Participating lenders offer SBA 7(a) loans with a partial guarantee from the U.S. Small Business Administration. Conversely, conventional business loans are not backed by the SBA; the individual lender offers them according to their products, underwriting standards, and terms. This doesn't make one option universally better. The right choice depends on what the business needs the money to accomplish, how established it is, how much cash it wants to preserve, how quickly it may be able to repay the debt, and what kind of flexibility it needs.
If you’re looking into obtaining financing for your small business, knowing how to compare SBA 7(a) loans with conventional loans may be an important part of the process.
Start with what you need the money to do
Choosing the right type of loan for your small business begins with deciding what you need your loan proceeds to accomplish. If you need to purchase equipment, refinance debt, fund working capital, or acquire another company, you may have different needs than a business that is looking for a relatively small amount of short-term capital. The SBA has a list of allowable uses for SBA loan funds. This list covers a wide range of allowable purposes, including working capital, equipment purchases, changes in ownership, and more.
Conventional loans may also be appropriate for those needs, but they may be governed by the lender's product structure and underwriting policies. SBA loans are largely governed by the Small Business Administration.
Consider how established the business is
Your company’s history may impact the type of loan you need because lenders must evaluate the business’s ability to repay debt. An established business may have years of financial statements, established revenue patterns, existing banking relationships, and a clearer record of how it manages expenses and debt.
Since SBA loans are partially guaranteed by the federal government, they may be able to help eligible borrowers who would not otherwise qualify.
SBA 7(a) eligibility typically includes several requirements. The business generally must operate for profit in the United States, meet SBA size standards, operate in an eligible industry, be creditworthy, and demonstrate a reasonable ability to repay.
Conventional lenders set their own eligibility and underwriting requirements, so there isn't one universal standard for every conventional business loan. A business owner's financial history, credit profile, cash flow, and existing debt as well as the purpose of the loan may all affect the decision.
Look at the cash you want to keep in the business
You should also consider how much cash you want to keep in your business. Using a large portion of your available cash to fund an investment may leave you with less liquidity, which is why obtaining a loan should be part of a larger financing strategy.
Borrowing may allow an owner to spread the cost of an investment over time rather than paying for the entire project from existing cash. However, preserving cash by itself isn't a reason to borrow. The financing still creates a repayment obligation, and you need to weigh the cost of that financing against the value of maintaining liquidity.
Think about the repayment horizon
It's also wise to think about the life of the investment. For instance, a business purchasing a new piece of equipment that should support operations for many years may have different repayment needs than a company trying to cover a temporary gap in working capital.
SBA loans typically have longer repayment periods than conventional loans. For a small business owner, being able to space the repayment of the loan out over a longer period of time is a powerful incentive. This may allow you to obtain financing while minimizing the monthly impact of repaying the loan on your cash flow.
Consider how the payment fits into projected cash flow, whether the rate is fixed or variable, whether there is a balloon payment or other structural feature, and how much interest the business must pay over the life of the loan. A longer repayment period may reduce the size of individual payments, but it may also increase the total cost of borrowing.
Compare more than the interest rate
The interest rate is an important part of the borrowing decision, but it shouldn't be the only number you consider when comparing your loan options. Fees, repayment period, payment structure, collateral requirements, and other costs may change the overall economics of a loan.
Interest rates on SBA 7(a) loans may be more competitive because of the backing provided by the government. However, interest rates are only one piece of the puzzle. Longer repayment windows help minimize the monthly cost of obtaining a loan, allowing business owners to lessen the impact on their company’s cash flow.
A conventional business loan may have a different rate and fee structure because it isn't subject to the SBA's policies. When comparing the two, look at the total borrowing cost and the value of the financing structure. In some cases, a loan with a somewhat higher rate may still make more sense if it provides a repayment structure or financing amount that better fits the business.
Take a closer look at collateral
Collateral may become an important part of the financing decision, particularly for larger loans. A lender may consider business assets, real estate, or other available collateral when evaluating a loan, although requirements vary by lender, loan type, and transaction. SBA loans often need some level of personal backing.
SBA guidance provides specific collateral requirements and policies that vary by loan type and amount. For example, SBA's rules for 7(a) small loans require lenders to follow their established collateral policies for similarly sized non-SBA commercial loans for loans above $50,000. Under those rules, they generally aren’t able to decline a loan solely because of inadequate collateral.
Conventional lenders may have their own collateral policies based on the size and structure of the loan and the risk associated with the transaction. If you're choosing a conventional loan, you should ask what assets will secure the loan, whether it requires a personal guarantee, and what happens if the business isn’t able to meet its obligations.
Make the decision based on the whole financing picture
Ultimately, the right loan type for your business depends on a wide range of factors. No matter what type of loan is right for your business, SmartBiz Bank® may be able to help. Find out if you pre-qualify today.
FAQs
What is the difference between an SBA 7(a) loan and a conventional business loan?
An SBA 7(a) loan is partially guaranteed by the SBA, while a conventional business loan is not guaranteed. The SBA 7(a) program has specific eligibility requirements, permitted uses, maximum loan amounts, interest-rate limits, and other program rules. Conventional loans are structured according to the individual lender's products and underwriting policies based on risk assessment.
Is an SBA 7(a) loan better than a conventional business loan?
Neither option is automatically better for every business. However, an SBA loan may be the right option if you need funding for one of the eligible uses outlined by the SBA. Since they’re backed by the federal government, they may provide more competitive rates and longer repayment terms. A conventional loan may be a better option when you need the funds faster or the intended use doesn’t align with what the SBA allows.
Do conventional business loans have lower interest rates than SBA loans?
Not necessarily. Conventional business loan rates vary by lender, borrower, loan type, market conditions, and other factors. SBA lenders often provide favorable terms since they’re exposed to less risk, as the loans are partially backed by the federal government.
What are the advantages of an SBA 7(a) loan?
One advantage of the SBA 7(a) program is the variety of eligible uses. Qualifying businesses may use 7(a) financing for working capital, real estate, equipment, certain debt refinancing, ownership changes, and other approved purposes. The SBA guarantee may also make it possible for participating lenders to provide financing under a structure designed specifically for small businesses. The partial guarantee provided by the SBA makes SBA 7(a) loans more accessible. It may also lead to more competitive rates.
When should a business consider a conventional loan?
A business may want to consider conventional financing when it has a specific borrowing need and a lender may offer a product that fits the business's financial position, intended use, and repayment capacity. This may include financing for equipment, working capital, or another business purpose, depending on the lender's products. Conventional financing may also be worth considering when the business has a strong financial profile, and the lender's terms may meet its needs without the additional requirements of an SBA-backed loan. Finally, conventional loans may pass through underwriting faster, which may provide quicker access to the funds you need for your company.
What factors should I compare when choosing a business loan?
Start by comparing the purpose of the financing, the amount available, and whether the loan structure fits the investment. Then, look at the interest rate, fees, repayment period, payment structure, collateral requirements, personal guarantees, and total borrowing cost. Consider how the payments fit into projected business cash flow. A loan that appears attractive based on its rate or monthly payment may not be the right choice if its structure doesn't match the business's needs.
