The government wants your small business to succeed. That's why
they have created the Small Business Administration. This agency helps secure loans for entrepreneurs to get their
companies up and running.
The end result of an SBA loan is the same as a traditional loan;
ultimately, you get money in your pocket. But the means by which it gets there is a little bit different. As you
can imagine, lending money to startup companies can be risky business. This is where the government steps in. To
stimulate lending to small companies, the government offers to guarantee a portion of the loan to the bank. This
means that if a business fails and is unable to repay its principal, the government will repay the bank for a
certain percent of the default. This reduces the risk of lending money for the bank and ultimately means more
resources in the hands of entrepreneurs.
It's important to note that the entrepreneur is not in the clear
if they default on the loan. Though there are plenty of stories of entrepreneurs whose debt was forgiven, the
government technically only makes a guarantee for the bank.
It's also important to note the role collateral plays in this
process. Most loans, SBA loans in particular, require the debtor to put up collateral. This is the first place a
bank will usually look if they need an alternative form of repayment. This means that if a business defaults, the
bank has a legal right to claim some pre-specified asset. Only after that asset is claimed will it request
repayment from the government.
SBA loans also differ from traditional bank loans in the way their
interest rate is calculated. Normal loans are calculated based on an assessment of the risk associated with a
business, along with consideration of current economic conditions. SBA loans interest rates also depend on economic
conditions-they are tied to the prime rate of interest, a composite index determined by a group of large banks.
Depending on the term, type, and amount of the loan there is also a fixed percentage added to the prime rate, to
determine the final interest rate of the loan.