Understanding the strict Small Business Administration requirements is key to be able to qualify for an SBA business loan. Knowing the criteria means you can become a qualified borrower that banks will love to approve.
When aspiring entrepreneurs need funding to start or buy the business of their dreams, one of the most common methods they turn to are loans from the Small Business Administration (SBA). They’re backed by the federal government, meaning if the loan should default, the bank will still be repaid up to 85 percent of the loan. Because SBA loans carry less risk for banks, lenders are usually able to offer lower interest rates and longer repayment terms, which make SBA loans an ideal method of small business funding.
While SBA loans are attractive for both business owners and banks, it’s hard to qualify for an SBA business loan; the process is challenging, lengthy, and intensive. Though these loans are less risky for banks overall, lenders still want to ensure candidates can pay back the loan by analyzing the borrower’s financial and business background. Knowing the qualification requirements and what to expect during the application process before diving in can help potential borrowers prepare better and take steps to become more qualified.
The 5 C’s of SBA Business Loans
In 2017, the SBA granted $25,447,458,500 worth of small business loans, a 42 percent increase from 2013. With so many loans approved each year, banks have their qualification requirements down to a science. Banks need to be persuaded that an applicant is a good risk to take — meaning they’ve proven they are a responsible borrower with a solid background of paying back debt on time with plenty of experience in business. The way banks analyze these criteria in each borrower are referred to as the 5 C’s of SBA loans: capital, credit, collateral, capacity, and character.
- CapitalCapital refers to the borrower’s equity injection or down payment. In other words, the amount of capital an individual is willing to put down at the start of the loan to show their good faith toward paying it back. For most SBA lenders, the down payment requirement will range between 20 percent (if you’re buying an existing business or franchise) to 30 percent (for new business start-ups). It’s important to note that opening a new franchise location is considered a start-up by banks, so be prepared to pay a higher down payment if you’re a franchisee.
The down payment requirement is usually non-negotiable for banks, so it’s wise to hold off on applying for an SBA loan until you’re able to provide it. If saving 20 – 30 percent of your loan amount isn’t a good option for you, there are other ways to fulfill the down payment requirement, such as 401(k) business financing. Also known as Rollovers for Business Start-ups, this method allows you to use funds from an existing 401(k) or IRA to put toward your loan down payment without incurring any tax penalties. Learn more about 401(k) business financing with our Complete Guide to ROBS.
- CreditBanks are especially interested in a borrower’s credit history and credit score. Not only will they look for a FICO credit score of 680 or above, but they’ll also dig into the details to ensure there are no recent bankruptcies or foreclosures and few to none delinquent payments. While it is possible to still qualify for an SBA loan with one of the above-listed negative factors, a significant amount of time should have passed since then.
Banks will also review a business’s Small Business Credit Score (SBSS). This number applies only to existing businesses or franchises and considers the business’s cash flow, expenses, operational history, etc., to assess its overall success. SBA lenders look for SBSS scores of 160 or above.
- CollateralEven though banks are guaranteed to be paid a certain percentage of an SBA loan in the event of a default, they still want borrowers to put up personal property to secure the loan from their end. Homes are the most common form of collateral, but other types of property are acceptable.
Collateral is the most flexible requirement in terms of the 5 C’s. Some people who have otherwise strong applications may still be approved for an SBA loan even if they don’t meet the collateral requirements.
- CapacityCapacity refers to the borrower’s ability to generate an income so they will be able to pay back their loan in monthly installments. The borrower’s current income, their spouse’s income, and their projected future business income all play a part in the bank’s evaluation of capacity. If you’re funding a new business, lenders will look for more outside income to offset any cash flow issues during the start-up phase. If you’re funding an existing business, they’ll look at the business’s past tax returns to ensure it’s capable of being profitable.
- CharacterWhen it comes to SBA loans, banks not only want to ensure the numbers line up on paper, but they also want proof that a borrower has a proven ability to run and manage a business. Banks look at resumes for relevant experience, require a business plan that lays out future projections for the business, and review personal history. Late child support payments, criminal convictions, and arrests can be red flags for lenders.
The Application Process for an SBA Business Loan
It’s important for potential borrowers to understand what the SBA loan process looks like so they know the requirements going into each stage.
Once a borrower has identified the business they want to buy and have a general understanding of the amount of funding they’ll need, there are three steps to applying for an SBA loan:
- Filling out application paperwork. SBA loan applications can be lengthy. The application usually asks for detailed information about personal and financial history, tax documents, financial declarations, business tax returns, and a business plan. Every lender usually requires a separate application, making for a significant investment of time if a borrower plans to apply with more than one lender.
- Underwriting. This stage is when the bank will review the borrower’s application package and ask for any additional information they need to make their decision. They’ll pull the borrower’s credit during this time and ultimately decide if they successfully demonstrate the 5 C’s. The underwriting process can take up to 90 days, which can extend even further if the bank asks for additional information (a common occurrence).
- Closing. If and when the loan is approved, the final stage of the SBA loan process is closing. This step requires its own documentation that must be provided to the lender including proof of down payment funds, lease or property ownership documents, entity documentation, and more. The closing step can take up to 90 days before funding is finally received.
SBA Loans Made Easy: How Loan Packagers Can Simplify the Process
Once you’ve taken steps to become the borrower banks want to see, the secret to business loan success is to work with a third-party loan packager. A loan packaging service, such as Guidant Financial, can streamline the application process, and their representatives can act as a liaison between the bank and borrower during underwriting to keep the process moving forward.
Learn more about your funding options: Pre-qualify Today.
Obtaining an SBA loan can be a long and complex process, especially for those who try to do it on their own. But the thousands of entrepreneurs who have received SBA funding have been given the ability to start the business of their dreams without having to pay high interest rates or deal with ballooning costs.
To learn more about SBA loans and working with a loan packager, read our Complete Guide to SBA Loans.