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.
What government loans are available to entrepreneurs?
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."
Editor's note: Looking for an alternative to a traditional bank loan? Fill out the below questionnaire to be connected with vendors that can help.
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.
5 of the most popular loan programs offered by 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. 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.
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 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.
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 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).
5. SBA disaster assistance
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.
How to qualify and apply for SBA loans
To be eligible for SBA loans, businesses or individuals must meet the following criteria.
- Location: The business must be located and operated in the U.S.
- Ownership: It must be controlled by a U.S. citizen or legal permanent resident of the U.S.
- Classification: It must be a for-profit business in addition to meeting the SBA's eligible industry requirements.
- Equity: It must have enough invested equity to operate soundly from a financial standpoint.
- Business type: It must 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 (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:
- 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 funding would improve cash flow and save or create jobs)
- Acquisition of a business (again, if it would save or create jobs)
7 options in these programs
- Business and Industry (B&I) Loan Guarantees: 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 to help stimulate local economies and kickstart job creation in rural communities.
- Rural Business Development Grants (RBDG): The USDA's RBDG program provides technical assistance and training grants that help develop and expand small businesses in rural areas.
- Rural Business Investment Program (RBIP): 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 loans. 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 (VAPGs): The VAPG program extends grants to agricultural producers to assist them in producing and marketing 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 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 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 or bankruptcies.
- 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 companies 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.
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.
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 – 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.
- Funding access: One of the most significant benefits of government loans is that they make funding available to entrepreneurs who otherwise might not have financing options.
- Easier loan terms: Compared to other types of business loans, government loans often have lower fees and interest rates as well as longer repayment terms. In many cases, your initial down payment will also be smaller, making government loans more accessible than their private counterparts.
- Easier qualification terms: Although not every entrepreneur qualifies for government loans, these loans often have more flexible terms than bank or private loans. They can be a more realistic loan option for business owners with low credit scores, poor lending histories or minimal proof of business success.
- Faster funding: SBA loans are often available within one month of applying. The turnaround time for most non-government entrepreneur loans is greater than two months.
What to consider before applying for government loans
Entrepreneurs entering these programs have some responsibilities to bear in mind.
Informational accuracy
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.
Loan fees
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.
Documentation
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.
Geographic limitations
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.
The final word on entrepreneur loans
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.