SBA vs. Conventional Loan Solutions: A Simple Comparison

Small business owners have options when seeking financing for expansion, working capital, debt restructure, and/or full or partial acquisitions. However, it can be challenging to determine which loan solution is best and which lender to choose. For example, small businesses can apply for an SBA loan or a conventional loan. What types of loans are available, what are the requirements, and what are the pros and cons of each?

SBA Loans

The U.S. Small Business Administration (an independent agency of the federal government) provides loan guarantees on SBA loans to mitigate risk for the lender. Borrowers must work with an SBA-approved lender, and there are roughly 800 nationwide. However, the SBA administration has its own set of minimum guidelines – in addition to any guidelines the lender may place – that borrowers must meet to apply for these loans.

Loan Requirements

The SBA requires applicants to be for-profit, do business in the United States, and have equity to invest. In addition, the SBA requires businesses to meets certain size standards to apply for their loans. This interactive tool will help determine if a business qualifies for an SBA loan.

There are three common types of SBA loans with different loan amounts and allocations for use:

• • • • 7(a) loans – up to $5M for working capital, refinancing, or purchase of furniture, fixtures, and supplies.
      • 504 loans – up to $5.5M for long-term fixed asset purchases like property.
      • Microloans –  up to $50k for working capital, inventory, supplies, equipment, and machinery. The maximum repayment term allowed is six years.
        
        

SBA Loan Pros

One of the main pros for an SBA loan is the lower costs. Bob Coleman, publisher of The Coleman Report, says, “For a patient entrepreneur who has her ducks in a row and is willing to go through the process, it’s a lot cheaper capital.” Because the government guarantees a percentage of the loan, lenders are more willing to offer lower interest rates for SBA loans. Moreover, SBA loans often have favorable repayment terms and offer 80%-90% financing.

SBA Loan Cons

The application process for an SBA loan can be cumbersome because of the additional requirements necessary for the governmental guarantee. This often equals more paperwork and a longer turnaround time. Also, small businesses in some industries are not eligible. Borrowers must demonstrate a need for the loan funds and that those funds will be used for approved purposes.

Any SBA loan of $350,000 or greater typically requires a 10% down payment. This is a mandatory cash injection from the borrower. For these loans, lenders are also required to get spousal agreement and take personal assets as collateral. This means that if the business loan defaults, the lender isn't limited to just seizing the business assets. They can pursue the borrower's personal assets, including their home, personal savings, or other properties. This significantly increases the personal risk for borrowers seeking these loans.

Additionally, if an SBA loan is used to fund a change of ownership, the seller must exit the business immediately. Furthermore, any sellers who retain any level of ownership must personally guarantee the buyer’s loan for a minimum of two years after the loan disbursement. This means the seller's personal assets – their home, savings, investments – are directly tied to the buyer's loan, even after they've left the business. Any existing owner increasing their direct or indirect stake in the operating company must be a co-borrower on the new loan, regardless of the percentage of ownership gained. Multi-step partial changes of ownership are not eligible. Partial business acquisitions must be done as stock purchases to ensure continuity of ownership and obligations.

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Conventional Loans

Conventional commercial loans are available from nearly 4,000 lenders nationwide who undertake all the risks for the loan repayment. Typical commercial loans have widely varying terms and interest rates available, depending on the lender, the loan purpose(s), and the strength of the borrower. The maximum loan amount depends on the lender’s capacity and the qualifications of the borrower.

Loan Requirements

To qualify for a conventional commercial loan, applicants may need proven historical financial performance, cash flow capabilities for the debt, and collateral, which will not likely sink into personal assets. A lender will run a risk analysis to determine the maximum loan amount, repayment terms, any guarantee requirements, and interest rate.

Types of conventional loan solutions include term loans, business lines of credit, and real estate loans.

• • • • Commercial term loans are similar to SBA guaranteed loans. The lender gives the borrower a lump sum of money with predetermined terms for payback. Terms and conditions are much more widely customizable and can vary well outside of the SBA’s allowable terms.
      • Business lines of credit allow businesses to borrow money as needed. Borrowers can receive payments from their line of credit over a pre-determined length of time.
      • Commercial real estate loans often have longer amortization periods but typically work similarly to term loans or lines of credit.
        
        

Conventional Loan Pros

The most important pro to a conventional loan is that personal and business assets are often treated separately. The borrower’s home and other personal assets likely will not be subjected to collateralizing the loan, and, therefore, would not be at risk if the borrower defaults on the loan.

Additionally, the amount of available credit can greatly exceed $5.5 million. Loans for acquisitions or succession do not have to follow the SBA’s guidelines for the seller to leave immediately and personally guarantee the loan. Lenders can be flexible, allowing staged acquisitions or multiple partial acquisitions among multiple partners. Some lenders allow for future access to funds for growth projects that may take place in stages over a long period of time.

Furthermore, conventional lenders typically don’t require a down payment from the borrower. This frees up liquidity for the borrower to further invest in their business.

Conventional Loan Cons

If a business doesn’t have good credit or is in a startup phase without a proven track record of business financial performance, terms may not be as favorable, and it is possible interest rates will be higher. Conventional lenders want proof that the business will have sufficient cash flow to make the monthly payments. Should the company fall on hard times, lenders do not have the guarantee of the SBA and will turn to the borrower for the entire amount of the loan and could take possession of the business assets. Because of this additional risk, some conventional lenders require additional covenants to monitor the health of the business throughout the life of the loan.

Conclusion

Both SBA and Non-SBA loans can be excellent choices for small businesses. The business plan, reason for a loan, or the loan amount will determine the best loan solution. For example, a conventional loan may be the right choice for borrowers pursuing an acquisition who want greater flexibility and to avoid pledging personal assets for the loan. On the other hand, an SBA loan might be the best answer for a real estate purchase. Above all, carefully research all options and lenders before making a final decision.