How business loans work

Business finance is a wider category than most people expect, and the differences between its parts matter more than the differences between providers within a part. Borrowing the wrong shape of money is a more expensive mistake than borrowing at the wrong rate.

The main kinds

Term loan. A lump sum repaid over a fixed period. Suits a known, one-off cost — equipment, a fit-out, an acquisition.

Revolving credit or overdraft. A facility you draw on and repay as needed, paying for what you use. Suits cash-flow timing rather than a purchase.

Invoice finance. Borrowing against invoices you have issued but not been paid for. Suits a business whose problem is that customers pay in sixty days.

Asset finance. The asset itself secures the borrowing — vehicles, machinery. Often cheaper because the lender can recover something.

Merchant cash advance. A lump sum repaid as a percentage of card takings. Repayment flexes with trade, which is genuinely useful, and the cost is usually high. It is worth converting to an equivalent annual rate before comparing it to anything else.

Using a term loan to solve a cash-flow gap, or an overdraft to buy machinery, tends to work badly regardless of how good the lender is.

What lenders look at

Broadly: how long you have traded, revenue and its stability, existing debt, the credit history of the business and often of its directors, and whether there is security.

Newer businesses are assessed more on the people than the accounts, which is why personal guarantees are common at that end.

Personal guarantees

A personal guarantee makes you personally liable if the business cannot repay. It is extremely common in small business lending and it is the single term most worth reading carefully.

Ask what it covers, whether it is capped, whether it is joint and several with other directors, and what would have to happen for it to be called on. A guarantee limited to a stated amount is a different commitment from an unlimited one, and the difference does not appear in the headline rate.

Why the advertised rate is rarely the cost

Business lending is quoted inconsistently. You may see a monthly rate, a factor rate, a total repayable, or an annual percentage rate — and they are not comparable as printed.

Before comparing anything, get each offer expressed as total amount repayable and total cost of borrowing in currency, over the same period. A factor rate of 1.2 on a short term is a much higher annual cost than it appears next to an annual percentage rate.

Then check for arrangement fees, early repayment terms (some facilities charge the full cost whenever you repay, removing any benefit to paying early), and whether payments are daily, weekly or monthly. Daily repayment on a business with lumpy income is a cash-flow product in its own right.

Security

Secured borrowing is usually cheaper because the lender has recourse. What is being secured, and what happens to it in a default, is the thing to be clear about — particularly where the security is a property somebody lives in.

Getting ready to apply

Lenders decide faster on complete applications. Most want recent filed accounts, recent management accounts, several months of bank statements, details of existing borrowing, and identification for directors.

Applying to many lenders at once can leave a trail of credit searches that itself affects decisions. Ask whether an enquiry is a soft search before you make it.

Questions worth asking

1. What is the total amount repayable, and the total cost in currency?
2. Is there a personal guarantee, is it capped, and what triggers it?
3. What does it cost to repay early?
4. What are the fees, including for arrangement, drawdown and default?
5. How quickly do you decide, and what do you need from me to decide?

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This guide explains how business finance products work. It is not financial advice and it does not recommend any lender listed in this directory. Terms vary; confirm everything with the lender, and consider taking professional advice before giving a personal guarantee.