances can reach as high as $500,000, depending on a number of factors. Applying for an SBA loan will require a much deeper dive into your company’s history and your own personal financial history. Your application will include submitting:
- A complete business plan
- Two years of business tax returns
- Two years of personal tax returns for you and any other owners
- Personal financial statements for you and any other owners
- Resumes for each owner
- Financial projections for 12-36 months
- Detailed cash flow statements
- Current profit and loss (P&L) statement
- Current balance sheet
- Detailed documents laying out how you propose to use the funds
You also need to be able to display a good amount of equity to qualify. The SBA’s standards, state that:
The owners must have enough of their own money at stake in the business:
(a) For a New Business (or when buying a business) you should have approximately one dollar of cash or business assets for each three dollars of the loan.
(b) For an Established Firm, the after-the-loan business balance sheet should show no more than four dollars of total debt for each dollar of net worth (i.e., a 4:1 Debt/Equity ratio – may vary by industry).
All of these factors set the bar too high for the average small business owner. This is why it is often in their best interest to save time by exploring more attainable lending and funding options right away.
2. Long Wait Times
As you can see from the previous section, there is a lot of paperwork involved in the SBA loan process.
That’s a lot of documents you need to gather and you may not even have everything they’re looking for. For example, you may feel the need to update your business plan to better reflect where your business is at today, compared to when you first wrote it. And then your lenders need to review and evaluate all of this.
This is why applying for an SBA loan can take weeks or even months, which is not good if you need the money in a hurry.
When a small business needs a loan or funding in a hurry, it usually means something big has happened. They might need an influx of cash to keep the business afloat during a crisis, such as damage to their building or the loss of a big client. In a lot of situations, this money could literally make or break your business. Without it, you may not be able to:
- Pay for repairs
- Pay for your regular expenses
- Pay your employees
Or, the situation could be an opportunity instead of a crisis. Maybe the opportunity to buy a big piece of equipment at an amazing price has presented itself. Buying it could be a game-changer for your business, helping you reach more clients or offer them more services. It could pump more revenue into your business… but you don’t have the money to buy it right now.
SBA Loans or traditional term loans for small businesses are not going to be much help when a sudden crisis or opportunity arrives. If you’re in need of fast funding, you’re better of looking into an MCA.
Your MCA application can be completed completely online and you can have an answer within 24 hours. That gets the much-needed funding into your account much faster.
3. A Lack of Spending Freedom
SBA Loans are also a bit uncompromising in how you spend your money and how you pay it back.
First of all, this money is not simply yours to spend how you see fit.
Let’s say you’re running a restaurant and the unit next door has suddenly hit the market. Your clientele has been steadily growing and expanding into that next-door space could really help you take your business to the next level. You wouldn’t be able to use your SBA microloan for a down payment because they are not to be used to buy real estate or to pay debt.
Or, perhaps you’re running a retail store. A pipe bursts and erupts over your storeroom overnight and it destroys your entire inventory. Well, SBA 504 loans don’t allow you to use your funds to buy inventory.
The same can be said for many business lines of credit available on the market. You can get revolving credit up to a certain amount of money. However, that money is not simply yours for the spending. In many cases, you have to submit a formal request explaining what you intend to do with the money.
4. Static Repayment Terms
The other issue with an SBA loan is that you’re required to make a loan payment of the same amount every single month. Your eligibility to get this loan in the first place is based on your perceived ability to make those payments.
Failing to make these payments on time can damage your credit and cost you your loan, regardless of how your business is doing.
Repaying a Merchant Cash Advance
On the other hand, an MCA would offer you far more flexible repayment terms.
You’re paying back your advance through remitting daily or weekly debits from your bank account through Automated Clearing House (ACH) withdrawals. It is also possible to pay back via an agreed-on percentage of your future credit and debit card sales.
Another key difference between an MCA and a loan is that MCAs do not deal with interest rates. Your provider will use a factor rate based on a risk assessment that typically falls somewhere between 1.2 to 1.5. The higher the factor rate, the higher the cost of borrowing may be. Multiply the amount of your advance by your factor rate to get your total repayment amount.
For example:
- An MCA for $50,000
- A factor rate of 1.4
- A total repayment amount is $70,000
How long will you be paying that amount back? Again, that all depends on how good your sales are.
If you were paying back $70,000 and remitting 10% of your transactions:
| If You Made $100,000 a Month in Sales | If You Made $70,000 a Month in Sales |
| You would pay $10,000 monthly | You would pay $7,000 monthly |
| You would pay off the advance in about 7 months | You would pay off the advance in about 10 months |
5. SBA Loans Can Be Risky
Lenders that offer SBA loan assistance want to protect themselves in the event you default on the loan. As a result, your loan terms may include:
- A personal guarantee
- Assets put up as collateral
Neither of these is particularly inviting to a business owner.
A Personal Guarantee
It’s always risky any time that you put your own personal finances on the line for a business transaction. Limiting this type of personal exposure is exactly why so many business owners choose to incorporate.
If you sign an SBA loan, many SBA lenders will make the personal guarantee a condition for your approval of the loan. This means that if you can’t pay back the loan according to your amortization schedule and terms, you are now personally on the hook. You now need to pay the money back using your personal accounts or via your own assets, which could mean anything from your savings accounts to your real estate.
The SBA also requires a personal guarantee from all owners with at least a 20% ownership stake in the company, not just the majority owner.
In the event of default on your SBA loan, you could eventually be faced with dealing with the US Treasury Department who can garnish your future wages and take your tax returns to pay the debt.
Assets Put Up as Collateral
Your SBA loan may also need to be secured with one of your business’ assets, or a few of your assets.
In fact, the SBA has stated that:
“When a loan guaranty is approved, we expect all available company assets to be offered as collateral. If company assets are insufficient to fully secure the loan, liens on personal assets may be required. Often, this means a lien on residential real estate.”
This means that if you can’t put up a big enough combination of business assets (i.e. Machinery, large equipment or vehicles), you are now putting your own personal assets on the line to secure this loan.
This is simply too risky for a number of business owners.
Closing Thoughts
We hope this has provided some insight into what the SBA loan process and standards are like, and what you could be facing if you decide to go this route.
There is certainly no such thing as a one-size-fits-all lending or funding solution in the world of small business. No two businesses are alike, nor are their financial situations or challenges.
An SBA loan could be the best option for your business and there are certainly a number of success stories that have come from that program. However, if you read the section about their lending criteria and said “That is going to be a problem,” you’re certainly not alone.
Those loans are often not the best option for a business that cannot meet the SBA standards for credit history, income or equity. The SBA’s loans are also likely not your best option if you’re in need of a fast influx of cash into your business, for one reason or another.
Knowing that you’re not an ideal candidate for an SBA loan in advance of the process is a good thing, and can save you a lot of time and effort. You can save yourself a 30-day (or more) application process that may eventually end in disappointment.
It may be best to explore more viable and flexible options right away. If your business is in need of fast funding, we invite you to contact Payvant Capital today to see that you do have options!
Our merchant cash advance program is designed to help business owners like you get the funding they need, with a fast application process and fair terms.