Small business loans explained
Many small businesses need capital to help them develop, and there have never been more funding options available, from traditional bank loans to leasing deals and even grants. But the type and terms of the funding could have a critical effect on your firm’s long-term future, so it’s important to choose wisely.
Here’s the lowdown on some of the options available to you.
If a company has lots of expenses to pay or needs money to see it through a rough patch then a short-term loan, usually lasting up to three years, could help ease its cash flow worries.
The attraction is you will usually pay less in interest than if you spread your repayments over a longer period, but your monthly payments will obviously be much higher.
But, if you need a loan to pay for everyday business expenses, or need the money in a hurry, then it might be worth looking at taking out a business credit card or even agreeing an overdraft with your business bank, as the interest rates on these might actually be lower than on a short-term loan.
If you need the money to buy equipment for your business then you could look into leasing deals. Many companies will arrange financing for small firms to encourage them to buy their goods and there are good deals on offer.
The 9% drop in business loan applications in 2016 (external link) was partly attributed by the British Bankers Association to more small businesses agreeing leasing deals, implying that many firms have found leasing to be cheaper and easier than bank loans.
Medium to long-term loans
Longer-duration lending agreements, usually five years or more, suit companies that need to repay the money slower, because the monthly repayments won’t take such a bite out of their working capital.
That can be good news for companies that know it will take them longer to get off the ground, or expect to see slower returns on their investment, such as setting up a new office.
How much a firm will repay will depend on the loan’s interest rate, which can either be fixed for the duration of the loan, or could vary, meaning the amount you owe could change according to the economic conditions.
These loans only tend to be offered by the high street banks, which are still rather reluctant to lend to small businesses, so you need to be patient (the process will take time) and the bank would expect you to provide a detailed business plan to back up your loan request.
Secured vs unsecured lending
The other big factor in how much interest a company pays on a loan, apart from its length, is whether it opts for a secured or unsecured loan. A secured, or asset-backed, loan is one where the borrower has pledged ‘security’, such as its vehicles, equipment or even office, which can be taken by the lender to pay off the loan.
Some small or start-up companies might not possess any assets that could be used as security, in which case its owners or directors might be asked to use their own properties to secure a loan for their business.
Or they might opt instead for an unsecured loan. You won’t be able to borrow as much as on a secured loan, you’ll have to repay it quicker and the interest rate will be much higher, as the lender tries to limit its risk of not being repaid.
You’ll also have to provide a lender with a lot of financial information, both for your company and yourself, to help it decide whether to loan you any money. Many new businesses won’t be able to provide several years of accounts, which may prevent them from getting a bank loan.
But, don’t worry, there are other options available to you.
Alternative sources of funding
Several new options have emerged as a result of banks’ reluctance to lend to small businesses since the global financial crash of 2008.
The government has stepped in to help the riskiest prospects: new businesses. Its Start-Up Loan Scheme (external link) provides no-fee, unsecured personal loans of £500 to £25,000 for up to five years at a fixed annual interest rate of 6%. Successful applicants also receive free mentoring advice and exclusive business offers to help get their businesses on their feet.
To get a start-up loan you need to pass a credit check, show your business is viable through a business plan and cash flow forecast, as well as provide a 'personal survival budget' which explains what personal income you have to survive (and to repay the loan).
Another way to raise the money is to apply for grants. There are lots of schemes available for small businesses from central, devolved and local governments, as well as charities, such as The Prince’s Trust.
There are start-up loans for new businesses, investment capital from Regional Growth Funds to initiatives run by the Scottish, Welsh and Northern Irish governments. The government’s ‘business finance support finder’ (external link) enables you to search for grants according to your company’s size, location and line of business.
But you need to keep in mind that most grants have specific objectives other than simply to help you to set up and grow small businesses, such as to promote innovation or job creation in a particular region or greener business practices.
So, as well as providing all of the financial information that would be required by a bank or lender, you will also need to explain how your business would meet the grant’s aim. Also, most grants won’t cover the full cost of a project, so you will also have to explain how much of your own money you will put up.
The Better Business Finance (external link) website offers small businesses a quick and free directory of approved lenders.
Although there’s now a wide range of options available for small businesses looking to raise money – we haven’t even mentioned peer-to-peer lending or crowdfunding – there aren’t any easy options.
Each will require some essential information: a strong business plan, detailing why your business deserves more money and what it will do with that cash, turnover projections, and even details of your own personal financial history to reassure a potential lender that you can repay it.
But if you do your homework there’s nothing to stop you getting the financing you need to either start or grow your small business.
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Disclaimer: The views expressed by the author do not necessarily reflect the views of Hiscox. We advise readers not to place any reliance on, or take any action based on, the content of this blog. Instead we recommend you undertake your own research and seek your own legal advice.