This article is part of a larger series on Business Financing.
Obtaining a Small Business Association (SBA) startup loan requires several steps and doing some homework before applying. Startup businesses are deemed higher risk because of historical failure rates that can reach as high as 50% within five years. As a result, SBA startup loans may require a larger down payment and additional collateral to get approval.
Here are the six steps to get an SBA startup business loan:
- Develop a detailed business plan: Before even starting a business, putting a plan on paper is essential to help set a roadmap for a new venture.
- Determine how much money you need: Financial projections and a budget are critical for determining the amount of financing needed.
- Determine your eligibility: Knowing the SBA’s requirements for borrowers will help you understand if you can qualify for financing.
- Obtain your down payment: Lenders and the SBA will require owners to contribute funds to their venture.
- Find an SBA lender: Business owners need to be able to find the right lender to help them get approved.
- Complete your application: Gathering the necessary information will save you time when applying.
Most Common SBA Startup Loan Types
SBA startup loans work like many of the other SBA loans that are available but are harder to obtain. While the SBA guarantees loans that lenders make to businesses, they do not directly issue loans except in cases of economic disaster. This means that banks and other lending institutions can choose not to work with startup businesses unless they are capitalized well, and business owners have very good credit.
SBA startup loans typically fall into one of three types:
- SBA 7(a) Loans: These loans can be used for working capital and operating expenses. Startups with a proven business model, such as franchises, may be able to qualify. Businesses can obtain up to $5 million in financing.
- SBA Express Loans: Express loans are a part of the 7(a) program and offer financing up to $350,000. Given the lower financing limit, newer businesses may be more likely to qualify for this loan.
- SBA Microloans: This program helps nonprofit intermediary lenders provide up to $50,000 in working capital to small businesses and nonprofit childcare centers.
1. Develop a Detailed Business Plan
A detailed business plan is critical for startup businesses to help establish a roadmap for the new venture. The business plan is especially important for helping educate lenders providing financing for startups. It allows you to explain your concept and show evidence that the startup will be successful.
The SBA requires a business plan be submitted with your loan application process. The more detail it contains, the better your chances are of getting funded.
The business plan should include:
- Executive summary: The summary briefly explains what your business will do and any products or services it plans to offer. This portion also includes who the owners are and their percentage of ownership in the business.
- Product or service overview: This section provides more detail about what products and services your business offers and how your business is different from the competition or provides something that is not offered.
- Target market: Identify who you are targeting as customers. Examples include age, income level, or geographic areas.
- Competitors: List your competitors, if any, and how your business will differentiate from them.
- Business projections: Create projections based on conservative estimates of how the business will perform financially, including a cash flow analysis.
- Financial plan: This is a detailed analysis of how much money you need to borrow, how you will spend it, and how you will be able to pay off the loan. The more detail you can provide lenders on how the money will be used, the less likely it is they will ask follow-up questions.
- Resume or personal background: Include relevant information on the owners’ professional history and how it relates to the new business.
Any of your business plan’s projections and forecasts should be backed up by relevant industry and geographic data. Be prepared to defend and justify those forecasts to a lender.
The SBA partners with several organizations, including the Service Corps of Retired Entrepreneurs (SCORE), Small Business Development Centers (SBDC), and Women’s Business Centers, to help small businesses develop business plans.
2. Determine How Much Money You Need
Part of a sound business plan includes putting together a sound financial plan that has a reasonable estimate of how much money your business will need. This requires the creation of a detailed cash flow analysis of your new business.
A cash flow analysis should include these steps:
- Forecast revenue for the next 24 months.
- Forecast expenses for the next 24 months.
- Factor in any desired working capital or major purchases, both at the start of the business and any planned purchases in the future.
- Subtract the total expenses from revenue. The difference is your minimum required capital.
Cash flow analyses should be realistic to the business’s capacity to grow and the market it is operating in. It should also account for seasonal variations in revenue and expenses as well as your loan payments to help create an accurate forecast. A spreadsheet can help make the process of putting together a cash flow easier.
3. Determine Your Eligibility
Getting an SBA loan involves meeting several requirements that involve your personal credit, relevant experience, and a sufficient amount of equity or down payment to invest in the project.
Typically, the SBA will require a credit score of 680 for any individuals with at least a 20 percent ownership stake in a business. The SBA also requires that all owners not have any recent bankruptcies, tax delinquencies, or defaults of government loans.
Having at least five years of relevant experience in the industry that you are starting a business in is essential for providing confidence to lenders. If you lack sufficient experience, your business plan needs to identify any hired staff or paid consultants with relevant experience who will assist you.
Lenders will look to place liens on any collateral that is available. This can be either personal real estate or business assets.
Lenders may require as much as 25% of the project costs as investment from startup business owners. This is higher than the requirement the SBA has in place for more established businesses due to startups having a historically higher rate of failure. This down payment can include a down payment on the purchase of a commercial property or equipment as well as accessible cash in reserve.
4. Obtain Your Down Payment
If your startup financing needs involve getting working capital, your down payment is never paid to the lender. SBA lenders will typically only approve startups for around 75% of the total cost of a project. This helps show the lender that you have sufficient skin in the game to help support the business.
For example, if a business needs $100,000 to fund a project fully, the lender will require the business owners to have $25,000, or 25%, in available cash at the time of loan closing. The lender would then provide the additional $75,000.
If you were purchasing commercial real estate, those funds would be provided to the lender at the time of closing as a down payment on the property purchase.
Putting together the funds for a down payment can come from several different sources. These sources include retirement funds, borrowing from friends, family, and other sources, and crowdfunding.
Many business owners use a portion of their retirement accounts to help provide initial financing to their startups. These can involve one of three methods: using a rollover for business startups (ROBS), borrowing funds from a retirement account, or withdrawing funds from a retirement account.
A ROBS is used to help get access to retirement funds before reaching 59 1/2 years of age without paying withdrawal penalties or taxes. For individuals with over $50,000 in retirement assets, it’s a good solution to help provide initial financing.
A ROBS works by rolling over funds from a 401(k) or individual retirement account (IRA) account into a new retirement account for your business. The retirement account then purchases shares in your business, providing you funds to pay any necessary business expense.
ROBS transactions are regulated by the IRS and United States Department of Labor to ensure funds are being used properly and that employees of businesses funded by ROBS have access to the retirement plans that are established.
An experienced ROBS provider, such as Guidant, can help you get set up with a ROBS and will assist you with any legal questions you may have prior to establishing a ROBS. Its initial consultation is free of charge.
If your retirement accounts have balances of less than $50,000, you still have the other two remaining options.
Borrow From Retirement Account
Borrowing from your 401(k) or IRA account requires that you pay it back within five years. Failure to do so would result in a withdrawal penalty on the unpaid balance of the loan, and you will be responsible for paying taxes on the unpaid balance.
Withdrawal From Retirement Account
If you are 59 1/2, this solution is available without withdrawal penalties. However, you will need to claim any portion of the withdrawal as income on your tax return if the funds are from a traditional IRA or 401(k) plan.
Borrow From Friends and Family
Starting a new business has a higher level of risk, regardless of how solid your plan is, and if something happens and you’re unable to repay these people, then it could damage your relationships.
Any borrowing from friends and family should include an agreement with terms and conditions established on repayment of monies borrowed.
Personal or Home Equity Loans
Some borrowers may take out unsecured personal loans to help them get sufficient down payment for a business loan.
Taking out a home equity loan to get the necessary down payment is an option if a business owner has sufficient equity in personal property and needs some financing to provide an extra down payment to get approved. Using available equity in one’s home may make sense, given interest rates are typically low, especially for borrowers with good credit.
The drawback with personal and home equity loans is that you would have an additional loan payment that would increase your debt to income ratio (DITR), which is one of the factors that lenders will look at for financing. Also, with unsecured loans, the interest rate may be significantly higher than with other types of loans.
Crowdfunding is a way to fund your project through the small financial contributions of many individual investors. Crowdfunding can involve offering a reward, equity in the business, or simply a donation to help the business owner meet a financial goal.
Successful crowdfunding involves strategic campaigning, a compelling story, effective and exciting communication about the campaign, and delivering on any promises that the business makes. While a lot of work, a crowdfunding campaign can provide a strong statement of the case for a business and help provide momentum in advance of the business’ launch.
5. Find an SBA Lender
The number of lenders that will provide SBA loans to startup businesses is limited. Many lenders who are SBA preferred will require your business to have at least one year in operation before they will consider your application. In cases where a business owner has significant industry experience or is well capitalized, the lender may consider your application.
Some questions you should ask potential lenders before you apply for an SBA startup loan are:
- Do you provide loans to businesses with less than a year of operation?
- What fees are involved with originating and closing on the loan?
- What does your application process entail?
- How long does it take to get a decision?
- What additional paperwork is required with the application?
- Is there a prepayment penalty?
Another path to finding the right lender is to use a broker or consulting company that works with SBA lenders. Brokers know exactly which lenders are willing to work with startup businesses and can match a business to a lender likely to fund your loan.
Guidant Financial works with a network of SBA lenders and can help startup businesses get the funding they need.
6. Complete Your Application and Submit
Gathering the sufficient paperwork and completing an application for a loan will take some time. When you apply, you should be prepared to submit the following documents:
- The completed loan application
- Your business plan with financial projections and cash flow analysis
- A personal financial statement, which will highlight your personal assets and any liabilities that are outstanding, such as a mortgage
- The last three years of personal tax returns from all individuals with at least 20% ownership in the business
- Copies of your business’s organization documents, such as articles of incorporation or limited liability company (LLC) formation
Once you apply, a decision on the loan can take several weeks or even a few months. Approval times vary based on the application’s loan amount and the lender’s familiarity with your business.
Business owners may also be asked by the lender to submit additional paperwork or answer questions relevant to the use of funds or to the business venture. Answering these promptly will prevent further delays in decisions from the lender.
While getting an SBA startup loan is not an easy process, it is attainable for businesses that have a strong business plan, sufficient down payment, and whose owners have very good credit and industry experience. Using a broker, such as Guidant, with experience in finding SBA startup loans could provide an added boost to a business’s quest for startup funding.