Not all businesses need loans for large amounts of money. In many cases, business owners who apply for traditional business loans are turned down simply because they aren’t looking for loans large enough for the lender to see them as being worthwhile. To help businesses grow by handling those less expensive needs, some lenders and other organizations offer microloans.

What Is a Microloan?

A microloan is simply a business loan for a relatively small amount of money, less than $100,000. In the United States, the average amount of a microloan ranges between $10,000 and $13,000. Microloans are a type of short-term loan and are typically meant to be paid off within a year. 

Traditional lending institutions, such as banks and investors, are unlikely to offer loans and investment capital to small businesses due to a variety of reasons. One barrier to microlending is a concern that startups and smaller enterprises are risky investments since growing businesses typically show dramatic bursts of growth and downturn. The perceived risk of these types of companies reduces the chances of a microbusiness obtaining business financing.

Another issue is that less established businesses typically require smaller amounts of capital, and lenders often believe that it is not an efficient use of their time or resources as they will not receive a substantive return on investment.

Types of Microloans

In terms of obtaining a microloan, there are a variety of different sources where they can come from. SBA microloans can be the most common, but online and alternative microlending are also prevalent.

SBA Microloans

The Small Business Administration (SBA) offers a microloan program. SBA microloans are available in amounts up to $50,000. Unlike other types of SBA loans, the SBA microloan program is funded with money from the U.S. government. Instead of applying through a lender like a bank or a credit union, people interested in SBA microloans need to apply through an approved non-profit organization, known as an intermediary, in their area. Each intermediary is free to set their own criteria for applicants to meet.

Banks are more likely to lend an SBA-backed microloan as there is less associated risk when operating as an intermediary. While lending small amounts directly to small businesses is typically not worthwhile, banks are often interested in serving small businesses with support from the SBA.

Online and Alternative Microlending

Online and alternative microlending can be used as an umbrella term for several alternative lending models, including direct private lending, marketplace lending, and even crowdfunding platforms. 

  • Direct private lenders use their own money to issue smaller-sized financing, rather than relying on depositors or investors. This allows direct private lenders to be extremely flexible in granting applications.
  • Marketplace lenders (peer-to-peer lenders) leverage a technological platform to circumvent banks and connect borrowers directly with investors. 
  • Crowdfunding platforms offer borrowers a place to raise small amounts of money from a large number of individuals. Generally, the borrower sets a goal and then markets their campaign to appeal to potential investors

Online and alternative microlending tends to be a more flexible option than conventional loans and is often a very fast business loan. Because small businesses are more sensitive to externalities, natural disasters, and cash flow shortages, alternative lending has become a go-to financing source for small businesses.

While most banks and conventional lenders could take weeks to approve or deny a microloan application, many alternative lenders can deliver funding in a few days. Additionally, the application process with alternative lenders tends to be simple, requiring only a credit score, tax returns, and bank statements rather than a detailed pro forma or business plan.

Microloans for Women

Studies show that women-owned businesses start with about half the capital men do and on average receive about 6% of the outside equity that male-owned businesses receive. Female entrepreneurs also receive less than 5% of conventional small business loans, even though they make up nearly 40% of all small businesses in the country.

Microloans are often favored as they offer an affordable way for women-owned businesses to secure competitive rates and terms. Additionally, these programs also offer mentoring and business resources to help scale your business. The Small Business Administration created the SBA Office of Women’s Business Ownership to help women-owned businesses find and obtain the funds they need to grow and thrive.

Advantages of Microloans

Many different types of businesses can qualify for a microloan even if they aren’t able to get a regular business loan. Unlike many other types of business funding, microloans are more accessible to startups and young businesses with a brief operating history. Microlenders tend to provide a pathway for small-business owners to receive the capital they need to grow their operation while building their credit score, improving your opportunity to obtain more traditional debt financing in the future. In addition, many microlenders will guide you through the loan process and offer advice to increase your likelihood of approval and sustained success. Plus, microloans can take as little as 14 days to be approved, whereas traditional loans backed by the SBA can take months.

Lenders who offer microloans do consider your credit score. However, since microloans are most typically sought by businesses who need a small amount of money for something that will allow them to grow and expand, microloan lenders are generally more inclined to focus on your long-term business goals and plans. Because microloans are more forward-looking in nature, you should not let a weak credit history prevent you from applying.

These programs make a huge difference in improving access to capital for female and minority entrepreneurs who are far less likely to be approved through traditional banks and lending institutions. With microloan programs dedicated specifically to these affinity groups, many businesses that would typically have a tough time receiving debt financing have an outlet they can look to for financing.

Disadvantages of Microloans

Microloans have a few drawbacks, but the biggest is the smaller funding amounts and the inflated interest involved. While you’ll pay less interest than a typical credit card, you will most likely have a higher cost of capital than you would if you received a traditional bank loan. And if you need a large sum of money to get your business off the ground, a microloan may not be helpful. It is also important to note that a missed payment on a microloan can still hurt your credit just as much as defaulting on a conventional loan.

Is a Microloan Right for Your Business?

Microloans can be a game-changer for a small business, but they aren’t right for everyone. While microloans are great for businesses who only need small funding amounts, or for ones who have difficulty applying for other financing options, they aren’t the cheapest option for established operations.

 In many cases, business owners who are interested in microloans are seeking money to pay for something that will help fuel their business’s long-term growth. Microloans can be used for a very wide variety of purposes, including paying employees, purchasing inventory or equipment, and marketing expenses. Since microloans have shorter terms than regular business loans, they’re not recommended for making major purchases like buying real estate or other long-term investments.

When applying for a microloan, consider how much capital you need, what you plan to use the capital for, and how likely you are to qualify for other financing options. Just because you can qualify for a microloan doesn’t mean that it is your best option.

Although applying for a microloan isn’t as complicated as applying for a larger business loan through a bank, careful planning will increase the odds of your application being successful. Lenders will still want to see a business plan that includes details about how you plan to use the funds from your loan and how it will help your business thrive in the long run. Many lenders also like to see that you have invested some of your own personal money into the business or would be willing to do so.

Microloans are an excellent loan option if your business needs a small amount of capital without the complications involved when applying for a larger business loan. Additionally, many microlenders can help provide the resources your business needs to reach the next stage of growth, which can be invaluable.