Business Startups and the Small Business Administration (SBA)

Most first-time entrepreneurs are under the impression that SBA loans are an easy, viable route to funding any startup. While the SBA is an excellent government program to assist American small business, keep in mind that it is a government program, with all that distinction means - the process is slow, the restrictions are strict, and the hurdles to approval are high. Before you commit countless hours and effort to pursuing an SBA approval, be sure you understand the realities of the programs as well as your alternative opportunities for financing your startup.

The SBA is well-organized with distinctive programs to cover various sizes of businesses at various stages. The most common SBA program for entrepreneurs is the 7a Regular, which provides loan guarantees to approved businesses for startup or expansion needs including working capital, equipment purchases and the like. These guarantees are not actual loans but are intended to improve the chances of obtaining a formal bank loan. After all, if the federal government is promising to repay 75% or more of the loan if the borrower defaults then the banks should be clamoring to provide the loans, right? Not so much. In fact, banks are less and less inclined to service SBA-backed loans because of the requirements (read paperwork) set forth in the SBA guarantee regulations and the higher risk of helping out small business. Finding a bank to service an SBA loan is even more difficult if you are trying to fund a startup. The SBA requires a good personal credit score to even have a chance at a 7a guarantee, and the banks will require excellent credit plus your personal guarantee and collateral before they even think about lending the cash.

The 504 program provides cash directly to Certified Development Corporations, local area Not-For-Profits that are concerned with business development in disadvantaged communities. This program is intended to provide up to 40% of the needed capital for land and buildings for small businesses. The 504 money is borrowed from the CDC, and the rest must be secured through a formal bank loan. The requirements vary, but generally the company accepting the loan commits to job creation at a certain level, such as one new job for every 50k in SBA dollars or other specific economic development or public policy goal, such as minority business ownership. Again, good personal credit, collateral (usually the long-term assets purchased with the money), and the owners' personal guarantee are required. The Microloan Direct program is probably the most viable option for most startups. The SBA distributes around 20M per year to intermediaries such as economic development NFPs throughout the country so they can provide loans up to 35k to businesses in their areas. The NFPs set their own approval processes with some guidance from the SBA. The average microloan is around 13k and most intermediaries also require collateral and a personal guarantee.

The recent Stimulus Plan includes incentives for banks to make more SBA-backed loans including reduced fees and increased guarantees to 90% of the total loan amount. Still, reports indicate that the banks aren't particularly swayed by these incentives and loans to small businesses, and especially startups, remain limited. The primary reasons are the high risk (one report indicates a failure rate of nearly 12% in 2008), the high cost of servicing SBA loans (even with the Stimulus Plan discount), and the little known fact that the SBA can back out of the guarantees even after the loan has been made.

The reality of securing an SBA loan is not as rosy as many startup gurus would have you believe, nor is it necessarily an entrepreneur's best bet. At best, these loans should be a backup plan if startup cash cannot be found elsewhere. SBA deals are expensive -- even the microloan interest rates are between at least 8% and 13% - it is time-consuming and tedious to qualify, and you will be required to support your application with your personal guarantee anyway. This means that your assets become fair game for the bank if the business doesn't work out for any reason. In addition, the chances of approval are much slimmer than most people think. Last year, just under 70,000 SBA 7a loans were funded, most of which were likely for established companies. The Microloan program distributed over $20M last year, but with an average loan value of $13,000, only around 1500 small businesses (not all startups) enjoyed the fruits of this program. In considering these numbers, keep in mind that over 600,000 new businesses with employees are started each year. There are no reliable numbers on the number of solo businesses that are also launched, but the estimates are that the total is significantly over 1,000,000 startups each year. Add to that the number of businesses seeking capital to grow and expand and the odds that any one startup will be funded through an SBA program are pretty low.

If you are looking to start your own business, don't make the SBA loan your first choice for startup financing. Determine how much you can get done out-of-pocket and look to family and friends investors to round out the funding. Financing your business yourself and through people who know you and want you to succeed provides you far more control and can be a stronger incentive to watch the pennies throughout the life of your venture. However you decide to fund your business, the first step is to develop a detailed plan, including financials, so you know exactly how much you need and when. If the total is more than you can finance yourself, the work you have put in to the planning can be easily organized into a formal business plan to entice investors, including the SBA.