What is a business loan?

11 min Read Published: 14 Mar 2024

What is a business loan?It is not unusual for businesses to require extra funding at some point. This could be when a new start up is trying to grow as quickly as possible, or when an established business hits a cash flow speed bump. Whatever the reason for your business needing some additional money, you should be able to find a type of business loan that matches up with your company’s financial situation. In this article, we explain how a business loan can help your company access the funds it needs, including all the different loans on the market and the situations they can be most useful in.

What is a business loan?

A business loan is a financial product that involves a business borrowing money that will be repaid in the future. As with most loans, a business loan will usually require monthly repayments in order to pay back what has been borrowed (the capital), plus any interest and fees.

The business could look to a bank for a loan, approach a specialist provider or access a government borrowing scheme. The business will often have to explain why the loan is required, what the money will be spent on and how the capital will be paid back.

The extra funds could be required to meet day-to-day costs, fund unexpected expenses or finance growth. Whatever the reason for the business loan, interest will usually be applied to the borrowed amount. Some loans may also need to be secured against assets owned by the business or guaranteed by a director.

Most types of businesses can access borrowing in the form of a business loan, though some lenders will only offer finance to limited companies. Loans to limited companies are not usually regulated by the Financial Conduct Authority (FCA). However, lenders will often need to be regulated by the FCA in order to lend to sole traders or partnerships.

We explain the processes involved in a business loan in our article 'How do business loans work?'.

What can you use business loans for?

Business loans can be used in a variety of different ways to fund a company’s expenses. The purpose of the loan should be business-related, which could include financing:

  • Staff salaries
  • Staff training
  • New business equipment
  • New marketing campaigns
  • Relocation costs
  • Stock purchases
  • Business expansion
  • Debt consolidation

Business loans can also be used to cover cash flow issues or fund everyday bills in the case of a drop in revenue.

Can I use a business loan for personal spending?

Exactly what you can use your loan for will depend on the specific terms and conditions set out by your lender. Most business loans will include restrictions on certain types of spending, such as for personal use. You will usually be asked for the purpose of the loan when you apply.

Using the money for something other than what you originally claimed it was for, and going against the lender's terms, could result in the loan being withdrawn.

Who can get a business loan?

Almost any business can apply to access a business loan of some kind. Keep in mind that some providers will only lend to limited companies, but sole traders and partnerships should still be able to apply for financing elsewhere. You may also find your business needs to be VAT registered in order to apply.

Your company’s chosen lender may also request that you meet additional criteria – such as a minimum turnover and two full years of accounts. However, there will also be lenders happy to accept borrowers with a lower turnover or limited trading history. Additional strict rules are applied by most lenders. For example, an individual applying for a business loan will usually need to be a UK resident over the age of 18.

As with personal loans, the application process requires a credit check to test your company’s reliability as a borrower. In some cases, the personal credit history of the individual applying will also be considered. If you or your business have a poor credit history and a low credit score, you may find that your application is rejected or you are offered a loan with worse terms than you were expecting. This could be in the form of a higher interest rate, a different repayment period or a reduced borrowing amount.

In some cases, the lender may request a valuable item as collateral to secure against the loan. This could be property or equipment that could be sold if you or your business are unable to repay the loan in full.

Read our article 'Who can get a business loan?' to learn more.

What are the risks of a business loan?

A business loan comes with the same main risk as all other loans – if your financial situation changes, you may struggle to pay it back. Late repayments can mean you have to pay extra charges, while missing payments altogether will damage your credit score and lead to you paying additional fees and extra interest. If a business defaults on a loan entirely and cannot repay the borrowed money, any assets held as security could be sold and individuals associated with the company could be liable for the debt.

Failing to repay a loan can have a negative impact on your personal credit score or your company’s credit score. You should also consider the risk of applying for a business loan and not being approved. Credit applications will leave a mark on your credit file. Too many applications in a short period will suggest you are struggling with your finances. This could make you or your business less appealing to lenders in the future.

What are personal guarantees by directors?

A personal guarantee involves a company director taking on a level of liability for the business’s debts. If the company cannot meet its repayment obligations, the responsibility of paying back the loan could fall to the nominated director.

Some lenders will require a personal guarantee in order to approve a business loan or offer its best rates. This is because it adds an extra level of protection for the lender in the event that the business cannot repay the money it has borrowed.

What are the different types of business loan?

There is not one single type of business loan that will fit the finances of every company. It is important to match your business with the right type of business loan. Here are the main types:

Bank loans

A bank loan, as you may have guessed, is a loan from a bank. A business agrees a lump sum to borrow and a schedule in which to pay back the money with interest. You may find that most banks require a personal guarantee by a director in order to approve a business loan. This could mean that the named individual is liable to repay the loan if the business fails to do so.

Unsecured business loans

Unsecured business loans, much like personal loans, are repaid in regular monthly instalments over a given period. The loan amount and interest rate is calculated by your lender based on the business’s financial circumstances and credit history, rather than any kind of valuable asset.

Secured business loans

Secured business loans are secured against a valuable asset owned by the business. In the event that the loan repayments are not met, the asset can be sold in order to repay the debt. These loans often come with a better interest rate than an unsecured loan, as the lender is taking on less risk.

Lines of credit

A line of credit is a revolving borrowing facility that allows a business to borrow up to a specified credit limit. The business can use the entire credit limit or a portion of it, whatever is required. Interest is then charged on the amount borrowed, rather than the full credit limit. A business could also borrow money, repay that money and then borrow again.

Invoice financing

Invoice financing involves a lender offering a business cash in exchange for a percentage of an unpaid invoice. This means the loan is essentially a cash advance on money already owed to the business. In some cases, the lender will take full control of an invoice and collect the money directly. Alternatively, the business pays the lender when the invoice is paid. Invoice financing can be offered by banks, building societies and specialist lenders.

Working capital loan

This a short-term loan designed to manage cash flow issues and fund day-to-day running costs. The money could be needed to pay staff or cover essential bills, but this is probably not the right option for long-term investment. Many working capital loan providers will also require a personal guarantee by a director.

Government Start Up Loans

This is a government-backed loan for businesses that have been trading for up to 36 months. Qualifying companies can borrow £500 to £25,000 at a fixed interest rate of 6%. The debt can be repaid over 1 to 5 years.

There are other eligibility criteria that a business needs to meet. You can find out more on this Start Up Loans page.

We cover other types of startup loans on our 'What are business startup loans?' page.

Asset financing

Asset financing is a means for a company to purchase business equipment without the need to pay up front. The cost of the purchase is instead paid for in instalments over a specified period of time.

Merchant cash advances

This involves a lender advancing the cash a business expects to earn in the future. The repayments are then made through deductions from the company’s income.

Pros and cons of a business loan

Applying for credit will not be the right financing option for every company. Here are the key advantages and disadvantages of a business loan to help you make the right call.

Pros of a business loan

  • Borrowing money will likely allow your business to access money faster than if you waited for it to accumulate the same amount through revenue.
  • You can grow your business at speed without waiting for revenue to increase in order to fund extra staff, new equipment or other expenses.
  • Expenditure can be spread over a long period of time, allowing your business to maintain cash reserves. We explore long-term loans in our article 'What are long-term business loans?'.
  • Taking out a loan means you can keep your existing business structure and secure extra cash. This would not be possible if you raised money through selling a stake in the company.
  • You can repay the money in regular instalments over a fixed period of time. This can help you plan for the business’s financial future.

Cons of a business loan

  • The business will need to repay the borrowed money, plus interest. This means that borrowing is more expensive than building a pot of cash through revenue streams.
  • Taking out a secured loan will mean putting a valuable asset at risk of repossession, should the business be unable to pay the debt.
  • Missed payments can lead to significant fees, additional interest and borrowing becoming more difficult in the future.
  • In some cases, a loan will need to be personally guaranteed by a company director. This can make that individual liable for the debt if the business cannot repay the money.

Do companies have credit ratings?

A business will usually have a credit file and credit rating, just like any individual applying for credit. When your business applies for a loan, the lender will run a check on its credit file to assess the company's credit history. This could be a credit file held by any of a number of business credit reference agencies (CRAs), including Experian and Equifax. The effect of this is that your business will not have one single credit score.

A credit check on a company will include information on County Court Judgements (CCJs) from the Registry Trust and accounts filed at Companies House. One way to boost your business’s credit score is to keep these up to date and filed in full, rather than as abbreviated accounts.

We explain business credit scores in more detail in our article 'What is a business credit score?'.

Having a poor credit rating will not necessarily block your business from being able to borrow money. We have more information in our article ‘How to get a business loan with bad credit’.

What about personal credit ratings?

If you run your business as a sole trader or a partnership, you will find personal credit ratings are just as important as business credit ratings. This is because the business is unlikely to have a credit file of its own for a lender to base a decision on.

Even if your business is a limited company, you may find that your personal credit score is checked by the lender. This is especially likely if the business has a limited financial history, or you are a director guaranteeing the debt.

In the UK, personal credit scores are calculated by the three main CRAs: Experian, Equifax and TransUnion. You can learn how to check you personal credit score by reading our article 'The best way to check your credit score for free'. We also have information on how to give it a boost in our article 'How to improve your credit score quickly'.

How to improve your company credit rating

You can improve the credit score of your business by:

  • Paying back existing debt in full and on time
  • Filing business accounts in full and on time
  • Maintaining your personal credit rating
  • Having your accounts professionally audited
  • Minimising the number of credit applications made in a short period
  • Answering any questions asked by the three main UK CRAs

If you are a sole trader, it is important to check your personal credit rating. We explain how to do so in our article ‘The best way to check your credit score for free’. If your credit score needs a boost, follow the tips in our article ‘How to improve your credit score quickly’.

What if a business loan application is declined?

An unsuccessful loan application does not need to spell disaster. There are a few steps you can take to boost the chances of your next application being successful.

The first is not to rush into a new application. Multiple rejections in a short period of time will look bad on your credit history and damage your credit score. Try to take stock and review your financial situation.

Your next step could be to review why you were rejected. Try to speak to the lender and find out why your application was unsuccessful this time. There may be some simple changes you can make to improve your situation.

A further step you can take if you have been rejected for a business loan is to utilise the government-backed Bank Referral Scheme. Under this system, a business that has been rejected by a participating lender – which includes major banks Lloyds, Santander, HSBC, RBS and Barclays – should be referred to an alternative organisation. These alternatives are online platforms that can help businesses get the funding they need. You can find out more on the British Business Bank website.

How to get a business loan

You can get a business loan by applying online, seeking out a specialist provider or going to a high street bank.

Before you apply for a business loan, it is a good idea to compare different options and find the best deal. In some cases you can check your eligibility without needing to go through the full application process. This is advantageous because it means you do not need to make multiple applications in a short period of time, which can damage your credit score. Instead, you can see which loans your business is likely to be accepted for and how much each option is likely to cost.

You can read more in our article ‘How to get a business loan’.