1. What is a bank loan?
A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend upon the size and duration of the loan and the rate of interest.
Banks usually charge interest on any loans that you get, but the terms and price will vary between providers.
Different types of bank loan include:
- working capital loans - for short notice or emergency situations
- fixed asset loans - for buying assets where the asset itself is used as a collateral
- factoring loans - loans based on money owed to your business by customers
- hire purchase loans - for long-term purchase of assets such as vehicles or machinery
2. The application process
Most lenders require you to:
- share the financial risk by providing capital to demonstrate your commitment and provide a contingency for repayment if things go wrong
- provide security for borrowing requests - eg personal or business assets, such as your home or business premises
- provide personal guarantees if you run a limited company, and the business cannot offer adequate security
- keep them informed of your progress, particularly if you envisage any changes or problems
- have a comprehensive business plan and cashflow forecast for larger borrowing requests
- have a good credit record - including a good payment record with other creditors
3. Getting the best loan deal
In order to get a good deal, you should:
- shop around - compare interest rates and negotiate to get the best deal, and ask for any special terms in writing. The British Bankers’ Association website offers a business account finder service
- use a finance broker - they can save you time and increase your chances of success by presenting your proposal efficiently to appropriate lenders. The National Association of Commercial Finance Brokers (NACFB) website provides a facility to find a suitable broker
- research the ‘small print’ - assess all lending criteria, such as interest rates, loan terms and set-up fees, plus special deals for start-ups. Consider having an expert, such as a solicitor, review the loan documents
- compare loans between different banks and be prepared to switch providers
- interest rates can be fixed or variable and the key figure to examine is the annual percentage rate (APR). This is the rate you will be charged once all fees have been deducted
- the credentials of lenders can be checked with the Financial Conduct Authority (FCA)
4. Agreeing the terms of your loan
You need to:
- establish the due date and interest rate
- establish what the lender's loan fees are
- check if you can make overpayments
- see if there is an early repayment charge
- find out if you can take 'repayment holidays'
- check to see that late payment charges are reasonable
If your application for a loan is rejected you have the right to appeal. Please enquire with your bank on their appeal process.
5. Pros and cons
- the terms can be tailored to meet the requirements of the business
- the loan is not repayable on demand and so available for the term of the loan - unless you breach the loan conditions
- loans can be tied to the lifetime of the equipment or other assets you're borrowing the money to pay for
- at the beginning of the term of the loan you may be able to negotiate a repayment holiday, meaning that you only pay interest for a certain amount of time while repayments on the capital are frozen
- you do not have to give the lender a percentage of your profits or a share in your company
- interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan
- there may be an arrangement fee that is paid at the start of the loan but not throughout its life. If it is an on-demand loan, an annual renewal fee may be payable
- there is tax relief on the interest repayments
- you may have difficulty securing a loan if you are a new business with no track record
- larger loans will have certain terms and conditions that you must adhere to, such as giving the bank quarterly management information
- loans are not very flexible - you could be paying interest on funds you're not using
- you could have trouble making monthly repayments if your customers don't pay you on time, causing cashflow problems or if your business is seasonal
- in some cases, loans are secured against the assets of the business or your personal possessions, eg your home. The interest rates for secured loans may be lower than for unsecured ones, but your assets or home could be at risk if you cannot make the repayments
- there may be a charge if you want to repay the loan before the end of the loan term, particularly if the interest rate on the loan is fixed
6. Common mistakes
It’s not a good idea to take out a loan for ongoing expenses, as it may be difficult to keep up repayments. Ongoing expenses are instead best funded from cash received from sales, possibly with an overdraft as backup.
Your bank may turn you down if you can’t:
- explain why you want the loan and how you will use it
- demonstrate that you understand the risks and that you have taken steps to reduce their effect
- explain who looks after your business’ finance and that you have solid financial systems in place
- provide financial data, ie accounts, budgets and forecasts
- provide security
- demonstrate a track record and ability to repay the loan
7. Funding sources
Banks are the main source of small business loans, but many other organisations provide loans at competitive rates. Building societies offer business mortgages and personal loans.
If you want to compare business bank accounts, the British Bankers’ Association website offers a business account finder service.