Business loans explained

Whether you’re just starting out, looking to expand or managing cash flow, a business loan can be an effective way to borrow the funds you need. But, before you apply for a business loan, it’s important to have a clear understanding of how they work and how to qualify.

At a glance

• Business loans enable you to borrow a lump sum of cash that you repay over a fixed term

• You can use a business loan to pay for equipment, buy new premises, hire staff, consolidate debt or manage cash flow

• Choose from secured business loans that require you to use an asset as security, and unsecured business loans that don’t

• Before applying for a business loan, consider the eligibility criteria, how much you can afford to borrow and what type of loan you need

• If a lender rejects your application, avoid reapplying for three to six months

What are business loans?

Business loans enable companies to borrow a lump sum from a lender, which they then repay with interest over a set period – known as the loan term. 

Amounts borrowed typically range from £1,000 to several million pounds, depending on the lender and the business’s financial standing. Repayment terms can range from a couple of months to several years, depending on the loan type.

How do business loans work? 

If you apply for a business loan, the lender reviews your application and, if you are approved, transfers the requested funds directly into your business bank account. You then repay the loan in regular installments (usually monthly), which include both the borrowed amount and interest charges.. 

The amount you can borrow and the interest rate you pay depend on several factors, including your business’s financial performance and credit score, your personal creditworthiness and the type of loan you’ve applied for.

Lenders typically offer larger loans with lower interest rates to businesses with strong finances and a solid credit record. If your business has a limited trading history or shows signs of financial difficulty, you may face higher rates or smaller loan offers. Read our key tips to find out how to find a business loan with bad credit.

What can a business loan be used for?

You can use a business loan for a wide range of purposes, including:

• Expanding premises or opening a new location

• Buying equipment

• Hiring staff

• Paying for marketing costs

• Consolidating existing debt

• Purchasing inventory 

• Managing cash flow

• Acquiring another business

What are the pros and cons of a business loan?

It’s important to weigh up the advantages and disadvantages of a business loan before applying for one.

Pros

• Access to capital: A business loan can give you the funds you need to get your company off the ground and expand

• You retain full control of your business: Unlike equity finance, business loans don’t require you to give away a share of your company in return for funds. This enables you to keep full ownership of your business

• Fixed repayments: Most business loans come with fixed monthly repayments, so you know exactly what you need to pay back each month, helping you to budget

• Builds business credit: Repaying your loan in full and on time helps strengthen your business credit score, which can give you access to better credit deals in the future

• Different loan types: Choose from secured and unsecured loans, and short-term and long-term loans

Cons

• Interest and fees: Loans can be expensive, particularly if your business has a poor credit score or lacks security. You may also have to pay fees for arranging the loan, making late payments or early repayment

• Limited flexibility: Unlike a business credit card or line of credit, loan repayments are not flexible, so you must repay the same amount each month, even in tough trading periods

• Risk to assets: If you fail to repay a secured business loan, you risk losing the asset used as security

• Strict lending criteria: Business loans tend to have tough eligibility criteria and a lengthy application process

• Potential credit score damage: As with any form of borrowing, if you make late payments or fail to repay your loan, you risk damaging your business credit score and/or your personal credit rating. This can make it more difficult to get credit in the future

Who offers business loans in the UK?

There are several loan providers to consider, including:

• High street banks

• Challenger banks

• Online lenders

• Peer-to-peer platforms

• Government-backed lenders, such as Start Up Loans

What are the different types of business loans?

When comparing business loans, you’ll come across both secured and unsecured loans.

A secured business loan requires you to put up business assets, such as property, vehicles or equipment, as collateral. If you are unable to repay your loan, the lender may seize these assets and sell them to recover the debt.

However, because the lender’s risk is lower, secured loans often come with lower interest rates, higher borrowing limits and longer repayment terms. 

By contrast, an unsecured loan doesn’t require any collateral. Instead, lenders assess your application based on your credit history, cash flow and trading history. You typically borrow a smaller amount over a shorter term, and you may need to sign a personal guarantee, making you personally liable for repaying the loan if your business is unable to do so.

Other types of business loans include:

• Start-up loans: You can apply for a start-up loan if your business is less than three years old. The government-backed Start Up Loan scheme offers £500 to £25,000, plus free mentoring and business plan support

• VAT loans: This type of business loan can help you cover the cost of your VAT bill. You repay the loan over a period of three, six, nine or 12 months

• Short-term business loans: As you might expect, you repay a short-term business loan over a matter of months. This type of loan can be helpful if you need cash quickly to cover emergency expenses, but repayments tend to be higher

• Peer-to-peer loans: These can offer a cheaper alternative to traditional loans because you borrow cash from other individuals or businesses through a peer-to-peer platform. However, you may not benefit from the same protection as you get with a traditional lender

• Asset finance: This type of loan gives you access to business equipment, machinery and vehicles without needing to pay for them up front

• Invoice finance: This enables you to borrow against the value of your unpaid invoices. A lender advances you a percentage of the invoice value up front, and you repay your loan once your customers have paid you

What should you consider before applying for a business loan?

If you’re thinking about applying for a business loan, ask yourself the following questions:

1. How much do I need to borrow? 

Think carefully about what you need the money for and how much you need to borrow. Don’t borrow more than necessary because you’ll end up paying more in interest. However, borrowing too little may require you to apply for a second loan to cover the shortfall.

2. Can I afford the repayments?

The interest rate and loan term have a direct impact on your monthly repayments. A longer loan term can reduce your monthly costs, but it usually means paying more interest over time.

It’s essential to ensure the repayments are affordable. If you fall behind, you risk damaging your credit rating, and if it’s a secured business loan, you could lose the asset you’ve used as collateral.

3. What type of business loan do I need? 

There are several types of business loans, so think about what best suits your company’s needs and how long you need to borrow the money. 

Newer companies may find it more challenging to qualify for a secured loan due to a lack of assets. At the same time, unsecured loans can also be difficult to obtain without a solid trading or credit history. In this situation, start-up loans can provide a useful alternative.

4. How much does the loan cost?

Ensure you understand precisely how much your business loan will cost you in interest charges and fees. Check whether there are any fees for applying for the loan, repaying it early or making late payments. 

What are the eligibility criteria? 

There’s little value in applying for a business loan you’re unlikely to qualify for, so check the eligibility criteria carefully before you apply. Many lenders require your business to have been trading for a minimum period — often six months to two years — and may set minimum turnover thresholds. Most also require your business to be actively trading in the UK.

How to apply for a business loan

You can usually apply for a business loan online. However, some lenders may accept applications made over the phone or in a branch.

When completing your application, you usually need to provide:

• Your personal details, including your name, date of birth and address

• Details about your business, including the company address and Companies House registration number if you’re a limited company

• The type of business you run

• The date you began trading

• Number of employees

• Annual turnover and net profit

• Projected turnover for the next 12 months

• Details of any existing business debts or loans

• Description of any assets you’re using as security 

• Business bank account details

Expect your lender to ask how much you wish to borrow and how you plan to use the loan to support your business. Some lenders may ask to see your business plan, too. 

Lenders review this information and carry out a credit check on your business to decide whether they are happy to let you borrow. It can take anywhere from a few hours to a few weeks for a lender to make a decision. 

Once accepted, the lender will generally transfer the funds to your business bank account within a few days.

What if I am rejected for a business loan?

If a lender rejects your application and hasn’t told you why, contact them to find out. Common reasons for rejection include:

• A poor credit score

• A lack of credit history

• Limited trading history

• Missing or incorrect information on the application form

• Annual turnover that’s below the required threshold

• Insufficient collateral

• Too much existing debt

Try to avoid making another loan application immediately. Ideally, you should wait at least three months, or ideally six months, before applying again. If you make a lot of applications in quick succession, lenders may think you are desperate for credit and reject your application again. 

Before reapplying, it’s worth checking your personal and business credit scores for errors and thoroughly studying the loan eligibility criteria to ensure you qualify.

What if I can’t repay my business loan?

If you miss any loan repayments, you may incur a late payment fee, and this can affect your credit score, too.

That’s why it’s important to speak to your lender as soon as possible. They may offer a longer repayment term, a payment holiday or loan restructuring to make your repayments more manageable. 

What are the alternatives to business loans?

If a business loan isn’t the right option for you, there are plenty of alternatives, including:

• Business credit cards: A business credit card gives you flexible access to funds, enabling you to borrow up to an agreed limit and repay as needed

• Business overdrafts: Many business bank accounts come with an overdraft facility that you can use to cover short-term gaps in cash flow. While useful for emergencies, overdrafts often carry higher interest rates and fees than other forms of borrowing

• Government grants: Unlike loans, government grants don’t need to be repaid. However, they come with strict eligibility criteria. Check what’s available in your area or sector by searching for business grants on gov.uk

• Crowdfunding: Crowdfunding platforms enable you to raise money from supporters or investors. In return, you offer shares in your business or other perks

• Angel investors: These investors put their own money into your business in return for a minority stake. They can also provide a wealth of knowledge and support to give your business a boost

Read more…

• Which business loan is right for you?

• Am I eligible for a business loan?

• How to apply for a business loan