How to get a business loan

Bank manager discussing business loan repayments with business owners

Want to start or expand your business but don’t have enough funds? A business loan could be the answer but it’s important to find the right loan for you. Here are some of the main options

There are many ways for a small business or sole trader to borrow money. It’s important to find an appropriate lending solution that does not become a burden that you can’t manage. Never forget that borrowing could put your business or personal assets at risk.

What is a business loan?

A business loan is a way of borrowing money to help your business grow or to get a start-up off the ground. Potential lenders include high street banks, online lenders and peer-to-peer lending platforms. Business loans typically start at £1,000 and can be several million pounds. Loans can be short-term (from just a few months) or long-term (up to 25 years). Interest rates are likely to be lower if the loan is long-term but as you are repaying the loan for longer you could end up paying more.

No matter what kind of business loan you are looking for, lenders will want to know what the loan is for; they will ask to see evidence of your income as well as details of how you plan to repay the loan.

Most loans work on the basis that you will repay the loan with a fixed interest rate over a fixed period of time. However, there could be penalties for missed payments or for repaying early. You can use a business loan calculator to work out the final cost of a loan before you agree to the terms.

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How can a business loan help your business?

It’s often said that you need to spend money to make money. Of course, that is not always the case - many entrepreneurs start a business with little or no money. However, many others have to borrow to get the funds they need to create a viable business or to invest in a business that has potential for growth.

Common reasons to take out a business loan include:

  • to get a new business off the ground;
  • to expand a business;
  • to buy more stock;
  • to take on new employees;
  • to move premises or invest in new equipment;
  • to invest in new technology or a marketing campaign;
  • to help with cashflow.

How do business loans work?

Most business loans work on the basis that you borrow an agreed amount of cash and pay it back over an agreed term with interest. This arrangement is what’s known as a “term loan”.

Another option for businesses is to agree a “line of credit” with your bank which allows you to borrow cash when needed (up to an agreed amount) so you only pay interest on the money you take out. However, if you go over your limit or repay late, extra fees could apply.

When you’re shopping around for a business loan, you’ll need to compare the interest rates and repayment terms offered by different lenders. Interest rates can be fixed or variable. There are pros and cons with each. A fixed interest rate can give you certainty but there may be fees for early repayment. Loans based on variable rates can be more flexible but there’s a danger that rising interest rates will make it harder to repay the loan.

Another important factor is security. Business loans are usually either “secured” or “unsecured”. A secured loan often uses assets as security. If you can’t make the loan repayments, the lender can sell the asset to get their money back. Business assets could include property, stock and machinery. Secured loans typically have lower interest rates than unsecured loans.

Unsecured loans are much harder to get and they are usually more expensive. Banks can also ask for a director’s personal guarantee - if your business is unable to repay the loan, you will be personally responsible for it.

If your business is struggling to get a loan, the government’s Enterprise Finance Guarantee scheme (EFG) could be the answer. EFG facilitates lending to viable businesses that have been turned down for a normal commercial loan due to a lack of security or a proven track record. However, participating lenders will still want to be satisfied that your business can afford the loan repayments.

What happens if you can’t pay back a business loan?

If you are struggling to repay a business loan and you miss some payments you will almost certainly have to pay late payment fees; you could also be liable for extra interest or administration fees. In the longer term, missing payments could damage your credit rating and make it harder to borrow in the future. If you fail to make a number of payments over several months, you will be seen to have defaulted on your loan. If your loan was agreed with a director’s guarantee, you will be personally responsible for paying back the loan. If you took out a secured loan, then your assets could be seized.

Where can I get a business loan?

There are more options than ever when it comes to business borrowing. It’s always worth approaching your business bank first as you already have a relationship with them.

As well as the high street banks, there are plenty of other small business lenders. You can use Nerdwallet's business loan comparison tool to find out what many of the leading providers offfer. 

Another option is peer-to-peer lending platforms (P2P) that match businesses that need funding with private investors looking to invest. Applications are made online and the process can be quicker than a traditional bank; lending could come from one person on the platform or from a pool of people. In other respects, P2P lending is no different from a bank loan - the lender earns interest on the loan and the small business pays it back within the agreed timeframe.

How can I maximise the chances of being accepted for a business loan?

A detailed business plan is absolutely key - backed up by evidence including company accounts, cash flow projections and realistic sales forecasts. If you use accounting software it’s easy to share financial reports with potential lenders. You may also need to show bank statements and tax returns.

You’ll have to explain why you want the loan and show how you intend to pay it back. Lenders will also ask about you and your management team, as well as investors. They will want to know how much equity you have in the business. Above all, remember that lenders are looking for a solid business that will deliver steady income.

Do I need a good credit rating to get a business loan?

Yes, lenders will look at your personal credit score to see if you have a good track record on managing finances. In fact, every member of your leadership team will need to have a rock-solid credit history. Your track record in business will also be a key deciding factor. If you run a limited company, your personal credit record will include the company accounts filed at Companies House.

How can I get a business loan as a start-up?

It can be difficult to get a loan for a new business because most lenders want to see at least two years’ of business accounts. One option is to take out a personal loan to start a business. A personal loan will be in your name; if you have difficulties paying it back it will affect your personal credit rating.

You can also apply for a government-backed Start-Up loan. The government start-up loan scheme offers loans of £500 to £25,000 to start or grow a business. It is not a business loan, but an unsecured personal loan. However, it comes with free guidance to help you write a business plan, and successful applicants get 12 months of free mentoring. Applicants must be over 18 and have (or plan to start) a UK-based business that’s been fully trading for less than 24 months. Start Up Loans charge a fixed interest rate of 6% per year. You can repay the loan over a period of one to five years; there’s no application fee and no early repayment fee.

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