How Do SBA Loans Work?

The United States Small Business Administration (SBA) offers three types of funding to help small businesses.

The SBA does not make direct loans to small businesses. Rather, the SBA sets the guidelines for loans, which are then made by its partners (lenders, community development organizations, and micro-lending institutions). The SBA guarantees that these loans will be repaid, thus eliminating some of the risk to the lending partners.

So when a business applies for an SBA loan, it is actually applying for a commercial loan, structured according to SBA requirements with an SBA guaranty. SBA-guaranteed loans may not be made to a small business if the borrower has access to other financing at reasonable terms. SBA loan guaranty requirements and practices can change as the government alters its fiscal policy and priorities to meet current economic conditions. Therefore, you can’t rely on past policy when seeking assistance in today’s market.

The SBA can guarantee as much as 85 percent of the loan proceeds, so while the lending institution will have some risk, it should also be willing to take on more risk than with traditional loans. SBA loans can be as large as $5 million. Most SBA loans are through banks. You can ask your bank whether it makes SBA-guaranteed loans, or you can go to the SBA website for a list of participating lenders. In addition, the SBA has a microloan guarantee program for loans up to $50,000. These loans are provided through nonprofit community-based organizations. You can find a list of participants on the SBA website.

SBA loans typically take extra time and extra paperwork, although the SBA also has programs for express loans with shorter forms. You can expect to sign a personal guarantee, and you will generally be expected to have some collateral. You may not get the entire loan at once; instead, you may get it in parts, such as after supplying invoices supporting the need for funds. The interest rate may well be higher than on a conventional loan. You may pay extra fees, such as a guarantee fee and a servicing fee, both based as a percentage of loan proceeds, on top of interest costs.

In addition to loan programs, the SBA offers the Surety Bond Guarantee (SBG) program, which helps small business contractors who cannot obtain surety bonds through regular commercial channels.
A surety bond is a three-party instrument among a surety (someone who agrees to be responsible for the debt or obligation of another), a contractor, and a project owner. The SBA’s guarantee gives sureties an incentive to provide bonding for eligible contractors, thereby strengthening a contractor’s ability to obtain bonding and greater access to contracting opportunities for small businesses.
SBA can guarantee bonds for contracts up to $5 million, covering bid, performance, and payment bonds, and in some cases up to $10 million for certain contracts.

Finally, the SBA supports a venture capital program. SBA’s Small Business Investment Company (SBIC) program is a public-private investment partnership created to help fill the gap between the availability of growth capital and the needs of small businesses. The SBA does not invest directly in small businesses, relying instead on the expertise of qualified private investment funds. The SBA licenses these funds as SBICs and supplements the capital they raise from private investors with access to low-cost, government-guaranteed debt. With these two sources of capital backing them, SBICs search across the U.S. for promising businesses in need of debt or equity financing. SBICs are similar to other investment funds in terms of how they operate and their pursuit of high returns. However, unlike other funds, SBICs limit their investments to qualified small business concerns as defined by SBA regulations.

Takeaways You Can Use

  • The SBA does not lend directly to small businesses.
  • The SBA lends indirectly by guaranteeing a large percentage of loan amounts through participating banks and organizations.
  • Not all borrowers will qualify for SBA loans.

About Bob Adams

Bob Adams is a Harvard MBA serial entrepreneur. He has started over a dozen businesses including one that he launched with $1500 and sold for $40 million. He has written 17 books and created 52 online courses for entrepreneurs. Bob also founded BusinessTown, the go-to learning platform for starting and running a business.