SBA loan or conventional bank term loan: how to tell which you want

Run both quotes. Most borrowers who qualify for a conventional loan never ask for one, because a broker told them SBA was the answer before anyone looked at the file.

Where the conventional loan wins

Where the SBA loan wins

The comparison to actually run

Get both offers on paper and line up:

1. Maturity, and whether there is a balloon. Put the balloon date in your calendar and ask yourself what you will do that year.
2. Down payment or equity required, in dollars.
3. Rate, expressed as base rate plus spread, fixed or variable, with the reset frequency.
4. All fees: guaranty fee, packaging, third-party costs, on both sides.
5. Collateral required, including whether a personal residence lien is involved. Some conventional loans ask for less; some ask for more.
6. Prepayment charges, on both.
7. Covenants. Conventional loans often carry financial covenants and annual reporting that SBA loans do not, and a covenant breach is a default even when you are paying on time.

What the balloon actually looks like

The balloon is the reason the program exists, and it is worth seeing in numbers rather than as a word on a term sheet.

That is the exposure. In year five you refinance more than nine-tenths of the original loan, at whatever rates exist that year, with whatever appetite the market has for your property type, based on whatever your financials look like after five years. If all three are favourable, the balloon costs you some paperwork. If any one of them is not, it is the event that ends the business.

A fully amortising structure removes that refinancing risk entirely. Whether that is worth a guaranty fee and a longer process is a judgment, but make it against $911,622 rather than against an abstraction.

Covenants are the term nobody compares

Conventional term loans commonly carry financial covenants — a minimum debt service coverage ratio, a maximum debt-to-worth ratio, sometimes a minimum tangible net worth — tested quarterly or annually, with financial statements due on a deadline.

A covenant breach is a default even while every payment has been made on time. The practical consequences range from a waiver fee and tighter reporting to repricing, a demand for additional collateral, or acceleration. SBA loans generally carry lighter financial covenants, and for a business with volatile earnings that difference can be worth more than the rate.

Ask both lenders for the covenant package in writing, then back-test it. Apply each covenant to your last three years of actual results and see how many quarters you would have failed. If the answer is any, negotiate the level now, while you are being courted.

Prepayment runs differently on each side

Conventional loans often carry a fixed prepayment schedule or a yield maintenance formula that can be expensive to unwind early. SBA loans with longer maturities carry a statutory prepayment charge in the early years of the term, and 504 debentures have their own declining prepayment structure.

Neither is a reason to choose one over the other, but both belong in the comparison, especially if you expect to sell the business or the property inside five years. Ask each lender for the payoff penalty in dollars at year one, year three and year five.

The rule of thumb

If the bank will write it conventionally and the structure works for the business, take the conventional loan. The SBA's credit-elsewhere requirement is telling you the same thing.

Take the SBA route when the thing you need is the thing conventional credit will not give: the term, the lower injection, or approval despite a gap in the collateral. Pay the guaranty fee and the extra paperwork for that, deliberately, knowing what you bought.

And ask the same bank for both. A lender with an SBA department can quote you side by side, and the answer to "which of these would you rather do" is informative on its own.