How do small business loans work?
One of the biggest hurdles an SME faces is gaining access to finance, especially if it has no backers, track record or even clients in the early stages. A lack of access to borrowing is one of the three common reasons half new businesses fold within five years. If you can secure a small business loan it could really help your company get off the ground or expand.
In this article we give you the lowdown on small business loans, taking you through the options available, how you choose and how your apply.
Reasons for taking out a small business loan
- Premises:Whether it's for purchase or rental, many companies require credit for acquiring commercial property from which they can operate their business. When it comes to purchasing, the most likely form of loan for this reason is a commercial mortgage.
- Equipment:A loan might cover digital hardware, tools, furniture and other equipment. Another alternative to buying is leasing, where the company makes monthly repayments based on the depreciation of items rather than the full cost, which will be cheaper. This can also be an effective way of ‘future-proofing’ against eventual improvements in technology, as the borrower might be able to upgrade to new equipment when the lease ends.
- Working capital:This covers day to day operations, wages etc. This might be necessary on a short-term basis, until earnings build to an extent where the income of the SME enables to company to become self-sufficient and pay for itself.
- Stock purchase:Variations in the calendar mean that some companies might have seasonal highs and lows, and may need to plan - and buy - ahead to fulfil stock orders.
- Training: Staff training is an important factor for many companies. Loans can be used to pay for expensive but invaluable courses and training schemes upfront.
Types of small business loan
- Asset financing loans are one of the best options for purchasing new equipment for growth when a company lacks capital. They are usually arranged on a hire purchase arrangement that last between 12 and 72 months.
- Bridging loans can be used as a stop gap loan when a purchase needs to be made quickly – often when there is not enough time to arrange a mortgage. They can be used to fund the purchase of commercial or residential property or for other purposes, perhaps for a few months until a mortgage is arranged.
- Invoice financing works by requesting that businesses pay a percentage of any amounts owed to their lender as a fee for borrowing the money ahead of schedule.
- Credit lines are a flexible source of finance available for companies that need additional capital. Applications can take as little as five minutes and the funds could be in your account within an hour if successful.
Comparing small business loans
- Know Your Money provides a comprehensive breakdown of some of the main brokers and lenders in our business loans section, and the potential funds available.
- Some lenders require as small a turnover as £12,000 pa, while others will require £100-200,000 or more.
- As well as the amount borrowed, look for other perks such as mentoring or a dedicated account manager for the process.
- Some brokers will do the comparisons for you, once you’ve provided details, giving you the best secured, unsecured asset finance and flexible facility loans from its panel.
Applying for small business loans
- An application can be completed online, over the phone or at a lender’s branch. They typically take as little as ten minutes.
- You’ll be asked to specify the amount you wish to borrow and the length of term, before providing details about your business such as the duration it has been trading, the annual turnover, and the purpose of the loan. You may also be asked if you have filed accounts that can be provided.
- Check for arrangement or security fees before signing up. Arrangement fees typically correlate with the amount being borrowed (eg fee of £250 for £10,00-£15,000). However, some banks do not charge; for example Lloyds has recently scrapped arrangement fees for business loans up to £25,000. Any arrangement fees will be deleted from the overall borrowed amount.
- When making a decision, lenders will look at a number of criteria, such as the company’s credit rating and financial history. Businesses involved with an IVA, a debt arrangement plan or bankruptcy are unlikely to succeed.
- The decision can often be made within 24-48 hours, depending on the lender, and the money can be in the nominated bank account shortly afterwards.
Interest rates and terms
- Interest rates vary greatly between lenders – from around 5% up to 24.9%. government-backed start up loans have a fixed interest rate of 6% per annum.
- The shorter the loan period, the higher the interest rate.
- The length of the loan repayments could be anywhere from a month to 15 years.
- Some companies offer mentoring and support after the loan has been accepted; an experience individual will offer business guidance on a 1:1 basis, advising on decisions and ideas but also providing a trusted shoulder to lean on when you’re feeling anxious.
What happens if I’ve been rejected?
- Speak to the company that rejected you to find out the reason - it could be your credit score, your finances, the industry you work in, or something else. Knowing this can help you work towards a successful application in the future.
- For example, if the lender is concerned about your lack of experience, perhaps you should build the business more and establish a track record before applying again. Paying off existing debts or at least keeping them low, and paying bills on time, will start the repair process. Not all companies consider a credit rating; some look purely at cash flow.
- Loan applications count as ‘hard check’, alongside applications for cars, mortgages and credit. If a lender searches your credit history and finds multiple hard checks that have affected your score (checks and new credit make up 10% of the overall score) they may be concerned. Most hard checks stay on your report for a year. Again, try to limit the number of checks you make within a given period.