The best types of loans for business

In this guide, we look at both conventional and start-up business loans and weigh up the criteria for each to help you decide on the best business loan options for your circumstances. We also briefly look at other credit options and methods of borrowing that may be available to you.

• Government backed start up business loans
• Secured and unsecured business loans
• Peer-to-peer lending
• Working capital loans 
• Available alternatives to business loans

Government backed start up business loans 

Government-funded Start Up Business Loans are for individuals looking to start a new business. Or for individuals who want to grow an existing business that has been trading for less than 36 months within the UK. 

In reality, it is a personal loan taken out for a start-up business. If you are approved, you would normally receive lower interest rates and higher loan amounts over longer repayment terms. Currently, these loan types come with a fixed interest rate of 6% and can be repaid over a period of 1 to 5 years. There is no application fee attached and no fee for early repayment either.

Successful applicants also receive 12 months of mentoring for free and business offers to help them succeed. The money you receive from your business loan can be spent in a wide range of business-related areas, for example, marketing, premises, equipment, and stock.

Secured and unsecured business loans

These are loans designed for new businesses and to help build existing businesses. Some lenders will offer short-term finance; these loans normally are for smaller amounts repaid over a short period, a bit like short term loans - except for businesses. While others will allow you to borrow larger amounts over a longer period. Usually, a company has to be VAT-registered to be able to apply for a business loan.

There could also be a minimum monthly turnover requirement, and some business loan lenders only lend to limited companies. Most lenders will run a credit check on your business, you and any other partners or directors. Lenders will also want to see details of your business, for example, up-to-date accounts, business plan and sales projections.

Business loans can be secured or unsecured. Unsecured loans depend on your and the business's creditworthiness, so the amount lent and the interest rate can vary. You should check your personal credit report and rating, as well as that of your business. Of course, economic growth, current Bank of England interest rates and the UK base rate forecasts also affect rates.

Secured loans are normally "secured" against an asset or even your house if you are a homeowner. So, it's very important to be confident that your business can afford the repayments. The assets you put up as security (including your home) could be at risk of repossession if payments are not made within the terms of the agreement - always seek help and advice from a qualified financial advisor.

While there is a difference between personal loans and business loans, some borrowers use personal loans to fund their business needs. However, some lenders stipulate that their loans cannot be used for business purposes. If the lender does allow a personal loan to be used for business purposes, it’s important to note that the borrower is liable for the repayments, whether the business can or cannot make repayments.

Peer-to-peer lending

Peer-to-peer loans cut out the more traditional lenders such as banks and building societies. Peer-to-peer business loan platforms usually have a large number of private investors who lend money to a business. Applying for these loans is mostly done online. Decisions could be made fairly quickly, if not instantly, which is a key benefit to borrowers to get quick funding.

Each peer-to-peer lender has different risk acceptance levels, so getting rejected by one lender doesn't mean another won't approve you. However, it is important to think about your credit rating in these circumstances as too many hard checks on your credit report can lower your credit score. Additionally, you may be charged a fee by the online platform you use to make the loan application.

Working capital loans 

Working capital loans are commonly defined as a business's current assets minus current liabilities. They are used to cover a company's short-term operational needs, this includes costs such as payroll, rent and any debt repayments. They are not intended to be required long term or used for any form of large investment, that is why it is termed 'working' capital – the funds are not tied up in anything and are readily available as cash.

These loans are normally used by companies that work on a seasonal basis helping them through times of reduced business activity. Usually, the loans are repaid by the time the company hits their busy season. Some can be unsecured, meaning that they can be quite easy to obtain.

A downside to these loans is that the interest rates tend to be higher to reflect the increased risk to the working capital lender. As the loans are tied to the individual’s credit score, any missed or defaulted payments can hurt their credit rating.

Available alternatives to business loans 

If you don't think a business loan is suitable to you, you might want to consider some other options that may be available. These are only really for short term use, but a quick way to access smaller sums of money.

Business credit card – These generally offer a limited interest-free period on purchases, which can be helpful in the short term. Many will charge an annual fee, and before your business can be accepted, you and your business will be subject to credit checks. The best way to avoid paying interest is to pay the balance off in full each month if you can, just like with regular credit cards.

Overdrafts – Some business bank accounts offer overdrafts; this should only be used for the short term. Overdrafts can be helpful for short-term cash flow problems. However, beware of interest rates potentially being higher than other forms of lending.

Final thoughts

When thinking about applying for a business loan, it is important to weigh up the benefits with the risks and to compare business loan options available to you. Here are a few things to remember:

• Check your credit report and credit rating (as an individual and a business) before applying.
• Ensure you meet all the business loan lenders’ requirements.
• Have a comprehensive business plan ready, your accounts are up to date, and all required business documentation is in order.
• Check if there are any limitations, such as limitations on what your business can do with the loan money.
• Make sure you can make the repayments before accepting a loan, and that you understand the risks, including the loss of assets used as security.

Finally, take your time to compare business loans and alternative funding options available to your business. You may also want to carefully weigh up the benefits against the risks of a loan during an economic slump - particularly if a crisis unexpectedly hits your business sector or there is a lack of demand.

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