If you’re thinking about getting a business loan, there are a lot of things you need to bear in mind. How much money are you looking to borrow? What are the funds for? Do you have any assets to secure the loan against? There are many reasons why you might need a business loan — maybe you need to finance an exciting new project that could drive business growth, or unexpected costs took you by surprise.
The alternative business finance market has developed a lot over the last few years. By now, there are many different lenders offering different types of loans. Generally speaking, the term ‘business loan’ is a broad category for a number of different products, so how do you you find the one that is the most suitable for your situation? Here are some of the things you need to think about when considering a business loan.
Secured vs. unsecured business loans
Based on the lender’s criteria and appetite for risk, business loans can either be secured or unsecured. If you have any assets you could use as collateral, such as property, machinery, or vehicles, you may be able to get a secured business loan. This means if your business defaults on payments, the lender will sell your assets to recover their money.
With a secured loan, the amount you’ll be able to borrow directly correlates with the value of your assets. So, you may want to think about what your assets are worth, because you won’t be able to borrow more than about 50-75% of the asset’s value. However, whether you can get a secured business loan or not depends on your trading history and the strength of your business too, and it’s not just about your assets.
Unsecured business loans, on the other hand, don’t require any collateral. They are usually based on the strength of your business, so if you’re a well-established business they might be a good option. The lender will look for strong profits, and will usually require a few years of trading history too.
However, young businesses might find it harder to convince the lender of their creditworthiness, and bear in mind too that unsecured business loans usually have higher interest rates since the lender carries a higher risk. The rates vary, but as a rule of thumb: the higher the risk, the higher the rates.
Long-term vs. short-term loans
Another key fact to take into account when considering a business loan is the term. Would you like to finance business growth? A long-term business loan may be a good solution here. Or do you need the funds to tide you over to the next payment? In this case a short-term loan may be the more suitable option. Depending on the purpose of the funding, the period you want to borrow money may change.
There’s a simple reason why: you wouldn’t want to pay interest on a long-term loan that you may not need after 6 months. Usually, short-term loans will have agreements between 3 months and 2 years. Loans of more than 2 years would be considered medium- or long-term loans.
Let’s say you need external funding for a short period because your bills turned out to be higher than you expected. You don’t have the cash to pay the whole amount immediately but you know you’ll have enough revenue to cover all costs over the next 3 to 6 months. To avoid late payment charges, a revolving credit facility may be just what you’re looking for.
There are many other business overdraft alternatives that work similarly to a short-term loan, and can tide you over to the next payment. However, it’s worth mentioning that short-term options also tend to have higher rates.
How much money do you need, and how quickly?
Some business loans are designed for speed, which means the money could be in your account within days. This is very useful when you need the funds for an emergency — for example, if one of your essential tools urgently needs replacing.
You should also ask yourself how much money you need. A common method lenders use to assess your loan application is by looking at the loan amount compared to your turnover. As a rule of thumb the lender may lend up to one month’s turnover without security. If you can offer security, you may be able to borrow more. Essentially, the lender won’t give you a loan you can’t afford to repay, which leads us to the next important aspect: eligibility.
Every lender will want to check your creditworthiness before offering you a loan. Lenders will want to check the following to assess how much your business is eligible for:
- Bank statements
- Turnover and profit
- Trading history
- Payment history (i.e. late payments, CCJs)
With some lenders you’ll have a chance to talk to the underwriter who’s assessing your application. This way you can explain certain aspects of your business’s history, and the underwriter can take this information into account.
This is useful if your business is going through a tough period. Your turnover and profit margin demonstrate how healthy your business is, and if you’re not making enough profit, the underwriter will want to know why. Maybe you’re just struggling with cashflow gaps, or perhaps the issue is more serious.
Identifying the financial needs of your business is a first step to getting the support you need. Once you’ve narrowed down the key points, you’ll get an idea of what type of loan you’re looking for. It can help you prepare your application, and make the process faster and easier. But don’t worry if you’re still not sure what your best option is. Funding Options can help you identify the most important aspects of your request, and help you find the most suitable business loan.