There’s a misconception that many small business owners have about loans made through the U.S. Small Business Administration (SBA). They think that the government hands out money to struggling small businesses. It doesn’t.

In fact, the SBA guarantees loans to small and mid-sized companies. Banks and other lending institutions make the loans themselves.

SBA-backed loans can encourage banks to lend to small businesses, giving them access to capital to help start or grow their businesses. But it’s important to understand the intricacies of the loans, says Denise Ching, associate director of the Illinois Small Business Development Center at UIC, part of the network of regional Small Business Development Centers that are funded by the SBA and state and local governments to provide free services to small businesses.

“The SBA is not a direct lender. [It provides] incentives for lenders to make more loans,” Ching says. “It’s up to lenders to decide whether they want to use the SBA loan guarantee or not.”

An SBA-backed loan can be a good solution for a young or start-up business that is turned down for conventional underwriting because it has insufficient collateral, it has been in business for less than two years, or it is funding a business acquisition, among other situations.

But an SBA loan guarantee is not a magic bullet. “That guarantee is not meant to cover up a bad credit decision,” Ching says. “It’s meant to help where there’s maybe one hole, but not when you’re covering five holes, you’re in trouble, and you’re losing money—that’s not when you get an SBA loan.”

“A loan is not to save you from a poorly managed business,” she adds. “You have to be able to pay it back. You have to be able to demonstrate in your financial statements that you can afford those loan payments every month for the next three to five years.”

To improve your chance for a SBA-backed loan, get your financial house in order by reviewing your personal credit history and assembling a complete financial package to make the case for the stability of your company. View the SBA loan application checklist on the SBA site and be prepared with the following tips:

Understand the types of SBA loans. The most common, most flexible type of SBA-backed loan is the 7(a) Loan Program, which can be used for a variety of purposes, including buying machinery, equipment, or furniture; purchasing real estate; making leasehold improvements; generating working capital; or even refinancing debt. There are different types of loans within the 7(a) category, including special purpose loans and express programs like the SBAExpress, which promises a response to an application within 36 hours.

Another type of SBA-backed loan is the CDC/504 Loan Program. This provides approved small businesses with long-term, fixed-rate financing used to acquire fixed assets such as major machinery or equipment for expansion or modernization.

And finally, the Microloan Program provides small (average $13,000) short-term loans to small businesses and some not-for-profit child-care centers through community-based organizations with experience in lending as well as management and technical assistance.

Gather financial statements. Assemble a complete application package including business and personal tax returns from the past three years, profit and loss statements from the past three years (for an existing business), projected financial statements, a recent balance sheet, and the company’s business plan, reference letters, business license or certificate, and loan application history. A complete package should give a lender a good feel for your company and for what you will use your loan.

Consider your collateral. The SBA requires that the applicant put up all available collateral for loan repayment. If business assets do not fully secure the loan, personal assets may be considered as collateral, including the equity in your home or any assets jointly owned with your spouse. The SBA requires personal guarantees from people who own 20 percent or more of the business, as well as from other individuals who hold key management positions.

Seek assistance. The SBA funds a broad network of regional Small Business Development Centers and SCORE mentors that help small businesses with free programs. These services provide valuable advice in preparing SBA loan applications.

Contact lenders. Find a bank, credit union, or other lender that works with the SBA. The SBA has a list of lenders by state, with a chart of the number of loans the lenders make along with the overall loan amount. Ching suggests dividing the loan amount by the number of loans to come up with an average loan size for each bank so you can match your needs with a lender that handles similar-sized loans.

A Chicago-based writer and editor, Eve Becker writes about personal finance, health and other topics. She is a former managing editor of Tribune Media Services.

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