What is a Business Loan?

A business loan can be used for a variety of reasons, from buying new equipment to covering temporary cash flow shortages. Learn more about the different types of business loan and all you need to know before you apply.

Rhiannon Philps Published on 01 June 2022.
What is a Business Loan?

Whether you’re a newly established start up or you’ve been running your business for years, there is likely to come a time when you need some extra funding.

When that time comes, you may not have the ready cash available to pay for all you need, in which case you may want to consider a business loan.

Read on to find out more about business loans, including their main features and what you can use them for.

Features of business loans

Business loans are a form of borrowing that allow businesses to access finance when they need it.

There are several types of business loans available that work in slightly different ways, but some of their main features include:

  • Potentially large borrowing limits, depending on the lender, type of loan and your business.
  • Lenders will charge interest on the amount you borrow.
  • The loan will be repaid over a specified period of time, ranging from a few months to several years.

The fact that business loans need to be repaid with interest is the main factor that differentiates loans from grants, which are non-repayable.

Unlike personal lending, where all lenders need to be regulated by the Financial Conduct Authority (FCA), most business lending is unregulated.

However, lenders do typically need to be regulated to offer loans to sole traders, partnerships with fewer than four partners, or any unincorporated association.

» MORE: How do business loans work?

Types of business loan

There are several types of business loans that are designed for different kinds of businesses and requirements. For example, some of the main types include:

  • Unsecured loans: These are loans that are typically repaid in regular instalments over an agreed period. They are not secured by any kind of business asset.
  • Secured business loans: These loans require you to put up an asset as security, such as a property. This often means you can borrow a larger sum of money and access lower interest rates, but the lender can repossess this asset if you fail to repay the loan.
  • Lines of credit: Rather than a lump sum, this gives you access to a credit limit which you can borrow from as much or as little as you like. You only pay interest on the amount you use.
  • Working capital loan: This is a short-term loan designed to cover a business’s everyday running costs.
  • Invoice financing: This is when a lender offers you a loan worth a percentage of an unpaid invoice.
  • Asset financing: This allows businesses to use equipment, machinery, or another asset without paying for it up front. Instead, you can make payments to cover the cost over an agreed period.
  • Merchant cash advances: This is when you borrow a lump sum based on your projected sales. It is repaid by deducting a percentage from your card payments.

What can you use business loans for?

Business loans can be used for a variety of different business-related purposes. For example, you could use a business loan to cover the cost of:

  • buying new equipment or machinery
  • expanding your business
  • purchasing stock
  • a short-term drop in cash flow
  • paying staff
  • training
  • marketing

Pros and cons of a business loan

If your business needs extra finance, a business loan could be a good idea. Some of the advantages of taking out a business loan include:

  • You can access funding quickly, rather than waiting until your business has enough cash.
  • You can repay the loan in fixed instalments over a period of time.
  • You retain control over your business, unlike if you sourced funding from an investor, for example.

However, before applying for a loan, it’s important to be aware of the risks involved so you can be sure that a loan is definitely the right course for your business.

Some of the potential disadvantages to bear in mind include:

  • You will need to pay interest on your loan.
  • If you miss a payment, you could face extra fees and your credit score could be affected.
  • Your property is at risk of repossession if you miss payments on a secured loan.
  • Many business loans are not regulated in the same way as personal loans.

» MORE: Pros and cons of bank loans for businesses

Who can get a business loan?

As a rule, to qualify for a business loan you will need to be at least 18 years old and a UK resident.

Lenders may set their own individual criteria beyond this, such as a minimum number of years’ trading history or a minimum turnover.

Your credit history will also be a factor that lenders consider to determine whether you’re eligible for a business loan.

Lenders will look at your business credit rating and, in some cases, your personal credit history to see how you have managed your finances and credit responsibilities in the past. They will use this information, alongside other details about your business, to make a decision on your loan application.

Even if you have a less-than-perfect credit history, some lenders may still offer you a loan. However, you are likely to face higher interest rates than a business with a better credit rating, and the lender may require some form of security or guarantee.

» MORE: Who can get a business loan?

How can you apply for a business loan?

Many providers offer business loans, including high street banks and online lenders.

To help you find a loan that’s suitable for your business, you can compare loans and check your eligibility without affecting your credit rating. This will allow you to see which business loans you could qualify for and how much you could potentially borrow.

When you apply for a business loan, the lender will need to know some key information about your business, such as:

  • details about you and any other company directors
  • your Companies House registration number (if applicable)
  • details about your business finances, including profit and loss statements
  • your cash flow forecast
  • a business plan

» COMPARE: Business loans

Image source: Getty Images

About the author:

Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more

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