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What are Microloans?
Microloans, are small, short term loans extended to entrepreneurs and smal busines owners to help kickstart the company’s growth. The amount of the average microloan ranges between $500 and $50,000 in the United States. One particular type of microloan is the SBA loan, which is a business loan guaranteed by the Small Busines Administration with interest rates starting at 7.75%.
Additionally, microlending (also known a microcredit or microfinance) can also refer to the extension of small loans to entrepreneurs in developing countries to help reduce poverty and spur economic development. In this guide we’ll focus on microloans in the United States. For international microlending visit this article.
Micro-loans are specific to businesses, and are sometimes confused with but different from consumer loans and payday loans.
Are you eligible for a microloan?
Technically almost every registered business can qualify for some sort of microloan, but the eligibility requirements depend on the lender.
Typically microloans programs are designed for businesses with little to no revenue or traction. Additionally, many lenders give loans to particular groups of people, such as veterans, women, minority business owners, or low-income individuals.
The SB microloan require an extensive questionaire, and has restrictions on what types of businesses can apply and what the capital can be used for. For example, businesses that engage in lending, political activities, or religious teaching are not eligible for any SBA loan
Is a microloan best for your business?
After you determine if you’re even eligible for a loan, it’s important to consider whether this type of financing is best for your business.
If you’re looking to raise debt capital, your first stop is typically a local bank or credit union. Unfortunately, traditional lenders have shyed away from small business lending and typically require collateral of some sort. If you can get a long-term loan from a bank with favorable rates, that’s great news. It’s also unlikely, as only 1 in 5 small busines loan applicants get approved.
The reason is simply: most brand new businesses have no financial history or assets to put up as collateral (unless you want to put up your house or other personal assets). Additionally, the amount of capital is low relative to the time and effort to manage that loan.
Another option is equity financing. If you have connections to wealthy individuals you might be able to sell shares in your company to raise financing. But equity is more expensive than debt, and you also may give up some measures of control.
So if bank lending is off the table and equity seems too expensive, what’s the solution? A microloan.
If you’re starting up a small business and looking for a short-term loan from $5,000 to $50,000, you’re in the sweet spot for a microloan.
How to get a microloan
Getting a microloan is quite easy compared to other forms of financing, but it does take a lot of time, patience and paperwork. Here’s how to go about securing this type of loan for your business.
1) Formulate a thorough business plan
Nearly every micro lending institution, and especially the Small Busines Administration, will require a thorough, well thought out business plan. Remember, the underwriters have virtually no track record or historical datapoints from which to evaluate your business. Thus, they need to see a clear vision for the future of your company and their repayment.
Your business plan should include the following:
- The goal of your business
- How you make money
- Use of funds
- How you’ll acquire and retain customers
- Customer storie
- Market opportunity
- Stakeholders
- Suppliers
- Team profile
Be sure that your business plan includes a healthy dose of quantitive material to support the vision. Include a financial model with all three financial statements. Be sure to include multiple scenarios: baseline, upside, and downside.
Of utmost importance in your business plan is how you’ll be using the capital. Is it working capital? Capex? This process will also help you clarify to yourself why you need this money and how you’ll put it to use.
2) Pull credit reports, increase creditworthiness
Just because you have a great credit score on Credit Karma doesn’t mean that there aren’t red flags hidden in your credit report.
Your persona credit score is less important for a microloan than for a personal loan, but bad credit can hurt. You want to make sure that everything is as squeaky clean as possible.
It’s actually quite common for people with good credit to have loans out for collection. Often these are medical bills or parking violations that the individual simply forgot about, and never thought twice since credit card companies are smart enough to ignore these signals.
One way to increase your creditworthiness is to open new cards and ask for your credit limits to be raised, but only do this well in advance of applying for the loan. Each time you apply for a credit card or line increase, a ‘hard inquiry’ is recorded. Too many hard inquiries signal that you’re desperate for credit, and that’s a big red flag
3) Determine personal investment / collateral / guarantee
Many lenders will require you to invest some of your own capital into the business. Skin in the game reduces risk in their eyes. Others might ask for you to put up personal collateral such as a home or a boat in order to secure the loan, while some may simply ask you to personally guarantee the loan.
This is not an easy decision. Going into business is always risky, and if the worst happens, you need to make sure you won’t suffer too much financial hardship. Be sure to model the worst case scenarios in Excel. If that happens, what happens to you? Can you afford to lose that capital, or give up some of your valuable assets
4) Research your options
Note that this is step 3 for a reason. It’s important that you have your business plan completely fleshed out before you even think about your options. This is because often the act of writing out your business plan clarifies your actual needs, and that may change what lender you are looking for.
In the next section, we’ll detail the best option for you.
5) Find a local intermediary (if applicable)
SBA loans in particular (which we’ll get into in the next section), are administered by local intermediaries. Find th closest one near you
If you have multiple options, be sure to research the best option for you.
6) Complete any training requirements
Many intermediaries require coursework or training on finance, management or other aspects of operating a business. Be sure to take these trainings seriously, and do them even if they are optional. This is one of the few datapoints lending intermediaries have when it comes to assessing how well you will run your own business.
7) Submit the application
Once you’ve done all the hard work to put together your business plan, check your credit, evaluate your risk, and choose the right options, it’s time to submit the application. The application itself isn’t too long, but the questions vary among microlenders and intermediaries (in the case of a SBA loan).
Be sure that you double-check all your answers with meticulous attention to detail
Once you’ve submitted the application, contact your loan officer (if applicable) and confirm that the application was recieved. Then, be prepared to wait. Again, the waiting period varies among microlenders, but the loan application may take 4 to 6 weeks to get approved.
The SB Microloan Program: the gold standard of microloans
The US Small Busines Administration has provided microloans since the early nineties to help economic development in areas of the market that are not served by banks. In particular, these loans are targeted at early stage smal busines owners. The loan sizes are all less than $50,000 and the interest rates are quite affordable.
Here’s a video straight from the SBA explaining the program:
How SBA Loans are administered
You might think that you submit a form SBA.gov and wait to hear a response. However, the US SBA doesn’t work that way. Instead, they partner with local non-profits that serve as middlemen. In theory, these non-profits are more in-tune with the needs and market in each locality and can make better lending decisions to benefit their communities.
Additionally, these intermediary lenders provide other value-added services, such as management training, a network of business owners, and technical help. Some intermediaries have a charter that states they are to give preference to certain groups of people, such as veterans, minorities, disabled people, or those from impoverished areas.
Ultimately, it is these intermediaries – not the SBA – that have final discretion as to the approval and terms of a loan.
SB microloan amounts
SBA-backed microloans have a cap of $50,000 and can be as little as $500. Some intermediaries might require a higher threshold than that, and according to SBA.gov, the average loan size is around $13,000. The loan size depends on your needs, your creditworthiness, and the intermediary’s assessment
Interest Rates
Annual percentage interest rates of SBA loans in 2019 range from 9-13%. These depend on a number of factors including your business’ cas flow, your credit history, and the general interest rate environment.
These interest rates are competitive with a small business bank loan from a traditional bank, but obviously a much smalle loan amount.
Repayment Terms
As with any business financing, there are a number of terms worth considering, but a bit one is the loan term. SBA loans can last up to 6 years, but the term length varies based on the amount of money, your business, your creditworthiness and more. Early repayment is another option.
Eligible Use of Funds
Working Capital
Working capital is technically current assets net of current liabilities. In practice, this is the capital required to run the business. It might be bills or employee headcount.
Inventory or Supplies
If your business sells physical goods or manufactures physical products, an SB microloan is a great option.
Furniture or Fixtures
Furniture or fixtures, whether they are customer facing or back office, are eligible to be purchased with an SB microloan. Be sure that you only invest in nice looking furniture if it’s customer facing and will have a good ROI. If it’s just your employees seeing it, Ikea desks are great.
Machinery or Equipment
Companies that need large amounts of equipment can benefit from SB Microloans because machinery and equipment are specific use cases. Manufacturers needed assembly line equipment, restaurants needing kitchen equipment, and mechanics needing tools are all great examples.
What may be less obvious is that computers, phones, and other electronics are also considered ‘machinery or equipment’. Equipment can also serve as collateral, which may get you more favorable terms.
What can’t you use SBA loans for?
Most business expenditures can be paid for with SBA loans. However, there are two specific exeptions.
- Existing Debt: SB Microloans are explicitly not to be used to pay down other loans
- Real Estate: These microloans cannot be used to purchase real estate
Alternatives to SBA loans
The U.S small busines administration is probably your best bet, but if there is no local intermediary or you get denied, there are still plenty of options.
For starters, there are nonprofit organizations like Kiva and Accion that offer credit to those that don’t have access to traditiona ban loans. The goal of the microcredit nonprofit community is to help reduce poverty through investment, so their credit requirements may differ.
The other option is for-profit financial institutions such as Grameen America. This type of microloa provider usually has some mission to reduce poverty, but also needs to make a higher return on the loans, so they may require a personal guarantee or have a different application process. Additionally, these types of microfinance lenders offer many other products such as savings accounts, business credit, and checking accounts.