Nearly every time someone talks about starting a small business, the suggestion of applying for Small Business Administration (SBA) loans comes up. SBA loans are wonderful things – since its inception in 1953 more than 20 million small businesses have received SBA loans – but there are some serious misconceptions and drawbacks to SBA loans.
For starters, the very term “ SBA loan” leads many to wrongly infer that the SBA is a lender. Rather, SBA loans are small business loans from commercial, private or nonprofit lenders that are backed by SBA loan guarantee programs.
Through SBA loans, small business owners who are denied loans are given a helping hand from the SBA through loan guarantees that back up to 90% of the loan total. The advantage for the lender is in sharing the risk of default with the government, so they’re far more likely to approve SBA loans that those without a guarantee.
Another serious drawback to SBA loans is the long and frustrating approval process – for most borrowers the procedure will take six to nine months, and even then the application may be denied. The reasons for this are simple. Borrowers have to go through a lengthy application process with the bank, and then go through an even more rigorous procedure with a federal agency.
But the nature of the loan guarantee is often another source of confusion about SBA loans. Many borrowers think that if they default on SBA loans, the SBA guarantee means they’re off the hook with the bank. Nothing could be further than the truth.
When small business owners default on SBA loans, the SBA may eventually pay a portion of the loan value to the lender, but only after the lender has made aggressive efforts to collect from the borrowers. If the SBA allowed lenders to sell them out to every defaulting borrower they’d soon be out of business, so instead they hold lenders’ feet to the fire. If that means the banks foreclose and seize borrowers’ business and personal collateral, so be it.
And finally, SBA loans can be expensive. The federal government charges a minimum of a 2.5% guarantee fee to the banks, and the banks pass that expense on to the borrowers.
None of this is meant to imply that small business owners shouldn’t attempt to receive SBA loans. It’s just a recommendation that prospective borrowers consider all their options.