Your business loan questions answered
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If you’re raring to go with a great idea, but held back by a lack of finance, taking out a business loan can turn your pipe dream into a profitable business. There are lots of borrowing options for your business: from crowdfunding with members of the public, to formal borrowing through a bank.
Like any borrowing, a business loan should be approached with responsibility and due diligence. But once you’re sure it’s right for you, it can help you realise your vision and be your own boss.
How do business loans work?
You’ll apply for a loan and a lender will consider your eligibility. The lender will look at any documentation you have available to support your application and ask questions to build a picture of you and your business. This helps them work out whether you’ll be able to manage the repayments and if lending to you is responsible.
The documentation required depends on the type of loan you’re applying for and whether you’re already trading. You may be asked to provide a deposit to secure the loan, a bit like when you take out a mortgage.
What are the different types of business loan?
Secured or unsecured
Secured loans are secured against an asset such as a business property. If you are unable to repay the loan, the lender can take possession of that asset. This gives the lender confidence to lend higher amounts. Unsecured loans don’t require any security but tend to offer smaller sums of money and attract a higher rate of interest.
Fixed or flexible
Like mortgages, loans can come with fixed or flexible repayments. Fixed rate loans have a pre-agreed rate of interest and repayment schedule. Flexible loans can have a variable interest rate and less rigid repayment structure, often allowing you to repay an agreed proportion of your monthly sales.
Short or long term
Short-term loans are usually a lower amount and repaid within a year. They often have a higher interest rate. Long-term loans run longer than a year. They tend to be for higher amounts and have a lower interest rate.
Where can I get a business loan?
There are a range of lenders that can provide a much-needed cash injection for your business.
High street banks and building societies – Can offer great rates but are often risk averse. Smaller lenders can be more flexible for small businesses
Specialist lenders – Lenders who work with businesses in a particular sector or of a particular size (eg SMEs)
Peer-to-peer lenders – Some lenders act as a broker between investors looking for a return on their money and businesses that need finance. They invite the public to invest with them, before lending that money to businesses. Funding Circle is a popular example
Crowdfunding – Securing small investments from a large number of individuals, usually via an online campaign
The government – The UK government support startup loans for new businesses to help entrepreneurs kickstart their business
Who can apply for a business loan?
Any business can apply for a business loan. It doesn’t matter what services or products you sell, or what size your business is.
However, limited companies may find it easier to secure finance because of their legal status. Limited companies are a separate entity from their owners and subject to higher levels of scrutiny, therefore many lenders are more likely to lend to them.
What can I use a business loan for?
There are lots of reasons why businesses need to borrow money. A loan can boost a business’ cash flow to help them invest and grow. It could be used to move premises, purchase equipment or hire staff.
Can I use a business loan to pay my own salary?
Yes. When applying for a business loan, you will need to provide your business plan and budget for the next few years. This should detail all operational overheads.
This includes salaries for any staff, which may just mean you. Be aware that any salary you take needs to be reasonable and stand up to scrutiny. Your trading status (sole trader vs limited company) may affect the salary you choose to draw as well as your tax liability.
I’m nervous about borrowing…
That’s not a bad thing. A healthy respect for financial responsibility can protect your business from risk. But being over cautious is risky too. Sometimes a business needs a cash injection to reach the next level. Being afraid of borrowing can hold you back.
Taking out a loan through a reputable lender is your first step to borrowing responsibly. They’ll look at your business plan, past finances and projected earnings, to build an objective picture of whether a business loan is right for you.
In fact, the process of applying for a business loan can make you more likely to succeed. When you apply for a business loan you’ll have to complete a business plan and budget. This can help you review and refine your strategy before you borrow.
How much should I ask for?
Business loans usually start at £500 but the amount you ask for depends on what you think you’ll need.
You need to work out a realistic budget for your business and any reasonable living expenses you’ll need. Get cost estimates for new projects or planned purchases.
It makes sense to overestimate rather than underestimate what you need to borrow, as going back to your lender for more money could be costly.
What are the interest rates on a business loan?
Interest rates vary for a number of reasons. Your interest rates are likely to be affected by:
which lender you choose
how much you borrow and how long for
the perceived level of ‘risk’ you represent to the lender
the economy overall
How do I compare business loans?
When comparing business loans, ask each lender for an illustration showing the full cost of the loan and fees payable. This will help you compare like-for-like.
Look out for hidden costs, such as:
late payment charge
early repayment charges
How are Start Up Loans different to business loans?
Start Up Loans are different to standard business loans. Funded by the Government through the British Business Bank, they’re designed to help new enterprises thrive.
Start Up Loans:
are available for people not yet trading, up to businesses under two years old
don’t require prior financial records
don’t favour limited companies
nurture new businesses with mentoring in their first year post-loan.
The most important difference is that they aren’t business loans, they are personal loans to help fund your business. So even if you are a limited company, you are personally responsible for repaying the loan.
What do I need to apply for a business loan?
If you’re already trading, you’ll need to show your business plan, accounts and tax returns. If you’re a startup, don’t worry. You’ll need a business plan and a financial forecast but there’s lots of support available to help you develop these.
The lender will ask you:
how much you want to borrow
how long you’d like to borrow it for
whether you want to secure the debt against any assets
Be prepared for scrutiny. This is for your benefit, not just the lender. Following the financial crash in noughties, lenders are focused on lending more responsibly and making sure borrowers can afford to repay what they owe.
How do I repay a business loan?
When you take out your loan, your lender will agree a repayment schedule with you. This means when you’ll make repayments, how often and how much for.
Repayment schedules vary from loan to loan, but you should expect to make monthly payments until the loan is paid off.
Some loans let you pay quarterly or annually, but these are less common.
What happens if you can’t pay back a loan?
Before you take out your loan, you need to be realistic and confident about your ability to make regular repayments. Failing to do so will result in you defaulting on your loan, which is when you fail to pay it back within the agreed timeframe.
This can have serious legal and financial consequences that will affect your ability to get credit in the future. If your loan is secured on something, like property, it can be repossessed.
If you don’t pay back a business loan, the lender can take legal action to reclaim the value of the loan, interest and costs.
The actual penalties for defaulting on your loan depend on the terms you agreed when you took out the loan. You may be liable for fines for late payment, as well as the admin costs of chasing you for payment.
Do I have to start making repayments straight away?
Not necessarily. You can arrange for a grace period before you start paying back your loan, or a ‘capital repayment holiday’. These are not guaranteed and will be negotiated with your lender on an individual basis.
A grace period is particularly helpful for startups and new businesses, where it may take a while to become established and start making sales.
What is a personal guarantee, and do I need one?
A personal guarantee means you’ll be personally responsible for a debt if your business fails to repay a loan. Providing a personal guarantee can make lenders feel more confident and increase your chance of being approved for a loan.
But they represent a financial risk to you personally and should not be given without due consideration of the pros and cons. Some lenders will only lend if you make a personal guarantee.