By Steve Nicastro
SBA loans can be a remarkably attractive financing option for small businesses looking to grow. So, obviously, there's a catch.
What makes them attractive: The loans carry lower interest rates and longer repayment terms than most other business loans, and you can use the funds for a variety of business purposes, such as buying real estate or equipment, refinancing debt, purchasing inventory or for long-term working capital.
The Small Business Administration guarantees a portion of these loans, which are then issued by participating lenders (banks, credit unions and non-bank lenders). The SBA says it backed a whopping $23.6 billion in its most popular 7(a) loans for 2015, setting a record. Borrowing amounts are up to $5 million, and the average 7(a) loan was $371,628 in 2015.
Here's the catch: Not everyone is eligible for financing; in fact, qualifying can be pretty difficult. Even if your business generates strong revenue, and you can provide a sound business plan and a clear use for the funds, you still may be denied financing.
We've surfaced five reasons borrowers may be disqualified for SBA loans -- as well as a couple of surprising factors that will not disqualify you:
1. You don't have assets to put in the deal
If you think you'll get 100% financing, think again.
Here's how the SBA figures it, says Robert Dwyer, of Freedom Small Business Lending BIDCO Inc., which provides SBA loans to small and medium-size businesses nationwide. When buying a car or a house, you'd likely have to put some money down to make the deal happen, right? That's also the case for SBA 7(a) loans.
"You are demonstrating that you are into this transaction, and we are in it together. It's a partnership," says Dwyer, executive vice president of the New Jersey firm. "We're providing the bulk of financing, but you have to step up and have some personal cash in the transaction. I run into folks expecting 100% financing, and that's few and far between."
2. You do have assets but don't want to use them
The SBA wants to know: If you can do it yourself, why are you coming to us?
The administration requires borrowers to use "alternative financing resources, including personal assets, before seeking financial assistance." If the borrower's personal and business resources are found to be excessive, the business will have to use those resources "in lieu of part or all of the requested loan proceeds," according to the SBA.
This means if you have the cash or other liquid assets to finance the expansion of your business, you'll have to tap into those funds first -- but not to the point where you're going to suffer financially, Dwyer says.
"They are reasonable," he says. "The SBA doesn't want to to drain all of your assets, because they want you to have some support as you go along."
You'll also likely need to back the loan with collateral: business or personal assets, such as equipment, inventory, or a home, that can be sold by the lender if you default. Can't provide collateral? Consider unsecured business loans, which are granted mainly based on the strength of your business.
3. You have poor credit, but bankruptcy may not be a dealbreaker
The SBA doesn't have a minimum personal credit requirement, but its lenders still expect good to excellent credit. And yet, you may find a past bankruptcy won't tank the deal -- as long as you have a good explanation for it.
Most lenders will want to see excellent credit (720 or higher), as it shows the borrower has a history of paying his or her bills on time. The exact credit requirements, however, will depend on each lender, and it may still be possible to get an SBA 7(a) if you've gone through a bankruptcy in the past, says Rob Wilson, chief executive of C7a, a non-bank lender based in Maine that provides SBA 7(a) loans. But you'll have to have a good explanation for it.
"We see a lot of small-business borrowers who have adverse events both on personal and business credit histories," Wilson says.
"Maybe we see short sales on houses. Some industries, we see people who have gone through bankruptcy," he says. "Our point of view is, as long as there is a plausible explanation for that, and people have acted responsibly and in good faith, then that's not necessarily an impediment to being a borrower."
Borrowers with poor credit or who can't assuage lender misgivings over a bankruptcy can also try business loans for bad credit.
4. You defaulted on a student loan
Are you late on your government-guaranteed student loan payments or on a Federal Housing Administration loan?
If so, don't bother applying for an SBA 7(a) loan.
Borrowers must be current on all government loans to qualify for SBA loans, and past defaulted government loans can disqualify borrowers, says Sean O'Malley, co-founder of SmartBiz, an online lender providing SBA loans.
"The SBA takes into account defaults on federally backed student loans, as well as government backed mortgages," O'Malley says.
5. Your past may be flawed, but teenage hijinks may be OK
The SBA requires your business and all its principals to show "good character," and a "statement of personal history" is required of each applicant so the SBA can make a decision about character and credit eligibility.
The SBA will ask you on this form if you've ever been charged with a crime, if you've been arrested in the last six months and whether the arrest was for something other than a minor vehicle violation.
"Basically," Dwyer notes, "if something pops up on your background, it will be a hindrance."
An arrest doesn't necessarily disqualify a small-business owner, O'Malley says, but having a criminal record delays the application process.
"Felonies take the longest to clear -- many months in some cases -- while minor misdemeanors can usually be resolved in a few weeks," he adds. "However, multiple misdemeanors are more difficult, and multiple felonies will disqualify a borrower entirely."
But if somehow you were able to get the principal's car on the roof of the high school, don't sweat it.
A prank you pulled as a teenager shouldn't be a big issue, Dwyer says.
"There are cases where someone did something a long time ago in college or high school that they wouldn't do 20 years later," Dwyer says. "In that case, you would take that case and go to the SBA directly and have them approve it for a dispensation."
To get more information about funding options and compare them for your small business, visit NerdWallet's small-business loans tool page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet's Ask an Advisor page.