Business loans play a critical role in the success of SMEs, from expanding operations and investing in new equipment to managing cash flow and overcoming unexpected expenses. However, navigating the complex business lending world can be overwhelming, with various loan options and eligibility criteria to consider.
This article aims to provide a comprehensive guide to business loans, including an overview of different loan types, eligibility criteria, the application process, and factors to consider when choosing a loan.
By the end of this article, small business owners should have a better understanding of how to secure the funding they need to achieve their business goals.
- Types of business loan
- Secured Business Loans
- Unsecured Business Loans
- Bad Credit Business Loans
- Small Business Loans
- Short-Term Business Loans
- Fast Business Loans
- Bridging Loans
- Government-Backed Start-up Loans
- Eligibility criteria
- Interest rates
- How to apply
- What documents are required?
- What type of security will you need?
- Factors to consider
- Risks vs Benefits
- Alternatives to Business Loans
- Business Loan FAQs
Types of business loan
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.
|Type of Loan
|Available to businesses without security/collateral
|High-interest loans for businesses with low credit scores
|Cater to businesses with smaller turnovers
|Loans for durations of 2 months to 2 years
|Designed to deliver cash quickly, sometimes within a day
|A short-term loan used to bridge the gap between the purchase of a new property and the sale of an existing one
|Government-backed start-up loan
|A government-backed start-up loan is a form of financial support provided by the government to assist new businesses in their early stages.
Secured Business Loans
Secured business loans are a type of financing where the borrower must offer some form of collateral to back the loan. This collateral could be property, equipment, or other assets owned by the business. In the event of a default, the lender has the right to seize the collateral to recover the outstanding loan amount. These loans are often preferred by lenders due to their reduced risk, and as such, they typically come with lower interest rates compared to other loan types.
Unsecured Business Loans
Unsecured business loans are funds lent to businesses without the need for any collateral or security. Because there’s no requirement for security, these loans are typically higher risk for lenders, and as a result, they may have higher interest rates and stricter credit requirements. They’re often used for short-term funding needs or when a business lacks substantial assets to offer as collateral.
Bad Credit Business Loans
Bad credit business loans are designed for businesses with low credit scores that may struggle to secure traditional financing. Due to the higher risk involved, these loans often come with higher interest rates and more stringent repayment terms. While not ideal, they can provide a necessary lifeline for businesses needing to finance operations, growth, or other expenses.
Small Business Loans
Small business loans cater specifically to businesses with smaller turnovers or those at an early stage of development. They can be secured or unsecured, and they typically offer more favorable terms for smaller businesses, taking into account their unique financial challenges and capabilities. These loans are often used to finance growth, purchase equipment, or cover operational costs.
Short-Term Business Loans
Short-term business loans are loans typically designed to be repaid within a period of two months to two years. They are often used by businesses for immediate financial needs, such as covering temporary cash flow shortfalls, purchasing inventory, or managing unexpected expenses. They typically have a straightforward application and approval process but often come with higher interest rates due to their short repayment period.
Fast Business Loans
Fast business loans are designed to deliver cash quickly to businesses, sometimes within a day. These loans are typically best suited for emergencies or urgent cash flow problems. While they offer the advantage of quick access to funds, they often come with higher interest rates and stricter repayment terms due to the increased risk for the lender.
A bridging loan is a short-term loan designed to bridge the gap between the purchase of a new property and the sale of an existing one. In a business context, this can be useful when moving business locations or acquiring new properties for expansion. The primary property usually serves as collateral, and once it is sold, the proceeds are used to repay the bridging loan.
Government-Backed Start-up Loans
Government-backed start-up loans are financing options supported by the government to encourage entrepreneurship and stimulate economic growth. These loans typically offer favorable terms, such as lower interest rates and longer repayment periods, to make it easier for start-ups to succeed. The government usually guarantees a portion of the loan, reducing the risk for lenders and making it easier for businesses with less established credit histories to secure funding.
What are the eligibility criteria for business loans?
While many variables are at play for loan eligibility, here are some common factors.
- Business Structure: The type of business structure, such as sole trader, partnership, limited liability company (LLC), or limited company, can impact eligibility for business loans in the UK. Some lenders may have specific requirements for the type of business structure they will lend to.
- Credit Score: A good credit score is often a key factor in determining loan eligibility. Lenders use credit scores to evaluate a business’s creditworthiness and determine the likelihood of loan repayment. The business should not have outstanding marks on its credit, CCJs, or other signs of owing money.
- Time in Business: Most lenders consider the length of time a business has been operating when evaluating loan applications. The business should have a trading history of more than two years.
- Annual Revenue: Annual revenue is another key factor in loan eligibility. Lenders want to see that a business has a steady source of income and that the loan amount is less than 25% of the business’s annual turnover.
- Financial Statements: Lenders typically require business owners to provide financial statements, such as balance sheets, income statements, and cash flow projections, to help evaluate the business’s health and determine loan eligibility.
- Industry and Purpose of Loan: Some industries and purposes of loans may be considered riskier by lenders so eligibility criteria may be stricter.
- Business Registration: The business should be 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 and credit and that the money you’re borrowing is a reasonable amount compared to your company size.
What are the interest rates for a business loan?
Interest rates for business loans vary depending on several factors, such as the lender, the type of loan, the loan amount, the credit score of the business owner, and the business’s financial history.
For alternative lenders, interest rates can range from a few percentage points to over 20%. It’s essential to shop around and compare rates from different lenders to find the best option for your business.
How much does a business loan cost?
The cost of a business loan can vary widely depending on the type of loan, the loan amount, the interest rate, and the repayment terms.
Business loans may include fees such as origination fees, application fees, and closing costs, in addition to interest on the loan amount.
To determine the total cost of a business loan, it’s important to consider the interest rate and any other fees or costs associated with the loan.
How to apply for a business loan
- Preparation: Before applying for a business loan, it is important to gather all necessary documentation and information, including financial statements, business plans, and tax returns. This will help ensure a smooth and efficient loan application process.
- Research Lenders: Research different lenders and compare their loan options, interest rates, and terms and conditions to find the best loan for your business. Consider both traditional banks and alternative lenders.
- Determine Loan Amount: Determine the funding you need and what it will be used for.
- Complete Loan Application: Complete a loan application and submit it to the lender along with all required documentation and information. This may include financial statements, business plans, and tax returns.
- Wait for Approval: After submitting your loan application, wait for approval. The approval process can take anywhere from a few days to several weeks, depending on the lender and the complexity of the loan application.
- Negotiate Terms: Once approved, you may have the opportunity to negotiate loan terms, such as interest rates and repayment periods. Be sure to carefully consider the terms before accepting the loan.
- Receive Funds: After accepting the loan, the final step is to close the loan and receive the funds. The lender will typically provide instructions for closing the loan and disbursing the funds.
What documents are required 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 two years audited by your accountant
What type of security will you need for your business loan?
The classic security for a loan is property, but 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 using 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 a 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 using personal guarantee insurance, which insures against the possibility of default. It can be paid by the company but provides useful protection for the director who is putting their personal property on the line for the company’s good.
Read our full page here on personal guarantee insurance.
Factors to consider when choosing a business loan
- Interest Rate: The interest rate is one of the most important factors when choosing a business loan. Compare the interest rates of different lenders and consider the total cost of the loan, including both interest and fees, to find the best loan for your business.
- Repayment Period: Consider the length of the loan repayment period and how it will impact your cash flow and financial situation. A longer repayment period may result in lower monthly payments but a higher overall cost.
- Loan Purpose: Consider the purpose of the loan and whether the loan is suitable for your needs. Different loans may have specific requirements or restrictions, such as equipment loans, working capital loans, and real estate loans.
- Loan Type: Consider the type of loan, such as secured or unsecured, and the requirements and benefits of each type. Secured loans may have lower interest rates but require collateral, while unsecured loans may have higher interest rates, but no collateral is required.
- Lender Reputation: Consider the reputation and experience of the lender and their track record in providing loans to businesses like yours. Look for reviews and feedback from other business owners to gauge the lender’s reliability and customer service.
- Fees and Charges: Consider the fees and charges associated with the loan, such as application fees, origination fees, and prepayment penalties. Compare the fees and charges of different lenders to find the best loan for your business.
- Flexibility: Consider the flexibility of the loan and whether the lender allows for changes to loan terms, such as loan amount or repayment period, as the needs of your business change. A flexible loan may benefit your business in the long run.
Risks vs Benefits
|Access to Capital
|Improved Cash Flow
|Increased Business Opportunities
Alternatives to Business Loans
- Bootstrapping involves using your savings, personal debt, or operating revenues to fund your business. While bootstrapping can limit the speed of your business’s growth, it allows you to retain complete control and avoids the need for repayment and interest charges.
- Grants: Some businesses might qualify for government or foundation grants, which do not need to be repaid. However, these can be highly competitive and often require specific usage.
- Equity Financing involves selling a portion of your business ownership in exchange for capital. This might come from angel investors, venture capitalists, or via equity crowdfunding platforms. While this method can provide significant funds, it does mean sacrificing a share of your future profits.
- Trade Credit: With trade credit, suppliers allow you to purchase goods or services now and pay later, usually within 30 to 90 days. This can help with cash flow, but paying on time is important to maintain a good relationship with your suppliers.
- Crowdfunding: Platforms like Kickstarter or Indiegogo allow businesses to raise funds from a large number of individuals, often in exchange for a future product or reward. This can be a good option for consumer-facing businesses with a compelling product or story.
- Leasing: Instead of buying equipment outright, consider leasing it. Leasing can free up cash for other
Business loans can be a valuable tool for businesses looking to access capital, improve cash flow, and take advantage of new opportunities. However, it is important to carefully consider the risks and benefits before taking on any type of loan.
If you’re considering a loan, ensure you weigh up factors such as loan amount, repayment terms, interest rates, and the impact on cash flow before making a decision.
Additionally, make sure you understand eligibility criteria, the process of applying for a loan, and the risks involved in case of default.
Businesses can reap the benefits and minimise the risks by taking a careful and informed approach to business loans.
Business Loan FAQs
What are the different types of business loans?
Some common types of business loans include secured loans, unsecured loans, bad credit loans, small business loans, short-term loans, fast loans, and bridging loans.
Who is eligible for a business loan?
To be eligible for a business loan, a business will typically require a trading history of more than two years, be running at a profit, have a loan amount that is less than 25% of its annual turnover, and have a clean credit history.
How do I apply for a business loan?
To apply for a business loan, you will need to submit a loan application to a lender, including information about your business, its financial history, and your plans for using the loan.
What factors should I consider when choosing a business loan?
When choosing a business loan, factors include the loan amount, interest rate, repayment schedule, impact on credit score, loan terms, and the lender’s reputation.
Can I get a business loan with a bad credit score?
Some alternative finance providers may offer loans for businesses with bad credit, but these loans often come with higher interest rates and more stringent repayment terms.
What happens if I can’t repay my business loan?
If you can’t repay your business loan, you may face legal action, seizure of assets, or a lien on your business property. Working with your lender to find a solution that works for both parties is essential.
What if I’ve been refused a business loan in the past?
If you’ve been refused a business loan in the past, it’s possible that your credit score or financial history was a factor in the decision. Before applying for another loan, reviewing your credit report and addressing any errors or issues affecting your credit score may be helpful. Additionally, consider alternative lending options such as peer-to-peer lending or crowdfunding, which may have more lenient requirements than traditional lenders.
Are business loans hard to get?
The difficulty of getting a business loan depends on several factors, including the credit score and financial history of the business owner, the size of the loan, and the type of loan. Traditional bank loans often have strict requirements and may be difficult to obtain for businesses with a limited credit history or lower credit scores. Alternative lending options, such as online or peer-to-peer lending platforms, may have more lenient requirements but may also come with higher interest rates or fees.
Can I repay a business loan early?
In most cases, yes, you can repay a business loan early. Repaying a loan early can reduce the interest you pay on the loan and may help improve your credit score. However, some lenders may charge prepayment penalties or other fees for early repayment, so it’s important to carefully review the terms of your loan agreement before deciding to repay early.
How long can I borrow for?
The length of time you can borrow for a business loan can vary widely depending on the lender and the type of loan. Traditional bank loans may have repayment terms of several years, while alternative lenders, such as online or peer-to-peer lending platforms, may offer short-term loans with repayment periods of just a few months.