A quick guide to microloans
When businesses need funding, they often turn to small business loans. While a traditional bank loan, like a term loan or equipment financing, can help with funding large-scale growth projects, there are other scenarios where a microloan may be a better fit. Here’s what you should know about how to get a microloan for small businesses and more about this type of business financing.
What is a microloan?
Microloans are small business loans that typically range from $500 to $50,000. These loans can be used by established businesses, but they are often favored by newer businesses that lack the revenue or credit history required for traditional forms of financing.
A microloan is generally designed for meeting smaller, short-term capital needs. These loans can be used by self-employed entrepreneurs, business owners seeking a low interest rate, or small businesses with only a few employees. Some microloan lenders specifically focus on serving low-income communities and underserved groups that have historically faced challenges in obtaining business financing, such as minorities and women.
How does microlending work?
Microloans follow the same general principles as other loans. You borrow a lump sum and repay that amount over time, with interest. Payments may be made weekly, biweekly, or monthly, depending on the loan provider.
- New businesses are eligible. The average cost to start a business is around $30,000, but many startups and new businesses do not qualify for a traditional bank loan. Why? Because lenders view them as riskier borrowers since they have little to no business history and no proven success. But these entrepreneurs still need capital to get their venture off the ground. Microloans for small businesses and other organizations that fall into this category could be just the ticket.
- They can help businesses build credit. A microloan can allow new businesses to establish and build credit when they make on-time payments regularly.
- Accessible for underserved entrepreneurs: Microloans can be a good option for business owners who have traditionally been underserved, such as minorities, women, veterans, and people with disabilities.
- Low borrowing limits. The $50,000 borrowing cap may not be high enough for some businesses — and that’s assuming you can get the full $50,000. For example, with the SBA Microloan program, you can only borrow above $20,000 if you’ve exhausted all financing options with comparable interest rates and if you’re able to demonstrate that you’re likely to be successful. In fact, intermediaries — the financial institutions given the authority by the SBA to issue new microloans for small businesses — are instructed to maintain a portfolio with an average loan size of no more than $15,000.
- A personal guarantee or collateral may be required. Since microloans are often used by businesses with limited credit history, a personal guarantee or collateral may be required — which means your assets could be at risk if you default on the loan.
- Longer process. Depending on the lender, time to funding could take as long as 60 to 90 days — which is significantly longer than online marketplaces in which you can get funding in as little as 10 days.
Microloans for small businesses: what are your options?
There are two main microloan providers: the Small Business Administration and alternative financing companies.
Small Business Administration (SBA) Microloan program
Through its Microloan program, the SBA gives direct loans and grants to intermediaries and non-profit groups, which then lend money to non-profit childcare centers and small businesses, including minority, veteran, and women-owned businesses. The program offers microloans of up to $50,000, with the average microloan coming in at just under $14,000 in 2017. The maximum loan term for an SBA Microloan is six years.
SBA microloans can be used for startup expenses and working capital needs, as well as for purchasing inventory or supplies, furniture or fixtures, and machinery or equipment. However, using funds to pay off existing debt or to purchase real estate is not permitted
If you’re wondering how to get a microloan with the Small Business Administration, they have certain general eligibility requirements you’ll need to meet. Those include:
- Being an officially registered, for-profit business
- Being physically located and operated in the United States
- Having your own time and money invested in the business prior to seeking funding
- Having exhausted other financing options
- Having a clear financial history — free of bankruptcies, defaults, or debts owed to the U.S. government
There’s also a size standard requirement for microloans. This is based on the number of employees or annual receipts your business has. Generally, to be considered a small business by the SBA, you must have fewer than 500 employees, less than $7.5 million in average annual revenue, and a net worth under $15 million.
While intermediaries determine what interest rate to charge borrowers based on a variety of factors including loan amount and planned use of funds, the SBA caps the maximum rate that can be charged — the cost of funds to the intermediary lender plus 7.75% to 8.50%, depending on the loan size. Interest rates typically range from 6.5% to 13%, averaging 7.5% in 2017.
The SBA doesn’t charge any fees for microloans. However, the intermediary lenders the SBA work with to administer and manage microloans for small businesses may tack on out-of-pocket closing expenses including:
- Origination fee (up to 2% of the loan amount)
- Application fees
- Credit check fees
- Loan closing costs
These intermediaries also have their own credit and eligibility requirements which you must meet to qualify.
Alternative microlending programs
In addition to the SBA, you can find microloans from a number of institutions, including nonprofit organizations like Kiva and Accion. Each one has individual guidelines on how to get a microloan, who they lend to, how much they lend, approval requirements for loans, and repayment terms.
With some microlenders, like Accion, loan funding comes from the organization itself. Others, however, are based on a peer-to-peer lending structure. Kiva, for example, connects entrepreneurs with individual lenders through its platform to facilitate the lending process, but it doesn’t actually fund microloans for small businesses or other types of organizations.
Some microlenders focus exclusively on providing financing opportunities to minority entrepreneurs. For example, the Business Center for New Americans (BCNA) offers microloans for New York City-based small businesses owned by immigrants and refugees. These loans range from $500 to $50,000, with repayment terms lasting six months to three years.
The Minority and Women Revolving Loan Trust Fund is another New York-based program whose goal is helping women and minority entrepreneurs secure funding to grow their businesses. Qualified borrowers can get working capital microloans of up to $35,000 or fixed asset microloans of up to $50,000.
These types of programs are designed to make it easier for minority small business owners to secure capital.
Who are they for, and what types of businesses use microloans?
Microloans can be used by virtually any business, but they may be more appealing for:
- Businesses that need smaller amounts of capital
- Business owners with a limited or less-than-excellent credit history
- Businesses seeking a way to build credit so they can graduate to a larger loan later
- Startups and first-time entrepreneurs
- Business owners who haven’t been able to get approved for a traditional bank loan
- Sole proprietors and freelancers
- Low-income borrowers and minorities
Microloans are designed to help businesses grow. What you might specifically use them for depends largely on your short-term needs and the type of business you have. Below are a few common examples of how a business owner may put a microloan to work:
Common use cases for business microloans
Restaurant/food service microloans
Whether you run a small bistro or you’re hoping to open a popup bakery, there are certain supplies and equipment you’ll need to have on hand to keep things running smoothly. A microloan can help you pay for them while preserving your cash reserves.
Common use cases for restaurant microloans:
- Ovens and ranges
- Prep tables and coolers
- Cappuccino and espresso machines
- Linens, flatware, and glassware
- Dining tables, chairs, and/or booths
- Light fixtures and decor
- Point-of-sale payment systems
- Credit card processors
- Advertising and marketing
- Employee uniforms
- Cooking utensils, pots, and pans
Salon and spa microloans
Similar to owning a restaurant or bakery, there are certain pieces of equipment that your salon or spa simply can’t operate without. If you’ve already found a space for your salon, the next step is outfitting it — and you can explore how to get a microloan to purchase the essentials.
Common use cases for a spa/salon microloan:
- Salon stations, styling chairs, and mirrors
- Hood dryers and handheld dryers
- Massage tables
- Manicure and pedicure stations
- Sanitation stations and drying lamps
- Capes and towels
- Reception desk
Yoga studio microloans
A yoga studio is a place to relax and leave worries at the door, but that may be easier said than done if you’re stressed over finding capital to equip your studio. With a microloan, you can check off the most crucial purchases on your list.
Common use cases for a yoga studio microloan:
- Mats and blocks
- Meditation pillows
- Hiring and training instructors
- Sound systems
- Installing steam or shower rooms
How to prepare to get a microloan
If you think a microloan might be right for your business, there are a few things you’ll want to do before applying for one. First up: making sure you understand each lender’s eligibility requirements.
Every microlender has different qualifications they expect borrowers to meet. In general, you can expect a microlender to consider:
- Your time in business
- The type of business you have
- Your business revenue
- Your personal credit score
Ahead of applying for a microloan, it’s wise to review your credit report and score. This can give you an idea of how likely you are to qualify.
It’s also important to consider whether a microlender makes loans to any type of business or if they target certain industries or segments of business owners. For instance, a microlender may only lend to businesses that operate in a specific geographic area or industry.
One step you shouldn’t skip when applying for a microloan is preparing your business plan. You should be prepared to explain how your business makes money, who your business serves, your goals, and the action steps you’ll take to achieve them.
Typical microloan terms
Loan terms, including the annual percentage rate, fees, borrowing limits, and repayment period are determined by the lender. Microloans for small businesses and other organizations can carry interest rates ranging from 5% to 20%, with repayment terms lasting as little as three months or as long as seven years.
Remember, with SBA microloans the maximum time you can take to repay a loan is six years.
Term loans from Funding Circle
As a business owner, you might be wearing twelve different hats on any given day. Funding Circle is here to deliver the business financing options you need quickly, so you can focus on what’s important — growing your business. And with loan amounts ranging from $25,000 to $500,000, terms from 6 months to 5 years, and rates starting at just 4.99%, we aim to make it as flexible and affordable as possible.
What can I use my business loan for?
Popular uses for a Funding Circle loan include expanding to a new location, purchasing equipment or inventory, and hiring staff.
How long does it take to apply for financing through Funding Circle?
Funding Circle’s application process is quick, easy, and transparent. You can apply for a loan in 10 minutes and get a decision in as little as 24 hours after document submission.
Do you offer microloans for startups?
We like to support all kinds of entrepreneurs, but our focus right now is on helping established small businesses grow and thrive. To qualify for a loan on our marketplace, your company has to have been in business for at least two years.