A guide to how small business loans work

Investing in your company could reap dividends, but it can be tricky to free up cash when your venture is still in its early days, or your income varies a lot. So whether you want to fast forward your business development, supercharge your staff’s skills, boost sales with advertising or invest in research and development, a small business loan could be the solution you’re looking for.

What is a small business loan?

Small business loans are a way to find cash for your business, when you need it.

You may need to consider how your business cashflow works. Do you run a highly seasonal business? You might find it hard to meet your repayment amount in the quiet months.

The amount, interest rate, length of loan and repayment structure can all vary by provider. Once you’ve found an option that suits you, it works like a personal loan. The lender gives you the cash, and you repay it in regular amounts according to the agreement.

What types of small business loans are available?

As a business owner, you can borrow either an unsecured business loan or a secured business loan.

What is an unsecured business loan?

An unsecured business loan lets you borrow money without using your business assets as security. If your small businesses doesn’t own any valuable assets, then this might be the right choice for you.

Unsecured small business loans tend to have higher interest rates, because they can be riskier for the lender to take on. You usually need to sign a director’s personal guarantee. This is a document that says the owner is personally liable if the business defaults and cannot repay its loan.

What is a secured business loan?

A secured loan lets you borrow money, using your business’ assets as security. If your small business has valuable assets like equipment, vehicles, or premises that you own outright, this might suit you. The lender may ask for a formal valuation of the asset before you can get a loan. The amount that you borrow needs to be equal to or less than the value of the asset you borrow against.

Once you agree to your loan – including the asset, amount, interest rate and repayment structure – the lender gets "charge" over the asset. This means that if you can’t make your repayments, they can seize the asset and sell it to cover their losses.

What can I use a small business loan for?

A small business loan can be used for almost any legitimate business purpose. These could include: investing in research and development, refurbishing your premises, expanding your operations, boosting inventory levels, mounting an advertising campaign, hiring or training more staff.

Business owners can also use a small business loan to cover unexpected bills, or fluctuations in your income if your business is highly seasonal.

What are the interest rates, loan lengths and repayment terms for a small business loan?

Conventional business loans typically range from £500 to £500,000, although some small businesses could borrow more.

The interest rate, loan length and repayment terms will depend on how much you’re borrowing, which lender you choose, and the type of product they offer. The rate you pay is also affected by factors like your credit history, the performance of your business and the sector you’re in.

Interest rates are normally fixed, meaning that you always pay the same percentage, but they can also be variable.

Who can apply for a small business loan?

Some small business loan providers only lend to companies that have been trading for two years or more. Others are open to companies with just two, three or six months of trading.

Is a small business loan right for you?

If your business is still in its early days, you might struggle to get a conventional loan from a high street bank. But banks aren’t your only option. Some non-bank lenders specialise in loans for SMEs.

What do small business loans look like?

Small business funding doesn’t have to mean a trip to the bank. As well as conventional loans from financial institutions, the market has been an explosion of innovative alternatives in recent years.

Merchant cash advances

Does your business take customer payments from a card terminal? If yes, then a merchant cash advance might be right for you. Merchant cash advances have only existed for a few years, but they’re already proving popular. A merchant cash advance is when you borrow cash against the card transactions you receive each month. Your business repays the loan through a percentage of your customer card transactions.

Unlike a traditional loan, you may not need to go through credit checks or accounts reviews – the lender can easily see what volume of money flows through your business each month. The repayment is usually a fixed percentage of your revenue. If you have a bumper month, you’ll pay back a higher figure, in quiet months, you’ll pay back less. You could be eligible for other lines of credit at the same time as a merchant cash advance.

Peer-to-peer business loans

Peer-to-peer lending or P2P is growing fast. The big difference between peer-to-peer lending and traditional finance options is that there’s no bank or financial institution involved. With no costly bank overheads, online P2P providers can often offer better interest rates than conventional lenders. The risk? You’ll usually have to give a personal guarantee, in case your business defaults on the loan. Providers include Zopa, Funding Circle and Ratesetter.

Invoice financing

Invoice financing is an umbrella term for several finance facilities. If your business is being held back by customers who are slow to pay their invoices, this option could work for you.

Invoice financing options allow you to borrow money against what your customers owe you. The lender gives you access to some of the funds you’re owed, immediately. Depending on the arrangement, your business might then pursue the repayment or the lender might follow up for you. You receive the rest of the amount you’re owed, minus any service fees. It’s like a secured loan on an asset, except that the asset is the cash owed to you by customers, instead of a physical asset like an office or car.

Invoice financing is unregulated in the UK, so you must take extra care to choose a reputable provider, and understand all of the costs, fees and charges.

Can I get a small business loan with bad credit?

If your credit score is on the low side, you might struggle to get a small business loan from a traditional lender. Alternative solutions (like the ones mentioned above) may be right for you, but make sure you understand the risks.

Will my small business loan application be successful?

Of all the small businesses in the UK who applied for conventional loans and overdrafts in the 18 months up to the end of 2017, 80% were successful, according to UK Finance. To maximise your chance of success, consider factors like the type of business you run, how long you’ve been trading, whether your income is seasonal or consistent, and choose a provider that specialises in businesses like yours.

Financial advice note

The information contained in this article is provided for informational purposes only and should not be construed as financial advice on any matter. You should not rely on the information published in this article. The information in this article does not take account of individual circumstances and may not reflect recent changes in the law. Do not act or refrain from acting upon this information without seeking professional financial advice.