What Is a Microloan and How Do They Work?

What Is a Microloan?

Broadly speaking, a microloan refers to any loan of $50,000 or less. Most traditional banks and lending institutions won’t offer smaller loans, which is why the U.S. Small Business Administration (SBA) has created a microloan program aimed at small business owners and startups.

The SBA microloan program provides funding to newly established startups and certain types of non-profit daycare providers. Business owners can borrow up to $50,000, though the SBA reports that the average loan amount is only $13,000.

Related Reading: A Business Owner's Guide to Business Loans

How Do Microloans Work?

Microloans work a bit differently depending on the specific lender. For instance, the SBA microloan program provides funds first to intermediary lenders. Borrowers then obtain their loans from these intermediaries, and in some cases, there are special programs aimed at veterans, female entrepreneurs, or underrepresented communities.

What is an SBA microloan term? SBA microloans are given for a maximum of 6 years with interest rates ranging from 8% to 13%.

Of course, the SBA microloan program isn’t the only game in town. Many peer-to-peer (P2P) microlenders have emerged, as have mission-driven microlenders to assist specific communities or entrepreneurs. 

Additionally, the USDA offers microloans to those working in the agricultural sector and eligible restaurants and grocery stores.

The mechanism of these microloans varies widely, though their common feature is low lending amounts geared towards entrepreneurs and startups.

How Can You Use a Microloan?

By design, microloans can be used for a variety of purposes, all related to the growth or launch of a new business. Some common examples include:

• Providing working capital
• Purchasing inventory
• Purchasing supplies
• Purchasing furniture or fixtures
• Purchasing or leasing machinery or specialized equipment
• Covering seasonal expenses

In fact, it might be more helpful to talk about what a microloan may not be used for. Business owners typically can’t use a microloan to cover past debts or overheads. The SBA microloan, in particular, cannot be used to cover debts or to purchase real estate.

How to Get a Microloan

To obtain a microloan, you’ll need to contact one of the individual microloan lenders. 

Keep in mind that you cannot obtain a microloan through the SBA directly because of how the SBA microlender program works. Therefore, there is no SBA microloan application in the traditional sense. Instead, you’ll need to contact one of the intermediary lenders.

Microloan Lenders

If you want to find SBA microloan lenders, your best option is to visit the website of the Small Business Association and search for lenders by state. Besides the SBA microloan program, you may also consider peer-to-peer microloans from companies such as:

• LendingClub
• SoLo Funds
• Kiva

Keep in mind, though, that these lenders have different rates and loan terms. Kiva, for example, limits applicants to loans of $10,000 or less.

If your company operates in certain community-based sectors, you could consider mission-driven microlenders such as:

• LiftFund
• Grameen America
• Accion Opportunity Fund

These lenders provide opportunities for businesses in specific industries, though you’ll generally be restricted to the narrow scope of these mission-driven companies.

Finally, some entrepreneurs turn to crowdfunding sites as a way of raising small amounts of capital to get their business off the ground. Though this method is less reliable than the others, it will save you the approval process associated with traditional lenders.

Eligibility Requirements

Eligibility requirements will vary considerably between lenders. The SBA microloan requirements are the most straightforward. To qualify for an SBA microloan, you’ll need to meet the following SBA microloan eligibility conditions:

• Demonstrate that you operate a qualifying for-profit business
• Provide an average credit history, or demonstrate financial strengths
• Demonstrate the ability to repay the microloan in the specified timeline
• Sign a personal guarantee
• Offer collateral on the loan
• Provide evidence of “good character”

The latter point warrants further explanation. A criminal record won’t prevent you from obtaining a microloan, but approval might be significantly more challenging if your past includes financial crimes such as fraud, theft, or embezzlement.

How to Apply for a Microloan

There’s no actual one-size-fits-all application process to obtain a microloan since each lender will have its particular process and eligibility requirements. Even SBA microloans will be contingent on the intermediary lender.

There are still a few basic steps that you can perform to streamline the process regardless of what lender you choose. To apply for a microloan, you can start with the following steps:

Create a Business Plan

A formal business plan is a wise idea regardless of your financing goals. Creating this foundational document will set the direction of your business for the foreseeable future. A good business plan will usually consist of the following:

• An executive summary that highlights the basics of your company, products, and goals
• A description of your company
• A summary of relevant market research
• A description of your company’s structure
• Your sales strategies
• Your specific funding needs (or funding request)
• Any financial projections

Lenders can use the information in your business plan to assess your eligibility, and your financial projections can illustrate your ability to repay any loans you receive.

Research Microlender Eligibility Requirements

Next, you’ll need to compare different microlenders to find the most favorable terms. You can find SBA microloan lenders on the SBA website. Certain niche businesses might also consider peer-to-peer microloans or community programs, though you’ll have to meet the unique requirements of each.

Gather Your Financial Documents

Before meeting with a lender, you will need to gather such documents as:

• Your business plan
• Your personal ID
• Financial statements
• Proof of collateral (if applicable)
• List of references

These documents will collectively serve to provide proof of your eligibility and may even determine the terms of your loan.

Submit Your Microloan Application

Each lender will have a different application process, so you’ll need to follow their instructions to receive final approval for your loan. Pay close attention to the repayment terms to ensure you stay in good standing with your loan.

Is a Microloan Right for Your Business?

While established businesses will usually have more extensive financial needs, a microloan can be ideal for first-time entrepreneurs or companies experiencing their first years of growth. A microloan can be just what you need to transform your vision into reality and gain momentum for the years ahead.

Some entrepreneurs may want to look into other funding sources, ranging from business equipment loans to invoice financing, which can provide alternatives to microloans for qualifying business owners.

Small Solutions for Big Dreams

Microloans may be small, but they can provide funds for some of your biggest dreams. The more you understand your financing options, the more you’ll be able to turn these dreams into reality. 

Find your next lender through the Fundid Capital Marketplace.