If a little more funding could make the difference between success and failure for your small business, a microloan might provide a solution. In this in-depth guide, we’ll take you into the world of microloans and explain what they are, who they benefit and how you can apply for one.
What Are Microloans?
Microloans are short-term business loans of up to $50,000 (or up to $100,000 through certain programs). They can provide a source of funding for businesses facing financing challenges, including startups and newer businesses that have not had time to build up a solid credit history.
Unlike conventional sources of credit, microloans are often easier for small businesses to procure. They also tend to offer favorable repayment terms and interest rates. This can make them a better option than other business financing such as credit cards or factoring (a type of financing in which a business sells its accounts receivable in exchange for funding).
A Short History of Microloans
The birth of microfinance is often associated with Muhammad Yunus, an economist who founded the Grameen Bank in 1983 to help female artisans in Bangladesh access small amounts of funding to buy materials to make their goods. Since then, the concept of microcredit has spread around the world. In 2006, Yunis and the Grameen Bank won the Nobel Peace Prize for their efforts.
Today in the United States, many small businesses—particularly those owned by women, minorities, and people with lower incomes—find the capital they need to grow through microloans, including microloans provided by the Small Business Administration (SBA).
How to Use a Microloan
While some business loans come with restrictions, you can generally use microloans for many different business purposes, although this varies by lender.
The SBA, for example, permits small businesses to use microloans for various purposes, including working capital and the purchase of fixed assets, such as equipment and furniture. You can’t, however, use an SBA microloan to pay off your small business’s existing debts or purchase real property.
Pros and Cons of Microloans
While microloans might seem like an ideal source of funding for your small business, they have their pros and cons. Here’s a look at some of the benefits and drawbacks.
Pros of Microloans
Less stringent credit requirements. Each microlender has its own set of eligibility criteria, but it’s typically easier to qualify for a microloan than other conventional means of financing. Many microloan programs primarily exist to provide assistance to small businesses that are struggling to grow.
Prioritizing underserved markets. Many nonprofit and community microlending programs prioritize small businesses owned by women, minorities and people with lower incomes—groups that have typically been underserved by traditional financial institutions.
Reasonable interest rates. Microloan interest rates tend to be lower than other nontraditional means of financing; in some cases, rates may be as low as those offered by conventional business loans. Interest rates on SBA microloans typically range from 8 to 13%, depending on the intermediary lender.
Free business resources. Many microlenders offer resources like business mentorship, financial management classes and other types of business training and assistance. These resources can be helpful to a newer business owner or a startup.
Build credit history. For new businesses without an established credit history or businesses working to improve their credit, microloans also offer the opportunity to build (or rebuild) a solid credit history.
Cons of Microloans
Short-term loans. If you need a long-term loan, microloans won’t be the right choice for you; they come with shorter repayment terms. The exact length of time varies from lender to lender. SBA microloans must be repaid within six years, while other microlenders might require repayment in as little as six months to a year.
Collateral or personal guarantee. You may need to provide collateral or a personal guarantee for your microloan. If you’re applying for an SBA microloan, this depends on the lending criteria of the SBA intermediary lender you apply through.
Small loan amounts. As its name suggests, microloans are for small amounts. If your business needs a cash infusion of more than $50,000 to $100,000, a microloan likely won’t work for you.
Training requirements. The business resources many microlenders offer can be a con if you’re required to take part in business training as a condition of the loan. Some small business owners feel they don’t need or have the time for the extra training.
Microloan Eligibility Criteria
While each microlender has its own eligibility criteria, most microloan programs want to see the following from its small business loan applicants:
Current revenues/revenue potential. Even if your small business isn’t generating significant revenues yet, a solid business plan showing your growth potential and projected revenue may be enough to help you qualify for a microloan.
Credit history. Microlenders are still lenders, so don’t be surprised if you’re asked to provide your business and personal credit history. But because microloan programs seek to give access to capital for small businesses with very little (or bad) credit history, a microloan may still be an option. Microlenders tend to be more flexible. They may consider your current financial management skills or provide resources to help you build these skills.
Personal guarantee or collateral. Because they typically provide funding to small businesses that would not be eligible for traditional forms of financing, microlenders take on more risk than conventional lenders. For that reason, a microlender may ask you to provide either a personal guarantee or collateral to help them mitigate their risk.
Where To Find Microloans for Small Businesses
The microlending market in the U.S. is still nowhere as large as it is globally. Last year, the SBA’s microloan program—likely the best known of all U.S. microloan programs— provided only 4,510 microloans, totaling $74.6 million. Compare this to the global microlending market, which was valued at $29.39 billion in 2021.
Given the smaller size of the U.S. microfinance industry, it can be challenging to find the right microloan for your small business.
However, it’s still possible for a small business to obtain microloan financing in the U.S. today. Here are some of the microlending options to consider.
The SBA offers microloans of up to $50,000 to eligible small businesses. You can apply for an SBA microloan through one of the SBA’s approved intermediary microloan lenders.
Unlike the SBA’s other loan programs, which work with traditional lenders, the SBA microloan program uses nonprofit and community organizations as intermediaries. These organizations typically have experience providing loans to small businesses and can often provide other financial resources and assistance.
USDA/Farm Service Agency (FSA) Microloans
If you run an agricultural business, you may be eligible to apply for two types of microloans offered by the Farm Service Agency (FSA), each of which provide loan amounts of up to $50,000.
- The direct farm ownership microloan allows borrowers to cover farm ownership expenses such as a down payment for farm property or for farm repairs and improvements.
- The direct farm operating microloan can be applied toward approved farm operating costs, including the purchase of farm-income-generating equipment and livestock.
You need at least three years of farm experience to qualify for the direct farm ownership microloan program, but the direct farm operating microloan is open to applicants with limited experience. The FSA will also consider your small business experience or self-guided farming apprenticeship experience when determining your eligibility for the operating microloan.
The Grameen America microloan program is based on the microlending model pioneered by Yunus and the Grameen Bank. The program, which offers an initial loan of up to $2,000 repayable over six months, is available to women business owners only.
Its eligibility requirements are unique among other microlending programs in the country. Applicants must:
- Form a group with four other women entrepreneurs.
- Take part in a week of financial training.
- Attend weekly meetings.
- Repay the microloan in weekly installments.
Successful participation in the initial loan phase opens up the opportunity to receive a larger loan with another six-month repayment term.
Nonprofit and Community Organizations
Several other nonprofit and community organizations provide microloans to disadvantaged communities, including women, people of color and low-income entrepreneurs and startups. Each program has its own eligibility requirements and lending criteria. Many offer Small Dollar Loan programs funded by the Community Development Financial Institutions Fund.
The following are some of the well-known nonprofit microlenders:
- Accion Opportunity Fund, which offers microloans of up to $100,000
- Liftfund, a Community Development Financial Institution (CDFI) providing microloans in fifteen states
- Justine PETERSEN, another CDFI that offers different microloan programs providing proceeds of up to $50,000
Additionally, there are microlenders that serve the needs of underserved populations in specific geographic areas, such as Accompany Capital, which provides microloans to small businesses in the New York area.
Peer-to-Peer Lending Platforms
Peer-to-peer (P2P) lending platforms use crowdfunding technology to provide microloans to individuals and small businesses.
Here’s how it works: Through a P2P lending platform, borrowers can access microloans funded by multiple individual investors, each of whom provide a small percentage of funding to several microloans.
P2P microlenders include:
- Kiva, a nonprofit founded in San Francisco in 2005, offers microloans of up to $15,000 at 0% interest.
- Prosper, also founded in 2005, provides microloans of up to $50,000 repayable over two to five years. Note that Prosper microloans are personal loans, rather than business loans, but they can be used for any purpose, including investment in your small business.
How to Apply for a Microloan
Application requirements vary from lender to lender. Here are some general tips to help you prepare for the microloan application process:
Have a business plan. If you don’t already have a business plan, preparing one will go a long way toward helping you qualify for a microloan. Microlenders are used to working with startups and newer businesses that may not have had enough time to develop a revenue-generating track record. A good business plan helps you show your vision for your business and the roadmap you’ll take toward success.
Clean up your credit history. While many microlenders are willing to work with businesses with poor or no credit history, it won’t hurt to check your business’s credit report (as well as your own). See what you can do to strengthen or repair your score prior to submitting a loan application.
Compare microloan terms. If you have access to multiple microloan programs, be sure to research the terms offered by each. Compare loans and choose the one that will work best for your business’s financial needs.
Gather your financial and tax documents. You’ll likely need to provide copies of recent tax documents along with recent and past financial statements, including your balance sheet, income statement (also known as a profit and loss statement) and cash flow statement.
Next steps: Interested in more small business financing tips to help your small business succeed? Sign up for the Small Biz Ahead newsletter today.