Small business owners who ask about government loans are often surprised to learn that the federal Small Business Administration, known as the SBA, rarely lends money itself. Its flagship program, called the 7(a) loan program, works through private lenders. The agency guarantees a portion of the loan, which reduces the lender’s risk and makes it more willing to approve loans that it might otherwise decline. Understanding that structure clears up many of the common misunderstandings about how to apply, what to expect and who is really making the decision.
This article is general information. It is not financial advice, and an owner considering a loan should talk with lenders, a qualified accountant or a free small business adviser about a specific situation.
What is a 7(a) loan?
The name comes from Section 7(a) of the Small Business Act, the law that authorizes the SBA to guarantee loans to small businesses that cannot obtain financing on reasonable terms through ordinary channels. The loan itself is made by a bank, credit union or other participating lender. If the borrower defaults, the SBA repays the lender a percentage of the loss. The borrower is still fully responsible for repaying the loan, and defaulting has serious consequences.
Because the guarantee reduces the lender’s risk, 7(a) loans often have longer repayment periods and lower down payments than conventional business loans. That can mean lower monthly payments, which matters for businesses with tight cash flow.
How big can a loan be?
For the standard 7(a) program, the maximum loan amount has been $5 million. The SBA guarantees up to 85 percent of loans of $150,000 or less and up to 75 percent of larger loans, subject to a cap on the SBA’s exposure. Several smaller or faster programs operate under the 7(a) umbrella, including Express loans with lower maximums and a smaller guarantee. Limits and guarantee percentages are set by the agency and have changed over time, so owners should check the SBA’s website for current terms.
What can the money be used for?
The program is flexible. Typical uses include:
- Working capital to cover inventory, payroll and day-to-day operating expenses.
- Purchasing equipment and machinery.
- Buying or building real estate for business use.
- Acquiring an existing business, including a change of ownership.
- Refinancing certain existing business debt under the program’s conditions.
- Renovating or expanding a facility.
Some uses are prohibited, such as paying personal debts or funding speculative activities. The lender will want to see that the proceeds go to a legitimate business purpose. Maximum repayment terms depend on the use: loans for real estate and some equipment can run for many years, while working capital loans usually have shorter terms. A loan used for several purposes may have a term that blends them.
Who is eligible?
The program is aimed at small businesses that operate for profit and do business in the United States. The SBA defines “small” by industry, using standards based on the number of employees or average annual receipts, and the thresholds differ widely among sectors. The business owner must generally have invested their own time and money in the business and must show that they cannot obtain credit elsewhere on reasonable terms. Certain types of businesses, including some lending, gambling and speculative enterprises, are ineligible.
Lenders look at the same things they would for any loan: the borrower’s credit history, the business’s cash flow, the owner’s experience, the purpose of the loan and available collateral. Owners holding a significant share of the business are typically required to provide personal guarantees, which means they are personally responsible for repayment if the business cannot pay. Collateral is usually requested, though the SBA’s guarantee means that a lack of full collateral does not automatically disqualify an application.
How does someone apply?
The application goes through a lender, and the process follows several steps:
- Prepare documents. Lenders usually ask for a business plan or description, financial statements, tax returns for the business and owners, a schedule of debts, and a statement of how the money will be used.
- Find a lender. Many banks and credit unions participate in the program, and some specialize in it. The SBA offers a free online tool called Lender Match that connects small businesses with participating lenders. It is a referral tool, not an application, and it does not guarantee a loan offer.
- Submit the application. The lender reviews it, and may send it to the SBA for approval or, for lenders with delegated authority, decide on its own.
- Close the loan. After approval, the borrower and lender complete paperwork, and funds are disbursed.
Timelines vary from a few weeks to several months, depending on the lender, the complexity and the completeness of the documents.
What does it cost?
Borrowers pay interest, which is set by the lender within SBA limits and can be fixed or variable, and the guarantee comes with fees. The SBA charges a guarantee fee that lenders typically pass on to borrowers, with the amount depending on the loan size and structure. Lenders may also charge closing and packaging fees. These costs affect the total price of the loan, so borrowers should compare the full cost, not only the interest rate. The SBA’s website lists current fee structures and rate caps.
What should owners weigh before borrowing?
Debt is a serious commitment. Owners should consider whether the business’s cash flow can support the payments in a slow month, what the loan would be used for and whether it will raise revenue enough to justify its cost, and what happens if the business struggles. Personal guarantees put personal assets at risk. Comparing the SBA route with other options, such as conventional bank loans, lines of credit, equipment financing, microloans and community development lenders, can show which fits best. Borrowers should also read the loan documents carefully, and consult an attorney or accountant if a term is unclear.
Where can San Diego owners find help?
Several free and low-cost resources are available. Small business development centers in the region offer one-on-one advising on business plans, financial projections and loan applications. SCORE, a nonprofit network of volunteer mentors, offers free mentoring, and the SBA’s local district office can point owners to lenders and programs. Community development financial institutions, which focus on underserved borrowers, may offer alternatives. For a business that is just starting, steps such as those in how to register a business in California generally come first, and lenders will want to see that the entity is properly formed, registered and in good standing.
Tax obligations also matter when preparing financial statements. Sellers must account for sales tax, as explained in how California sales and use tax works for sellers, and lenders will review whether returns have been filed and taxes paid.
Many small business owners in the region work in sectors with strong local demand, such as those described in the regional economy guide, and lenders familiar with those sectors may be better placed to evaluate a proposal. Beware of anyone who promises guaranteed approval for a fee. The program’s information is free from the SBA, and legitimate advisers are open about their charges.
Sources: U.S. Small Business Administration; SCORE; America’s Small Business Development Center Network
