Small businesses that have trouble qualifying for financing can seek help from the U.S. Small Business Administration. But to be approved, a business must meet standards that vary based on the lender and the type of loan. Factors that lenders weigh when determining whether your small business qualifies for an SBA loan range from your credit score to the length of time you’ve been in business and the amount of collateral you’re able to put up.
[Read: Best Small Business Loans.]
What Is an SBA Loan?
The U.S. Small Business Administration backs loans made to small businesses by commercial lenders, such as banks and credit unions. In case a business defaults on an SBA-backed loan, the agency will cover as much as 85% of the loss; this is known as a guarantee.
The SBA reviews a loan application submitted to a lender to make sure it meets eligibility and credit requirements. The agency then signs off on the loan, but final approval rests with the lender.
The Basic Requirements for an SBA Loan
The SBA has certain basic standards in place for its loans. In general, a company seeking an SBA loan must:
— Be a small business as defined by the SBA. To figure out whether your business meets the definition of a small business, visit the SBA website.
— Be legally organized as a sole proprietorship, corporation, partnership or LLC.
— Operate as a for-profit entity.
— Do business in or plan to do business in the U.S. or a U.S. territory.
— Have a reasonable amount of owner equity.
— Use other financial alternatives, such as an owner’s personal assets, before pursuing an SBA loan.
Of course, these are broad requirements. Other more specific criteria also apply, depending on which loan you apply for, and lenders themselves may have their own requirements.
What Kinds of Businesses Qualify for SBA Loans?
Business types eligible for SBA 7(a) loans, the most common type of SBA loan, include:
— Restaurants and bars
— Retail stores
— Franchises, such as those for restaurants and hotels
— Professional services, such as accounting or law firms
— Farms and agribusinesses
— Properly licensed medical facilities, such as hospitals, clinics, emergency outpatient centers, nursing homes, and medical and dental labs
Some ineligible business types include:
— Businesses whose primary source of revenue is gambling or speculative
— Real estate firms that buy and sell properties as investments
— Lenders, such as banks and finance companies
— Businesses involved in illicit activity, such as a motel that caters to illegal prostitution
— Businesses that rely on pyramid sales schemes
— Religious, charitable or nonprofit organizations
Business Experience Needed for SBA Loans
By and large, SBA lenders shy away from industry newbies; they’re looking to lend to entrepreneurs who have a track record. So, if you’re hoping to launch a clothing boutique but have zero experience in the sales or fashion industry, you could be out of luck.
Hal Shelton, mentor with the nonprofit small business counseling group Score, angel investor and author of “The Secrets to Writing a Successful Business Plan,” recalls a Score client who was rejected for an SBA loan to open a cupcake store. The client met all the other requirements, such as the amount needed for collateral, Shelton says. But the entrepreneur had not worked in either the retail or baking sector, so lenders deemed the applicant too risky and he pursued other options.
Revenue Needed for SBA Loans
Generally speaking, your business will need to show profitability. A lender will likely consider annual revenue based on industry standards. However, that lender will judge each business on its own merits.
Also, a lender generally likes to see that a business has been around for at least two years and has sufficient cash flow. However, a lender will weigh each business’ circumstances. For example, some lenders do offer SBA loans to startups.
“If the business has demonstrated steady growth over … time, that’s an indicator that they are on a growth path and are sustainable enough to pay back the loan over the term of the loan,” says Tendai Ndoro, regional director of the New Jersey Small Business Development Center at Rutgers University-Newark.
Credit Score Needed for SBA Loans
When it comes to your personal credit score, a lender typically will want to see a minimum of 640 to 680 to qualify for an SBA loan. The SBA doesn’t mandate a minimum personal credit score, but lenders are required to maintain prudent lending standards. If your business has a FICO credit score, the lender will look for one that’s at least 140 to 160, on a scale of zero to 300.
“The owner’s credit is more relevant than business credit because, in most cases, the owner is required to give a personal guarantee for the business loan,” Ndoro says. “However, it’s always good to have other financial instruments like a business line of credit or a business credit card to demonstrate (positive) patterns of business behavior in paying back the loan.”
Aside from a decent credit score, you’ll need a credit history clear of recent bankruptcies, foreclosures or tax liens.
If you’re behind on paying a federally backed student loan or a Federal Housing Administration-backed mortgage — or, worse yet, if you’ve defaulted on either of those loans — you’ll be disqualified from receiving an SBA loan.
Collateral Needed for an SBA Loan
An SBA lender typically wants anyone with at least a 20% ownership stake in the business and anyone with a key management position to have skin in the game. That comes in the form of a personal guarantee, meaning you personally promise to cover the loan if the business can’t. In other words, your personal assets and your credit score could be in jeopardy if the loan goes into default.
“So, if things get tough, (the lender wants to be sure) you’re not going to throw the keys at the bank and say, ‘It’s your problem,'” Shelton says. “They clearly are not in the business of making loans that aren’t going to get paid back.”
[Read: Best Unsecured Business Loans.]
It’s not unheard of for an entrepreneur to provide 100% backing of an SBA loan through a pairing of a cash guarantee and collateral.
Under the SBA 7(a) program, collateral isn’t required for a loan that’s less than $25,000. As for loans of more than $350,000, the collateral must cover as much of the loan as possible, up to the loan amount. Types of collateral that are allowed include:
— Office equipment
— Accounts receivable, such as pending invoices
— A second mortgage on a home
“They don’t want your car. They don’t want your stamp collection,” Shelton says.
Can Your Business Qualify for an SBA Loan?
Although the SBA has some requirements that are inflexible, including the types of businesses that can qualify, lenders can set their own standards for other requirements. Business experience, revenue and credit rating requirements needed to qualify can vary by lender.
If your business qualifies under the basic SBA loan requirements, talk to multiple lenders and find out their specific standards for loan qualification. If you don’t qualify for a loan with one SBA lender, you may be able to get a loan with another.
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