Building a business without the right amount of capital can be incredibly difficult, so it’s common for both new and established businesses alike to borrow money and leverage that debt to grow the company.

Microloans for small businesses are just one of many types of business financing from which you can choose, though their unique features make them more appealing to new business owners. 

Here’s what you need to know about how microloans work, how to get one, and what you should consider before applying.

What Is a Microloan?

A microloan is a small business loan that provides a small amount of funding, primarily for newer businesses. Depending on where you look, these loans can range from $500 to $50,000. 

Because they’re on the smaller side compared to other business loans, microloans tend to be used for startup costs, working capital needs, and small investments in inventory, supplies, and other expenses that startups need to get their businesses off the ground.

Microloans are generally more affordable than short-term business financing options, but their eligibility requirements typically aren’t as stringent as you’ll find with traditional bank loans, particularly when it comes to your revenue figures and operating history.

Microloans are typically available from banks, credit unions, and nonprofit organizations. You can also apply for a microloan through the Small Business Administration’s microloan program. 

While the loan is actually originated by an intermediary organization, it’s partially guaranteed by the government agency.

Microloans are available for various types of small businesses, but many microloan programs are designed specifically to help low-income communities.

They are also designed for groups that have been historically underserved by commercial lenders, including women, minorities, people with disabilities, and veterans. 

How Do Microloans Work?

Microloans are term loans, which means that they function similarly to a personal loan or an auto loan, at least in terms of being a form of installment credit.

When you take out a microloan, you’ll receive a lump-sum payment for the amount of the loan. Then, you’ll pay it back over a set repayment period in equal installments. They typically have fixed interest rates, so you don’t have to worry about your monthly payment changing.

Microloans, which typically provide $50,000 or less in funding, charge relatively reasonable interest rates, especially compared to online business loans. 

Depending on where you look, interest rates are often lower than 20%. Some may charge no interest at all, while others may charge upwards of that threshold.

Depending on the lender and the loan amount, microloans may have repayment terms ranging anywhere between a few months and several years. 

When you receive microloan funds, you can use the money for just about anything you want. However, they’re typically used for the following purposes:

• Working capital
• Inventory
• Supplies
• Furniture
• Fixtures
• Machinery
• Equipment

Certain microloans may have restrictions on how you can use the funds. For example, you may not be able to use one to consolidate existing debt or to purchase real estate. 

Like many other small business loans, microloans typically require a personal guarantee when you apply. We’ll cover that more in a minute. 

Best Types of Microloans for Small Businesses

As previously mentioned, there are a few different ways you can obtain a microloan for your business. Depending on the source, the requirements and terms of the loan can vary. As a result, it’s important to shop around and consider multiple options before you settle on one.

Also, keep in mind that some lenders may have special microloan programs tailored to meet the needs of specific communities and groups of business owners. The more research you do, the easier it will be to find the best fit for you and your business. 

With that said, here’s what you should know about SBA microloans, bank microloans, and nonprofit microloans.

SBA Microloans

The SBA microloan program provides loans of up to $50,000 to eligible small businesses and not-for-profit childcare centers. While it’s possible to get up to that amount, the government agency states that the average SBA microloan is $13,000.

Instead of originating the loans itself, the SBA works with intermediaries — nonprofit community-based organizations — to administer the microloan program for eligible borrowers.

This means that you’ll apply directly with one of those organizations rather than the SBA. Each intermediary has its own eligibility requirements, but you can generally expect to provide some form of collateral and a personal guarantee in the event that your business can’t repay the debt.

To find an authorized SBA microloan lender in your area, you can contact your local SBA district office.

As with the eligibility criteria, interest rates and repayment terms can also vary from lender to lender. That said, the SBA states that interest rates generally range from 8% to 13%, which is much cheaper than an online business loan or a business credit card. 

Your repayment period will generally be based on the amount, how you plan to use the funds, your business needs, and the lender requirements. The maximum repayment term allowed by the government agency is six years.

SBA microloan funds cannot be used to pay existing debts or to purchase real estate.

Bank Microloans

It’s possible for local banks and credit unions to offer microloan programs, but it’s not very common. You’ll be hard-pressed to find one from a major bank. 

If you find a bank or credit union that offers a microloan program, the terms and eligibility requirements likely won’t be as predictable as they are with SBA loans. Instead, everything will depend on the financial institution that’s offering the loan.

You can also obtain a small loan from an online lender, with some offering loan amounts under $1,000. But these loans typically come with high-interest rates, and you may also need to have a certain amount of time in business and meet minimum annual revenue requirements.

Finally, if you’re just starting out, you may also consider a personal loan to help you start your business. You can get a personal loan from many big and small banks, as well as from credit unions. 

Keep in mind, though, that some lenders don’t allow you to use personal loan funds for business purposes.

Personal loans are generally unsecured, so you don’t have to worry about putting up collateral. Interest rates can also be lower than online business loans. 

However, they won’t help you build your business credit scores, so it may only be worth it if you can’t find any other business loan options. 

Nonprofit Microloans

There are several nonprofit organizations that offer microloan programs for startups and other small businesses. These microloan programs typically don’t have stringent credit requirements, and many of them are targeted toward minority business owners.

They can also be incredibly cheap, though they may also have lower loan limits than what you’ll find with the SBA microloan program. For example, the Kiva microloan program only offers loans as high as $10,000, but there’s no interest. 

The process of getting a microloan from a nonprofit organization can vary. In some cases, you may need to get the process started by crowdfunding peer-to-peer involvement from your friends and family. 

In others, you may be part of a lending circle, where each business owner receives a loan in turn, with the other business owners in the circle funding the loans.

As with other institutions that offer microloans, it’s important to take your time to shop around and consider multiple options from nonprofit organizations to determine the best fit for you and your business needs.

How Do You Qualify for a Microloan?

Microloans are specifically designed to help startups and other small businesses in the early stages of their development. However, all small businesses are eligible to apply for one, as well as certain nonprofit child care centers (for the SBA microloan program).

Unlike many traditional small business loans and lines of credit, microloans can be available to you, even if you don’t have an established business or personal credit history. 

You also don’t necessarily need to have annual revenues yet, though some SBA microloan lenders may have some requirements in place related to these things.

And while any small business owner can apply, most microloan programs are geared toward women and minority-owned businesses, as well as veterans, people with disabilities, and small businesses located in low-income communities.

Application and document requirements can vary if you’re getting a loan through a nonprofit microloan program. When you apply for a microloan through the SBA microloan program, you may need to provide the following information and documentation:

• Business plan
• Recent tax returns (typically two years)
• Recent pay stubs
• A list of collateral options
• Contracts or purchase agreements, if applicable
• Business tax returns
• Balance sheet
• Income statement
• Cash flow statements and projections
• Business licenses
• List of existing business assets

Note that if you’re just starting out, you may not have some of these. Don’t fret, though. You may still be able to qualify for a microloan without an established business operation.

In addition to collateral, you’ll typically be asked to provide a personal guarantee when you apply for a microloan. 

This clause, which is also known as a joint and several liability clause, states that if your business can’t repay the debt it’s incurred, that you’ll be held personally liable to pay it off.

In other words, you’ll have to use your personal assets, such as income, savings, or other assets, to pay off the debt. If you don’t, the lender may sue you to collect the outstanding balance.

What Is a Microloan Used For?

Microloans for small businesses can be used for many different purposes. As outlined above, that can include:

• Working capital
• Inventory
• Supplies
• Furniture
• Fixtures
• Machinery
• Equipment

Depending on where you get the loan, there may be restrictions like the ones in place for the SBA microloan program. But that’s not always the case. 

As you consider whether a microloan is right for you, take some time to determine how you plan to use the funds. Think about how it will help grow your business and whether it’s the best way to help you achieve that goal.

Also, think about the potential consequences if you can’t repay the debt. While it might make sense to use a microloan to furnish your office, is that what your business needs right now? 

And if your business doesn’t generate enough cash flow to make those payments, how do you feel about paying it back with your own assets?

In other words, before you take out a microloan — or any small business loan for that matter — think carefully about whether it’s the best move for your business right now.

Microloan Advantages and Disadvantages

As with any small business loan, there are both benefits and drawbacks to using a microloan program to help fund your business. If you’re thinking about getting a microloan, here’s what you should keep in mind.

Pros

• Lower eligibility standards: Not only are microloans available to new businesses, but they can also be accessible even if you don’t have strong business credit or personal credit.
• Accessible for underserved groups: Women and minority entrepreneurs have historically had a difficult time obtaining affordable financing for their business ventures. The same goes for veterans and people with disabilities. If you belong to one of those communities, a microloan may be the ticket you need to build your business.
• They help build business credit: Unlike a personal loan or personal credit card, you can use a microloan to build your business credit history, making it easier to obtain financing again when you need it in the future.

Cons

• Low loan limits: Microloans max out at $50,000, but many lenders offer much lower loan amounts than that. Depending on how much you need, it might not be enough to accomplish your plans.
• Collateral and personal guarantee: You’ll likely be personally on the hook for repaying a microloan if your business can’t. That’s true for many other business loans as well, so it’s important to carefully consider all of your options before applying.
• Can be a long process: If you’re applying for an SBA microloan, it can take several weeks or even months to complete the application and approval process.

The Bottom Line

Microloan programs can be a great way to get the funding you need to get your business off the ground. 

They don’t have the same strict eligibility requirements as traditional bank loans, and with the right program, you don’t have to worry about drowning in high-interest charges or crippling monthly payments.

However, microloans for small businesses aren’t a guarantee, even if you belong to a community of business owners that are designed to help. And if you need more money than what microloan lenders are willing to provide, you may need to seek out alternatives. 

Do your due diligence to determine whether a microloan is right for you, and take your time to compare multiple loan programs to find the best fit for your business.

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