Small business loans can be an efficient and flexible financial tool to get your business moving in the right direction at a quick pace. Saving up cash will take time, while a small business loan allows you to access money fast in order to spread costs over a long period. However, it is important to know the details before you rush into anything. Not every loan is the same and understanding how each one works can help you make the right call for your business. In this article, we explain how small business loans work and how to find the best type of loan for your company.
How do small business loans work?
A small business loan is a form of borrowing designed for specific companies under a certain size. It can be used to grow the business by covering the cost of new staff, relocation or even new equipment. Alternatively, a small business loan can ease cash flow issues by meeting everyday costs – such as salaries and bills – to help the company through tough times.
Not all lenders agree on what constitutes a ‘small’ business, but many will have an annual turnover restriction, such as under £2 million, and an employee limit, such as less than 50 people. How much the company can borrow will vary significantly based on the length of the loan, the credit history of the business, its annual turnover and the type of loan taken out, among other factors.
Are small business loans secured or unsecured?
Most small business loans are unsecured, as many small businesses will not have the assets to support a secured loan. However, there are UK lenders that offer secured loans to small businesses.
The best loan option for your small business will depend on the assets it owns, how long it has been trading for and what amount of money it is looking to borrow.
What are the different types of small business loan?
There are a few different types of small business loan in the UK, though all can be categorised as either secured or unsecured.
|Type of business loan
|Secured business loan
|If your company takes out a secured small business loan, you will need to provide some sort of collateral. This could be a property, a vehicle or any other expensive asset that can be sold in the event that the loan is not repaid. Secured loans present a lower level of risk to lenders than unsecured loans, because there is the security of selling the asset if the borrower defaults. This usually means that you can borrow more money at a lower rate.
|Unsecured business loan
|Unsecured small business loans do not require a valuable asset as collateral. This can make them more suitable for a small business that has yet to accumulate any significant assets. Typically, you can expect to pay more fees with an unsecured loan and your credit history will come under scrutiny. Without an asset to base the value of the loan on, lenders will look at the business credit file and that of any relevant individuals. A good credit score means that you should be able to borrow more at a lower rate, while a low score could make getting the loan you want more difficult.
|Merchant cash advance
|The business is lent a lump sum that is then repaid through the lender taking a percentage of card payments made by customers.
|A lender provides the borrower with a cash advance on unpaid invoices. As the invoices are paid, a percentage of the money coming in goes towards repaying the debt.
Who can get a small business loan?
There is a basic set of criteria that a small business will need to fulfil to get almost any loan. The applicant needs to be over 18 years old and the business must be registered in the UK. On top of this, many providers will require that the business has been trading for a minimum of six months, its turnover exceeds a certain minimum and the business is not involved in illegal activity.
Beyond these basic requirements, almost any fledgling company will be able to access a small business loan of some kind. For more established small businesses, this could be through a major lender or a high street bank. For new businesses, the best option could be a specialist online lender. The right option will depend on what field your business operates in, how long it has been around and how much it needs to borrow.
We expand on this topic in our article ‘Who can get a business loan?’.
How much can you borrow with a small business loan?
Small business loan providers offer a range of different products that could allow your company to borrow anything from a few hundred pounds to hundreds of thousands. The exact amount your business can borrow will be specific to its circumstances and based on a few key factors.
- Security: Secured loans generally have higher upper limits on the amount that can be borrowed than unsecured loans, but it depends on what is being used as collateral. Remember that whatever you put up against the debt will be at risk.
- Credit history: How much you can borrow with an unsecured loan is based on the credit history of the business and any relevant individuals. Having a good credit score suggests you are a trustworthy borrower who can be relied upon to repay large amounts on time. A low credit score suggests you are more of a risk, which means a lender may only offer you a lower amount. Read our article ‘What is a business credit score?’ for more information. We also cover getting a loan with bad credit in our article 'How to get a business loan with bad credit'.
- Term length: If you agree to pay the loan back over a longer period, you may be able to borrow more money. This is because the debt is spread out over more months, which reduces each monthly repayment. However, borrowing over a longer period will mean more time for interest to compound, resulting in the business paying more overall. We go into more detail in our article 'What are long-term business loans?'.
- Field of business: Some businesses are more risky than others. If your lender thinks your business may fail – meaning the money will not be repaid on time – your loan amount may be reduced.
- Revenue streams: A business with a history of consistent profit and a solid bank balance should be able to borrow more than a struggling company.
- Business history: A new business may struggle to prove to lenders that it can be relied upon to repay a significant amount. In contrast, an established business may be seen as a trustworthy borrower that can manage a larger debt.
- Business wealth: A company with money in the bank or significant assets may be more attractive to lenders, as in theory, it could repay a larger loan even if revenue decreased.
What fees are charged on a small business loan?
It is important to keep an eye on the fees charged by your chosen lender. Comparing loans by APR can be a useful way of making sure you know what the cheapest option is. This figure includes any compulsory fees in the percentage figure, which can help you avoid picking a low-interest loan with a high fee. Read our article ‘What is representative APR?’ to learn more.
In addition to standard charges when you take out the loan, there are a few more fees to watch out for, including:
- Appraisal and underwriting fees: The lender may need to value your assets and will usually charge a fee to do so.
- Early payment charges: Paying too much of your debt back early can attract a fee on some loans.
- Referral fee: If your loan is arranged through a third party, the lender may pass on any fees it is charged to your business.
- Default fees: Late repayments and missed repayments can quickly become very expensive as most lenders charge fees if an instalment is not paid on time.
What can you use a small business loan for?
You can use a small business loan to cover almost any company expense. This can be anything from hiring new staff to relocating to a new office to buying new equipment or restructuring debt.
The money needs to be for legitimate business expenditure, not for personal use or to fund anything banned by the lender in the loan conditions. If you need money to fund a personal expense, your best option is to explore personal loans or secured loans. Read our articles ‘What is a secured loan?’ and ‘What is an unsecured loan?’ to learn more.
How to apply for a small business loan
Applying for a small business loan can involve a face-to-face meeting in a bank, submitting a form online or completing everything over the phone. Many alternative lenders will only operate online, while most major banks will require you to visit a branch to confirm certain details.
When you apply for your loan, you will need to provide information on your business. This can range from how long it has been trading to how you expect to grow the company in the future, as well as other basic details and relevant information. Read our article ‘How to get a business loan’ to learn more.
Government small business loans
Small business loans can come from major providers, high-street banks and online lenders, but also from the UK government. The money may come directly from the government, or from a private lender with the debt backed by a government scheme.
Some small businesses will be able to access the government-funded Start Up Loans scheme if they have been trading for less than 36 months.
For small businesses that do not qualify for this scheme, available lending may be limited based on where your business is located. The best places to find out more information are the British Business Bank page on Nations and Regions Investment Funds and the GOV.UK page on National and regional funds.
You could also look at the wider range of startup loans in our article 'What are business startup loans?'.