Guide to Microloans & Their Uses

By Sulaiman Abdur-Rahman · April 24, 2024 · 9 minute read

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Guide to Microloans & Their Uses

For many small business owners, the process of accessing capital for starting or supporting a newer business can be daunting. Many banks don’t lend to newer businesses because they see it as risky or perhaps there’s limited profit to be gained. This can leave potential borrowers with limited options for funding, which might be required for working capital and other startup costs.

Thankfully, with the growing trend toward microlending, small business owners can obtain loans, typically up to $50,000, to help them with small business financing. While microloans are small, they are often exactly what small business owners need to cover essential costs associated with launching their business.

There are a number of ways for business owners to apply for microloans, including through Small Business Association (SBA) loans, nonprofits, and alternative lenders, but it’s important to understand the different types and how they work to help ensure that you choose the one that best aligns with your business needs.

What Is a Microloan?

There’s no precise microloan definition, but a microloan is typically financing of up to $50,000 that is targeted to small businesses with fewer than five employees.

Community-based microlenders may offer SBA loans or non-SBA loans to small business owners, entrepreneurs, and nonprofit child care centers. Such microlending may provide financing to the smallest of businesses, including new firms that may not qualify for bank loans.

The average SBA microloan is about $13,000, according to the SBA. Microloans for small businesses are typically offered by nonprofits, government agencies, or individual lenders to be used for a variety of business expenses. Microloan programs can differ with focus on specific types of businesses, such as female entrepreneurs, underserved communities, or veterans. Some microloans specify that funds be used for specific purposes.

Microloan uses may include:

•  Working capital

•  Inventory or supplies

•  Furniture or fixtures

•  Machinery or equipment

•  Initial startup expenses

In addition to lending money, some microloan programs offer assistance with things like marketing, financial counseling, training, and technical assistance to support budding entrepreneurs. For new business owners, this support can be valuable to help them responsibly use capital and plan for the future of their business.

Recommended: Typical Small Business Loan Fees

Common Microloan Rates and Terms

Microloan interest rates and terms vary from lender to lender and depend on the type of loan program and the individual borrower’s qualifications. However, they are generally offered as monthly installment loans with fixed interest rates. Terms can vary from a few months to six or seven years. Some lenders may offer longer terms.

Factors that may contribute to loan repayment terms include:

•  Loan amount

•  How funds will be used

•  Specific lender requirements

•  Needs of the borrower

 

Microloan features Typical microloan terms
Amount Up to $50,000
Interest rates Varied
Repayment terms A few months to seven years

While there are other loan products that small business owners may be able to access, microloans may be a more predictable and sustainable lending option compared to merchant cash advances, which typically have high borrowing costs and less regulatory oversight.

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4 Types of Microloans

To find the right microloan for your business, it helps to understand the different types of microlenders. What is microlending? It’s when community-based organizations offer financing to small businesses and startups with fewer than five employees. Many lenders offer microloans of up to $50K in addition to other loan programs, while some lenders specialize in microlending to specific communities.

Below, you’ll find information on different kinds of microlenders and generally how a microloan works for each type.

1. SBA Microloans

The SBA’s Microloan program provides direct, government-backed loans to intermediary microlenders who can then offer borrowers necessary funding and training to start and run a small business. Loans can be up to $50K with some programs specific to women, veterans, and other underserved communities.

Terms and conditions are negotiated directly with the intermediary lender, not the SBA, but general SBA microloan interest rates and terms are:

 

SBA loan features Typical SBA loan terms
Max loan term 6 years
Interest rates Varied

For more information on where to find a local SBA intermediary lender or get more information about microloans, contact your local SBA District Office.

2. Peer-to-Peer (P2P) Microlenders

Peer-to-peer (P2P) business lending allows borrowers to access capital directly from other individuals (investors), without a financial institution acting as a “middle man.” Using online platforms to connect, borrowers can often find funding quickly from lenders who want to invest.

For small business owners with little or bad credit, P2P lending may be a useful resource for accessing microloans. Many investors don’t require the same level of qualifications that a bank or credit union does (like collateral or good credit), but it’s still important to research P2P lenders and their terms and conditions to ensure they meet your business needs and financial outlook.

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3. Mission-Driven Microlenders

Many microloans are offered by mission-driven lenders who desire to support specific communities and people groups with economic and entrepreneurial opportunities. These microlenders can be nonprofits or Community Development Financial Institutions also known as CDFIs. A few examples of CDFIs include:

•  Community Development Banks

•  Community Development Credit Unions

•  Community Development Loan Funds

•  Community Development Venture Capital Funds

Some microlenders actually maintain CDFI certification, which tells borrowers that an institution is committed to the principles of CDFI. The U.S. Department of the Treasury offers a complete list of CDFIs for borrowers who prefer to apply with microlenders who have CDFI certification.

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4. Online and Alternative Lenders

Alternative small business loans are those offered by individuals or lenders that aren’t a traditional bank. Alternative microlenders may include:

•  Crowdfunding sites

•  Online small business lenders

•  Angel investors

•  Venture capitalists

•  Friends and family

If you’ve been in business for several years and need working capital, small business loans may be right for you. Such financing can come from online lenders and major banks.

Recommended: Peer-to-Peer Business Loans

Pros and Cons of Microlending

For small business owners, microloans may be a vital part of their business success. Yet, even with the advantages, there are some potential risks to be aware of before applying for microloans.

Pros of Microloans

Here are some of the pros of microlending:

•  More flexible borrower qualifications

•  Additional services (training, marketing, counseling)

•  Fast turnaround time on application and access to funding

Cons of Microloans

Here are some of the cons of microlending:

•  Smaller loan amounts

•  Some microloans have limits on how funds can be spent

•  Potentially higher interest rates than a traditional bank

How to Get a Microloan in 4 Steps

Before you apply for a microloan, it’s important to research microlenders and have a thorough understanding of your business financials and goals. The following basic steps may help you prepare to apply for a microloan:

1. Creating a Business Plan

A business plan is helpful when planning for your future and may even be required by some microlenders. Taking time to make a formal business plan may help you assess your needs as you seek out funding. A traditional business plan can include an executive summary of your business goals and mission statement as a small business owner.

2. Determining Eligibility

Microlenders may have their own eligibility requirements depending on the loan program and lender, but in general, small businesses should meet the following criteria:

•  Be the sole business owner or co-owner of a for-profit small business

•  Have no recent bankruptcies, late payments, outstanding tax liens, or foreclosures

•  Have the ability to repay the loan with current income/revenue

•  Proof of good payment history with creditors

•  Have a clear, strong business plan for the future

•  Meet any special demographic requirements (e.g. veteran, minority, low-income), when applicable

There may be startup business loans for business owners with bad credit, but lenders may charge higher rates to compensate for the higher credit risk.

3. Choosing a Microlender

After conducting research based on your business plan and needs, it’s time to choose a microlender. Narrow your search to find a microlender that’s right for you. This may be a nonprofit, community-based organization that offers SBA microloans or a private lender that offers non-SBA microloans.

4. Gathering Documents and Information

Lenders may have different document requirements, so have the following ready to provide with your application or upon request:

•  Government-issued ID

•  Proof of income

•  Business and personal financial statements

•  How you’ll use the microloan

•  A detailed business plan

•  Proof of collateral, if applicable

•  A list of references who can vouch for you personally and professionally

Gathering the above documents and information can streamline the application process when applying for small business loans. You may not qualify for a microloan if you lack proof of identity or proof you’re a small business owner.

Lenders Who Offer Microloans

As mentioned earlier, nonprofits, government agencies, and individual lenders may offer microloans to small business owners.

The SBA provides funding to community-based nonprofits that offer microloans to eligible businesses. States may offer microloans under the State Small Business Credit Initiative (SSBCI), and the U.S. Department of Agriculture has a microloan program for small or nontraditional farm operations.

Private lenders may offer top small business loans for startups, including microloans to entrepreneurs.

Alternatives to Microloans

Here are other financing options you may consider:

Working Capital Loan

A working capital loan is any loan product that covers everyday expenses like payroll, monthly bills, and repairs. Many small businesses rely on working capital loans to manage cash flow fluctuations.

Business Line of Credit

A business line of credit is a short-term loan option that gives borrowers access to cash up to a set credit limit determined by the lender. Interest is paid on the money withdrawn from the credit line. Some lines of credit are revolving, while others end once you use and pay off the full loan amount.

Equipment Financing

An equipment loan is used to purchase business equipment. The length of the loan is typically equal to the expected life span of the equipment. The equipment acts as collateral for the loan. Rates may vary depending on the type of equipment, industry, and qualifications.

Top Small Business Loans

Entrepreneurs may be eligible for microloan funding. In some cases, a microloan may not be sufficient. For instance, a microloan may not be right for you if you need more than $50K.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.


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FAQ

How does a microloan work?

A microloan typically works like any other small business loan that has to be repaid over a set term. A microloan can provide small business owners with up to $50,000 in fast funding.

Who is eligible for a microloan?

Small business owners with fewer than five employees may be eligible for a microloan. Entrepreneurs may also be eligible for a microloan.

What is the benefit of a microloan?

The benefit of a microloan is it may provide small business owners with up to $50,000 to meet critical business needs. Community-based nonprofits may offer microloans to entrepreneurs and new small business owners who may be ineligible for traditional financing.


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