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What is a Business Microloan?
A business microloan is a business loan for a relatively small sum. Microloans are typically granted to startups or other new businesses, to help cover the costs of starting a business and the expenses of running it before it can start making a profit. Most microloan lenders have restrictions on what you can use the funds for and will ask you for your plans with the funds beforehand.
A microloan can range from as little as $1,000 to as much as $50,000 (although microloans above $35,000 are rare). The average size of a business microloan is $13,000. The small size of a business microloan makes it a lower risk for lenders, so they are more likely to be granted to businesses with little-to-no business credit history.
Due to their small size and the relative ease with which they are obtained, business microloans are useful for new businesses which are trying to establish business credit history to obtain a larger loan with a better rate. It is much easier to get a microloan if you can show you have or are prepared to invest a significant amount of your own money into the business.
There are also business microloans that are supported by the Small Business Association (SBA) or various non-profits, which are designed to help entrepreneurs from disadvantaged societal and economic backgrounds.
In most cases, business microloans have higher interest rates and APRs than a full-sized business loan. APRs can be as high as 20%. The underwriting and administrative costs for a bank is roughly the same for a large loan as it is for a small one. To cover these costs and still turn a profit, banks need to charge more in fees or a higher interest rate. For this same reason microloans of just a few thousand dollars tend to have higher rates than loans closer to the $50 000 range.
The lender will also likely take a risk assessment into account. The most important factor in a typical risk assessment is your personal and business credit score, but the lender may also consider other factors, such as the amount of revenue your business has generated and the quality of your business plan. Secured microloans (which have collateral backing them up) are also considered to be a lower risk. Lower risk loans usually have lower rates.
Business microloans backed by SBA or a non-profit tend to have much lower rates than those without backing. The SBA will guarantee repayment of your loan if you fail to repay, this makes the loan a much lower risk. The SBA backs loans to support business owners from disadvantaged backgrounds (like women and minorities), or to stimulate the growth of businesses which generate jobs for local economies. There are several nonprofit organizations which give low interest or no interest loans for the purposes.
Credit requirements vary between different lenders, but most lenders (especially for profit lenders) have some minimum credit requirement. Business microloans tend to be more flexible about less-than-perfect credit than larger loans, but have higher credit standards than many modes of alternative financing.
Some microloans are designed specifically for startups. Since startups usually have no business credit history, lenders use the personal credit history and other factors to establish their risk assessment.
Some SBA backed (such as the SBA 8a), and nonprofit microloans are designed to help individuals from backgrounds which often have more difficulty acquiring loans. To counterbalance this tendency, these organizations look at your credit rating within the context of your social and economic conditions, which can cause them to be more lenient.
For Bad Credit
Bad credit can be a source of complication when it comes to obtaining financing for their business. While most business microloans have a credit minimum, most microloans are more flexible than traditional loans. Some lenders will grant microloans to businesses with bad credit if the business owner has a good enough business plan and training. If you have or show that you are willing to make a significant investment of your own money into your business, lenders may be more willing to give a loan despite bad credit. The SBA helps many individuals from disadvantaged backgrounds get loans while they have bad credit.
If you cannot get a loan because of your bad credit, you have some options that could help improve your credit rating. Occasionally a borrower will have a bad credit rating because of a clerical error. If you think this is the case, you can get a copy of your credit history from any of the major credit checking firms (this service is free). If you can find an error and have proof that it is an error you can have your credit history revised.
Making regular payments on your bills or by paying down outstanding debts will help to improve your credit rating. If your credit rating is weak because it is too short, you can help improve it by getting a business credit card, or by getting a smaller “credit building” microloan. Credit building microloans tend to be very small and have much higher rates, but they are a useful tool for establishing credit history to apply for a more substantial loan later.
Collateral such as real estate, property, inventory, or offering future receivables may be suitable for the right lender to get approved or lower the interest rate. If a borrower provides collateral for a loan, it is called a secured loan. Since the lender can seize the collateral if the borrower fails to pay, a secured loan is considered a much lower risk than an unsecured loan. The value of the collateral should be relatively similar to the total amount of the loan.
Business Plan for Microloan
If you are a new business, a lender may request to see at what stage you are at and ask to view your business plan. A lender will review your plan to know both where your business is right now and how it intends to grow. With startup microloans, a business plan becomes more significant, since the lender has little to no credit history to assess the borrower with.
To get an SBA or nonprofit loan the lender will use your business plan to assess the impact your business will have on the community, regarding job creation and the services it brings.
A robust business plan can be the difference between qualifying for a business microloan or not. Our Blank Template is a good place to start.