SBA vs. Conventional Loan Solutions: A Simple Comparison

Small businesses have options when seeking financing for expansion, working capital, or acquisition. 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) manages SBA loans. These loans are backed by the government to mitigate risk for the lender. Because of this, the pool of qualified borrowers for an SBA-guaranteed loan is wider. However, the SBA administration has its own set of guidelines – in addition to the lender’s – 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 require low down payments.

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.  Furthermore, in addition to the pledge of business assets, SBA loans require individual guarantees, often secured by the borrower’s personal assets such as real estate or other forms of personal collateral.

Should the borrower default on the loan, the lender could collect these personal assets, such as homes, 401k investments, or vehicles. Additionally, if an SBA loan is used to fund a change of ownership, the selling shareholder must leave the business no later than 12 months from the time of the loan.

Conventional Loans

Conventional commercial loans are available from various lenders who undertake all the risks for the loan repayment.  Typical commercial loans are over $100,000 with varying terms and interest rates available, depending on the lender. 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 will need proven historical financial performance, cash flow capabilities for the debt, and collateral. A lender will run a risk analysis to determine the maximum loan amount, repayment terms, and interest rate.

Types of commercial 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.
• 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.

Conventional Loan Pros

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

Additionally, conventional loan solutions are available for a wider variety of reasons, such as mergers, acquisitions, partner buyout, or debt consolidation.  The amount of available credit can greatly exceed $5 million.

Loans for acquisitions do not have to follow the SBA’s guidelines for the seller to leave within 12 months of the sale. Some lenders allow for future access to funds for growth projects that may take place in stages over a long period of time.

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.

Conclusion

Both SBA and Non-SBA loans are 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 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 lower rates and longer repayment terms. Above all, carefully research all options and lenders before making a final decision.

Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.