Financing is an essential step for any business, whether it’s finding investors or taking out a loan. Entrepreneurs who need a loan might automatically look to a bank, but there is another major source of capital for businesses: the federal government.
Several loan programs are available to startups and growing businesses. Understanding which ones you can take advantage of might be the key to unlocking additional capital for your business venture. Here’s a look at some federal loan programs, how they work, and how to qualify and apply for them.
Government loan programs are available through the federal Small Business Administration (SBA) and the U.S. Department of Agriculture (USDA) for qualifying businesses that intend to use the funds for specific purposes.
“The main benefit of these loans is they offer small businesses the opportunity to receive financing on terms more favorable than they would otherwise receive with the SBA guarantee,” said Lou Haverty, CFA at Financial Analyst Insider. “In many cases, small businesses could struggle to find any financing for new and unproven businesses without a partial government guarantee.”
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The SBA is a primary source of financial assistance for entrepreneurs throughout the country. These loans are provided by banks and other lenders such as community development organizations and microlenders, with the federal government guaranteeing a portion of the loan. The SBA’s Lender Match tool on the agency’s website can help you find a lender.
This is one of the most popular and flexible federal loan programs. The 7(a) loan guarantee program is generally used to help finance startups or growing businesses. It can be used to buy land, cover construction costs, purchase or expand an existing business, refinance existing business debt, and purchase machinery, furniture, supplies or materials.
The SBA will guarantee up to $5 million for this type of loan. If you’re looking for a loan of $350,000 or more through this program, the SBA will require your lender to ask for the maximum possible amount of collateral to offset the risk of default.
The 504 loan program is intended for businesses that will benefit their communities directly, either through the creation of jobs or by filling a much-needed demand in the local market. These loans have a fixed rate and are intended for long-term financing, and the maximum value is set at $5 million.
Typically, when a 504 loan is funded, the lender will initially cover 50% of the borrower’s costs at the outset and the SBA will cover 40%, with the borrower responsible for the remaining 10% of financing the project at the outset. The borrower must personally guarantee at least 20% of the loan.
The SBA’s microloan program is often used for short-term financial needs, like bolstering inventory or furnishing office space. The maximum amount for this type of loan is $50,000.
SBA loans can be quite small, sometimes less than $50,000.
The SBA Express loan program is a good option for business owners who need cash fast, as SBA Express applications are reviewed within 36 hours – though it may still take at least 30 days to receive funds. Loans of up to $350,000 are available to SBA Express financing applicants, but collateral may be required for loans over $25,000. An SBA Express loan can be used as working capital (five- to 10-year term), as a line of credit (seven-year term) or as a commercial real estate loan (25-year term).
The federal government’s disaster assistance loan program extends low-interest, long-term financing to renters or property owners who seek to restore their properties to pre-disaster condition. This is useful for businesses that have been damaged as a result of natural disasters.
To be eligible for SBA loans, businesses or individuals must meet the following criteria.
The SBA loan application process typically works like this: Business owners first apply for a conventional small business loan (that isn’t backed by the SBA). If they don’t qualify for a loan without SBA backing, the lender can request the SBA guarantee. Borrowers are not permitted to apply for SBA loans directly. [Read related article: How to Get Your Business Loan Application Approved]
The USDA is highly focused on rural regions and the agricultural industry, which is often capital-intensive. The USDA maintains several business development grants and financial assistance programs for qualifying businesses. These grants and financial assistance programs can be used for:
To qualify for USDA business and industry loans, businesses or individuals must:
To qualify for a USDA loan, you should also have top business liability insurance. This requirement varies and may include hazard, life, workers’ compensation, flood or other coverage.
Some lenders may require that borrowers meet additional criteria to qualify for USDA business and industry loans.
The USDA’s Rural Business Services Program Discovery Tool can help you learn more about the available loan and grant programs and program eligibility requirements. Consult your state’s Rural Development Office to start the loan application process.
In most cases, these federal loan programs do not provide financing directly. Generally, the federal government serves as a guarantor of a portion of the debt so that conventional lending institutions such as banks feel more secure authorizing a loan to a business.
Through programs like these, businesses that would otherwise be denied funding – because of a lack of credit, an unproven business model or other reasons – are more likely to secure it because banks consider the federal government a reliable debtor.
“The SBA and the USDA provide guarantees to banks on a portion of the loan balance with a corresponding underwriting guideline that opens up the borrowing opportunity to a larger group of businesses,” said Bernie Dandridge, SBA and USDA business development specialist at Florida Capital Bank.
Businesses applying for the support of a federal loan program will have to engage the appropriate agency and go through the process of applying, which sometimes can take a while. It also means opening your financial recordkeeping to inspection and being prepared to divulge sensitive information to decision-makers within the program.
“[Entrepreneurs] should expect a careful financial review and be prepared with their financial documents, including a business plan,” Dandridge said. “They should also understand that working capital and debt coverage are very important components in the evaluation.”
Why entrepreneurs should consider a government loan
Government loans offer several important benefits.
Entrepreneurs entering these programs have some responsibilities to bear in mind.
First, you must accurately and entirely complete the application process, verifying that all submitted information is true to the best of your knowledge. Be aware that misrepresenting or inflating the figures in a loan application raises a red flag with lenders and often results in a refusal of funds.
Like most loans, government loans have additional fees. According to Dandridge, these fees could be as much as 3.75% of the guaranteed loan amount. Businesses that qualify for a standard conventional commercial loan are not required to pay such fees.
SBA and USDA loans are guaranteed by the government, so there’s a lot of documents to fill out and guidelines to follow. You can address this concern by closely examining all your paperwork. With this information in hand, you can then gather it and store it in a convenient location for your application.
USDA loans have population-driven geographic limitations, which means that you simply can’t access USDA loans in some regions. Other entrepreneur loans – such as SBA loans, which have no geographic limitations – may be necessary depending on your location.
Planning properly and ensuring you can meet the obligations of a loan guaranteed by the federal government should be your primary consideration before you accept financing. However, if you can reliably service your debt, you should have little to worry about.
“As long as you meet your repayment obligations and provide periodic financial reports as required under your agreement, your banker will be your biggest advocate,” Haverty said. “But if you fall behind and your loan goes into default, the … process could end up being more unpleasant than an audit from the IRS.”
Max Freedman and Julie Ritzer Ross contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.