Every SME owner knows the difficulties in securing funding. Even finding traditional loans from high street lenders has become more challenging since the turn of the decade.
That’s before you’ve even delved into the jargon: secured vs unsecured, personal guarantee, open and closed loans, asset-backed lending.
To help you wade through, we’ll be looking at some of the business loan types that you can apply for. You can also head straight to the type of loan you’re most interested in.
- Business credit cards
- Bridging loans
- Equipment financing
- Invoice finance
- Merchant cash advance
- Overdrafts
- Revolving credit facility
Demystifying loans jargon
Exhausted before you’ve even started? Let’s look at some terminology.
Secured business loan
With a secured personal loan, you agree the payment, repayments and repayment period upfront. This type of loan is backed by an asset, often your house. This means that your asset is collateral and can be used in the event that you can’t make your repayments.
Unsecured business loan
On the other side, you get a loan for your small business without using any assets as security. These are a good idea for new businesses that don’t have any assets yet and are commonly used for smaller purchases. In exchange, you may have to stump up a personal guarantee (and lenders are increasingly expecting this), so if your business can’t repay a loan, it’ll have to come from you.
An unsecured loan will usually come from a high street bank or a specialist lender. There are a few others, including merchant cash advance and overdrafts, which we’ll go into in a bit.
Asset finance
Asset finance allows you to buy equipment or machinery without having to pay the full price upfront. Businesses can spread the cost of the asset over a pre-agreed period to better manage their cashflow. Hire purchases and operating leases are just two examples. Again, we’ll go into these later.
Personal guarantee
This is a legally binding agreement which dictates that you as the business owner will be liable for the loan if the business is unable to make repayments.
What types of loans are out there?
Here are the types of loans you can expect to see when you’re researching your options.
Business credit cards
Business credit cards can be used as an extra form of credit to give you more flexibility to make more spending decisions. They’re typically unsecured, so you don’t need to put up any collateral as security to take one out. Be warned, though – this could mean you’re paying higher fees. But then, like a lot of fast funding, it is more flexible and easier to apply for, so there’s that.
Pros
- Flexible
- Can earn rewards such as points or cashback
- Easier to apply for
Cons
- Can lead to overspending
- Higher rates and fees
- Might incur an annual fee
Bridging loans
Bridging loans, as the name suggests, is a short-term loan which can effectively help you to bridge the gap when you want to buy something, but are waiting for the funds to be released from another purchase. They’re typically taken out over a period of two weeks to three years.
You can choose between open and closed bridging loans. An open loan has on fixed repayment date and can be repaid whenever your funds become available, though these tend to be a year. A closed loan, as you’ve probably gathered, does have a fixed repayment date, based on when you know that your funds will be available. As it’s fixed, a closed loan is normally cheaper.
Lenders will want to know what your repayment plan looks like, i.e. how long it will take and how you will pay it off, such as a house sale.
You might have come across first charge and second charge bridging loans. If you have no loans secured against your property, then it’ll be a first charge loan. If you can’t make a repayment and your home is sold off, the lender will get the repayment first.
One or more loans against the property will mean – you’ve guessed it – a second charge loan. If you can’t make the repayment, then your mortgage provider gets paid before the lender.
Bridging loans are generally between £5,000 and £25m. As they’re short-term, they’re normally more expensive.
Pros
- Cashflow injection can be immediate
- Can borrow larger sums
- A flexible financing option
Cons
- More expensive than other financing options
- Puts your assets at risk
- Extra fees may be involved
Equipment financing
A type of asset finance, equipment financing lets businesses purchase equipment and machinery on credit in the form of a hire purchase, finance lease or operating lease.
The lender will pay for the equipment and insurance for any period from one to seven years. The size of the loan will depend on how expensive the equipment is, as well as how much it’s likely to decline in value and the length of loan your lender is willing to offer.
In this instance, the equipment itself is used as security. So, failure to keep up with repayments will mean that equipment taken back from you.
Hire purchase is good for the short term and spent on equipment that you plan on replacing after the lease is up. You’re buying the item and paying it off in instalments. It will appear on your balance sheet from the start.
An operating lease is long-term and you can often buy the equipment at the end of the lease.
A finance lease is where the borrower can rent equipment for most of its valuable life.
Pros
- Lets you spread out the cost of major purchases
- Doesn’t require additional collateral
- Could have equipment at the end
Cons
- You take responsibility for equipment faults and repairs
- Equipment may have dropped in value by the time it’s paid off
- Restricted in what you can use the finance for
Invoice finance
Invoice finance allows a lender to use an outstanding invoice as security against a loan.
It comes in the form of:
- Invoice factoring
- Invoice discounting
Invoice factoring will allow you to generate money against unpaid invoices. Your lender will lend you up to 90 per cent of the value of your invoices. It will also collect invoices directly from your customers. From there, it will take the cost of its factoring service and send over the remaining money to you.
Invoice discounting works in much the same way, except that you keep control of your customers’ payments. This means it’s also your responsibility to get customers’ payments on time.
Related: Breaking down invoice finance – Funding Options founder and CEO Conrad Ford strips away the jargon surrounding invoice finance, explaining when and why you may need these solutions when growing your business.
Pros
- No additional collateral required
- Quick access to finance
- Good for businesses that are growing quickly
Cons
- Invoice factoring can affect trust with your customers
- An expensive financing option
- Your responsibility to get customer payment with invoice discounting
Merchant cash advance
A merchant cash advance can seem complicated at first glance. With this agreement, you provide a lump sum payment based on a percentage of your future credit or debit card sales. They’re best for businesses who take a lot of their sales through card payments.
The amount you pay back can fluctuate depending on card sales, so it could also be a better option for seasonal businesses. The percentage is taken from daily card sales so you could do a bulk of your repayment during the Christmas period, for example.
Pros
- Accessible to businesses with low credit score
- Repayments are low during quieter periods
- Quick access to cash
Cons
- Not good for businesses with low card sales
- No benefit to repaying early
- High fees and interest rates
Overdrafts
Another line of credit, which comes from your business bank account. You can pay it back as and when but, as per your bank’s terms and conditions, they might want it repaid by a particular point.
Pros
- Can be flexible
- Convenient
- High approval rate
Cons
- High interest rate
- More expensive than business loans
- Overdraft limit means it’s more suitable for smaller borrowing amount
Revolving credit facility
In short, a revolving credit facility allows you to withdraw money, use it for your business, repay it and then withdraw again whenever you need it. It’s up to you how you want to use it. You could use it for a larger purchase or to support your cashflow.
Pros
- Only pay interest for the money you use
- Flexible
- No extra security needed
Cons
- You may need to give personal guarantee
- Extra fees for setting up facility
- Higher interest rates
I’m still not sure which type of loan is best for my business
A financial advisor can be invaluable here. Alternatively, you might want to get in touch with a fellow business owner who’s taken out a loan to find out what advice they have.
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