November 04, 2020
How Are SBA Loans Different from Other Funding Options?
Currently, many business owners are seeking financing from banks and online lenders to maintain their operations. In addition, others require financing as their business recovers from the COVID-19 pandemic. Due to this, it's imperative to weigh your business's funding options.
Knowing how SBA loans work and how they differ from other financial products will allow you to decide which option is right for your business. Keep reading to find out how SBA loans work in comparison to other types of business funding.
How Do SBA Loans Work?
SBA loans have an approval process similar to traditional commercial loans. This is because when you receive an SBA loan, it's actually a bank that lends you the money. It's important to note that the SBA doesn’t lend the money to small businesses. Instead, the SBA partners with banks and participating lenders who provide the funds. Luckily, because the SBA is guaranteeing the loan, it allows for many businesses to qualify for loans that might not qualify for traditional financing options. Before applying for a small business loan from an SBA lender, there are four main requirements, which include:- Be an officially registered business
- Conduct business in the United States
- Have equity in your business
- Exhaust other financing options
How Other Financing Options Differ
It’s important to understand how SBA loans fit into the financial product landscape. One of the best ways to do that is to compare them to other popular financial products.Traditional Bank Loans
These types of loans are often difficult for small businesses and startups to qualify for because of their strict prerequisites. Most banks won’t work with recently opened businesses, and usually require an overall favorable financial history and high credit score. In comparison, because the SBA guarantees the loan, risks are removed from lenders and transferred to the SBA. This reduces the qualification standards and allows more businesses to qualify for an SBA loan.Line of Credit
A line of credit can be used at will. Once the line is provided, the business doesn’t have to get approval to “draw” from it, and can draw up to the limit. Unlike an SBA loan, terms are not as stringent with a line of credit. Thus, there isn’t an amortization period with fixed monthly payments. In addition, interest rates on lines of credit are usually variable. This can be good and bad. The interest rate might be lower than that of an SBA loan, but can increase as FED rates rise. In comparison, an SBA loan requires a lengthy approval process and is usually meant for a specific purpose. Although a line of credit can be difficult to get approved for, they are flexible in how they can be used.Credit Cards
According to the SBA, 46 percent of small businesses use personal credit cards. Although credit cards are an easy source of financing, they must be managed responsibly to avoid having interest get out of control. In comparison to an SBA loan, credit cards have much higher interest rates. When applying for a business credit card, you'll be more likely to qualify if you have a good personal credit score. In addition, you might benefit from submitting your business’s credit score, so that you can show that you’ve managed your businesses finances appropriately. There are rarely usage restrictions for credit cards. As we previously mentioned, this isn't the case for SBA loans. Once you receive a business card, it's crucial that you avoid overspending. Although it can be tempting to spend beyond your means using your business's credit card, this can lead to significant debt. Once you've acquired debt, it'll likely be difficult to pay off while also affording your business's bills and other expenses. In addition to being challenging to pay off, credit card debt can be extremely detrimental to your credit score.Merchant Cash Advance
When you receive a merchant cash advance, you’ll acquire lump sum financing, without set terms. To remit a merchant cash advance, a percentage of your business’s credit card sales will be used to fulfill your obligation. This can benefit businesses because the process depends on the flow of their sales. This is unlike the financing that the SBA offers, which will certainly have set repayment terms. A merchant cash advance rarely has usage restrictions, while an SBA loan will have some limits depending on the product. In addition, it is important to note that if your business doesn’t accept frequent credit card payments, you likely won’t qualify for this product. This is because a cash advance provider will review the amount of credit card transactions your business typically processes. If you rarely receive credit card payments, your business won't be able to fulfill your obligations.Conclusion
SBA loans can be difficult to qualify for and have a lengthy approval process. Still, they can be beneficial to small business owners seeking financing. Before you apply, review the other options featured in this post to determine if one of them will be a more suitable fit for your business.
Editor’s Note: This post was updated for accuracy and comprehensiveness in November 2020.