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A business loan is one option if you need some extra funds to run your business. However, there is no one single type of business loan, as each business and its funding needs are different.
All business loans will need to be repaid with interest, but the exact way they work varies. Read on to find out more about the types of business loans available, what they might be used for, and whether any of them could be a good match for your business.
Unsecured business loans
With this type of loan, you borrow a lump sum and repay it in fixed instalments over an agreed period.
With an unsecured business loan, you don’t need to put up any kind of security to act as collateral. Lenders will look at a range of factors, including your overall business finances and your business credit rating, to work out whether to offer you a loan.
Because there is no security, interest rates on unsecured loans tend to be higher than on secured loans.
Although these loans are unsecured, some lenders may require a personal guarantee. This is when a company owner or director promises to repay the loan themselves if their business can’t, so they would be personally responsible for repaying the debt.
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Secured business loans
Businesses can use secured loans to access a lump sum of cash and repay it with interest over an agreed period of time.
However, unlike unsecured loans, these require businesses to put up an asset as security. This will typically be a property, but it could also be another high-value asset such as equipment or a vehicle.
A secured loan is less risky for lenders as, if your business fails to repay the loan, the lender is entitled to repossess the asset.
As a result, lenders may view an application for a secured loan as lower risk than an unsecured loan because they have the extra reassurance that they can claim back their money if necessary. Lenders may also offer a larger amount with a longer repayment period and lower interest rates.
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Short-term business loans
As the name suggests, a short-term business loan is a type of loan that’s designed to be repaid over a shorter period of time than a standard business loan.
These can be suitable if your business needs to cover an emergency expense or any kind of immediate cost.
However, with these kinds of loans, your business would usually need to repay it within a few months, or possibly up to two years. As a result, you would need to be confident that your business could afford to repay the loan in full.
It is normally fairly quick to apply for a short-term business loan, but the interest rates may be higher than on a longer-term business loan.
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Working capital loans
Working capital loans are another type of short-term finance for businesses. They can be used to help cover gaps in cash flow, so you can carry on with the running of your business.
You may not always have the cash in your account to pay bills or to pay for stock, for example, which are crucial to the running of your business. This may particularly be the case if you have a seasonal business that experiences peaks and troughs in income throughout the year. A working capital loan is designed to cover this kind of shortfall in your finances.
However, you need to be certain that your business will have the cash in the future to allow you to repay the loan in full and on time.
» MORE: Working capital explained
Invoice financing
This is a secured form of business finance, as the amount you borrow is based on the value of your unpaid invoices.
Rather than waiting for a customer to pay an invoice, if you need to access cash relatively quickly, you could ‘hand over’ the invoice to a lender. The lender will then offer a loan, up to a percentage of the value of the invoice, which you then repay later. You can typically access between 70% and 90% of an invoice’s value.
The amount you can borrow through invoice financing will clearly depend on the value of your unpaid invoices. It can also work in slightly different ways, depending on whether you choose invoice factoring or invoice discounting.
Invoice factoring is when the lender takes control of the invoice, so the customer who needs to pay the invoice will pay the lender directly. The lender will be responsible for chasing up the payment.
With invoice discounting, you continue to ‘manage’ your invoices. As a result, the customer won’t know that you are using this credit facility as they will pay you directly. You will then need to repay the lender as per the terms of your agreement.
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Asset financing
Asset finance is another type of secured borrowing. The finance is secured against assets, such as equipment or machinery, allowing businesses to access the tools they need, even if they can’t afford to buy the items outright.
Asset finance can work in a number of different ways. For example, it can work like a lease agreement, where you pay a sum each month to use a piece of equipment for an agreed period of time, after which you return the item.
Alternatively, you may be able to spread the cost of an asset over a set period, and once you’ve made all the payments you will then own the item outright.
If you already own a high-value asset and you need to release some cash, asset refinancing could be an option. This is where a lender offers you a loan up to a certain percentage of the asset’s value, which you then repay.
» MORE: Asset finance explained
Credit lines
A credit line, or line of credit, is a flexible form of finance for businesses. Rather than applying for a fixed sum of money, with a line of credit you can borrow as much or as little as you need.
It works in much the same way as a credit card, as the lender sets a limit to say how much you can borrow. When you have this approved limit, you can then borrow money up to this limit whenever you need to. You only pay interest on the amount you use, not the whole credit limit, and repayments are typically more flexible than on term loans.
Some credit lines are ‘revolving’ meaning that once you pay back what you owe, you can access the full amount again, assuming you stick to the terms of the agreement.
The flexibility this type of finance offers may be suitable for businesses which think they may need to borrow money in the future, but they’re not sure how much. It means you only borrow and pay interest on the amount of money you need.
Lines of credit can be both secured and unsecured.
Merchant cash advance
A merchant cash advance is another way a business can borrow a lump sum of money. However, rather than repaying the loan in fixed instalments, it is repaid through card transactions.
As a result, this option would only be suitable if your business handles a lot of card transactions.
When a customer pays via a card terminal, a percentage of the transaction is deducted and goes towards paying off the loan. The lender and the provider of the card terminal work together to facilitate this.
Unlike a standard business loan, you don’t have to make a minimum or fixed repayment each month. Repayments are made solely from the card transactions, so the more money you make, the quicker you pay off the loan.
The amount you can borrow will depend on a number of factors, including how much money your business makes from card transactions each month. Because merchant cash advances are so heavily based on the income of your business, you may not be able to borrow as much compared to other types of loan.
Government loans
To help businesses develop and grow, there are a number of national and regional government business loans.
One example of a government loan is the Start Up Loans scheme. Through this scheme, businesses that have been trading for under three years and that meet the other eligibility criteria can access loans from £500 up to £25,000. If approved for a loan, businesses also have access to free advice and mentoring.
Another key example is the Recovery Loan Scheme. This government-backed scheme allows small businesses access to a variety of loans. The products on offer include an existing term loan, revolving credit facility, invoice finance and asset finance and asset-based lending.
It is also worth seeing if your business is eligible for any local or national grants. Business grants can help you get funding and, unlike business loans, they won’t need to be repaid.
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