For more than sixty years, the Small Business Administration has helped American businesses grow. The SBA was slow to adopt programs and policies that could help tech entrepreneurs, but now they fund far more than just main street mom-and-pops — there are several startup business loan options that a young tech company might find useful.
The most common of these is the standard 7(a) SBA loan. Let’s review how it works and break down the details.
How the SBA 7(a) loan mitigates risk
7(a) loans are designed to mitigate lenders’ risk and maximize businesses’ loan amounts.
The SBA doesn’t directly issue it’s standard 7(a) loans itself. Instead, it works with approved lenders to guarantee a portion of the principal, usually 75-85%. In order to get a 7(a) loan, you’ll actually be working with an approved lender to put together an approval package.
This means smaller, newer, and riskier businesses that traditional banks might not normally loan to can get 7(a) loans—the lender knows the principal is covered, so their risk is mitigated. This is good, because the default rates on 7(a) loans are high—almost 20%—and traditional lenders wouldn’t be comfortable extending credit to smaller businesses at competitive interest rates if they knew one in five would fail.
This makes the 7(a) a win-win program: small businesses win because they can access capital at interest rates they couldn’t normally get, and lenders win because even if the company goes under, the SBA has the majority of the principal covered.
Getting started with the SBA 7(a) loan application
First, you should make sure your business is eligible. As of this writing, the SBA requires that your business:
Operate for profit
Be small, as defined by SBA
Do business in the US
Have reasonable invested equity
Use alternative financial resources, including personal assets, before seeking financial assistance
Be able to demonstrate a need for the loan proceeds
Use the funds for a sound business purpose
Not be delinquent on any existing debt obligations to the U.S. government
The SBA website has much more information about ineligible businesses and special considerations. You also need to make sure your intended use of the proceeds from the loan is SBA-approved. Read their guidance here.
If you read the requirements, you’ll see that they’re also underwriting the principals of the company. Since these loans can be risky, they want to know how credit-worthy the owners and operators of these businesses are. They also want to know how deep their pockets are. An owner that could potentially inject more cash equity is less likely to have problems paying their bills and servicing debt without outside help. Be prepared to provide your personal financials in addition to your business information.
Next, you’ll need to find a lender. You can use the SBA LINC tool to connect with potential lenders in your area that are SBA-approved. To use the tool, you’ll need to create an account with the SBA and fill out a short questionnaire. The SBA will review your information and send you an email with contact information for lenders that may be able to work with your company.
Once you’ve identified a lender you’d like to work with, you can reach out and begin the process of putting together your package. You’ll submit your package, and the SBA will process it before they let you know if your loan is approved.
SBA 7(a) loan pricing
Pricing can vary depending on the lender you choose, but the SBA sets general guidelines. Your loan may have fixed or floating interest rates. As of May 2015, the maximum rates varied between 4% and 10%, depending on the characteristics of the loan.
If your loan has a floating rate, there will be two components to your interest rate. The first component is the base rate, which can be one of three different standards:
One month LIBOR (London Interbank Offered Rate) plus 3%
The prime rate (based on the federal funds rate set by the Federal Reserve)
The SBA peg rate (a standard set by the SBA)
These base rates can vary from day to day and represent the floating portion of your floating interest rate. The second component is a fixed percentage you negotiate with the lender that is applied on top of these floating rates. These rates tend to vary from 2.25% to 2.75% over the floating base rate.
So, for example, say the prime rate goes from 3.25% to 3.75%. If you negotiated a fixed percentage of 2.25% with your lender, then your total interest goes from 5.50% to 6.00%.
The other major expense for your SBA 7(a) loan is a fee charged by the SBA for guaranteeing a portion of the principal. The table below can give you a sense of what that fee might look like:
Loans under $150,000Loans between $175K and up to $700KLoans over $700K up to the $5M maximum*Loans that mature in one year or less0.00%0.25%3.00%Loans that mature in more than one year0.00%3.00%3.50%
*Loans require an additional 0.25% fee for the guaranteed portion over $1,000,000.
The 7(a) loan program is only one of the SBA’s programs that could work for tech startups. They also offer R&D loans to early-stage tech companies, lines of credit, and equipment loans. Be sure to check the SBA website for other products that may work for your business, and remember that their terms, conditions, and pricing change from time to time.
All in all, the Small Business Association and its programs can be a great source of capital for the right business with the right qualifications and needs.