Skim through an issue of Forbes, Inc. Magazine, or the Wall Street Journal, and you’re bound to come across an article or two detailing the latest hot startups preparing for rounds of Venture Capital funding. Flip to an episode of Shark Tank. and you’ll see business owners pitching for a chance at hundreds of thousands (if not millions) of dollars in capital.
We hear all the time about the various ways startups or small businesses can apply for big sums of financing. But what if your expenses aren’t quite so high dollar?
According to the U.S. Small Business Administration, the median size of a small business bank loan in the U.S. is between $130,000 and $140,000. with SBA-guaranteed loans averaging $371,000.
By contrast, businesses requiring less than $50,000 in funding often have a much harder time qualifying for traditional bank loans, because the loan size is too small to be worth servicing for the lender. From the lender’s point of view, taking on these low-principal loans simply isn’t profitable.
All the same, for a first-time entrepreneur with a limited business model, personal savings only go so far. Coming up with thousands of dollars in capital can become a daunting barrier between you and the next level of business development.
Responding to this challenge, in 1992, the Small Business Administration launched its microloan program—partnering with intermediary nonprofit lenders to help borrowers launch or grow successful businesses. And in addition to the SBA-backed program, a growing number of microfinance institutions have emerged across the U.S. in the last several years to meet the increasing demand for these smaller loans.
But just what is a microloan, how does it work, and who can qualify to receive one? We’re diving deep into the macro on microloans, investigating everything you need to know before pursuing this smaller lending option for your small business dreams.
What are Microloans?
Microloans are typically defined as very small, short-term loans with a low-interest rate, extended to self-employed individuals, startups with very low capital requirements, or small businesses with only a few employees.
Typically, microfinance organizations offer loans between $500 and $50,000, with SBA-backed microloans averaging around $13,000 each. They are designed for businesses who have never before received a bank loan, as well as those who have low or no business credit history.
In other parts of the world, microloans are used as a solution for funding impoverished borrowers in underdeveloped countries. In those areas, the system of lending in small amounts has successfully encouraged entrepreneurship and economic growth for developing nations. Collectively, more than 74 million borrowers worldwide have obtained over $38 million in loans from microfinance institutions ( according to the 2009 Microfinance Information Exchange study ).
Within the United States, the Small Business Administration and other nonprofit and for-profit lenders have been establishing themselves for over a decade as a solution to the growing demand for smaller loan values.
Why Apply for a Microloan?
Traditional banks may be reluctant to approve small quantity loans, especially from new businesses with limited operating history. And with interest rates in the realm of 22% APR, credit cards can quickly bankrupt a new business.
If you have a relatively new startup business with funding needs too small to be serviced by a traditional bank loan but too high to rely on a business credit card, a microloan may be a great borrowing alternative for your company. SBA-backed microloans can be especially useful to first generation entrepreneurs who may benefit from the intermediary lender’s business expertise and training programs.
Who is Eligible for Microloans?
Although exact eligibility standards vary between lending institutions, technically almost any registered business can qualify for a microloan. In fact, microloans are particularly recommended for small startups with limited capital requirements and little to no revenue history. Some lending institutions even give priority to minority business owners, women, and low income applicants in an effort to encourage entrepreneurship among these groups.
Qualifying for a Microloan
Fortunately for small business owners, the standards needed to qualify for a microloan are typically much less stringent than for other types of business loans at higher borrowing amounts. Still, there are several steps you can take to put yourself in the best possible position to qualify for a great microloan with the lowest possible interest rate.
1. Finalize Your Business Plan
Microfinance lenders will look to your business plan to determine the strength of your business model, decide whether you are serious about growing your business, and ultimately decide whether you qualify for a microloan.
Essentially, your business plan details the goal of your business, how your business makes money, what stakeholders, suppliers, and other sources you rely on to make your business function, and how you will reach customers for your business. It may sound complicated, but really, this is simply a formal process of writing out a lot of information that likely is already in your head.
Not only is formulating a written business plan an important exercise for the organizational health of your business—this document is also incredibly important in the loan approval process.
If you haven’t yet developed a written business plan, do so immediately. If you’re not sure how to write a business plan. check out a simple plan builder like LivePlan. or follow one of many free step-by-step guides online.
2. Clean Up Your Credit Report
Compared with other small business loan products, the pressure for perfect personal and business credit when applying for a microloan isn’t as great. Because of the smaller principal amount, microloans are seen as a great “starter” loan for brand new businesses with no credit history, or even for businesses bouncing back from bankruptcy.
Nevertheless, for your best chance at loan approval—and to qualify for the best possible interest rates—it’s worth the time and effort to make sure your personal and business credit reports are in top shape.
Before you apply for a microloan, pull your personal credit report and score from all three major credit reporting bureaus— TransUnion. Experian. and Equifax —to make sure all the information is correct. Check for accounts that may have been linked to your name by mistake, delinquent balances that you’ve already taken care of…anything that could bring your credit score down and mislead lenders about your true creditworthiness.
You’ll want to do the same for your business credit report through the business credit reporting agency of record, Dun & Bradstreet. If you have a brand new business and haven’t taken out credit (such as a business credit card) before, don’t be surprised if your business credit report is blank! That’s common for microloan applicants, so don’t worry too much about it. For now, you’re just making sure that the credit history attached to your business is accurate.
If you do encounter an error, reach out to the credit bureau in writing to solve the problem. Unfortunately, the process of getting an error on your credit report fixed can be long and tedious—but if you’re serious about qualifying for business financing now and in the future, the benefits are worth the trouble.
3. Consider Offering Collateral or a Personal Guarantee
Because microloans are routinely serviced to businesses with little credit history, and to business owners with no credit or poor credit, you may be asked to offer collateral or a personal guarantee in order to qualify for a microloan.
In the case of collateral, the lender will have you legally guarantee some valuable personal property, such as your home, as repayment in the event that you default on your microloan payments. If you don’t own a home or other property equal in value to the loan amount, you could be asked to sign a personal guarantee, which would allow the lender to seize any of your current or future personal savings, investments, or other assets as repayment for the loan.
The good news here for microloan borrowers is that even if you do default on your loan payments, lenders can only collect up to the amount of principal plus interest owed on the microloan. Because you’re borrowing a relatively small amount of capital, the implications of offering collateral or signing a personal guarantee aren’t as overwhelming as for an entrepreneur signing a personal guarantee for hundreds of thousands of dollars.
Even so, it’s essential that you fully understand the terms of the agreement before you sign over collateral or a personal guarantee. Particularly if you’re financing a business with multiple owners, the terms can be confusing. If you’re unsure, have an independent attorney look over the agreement with you before you sign.
4. Be Prepared to Invest Some of Your Own Money Into the Business
If you’re seeking a microloan, it’s likely because you don’t have enough savings to fully fund your business on your own. All the same, lenders want to see your earnest effort and intention to invest your own time, effort, and money into your business venture.
In particular, the distribution of SBA-backed microloan funds is in many ways need-based, so your personal savings and income level as a business owner can impact your ability to qualify for a microloan.
When you apply for a microloan, certain intermediary lenders may request your recent income tax returns, then compare that information to your company balance sheet to see what proportion of your income you have invested into your business.
The SBA Microloan Program
In 1992, the U.S. Small Business Administration launched an effort to encourage the economic development of entrepreneurs in underserved communities through what became the SBA Microloan Program.
Through its program, the SBA partnered with local intermediary nonprofit organizations to fund
small loans of less than $50,000 that were not otherwise being serviced by traditional banks.
The Role of the SBA
It’s important to clarify that although funds for SBA-backed microloans do come from the U.S. Small Business Administration, the government agency itself does not actually service loans directly to borrowers. Rather, the SBA distributes microloan funds to designated community-based nonprofit organizations with experience in business management and lending assistance who serve as the intermediary lenders.
When you go to apply for a loan through the SBA Microloan Program, you’ll need to seek out a local intermediary lending organization through which to apply for your loan.
The Role of Intermediary Lenders
In addition to administering these microloans, these intermediaries also provide management and technical assistance to help borrowers launch or grow successful businesses. A list of participating microloan intermediary lenders around the country is available on the SBA website.
Lending and credit requirements for individual microloans are at the discretion of each intermediary lender, who may require the business owner’s personal guarantee and/or some type of collateral. Though not expressly required by the SBA, some intermediaries give preference to businesses that are minority or woman-owned, or businesses operating in financially distressed communities.
Financial Nuts and Bolts of the SBA Microloan Program
Although the financial specifics of microloans within the SBA program can vary between different intermediary providers, there are certain guidelines provided by the SBA at large that can help you know what to expect when you go to take out a microloan through one of the Small Business Administration’s intermediaries.
The maximum borrowing amount for a SBA-backed microloan is $50,000, but average borrowing amounts are closer to $13,000. Some intermediaries offer loans as little as $500. As with any loan, your borrowing amount would be negotiated directly with the intermediary lender and would depend on the intended use of the financing.
The only specific requirement of the Small Business Administration is that microloans may carry a maximum term of 6 years. Beyond that stipulation, the term of a microloan is similar to any traditional loan—it can vary based on several factors, such as the loan amount, the needs of the borrower, planned use of the funds, and the standards of the intermediary lender.
In general, interest rates for microloans funded by the SBA fall between 8 and 13 percent. However, these rates can vary between intermediary lenders and depend on costs from the U.S. Treasury.
Ways to Use Microloan Program Funds
One of the benefits of a microloan is that it can be used toward a wide variety of business needs. Here are the various ways you may choose to use microloan funds for your business.
If you simply need cash on hand to hire employees or pay for regular expenses, or pay for basic expenses, acquiring working capital through a microloan can make a big difference.
Inventory or Supplies
Use microloan funds to purchase inventory for your retail business or for production supplies and materials. This is a great way for very small businesses to scale their product offering by having the upfront funds to add inventory to their collection.
Furniture or Fixtures
Retail establishments or restaurants can use microloan funds to purchase furniture, decor, or other fixtures for their retail space. Businesses can even use these funds to purchase office furniture or fixtures. However, keep in mind that you will need to make repayments on these funds, so it’s in your best interest to avoid using microloan funds on aesthetic improvements that won’t impact your customer experience or your bottom line.
Machinery or Equipment
Manufacturing companies, restaurants or bakeries needing kitchen equipment, or other businesses in need of computers or IT equipment can use microloans to purchase this large scale equipment. In some cases, you may even be able to use the equipment itself as collateral on your microloan to avoid signing a personal guarantee.
The two notable exceptions to using SBA-backed microloans are purchasing real estate or paying existing debts on a previous loan. But, for the most part, any other business need can be considered a fair use of the funding.
How to Apply for a Microloan
Are you convinced that a Small Business Administration-sponsored microloan is the right choice for your business need? Great! Follow these steps to begin your loan application:
1. Find an Intermediary Microloan Provider
To apply for a microloan, contact an approved intermediary provider in your community. While there are intermediary providers available all over the country, the SBA recommends choosing a provider in your local community to take advantage of the business development opportunities available to microloan borrowers.
2. Complete Any Business Development Requirements
Before considering your application, certain intermediary microloan providers may require you to fulfill business training requirements before they will consider your application. These requirements are meant to educate you about business and financial management, and improve your likelihood of succeeding as a business owner.
Because microloan approvals can be a subjective process that varies among intermediary lenders, your level of participation in these exercises can significantly impact your ability to obtain funding from a particular intermediary lender.
3. Submit Your Application
Once you’ve completed all the steps above, you are ready to submit your application to the intermediary microloan provider. While the application itself is typically a fairly quick process, the exact components of every application vary between intermediaries, so contact your loan officer shortly after submitting to confirm that your application is complete.
After that, though, be prepared to wait awhile before being approved or denied for your microloan. Because your application has to be approved by both the intermediary provider and the SBA, average approval times hover around four weeks and can sometimes take much longer. Be patient and give your intermediary lender plenty of time to review your application before you make any attempts at checking in.
Alternative Microfinance Providers
Although the Small Business Administration is the primary source of microloan funds throughout the U.S. it is by no means the only game in town. Some microfinance institutions receive funds from state or local governments, philanthropies, and even peer-to-peer and crowdfunding models.
If you haven’t qualified for a microloan through an SBA intermediary, or don’t have a local SBA intermediary in your area, consider some of these alternative microfinance providers.
Accion is a global nonprofit organization based in Brooklyn, New York, with a mission to give people worldwide the financial tools they need to grow healthy businesses. The domestic arm of Accion, Accion USA, is the country’s largest network of local microlending organizations. Through its offices in nearly 30 cities across the country, Accion has provided nearly 50,000 loans, totaling over $450 million (as of January 2014).
Microloans obtained through Accion work very similarly to SBA-sponsored microloans, though funds are obtained through a wide variety of sources. The company maintains corporate partnerships with Citibank, Sam’s Club, and Samuel Adams Brewing (to name a few) and remains committed to providing entrepreneurship education to its borrowers and throughout the communities served by its national network.
Unlike other microfinance organizations, TrustLeaf is not funded by a non-profit, a government agency, or any other third party organization. Microloans obtained through TrustLeaf are privately crowdsourced through the applicant’s friends and family.
Through TrustLeaf, business owners can set up a campaign, providing all the necessary information about their business. They set their own loan terms, interest rates, monthly payments, and other repayment requirements. Once finalized, the borrower can make the site available to friends and family, who can opt to lend them small amounts through the site platform.
The TrustLeaf model is in many ways a hybrid of a traditional microloan and good old fashioned “friends and family financing” for a small business. The benefit is that, unlike with typical paper napkin agreements with friends and family, the loan’s terms are clearly stipulated from the beginning for everyone to see. And if one or a few family members can’t fund the loan on their own, the borrower can crowdfund the loan through various contacts who may or may not know each other.
PayPal Working Capital
Online sellers and customers alike recognize PayPal as the world’s leading online payment processing service. The company has more than 152 million active accounts and processes more than nine million payments per day on average. In 2013, the company launched PayPal Working Capital, offering microloans to a select number of PayPal sellers, ranging in amount from $5,000 to $60,000.
For retailers and seasonal businesses with uneven or unpredictable sales patterns, PayPal Working Capital is an ideal solution because instead of the traditional monthly payment model, loan repayments are based on a fixed percentage of total monthly business sales. And because PayPal’s deciding factor in approving lines of credit is the applicant’s sales history within its namesake payment service, no credit check is performed on the business or the owners.
Choosing the Right Microloan For Your Business
Regardless of what organization you choose to service your microfinancing needs, the benefit comes from knowing that you’ll have the cash on hand to grow your company and make your business dreams a reality.
Ultimately, the decision comes down to how a particular lender’s terms match with your qualifications, financial, and business development needs. Take the time to explore your options, research the costs of each, and prepare a strong application for the organization you choose. The steps to microfinancing may feel tedious now, but they are a pathway to the business goals you’ve been waiting to pursue!
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