Dangers of Minority Business Loans

Minority business loans through the Small Business Administration help minority and female business owners to start or expand their operations. The SBA does not directly provide the loan; instead; it guarantees a loan provided by a private lender. These loans are often available with lower qualifications and lower interest rates than loans not guaranteed by the SBA. The goal of these loans is to make business financing affordable for typically economically disadvantaged portions of the population. While this can be very beneficial, there are also inherent dangers for borrowers with these loans.

Risks of Too Much Financing

Banks have loan qualifications for a reason. They use these qualifications to ensure borrowers can make monthly payments and pay off the loan according to schedule. Small business loans are often high cost, and lenders will only distribute these to businesses with a good financial record or high profit potential. When the federal government asks banks to lower these standards, the banks and lenders may provide the loan program as an option to a borrower who is not qualified under normal standards. 

This can be good for minority owned businesses in the short run but bad in the long run. If the business cannot truly stand on its own legs, make a profit and repay the loan on time, the financing will end up in default. Over-financing a business is not a good idea even if you can qualify for the loans. If business owners are not savvy about these choices, lenders can be placing them at a high risk for bankruptcy by giving them the financing.

Prevent Changes in Ownership Structure

If your loan has been extended on the basis of your status as a minority, a change in ownership structure for your company may not be possible. For example, if you want to take on an investor or partner, that person may be from a non-minority group. You may have to reject this option if you loan contract excludes you from changing your ownership structure in this way.

While this may seem unfair, it is done to prevent businesses from seeking a minority owner solely for the purpose of attaining guaranteed loans in the beginning. The result is the loss of control in who can be on your business's board of directors or share in ownership of the company.

Prescribe Loan Usage Guidelines

When you work with the government instead of a private lender, you will have less freedom in how you use the loans. You will often have to allocate the funds to specific purposes as determined by your loan contract. If you wish to seek additional financing, moreover, you may have to break your loan contract to do so. The government will only guarantee loans if they meet very specific criteria, and taking on more debt can be outside of that criteria.

Ultimately, a federally guaranteed loan is much less flexible than a private loan. You should only use this option if you are willing to sacrifice some degree of control in order to save money on financing costs.