SBA vs. conventional loan: What you need to know

Many banks and credit unions offer business loans to established businesses. And while newer businesses may not qualify for a conventional term loan, they may qualify for alternative online lending.

For business owners who want to take advantage of low rates, a loan from the Small Business Administration (SBA) is a good option. While you will still need to apply through a lender, and the application process is very competitive, the SBA provides funding for businesses that have exhausted other options.

When looking for funding, you’ll want to consider both SBA loans and conventional business loans. Here’s what you need to know and how to determine which is best for your business.  

What’s the difference between an SBA loan and a conventional business loan?

A conventional loan is funded entirely by the lender. Most types of business loans are conventional loans. The interest rates, loan amounts and eligibility criteria vary widely between options. So do the types of lenders that offer them, with banks, credit unions, finance companies and online lenders all offering small business loans.

A variety of lenders also fund SBA loans, which are backed by the federal government through a guarantee. An SBA guarantee typically ranges from 50 to 90 percent of the loan amount up to $5 million, depending on the loan program. They are more competitive but tend to have lower rates than conventional business loans.

What is an SBA loan?

The SBA (Small Business Administration) is a government agency that partners with approved lenders to offer a variety of loans for businesses. With SBA loans, the SBA guarantees a portion of the funds to lower the lender’s risk, resulting in lower rates on average.

There are several types of SBA loans. For many businesses, the 7(a) loan gives access to working capital to cover various business expenses. The 504 program is similar, although its funds can only be used for equipment or commercial real estate. Both can be difficult to qualify for and are highly competitive — and half of the 7(a) loans funded in the 2023 fiscal year have gone to businesses that are over two years old.

While some loan options are available to startups, SBA loans are geared toward established businesses with strong revenue that have exhausted other funding options.

However, startups and younger businesses can benefit from the SBA microloan program. In the 2023 fiscal year, the program funded $87 million in microloans for over 5,500 small businesses, especially those owned by members of underserved communities.

While the maximum amount your business is eligible for is set at $50,000 — and the average microloan is only $13,000 — they can be extremely helpful for businesses that are early in their growth phase.

The SBA also offers the Community Advantage loan, another option for business owners who have historically lacked access to capital. This includes minorities, women and veterans. The SBA prioritizes minority groups in other loan programs as well. According to the SBA’s 2023 fiscal year microloan data, 35 percent of microloans went to Black-owned businesses, while 15 percent went to Latino-owned businesses.

Requirements of an SBA loan

There are four main requirements for an SBA loan: 

1. Your business must be for-profit
2. You must operate in the U.S.
3. Each business owner must have invested personal equity in the business
4. You must have exhausted other conventional loan options

Each business owner will have to meet eligibility criteria as well. The most common is a credit score requirement. The minimum will vary based on the lender you apply with, but a score of 670 is the usual minimum.

Your small business must meet SBA size standards, which includes being under a certain annual revenue or number of employees, depending on your industry. Other requirements will also depend on the type of loan you’re applying for, such as SBA Form 413.

Key aspects of an SBA loan

• Range of loan amounts: The SBA’s 7(a) Small loan provides business loans of up to $350,000, while the Standard 7(a) loan offers funding up to $5 million.
• Longer loan terms: SBA loans have repayment terms of up to 25 years for real estate and 10 years for other fixed assets and working capital, which could make monthly payments more manageable. Conventional loans typically have terms of up to 10 years.
• Interest rate limits: There is a cap on the maximum interest rate for SBA loans. It’s equal to a base rate, such as prime, plus a percentage.
• Longer wait times: Because a conventional loan only has to be reviewed by an institution’s internal underwriting team, approval times are often faster than SBA loans. SBA loans require more paperwork and approval from SBA before the lender can fund the loan. 
• You must meet SBA and lender requirements: The application process and approval can take longer, and businesses must meet eligibility requirements from both the lender and the SBA.

How to apply for an SBA loan

The first step to applying for an SBA loan is visiting SBA.gov and filling out the SBA lender match form. The form takes about five minutes to complete and asks applicants to describe their businesses and their needs.

Within two days, you should receive an email with a list of lenders you’ve been matched with. You can then contact private lenders individually to compare interest rates, terms and other details before making a decision. Once you decide on the lender, you will submit an application directly to them.

You can also apply directly with a lender in the SBA’s Preferred Lenders program, which can speed up the approval process.

What is a conventional business loan?

Conventional loans are typically offered by banks, credit unions and other financial institutions. Online lenders are increasingly likely to offer business loans as well, and they may work with startups and businesses with lower credit scores that struggle to work with larger banks.

Lenders provide approved businesses with funding, and the businesses repay the loans — plus interest and any applicable fees — over an agreed-upon term.

Depending on your loan agreement, business loans can be used to expand your business, buy business-related equipment or consolidate business debt. The loan can also be used as working capital.

Unlike with SBA loans, which the government backs, the lender for a conventional loan bank is at risk if your business defaults. Since conventional business loans have high stakes for private lenders, banks often require borrowers to have good credit and require personal guarantees or collateral to mitigate risk. 

Requirements of a conventional business loan

A business looking for a conventional loan will need to demonstrate its ability to repay the loan. Your lender may use a debt-to-equity ratio, debt-to-total assets ratio or debt-service coverage ratio to assess how likely you are to repay your loan on time. The latter is calculated by dividing your EBITDA (earnings before interest, taxes, depreciation and amortization) by the interest and principal required to pay the loan. 

You may also need to provide the lender with a business plan that outlines its details and financial projections. The number of years your business has been in operation and your industry also matters. If you operate in a stable, profitable industry, you may see a faster approval or higher approval amount.

Lenders also require a good business credit score and a strong personal credit score. Like any funding, your business will qualify for lower rates with a higher credit score — though lenders often consider more than just your credit score. Outstanding debts, annual revenue and other financial information will also influence a lender’s decision. 

Key aspects of a conventional business loan

• Business and personal credit scores: Large banks typically require strong credit scores to qualify. But many small banks, credit unions and online lenders work with a variety of credit scores.
• Variety of rates: The rate you receive will depend on the type of loan and your business’s overall financial wellbeing. Some conventional loans from banks offer lower interest rates. But there are bad credit business loans that have higher rates — but less strict eligibility criteria.
• Variety of loans available: Lenders offer business loans in various amounts and with different terms and payment schedules. For instance, a line of credit is ideal for anyone who needs revolving credit, while equipment loans are good for buying new assets that grow your business.
• Faster approval process: Lender approval is based solely on the lender’s underwriting criteria, meaning less paperwork and less time needed to make a decision than with an SBA loan.

How to apply for a conventional business loan

You can apply for a business loan directly with your preferred lender. Many lenders accept applications in person at branch locations, over the phone and online. Funding can take anywhere from a few hours to a few weeks.

To get started, determine which type of business loan is most appropriate for your needs. Then, get your credit score, revenue and cash flow in the best shape possible to increase your chances of approval. 

The application process depends on the lender and the type of loan. You can streamline the process by gathering any required documents in advance. Submitting an accurate application can also help you avoid unnecessary delays.

SBA loan vs. conventional loan: Which is best?

Consider the age of your business, credit history and overall financial health to help determine whether an SBA or a conventional loan is best. Additionally, you should calculate the cost of a business loan to see which is the most affordable option for your business.

The best type of loan will depend on your specific situation.

When to choose an SBA loan:

• If your company is at least two years old and has already gone through other funding options
• If you have an established relationship with an SBA-approved lender
• If you can’t meet the requirements of a conventional loan but are able to qualify for the more relaxed terms of some SBA loans, including microloans

When to choose a conventional business loan:

• If you are able to get a lower interest rate with a conventional business loan
• If you want to work with a lender that is not SBA-approved
• If you need a loan quickly and can’t wait up to 90 days for funding

Bottom line

Conventional business loans are a good option for businesses at any stage who want to scale their company or need help with cash flow. Whether or not an SBA loan is right for your organization largely depends on your specific business needs and whether or not you’ve exhausted other types of financing. Explore your options, speak with a financial advisor and compare multiple lenders before making a final decision.

Frequently asked questions

• Is an SBA loan a conventional loan?

  No. While an SBA-approved lender funds an SBA loan, it is not a conventional loan since a portion of the funds are guaranteed — or backed by — the federal government.
  

• What is a conventional loan for business?

  A conventional business loan is funded directly by the lender. With a conventional business loan, no third party guarantees the repayment of the loan.

• Why are SBA loans so hard to get?

  Because SBA loans have low rates and are backed by the government, they have a competitive application process. In the 2023 fiscal year, just over 57,000 SBA 7(a) loans were approved — up from around 47,000 in fiscal year 2022. SBA 504 loans saw a significant drop, however, from a little over 9,000 in 2022 to under 6,000 in 2023.