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How Do Business Loans Work?
You know that you need capital for your business, you know that you can get a loan to help, and you know that it means having to pay back money over time, but really, how do business loans work?
At Clifton Private Finance, we’re here to tell you.
How Business Loans Work - The Basics
Everyone knows the basic concept of a business loan, but it doesn’t hurt to have it all laid out clearly, so:
- A loan is an amount of money that is provided to your business that is paid back over time.
- A loan has ongoing regular repayments - often monthly - that you must make.
- Over time you will pay interest on your loan, meaning you pay back more than you borrow.
- Failure to repay a loan payment will have a negative impact for your business. Loan repayments should be considered a high priority.
- Once the loan is repaid, the business is clear of that responsibility.
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The Purpose of a Business Loan
Alternatives to a Business Loan
The Purpose of a Business Loan
A business loan is there to provide substantial working capital for your company that you may not otherwise have.
It is possible to get loans that are for a specific purpose or general use loans that simply provide you with an injection of cash to use in any way you see fit. In both cases, the point is to enable you to invest in something that will help your business.
As a business loan comes with interest, so it is sensible to only take out a loan if you really need it. Unnecessary borrowing will only burden the business with repayments and responsibilities it would otherwise be free of, ultimately costing more than the gain.
Reasons for getting a business loan are many but include:
- Starting a new business
- Investing in necessary equipment
- Purchasing stock
- Expanding staff
- Purchasing a building
- Research and development costs
- Getting company vehicles
- Paying other bills and responsibilities, such as a tax payment
- Providing cash flow during a slow period
- Investing in marketing to aid business growth
A business loan can give your company a boost when you need it and can facilitate expansion in ways that may otherwise seem impossible.
Related: 2024 Spring Budget - What it Means For SMEs
Alternatives to a Business Loan
A business loan isn’t the only way to get money for your business. Other alternatives include:
- Business grants
- Asset leasing
Each of these alternatives may provide your business with a suitable way to achieve the end goal, but they have their own advantages and considerations.
For example, grants can provide working capital that doesn’t have to be paid back but may have strict eligibility criteria. Asset leasing options can offer a way to spread your investment costs but mean your company doesn’t own your equipment.
It’s important to consider the benefits and hindrances of any loan alternative before making your final decision.
To learn about business loans for limited companies in more depth, watch our short video below.
Understanding Business Loans - The Terminology
There are many words that exist in the world of business finance. Some of the key terms can be confusing if you haven't encountered them before. We've listed a few, alongside their explanations, below.
Capital
Working capital is the money available to your business for it to run and expand. It can be thought of as the amount in the bank that you can use to buy equipment or pay salaries.
Loan
A loan is funding provided by one organisation (“the lender”) to another (“the borrower”). It is repaid over time, typically with interest.
Principal
The original amount of the loan before any interest is added.
Interest
Additional money is added to the loan as a payment to the lender. It is the cost of borrowing money.
Interest rate
The percentage by which interest is calculated. Interest rates are typically calculated annually, though they are applied monthly.
Term
The number of months the loan is set to last, with repayments throughout the period until the principal loan and all interest is repaid.
Grant
Money provided with no requirement for repayment.
Investment
Money provided by another in return for a stake in the business.
Asset
An item owned by the company that has value.
Collateral
Collateral is an asset pledged as a guarantee on a loan that is forfeited if loan repayments are not met.
Secured
A type of loan where collateral is required.
Unsecured
A type of loan where collateral is not required.
Credit rating / Credit score / Credit history
Terms used to reference the business’s past financial dealings used as a measurement of reliability and trust.
Types of Business Loans
There are many different types of business loans, with specific loans being optimised for their intended use.
However, despite this potential complexity, business loans fall into three categories, as follows:
Unsecured Business Loans
An unsecured business loan is any loan where collateral is not required. These are perhaps the most common type of loan, especially for smaller and medium-sized businesses.
Unsecured loans focus heavily on the credit history of the business and, in many cases, the credit history of the company directors.
Unsecured loans are a risk to the lender, so a considerable amount of due diligence must be undertaken by them to minimise that risk.
This begins with your credit history but may also involve the lender wishing to see detailed business and project plans, financial forecasts, current banking status, and more.
Because of the increased risk to the lender, unsecured business loans also tend to have higher interest rates, so can be more costly to your business.
Failure to repay an unsecured loan can lead to the lender adding additional charges, court involvement, damage to your credit rating, and in extreme cases, even bankruptcy.
Depending on the size of your business, your need, and your credit rating, you may be able to obtain an unsecured loan of any size, from £1,000 to £15 million.
Secured Business Loans
In contrast to an unsecured business loan, a secured loan is one where collateral is provided as a security upon the loan.
If repayments are not met, then the lender is able to seize the asset that is marked as collateral and repossess it.
Examples of secured business loans include commercial mortgages and many types of asset finance, such as car finance.
As a secured loan is less risky for the lender, there are some advantages to the borrowing business, including a lower interest rate and a potentially easier application process.
However, just because the loan is secured doesn’t mean the lender ignores other factors.
Your credit history and business plan are likely to be considered here just as they are for an unsecured loan - though the lender may be more lenient with its decision-making.
Secured loans are available for any size, from £5,000 to £25 million or more.
Revolving Lines of Credit
One type of business loan that is often overlooked is that on an ongoing line of credit. These useful loans allow you to dip in and out as required to help with cash flow for your business.
While there are some specific loans for this function that can be applied for, the two most common types tend to be already utilised by most businesses - credit cards and overdraft facilities.
Like any loan, both credit cards and overdrafts will charge regular interest. However, as ongoing lines of credit, they do not typically have a term length.
Revolving lines of credit can be best for businesses that have fluctuating cash flow, such as those with seasonal peaks and troughs. However, they should not be leaned on too heavily because their interest rates are generally far higher than other types of business loans.
The size of any revolving line of credit depends on business needs and credit history, though it is typically easy to get smaller loans of this type.
Using a Finance Broker
Here at Clifton Private Finance, our business finance specialists offer a complimentary advice service and can help you choose the right finance solution for your business requirements. They have access to a wide range of finance solutions from across the market.
Our team of advisers will help you to source the most competitive cash flow funding solution.
Our business loan service provides:
- Market-leading rates
- Fast service - finance within 2 to 7 days
- Access to specialist lenders
- Expert advice - professional service
Call us on 0203 880 8890 to discuss your requirements.
Or you can book a free consultation with one of our expert advisors at a convenient time for you below.
FAQs
Can I Get a Business Loan?
You can get a business loan - if you fit the eligibility criteria. Obtaining a business loan can be easier than you might expect, but eligibility requirements will vary depending on the type of loan, your business, and how much you're looking to borrow.
Lenders want to sell their products, and if you are confident that you can repay a loan, then chances are usually good.
While it will impact your credit score and history to make a full loan application, it is possible to research the market and understand the types of loans you could get without any hard searches - so there’s no downside to finding out.
How Long Does It Take to Get a Business Loan?
It depends on the type of loan you are looking to get, but some loans can be approved within hours.
The time it takes to get a business loan can vary widely depending on several factors, including the type of loan, the lender you're working with, and how prepared you are for your application.
The complete timeline can be influenced by elements like the completeness of your application, your lender's workload, and the complexity of your business's financial situation.
To make sure everything goes smoothly, make sure you are prepared with all the necessary documentation before you apply. Or you can seek the help of an experienced broker who can guide you through the process.
Am I Personally Liable for My Business Loans?
If you have a limited company, then in most cases, your liability is protected. However, some lenders may ask for a personal guarantee. Sole traders and partnerships are personally liable for their loans.
What Loan Terms Are Available?
Loans can be arranged from very short term (12 months or less) to long-term asset-based loans of 20 years or more. Most unsecured business loans range from 2 to 7 years.
Do I Need to be the Company Owner to Apply for a Loan?
No. Any of the registered company directors can apply for a business loan.
Can My Company Have Multiple Loans at Once?
Yes. While existing loans will have an impact on your credit history and will affect the lender’s consideration when determining your business’s suitability for a new loan, there is no limit to the number of loans you can have.
However, second asset-based loans cannot be taken out on a single asset.
Can I Take Out a Loan to Pay Off a Loan?
Yes. This is termed refinancing and is a regular practice in business finance.
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