If your small business needs a little extra money to succeed, a microloan could be the answer. In this detailed guide, we’ll explain what microloans are, who can benefit from them, and how you can apply.

What Are Microloans?

Microloans are small business loans that provide funding of up to $50,000 (or sometimes up to $100,000 through specific programs). They are designed to help businesses facing financial challenges, including startups and newer businesses that haven’t established a strong credit history yet.

Microloans are often easier for small businesses to obtain compared to traditional sources of credit. They also offer favorable repayment terms and interest rates, making them a better option than credit cards or factoring (a financing method where a business sells its accounts receivable to get funding).

A Brief History of Microloans

The idea of microfinance is often associated with Muhammad Yunus, an economist who started the Grameen Bank in 1983 to assist female artisans in Bangladesh by providing small loans for buying materials. Since then, microcredit has spread worldwide. In 2006, Yunus and the Grameen Bank received the Nobel Peace Prize for their efforts.

Today, in the United States, many small businesses—especially those owned by women, minorities, and individuals with lower incomes—find the funding they need to grow through microloans, including those offered by the Small Business Administration (SBA).

How to Use a Microloan

Microloans can generally be used for various business purposes, although specific usage may vary depending on the lender.

For example, the SBA allows small businesses to use microloans for working capital or purchasing fixed assets like equipment and furniture. However, SBA microloans cannot be used to pay off existing business debts or buy real estate.

Pros and Cons of Microloans

SBA Microloan

While microloans can be a great funding source for small businesses, they have their advantages and disadvantages. Let’s explore some of the benefits and drawbacks.

Pros of Microloans

  1. Easier credit requirements: It’s typically easier to qualify for a microloan compared to traditional financing. Microloan programs often aim to assist struggling small businesses.
  2. Support for underserved markets: Nonprofit and community microlending programs often prioritize small businesses owned by women, minorities, and individuals with lower incomes who have historically been underserved by traditional financial institutions.
  3. Reasonable interest rates: Microloan interest rates are often lower than those of nontraditional financing methods, sometimes comparable to conventional business loans. SBA microloan interest rates usually range from 8% to 13% depending on the lender.
  4. Business resources: Many microlenders provide valuable resources such as business mentorship, financial management classes, and other types of training and assistance. These resources can be helpful for new business owners or startups.
  5. Building credit history: Microloans offer an opportunity to establish or rebuild a solid credit history for businesses that lack credit history or need to improve it.

Cons of Microloans

  1. Short-term loans: If you need a long-term loan, microloans won’t be suitable because they come with shorter repayment terms. SBA microloans must be repaid within six years, while other microlenders may require repayment within as little as six months to a year.
  2. Collateral or personal guarantee: Some microlenders may ask for collateral or a personal guarantee to mitigate their risk, as they often work with small businesses that don’t qualify for traditional financing.
  3. Small loan amounts: Microloans are meant for small funding needs. If your business requires more than $50,000 to $100,000, a microloan might not be sufficient.
  4. Training requirements: While the business resources provided by microlenders can be beneficial, some borrowers may find mandatory business training burdensome if they don’t need it or lack the time for it.

Microloan Eligibility Criteria

While each microlender has its own requirements, most microloan programs typically consider the following factors:

  1. Current revenues/revenue potential: Even if your business is not generating significant revenue yet, having a solid business plan that demonstrates growth potential and projected revenue can help you qualify for a microloan.
  2. Credit history: Microlenders may still check your business and personal credit history, but they are often more flexible and willing to work with businesses with limited or poor credit history. They may also consider your current financial management skills or provide resources to help you improve them.
  3. Personal guarantee or collateral: Microlenders take on more risk than conventional lenders, so they may require a personal guarantee or collateral to protect themselves.

Where to Find Microloans for Small Businesses

The microfinance market in the United States is not as extensive as it is globally. In 2022, the SBA’s microloan program, one of the most well-known microloan programs in the country, provided only 4,510 microloans totaling $74.6 million. This is relatively small compared to the global microlending market valued at $29.39 billion in 2021.

However, small businesses can still access Microloan financing in the United States today. Here are some microlending options to consider:

  1. SBA Microloans: The SBA offers microloans of up to $50,000 through approved intermediary microloan lenders. These lenders are nonprofit and community organizations with experience in providing loans to small businesses. They may also offer additional financial resources and assistance.
  2. USDA/Farm Service Agency (FSA) Microloans: Agricultural businesses can apply for microloans through the FSA. The direct farm ownership microloan helps with farm-related expenses, while the direct farm operating microloan covers approved operating costs. Eligibility requirements vary, but prior farm experience is usually necessary.
  3. Grameen America: This microloan program, based on the model pioneered by Yunus and the Grameen Bank, provides initial loans of up to $2,000 repayable over six months to women business owners. Participation in the initial loan phase opens up the opportunity for a larger loan.
  4. Nonprofit and Community Organizations: Several nonprofit organizations provide microloans to underserved communities, including women, people of color, low-income entrepreneurs, and startups. Each program has specific eligibility criteria. Some examples include Accion Opportunity Fund, Liftfund, Justine PETERSEN, and Accompany Capital.
  5. Peer-to-Peer Lending Platforms: Peer-to-peer lending platforms use crowdfunding technology to connect borrowers with multiple individual investors who contribute small amounts to fund microloans. Examples include Kiva and Prosper (for personal loans that can be used for business purposes).

How to Apply for a Microloan

Application requirements vary among lenders, but here are some general tips to help you prepare:

  1. Develop a business plan: Creating a business plan will increase your chances of qualifying for a microloan. Even if your business is new and lacks a revenue history, a well-thought-out plan demonstrates your vision and the path to success.
  2. Improve your credit history: While many microlenders work with businesses with poor or no credit history, it’s beneficial to check and strengthen your business and personal credit scores before applying for a loan.
  3. Compare loan terms: If you have access to multiple microloan programs, research and compare the terms offered by each lender. Choose the loan that best suits your business’s financial needs.
  4. Gather financial and tax documents: Be prepared to provide recent tax documents and financial statements, including your balance sheet, income statement, and cash flow statement.

Remember to research and choose the microlender and microloan program that aligns with your business’s needs and goals.

Microloans For Small Businesses | Small Biz Ahead (thehartford.com)

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