What is microlending? Accessible funding alternatives for small businesses

Lack of funding is one of the biggest reasons small businesses in the US fail—and the current lending system doesn’t help. 

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A 2020 Federal Reserve Bank survey revealed that 38% of small businesses seek $50,000 or less in business funding, yet most traditional lenders refuse to give out loans below that amount. And let’s not forget the entrepreneurs and companies that find themselves deprived of traditional financing due to less-than-perfect credit histories, not enough money in the bank, or cash flow issues.

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To solve this growing problem, many business owners have turned to an alternative method of financing called microlending. In this article, we’ll look at what microloans are, who can benefit from them, and the different options and alternatives available to small business owners looking for funding. 

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What is microlending and how does it work?

Microlending is the practice of granting small amounts of money known as “microloans” to people or businesses without access to traditional financial services. 

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These loans, which typically are less than $50,000, are often provided by government agencies, microlending platforms, and nonprofit organizations that target specific communities or demographic groups. In order to support these individuals in their ventures, microloan providers may offer affordable interest rates and reasonable loan terms. 

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Once they receive the funds, borrowers use them to start or expand their business. They’re typically required to pay back the loan amount in installments with interest until the debt is fully repaid. 

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What needs or situations can microloans address?

Much like traditional bank loans, small businesses can use microloans to fund their business operations, pay employees, purchase equipment, stock up on inventory, and more. 

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Unlike traditional loans, however, microloans address the needs of three types of companies that typically don’t qualify for these opportunities:

Lending to companies with bad credit

Many small business owners in search of financing encounter barriers due to bad personal or business credit. Additionally, some entrepreneurs and startups don’t have good standing with lenders simply because their venture has no credit history to begin with. 

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Microlenders aim to help these businesses with their funding efforts, although they may tack on additional lending requirements to offset their risk. 

Lending to companies that only need a small amount

Most banks avoid offering loans of less than $50,000, since they make less of a profit on them. And in the current economy, fewer business owners have the ability to close smaller financing gaps on their own with home loans, credit cards, and other alternatives. 

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Microloans help business owners cover these revenue gaps without resorting to predatory lending methods that can stifle cash flow in the long term.

Lending to businesses owned by people from underserved populations

Minority-owned small businesses historically don’t receive the same amount of funding or resources as their counterparts. As a result, some nonprofit organizations focus their lending efforts on underrepresented or low-income small business owners. 

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Many of these microloan providers also offer additional resources—such as business coaching, financial education, and mentorship opportunities—to ensure borrowers make the most of their funds and give their businesses the best chance to thrive. 

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Pros and cons of microlending

Like any other type of business financing, microlending comes with its fair share of advantages and disadvantages.

Pro: Accessibility for a wider range of businesses

Due to their financial situation, many new businesses don’t have the luxury of choosing between a traditional business loan vs. a line of credit. Microloans, with their broader range of requirements, alleviate this issue. 

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Traditional lenders typically require strong business and personal credit scores, a low debt-to-income ratio, minimum annual and monthly revenue thresholds, and loan collateral. In comparison, you don’t need the best credit score or the most impressive business plan to receive a microloan, and you might have access to better terms, too. 

Pro: Additional resources to grow your business

Many microlenders offer borrowers resources to improve their business, as this may increase their ability to fully repay the loan. Depending on the provider, you may get access to business education and training, marketing and sales support, networking opportunities, and more. 

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Some lenders will also report your repayments to one of the commercial credit bureaus—Equifax, Experian, and Dun & Bradstreet—which can help build business credit and give you access to better financial products later on. 

Con: High interest rates

Because microloans are much more accessible than their traditional counterparts, providers attract applicants who are far too risky for banks and other lenders. To offset these risks, microlenders may charge higher interest rates on their products. 

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As a result, borrowers might spend more money paying back the debt than they would with other financing methods.

Con: Personal assets as collateral

Many financial institutions reduce their risk by securing assets as collateral—a practice some microlenders have picked up as well. 

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You’ll want to know upfront if a lender will require collateral, and decide whether it’s worth it to put up something as valuable as your home for it. If not, you’ll be better off going to another provider for the funds you need. 

Con: Length of time to receive the funds

If you’re looking for a quick cash infusion for your business, a microloan may not be your best choice. Although microloan applicants often get approved faster than those for traditional loans, it may still take some time for the lender to review your application.

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Some microlending organizations also have other requirements that borrowers must fulfill—like completing business training or raising funds from their personal network—before receiving the loan, which further increases the length of time between approval and disbursement.

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Applying for microlending

Application and loan requirements can vary widely between microlenders. However, you’ll find that the general process is similar to that of traditional banks and other financial institutions:

1. First, compare providers to get a sense of their requirements. Typically, microlenders that aim to make a profit have higher interest rates and stricter qualifications, while mission-driven organizations tend to have better terms and offer additional resources for borrowers. 
2. Once you choose a microlender, put together the documents needed to submit your application. This will usually include your personal contact and financial information, a strong business plan, and details on your company’s financials.
3. The underwriting process begins after you submit your application. The lender will review your application, your credit history, and your company’s current standing and financial projections. 
4. Once your application is approved (and you meet any additional guidelines required by the lender), you’ll receive the total loan amount, typically via direct deposit to your bank account.

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Popular microlending options 

SBA microloan program

The Small Business Administration (SBA) offers microloans of up to $50,000 for new and expanding small businesses for a variety of purposes, including working capital, equipment, inventory, supplies, and machinery. The federal agency works with a number of approved nonprofit lenders throughout the country to administer these loans. 

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By covering a portion of the total loan amount itself, the SBA makes it less risky for these institutions to grant loans to the businesses that need them. Since lenders handle much of the process themselves, they’re also allowed to set their own lending and credit criteria for borrowers. 

US Department of Agriculture microloans

USDA Farm Agency Service (FSA) microloans are designed to support the needs of new, small, niche, and non-traditional farming operations in the US. Borrowers can apply for up to $50,000 in funding and use the proceeds towards expenses such as down payments on a farm, building repairs or improvements, tools, equipment, and marketing costs. 

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As collateral, the USDA may require borrowers to put up farm property or agricultural products valued at 100%-150% of the loan amount. 

Kiva

One of the most popular microlending platforms today, Kiva is a nonprofit that uses a crowdfunding model to provide loans of up to $15,000 with 0% interest. Rather than the traditional underwriting method used by most lenders, Kiva uses what it calls “social underwriting.” 

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After a prospective borrower’s initial application is approved in this process, they have 15 days to recruit lenders from their own network as an endorsement of their character and creditworthiness. Once the requirement is met, the borrower can then appeal for funds from the entirety of Kiva’s investor network for 30 days. 

Grameen America

Grameen America offers microloans starting at $2,000 to women entrepreneurs who live below the federal poverty line in a unique business model that sets them up for success. 

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Approved applicants form groups with 4 other women they trust, open a free savings account at a commercial bank, and receive extensive financial training—after which borrowers receive their loan. Each group continues to meet once a week until the loan is repaid. During this time, they receive additional financial education and support. 

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To further improve the financial outlook for borrowers, Grameen America reports repayments to Experian so they can build their credit profile and qualify for more financial opportunities. 

Accion Opportunity Fund

The Accion Opportunity Fund grants small business loans from $5,000 up to $100,000, particularly for businesses owned by women, people of color, and immigrants. 

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But that’s not all. In addition to providing loans to applicants with Individual Taxpayer Identification Numbers (ITINs), the nonprofit offers educational resources, personalized coaching opportunities, and support networks for borrowers in English and Spanish.