Everything You Need to Know About Microloans for Startups

What are Microloans?

Microloans are small loans that businesses that can't access traditional loans or other finance options. It could be because they don't have any — or great — credit. It could be because their businesses aren't very established yet or they're locked out of the traditional financing options for a variety of reasons. They're usually short-term loans, with low-interest rates.

Microloans started in Bangladesh with economist Muhammad Yunus in the early 1980s. It was primarily to help people in developing countries who didn't have access to traditional small business loans. Access to a microloan program gave them funding to start businesses and raise themselves out of poverty. There are now a huge range of microlending options worldwide and a large percentage of new businesses cite having taken advantage of a microloan program at the early stages, after having been denied traditional business loans or small business loans due to a lack of credit history or a bad credit score. There are even startups that have taken this funding possibility and made it even more innovative.

Should you consider a microloan?

While a traditional bank loan is a great option if you can get one, four out of five small business owners don't. Small businesses and startups are risky businesses and the fact of the matter is, banks don't like taking on big risks. Also, relatively “tiny” loans — which feel big for your business — cost as much as large loans for banks, but bring a smaller return.

Another thing to consider is the size of your loan. Microloans — as you can probably tell from the name — are usually for small amounts (the average microloan is $13,000). For loans up to $50,000, you might have a hard time with a traditional loan from a bank. That's a good time to consider a microloan.

Who are the major microlenders?

There are two main sources of microloans: Online lending institutions and the government. Let's take a look at both.

Online lending institutions

Since the days of Muhammad Yunus' Grameen Bank, a host of online lending institutions have popped up to help people around the world access microloans. Here are some of the major ones to help you compare small business loans.

Kiva 

Kiva is the first online lending institution to connect individual people as investors to entrepreneurs who need funding around the world. Kiva's microloan program combines crowdfunding with microloans to raise money for everything from businesses to education to buying livestock to helping refugees who have lost everything. Investors can put in as little as $25, choose where their money goes, and get their investments returned — hopefully to invest again.

And while Kiva is known for its international work, they also offer loans to small business owners in the United States who are working to get their businesses off the ground.

Kabbage 

While traditional banks and lending institutions rely on markers like Credit Score to determine whether or not they're willing to take a risk on an entrepreneur, Kabbage takes a totally different approach. This online lending institution uses a proprietary algorithm that examines factors like a company's Quickbook or PayPal or whatever online program the company uses.

Because the company uses an algorithm, startups can find out right away whether or not they qualify. Once a company qualifies, Kabbage looks at its social media and can decide to increase the company's credit line based on that data.

Accion 

Accion offers microloans, with a loan amount of up to $50,000 to low- and moderate-income entrepreneurs. They also focus on women and other people who may have difficulty accessing traditional loans, including veterans, people of color, Native Americans, and people with disabilities through their Accion Opportunity Fund. They've been lending money for over 25 years and have served more than half a million American entrepreneurs.

Lending Club 

Lending Club looks more like traditional microloaning than some other companies, as they offer peer-to-peer lenders the ability to provide a small business owner a loan. They do take credit scores into consideration, but they're willing to accept scores that are a little lower than traditional banks. Entrepreneurs with credit scores of at least 660 can apply for loans up to $500,000. They also offer personal loans, up to $40,000.

Borrowers can apply online for their loans, get their loan approval and get their money directly in their bank accounts quickly after loan closing.

Coralus (formerly SheEO)

 SheEO loans out $5,500 per year to five woman-run companies, equity-free. Every applicant also gets feedback on their application, regardless of whether or not they're accepted.

Prosper 

With nearly 1 million borrowers and over $15 billion borrowed, Prosper was the first peer-to-peer lending marketplace in the United States. They offer online, fixed-rate loans between $2,000 and $40,000. They allow individuals and institutions — including Sequoia Capital, Francisco Partners, Institutional Venture Partners, and Credit Suisse NEXT Fund — to invest in businesses. They also offer personal loans for needs like baby and adoption, special occasions, home improvement, medical costs, and a range of others.

Government Agencies

In addition to private loans, the US government also has some microloan programs through the SBA. The Small Business Administration was founded in 1953 and is a federal government program that provides support to small business owners in the form of mentorship, workshops, counseling, and small business loans through an intermediary lender with a reasonable interest rate. While the SBA backs the loans in case the borrower defaults, they don't come directly from the SBA. You'll have to find local intermediary lenders who provide SBA loans in order to access the funding. They each have their own application process and eligibility requirements.

7(m) SBA Microloans

7(m) Microloans are approved and financed by the SBA via non-profit, community-based intermediaries. Typically, an SBA Microloan is quite small, with an upper limit of $50k and an average loan amount of $13k lump sum. The SBA Microloan program was created specifically to help women, low-income, veteran, and minority entrepreneurs, as well as other small businesses with limited credit in need of small amounts of financial assistance for a startup, operating expenses, or working capital.

In order to qualify for an SBA microloan, eligible borrowers must first meet the SBA size standards, because SBA loans are specifically for small businesses.

Farm Service agency

While only applicable to agricultural businesses or community-supported agriculture projects, the Farm Service Agency also allows underserved entrepreneurs in the ag space to access capital. Farms participating can obtain sufficient credit for farm buildings, equipment, working capital, and to help with cash flow or even ownership loans. Like SBA microloans, those from the Farm Service Agency are backed by the FSA but are funded through an intermediary lender, who defines the eligibility requirements, interest rate, maximum repayment term, etc.

Requirements for microloans and how to get one

Each microloan is going to have its own credit requirements and eligibility criteria, as outlined above. Some will want a sufficient credit level/credit history and existing debt from the business owner, while others won't even ask for a credit report but will take a look at your company's financial records to determine eligibility, interest rate, need for a down payment, etc. However, regardless of the loan, you decide to go for, or its credit requirements, here are some general steps you can take to get prepared.

1. Get your business plan in order.

For the typical business owner, writing a business plan feels like the startup equivalent of homework. It's the thing you know you have to do, but nobody actually wants to do it. Here's the good news: writing your business plan doesn't have to be this daunting, cumbersome chore. Once you understand the fundamental questions that your business plan should answer for your readers and how to position everything in a way that compels them to take action, writing it becomes way more approachable.

Check out our complete guide to business plans and our guide on how to write a business plan to help you through this step.

2. Do a credit check and clean.

While some microlenders aren't as concerned with business owner credit, it's still a factor that may be taken into consideration. It's worth checking your credit with one of the three major credit institutions. A good credit score can also help you get more favorable interest rates.

Most lending institutions use the FICO scoring system, which is as follows: Excellent Credit: 750+ Good Credit: 700-749 Fair Credit: 650-699 Poor Credit: 600-649 Bad Credit: below 600

If your credit falls below the “good” level, you might need to do a little credit maintenance before you apply for your microloan.

3. Be ready to invest in yourself.

Most entrepreneurs who are applying for a microloan don't have a ton of cash in the bank. (If they did, they wouldn't need to apply for a relatively small amount of money.) But lending institutions do like to see that you're investing in your company, so get your financial documents — like your most recent tax returns — together to prove that you've also been putting your own money toward your venture.

Another thing to consider is whether or not you have some collateral to offer up for the loan. That could be in the form of your home, for example, or other high-value personal property you own. When you offer collateral, the lender has a legal right to confiscate your property if you don't pay them back.

If you don't have any collateral, your lender may ask you for a personal guarantee. With a personal guarantee, the lender has the right to seize current or future personal savings, investments, or other valuable assets if you don't repay the loan.

Pros and cons of microloans

Pros of microloans

1. Access to capital. The biggest advantage of a microloan is expanding access to and leveling the financial playing field. People and companies who don't have access to other forms of capital might find it easier to qualify for a microloan than for a larger or more traditional loan type for their financing needs. People with low income, bad credit, new business owners, small businesses, and business owners in underserved communities all may find it easier to qualify with a microlender than with a traditional lender. Lack of access to funding has been the bane of the underestimated entrepreneur and diverse business owners since the dawn of business.

2. They can help with credit. Many people who apply for microloans have bad credit, but obtaining and paying back a microloan can be a good step toward rebuilding good credit, and microloan programs often offer some level of technical assistance when it comes to credit history repair.

3. Fixed rate interest. Microloans generally have fixed interest rates. Those rates are usually lower than those on credit cards or other forms of short-term loans. They also make repayment easier, because you know how much you'll owe each month. Rates will vary depending on a number of factors including the typical factors for credit decisions, but also what the funds are being used for, and the total requested loan amount.

4. Some include training. In addition to funding, many microlenders offer free training, technical assistance, and consultation to entrepreneurs to help them improve their businesses and manage their funds more effectively.

5. Flexible Terms. A core tenet of a microloan program is flexible terms. In addition to being more flexible with who they accept, they are generally also more flexible with their repayment terms, for example.

Cons of microloans

1. Small amounts. Microloans are called “micro” for a reason. The loan amounts are relatively small, compared to other loan types, with the average microloan being around $13,000.

2. Higher interest rates. Some microlenders may charge higher interest rates than traditional financial institutions because they're taking a higher risk. It's not the case with every microlender, but it is a possibility.

Other funding possibilities

Federal Government Grants for Small Business: What You Need to Know

Venture Capital: What It Is & Why Use It

Series A, B, C, D, and E Funding: How It Works

What is Crowdfunding?

Types of Crowdfunding: Donation, Rewards, and Equity-Based

Private Investors for Startups: Everything You Need to Know

Convertible Notes (aka Convertible Debt): The Complete Guide

Small Business Startup Loans: What You Need to Know