How to choose the best loan for your business

The right type of business loan for your company depends on how much you need to borrow, why you want the money, and what type of business you run. Here, we outline the main types of borrowing available to businesses based in the UK.

What types of business loans are available in the UK?

From start-up loans for new companies to secured loans for businesses looking to invest in assets or equipment, there are eight types of small business loans to choose from.

The main types of business loans available in the UK are:

• Start-up loans: For businesses that have been trading for less than three years, including brand new companies. To qualify, you must provide a business plan showing how you intend to repay the loan and have a decent personal credit score

• Working capital loans: Short-term finance agreements that can help to cover gaps in cash flow – for example, if you have a seasonal business. You can find out with our short cash flow management guide

• Invoice financing: Another short-term finance arrangement that enables you to borrow against unpaid invoices. As an example, this could allow you to borrow 80% of the value of an invoice, which is then paid either to you as usual (invoice discounting) or directly to the lender (invoice factoring)

• Asset finance: A type of secured borrowing that can help you buy or refinance business assets such as machinery. Loans of this kind can be lease agreements, in which you make monthly payments to use a piece of equipment for an agreed period. In some cases, they can also let you spread the cost of an asset, which you will own once the loan term ends

• Lines of credit: Secured or unsecured agreements that allow you to borrow as much or as little as you need up to a maximum amount set by the lender. You only generally pay interest on the amount you borrow

• Merchant cash advance: You pay off these short-term loans by deducting a percentage each time your customers pay by card. The amount you can borrow depends on how much you make from card transactions

• Bad credit business loans: These are loans for companies that find it challenging to borrow due to past credit problems. They are usually secured loans with higher interest rates

• Government loans: The Start Up Loans scheme offers loans of up to £25,000 to new businesses, while the government-backed Growth Guarantee Scheme can help small businesses access development loans

Secured vs unsecured business loans

Business loans fall into two main categories: secured loans, which are backed by collateral, and unsecured loans, which aren't.

What is a secured business loan?

Taking out a secured business loan involves offering an asset, such as a vehicle, as security. This can make it easier to get a loan and can also lower the cost of borrowing. But beware – it also means the lender can claim the asset if you fail to meet the repayment terms.

Reasons to choose a secured business loan include:

• You can often borrow more, especially if the asset used as security has a very high value

• You may be able to pay the loan back over a longer period, which can reduce the amount you pay each month

• Secured loans often have lower interest rates than unsecured loans

• It can be easier to take out a secured business loan, especially if you and/or your company don’t have a perfect credit history 

Don’t forget to factor in arrangement costs, such as asset valuation fees, when comparing secured and unsecured deals. Having to value an asset can also make getting a secured loan take longer.

What is an unsecured business loan?

An unsecured business loan is a form of financing where a lender provides your business with a lump sum that you repay with interest over an agreed term. Unlike secured loans, no collateral is required. While many unsecured business loans involve fixed monthly payments, some lenders offer weekly or even daily repayment schedules to better match your business's cash flow patterns.

Reasons to choose an unsecured business loan include:

• You can often receive the money quickly — within a few working days — especially on smaller loan amounts

• You don’t need a valuable asset to put up as security

• There is no risk of losing your van or business premises if you fall behind with your loan repayments

• You may be offered flexible terms that enable you to modify your repayment schedule depending on your circumstances

However, not all businesses can qualify for unsecured loans. The amounts available to borrow this way are also quite limited, while the interest rates tend to be higher than those on secured loans.

What are the main alternatives to a business loan?

Popular alternatives to business loans include:

• Business credit cards: These are available to businesses of all sizes and can be a handy way to access extra cash in the short term. However, they generally aren’t suitable for long-term borrowing because they have higher interest rates than most business loans

• Business overdrafts: Linked to business current accounts, these offer a line of credit you can use to cover cash flow shortfalls or unexpected expenses. As with credit cards, however, they are generally an expensive way to borrow over an extended period

• Crowdfunding: Convincing multiple individuals to invest small amounts in your company is an increasingly popular way to fund businesses in the UK. Check out crowdfunding sites to find out whether it could work for you

• Small business grants: Grants are essentially a business loan you don’t need to repay. However, to qualify, you generally need to meet very specific eligibility criteria, and applying can be time-consuming. You can search for a suitable scheme on the government website 

How do I choose the right loan for my UK business?

When choosing a business loan, ask yourself why you need the money and how you plan to repay it. Things to consider include:

• Am I likely to qualify? Can you provide the necessary information to apply for a UK business loan?

• How long do I need the loan? Do you want to borrow money over the short, medium or long term?

• How is my business set up? Sole traders, such as freelancers or contractors, are directly responsible for any business debts they take on. Limited companies, on the other hand, can borrow money in the company’s name, which may make it easier to get a business loan

• How much do I need to borrow? And could you access the money any other way?

• Why do I need the money? If you are buying a high value item, securing the loan against it might help to cut the cost

• Is a business loan the best option? Or might an alternative, such as a business credit card, be a better fit? Our guide to the pros and cons of a business loan versus a business credit card may help with this. 

Read more …

• How do business loans work?

• Am I eligible for a business loan?

• How to apply for a business loan