An Introduction to Small Business Administration Loans

If you're in the market for a small business loan, you'll need to understand the services the Small Business Administration provides.

Established in 1953, the SBA is an independent agency of the the federal government charged with the responsibility of providing four primary areas of assistance to American small businesses: advocacy, management, procurement, and financial assistance. Financial assistance is delivered primarily through the SBA's investment programs, business loan programs, disaster loan programs, and bonding for contractors. The SBA's business loan program is one of its significant areas of financial assistance.

The stated mission of the SBA is to "maintain and strengthen the nation's economy by aiding, counseling, assisting, and protecting the interests of small businesses and by helping families and businesses recover from national disasters."

The SBA Web site is an excellent resource for small businesses. It's very well-organized and easy to navigate and provides a wealth of information.

SBA Loan Programs

The SBA offers a variety of loan programs to assist small businesses. It's important to note, however, that the SBA is primarily a guarantor of loans made by private lenders and other institutions and not a lender itself. The SBA's business loan programs supplement the ability of certain lenders to provide both long- and short-term financing to small businesses that might not otherwise qualify for loans through traditional lending sources. The SBA may not guarantee a loan if a business can obtain funds on reasonable terms from a bank or other source.

There are three basic types of SBA loan programs and several special-purpose categories of Section 7(a) loans, including:

• The Basic Section 7(a) Loan Guaranty Program
• The Section 504 Certified Development Company Program
• The microLoan, a Section 7(m) loan program

The different sections under which SBA loans may be obtained refer to sections of the Small Business Act.

Basic Section 7(a) Loan Guaranty Program

The Basic Section 7(a) Loan Guaranty Program serves as the SBA's primary business loan program to help qualified small businesses obtain financing when the business might not be eligible for business loans through normal lending channels. It's the SBA's most flexible business loan program. The customers for this program are startups and existing small businesses.

Loans under the 7(a) program are provided by lenders who are called participants because they participate with the SBA in this program. Most American banks participate in this program, although not all lenders do. Loans under the 7(a) program are available only on a guaranty basis, which means that the loans are provided by lenders who have decided to structure their own loans according to the SBA's requirements and who apply to and receive from the SBA a guaranty on a portion of the loan. This is not a guaranty for the full amount of the loan; the lender and the SBA both share the risk that a borrower may not be able to repay the loan in full. The guaranty protects against payment default.

Under this concept of guaranty lending, commercial lenders make and administer the loans, and the business applies to a lender, not the government, for the loan. The lender decides if it will make the loan itself or if the application has some weaknesses, which will require an SBA guaranty if the loan is to be made. A borrower must have been turned down for and be unable to obtain a traditional loan. The guaranty on the loan is available only to the lender, not the borrowing business. The guaranty assures the lender that if the borrower does not repay the obligation, the government will reimburse the lender up to the percentage of the SBA's guaranty. Nevertheless, the borrower remains obligated for the full amount due.

Loans under this program must meet certain criteria. The business gets a loan from its lender with a 7(a) structure, and the lender gets an SBA guaranty on a percentage or portion of the loan.

Eligibility Criteria for SBA Loans

To obtain a loan under any of the SBA loan programs, the applicant must first be eligible. Unless otherwise specifically stated, most of the SBA loan programs use the Basic Section 7(a) eligibility criteria, which are broad and designed to accommodate the most diverse number of small business financing needs. All businesses must meet the following SBA 7(a) Loan Program eligibility criteria to be considered for financing:

• Size
• Type of business
• Operation in the United States or its possessions
• Availability of funds from other sources
• Use of proceeds
• Repayment

The maximum size of an eligible business is defined by size standards developed by the SBA. Under the Small Business Act, an eligible small business is defined as one that is "independently owned and operated and not dominant in its field of operation." The act authorizes the SBA administrator to establish small business size standards, usually based on annual receipts or number of employees, taking into account differences in companies by industry. A business cannot exceed the annual receipts or employee size standards developed by the SBA.

A size standard has been developed for each industry listed in the North American Industry Classification System. The SBA uses the following criteria to determine whether a business qualifies as a small business that is eligible for SBA loan assistance:

• Construction: Average (three years) annual sales or receipts of not more than $33.5 million, depending upon the specific business type
• Manufacturing and mining: Not more than approximately 500 employees
• Retail or service: Average (three year) annual sales or receipts of not more than $35.5 million
• Wholesale: Not more than 100 employees
• Special trade contractors: A limit of $14 million
• Agricultural industries: A limit of $.75 million

The business must be a for-profit enterprise and be an eligible type of business. Certain types of businesses and applicants require additional considerations regarding eligibility for SBA loan programs. Moreover, although the majority of businesses will be eligible for financial assistance from the SBA, some types of businesses are completely ineligible.

Additional considerations are required for the following business types and applicants:

• Aliens
• Change of ownership
• Eligible passive companies
• Farms and agricultural businesses
• Fishing vessels
• Franchises
• Medical facilities
• Probation or parole
• Recreational facilities and clubs

Specific types of ineligible businesses include the following:

• Charitable, religious, or other nonprofit organizations
• Gambling activities
• Illegal activities
• Lending activities
• Other speculative activities
• Pyramid sales plans
• Real estate investment firms

The proceeds of a 7(a) loan may be used by a new or existing business to do the following:

• Construct commercial buildings
• Expand or renovate facilities
• Finance receivables and supplement working capital
• Finance seasonal lines of credit
• Purchase machinery, equipment, fixtures, and leasehold improvements
• Purchase land or buildings
• Refinance existing debt under some circumstances

The proceeds of a 7(a) loan may not be used for the following purposes:

• For a non-sound business purpose
• To repay delinquent state or federal withholding taxes or other funds that should be held in trust or escrow
• To make a partial change of ownership or change in the business that will not benefit the business
• To refinance existing debt where the lender might sustain a loss and the SBA would cover the loss through refinancing
• To permit reimbursement of funds owed to any owner of the business

The business must be engaged in or intend to do business in the United States or its possessions.

The SBA loan program will not provide funds for businesses that are able to obtain or provide their own financing. Alternative resources for funding, including personal assets, if available, must be used first.