Small Business Loans
As more and more Americans are dealing with the pressures of a struggling economy, many are attempting to supplement their income or build financial independence by operating their own small business. Small businesses are vital to our consumer-driven economy and account for 2/3 of all new jobs in America, but many of them fail within the first 5 years due to poor planning and the lack of adequate funding. Small business loans can be a valuable source of operating capital, but it is important that budding entrepreneurs do their homework so that their chances of approval, as well as rates and terms, are as competitive as possible.
The Small Business Association (SBA), an independent agency of the federal government is a great source of information and assistance for small business owners. The SBA will assist with business plans and financing options, and will guarantee up to 85% of small business loans made through secondary lenders. In an interview with Dave Lentell, a business development specialist for the SBA, “If the SBA agrees to participate in the risk (of
loaning money to a small business) by offering a federal guarantee of repayment, lenders are more likely to extend long term loans to entrepreneurs.” (Kelley, 2007) This guaranty does not exempt business owners from the qualification process. Once approved, the lenders will compile the paperwork and send it to the SBA for review and a request for guaranty.
The most common type of loan by the SBA is a 7(a) loan. These loans must be processed through a commercial lender, which means that they must be approved by the lender. Business owners must contact lenders directly and complete all of the lender’s required paperwork, which could include a detailed business plan, purpose of the loan, up to 3 years of bank statements and personal financial information on the owners themselves, as well as any current financial documentation for the business itself. Approval by a lender depends on a variety of factors including income derived from the business itself, collateral, equity and purpose of the business. The interest rate for a 7(a) small business loans is determined by the lender but must follow SBA guidelines and maximums. On loans of $50,000 or more, the rate cannot exceed 2.5% plus the prime rate for loans with a maturity of 7 years or less and 2.75% plus the prime rate for loans with a maturity exceeding 7 years. Loans of less than $50,000 are treated similarly. The rate added to the prime interest rate is 3.25% for loans maturing in less than 7 years and 3.75% percent for longer term loans. Other points to keep in mind when applying for an SBA loan is that there are prepayment penalties ranging from 2% to 3.75% of the original loan amount.
The SBA has recently revised guidelines on another popular loan program, the Community Express, which has historically been reserved for women and minorities as well as veterans and those operating a business in a low-income area. Beginning October 1, these loans will be available to anyone; however “loans over $25,000 would be earmarked only for historically underutilized business zones.” (Fait, 2008) The rates of Community Express loans have also been adjusted and must now adhere to the same guidelines as the 7(a) loans rather than the current interest rates, which range from 4.5% to 6.5% above prime.
Commercial banks and lending institutions also offer financial assistance to small businesses in the form of loans and lines of credit. Installment loans are available that offer an initial interest-only draw period, usually 6 months, and then convert to a standard fixed term loan. These commercial small business loans may actually carry lower interest rates than those guaranteed by the SBA, but the terms are often shorter terms and these loans don’t carry the guaranty of the SBA, which means more stringent qualification criteria in many cases. Interest will vary with market conditions. A recent survey by the National Federation for Independent Businesses (NFIB) indicates that average interest rates decreased in the second quarter of 2008 to 7.2% compared to an average of 8.2% in the first
quarter. (Dunkleburg and Wade, 2008) Actual rates paid will, of course, be dependent on the financial condition of the business and the personal credit history of the business owner. Lines of credit are typically more difficult to qualify for but offer the small business owner more repayment flexibility and the ability to draw the funds only as needed. These funds also become available again as the line of credit is paid down.
Funding for small business ventures can also come from the government in the form of grants. Grants do not require credit checks or collateral and do not have to be paid back. Small business grants are not currently offered by the federal government, which provides its assistance in the form of SBA-backed loans, but most state governments offer a variety of grants and financial assistance programs. These programs are often geared toward businesses that offer products or services that are in line with the government’s economic objectives or that benefit the community, especially in low-income areas. Small business owners interested in obtaining grants should be prepared to do a lot of research to find a program that fits their particular niche. They should also be prepared to follow specific guidelines for presenting their grant request.
One of the keys to growing a successful business is ensuring the availability of enough operating and investment capital. The government and commercial lending institutions can provide financial assistance. Small business loans are a good option as long as business owners understand their own needs and work to obtain competitive rates and terms that will fit their business and budget. Understanding the options and having the right documentation to support a loan request is the first step to obtaining this type of funding.
Fajt, Marissa, American Banker; 7/21/2008, Vol. 173 Issue 139, p5-5, 1/3p
Kelley, Tracy, Small Business Loans for Women: An Interview with the Small Business Association, www.lovetoknow.com, 01/25/2007
Dunkelburg, William C. and Wade, Holly, Small business Economic Trends, NFIB, 07/2008, p. 14