For the lucky few that received government business loans, the affordability of their interest rates is unmatched. Yet, SBA loans are far from the ideal funding option for all entrepreneurs. To help you decide if government business financing is right for you, this post will weigh its pros and cons. Also, for those who decide government business loans aren’t the right fit, we’ll highlight several alternatives worth considering.
The Pros and Cons of a Government Small Business LoanBefore you start the process of applying for federal government financial assistance or program loans, you should take time to weigh the pros and cons. Although the SBA offers numerous loan and grant programs, such as the Paycheck Protection Program and the Economic Injury Disaster Loan, they may not be the right fit for your business. Keep reading to determine if a government small business loan is the best financing option for your business in the short and long term.
The Pros of Government Business Loans
1. Competitive interest ratesFor most borrowers, the affordability of government small business loans is their greatest benefit. You typically can’t find comparably sized loans with rates as low as they are on a government business loan. This is because government loans are guaranteed by the U.S. government, which makes them far less risky for lenders to originate.
2. Large loan amounts available for riskier borrowersTo be eligible for government business financing from the SBA, you need to have exhausted all other business financing options. The SBA has this requirement because government business loans are meant for borrowers who couldn’t otherwise obtain financing. Usually, banks would reject these kinds of borrowers. However, with a government loan, the bank’s risk is greatly reduced, so they’re willing to lend larger amounts to risky borrowers.
3. Relatively low down payment requirementsLarge down payment requirements are one of the many ways business financing lenders reduce their downside risk. Large down payments not only reduce the size of the business loan but they also put more skin in the game for borrowers. Both these effects—lower loan amounts and more skin in the game—help business lenders mitigate risk. However, as mentioned before, government backing on a loan mitigates risk even better than a large down payment. Therefore, business funding lenders don’t need to require a large down payment on government business loans.
The Cons of Government Business Loans
1. Can only be used for certain business expensesThe government has dozens of small business loan programs. Certain programs have specific requirements as to how the funds from the loans must be spent. For example, the government’s 504 Loan program is designed exclusively for financing “major fixed assets that promote business growth and job creation.” Certain government business loans have less restrictive use of funds rules. However, even those can be restrictive compared to a private small business loan.
2. Highly competitive loan application processThe affordability and availability of government business financing make it extremely popular. As a result, the application process is competitive, and it can be tough to get approved. The SBA has rigorous standards for your credit score, time in business, financial performance, and more. Not only that, applying for a loan requires plenty of paperwork. In some cases, government business loan funds are limited, making the application process even more selective. For example, after the COVID-19 pandemic, many small businesses were left in need of additional funding to keep their businesses operational. Due to this, the SBA had to limit PPP loan amounts, meaning not all applicants were provided with funds.
3. Personal guarantees are requiredAll government business loans require a personal guarantee. When you sign a personal guarantee, that means you agree that you are personally responsible for repaying the small business loan. If you’re unable to pay back the loan, the business financing lender can come after your personal assets to recoup their losses. These assets can include your home, other real estate, vehicles, business equipment, valuable inventory, and other expensive collateral. On loans where a personal guarantee isn’t required, as is the case with some private loans, your personal assets have greater protection. If you're concerned about losing valuable collateral, you'll be better off pursuing an unsecured business loan.
Business Financing Alternatives to ConsiderIf government business financing doesn't sound right for you, don’t worry—you have alternatives. Even if your credit history is less than stellar, alternative lenders provide a variety of options that may be a fit for you. Financing alternatives you should consider include:
- Business lines of credit
- Invoice factoring
- Franchise startup loan
- Equipment loans
- Merchant cash advances
- Online loans
Is a Government Business Loan Right for You?A government business loan may be a good fit if you:
- Meet the eligibility criteria
- Have the time to apply
- Can comply with the use of funds restrictions.
- Are prepared to have your loan application denied.
- Are willing to sign a personal guarantee.