How do business loans work?

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If you need funds to help your business grow or expand, a business loan could offer the solution you need. Here’s how they work and how to get the right loan for your business.

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There are lots of ways to finance your business, from company credit cards and overdrafts to crowdfunding and angel investment, but a business loan might be the first option that springs to mind. They’re a relatively straightforward way to borrow if you want to raise money to invest in your business and don’t involve giving up any equity.

What is a business loan?

Business loans are a type of borrowing designed for commercial organisations rather than individuals that you usually pay back on a monthly basis. With a business loan you could:

  • Borrow between £500 and £15 million

  • Pay the loan back over one month to 25 years

They can be short term or longer term and secured or unsecured. 

You can borrow higher amounts at lower rates with business loans than personal loans but the application process is more complex, as the lender will want to look at your personal credit score as well as your business credit score and finances. This means it can take longer to get your money.A loan is just one way of getting money to help your business. For more options here are 6 easy ways to get finance for your business.

What are business assets?

A business asset is anything of value your business owns. It adds to the overall value of your business as it’s something that’s either used as part of running your business, such as manufacturing equipment or premises, or can be sold to provide funds or profit.

Business loans can be secured on an asset to help you get a larger or more favourable business loan, as the lender will be able to sell the asset to get their money back if you can’t repay the loan. Some of the business assets you could use to help your company borrow money include property, stock, machinery and vehicles.

What can you use a business loan for?

You can use them for almost any purpose relating to your business, including:

  • Purchasing stock if you don’t have the cash to buy it outright

  • Taking on new staff or investing in your existing staff by providing training

  • Moving premises, which you might need to do to grow your business

  • Paying off debts. This could help you save money on interest or make your monthly payments more manageable

  • Buying new equipment, which could help you boost your productivity

  • Expanding operations. This could include by moving to bigger premises, taking on more staff or buying more equipment

  • Marketing or advertising to raise your profile and attract new customers

There’s no limit to the number of loans a business can take out but you will need to show your business can afford each loan when you apply.

Find out more about using a business loan.

What types of business loans are available?

There are lots of different types of business loan but they all fall into one of two categories:

  • Unsecured: These loans allow your business to borrow money without having to use your business assets as security.

  • Secured: These loans let your business borrow money using an asset as security. If you don’t pay back the loan, the lender can sell it to get their money back. Secured business loans tend to have lower interest rates than unsecured ones and are useful for borrowing larger amounts.

There are lots of different types of specialist business finance depending on your business sector, but the main types that are available to most businesses include:

Bank loans

These are cash loans offered by banks and building societies. Your business borrows a lump sum and pays it back over a set period of time with interest.

Banks usually require a personal guarantee for unsecured business loans. This means that if your business is not able to pay back the loan, the business owners or directors will be personally liable for the debt. 

Revolving credit facilities

A business credit facility lets you borrow money as and when your business needs it so is more flexible than a standard business loan.

You only pay interest on the money you withdraw and can pay it back when you have the funds available. You can also pay it back and then withdraw it again.

Peer-to-peer lending

This is a type of social lending, offered by online lending platforms, where you borrow money from private investors looking for a return on their money.

As with bank loans, peer-to-peer lenders may ask for a personal guarantee when you apply for a loan.

Asset backed

This is a type of secured loan backed by a business asset. You could borrow more at a lower interest rate with this type of loan than with some of the other types of business loans in the market.

Assets that can be used to back a loan include:

  • Machinery

  • Property

  • Stock

  • Land

  • Vehicles

Invoice finance

Invoice finance works slightly differently than a normal cash loan.

Rather than lending you a cash lump sum the lender buys outstanding invoices from your business for a fee, releasing the money you are owed by your customers.

There are two main types of invoice finance:

  • Invoice factoring: where the lender manages your sales and collects the money directly from your customers.

  • Invoice discounting: where the lender releases a percentage of the funds before your invoices are paid and gets their money back when the invoice is paid.

You can get invoice financing from banks, building societies and independent companies that specialise in invoice finance.

Cash advance

A business cash advance loan is where you borrow money against your future debit or credit card sales.

For example, you borrow £50,000 to refurbish your restaurant and then pay back 20% of every card transaction until the total cost of the finance is paid back. This means you’ll pay back more when takings are higher and less when they’re lower so it’s a flexible way to borrow. 

Working capital

A working capital loan is designed to help pay for the day-to-day running costs of your business, such as wages, rather than long-term investments.

Like bank loans, most working capital loans need a personal guarantee from company owners or directors.

Government start up loan

These loans are a government-backed initiative specifically for startup businesses or existing businesses that have been trading for less than three years in the form of unsecured personal loans.

You could borrow between £500 and £25,000 and pay it back over one to five years. There’s a fixed rate of interest of 6% per year but no other fees to pay on top of this.

You can find out more about start up loans by visiting the Start Up Loans website.

Business vehicle finance

This type of finance helps you buy vehicles for your business, such as vans, cars or trucks, which you may need to run or expand your business. 

Rather than paying for the vehicles upfront, you can spread the cost by paying for them monthly. Ways to do this include hire purchase, leasing and contract hire.

Find out more about business vehicle finance and compare available deals.

How much can you borrow with a business loan?

You can borrow anything between £500 and £15 million with a business loan but how much a lender will agree to lend you depends on your business’s finances and how much you can afford to pay back. This means that how much an individual business can actually borrow varies widely.

There are also a wide range of repayment terms you can choose from – generally between one month and 25 years. While choosing a longer term will make monthly repayments more affordable and potentially give you a lower interest rate, you’ll generally pay more interest overall than with a shorter term.

A short-term business loan tends to last for just a few months, but you could potentially borrow for just a few days. As short-term business loans often charge higher interest rates than other types of loan, make sure you know exactly how much it will cost before you apply.

You can visit our business loans page to see the loan amounts and term lengths available but to find out exactly how much you could borrow and what repayments would be over different terms it’s worth speaking to a specialist broker. They can also help you find the best deal for your circumstances.

Which businesses can get a loan?

Most businesses can get a loan of some kind but your options may be limited by the type of business you have so check before you apply.

For example, government start up loans are only available to new businesses that have been fully trading for less than three years, while many cash advance loans require you to have been trading for a set period of time before you apply.

It may be harder to get a business loan if you’re a sole trader rather than a limited company as sole traders are seen as higher risk and you don’t have to file your annual accounts with Companies House.

How do you get a business loan?

You can apply for a business loan online or in a branch of a lender.

You’ll need to provide a range of documents so the lender can assess you for the loan. These are likely to include your business bank statements from the last six months and your accounts, so it’s a good idea to get these together before you apply and make sure your accounts are in order.

Other documents you may be asked to provide include proof of any other finance you have, details of business assets if you’re using them as security, a business plan, financial forecasts and balance sheets.

The lender will also check your business credit report, so to boost your chances of being approved, get a copy of your report from a credit reference agency such as Experian before you apply for the loan to make sure it’s accurate and up to date.

Other ways to make sure you’re in the best position to be granted a loan before applying include paying off any outstanding debts if possible and calling in money you’re owed. You should also think carefully about what you’ll use the money for and how you’ll pay it back.

How long it will take to get a loan depends on your business, which type of loan you choose and whether you need to provide security or not.

If you apply online for an unsecured loan and have a good credit record you could have a decision within a few days or even hours in some cases.

If you choose a secured loan and your assets need to be valued, it will normally take longer.

Read more about how to get finance for your business.

Do companies have a credit report?

Yes, businesses have a credit record in a similar way to individuals and it may affect whether or not your loan application will be accepted.

If you run a limited company your credit record will include your accounts filed at Companies House, so make sure these are kept up to date and try to file full rather than abbreviated accounts.

Other things you can do to improve your business credit rating include:

  • Always paying back your loans and borrowing on time

  • Filing your accounts well before the deadline

  • Paying to have your accounts audited to give them more credibility

  • Completing any questionnaires you are sent by credit reference agencies in full

  • Keeping your personal credit record in good shape, especially if you are a new business

  • Only applying for credit when absolutely necessary

  • Using business finance rather than personal credit 

  • Updating your details, like your business address, with customers, suppliers and organisations such as Companies House as quickly as possible if they change

You can check your business credit score through Experian, Equifax, Creditsafe, Credit Passport or Dun & Bradstreet

How to pick the right business loan

To get the right loan for your business you should follow these steps:

  • Work out how much you need to borrow: get costing estimates for new projects and purchases so you know exactly how much you need to borrow. If you borrow more than you need to you’ll end up paying unnecessary interest.

  • Decide how long you need to pay it back: the longer the term of the loan the more interest you’ll end up paying overall but the more manageable your monthly repayments will be so try to strike a balance.

  • Assess how much you can afford to pay back each month: this will determine how much you should borrow and the length of term you take the loan out for.

  • Choose the type of loan: consider which loan options are suitable for your type of business and the size of loan you need.

  • Decide whether you want a fixed or variable-rate loan: while fixed rates may start at a higher level than variable rates, the rate won’t change for a set period so you’ll know exactly what your repayments will be. While variable rates can go down as well as up, you won’t know what the cost of repaying the loan will be from month to month. 

  • Look for the cheapest option: never just go with the first lender you find – shop around and compare the total cost of borrowing with what is available from other lenders before you apply.

  • Check the conditions and eligibility criteria: you may need to give a personal guarantee or have been trading for a certain amount of time for example.

Compare different business loans interest rates side by side

Paying back your loan

Once your loan has been approved and the funds have been transferred you will have to start paying back your loan.

How you pay it back will depend on the type of loan you have chosen. Some common ways include:

  • Direct debit

  • Standing order

  • Direct from outstanding invoices, as with invoice finance

  • A set percentage of your card takings, as with cash advance loans

What happens if you can’t repay your loan?

If you miss payments you’ll have to pay late payment fees and extra interest. You could also be charged administration fees. 

The lender will register missed payments on your business’s credit record, which will make it more difficult to get finance in the future, especially if you default on the loan. You may be considered to have defaulted on a business loan if you’ve failed to make two or three payments but the exact terms will be set out in your loan agreement. 

If you’ve taken out a secured loan the lender can seize your assets to get its money back or if you’ve taken out an unsecured loan and given a personal guarantee you’ll have to pay the loan back yourself.

Business loan FAQs

Do I need to be the owner of a company to get a loan?

No, most loans can be applied for by a registered company director.

Do I need a business account for a business loan?

It depends on the loan you choose and the lender but most banks require you to have a business account before offering you a loan.

What is a personal guarantee?

It’s a legal guarantee you sign as a business owner or director that commits you to personally paying back the loan if your business is unable to do so.

Could I lose my home if my business defaults?

It depends on the type of loan you choose, whether it is secured and if you sign a director’s guarantee. Always check the terms and conditions carefully.

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