What Is a Microloan?

A microloan can refer to any type of small loan. However, in the business world, it often refers to specialized loans made to particular types of companies, such as those headed by veterans or minorities. Microloans are important because most companies that receive them typically have a more difficult time accessing capital.

Read on for more information about getting a business loan, so you can better decide if a microloan is right for you.

Microloans vs. Typical Business Loans

When a company begins operations, it needs capital to function. For startups, many expenses are front-loaded; new companies can’t begin selling products without offices, supplies and so forth. With no sales bringing in revenue, those initial costs must be paid out of pocket. Most new companies need either seed funding — from angel investors or venture capital firms — or loans. But it can be hard for new companies to get traditional loans from banks. Microloans can serve as initial funding for companies who don’t yet have the capital to hire employees or stock up on initial inventory.

Microloans are small, short-term, low-rate loans specifically targeting startups in need of capital. Some microloans are offered by nonprofit organizations with a specific social mission. For example, one type of microlender might seek out companies working on alternative energy, whereas another might offer startup business loans to companies run by women.

Many different financial institutions offer microloans, including some that are organized through the Small Business Administration. The term “microloan” refers to the size of these loans; typical microloans are for $50,000 or less. The average SBA microloan is about $13,000.

Read: How to Get a Business Loan With Bad Credit

Who Is a Candidate for a Microloan?

Microloan candidates are typically new companies that might otherwise have a hard time raising money to fund their operations. Traditional business loans require two years or more of financial statements, and many lenders require a business to already be profitable. As a result, four out of five business owners who apply for bank loans get denied. New companies can’t typically meet the requirements for a traditional bank loan, making them excellent candidates for microloans.

Traditional candidates for microloans include companies run by demographics typically underserved in the business community, such as American Indians. However, microloans have now expanded to everything from farms to schools, who use the funds to pay for education and healthcare in addition to daily operational needs.

What to Do Before Pursuing a Microloan

Some microlenders are not in the game to generate huge profits, but rather to help certain types of businesses succeed. However, microlenders are not in the business of losing money, either. To be a viable candidate for microcredit, a business needs to undertake four steps:

1. Develop a Business Plan

Companies need a roadmap as to where they want to go if they wish to succeed. A lender is going to be reluctant to lend to a company that has no direction or vision as to how they will become profitable.

2. Have Clean Credit

A microloan is still a loan, meaning you’ll need to show evidence of your intention and ability to pay it back. The better your credit, the more likely a lender will take the risk of financing your company.

3. Offer Collateral

A loan for a new business is always risky, no matter how primed the company might be for success. If you can offer the lender collateral, you’re more likely to generate financing offers. Sometimes, a personal guarantee will help you obtain the loan, especially if your business doesn’t have any assets to borrow against yet.

4. Invest in Your Own Business

Lenders like to see that business owners are personally invested in their own companies. Why should lenders take the risk of lending money to a business if the owner isn’t willing to risk their own money?

Be Informed: 7 Surprising Costs That Come With Starting a Business

How to Apply for a Microloan

The general process of applying for a microloan is the same as if you applied for a traditional loan, but there are some additional steps. The Small Business Administration has a tool to help borrowers through the microfinance process, which includes the following steps:

1. Articulate Your Needs

The SBA has an online tool where you provide information about your business, which takes about five minutes.

2. Wait for a Lender Who Is Matched to Your Needs

Within two days, you can expect an email from a lender interested in working with you.

3. Talk to Lenders

Review all the financials of the loan you’re being offered, including rates, fees and terms.

4. Apply for the Loan

Once you’ve decided on a loan you like, you’ll submit a formal loan application, just as if you were applying for a traditional loan at a bank.

Before you actually apply for your loan, the SBA recommends you compile the following information and documentation:

• Business plan
• Amount of money you need
• Intended use of funds
• Credit history
• Financial projections
• Collateral
• Industry experience

The SBA partners with over 800 lenders nationwide. Whether you use the free assistance of the SBA or not, you’ll have to go through a similar process.

Related: 7 Best Business Lines of Credit

Pros and Cons of Microloans

Depending on the needs of an individual business, microloans can have both advantages and disadvantages. So you can better understand whether this is the right financial strategy for you, here’s a list of the benefits and drawbacks of microloans:

Pros

• Low interest rates
• Funding provided to companies and underserved communities with no other access to capital
• Nonprofit organizations included as lenders
• SBA can act as an intermediary in the process

Cons

• Need good personal finances to qualify
• Can be difficult to obtain if not in a targeted type of business
• Typical $50,000 cap might not be enough capital for some businesses
• Terms might be too short
• Might have to put up collateral or a personal guarantee

When exploring a microloan, compare the features, benefits and availability against more traditional small business loans to determine what is best for your particular business.

Global Microloans

Beyond the American business community, microloans are used all over the world to fund the growth and development of individuals and small businesses. Grameen Bank was one of the first banks to develop and offer microloans, according to American Banker. The bank began by making microloans to female-run small businesses; the social community put pressure on one another to pay these loans back. Those loans helped these small businesses survive and thrive, as they had no other access to capital.

The same process lives on today, enhanced by technology. Smartphones and tablets now allow both borrowers and lenders from around the globe to connect, facilitating the transfer of capital. Artificial intelligence helps screen borrowers and protect against fraud, making the entire process safer. As the global microloan movement grows, both in terms of technological advancements and greater availability and options, borrowers are the ones who stand to benefit.

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