How do business loans work?

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

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What is a business loan?

It is a type of borrowing designed for commercial organisations, rather than a person. With a business loan you could:

  • Borrow between £1,000 and £3 million

  • Pay the loan back over 1 month to 15 years

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

  • Unsecured: These loans allow your business to borrow money without the risk of using your business assets as security.

  • Secured: These loans let your business borrow money using an asset as security. If you do not pay back the loan, the lender can sell it to get their money back.

A loan is just one way of getting money to help your business though, here are 6 easy ways to get finance for your business.

What are business assets?

A business asset is anything of value that your business owns.

Some of the business assets you could use to help your company borrow money for example include property, stock and machinery.

Are business loans regulated?

Lenders only need to be regulated if they are offering loans to limited companies, which means that some lenders who only lend to sole traders may be unregulated.

What can you use them for?

Almost any purpose relating to your business, including:

  • Purchasing stock

  • Taking on new staff

  • Moving premises

  • Paying off debts

  • Buying new equipment

  • Expanding operations

Here is how a loan could boost your business

What businesses can get a loan?

Most businesses can get a loan of some type 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 while many cash advance loans require you to have been trading for a set time before you apply.

How many loans can a business have?

There is no set 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.

Types of business loan

There are lots of different specialist types of 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.

Most bank loans also require a directors' guarantee. This means that if your business is not able to pay back the loan, the directors will be personally liable for the debt.

Compare business loans

Revolving credit facilities

A business credit facility lets you borrow money as and when your business needs it.

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

Compare credit facilities here

Peer to peer

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

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

How does peer to peer lending work?

Short term

A short term business loan tends to last for just a few months, but you could potentially borrow for just a few days.

Short term business loans often charge higher interest rates than other types of loan.

Some short term lenders charge monthly interest rather than an annual rate, so double check you know exactly how much it will cost before you apply.

Asset backed

This is a type of secured loan backed by a business asset.

You could borrow more with this type of loan than 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

Invoice finance

Invoice finance works slightly differently than a normal cash loan.

Rather than lending 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:

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

  • Invoice discounting: where the lenders releases funds before your invoices are paid and you then owe them the outstanding balance.

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

Working capital

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

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

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 your card takings over the next 12 months to pay back the loan.

Cash advance loans often do not quote an interest rate because the amount you pay back depends on your card takings, instead there will be set fees at the start of the loan and daily charges until the money is repaid.

Government start up

These loans are a government backed initiative specifically for start up businesses and offer a mixture of low rate loans and grants to new businesses.

If you are starting a new business, you could borrow up to £25,000 and pay it back over one to five years using a Start Up Loan.

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

Do companies have a credit rating?

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

You can check your business credit score by visiting the Experian website.

Pick the right 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.

  • Choose the type of loan: Consider which loans are suitable for your type of business and the amount of money you need to borrow.

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

Compare different business loans side by side

How long will it take?

This depends on your business, which type of loan you choose and whether you need to supply 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.

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

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 - normally for invoice finance

  • A set percentage of your card takings - normally for cash advance loans

What happens if your business cannot pay back a loan?

You will normally be charged a fee by the lender and may have to pay more interest as well.

The lender will also register the default on your businesses credit record which will make it more difficult to get finance in the future.

Business loan FAQs

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

It depends on the loan you choose and the lender. Some banks may require you to have their business account before offering you a loan.

It is a legal guarantee you sign which commits you to paying back the loan if your business is unable to do so.

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