Contract Loan Program: Disadvantages

A government guaranteed contract loan can provide small businesses the resources to secure a contract with a large, federal organization. Many small, privately held businesses lack the resources needed to develop and fabricate a product in order to go after a government contract. These loans, largely funded through the Small Business Administration, are aimed at ensuring small businesses have an equal opportunity to secure the contracts and diversify the government's portfolio of contractors. While there are a number of advantages to obtaining a contract loan, there are also some drawbacks to be aware of.

Stringent Requirements

Contract loans are guaranteed by a government agency but given by private lenders. These lenders must meet the requirements set by the agency in order to receive the guarantees. Those requirements are actually requirements for the borrower. For example, a lender may typically extend a loan to a business with a credit score of 700 at 3% down payment. The federal government, however, may allow for 0% down payment, but only if the business has a credit score of over 800 and a monthly profit minimum. These regulations are set each year and vary by the type of loan being sought.

Other requirements may be that you are the sole owner of the company, that you reside in a certain state, or that your company does not receive funding from investors. All of these criteria are dictated from the top down. In the end, you must fit into a fairly narrow window to quality for most contract loans and SBA loan guarantees.

Lack of Control

Stricter loan qualifications are not just present at the time of your application. Most of these loans will have very strict terms you must follow throughout the lifetime of the financing. Even though these are generally short-term loans, it can be difficult for entrepreneurs to have to follow a specified set of rules about how to do business.

Some restrictions may include the other types of companies you engage during the loan cycle. Most of the loans will prohibit the borrower from seeking additional financing through private investor or otherwise during the loan. Some may prohibit a business from going public for a period of time after the contract. All of these can become very burdensome on an otherwise flexible small business owner.

Short-Term Financing

Contract loan programs generally extend short term business expansion loans. However, it can be very costly to work with the government once you secure the contract. Often, the federal government has large debt cycles with your business. This means you will have to continue to work and produce a product before getting paid.

Some small businesses will be turned down for contracts if they do not appear to have enough financing to carry out the project beyond it initial development. You may need to seek additional financing in order to secure the contract in the long-term and make the money you spent on your contract loan pay off.