How do business loans work?

If you want to expand your business, you’ll usually need funding, which is where business loans come in. They can also help if you need money to run your business.

All business loans involve borrowing money from a lender, which you then pay back with interest - either at a fixed or variable rate. This happens over a set timeframe, usually up to 25 years.

You can pick from various options based on how much you need, why you need it, how long you want to take to repay, and what you can afford. Also, if you have assets, you can use them as security for the loan.

What are business loans used for?

Business loans can be used for anything you need to pay for in your business, including:

• Equipment, such as tools or machinery

• Stock

• Moving to bigger premises

• Buying premises

• Taking on more staff

• Improving cash flow

• Acquiring another business

• Expanding into new markets

• Marketing

• Consolidating debt

• Day-to-day running costs

Types of business loans

Business loans broadly fall into two categories: secured and unsecured.

Secured loans

With a secured business loan, you offer something you own, like property or stocks, as security for the loan. This means if you can't repay the loan, the lender can sell the asset to get their money back, putting your asset at risk. Secured loans usually have lower interest rates compared to unsecured loans and can let you borrow more.

Secured business loans come in various types:

Invoice financing: This involves using your outstanding invoices as collateral for the loan. Two primary types are available.

• Factoring allows you to borrow up to 90% of the value of your unpaid invoices from a finance provider. The provider collects invoice payments and deducts the cost of its service before paying you the remainder

• Invoice discounting works in a similar way but you collect the customer payments yourself

Bridging loans are short-term loans that enable you to borrow money until you receive an expected payment, like money from a property sale. They generally have higher interest rates than longer-term loans.

Asset refinancing allows you to borrow against the value of assets you own, such as machinery or vehicles. You do not need to fully own the asset – you can still use it as collateral even if you're buying it through hire purchase. In this case, the lender pays off the company from which you're purchasing the asset, effectively transferring ownership to itself.

Unsecured loans

With an unsecured loan, you don’t provide security for the loan, so your assets aren’t at risk. However, you may need to give a personal guarantee that you’ll repay the loan yourself if your business can’t.

Unsecured business loan types include:

Start Up Loans specifically help businesses get up and running. They are funded by the government and offered through the Start Up Loans Company. They let you borrow between £500 and £25,000 over one to five years at a fixed interest rate of 6%. There are also other types of startup business loans. 

Business overdraft is a credit facility offered through your bank account that allows you to borrow money as and when you need it up to a pre-agreed amount. You only pay interest on the money you actually borrow and can pay it back at any time. You may have to pay a fee for a business overdraft.

Merchant cash advance is a way for businesses that accept credit and debit cards to get short-term funding to help with cash flow and running costs. You borrow a sum of money from a lender, then repay it (with interest) using a percentage of the money you take through credit and debit card transactions.

Will banks always lend a business money?

There's no guarantee that your business will be able to borrow money. Lenders look at a number of factors when deciding who can get a loan. You'll need to be based in the UK and show that you can afford to repay the debt. 

Your business credit score will affect whether you can borrow money and on what terms. If you've had credit problems in the past, such as late payments or county court judgments, you'll have fewer borrowing options. In fact, you'll usually have to pay a higher interest rate and may not be able to borrow as much. There is even a chance that you won't be able to get a loan at all. 

If you're having trouble getting a loan because of your credit score, you may be able to get a loan specifically designed for businesses with bad credit. A secured loan could also be an option if you have assets that you can use as security for the loan, as this reduces the risk to the lender. 

Another option is to find a guarantor, such as a friend or family member, who is willing to repay the loan if you can't. It may also be worth considering a cash advance. This type of loan is based on future sales, so you may be able to get one despite your credit history.  

Find out more about how to get a business loan.

How much can you borrow with a business loan?

How much you can borrow depends on the type of loan, how much your business can afford to repay and your credit history.

You could borrow up to £750,000 with an unsecured loan and as much as £15 million with a secured loan. Government Start Up Loans let you borrow up to £25,000.   

Lenders’ websites often have tools that let you see how much you might be able to borrow based on details you enter, without affecting your credit score.