Microloans: Small Loans for Small Businesses

Microloans and microcredit are a form of business funding that many people often associate with developing countries and particularly impoverished and disenfranchised populations.

That may be due to the fact that microlending is generally considered to have originated in Bangladesh, where Grameen Bank founder Muhammed Yunnus began giving small loans to the rural poor decades ago.

Such microloans, as Yunnus envisioned them, have many noble goals, including providing an alternative to loan sharks, supporting entrepreneurship, alleviating poverty, empowering women, and by extension, uplifting entire communities. All of which led to Yunnus winning the Nobel Prize in 2006 and the concept as a whole spreading around the world.

The moral of the story is that these types of loans are also available in the United States, for small businesses that may not have a substantial credit history or that are perhaps owned by women or minorities – populations that typically do not have as much access to financing.

In fiscal year 2016, for instance, the U.S. Small Business Administration’s Microloan Program provided 4,472 microloans totaling more than $60 million, and about 40% of the loans went to minority-owned small businesses and nearly 40% went to women-owned businesses.

In addition, more than 40% of all of the microloans closed under the SBA program during 2016 went to small businesses that were just two years old or younger.

“Microloans are more targeted to people who have trouble accessing traditional credit,” explains Joyce A. Klein, director of the Aspen Institute’s Microenterprise Fund for Innovation, Effectiveness, Learning and Dissemination (FIELD). “Microlenders tend to be more flexible then banks are. If someone doesn’t have great credit, if they have thin credit, not that they haven’t performed well, but rather don’t have an extensive credit history, then microlenders are more willing to look at other factors, such as the cash flow of the business.”

If your business fits this description, or if all you’re seeking is a small infusion of cash to carry your business forward, then read on for some of the key details about microloans.

How much money can you borrow using a microloan? The microloan borrowing limit is $50,000, but the average loan size is around $13,000, according to SBA.

What can the money be used for? Businesses may use the funds as working capital or to buy needed inventory, supplies, furniture, fixtures, machinery, or equipment.

Typical repayment terms: Loans closed under the SBA Microloan Program cannot exceed six years, and generally carry interest rates below 10%, according to Jamie Davenport, the SBA’s acting director of the Office of Economic Opportunity/Capital Access.

The nationwide network of SBA program lenders however, are just one example — there are many other nonprofit microloan lenders out there. “Most have traditional loan terms,” says Klein. “But if you were comparing microloans to larger, long-term business loans, the (microloan) rates may seem expensive.”

That’s because, according to Klein, the business borrowing the money may be relatively young, or possesses weaker credit or weaker collateral, which makes the loan riskier in some ways.

Documentation Required to Obtain a Microloan

The SBA suggests having a business plan prepared. If that sounds intimidating, the good news is that the SBA provides resources such as Small Business Development Centers and Women’s Business Centers that can help with writing a business plan, says Davenport.

In addition, microlenders will typically want to look at some financial information from the business, says Klein, of the Aspen Institute. This may be in the form of a businesses’ tax returns, or the businesses’ bank statements.

And depending on the lender, still more financial information may be requested.

“Different microlenders use different criteria,” Klein explains. “They typically look at someone’s personal credit report. But one of the features of microlenders is that they are more flexible in terms of how they look at someone’s credit then a traditional lender, but they still look at personal credit.”

“Like many traditional lenders, they’re trying to get a sense of what the financials of the business looks like,” Klein adds.

How to Choose a Microlender

Through the SBA Microloan Program there are specifically designated intermediary lenders across the country. These lenders are nonprofit organizations that have experience in lending and in providing small businesses with technical assistance.

The SBA website provides a directory of its participating lenders, which are located all across the country, from Alabama and Arkansas to California, Tennessee, and Vermont.

“One way for small businesses to find an SBA lender in their area is to use SBA’s LINC tool,” says Davenport. “A business answers some simple questions about their business and their financing needs, and then we instantly connect or match that small business with lenders in their community.”

The upshot of using an SBA microlender is that in addition to money, the lender is required to provide the business with technical assistance and guidance, such as free management training.

“This combination of free training and reasonably priced capital gives small businesses the best chance to grow and be successful,” says Davenport.

But the SBA program is just one option — there are many other microlenders out there as well. Klein points to the nonprofit Justine Petersen in St. Louis, noting that the organization is doing interesting work helping small businesses build credit, as well as providing a source for funding.

The Opportunity Fund is another well-known and respected name in the industry, and is California’s largest microlender.

And one last organization worth noting, Kiva, is an online nonprofit organization that connects microlenders and borrowers. To date, a total of $936.5 million has been lent through the site, in 82 countries. About 1.6 million borrowers have accessed funding through Kiva and the repayment rate has been 97.1%.

One caveat with Kiva, however: In order to receive an interest-free loan through the organization, borrowers first must have friends and family members contribute to their venture. This helps establish the creditworthiness of the borrower.

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