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A Quick Guide to Understanding SBA Loans in 2019

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

SBA loan rates
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SBA loans are attractive financing options for small businesses — they come with relatively low rates and are available to borrowers who aren’t able to get funding elsewhere. SBA loans tend to be focused on leveling the playing field in small business lending so underserved communities can gain access to capital and get the benefit of business growth in their neighborhoods.

What is the SBA?

The U.S. Small Business Administration is a government agency that assists small businesses throughout the country with business financing, education and technical assistance, federal procurement and advocacy.

A core aspect of its mission is providing small businesses — especially those that find it difficult to borrow elsewhere — with financing options to grow and improve. SBA approves partner institutions to administer loans from $500 to $5.5 million with agency backing to enable businesses to get access to working capital, purchase fixed assets and satisfy many other business needs. The SBA guarantees up to 85 percent of loans, so there is a reduced risk to the lender.

Loans offered through the SBA

There are three main SBA loan programs: the 7(a) loan program, the CDC/504 loan program, and the microloan program.

The 7(a) program provides loans up to $5 million for almost any business purpose, including purchasing equipment, supplies or real estate; refinancing existing debt; and buying or expanding an existing business. These loans come with various fees, including guarantee fees and prepayment penalties under certain conditions, so research the details before applying. Subprograms of the 7(a) loan program are focused on funding specific groups, such as exporters, underserved communities, military veterans and their families; and small businesses owners looking for cyclical working capital.

The CDC/504 program helps businesses buy fixed assets to enable expansion or modernization as a way to assist in community development. Administered by Certified Development Companies (CDCs), these long-term fixed-rate loans are geared toward helping business owners buy fixed assets such as buildings, land, facilities and machinery; or refinance debt in connection with an expansion.

The microloan program provides small loans up to $50,000 and are designed to help small businesses start up and expand. Averaging around $13,000, SBA microloans are targeted to female, low-income, veteran and minority borrowers and are most often used for working capital.

Who sets the interest rate for SBA loans?

The SBA sets permissible interest rates by regulation, as defined in its standard operating procedures and noted in the Federal Register. Lenders in turn decide what rates to charge their borrowers based on the SBA’s parameters. Lenders cannot exceed maximum rates approved by the SBA.

Fixed vs. variable SBA loan rates

It’s important to understand the difference between fixed and variable rates when investigating your loan options.

Fixed rates do not change over the course of a loan — you pay the same amount every month until the loan is fully repaid. From the beginning you know the total interest you’ll end up paying.

Variable rates, also called floating rates, on the other hand, go up and down over the life of a loan as prevailing interest rates fluctuate. The interest rate at the start of the loan may be lower than with a fixed rate, but there’s no guarantee that it will stay that way. These loans usually come with a cap on the interest rate, but that cap is extremely high in relation to typical fixed rates.

The SBA provides fixed and variable rate options. SBA 7(a) loans can have fixed or variable rates, while fixed rates are required on the 504 loan program. Generally, the 504 rate is lower than the 7(a) rate, according to the SBA.

How the SBA loan process works

The SBA does not actually lend money — it works with approved partner lenders, which administer the loans following the parameters set out by the SBA. Because the SBA guarantees a large portion of each loan, its partner lenders are more inclined to take risks on borrowers who may be underserved by commercial lending institutions.

The SBA has specific eligibility requirements for its loans: Borrowers must be a for-profit small business not larger than a certain size. They must do business within the United States, and the business owner must have invested some amount of their own money and/or time into starting and growing the business. The borrower must also have exhausted their options for financing from commercial lenders.

Eligible borrowers approach SBA’s lending partners directly to seek a loan, and the lenders instruct the business owners on what documents and SBA forms are needed to apply. The borrower gets the funding from the partner and pays the money back to the partner on the agreed-upon schedule.

How to apply for an SBA loan

Applying for an SBA-backed loan is similar to applying for any other commercial loan — private lenders who are approved by the SBA set the application requirements and administer the loans. The application process is different from any other commercial loan process in that borrowers must certify that they meet specific eligibility requirements stipulated by the SBA, such as the size of the business and history of unsuccessful attempts to borrow.

The first step in applying for one of these loans is finding a lender approved by the SBA. A good strategy is to consult with your local SBA District Office for referrals and advice. Approach the lender with answers to the following questions:

  • What will the loan be used for?
  • How much money do you need?
  • When do you need the funding?
  • How and when will you repay the money?
  • What collateral can you offer?
  • Can you provide a personal guarantee?

Most SBA loan applications will have to include a statement of purpose, a business plan and several financial statements: a cash flow statement, an income statement, a balance sheet and a personal financial statement. Other documentation will probably be required, including official SBA forms that are required for each loan type. For example, all SBA borrowers will need to submit SBA Form 1919, which provides borrower information for each proprietor, general partner, officer, director and managing member of an LLC. Your lender will be able to tell you exactly what to submit.

The bottom line

SBA loans can be a very good option for business owners who have found it difficult to gain financial support from regular commercial lenders that don’t have the backing of the SBA. Those in communities particularly targeted by SBA loans — such as minorities, women and the military community — may want to look into the possibility of getting funding through one of the SBA programs. Those who do gain SBA-backed funding will enjoy low interest rates to help their businesses grow.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Katherine Gustafson
Katherine Gustafson |

Katherine Gustafson is a writer at MagnifyMoney. You can email Katherine here

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Small Business

How to Convert Your For-Profit Business into a Nonprofit

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Converting a for-profit business to a nonprofit entity could be a smart move if charity and community impact has become your focus as a business owner. But making the change requires more than applying for tax-exempt status.

The process would largely depend on your state’s laws regarding business conversions, and not every company can become a nonprofit organization without a good reason for doing so. Only certain types of businesses can turn into a tax-exempt entity, a procedure that requires filing paperwork with state organizations and the IRS.

Keep reading to learn what it takes to turn a for-profit enterprise into a nonprofit organization, and if it’s the right move for your business.

Reasons to convert a for-profit business to a nonprofit

Although there are several tax-exempt designations within the IRS’ Internal Revenue Code, most nonprofits fall under the 501(c)(3) umbrella for charitable, religious and educational organizations.

The benefits of 501(c)(3) status include exemption from federal income tax, as well as the ability to receive tax-deductible charitable donations. Organizations with the 501(c)(3) designation are also more likely to receive recognition from grant-making institutions and foundations.

Before you can be awarded tax-exempt status, you would need to meet the IRS’ criteria. Organizations may not be formed to benefit private interests, and no portion of the organization’s net earnings can benefit a private shareholder or individual. Nonprofit employees can earn a salary though.

Meeting these requirements could be difficult as a for-profit business, unless you’ve had charitable intentions from the start, said Gene Takagi, an attorney with NEO Law Group, which represents nonprofit and tax-exempt organizations.

“Consider making that conversion if the existing for-profit entity really has a goal that’s not financial…but is really all about providing a public service or public good for charitable or welfare purposes,” he said.

Here’s an example: A neighborhood store that sells the work of low-income artists started as a for-profit business to get equity investments from community members but was unable to generate substantial interest and capital. Turning the business into a nonprofit organization would allow the owners to collect philanthropic donations to keep the store open. Because the business had a charitable, community-focused intent from the start, it could be approved for tax-exempt status.

But if a business seeks 501(c)(3) status for less charitable reasons, the IRS could deny the request, Takagi said. For instance, a failing business looking to get out of tax obligations couldn’t become a nonprofit without making operational changes.

“You’re really going to have to make a good case to the IRS,” he said. “It’s got to look different than what you were doing in the past.”

Converting for-profit to nonprofit: 5 steps to follow

Nonprofits are highly scrutinized, and business owners may be faced with more regulations than they’re used to, said Brenda Asare, president and CEO of The Alford Group, a consulting firm that advises nonprofits.

“Those processes are in place to dissuade people who may want to come into this sector to take advantage of other people philanthropically,” Asare said.

To make sure you correctly convert your for-profit business to a nonprofit, here are a few steps to follow.

1. Check entity conversion laws in your state

When you form a business, you must set up a certain entity, or structure, which determines the number of owners a business can have, the owners’ personal liability and taxes the business owes. Common entities include sole proprietorships, limited liability companies (LLCs) and corporations. Nonprofits are usually formed as corporations, though they are able to receive tax-exempts status.

When changing your business to a nonprofit, you would have to convert the current structure to a nonprofit corporation structure. Depending on where you live, only some entities may be eligible for conversion.

In Louisiana and California, for example, corporations, LLCs, general partnerships and limited partnerships can convert to another type of entity through the state’s Secretary of State office. On the other hand, New York does not permit statutory conversions for business entities. Instead, business owners must establish a new entity, then merge the two companies into one.

Check with your state’s Secretary of State office to make sure you would be permitted to change entities.

2. File conversion paperwork

Because nonprofits are corporations, they must be incorporated through the local Secretary of State. If your for-profit business was formed as a corporation, a conversion could be as simple as amending your incorporation documents, also known as articles of incorporation. You’d need to file incorporation forms again to make the conversion, which would typically range in cost from $50 to $150. Additionally, because a nonprofit corporation does not have ownership, as a board of directors shares responsibility of the organization, existing shareholders of the for-profit business would have to forfeit ownership.

If your business is not a corporation, you would need to file new articles of incorporation with your Secretary of State. The articles of incorporation would call for the organization’s name, the purpose of the nonprofit and a designated registered agent to receive lawsuits and correspondence on behalf of the organization.

Other requirements when forming a nonprofit corporation include appointing a board of directors to make decisions about the organization’s activities, finances and legal compliance and drafting bylaws that regulate the board’s management and activities. The board of directors would also approve your compensation as the executive director or CEO of the organization, including your salary, health insurance and paid leave.

3. Apply for tax-exempt status with the IRS

You would need to submit IRS Form 1023 to apply for tax exemption under the 501(c)(3) code. Additionally, you would need to include a statement of your receipts and expenses, a copy of your articles of incorporation, a written description of your organization’s activities and a copy of your bylaws. You may need to apply for tax exemption at the state level as well.

For instance, nonprofits in California must file Form 3500A with the California Franchise Tax Board to be exempt from state income taxes. Organizations in Texas need to file Form AP-204 with the Texas Comptroller of Public Accounts, while nonprofits in Florida must submit Form DR-5 to the state’s Department of Revenue.

Timing is key when forming a nonprofit and requesting 501(c)(3) status, Takagi said. Make sure your organization is compliant as a nonprofit — meaning you have a charitable purpose, board members and bylaws in place — as soon as you make the entity conversion. This could help you avoid getting turned down for tax-exempt status and owing taxes to the IRS, he said.

4. Decide what to do with your business assets

After you convert a for-profit corporation to a nonprofit organization, all existing business assets would be held in a charitable trust, which means assets could only be used for the organization’s charitable purposes going forward. Intellectual property could be included as well, such as books, music or art.

You could take assets out of the business before making the conversion if you want to limit the assets that are put into the nonprofit, Takagi said. Then, any assets you decide to put into the nonprofit at a later time could be categorized as a charitable donation.

If you’re concerned about a delay in receiving tax-exempt status, you may not want to lock all of your assets in a charitable trust right away. You could form a separate nonprofit and continue running your business to maintain access to your assets, Takagi said.

“It might be more practical in some cases to not convert but run them side by side for a little while,” he said. “Then either merge or dissolve the company and then donate assets to the nonprofit at that time [when] you already know the nonprofit has 501(c)(3) status.”

5. Set up your fundraising strategy

Once you no longer run a for-profit business, you must begin collecting charitable donations to keep the operation afloat. Nonprofits need to generate a profit, despite their title, but those profits must be reinvested in the organization rather than distributed to owners and shareholders, as a business would do.

State laws regulate fundraising activities. You may be required to register with a state entity before you begin soliciting donations from local residents, and you may need to register in multiple states if your donor base crosses state lines. For example, nonprofits in North Carolina must obtain a license from the Charities Division of the Secretary of State’s office. Depending on your state, you could be required to renew your registration each year to continue legally accepting donations.

Private and public grants and individual donations are common funding avenues for nonprofits. Donors would likely want to understand the organization’s mission and target market before giving money. A misconception about the nonprofit sector is that organizations can easily secure money with few strings attached, Asare said. However, donors often scrutinize nonprofits before making a contribution.

“Nowadays, there aren’t many places you can get money without the expectation that organization is making an impact,” she said.

Donors could be suspicious of a nonprofit that was formerly a for-profit business, Asare said. Be prepared to explain how you plan to spend donations to show you’re not seeking personal financial gain.

“I think a good measure would be looking at what percentage of the dollar is going to the services and programs,” she said. “This is something donors are interested in and they will ask.”

Ongoing requirements after making the switch

After you’ve made the change from for-profit to nonprofit, you’d need to meet ongoing requirements to remain compliant as an organization. From filing certain tax forms and reports to paying particular taxes, here are some requirements to keep on your radar:

Form 990: Most tax-exempt organizations are required to file IRS Form 990 each year. Nonprofit entities must describe the organization’s activities, governance, financial information and accomplishments to justify its tax-exempt status.

Organizations that have generated at least $200,000 annually or have assets worth at least $500,000 must file Form 990 yearly, while organizations with fewer assets and a lower income can file Form 990-EZ, a shorter version of the form. Form 990-N, which is even shorter, is available to nonprofits with gross receipts of $50,000 or less.

Employment taxes: Nonprofits with employees must pay employment taxes, which include federal income tax withholding and Social Security and Medicare taxes. You could be responsible for federal unemployment tax as well.

State filings: States often require nonprofits to file reports each year. These reports could include corporate filings, financial reports, fundraising registrations and state tax-exemption forms. Failing to file annual reports with your state office could result in penalties or loss of your tax-exempt status.

The requirements for nonprofits may seem excessive, but policies are in place to ensure that organizations are honest about how the program uses donated money, Asare said. Compliance standards act as a safeguard to make sure money is going toward services and not into the pockets of the people in charge.

“The window is closing on some of that bad behavior,” she said.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Melissa Wylie
Melissa Wylie |

Melissa Wylie is a writer at MagnifyMoney. You can email Melissa at [email protected]

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Small Business

Brick-and-Mortar vs. Online Banks: Which is Better for Small Businesses?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Separating your personal and professional finances is crucial when starting a business, and changes in technology are making it more convenient to do so. Not only could you turn to traditional brick-and-mortar banks, but you could take advantage of the resources that digital banks offer.

Opening a business bank account would allow you to clearly track your income and expenses without putting your personal spending in the mix. Managing a business bank account would also help you build your credit profile — you could become eligible to open a business line of credit or credit cards connected to your account.

Whether you choose an online bank or a brick-and-mortar bank would depend on which type fits your needs as a business owner. Keep reading to find out what kind of bank would be best suited for you.

Small business banking: Brick-and-mortar vs. online banks

A key difference between traditional and online banking is the flexibility that digital banks provide, said Barry Coleman, vice president of counseling and education programs at the National Foundation for Credit Counseling. Small business owners could have around-the-clock access to online banking services as long as they have a device and an internet connection.

“This can certainly help busy business owners who are strapped for time by allowing them the option to bank on their schedules,” he said.

Brick-and-mortar banks

Although most brick-and-mortar banks now offer online banking features, consumers still must make some transactions in person, Coleman said, such as cash transactions that require personal identification. When opening a business checking account with Chase, for example, customers must meet with a business banker before enrolling in online and mobile programs. Still, this could be a draw for some business owners.

“Some consumers are simply more comfortable having a physical banking location where they can perform transactions and speak to banking associates in person,” Coleman said.

New business owners could also benefit from the guidance that bankers provide, said Grier Melick, business consultant at the Maryland Small Business Development Center. Establishing a personal relationship with a banker could also be beneficial if you plan to apply for a small business loan. You may have a better chance of being approved for funding if the bank already knows and trusts you.

“Oftentimes, small business owners do not know everything that they need to from a business banking perspective,” Melick said. “Having some direct human involvement can help with that.”

Online banks

Online banks have lower overhead costs than traditional banks, and those lower costs typically result in higher interest rate yields on deposits for digital banks than branch-based banks, he said. For instance, a high-yield business savings account could have an APY as high as 2% and no minimum account balance.

However, brick-and-mortar banks have the advantage of allowing customers to make cash deposits or withdrawals; an online bank typically wouldn’t offer that feature, Coleman said. However, online banks sometimes belong to free ATM networks, like Allpoint, which would allow you to avoid the withdrawal fees that you’d incur at other ATMs.

Best of both worlds

It’s possible to have accounts at both types of banks, Melick said. For example, the owners of a brick-and-mortar store may start with an account at a local bank branch, then open a digital account when they decide to start selling online.

“Instead of severing ties with the bank, they could open an online account as well to handle their other revenue streams,” he said.

You could be subject to banking fees at both traditional and online banks, Coleman said. However, online banks generally charge considerably fewer fees and you may be able to avoid overdraft, monthly maintenance and ATM fees that come with a traditional bank account.

Here’s a quick look at how the two types of banks stack up.

Online banksBrick-and-mortar banks
24/7 access to accounts and banking features.Online banking features typically offered, but some transactions may have to be completed in-person during bank hours.
High-yield accounts available.Lower interest rates because of overhead costs.
Customers cannot complete in-person cash transactions or meet with bank representatives.Customers can make cash transactions, and bank representatives are available for meetings.

Digital services on the horizon for traditional banks

Online banks are growing in numbers and popularity, Coleman said. Traditional banks have taken this trend as a cue to bolster digital offerings for consumers.

“As a result, we are seeing traditional banking introduce more digital options for providing services,” he said.

The presence of digital financial technology is expanding within the financial services industry, comprising 7% of the total equity of U.S. banks, according to research from consulting firm McKinsey. To keep up, traditional banks must consider ramping up digital efforts in areas such as design, innovation, personalization, digital marketing, data and analytics to provide value to customers.

A few traditional banks rolling out expanded digital services include:

Bank of America

Earlier this year, Bank of America created Business Advantage 360 for customers who have business deposit accounts with the bank. The free tool provides a digital dashboard showing business owners their major expenses and transactions, as well as automated cash flow projections that can be adjusted to account for new sales or other data. Users can also connect with small business bankers through the dashboard.

PNC Bank

PNC Bank rolled out a digital business lending platform this year in partnership with OnDeck, an online small business lender. Leveraging OnDeck’s digital loan origination process, PNC aims to provide customers with business financing in as few as three days, a significantly faster timeline than how long it would take to process a conventional bank loan.

Popular Bank

Similarly, New York-based Popular Bank announced a partnership last year with Biz2Credit, an online lender serving small businesses. Popular Bank leans on Biz2Credit’s technology to digitally process loan applications outside of regular bank hours, effectively speeding up time to funding.

As the lines begin to blur between online and brick-and-mortar banks, business owners may find themselves with an increasing amount of digital opportunities. However, a demand for brick-and-mortar banking will likely remain. Small business owners who borrowed from an online lender reported feeling less satisfied than those who borrowed from a community bank — 49% vs. 79% — according to a Federal Reserve survey.

“Whether consumers turn to online only banks, or traditional banks that offer online products and services, the availability of online options will more than likely continue to grow,” Coleman said.

Which bank is best for your small business?

Whether you choose an online bank or a brick-and-mortar bank to house your business funds would depend on your personal preference, Coleman said.

No matter which you pick, make sure the Federal Deposits Insurance Corporation insures your bank of choice, he said. Single consumer accounts, joint accounts and business accounts, among others, would be protected at FDIC-insured banks in the event of bank failure. Deposits up to $250,000 should be safe and covered.

If you like having the ability to sit down with a banking professional to discuss your business needs, a branch-based bank could be the better choice, Coleman said. The physical presence that traditional banks provide could add a level of trust and reassurance. Keep in mind, though, that most locations have standard business hours that may not be conducive to your schedule as a business owner, he said.

A digital bank would allow you to complete your banking activities on your own time, said Coleman, though traditional banks oftentimes provide online services as well. He also noted that you may want to avoid using a public WiFi network to make business transactions, as those networks may not be secure and your information could be vulnerable.

A digital bank wouldn’t offer the same in-person service as a traditional bank, Coleman said, but you may not feel like you’re missing out.

“If the business owner already knows what they are looking for in a bank, and the online bank meets their needs, then they may prefer the online bank for its convenience, potential lower fees and higher interest on deposits,” he said.

All business owners should at least consider opening a high-yield savings account for cash that isn’t needed for daily operations, Melick said.

“Small businesses need to make sure that every penny they make works for them,” Melick said. “Oftentimes, the best way it can is through online banking accounts.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Melissa Wylie
Melissa Wylie |

Melissa Wylie is a writer at MagnifyMoney. You can email Melissa at [email protected]