Should You Use a Microloan to Fund Your Small Business?

It’s not uncommon for new entrepreneurs to struggle with business finances, as untested companies are riskier bets for risk-averse lenders. Creative funding solutions, like crowdsourcing, can help you avoid dipping into any personal savings to help get your business started, but a small microloan is another option to jump-start your company.

What is a microloan?

Like traditional loans, microloans are funds borrowed in a lump sum, just in smaller amounts — according to the U.S. Small Business Administration (SBA), the average amount given to a borrower is $13,000. Terms can vary depending on the type of microloan. For example, an SBA loan has a maximum repayment term of six years, while the USDA Direct Ownership Microloan can reach up to 25 years.

Besides smaller borrowing limits and flexible terms, microloans can come with lower interest rates and fewer fees than traditional business loans.

The catch? The maximum borrowing amount for microloans is only $50,000, limiting how you can use the funds. They also tend to come with short repayment terms or require collateral or a personal guarantee.

When is a microloan a good fit?

A microloan may be a good option for a startup that needs a small lump sum to help get its business running and can’t qualify for traditional business loans. This type of loan may also be better suited for those with low income or entrepreneurs within underrepresented communities and who may have poor credit scores. (Minority business owners or women-owned businesses are prioritized when it comes to eligibility requirements for microloans, but others can apply as long as the lender’s qualifications are met.)

Recently, Umpqua Bank partnered with the nonprofit organization Kiva to help support underserved business owners in California, Washington and Oregon by offering $1 million in microloans, according to The News-Review. Since April, the program has helped 185 business owners in these areas.

Entrepreneurship mentoring or business classes may be offered with a microloan, which can benefit new owners interested in growing within the industry. Depending on the lender, a borrower may even be required to partake in a training session to receive the loan.

Are you eligible?

Microloan requirements are usually less stringent about your credit score, making them ideal for startups in growth mode that may not have a long credit history yet. However, credit scores may still be considered, along with the following:

• Business revenue
• Business plan
• The length of time your company has been in business
• Other sources of income available
• Active bankruptcies reported

While these are some of the main factors a lender may look at when determining eligibility, each has its own requirements. Be sure to check if the lender you’re interested in lends in your area and particular industry, as some have location and business restrictions.

Interested? Shop around and compare alternatives

One of the first steps you should take when looking for business funding is to shop around and compare different terms and rates for multiple lenders and loan products. Microloans can be a great option, but they come with a few strings, most notably the possibility of a personal guarantee. If the threat of posting collateral or high turnaround times make you nervous, you may want to consider some possible alternatives:

• Business line of credit: Pay for your business expenses with revolving funds, then once funds are repaid, the full credit amount becomes available to use again.
• Equipment financing: A business loan specifically used for equipment purchases and upgrades, which can include anything from small electronics to large appliances.
• SBA loans: Loans with a wide range of borrowing limits authorized by the U.S. Small Business Administration and can offer affordable rates to borrowers.
• Accounts receivable financing: Funds can be received from unpaid invoices by getting a cash advance as a lump sum (loan) or a revolving line of credit. A fee will be withdrawn from each payment once a customer pays an invoice.
• Invoice factoring: Business owners sell outstanding invoices to a factoring company to receive funding. Customer payments are received by the factoring company and then the remaining amount is provided to the business owner (after a fee is collected).