Business loans are a common financing option for UK businesses, particularly those operating in the Backbone Sectors. These loans can provide the capital necessary for business finance growth, help manage cash flow, and overcome financial challenges, but there are some downsides too.
This guide will take you through everything you need to know about Business Loans and what to look out for.
At Alderway, our mission is to unlock value in undervalued businesses through Partnership Capital, and understanding different loan options is a part of this process.
Seek independent financial advice to make informed decisions about your financing needs.
What is a Business Loan?
A Business Loan is a sum of money borrowed by a business to fund various operational needs, such as expansion, working capital, equipment purchases, or managing cash flow and keeping a clean balance sheet. The loan is repaid with interest over a specified period.
What are the Uses of Business Loans?
There’s a number of reasons you might need to secure a business loan such as:
Expansion: Opening new locations, launching new products, or entering new markets.
Working Capital: Covering day-to-day operational expenses.
Equipment Purchase: Buying or leasing equipment necessary for business operations.
Debt Consolidation: Refinancing existing debts to manage cash flow more effectively.
Cash Flow Management: Bridging gaps in cash flow during slow periods.
Types of Business Loans
Secured vs. Unsecured Business Loans:
Secured Business Loans: Require collateral (e.g., property, equipment) and typically offer lower interest rates but involve more risk if the business cannot repay.
Unsecured Business Loans: Do not require collateral but usually come with higher interest rates and stricter eligibility criteria.
There are also a number of other funding options such as:
Term Loans: Traditional business loans where a lump sum is borrowed and repaid over a fixed term with interest. These are often used for larger investments like expansion or major purchases.
Lines of Credit: A flexible borrowing option that allows businesses to draw funds as needed, up to a predetermined limit. Interest is only paid on the amount borrowed.
Invoice Financing: Businesses can borrow money against unpaid invoices, helping manage cash flow by getting advance payments on outstanding invoices.
Merchant Cash Advances: Businesses receive a lump sum in exchange for a percentage of future sales, typically through credit card transactions. This option is often used by retail and service-based businesses.
Equipment Loans: Loans specifically for purchasing equipment, where the equipment itself often serves as collateral.
Short-Term Loans: Designed for immediate cash needs, typically with higher interest rates and shorter repayment periods.
SBA Loans (Specific to the UK context): UK government-backed loan schemes that support small businesses, offering favourable terms and lower interest rates.
How Business Loans Work
The application process for a loan can be complicated depending on a number of factors but we’ve broken it down below.
Step 1 - Preparation: Gather your financial statements, business plans, and credit history and have everything ready so that you’re not caught off guard.
Step 2 - Choosing a Lender: Have a good look around for the lender that best suits you and your needs. You should look carefully at factors such as loan type, terms, and interest rates. Interest rates and fees are determined based on the type of loan, the business’s creditworthiness, and the lender’s policies so make sure you’re clear on all of these points. It’s also important to understand the difference between fixed and variable interest rates and the repayment terms. Typical repayment terms include monthly payments, interest rates, and loan duration so be sure to understand the total cost of the loan over its lifetime.
Step 3 - Submitting an Application: This will differ between lenders but you will have to complete the application form provided and send over the required documentation.
Step 4 - Approval Process: This is where it’s good to know ahead of time what the lender’s criteria for approval is and should be a factor in step 2. Here, you’ll be waiting on the lender’s decision which may factor in credit score, business history, and collateral.
Step 5 - Receiving Funds: Once approved, the loan amount is disbursed, and repayment begins according to the loan terms.
Advantages and Disadvantages of Business Loans
Advantages:
Access to Capital: Provides immediate access to funds for growth, expansion, or operational needs.
Ownership Retention: Unlike equity financing, business loans allow owners to retain full control of their company.
Tax Benefits: Interest payments on business loans are often tax-deductible, reducing the overall cost of borrowing.
Building Credit: Successfully repaying a loan can help improve the business’s credit score, making it easier to obtain financing in the future.
Disadvantages:
Debt Obligation: Loans must be repaid with interest, regardless of the business’s financial situation, which can strain cash flow.
Collateral Requirements: Secured loans require collateral, putting business assets at risk if the loan cannot be repaid. You will need an asset as security and that’s always a risk.
Creditworthiness Impact: A poor credit history or lack of credit / poor credit score can result in higher interest rates or difficulty securing a loan and could impact your credit rating in the future.
Complexity and Time: The application process for business loans can be time-consuming and require detailed financial documentation.
What to Consider When Applying for a Business Loan
When deciding if a business loan is right for you there are many considerations. It should not be a decision that’s taken lightly and you should seek independent expert advice to ensure it aligns with your business’s financial situation and goals before going ahead. Some of the considerations should include:
Loan Purpose: Clearly define the purpose of the loan and how it aligns with your overall business strategy.
Eligibility Requirements: Common eligibility requirements include credit score, business history, annual revenue, and collateral. Meeting these criteria improves the chances of approval.
Interest Rates and Loan Terms: Compare interest rates and loan terms across different lenders to find the most favourable conditions.
Repayment Ability: Assess your ability to meet repayment obligations, considering your cash flow and financial projections. In some cases you may have a personal guarantee which is a contract to hold you personally responsible for paying back the loan if the company cannot.
What to Do if Your Business is Declined a Loan
If you’re declined a loan the first thing to do is understand the reasons for rejection. It’s important to know the reason so you can plan your next move. Ask lenders for feedback on why your application was declined, whether due to credit score, lack of collateral, or insufficient revenue.
Following this you should be looking at improving your financial position. Tips to improve your business’s financial standing include:Paying off existing debtsImproving cash flowEnhancing your business plan.
You could also at this point begin to explore alternative financing options. Alternatives to traditional business loans include:
Peer-to-Peer Lending: Borrowing money from individual investors through online platforms.
Angel Investors and Venture Capital: Raising capital by selling equity to investors.
Crowdfunding: Raising small amounts of money from a large number of people, typically via online platforms.
Grants and Government Programs: Exploring non-repayable grants or government-backed loan schemes.
Finally you could try reapplying. Strengthen a reapplication by addressing the reasons for the initial rejection and improving the overall loan application.
Understanding different types of business loans, their advantages and disadvantages, and the key considerations when applying is crucial for UK businesses. Seek independent financial advice and explore all available options before making a decision.
Assess your financing needs carefully and consider how Alderway’s Partnership Capital approach can support your growth and success, particularly if you face challenges securing traditional business loans.
By following this comprehensive guide, UK businesses can make informed decisions about their financing options and leverage business loans to achieve remarkable returns.
Comments