Business loans

When it comes to accessing finance for a small business, a loan is often one of the most common methods for business owners.

A business loan involves borrowing capital from a lending institution and repaying it, with interest, over a predetermined period.

In this guide, we’ll explain what a business loan is, the different types of loan available, and the various benefits and drawbacks of using this particular type of finance to support your business.

As with all types of finance, it’s a good idea to seek independent financial advice to ensure a business loan is right for you and your business.

What is a business loan?

Business loans are very common and one of the first options for businesses looking to raise finance.

The lender provides money that you, as the borrower, pay back, with interest, over an agreed period.

Business loans are a very versatile form of finance, capable of supporting everything from covering major business expenses like buying new equipment to boosting the working capital reserves of your business.

Given that business loans are so versatile, it’s not surprising that they come in a variety of different forms, depending on what you would like to do with the funds.

Examples of different types of business loan include:

• Bridging loans
• Invoice finance
• Asset based lending
• Revolving credit facilities
• VAT Loans
• Start Up Loans
• Mezzanine finance
• Business overdrafts
• Merchant cash advance
• Working capital finance.

What can a business loan be used for?

Business loans are one of the most versatile financial products available to businesses in the UK and can be used for a large number of different purposes including:

• buying new equipment
• hiring new employees
• moving to new premises
• buying another business
• consolidating debt
• marketing
• boosting cash flow
• purchasing inventory
• market expansion
• managing day-to-day running costs.

What are secured and unsecured business loans?

There are many types of business loans available in the UK.

They range from short-term to longer-term loans and can be either secured or unsecured.

Secured business loans

With these loans, you’ll need to use an asset from your balance sheet as security.

The lender may also consider third-party security, such as a guarantee, instead of or alongside other security.

Usually, property is used as security, although other assets like stocks and shares can be used too.

Unsecured business loans

This allows you to borrow without using any business assets as security.

Often, you’ll need to provide a personal guarantee that says you’ll pay back the loan personally if the business can’t.

Unsecured loans typically have higher interest rates than secured loans.

Read more about the different types of business loan.

How does a business loan work?

You have the option to apply for a business loan either online or in-person, depending on the lender.

The approval of your application may hinge on your company's financial health, its current financial status, and your personal creditworthiness.

Once your loan is approved, the lender will send the funds to your bank account, which you will need to repay within a mutually agreed timeframe.

The loan amount that you can secure is dependent on both your request and your company's financial position.

Business loans can be for any amount, from £1,000 up to multi-million pound loans.

The amount you can borrow will depend on a number of factors, including your application and the lender's assessment of your repayment capacity.

Repayment period

Your business loan will have a set repayment period.

During this time, you’ll need to pay back the amount you borrowed, plus interest.

The lender may charge you for paying off your debt early as it will have already committed that money to your business.

Interest rate

The rate of interest you pay depends on how risky the lender deems it is to advance you the money.

For example, if you:

• have good personal and business credit scores
• are willing to use an asset as security

you’ll be deemed less of a risk than someone who:

• has poor personal and business credit scores
• is unwilling to provide security

As a result, you’re more likely to be approved for a loan with a favourable interest rate.

The lender might also offer you a fixed or floating interest rate.

A fixed interest rate doesn’t change, so you know exactly what you need to pay for the duration of the loan.

Floating rates can change, according to both the lender’s interest rate and the rate set by the Bank of England.

Learn more about how interest rate changes can impact your business.

Who offers business loans in the UK?

There are lots of business loan providers in the UK. They include:

• high-street banks
• challenger banks
• Community Development Finance Institutions (CDFIs)
• peer-to-peer platforms
• other online providers

The one that suits you best depends on what you can afford and whether you meet the lender’s eligibility criteria.

What are the advantages of taking a business loan?

As with all finance types, there a number of potential benefits for your business, depending on your financial circumstances and the type of loan you use.

Chance to grow your business

Securing a business loan can accelerate your business growth by providing the necessary funds without the need to wait for sufficient income generation.

For instance, if you identify a gap in the market you can apply for a loan to seize the moment and boost business expansion rather than waiting to accumulate the funds through income generation, by which time the opportunity might have disappeared.

Retain full control of your business

Unlike equity finance such as angel investment or venture capital, when taking out a loan, a business owner doesn’t give up any shares in their business in return for the funds, meaning they retain full control.

Flexibility

With most types of business loan, you’ll have flexibility in how you use the loan once you secure it.

While you are often required to present a business plan during the application process outlining how you intend to make use of the funds, you retain the flexibility to adjust and modify these plans once the funding has reached your account, subject to the terms of the loan.

What are the disadvantages of taking a business loan?

As with the advantages, business loans come with their own particular drawbacks such as:

Charges

You might have to pay a fee if you’re late with a payment or miss one altogether.

Long application process

The process of applying for a business loan can be quite time intensive.

It involves not just completing an application form for each potential lender, but also the submission of documents such as a business plan, account history, and financial projections to demonstrate your business's lending viability.

Traditional banks often require a considerable amount of time to thoroughly review this information and make a lending decision.

This can be particularly true if your business is seeking a large loan.

Your credit report

The lender will carry out a credit check to determine whether you qualify for a business loan.

This will have an impact on your business credit report.

If you default on your loan repayments (fail to make them), it may affect your business credit report and/or your personal credit rating.

This could have the knock-on effect of making it more difficult for you to obtain finance in the future.

Learn about how your credit report can impact your finance options.

Assets as security

Any assets you use as security (property, for example) may be at risk if you default on a business loan.

If you fail to keep up with the payment schedule agreed with your lender, there's a possibility that the asset you've offered as security could be seized.

This underscores the importance of thinking carefully before deciding to proceed with any form of secured loan.

Strict lending criteria

Loan approval processes for business owners can often be rigorous.

Lenders take into account a variety of factors before making their decision.

These include the financial health of your business, its credit history, and your personal credit rating.

All these elements are critical in determining whether the loan will be approved and what interest rate will be offered.

This means that it can be more difficult for start-ups and newer businesses to access a business loan due to not having sufficient financial or trading history to support their application.

The amount you can borrow

Sometimes a lender might approve a loan application, but not for the entire amount asked for.

This could be because the lender has determined that the full sum isn't necessary to achieve your outlined plans, or they may deem it too risky to offer the full amount.

It's a good idea to consider this scenario beforehand and work out how to finance your business plans with a smaller capital injection.

What do I need to consider when applying for a business loan?

Every loan and loan provider is different but there are some common requirements that all applicants will need to meet.

Your business must:

• be able to demonstrate that it can afford to repay the loan
• be based in the UK
• have no late payments or outstanding county court judgments (CCJs)

Your business credit score will have a direct impact on whether or not your application is approved.

However, when reviewing your loan application, lenders are likely to check your personal credit report and score too.

If either score is poor, you may find it more difficult to get a business loan.

At the very least, you may not get the low rate of interest you’d originally hoped for.

There are several websites that let you check your credit score online before you complete a loan application.

They also provide details around how your score is calculated and what you can do to change it.

Some questions to ask yourself

• How will I use the business loan?
• Do I have assets against which to secure the loan?
• Can I afford the repayments?
• Will I pay the loan off early if I'm able to?
• What’s the interest rate? Is it rate fixed?
• How long is the loan for?
• Are there charges for paying it back early?

How do I get a business loan?

To get a business loan from a bank or other lender, you can apply:

• online
• in person at a branch

You'll need to submit relevant documents that the lender will use to carry out its checks.

There are lots of eligibility checkers online.

These allow you to gauge whether your application will be successful, before you submit it.

This is known as a soft credit check and doesn’t affect your credit score, even if your application is turned down.

What if my business is declined a loan?

If your business has been unsuccessful in applying for finance from some of the UK's major banks, the Bank Referral Scheme could help you find finance elsewhere.

If the scheme doesn't work for you, the participating banks must, by law, offer you a referral to another finance platform.

Learn more about the Bank Referral Scheme

You can also approach a Community Development Finance Institution (CDFI).

CDFIs specialise in lending to businesses that don’t fit other lenders’ criteria.

They can take into account information about your business that other lenders aren’t able to - 9 out of 10 of the businesses they lend to have been declined by another lender - and offer loans alongside business support.

Learn more about CDFIs with Responsible Finance