How Do SBA Loans Work?

Businesses usually seek capital for one of two reasons:

  1. They’re in survival mode, trying to start up or simply stay in business, or
  2. They’re looking to expand.

Businesses in Survival Mode

Businesses in survival mode are looking for subsistence funding just to stay alive. In the case of start-ups, they need money to secure locations, purchase materials and inventory, develop marketing materials, and pay the bills so they can keep their lights on. For other businesses that may have already been in existence, they’re in survival mode because of any number of factors — an economic downturn, construction blocking their entrance, or the emergence of a new competitor, for example.

Expansion-mode Businesses

On the other hand, expansion-mode businesses have a track record of success. They’re profitable and need to grow to increase profits and meet consumer demand. Banks like expansion-mode businesses.

But it’s often survival-mode businesses, particularly in a tough economic times, that are seeking loans. Perhaps they’ve exhausted all their families’ and friends’ resources, have maxed out their credit cards, or simply can’t afford to compete without an injection of funds.

Meanwhile, most commercial lending banks see survival mode businesses as a great risk; they often prefer lending to businesses that are expanding, who can prove their accomplishments and have considerable assets that ensure they can pay back their loans. And this simply isn’t possible for many small businesses. Here’s where the SBA steps in.

How the SBA Helps

First, it’s important to note that the SBA itself actually doesn’t do any lending. Rather, it sets guidelines for loans made by traditional lenders that it partners with, then acts as a guarantor for those loans made to business owners who might have trouble qualifying for traditional bank loans. The guaranty provided by the SBA on a large percentage of the loan ensures the bank that the majority of the loan will be paid back.

To get an SBA loan, a business owner goes to one of the SBA’s partner banks or lending institutions and applies for the loan directly through this lender. If approved, the loan is eligible for an SBA guaranty, which is a percentage that represents the portion of the loan that the SBA will repay the bank if the business owner defaults on the loan. In this follow up article, learn how to apply for an SBA Loan.

For more information about SBA Loans, please see my book Finance Your Own Business: Get on the Financial Fast Track.

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