Pros and Cons of SBA Loans

Consider if the cons outweigh the pros of an SBA loan

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Small business owners often need financing for a variety of reasons, but sometimes, getting a traditional business loan can be a challenge. That’s because lenders view new businesses that don't have established financial histories as more of a risk.

So, the Small Business Administration (SBA) has created a solution for small business owners who need financing through SBA loans. These loans give business owner better access to financing through approved lenders who can offer reasonable terms.

Let's learn more about the pros and cons, so you can determine if SBA loans are the right solution for your financial needs.

Key Takeaways

  • SBA loans provide accessible funding for small business owners who may not qualify for traditional funding.
  • Business owners can receive anywhere from $5,000 to $5.5 million, depending on the type of SBA loan.
  • SBA loans have favorable repayment terms, lower interest rates, and access to mentorship.
  • Among their disadvantages, SBA loans tend to have a longer application process and may require a larger down payment.
  • SBA loans often have stricter terms for fund usage.

What Are SBA Loans?

The SBA works with various financial institutions to create funding guidelines that reduce the risk for the lender and increase a small business’s chance at getting a loan.

These loans are funded from SBA-approved or preferred lenders and are guaranteed up to 90% by the SBA. The SBA agrees to pay up to the guaranteed amount if the loan goes into default, creating lender security. However, the business owner still needs to repay the defaulted amount, so the SBA could, for example, liquidate collateral and or put a lien on your income or tax return.

Eligibility varies based on the loan type, business structure, and use of funds, but generally, you need to meet these base requirements:

  • Be a for-profit business
  • Fit the SBA small business size standards
  • Do business in the U.S.
  • Have invested equity (time or money) as the business owner
  • Exhaust financing options (use no other financing sources)

SBA loans need to be approved by both the lender and the SBA, which can extend the process. Working with a lender that is authorized by the SBA to make the final loan decision can improve the process.

Types of SBA Loans

SBA loans provide small businesses with up to $5.5 million to cover the purchase of fixed assets or provide working capital. Knowing the use of the funds is crucial to apply for the most appropriate SBA loan. Loan types include:

7(a) Loans

The 7(a) loan program is the SBA’s most popular loan program. It provides a revolving loan of up to $5 million in funding for most business expenses, including the purchase of new equipment, acquisition costs, or real estate. The SBA guarantees up to 90% of the loan based on loan amount and creditworthiness. 7(a) loans have a 5- to 25-year maturity rate and fixed or variable interest, depending on the lender.

504 Loans

The SBA works with CDCs (Certified Development Companies) to provide up to $5 million for the purchase or improvement of major fixed assets, such as land, new or existing buildings, and machinery. 504 loans offer fixed rates and 10- or 20-year maturity terms.

Microloans

Microloans provide business owners up to $50,000 to cover start-up costs. They are available through community-based lender organizations that often focus on underrepresented founders. The SBA sets a maximum repayment of six years, and the interest rates are generally 8% to 13%.

Disaster Loans

The Disaster Loan program provides funds to businesses located in declared disaster zones to cover operating expenses and losses not covered by insurance. Unlike the other programs, these loans are issued by the SBA.

Pros and Cons of SBA Loans

SBA loans make financing more accessible for small businesses that are often turned away from traditional loans. These programs have several advantages, including favorable terms. However, there are some disadvantages to keep in mind as well, such as a lengthy application process. 

Pros
  • Favorable terms

  • Loan amount variance

  • Business mentorship

Cons
  • Specific fund use

  • Lengthy approval process

  • Personal guarantee requirements

SBA Loan Pros Explained

Favorable Terms

SBA loans tend to be more affordable for small business owners because of their favorable terms. First, the SBA caps the interest rate that lenders can charge with a base rate connected to the federal prime rate or LIBOR. Second, maturity tends to be longer than traditional loans, up to 25 years, which makes repayment easier.

Both interest rate and repayment terms are set by the lender. Factors such as personal and business credit scores impact your terms.

Loan Amount Variance

SBA loan programs give business owners a way to purchase fixed assets or add working capital. So the amount needed can vary greatly, and SBA loans offer a wide array of funding. The smallest loans are often $5,000 via a microloan program. Larger 504 loans can fund up to $5.5 million. But you’ll want to ensure you apply for the proper program based on how you will use your funding.

Business Mentorship

Some SBA loans give business owners access to business counseling and mentorship. You can obtain guidance on topics from submitting a loan application via an SBA program to developing management skills. Underserved communities have the option for additional support through business centers working with the SBA.

SBA Loan Cons Explained

Specific Fund Use

Each SBA loan comes with specific rules on how funds can be used to support your business. 7(a) loans cover fixed assets and working capital, making it the loan option with the most variety in accepted uses. 504 loans specifically cover fixed asset purchases or improvements, and microloans can’t be used for real estate or debt restructuring. This could limit the type of loan you go after or hinder your ability to use funding as needed.

Lengthy Approval Processes

One of the biggest downsides of SBA loans is the lengthy application timeline, which can take from a few weeks to a few months. For any non-SBA-preferred lender, the approval process is twofold, as both the lending institution and the SBA need to accept the application. This could also mean you’ll have to provide additional paperwork for each organization.

Using an SBA-preferred lender may help reduce the length of the process, because these lenders make the final decision without the SBA’s secondary review.

Personal Guarantee Requirements

The SBA wants to see that you, as the business owner, are serious about the repayment of the loan.

First, you must have invested equity to be eligible for an SBA loan. Second, you need to put a personal guarantee down to share the risk with lenders and the SBA. For example, a loan may require a 10% or higher down payment or have a collateral requirement such as the asset being purchased with the loan.

SBA Loan Alternatives

A review of the pros and cons of SBA loans may have you looking into other funding options. Here are a few alternatives that may better suit your business structure and funding needs:

  • Crowdfunding: With crowdfunding, average consumers invest in your business without expecting a return on their investment. Crowdfund contributors often expect a “gift” in return for their investment, such as a product or promotion, but you are not obligated to repay them.
  • Bootstrapping: Bootstrapping is when you use your own resources, including money in savings or retirement accounts, then you develop strict budgeting. You may also turn to family and friends for contributions.
  • Business credit cards: A credit card allows you to build a business credit score, receive the card benefits, and showcase a reliable financial history when making timely payments.

Is an SBA Loan Right for You?

SBA loan programs come with a variety of advantages, including longer repayment periods, lower interest rates, and a wide loan amount offering. Yet they do come with disadvantages, including long approval timelines, a required personal guarantee, and specific fund use.

For some small business owners seeking to buy major assets or grow working capital, SBA loans are affordable options. Review SBA loans pros and cons and your own financial situation to see if an SBA loan could potentially work in your favor.

Frequently Asked Questions (FAQs)

How long do SBA loans take to process?

SBA loans can take anywhere from a few days to a few months to process. The timeline depends in part on how thoroughly you complete the application, have additional documents ready, and what type of lender you work with. A 7(a) Express loan will typically be your quickest option as it is designed to expedite the process of getting credit.

How many SBA loans can you get?

There is no strict guideline on how many SBA loans you can take out at one time. However, a loan impacts your business credit score, and that may affect your ability to take out a secondary loan.

What can SBA loans be used for?

Each SBA loan comes with specific guidance on how it can be used. For example, 7(a) loans cover a variety of uses, 504 loans are used for fixed assets, and microloans can cover smaller working capital or asset needs.

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Article Sources

  1. U.S. Small Business Administration. “Small Business Administration: A Primer on Programs and Funding.”

  2. U.S. Small Business Administration. “Loans.”

  3. U.S. Small Business Administration. “7(a) Loans.”

  4.  U.S. Small Business Administration. “504 Loans.”

  5. U.S. Small Business Administration. “Microloans.”

  6. U.S. Small Business Administration. “Disaster Assistance.”