Financing is an essential component for any business, whether it's finding investors or taking out a loan. Entrepreneurs who are looking for 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.
What government loans are available to entrepreneurs?
Government loan programs are available to assist entrepreneurs 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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SBA loan programs
The U.S. SBA is a major 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.
Here are five of the most popular loan program options on offer from the SBA.
1. SBA 7(a) Loan Guarantee Program
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 and can be used to buy land, cover construction costs, purchase or expand an existing business, refinance existing business debt, and buy 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.
2. SBA 504 Loan Program
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 are fixed-rate and 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.
3. SBA Microloan Program
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.
4. SBA Express Loan Program
The SBA Express 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 loan amounts that exceed $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 commercial real estate loan (25-year term).
5. SBA Disaster Assistance
The federal government’s disaster assistance loan program extends low-interest, long-term financing to renters or property owners that seek to restore their properties to pre-disaster condition. This is useful for businesses that have been damaged as a result of natural disasters.
How to qualify and apply for SBA loans
To be eligible for SBA loans, businesses or individuals must meet the following criteria:
- Location: Be located and operated in the U.S.
- Ownership: Be controlled by a U.S. citizen or legal permanent resident of the U.S.
- Classification: Be for-profit in addition to meeting the SBA's eligible industry requirements
- Equity: Have enough invested equity to operate soundly from a financial standpoint
- Business type: Qualify as a small business, according to the SBA's Table of Size Standards (which can be found in the Electronic Code of Federal Regulations). Size requirements vary by industry and the number of employees or average annual receipts.
The SBA loan application process typically works like this: Business owners first apply for a conventional small business loan (which 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]
USDA loan programs
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:
- Business modernization, development or repairs
- Commercial real estate purchase, development, or improvement
- Purchase of machinery, equipment, supplies or inventory
- Working capital
- Debt financing (in cases where such financing would improve cash flow and save or create jobs)
- Acquiring a business (again, if it would save or create jobs).
These programs include the following seven options.
- Business and Industry Loan Guarantees (B&I). Through the B&I program, the federal government acts as a guarantor of private loans for rural businesses, extending the private credit that is available to entrepreneurs in those regions.
- Intermediary Relending Program (IRP). The Federal IRP provides low interest rates to intermediaries that lend to businesses locally in a bid to help stimulate local economies and kickstart job creation in rural communities.
- Rural Business Development Grants (RBDG). The USDA's RBDG program provides grants for technical assistance and training that help develop and expand small businesses in rural areas.
- Rural Business Investment Program (RPIP). The RBIP supports investment companies based in rural areas to help meet the financial needs of communities in those regions.
- Rural Economic Development Loan and Grant (REDLG). This program provides funding for infrastructure projects in rural areas through local Those loans are then passed on to local businesses in the community for projects that establish lasting jobs.
- Rural Microentrepreneur Assistance Program (RMAP). Much like the SBA's microloans program, the USDA provides loans and grants to qualifying organizations to support their growth and offer training and technical assistance.
- Value-added Producer Grants. The VAPG extends grants to agricultural producers to assist them in the production and marketing of new agricultural products. New or disadvantaged producers receive priority in the program.
How to qualify and apply for USDA loans
To qualify for USDA business and industry loans, businesses and/or individuals must:
- Be located in a rural area. Any area other than a city whose population is more than 50,000 or the urbanized area adjacent to that city. Check the USDA's Rural Business Services Property Eligibility tool to check for eligibility.
- Be a U.S. citizen or a permanent resident of the U.S. This requirement applies to individual borrowers and businesses For businesses, at least 51% must be owned by a U.S. citizen or permanent resident.
- Be an eligible borrower. The USDA considers an eligible borrower to be a for-profit business, nonprofit entity, federally recognized tribe, public body or individual.
- Have sufficient cash flow. You must have enough money coming in to repay your loan.
- Have a good credit history. Individuals must have a credit history that spans at least several years and a credit score of at least 680. Businesses need a history of on-time payments, low credit utilization, and no derogatory marks, such as judgments, liens, charge-offs, bankruptcies. [Read related article: When Does Your Business Credit Score Matter?]
- Have a tangible balance sheet equity position. This is the equity on a business’s balance sheet, minus the value of any intangible assets (such as amortized loan costs, licenses, goodwill, customer lists, patents, copyrights, proprietary rights and trademarks). The accepted tangible balance sheet equity position is 10% for existing businesses, 20% for new businesses, and 25% to 40% for energy projects.
- Complete a feasibility study. This requirement is for new businesses and must be conducted by an independent consultant.
- Pledge collateral. You must have property, equipment or other assets of monetary value that the lender can seize if you default on your loan. [Read related article: Unsecured vs. Secured Business Loans]
- Sign personal and corporate guarantees. The business owner(s) must personally guarantee that the loan will be repaid. [Read related article: The Risks Associated With a Personal Guarantee]
- Have business liability insurance. This requirement varies and may include hazard, life, workers' compensation, flood, or other coverage.
Some lenders also may require that borrowers also meet additional criteria to qualify for USDA business and industry loans.
The USDA's Rural Business Services 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.
How do these loans work?
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 – either because of a lack of credit, an unproven business model or for 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/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 record keeping 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."
Entrepreneurs entering these programs have some responsibilities to bear in mind. First, they must accurately and entirely complete the application process, verifying that all submitted information is true to the best of their 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.
In addition, according to Dandridge, there are three limitations these programs present to entrepreneurs:
- There are additional fees, which 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.
- The loans are government guaranteed, and that means there are a lot of documents and guidelines to follow.
- USDA loans have geographic limitations, which are population-driven.
Proper planning and ensuring you can meet the obligations of a loan guaranteed by the federal government should always be a primary consideration before accepting financing. However, if you can reliably service your debt, Haverty said, 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," said Haverty. "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."
Additional reporting by Julie Ritzer Ross.