Advantages and Disadvantages of Bank Loans for Small Businesses

Businesses often look to bank loans for additional finance, but it’s important that their pros and cons are understood.

Small businesses need extra funding for all sorts of reasons, and a bank loan is where many business owners look first. But how do you know if a bank loan is the right option for your business? Read on to learn about the pros and cons of bank loans for small businesses, to help you decide.

Key summary: bank loan pros and cons

Advantages	Disadvantages
Could allow you to grow your business	Eligibility criteria can sometimes be hard to meet
Could aid cash flow and help cover other expenses	It can take time to apply and receive funds
You keep full control of your company	Secured loans carry the risk of losing your asset
Interest rates may be lower than on other funding options	Personal guarantee puts your personal finances at risk
Could help build business credit

What are the advantages of bank loans in business?

1. Allow you to grow your business

Any business loan, whether from a bank or another lender, can be a convenient way to get extra finance, without needing to wait until your business has generated enough profit to fund expansion yourself. Taking out a loan means you can put your plans into action much earlier, market your business, and take advantage of any business opportunities that present themselves, enabling faster and more accelerated growth.

2. Help cash flow and cover other costs

A loan can help cover challenges your business may have with cash flow, whether they are unexpected or due to your business having seasonal lulls. There are few restrictions on use, as long as it’s related to your business. For example, the financial buffer a loan can provide could help buy stock, cover wages or also help pay for unanticipated expenses.

3. You retain full control of your company

A traditional bank loan, and many other types of business loan, offers the ability to secure a financial injection without relinquishing any control of your company. With some other funding options, like equity finance, you will be selling company stock to investors to get immediate funding which means you will have to share out the profits while the investor(s) are on board. By contrast, once you pay off a loan you will have no more obligation to the lender.

4. Favourable interest rates

The interest rates on small business loans are often more favourable than using an overdraft, credit card, or a personal loan. This can help keep the cost of borrowing to a minimum. Solid financial performance, a viable business plan and a good credit score are usually needed to secure the very best rates.

5. Build your business’s credit score

Taking out a business loan, whether through a bank or another lender, and repaying it on time and in full will help improve the credit score of your business. In turn, this could make it easier to take out credit, and access the best rates, if you need to borrow again in the future.

What are the disadvantages of bank loans?

1. Eligibility criteria is sometimes hard to meet

Banks and other lenders can sometimes be cautious about lending to small businesses. A business’s financial and trading history will be assessed by a lender before offering a loan and business plans scrutinised carefully if you have a newer venture. Specialist start up business loans are available, but it’s usually more established businesses with a good credit history that find it easiest to get a loan.

2. It can take time

Getting a business loan, particularly from a bank, will often take time. In order to apply, you’ll need various documents, including bank statements, financial accounts, tax returns, your business plan and forecasts.

Some online business loan lenders can turn loan applications around quickly, maybe within a day. However, other providers such as the traditional banks that you find on the high street could take a few weeks.

3. An asset may be needed for the loan

Taking out a secured business loan involves putting forward an asset from your business as security for the loan. Interest rates are often lower on secured loans, and they can be easier to get with poor or a limited credit history. Importantly, however, the asset is at risk, and could be taken by the lender if loan repayments aren’t met.

4. Personal guarantees bring personal liability

Some business loans, including from banks, require you, as the business owner, to provide a personal guarantee for the loan. This makes you liable to repay the loan from your own personal finances if your business can’t make the repayments, and could put your home at risk. Lenders are more likely to ask for this guarantee on an unsecured business loan, where an asset isn’t needed as security.

Are there any other funding options?

A seemingly ever-growing number of online and alternative business loan providers means that banks are definitely not the only lenders available to small businesses.

Often, it is these newer alternative lenders which offer the most flexibility around eligibility and the widest range of funding solutions.

Because their overhead costs are typically lower than high-street banks, online lenders may be able to offer better interest rates. They may also be more prepared to offer loans to businesses that are less established or bad credit business loans to companies with a less-than-perfect credit history (although this would typically be reflected in high interest rates).

Many alternative lenders offer more specific types of loans, such as invoice financing, asset financing and merchant cash advances too.

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Advantages and Disadvantages of Bank Loans for Small Businesses

Key summary: bank loan pros and cons