The market for business loans is thriving in 2019, with a wide range of well priced deals on offer for businesses of any size.
Let us talk you through how these loans work, what to look out for, and what are the viable alternatives.
What is a Business Loan?
A business loan is a loan for specifically business purposes. Either secured or unsecured, these loans entail the creation of a debt and an agreed repayment rate of interest.
While alternative forms of finance such as invoice finance are considered business loans, the traditional form of a business loan is to borrow a sum of money from a lending institution (i.e. a bank).
Almost all lenders will insist on some form of collateral, usually a fixed asset of some kind such as a property. Where a business doesn’t have the necessary assets, unsecured loans are possible although their upper limit will be capped.
How long you have to repay it depends on the agreement you have in place: typically, terms last from a few weeks to as long as five years.
There are many different types of business loans. Below, we’ve listed some of the key categories you may encounter. NB these are not mutually exclusive, you might find a ‘bad credit loan for small business’, for example.
- Secured – Requiring collateral
- Unsecured – Available to businesses with no security/collateral to offer
- Bad Credit – Some alternative finance providers specialise in higher interest loans for those who would normally fall outside the lending paramers
- Small Business – These loans cater to smaller turnover businesses.
- Short Term – For durations of 2 months to 2 years
- Fast Loans – Loans designed to deliver cash as quickly as possible, sometimes in less than a day.
How do you Qualify for a Business Loan?
Qualifying for a business loan depends, principally, on how much you want to borrow, how long you’ve been trading and how much security you have to offer.
Even if you’re not a startup, a sound business plan outlining how you’re going to scale the business is a useful supporting document. The lenders will want to understand how you’re going to use your loan, and what effects you predict it to have on the bottom line.
Both your company credit score and those of the directors may be a factor, plus your annual revenue, your debt to credit ratio, and the age of your business.
Your may also need recent tax returns, ongoing balance sheets, and profit and loss statements for the last 2 years.
Secured Vs. Unsecured Business Loans
For any lender, loan security ranks as their highest criteria when considering whether to lend. If you sign over a security entitling them to a legal charge over a property, for example, their risk drops substantially. Should you default on the payment, the value of the assets means they can simple force sale and recoup what they’re owed.
Many businesses, however, don’t have the luxury of a commercial asset to offer as collateral. In those instances they have two options:
- Sign a director’s personal guarantee document
- Opt for an Unsecured business loan
Personal guarantees (covered in more detail later on) are only available where one of the directors has an asset, usually a family house, they can offer.
Unsecured business loans are capped at a much lower rate and come with higher interest due to the increased risk for the lenders.
What Documents Will We Require for a Business Loan?
All lenders will have slightly varying requirements but the normal documents to ask for will include:
- Business Plan detailing how you intended to repay the loan
- Proof of ID (Directors)
- Proof of Business Address
- Accurate Cash Flow Forecast
- Bank Statements for the Last 2 Years (Obviously, this won’t be possible if you’re a Start Up)
- Profit, Loss and Balance Sheet for the last 2 years audited by your accountant
What’s the Eligibility and Criteria for Business Loans?
While there are many variables at play for loan eligibility, here are some common factors to consider.
- Loan amount is less than 25% annual turnover
- The business is running at a profit
- You have a trading history of more than two years
- You do not have outstanding marks on your credit, CCJs, or other signs of owing money
- Your business is registered in the UK
If you fall outside these criteria, there are still many ways to borrow money but you will pay extra for the privilege. To gain access to the best rates, you need to show you’re an established business with a good cash flow, good credit and the money you’re borrowing is a reasonable amount compared to your company size.
What type of Security Will You Need for Your Business Loan?
The classic security for a loan is property, but in fact a wide range of things can be used as loan collateral.
These include equipment, vehicles, inventory, accountants receivable and even old fashioned cash although this is a rarity. Both residential and commercial property can be used, as well as agricultural land. Even the open market value of the business itself can be used as security in some instances.
Loan providers will perform their own independent valuations of the collateral you’re offering.
You can still sell the asset you’ve offered as collateral during the running of the loan, but only if you’ve got another form of security to offer in its place
When the company directors don’t have commercial security to offer, the lenders will ask for a personal guarantee. These documents allow the using of a personal asset to secure a commercial loan, commonly a family house.
While personal guarantees are now standard practice and facilitate much needed finance, they should also be used with caution and always with full understanding of the potential consequences.
If the business should other default on the loan, or become insolvent with the loan outstanding, the personal guarantor’s property will be sold. While the limited company structure commonly protects directors from the fallout of business insolvency, with its clear separation between corporate and personal debt, personal guarantees are specifically designed to surmount these laws and breach the corporate veil.
If a personal guarantee is to be used, we recommend the use of personal guarantee insurance which insures against the possibility of default. It can be paid by the company, but provides a useful protection for the director who is putting their personal property on the line for the good of the company. Read our full page here on personal guarantee insurance.
What is a Good Credit Score to get a Business Loan?
Most lenders expect to see a business credit score of at least 50/100.
To achieve the best rates, you’ll need to aim higher than that: for 80/100 or more.
Experian, which is perhaps the most common UK credit checking tool, classify 90/100 as very low risk.
Does Your Personal Credit Score Affect a Business Loan?
While a limited company is a separate legal entity from its directors, it is normal for business lenders to check the credit scores of key stakeholders. It’s a useful metric, amongst others, for measuring the overall reliability of a company, and particularly its leaders.
Where it can be seen that a director has a poor credit history, this is likely to raise red flags and lower the total amount of loan which is offered. It may also have an adverse affect on interest rates or other variables as the lenders algorithm will fluctuate according to perceived risk.
NB, this doesn’t mean you cannot apply for finance for your business if your personal credit history is flawed.